The ECB was modeled after the German Bundesbank in that the central bank goal is to follow a rule that only targets inflation. However, there are many who are now trying to alter central bank rules so that they can help aid countries such as Greece, Ireland, Portugal, Spain and Italy. The ECB has been conducting bond purchases in recent months aimed at helping these ailing countries, but the purchases have been sterilized through facilities which drain liquidity from the system. Bond purchases in the euro-area have been sterilized unlike in the U.S. where bond purchases have been conducted and expanded the Fed’s balance sheet.
The danger of stopping sterilization is the German’s fear of runaway inflation. However the alternative might be very costly as well. If the ECB does not do additional intervention, there is a looming threat that the euro might fall apart. There is no plan in place for any country to leave the euro, and a disorderly unwinding might lead to widespread bank runs as either all the rich or poor countries abandon the common currency. The ECB has been running a stabilization fund that is hoped to help keep the euro from collapsing, but there are fears that the fund is not large or stable enough to actually help in the medium to long run.
Questions you might answer:
- Do you believe the ECB should stick to its strict goal of inflation targeting, or should they also consider trying to reach full employment across the euro zone.
- Should we just allow the euro to collapse? If these countries put themselves in this situation, what reason can you think of for either bailing them out or not? Are they solely to blame for the overspending on real estate and government programs? Or do surplus countries like Germany share the blame? Does the possibility of forcing debtor countries to work and repay their debts in the long run have any potential consequences?
- What problems might arise if the ECB dropped their strict inflation target? Are we guaranteed to experience runaway inflation?