The European Central Bank must act as a last resort lender, or else

By Luis Arroyo, in Madrid | What we were promised it would happen when adopting the euro is, indeed, not what we have got. We were promised the end instability, the end of ‘competitive’ devaluations, the beginning of a virtuous circle whereby, in the absence of possible devaluations, flexible markets would adjust wonderfully to shocks. And, of course, that everyone’s cycle would become standardised. Thanks to the free movement of capital and labour, levels of unemployment were meant to become harmonised via the displacement flows of workers from depressed areas to the dynamic ones.

All this has not happened. In fact, quite the opposite has occurred. Just like bad scientists, the promoters of the idea now say that the original idea was not carried out as it should have been and that it’s not the euro’s fault, nor theirs; the blame should be put on the squanderers and employees, who earn too much.

In a graphic that I have taken from Martin Wolf’s Creditors can huff but they need debtors, we can see that external imbalances have been accentuated with the euro. This means that the mechanisms that were to replace the exchange rate have not worked. If you eliminate the exchange rate, the only way to adjust is internally. But almost all economists know that prices and wages are not as flexible as they assume in their models.

As soon as some countries adjusted more quickly than others, the asymmetries and imbalances increased. In a political union, this would have been offset by natural income transfers between regions with high and low cycles: unemployment subsidies, and all the centralised expenses that are automatically redirected toward the depressed area, while the factors move toward the area on the rise.

These income movements take place in the US, and in any country, among regions that are the least favored and the most favored by the cycle (note, it is not a mechanism of income distribution; it is a cyclical compensation mechanism). This institutional unity also ensures that the monetary policy is assigned to all markets effectively.

Therefore, when Kansas goes through a worse cycle than Massachusetts, it does not need to devalue to restore competitiveness and its lost capital.

In the EU, we do not have these mechanisms, for various reasons which I will not go into here.  Countries such as Spain that sells 70% of its exports to EU countries (some have devalued its currency, like in the UK) would have to carry out an impossible internal revolution.

As they have not done so, they grow less and less, their debts weigh more and more, and, as time goes by, the differences become greater. In addition, there is, as it can be seen in the figures, an asymmetry over global credits and debits: the problem is that while Spain almost owes everything to the rest of the EU countries, Germany is the second lender in the world after China. Thus, Germany does not need us that much. Germany has diversified its exports while Spain has not. Therefore, the asymmetry, which we were told it was going to be corrected with the euro, has rocketed.

This is regarding the process of adjustment. Now let’s talk about the ECB. The ECB has in truth acted as the Central Bank of Germany: so far, the policy has been restrictive, with the excuse that inflation has increased.

What inflation? Of consumer goods? There are asset prices that have fallen and have not recovered. There are bankrupt banks because of this, but as German bonds and German shares have not fallen, (they actually have increased) the ECB does not consider it necessary to act as a last resort lender in case of systemic risk. But the problem is one of contraction of the total demand in the area, which exerts induced effects in each economy-contracted country.

If we defend the euro, we must insist that the ECB act as a last resort lender and as demand stabiliser. For the way things go now, with no cost adjustments, no financial stability, nor support of the demand… It will be a catastrophe.

Luis Arroyo is a former Bank of Spain economist. He writes for

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