Our good friend and die hard British market monetarist Britmouse has a new post on his excellent blog Uneconomical. I think it might just be the coolest idea of the year. Here is Britmouse:
“Will the ECB will stand by and let Spain go under? Spain is a nice country with a fairly large economy. It’d be a… shame, right? So if the ECB won’t do anything, I think the UK should act instead.
David Cameron should immediately instruct the Bank of England to print Sterling, exchange it for Euros, and start buying up Spanish government debt. Spain apparently has about €570bn of debt outstanding, so the Bank could buy, say, all of it.
We all know that the Bank of England balance sheet has no possible effect on the UK economy except when it is used to back changes in Bank Rate. Right? So these actions by the Bank can make no difference to, say, the Sterling/Euro exchange rate, and hence no impact on the demand for domestically produced goods and services in the UK. Right?
Sure, the Bank would take on some credit risk and exchange rate risk. But they can do all this in the Asset Purchase Facility (used for conventional QE), which already has a indemnity from the Treasury against losses.”
Your reaction will probably be that Britmouse is mad. But you are wrong. He is neither mad nor is he wrong. British NGDP is in decline and the Bank of England need to go back to QE as fast as possible and the best way to do this is through the FX market. Print Sterling and buy foreign currency – this is what Lars E. O. Svensson has called the the foolproof way out of a liquidity trap. And while you are at it buy Spanish government debt for the money. That would surely help curb the euro zone crisis and hence reduce the risk of nasty spill-over to the British economy (furthermore it would teach the ECB as badly needed lesson…). And by the way why do the Federal Reserve not do the same thing?
Obviously this discussion would not be necessary if the ECB would take care of it obligation to ensure nominal stability, but unfortunately the ECB has failed and we are now at a risk of a catastrophic outcome and if the ECB continues to refuse to act other central banks sooner or later are likely to step in.
You can think of Britmouse’ suggestion what you want, but think about it and then you will never again say that monetary policy is out of ammunition.
Update – this is from a reply below. To get it completely clear what I think…
“Nickikt, no I certainly do not support bailing out either bank or countries. I should of course have wrote that. The reason why I wrote that this is a “cool idea” is that is a fantastic illustration of how the monetary transmission mechanism works and that monetary policy is far form impotent.
So if you ask me the question what I would do if I was on the MPC of Bank of England then I would clearly have voted no to Britmouse’s suggestion. I but I 100% share the frustration that it reflects. That is why I wrote the comment in the way I did.
So again, no I am strongly against bail outs and I fear the consequences in terms of moral hazard. However, Spain’s problems – both in terms of public finances and the banking sector primarily reflects ECB’s tight monetary policy rather than banking or public finance failure. Has there been mistake made in terms and public finances and in terms of the banking sector? Clearly yes, but the main cause of the problems is a disfunctional monetary union and monetary policy failure.”