European Central Banks Role to Solve Euro Crisis - Essay Example

Would A More Active European Central Bank Have Been Able To Solve The Euro Crisis? Table of Contents Table of Contents 2 Introduction 3 European Central Bank’s Role to Solve Euro Crisis 3 Conclusion 7 References 9 Introduction The European Union (EU) is going through a phase of debt crisis and there has been an increased concern towards this crisis within the European Council. It has been revealed that Greece’s contagion of debt crisis has posed a huge threat to the economy of EU. Therefore, if the crisis faced by Greece is completely isolated then there is a possibility that the economy of EU would recover from the problem being faced in Eurozone. The European leaders have undertaken several meetings after which it was evident that these leaders have failed to reduce the effect relating to Greece’s contagion of debt crisis. The main reason for this threat is that the government bond markets of the union are enormously vulnerable as they issue debt through foreign currency and do not have any control over it. Thus, the government cannot assure liquidity of these bonds to the bondholders even if it gets matured. Henceforth, the absence of such assurances makes the bond market of EU more prone to threats from the contagion of debt crisis in Greece (Grauwe, 2011). Correspondingly, the essay is primarily focused on how the European Central Bank (ECB) can act proactively in order to solve the issue of euro crisis. European Central Bank’s Role to Solve Euro Crisis Before the occurrence of debt crisis in the Eurozone, the ECB primarily concentrated on price stability due to which it gained a name as the guardian of euro area. However, when there was an intense crisis in the EU in 2010, it was observed that the role of ECB had significantly increased in relation to the monetary policy in the union. Thus, the ECB implemented a broad range of measures in its functioning that involved bringing financial stability and improving monetary transmission. These measures were initiated by providing banks more liquidity in their monetary aspect and reforming collateral rules that introduced a purchasing agenda of two government bonds (Darvas & Merler, 2013). ECB’s in order to respond to the crisis being faced highly depended on banks as intermediaries that confirmed uninterrupted financing of firms and households (Andriuškevičiūtė & Balčiūnas, 2013). In relation to the contagion problem in the Eurozone bond market, ECB took up the initiative of being the lender of last resort which meant that the ECB would promise to pay out the bond holders after their bonds gets matured. ECB had undertaken this function by directly purchasing government bonds and accepting government bonds indirectly which would act as collateral for the provision of liquidity in its banking system (Grauwe, 2011). The global financial crisis has extended the functions and policies of ECB. Unconventional type of monetary policy has been common that involves “quantitative easing” and “credit easing” of the economy in numerous ways. Subsequently, ECB has been the most reluctant bank as compared to others in using these measures as it introduced its own measure of procuring debts for financially concerned members of the EU through purchasing government debts of Greece in the year 2010. This measure has created an operational stability and effectiveness in the monetary market of member nations and provided a financial support. In the present day context, ECB has been insisted to go even further in its action towards the debt crisis through unlimited purchase of government bonds which would ensure that the member nations can easily access the capital market at a reasonable circumstance. It has been suggested that the EU should extend its banking licence to European Financial Stability Facility that would provide no restriction on access of ECB credit which in turn can transform the financial problems faced by member nations. However, extending the banking license would result in mixing both fiscal and monetary policies that would endanger the entire Eurozone. If the monetary policies are decided by the fiscal authorities then there is a huge risk to financial and monetary stability in the EU member states. On the other hand, if the monetary policy is independent for the fiscal decisions then there is a possibility that the economy of EU might become stable for a longer time (Baltensperger, 2012). Recently, the ECB decided that it is going to discontinue its role of directly purchasing government bonds as there was unwillingness within the bank officials to continue purchasing government bonds that would thereby reduce liquidity to the banking system. As the ECB became reluctant of playing its role as a lender-of-last-resort, there it in turn has not resulted in preventing the forces of contagion in the bond market of Eurozone. Lender-of-last-resort can be regarded as an insurance mechanism that was being provided by ECB, therefore this mechanism must be initiated again that would instigate financial stability in the economy. Additionally, as the Eurozone has been facing crisis situation, it is considered that its future is at jeopardy if the ECB does not play its role as a lender of last resort. However, due to this insurance mechanism there is a possibility of risks related to moral hazard that is if there is liquidity within the banks to pay out its independent bond holders then the government will have to issue a lot of debt. Thus, if the government has to issue debt to a greater extent, then there is a huge risk of moral hazard to the banking system. Consequently, the only approach to deal with this moral hazard is that certain rules must be imposed that restrain the government in issuing more debts. To be precise, the lender of resort role must be used only when the banking system is going through problems in its liquidity aspect that is if the banking system is going through an insolvency phase. When an independent situation of debt crisis arises, it has been observed that in these situations there is a problem relating to both solvency and liquidity. On one hand, liquidity crisis increases the rate of interest while debt is issued by the government that reprobates into problems of solvency. On the other hand, problem of solvency frequently gets intensified due to liquidity crisis within the banking system (Grauwe, 2011). Likewise, based upon the directives provided by the Treaty on the Functioning of the EU (TFEU), the ECB had been assigned certain tasks in the Eurozone. These tasks include maintenance stability in price, supporting the economic policies of the EU, functioning as a lender of last resort for the banks in the European region, introducing collateral policies, quantitative easing that is easing the credit burden through purchasing assets, sterilising the purchase of government bonds, crafting, approving and monitoring the programmes related to financial support. Besides, certain other pertinent responsibilities entail functioning as a supervisory body in the frameworks provided by the Single Supervisory Mechanism (SSM), assessing the comprehensive balance sheets of credit institutions, responsibility of preventing the risks related to financial stability through macro prudential error with the EU financial system, active involvement in the macroeconomic investigation missions and performing the function of an agent in the activities of secondary market for the European System of Financial Supervision (ESFS) and European Stability Mechanism (ESM). Eventually, these tasks pose a huge threat to the ECB and increase the possibility of either synergies or clashes of interests. In addition, the provision of liquidity provided to the banking system in a greater extent can result in bringing stability in the financial market and also increase insolvency among banks. According to the TFEU mandates of tasks, it is the role of ECB to synergise monetary policies along with micro and macro prudential policies but there is a huge extent of risks to the financial sector because even if the price stability is attained by the ECB, only the monetary policy cannot balance the risks to the financial sectors (Grauwe, 2011). On the whole, it can be ascertained that the active involvement of ECB alone has not been enough to solve the problem of financial crisis in the Eurozone. Furthermore, there is a requirement of fundamental renovation in the institutions within Eurozone. In this renovation, it is quite important for the ECB to take complete responsibility as a lender of last resort in the Eurozone for the governmental bond markets. This responsibility can contribute in reducing the impact of debt crisis and bring financial stability in the economy (CitizensforEurope, 2011). Conclusion European Union (EU) has been facing problems due to the independent debt crisis that occurred in Greece. It has been observed that the contagion of debt crisis from Greece has resulted in affecting the entire Eurozone to a huge extent. Thus, when the EU faced this crisis in the year 2010, it was noticed that the ECB implemented various new measures in its functions with a motive to bring financial stability in the economy and developing a good monetary policy. Initially, during the earlier phase of this crisis, the ECB functioned as a lender of last resort which eventually changed in the later phase this crisis wherein the ECB became reluctant to be a lender of last resort. Although, the ECB took many steps to instigate financial stability in the economy through various tasks mandated to the ECB by TFEU, there was not much of solution being provided to the actual situation of debt crisis. Therefore, it is considered that this crisis could have been mitigated through political unification and strengthening of the process of national budgetary along with improvement in the EU’s macroeconomic policies. Moreover, an active participation of ECB would have been of greater help as a contributing factor to resolve the Euro Crisis. References Andriuškevičiūtė, D. & Balčiūnas, N., 2013. The monetary policy of the European Central Bank in the period of sovereign debt crisis. Vilnius University, Lithuania, 92(2), pp. 20-31. Baltensperger, E., 2012. Assessing the European Central Banks euro crisis policies. University of Bern and Study Center Gerzensee, pp. 9-13. CitizensforEurope, 2011. A more active ECB to solve the euro crisis. [online] Available at: [Accessed 25 March 2014]. Darvas, Z. & Merler, S., 2013. The European Central Bank in the age of banking union. Bruegel policy contribution, pp. 1-17. Grauwe, P. D., 2011. Only a more active ECB can solve the euro crisis. 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