The ECB as dealer of last resort

A eurozone government can only find itself short of euros when it cannot sell its bonds, and that only happens when the ECB declines to stand behind them. As long as the ECB acts as dealer of last resort, buying member-state bonds on the secondary market whenever it is needed, a member state cannot be forced into default.

Because a eurozone government closes the gap between spending and tax receipts by selling bonds, the one way it can get into trouble is if buyers stop taking them. Every central bank can prevent that, because it issues the currency and cannot run short of it: it can buy government bonds from banks and simply credit their reserve accounts. The ECB is barred from buying directly from governments, but it can buy on the secondary market. Whether it does so decides whether a member state's bonds are safe.

The record is clear. Greek ten-year yields climbed above 30% in early 2012, when the ECB still treated support for government debt as outside its role. In July 2012 its president pledged to do 'whatever it takes' to preserve the euro, the Outright Monetary Transactions programme followed in September, and yields fell back. In March 2020 the ECB launched the Pandemic Emergency Purchase Programme while the general escape clause suspended the deficit rules. Greece's public debt rose above 200% of GDP that year, yet its ten-year yield averaged around 1.3%. The level of debt was not what moved the yield.

Since July 2022 the ECB has had the Transmission Protection Instrument, which allows purchases targeted at a country facing unwarranted, disorderly market dynamics. Its eligibility criteria (compliance with the EU fiscal framework, debt sustainability and sound policies) are an input into the Governing Council's decision, not an automatic trigger, so the ECB can act whenever it judges it necessary. No member state is too large for it to support.

The reform case is that this role should be permanent and unconditional. A technocratic institution should not be able to make support for a democratically elected government depend on that government's policy choices.

Wouldn't an unconditional backstop let governments overspend? The limit on spending would then be the one that actually matters: inflation and the real resources available. A fiscal framework aimed at full employment and price stability, rather than a central bank's discretion, is the place to manage it.