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The Atlanta Fed's macroblog provides commentary on economic topics including monetary policy, macroeconomic developments, financial issues and Southeast regional trends.

Authors for macroblog are Dave Altig and other Atlanta Fed economists.


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November 09, 2005


The ECB Says Enough With The Deficits

Yesterday's story was about the European finance ministers offering some advice to the European Central Bank.  Today it looks like the ECB has in store some advice of its own -- and is willing to back it up with the power of its portfolio decisions.  From the Financial Times:

The European Central Bank will sharply step up pressure on Italy, Greece and other eurozone fiscal laggards by warning that it will refuse to accept their sovereign debt as collateral if their credit ratings slip.

In an attempt by the ECB to warn European governments about the consequences of overspending, the bank is to state that it will only accept bonds with at least a single A- rating from one or more of the main rating agencies as collateral in its financial market activities, European Union financial policy-makers said. A refusal by the ECB to accept a government's bonds would amount to a humiliating swipe at that government's policies, and make its bonds harder to sell. So far, no eurozone government bond has been excluded, but the ECB's existing list of eligible collateral does not include assets rated below A-.

So far, the ECB has "refused to comment on its plans."

November 9, 2005 in Deficits, Europe | Permalink

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"So far, the ECB has "refused to comment on its plans.""

Well Trichet now has:

"Jean-Claude Trichet, ECB president, confirmed a report in Wednesday’s FT that it would only accept bonds with at least a single A- rating in its financial market activities. He described the ECB’s move as a “clarification” of existing policy, which had never been stated explicitly."

Today's FT.

I think this is an incredibly important move. I have put up a post at Afoe where I use the expression 'landmark decision'.

Basically the ECB is saying to the Commission 'put your house in order, or we'll get the markets to do it for you'.

The thing is you shouldn't do things like this unless you mean to back them up (moral hazard).

The question then is whether you think it is 'doable' for Italy to put its house in order whoever is doing the threatening. If, like me, you think there are sound macro reasons why it can't (at least not in the time frame involved), then confrontation is guaranteed.

And of course, any turmoil in the eurobond markets will have impacts across the Atlantic too.

Basically I think this isn't for tomorrow, but it definitely is now coming.

Posted by: Edward Hugh | November 10, 2005 at 06:13 AM

It's me back again. I think over lunch I just twigged why IMHO this is now a done deal. The situation is circular.

Ask the question, why is Japan's credit rating below that of Italy?

Economically the former is still, despite all the problems, a lot stronger than the latter.

The obvious answer is that the ECB has been effectively guaranteeing Italy's credit worthiness. That's why they are at AA-.

Now if the ECB no longer guarantees, really the rating should go down. And so on and so on.

Obviously it is extraordinarily difficult to lose a single A- for sovereign debt, but just give them time, just give them time.

Posted by: Edward Hugh | November 10, 2005 at 10:19 AM

"the ECB has been effectively guaranteeing Italy's credit worthiness"...

well, this is the multi-million euro question. The ECB is explicitly NOT the 'lender of last resort' for the Euro-zone countries. Legally it cannot bail them out in case of a default or threat of defaul, which amounts to the same thing. Yet the markets have discounted that piece of legislation as non-credible. How can a technocratic institution like the ECB not bend to the will of the political masters. If that is indeed the logic of the markets, then ECB's refusal to accept Greek or Italian bonds as collateral may not be credible. Carrying this ad absurdum, even if Italy cannot swap its sovereign bonds for liquidity the markets will not speculate against Italy because they believe ultimately the ECB will step in.

Personally, I have believed that the markets should have punished the SGP-laggards a long time ago and wish that this move by the ECB prompts just that but having been proven wrong before, I am not sure ECB's announcement is sufficient.

Posted by: russki | November 10, 2005 at 07:38 PM

"even if Italy cannot swap its sovereign bonds for liquidity the markets will not speculate against Italy because they believe ultimately the ECB will step in."

I fully accept the force of this point russki. The Italian government may also believe it, which may mean they don't take the warning too seriously either, and carry on regardless. In which case a "push comes to shove" situation may arise (in fact I personally am convinced it will). Since on the view you provide, no-one will have been discounting anything, then in the crunch moment the adjustment can indeed be sudden and dramatic. What's it called, oh yes, a *hard* landing.

Posted by: Edward Hugh | November 11, 2005 at 04:17 AM

i was talking to a representative from the ECB on Friday who said that there has ALWAYS been a provision that only A- bonds will be accepted as collateral. The man somewhat painfully glossed over the recent announcement by saying that the ECB merely 'never made public' this piece of legislation.

Even if this is true, then the question beckons as to why the ECB chose this moment to explicate something that was implicit before.

A separate note - if this has indeed been the case it just goes to underlie my initial point that the markets have a somewhat skewed understanding (if any) of what the ECB can do. Bond traders may be in for a surprise, therefore.

Posted by: russki | November 14, 2005 at 02:28 PM

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