Prominent commentators, whose positions of respect are well-earned, are calling for the ECB to take on the role of lender of last resort. While I agree that this is part of a complete solution to the Eurozone crisis, I think it is far from clear that now is the time for the ECB to take on this role.
The underlying problem in the Eurozone is the intra-European balance of payments problem. Until a politically feasible plan to manage European imbalances is in place, the aggressive action by the ECB, called for by Martin Wolf and Paul DeGrauwe, may well turn out to be nothing more than a palliative. Such palliatives are dangerous, because the need for political action is so great that anything that lulls Europe’s politicians into a sense that they do not need to act boldly today, may have the effect of aggravating the fissures leading to crisis and create a problem that is even harder to resolve.
My reference point in these thoughts is the central bankers’ decision in 1925 to work with the Bank of England in its project of maintaining the peg to gold. Over six years the imbalances that made the peg unsustainable did not resolve, but instead were aggravated by politicians making parochial decisions and by a general sense of stability that allowed imbalances to grow ever greater. In 1931 when Britain finally abandoned the peg to gold, the world economy faced a greater crisis than it probably would have faced in 1925.
I think the ECB is doing a good job of making sure that the politicians know that they are the ones who need to act. While none of us can be sure that Europe’s politicians will successfully muddle through and give birth to a stronger Eurozone, the likelihood of success is much greater while the pressure of looming financial crisis bears heavily on the shoulders of the politicians.