Friday, December 23, 2011

Quantitative Easing Operations by the European Central Bank


On December 22, 2011, the Financial Times has discussed the possibility and appropriateness for the European Central Bank to carry out quantitative easing operations. In his FT interview, Lorenzo Bini Smaghi has argued in favor of such operations and called for “policymakers not to hide behind lawyers to avoid taking action”.

When reading this interview, I was wondering if and how policymakers can hide. My conclusion is that the legal texts support Smaghi’s point of view and, as a matter of fact, contain no stipulation that could reasonably justify a prohibition of QE operations.

Let’s have a look at the texts:

The Statute of the European System of Central Banks (Protocol No. 4 of the Treaty on the Functioning of the European Union) reads as follows:

Article 18 - Open market and credit operations

18.1. In order to achieve the objectives of the ESCB and to carry out its tasks, the ECB and the national central banks may:

- operate in the financial markets by buying and selling outright (spot and forward) or under repurchase agreement and by lending or borrowing claims and marketable instruments, whether in euro or other currencies, as well as precious metals;

- conduct credit operations with credit institutions and other market participants, with lending being based on adequate collateral.

18.2. The ECB shall establish general principles for open market and credit operations carried out by itself or the national central banks, including for the announcement of conditions under which they stand ready to enter into such transactions.”

Art. 21 – Operations with public entities

21.1. In accordance with Article 123 of the Treaty on the Functioning of the European Union, overdrafts or any other type of credit facility with the ECB or with the national central banks in favour of Union institutions, bodies, offices or agencies, central governments, regional, local or other public authorities, other bodies governed by public law, or public undertakings of Member States shall be prohibited, as shall the purchase directly from them by the ECB or national central banks of debt instruments.

[…]”

On the basis of the above, my conclusions are as follows:

The ECB has 3 alternative possibilities to act on the financial markets:

- buying and selling [claims and marketable instruments] outright (spot and forward);
- [buying and selling claims and marketable instruments] under repurchase agreement;
- lending or borrowing claims and marketable instruments.


In my view, the first alternative covers quantitative easing operations. As a matter of fact, only direct underwriting is prohibited by Art. 21.1 of the Statute.

Based on Art. 18.2 of the Statute, the ECB has established its guidelines on monetary policy instruments and procedures of the Eurosystem (lastly modified on September 20, 2011). It is right that, today, these guidelines do not provide for QE operations (See Art. 1.3.1). However, the ECB can modify its guidelines on its own, and the European treaties should not contradict such modification.