Monday, November 28, 2011
Why the ECB refuses to be a Lender of Last Resort
November 28, 2011
The euro has a matter of weeks to save itself, with several institutions now preparing for its collapse. Given this, why does the ECB still refuse to bail out Europe’s heavily indebted countries? This column provides an explanation. It says that the ECB may well be behaving rationally but adds that such behaviour is also foolish – and dangerous.
A number of analysts are calling for the ECB to act as the lender of last resort in the Eurozone government bond market (see for example Wyplosz 2011 on this site). Up to now it has resisted. But why should the ECB refuse to take up the role of last-resort buyer?
A rational, non-dogmatic explanation
Here is a possible explanation that has the merit of being based on rational behaviour. Other explanations that have been popular are based on a belief that the persons deciding about this issue are driven by dogmatic thinking preventing them to see the need to act. This may be the case, but it remains interesting to try to explain the ECB’s behaviour assuming that its decision-makers behave rationally.
When a central bank is called upon to be the lender of last resort it has to evaluate costs and benefits of its actions. Let us rephrase the problem in terms of the costs and benefits of inaction, ie of not providing the last-resort buying service.
Posted by Yulie Foka-Kavalieraki at 6:30 PM