Does Europe Need a Lender of Last Resort? Essay

1535 Words May 31st, 2012 7 Pages
Does Europe need a lender of last resort?
German Chancellor Angela Merkel and French President Nicolas Sarkozy appear to hope their recent Summit will avoid further increasing Euro rescue fund, the European Financial Stability Facility (EFSF), or issuing joint Eurobonds.
Both measures are extremely unpopular in Germany, which sees itself as the financier of spendthrift southern Euro zone member countries.
Germans are only willing to pay with “their” money in “return” for strict austerity measures. And, as Merkel has said, Eurobonds would only be considered as last means.
The German Chancellor seems to believe that the Euro zone is not yet at the point where last resort measures need to be considered seriously.
Unfortunately, Mrs
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Belgian economist Paul De Grauwe rightly reminds us the fundamental problem is the lack of a lender of last resort in the government bond market in the Euro zone.
Unlimited liquidity
A country with its own currency that borrows in its own currency always has a central bank that can provide unlimited liquidity. Hence, there is always an implicit guarantee that bondholders will be bailed out.
Like in deposit markets, the pure existence of the central bank as a lender of last resort to banks prevents a bank run – and thus a bail-out will not even be necessary.
With a debt-to-GDP ratio of more than 200%, Japan is more indebted than any problem country in the Euro zone.
Yet it is considered as a safe haven. Similarly, if the Euro zone would have a credible lender of last resort in the government bond market, sovereign debt crises could be avoided.
It is the lack of a lender of last resort in the Euro zone which makes in principle every country vulnerable – even Germany. But when Germany or France could also be attacked, who would then guarantee their debts and finance the EFSF?
And even if Germany would remain the safe haven, it still has neither the financial means nor the political will to bail out the rest of the Euro zone.
As the funds of the EFSF could never be big enough, a

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