How to end the European crisis – at no further cost and without the need for political changes

Abstract

There is a solution to the twin problem of large non-performing loans in the banking systems and the funding crisis for sovereign borrowers that is affecting especially Spain, Portugal, Ireland, Cyprus, Greece, but to some extent also Italy and other countries. The needed policies constitute ‘true quantitative easing’: as argued in 1994 and 1995 in Japan, there is no need for a recession due to the bad debt problems in the banking system. Necessary and sufficient condition for a recovery is an expansion in credit creation – which was originally called ‘quantitative easing’, an expression that was later used by central banks to refer to the type of traditional monetarist policy (bank reserve expansion) that was not likely to be sufficient. True quantitative easing can be achieved quickly and without extra costs in a two-part process as follows: 1. The central bank purchases all actual and likely non-performing assets from the banks at face value (book value) and transfers them to its balance sheet. In the case of non-securitised loans, if needed a law should be passed to allow compulsory purchase by and reassignment to the central bank. 2. The government stops the issuance of government bonds. Instead, it funds any future borrowing requirement (including all scheduled ‘roll-overs’ of bonds) by entering into loan contracts with the domestic banks, borrowing at the much lower prime rate. Ideally, these two measures are combined, and part and parcel of a larger policy package. For a fuller list of measures, see our CBFSD Discussion Paper No. 1-12. But they can also be implemented separately, so if ECB and national central bank support cannot be gained for measure 1, national governments can end the negative vicious cycle and end their sovereign debt problems by going ahead on their own with part 2.