On 2 November 2020, EuPEP hosted a European Studies Seminar series webinar on Daniel Hardy’s proposal for the ECB to issue debt certificates (The underlying paper is available at https://www.economics.ox.ac.uk/materials/working_papers/5342/ecb-debt-certificates-v9.pdf). The event, chaired by Tim Vlandas, brought together the two main agencies that could be involved in such an innovation, with Demosthenes Ioannou from the ECB and Gabriel Giudice from the European Commission acting as discussants.
The development of an EU-level safe asset is a key building block for the capital markets union, which in turn is a priority for strengthening EU architecture and preventing a repeat of Europe’s debt crisis. Hardy’s proposal for ECB debt certificates would create a safe asset with many attractive characteristics, while avoiding many of the objections that have impeded the creation of such an asset in the past. Specifically, Hardy recommends that the ECB regularly issue a large volume of liquid short-term financial paper, along the lines of US T-bills, which might be called “euro liquidity management instrument” (or ELIs).
Currently, the EU has no region-wide financial instrument akin to T-bills, meaning that banks with excess liquidity have few alternatives to piling up large deposits at the ECB, and euro investors and liquidity managers are short of best-quality, usable collateral. The creation of ELIs would give banks more flexibility and would expand the capital market beyond banks by giving investors a new euro-denominated security. Its short maturity (Hardy proposes six months), and capacity for the ECB to issue it in large volume (Hardy envisages an eventual stock of 1.3 trillion euro), would make it safe, liquid, and desirable. Its existence would create a new source of high-quality collateral and help stabilize risk premia across the EU financial system. All of these attributes would enable the euro to expand its role in global financial markets.
Hardy anticipated some possible objections. Issuing ELIs would not be linked to monetary contraction or budget funding, since ELIs would merely replace a small part of existing excess reserves on the ECB balance sheet with negotiable instruments. Rather, the availability of ELIs would reduce the risk of the sort of money market fragmentation that was seen around 2012 during the euro crisis, and thus help ensure the smooth transmission of monetary policy. The possible objection that issuing any new instrument would entrench the expansion of the Eurosystem balance sheet, is unreasonable in general; in the specific case of ELIs, their availability would in fact give the ECB more flexibility in managing quantitative easing, since ELI operations would not be constrained by the capital key. Unlike under some other proposals, markets for sovereign bonds, which are essential for government financing and debt management, would be unaffected or even enhanced. Finally—and also unlike other safe-asset proposals—an ELI-issuing policy would be easy to implement, since the proposal is designed to rely on existing laws, regulations, and institutional arrangements.
Both discussants saw merit in the proposal; they recognized the need to address the problems that would be resolved by ELIs, and agreed that most of the potential objections were second-order. They raised, however, some issues that ELIs would not address. Keeping ELIs uniform, with a single maturity, would allow the volume of issue to be larger, but at the cost of not creating a yield curve. Thus, they could be at best a partial solution to safe-asset development. Giudice concluded that ‘ELIs may not be the safe asset, but it could help if they were to exist’.
Another question is whether or not the ECB would be the right agency to issue such an instrument. It might not want to take on such a role (in the US the Treasury rather than the Federal Reserve issues T-bills). Ioannou underlined that it was one thing to issue instruments to manage liquidity and another to do so in order to create a securities market segment. The ECB issuing ELIs might well intensify criticism over the putative intermingling of fiscal and monetary policy, as some have already alleged in the case of the ECB buying government bonds under its non-standard monetary policy measures. There is also already a broader debate about how far the ECB should take into account other objectives, such as support for the transition to a more sustainable economy.
Both discussants pointed out that the landscape for European capital markets has just now been significantly altered by the introduction of the Next Generation EU and Recovery and Resilience Facility. This breakthrough for the EU budget, with the introduction of a borrowing capacity of 672 billion euro, means that the Commission will greatly expand its issuance of bonds. As Giudice reported, the first issue was massively oversubscribed, confirming the thirst for euro-denominated paper and signaling the potential for the Commission to become one of the largest issuers in Europe. The new instruments are protected from creating debt mutualization—a main objection to many safe-asset proposals—by inclusion of a provision that each member state is liable only up to its own contribution to the EU budget. Although the borrowing is supposed to be temporary, Giudice expects large amounts to be outstanding for the coming decade, and to create new dynamics towards capital markets union. Hence, further work on the case for developing ELIs would need to take account of this new form of competing asset.
Hardy reminded the panel that it is the job of the ECB rather than the Commission to further the functioning of euro funding markets, particularly since the Commission’s purview includes non-euro area countries. Also, in his view, short-term instruments play a special role in financial markets; the Commission’s longer-term bonds would not fulfill this role.
In the general discussion, questioners raised other options for issuing safe assets, for instance, by the European Stability Mechanism—although it is not clear that its mandate would allow it to do so beyond its existing practices. There was also discussion of whether ELIs could help alleviate the doom loop problem, by allowing banks to diversify out of own-government debt—but the panel thought the impact in this area would be minor. Speakers and participants agreed that the ELI proposal would not help in resolving fiscal and distributional tensions within the EU, but there was broad consensus that it could be important in furthering the capital markets union and widening demand for the euro.
Adrienne Cheasty (Academic Visitor with EuPEP at St Antony's College, Oxford)
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