Central Banks as Lenders of Last Resort

There have been strong pressures on the European Central Bank to play the role of the traditional, rich and generous uncle, for some of the countries that use the euro. Many observers have been urging the ECB to buy, directly, from the issuing governments, or indirectly, through the secondary market, the bonds of the governments of the countries in difficulty. It has been argued that this action would keep the spreads low, without leading to inflation, because of the high unemployment and excess capacity that exists in those economies. It has also been argued that the spreads may not be justified because they are the result of irrational confidence crises fed by some “herd behavior” on the part of holders of government bonds. Some other observers, and especially Hans-Werner Sinn, a German economist, in several recent papers, have argued that so-called TARGET2 balances have indirectly allowed huge funds to work their ways to countries in difficulties, and especially to Greece, thus reducing the need for these countries to adjust. We shall discuss later, in another chapter, this complex issue that has attracted much debate, especially in 2012.