Proposals

#8 Change European Union Treaties to allow for direct financing of government spending

Under EU law, the European Central Bank (ECB) is prohibited from financing governments or EU institutions directly. This is meant to ensure the ECB does not become pressurized by politicians, and to protect the ECB’s independence.

However in practice, the ECB’s intervention through quantitative easing (QE) and negative interest rates are already helping governments a lot. Today, most governments can borrow money from investors at a negative interest rate due the ECB’s measures, meaning investors lend money to governments knowing they will get less money back. 

In practice, while government debt is increasing significantly due to the Covid-19 crisis, the cost of that debt is actually smaller than it used to be. In other words, despite the fact that governments have more debt, they are paying less for it.

But this cannot last forever. At some point, the ECB is likely to eventually reverse its policy (i.e. stop QE and raise interest rates). When this happens, it will cause the large stock of debt to become more costly, as governments will gradually need to replace previously issued cheap bonds by new more expensive ones.

This may cause a problem of “debt sustainability” (the affordability of debt and the ability to pay it back on the long-term), and force governments to reduce public spending and implement austerity measures, such as cutting spending and raising taxes.

To avoid this problem, the European Union (EU) could revise the EU Treaties to ensure that the ECB can support governments even more than it does today. Currently the ECB is prohibited by the EU Treaties from financing governments directly. In other words, the ECB can only purchase government bonds from financial markets, and not directly from governments.

During times of economic crisis, the ECB should be allowed to give money directly to governments so that a short term crisis does not automatically result in long-term public debt skyrocketing.

Such a change to the EU Treaties cannot be decided by the ECB on its own, but requires the agreement of all 27 governments in the EU (and not just the 19 eurozone governments)  — this is called the rule of unanimity.

➕ Pros

• It would create more confidence in the ability of governments to spend money today.
• The purpose of the monetary financing prohibition is to reduce the risk of inflation, but the risk of inflation is virtually non-existent today.

➖ Cons

• It would reduce the independence of the ECB in the future, leading to a risk that the ECB will not do enough to tame future increases in the inflation rate.
• Even if inflation is too low today, removing the monetary financing prohibition would undermine trust in the stability of prices in the eurozone. Lack of investor  and consumer confidence in the purchasing power of the euro may create self-fulfilling expectations of high inflation.
• It may encourage politicians to spend money foolishly, especially ahead of elections.
• Reforming the EU treaties is almost impossible due to the unanimity rule of the European Council.