The problem creating the finance requirement can be overcome with a comprehensive economic program. In addition, the politicians to implement the program have to be credible.

Why does the European Central Bank (ECB) act reluctant to purchase sovereign bonds of troubled countries Italy, Spain, Portugal, Ireland, Greece, and others to be added to the list in order to prevent interest rate hakes? Why do other countries, Germany and Holland among these, oppose to this option?

We can answer the above questions in the context of Turkey’s experiences. During the first months after the 2001 crisis, the balance sheet of the Central Bank of Turkey (CBT) had changed significantly. The size of the balance sheet had grown by 3.4 times from the beginning to the end of 2001. The mean reason for this was that the CBT had purchased some part of the Treasury bills and bonds which were given to public banks in exchange for their receivables from the Treasury and to banks transferred to the Savings Deposit Insurance Fund in order to strengthen their capital structure. As a result of the mentioned transactions, the “Receivables from the Treasury” item under the CBT’s balance sheet had grown from 1.5 billion TL to 34.4 billion TL.

Following the transaction, the arising liquidity surplus had been withdrawn by the CBT to a large extent in order to prevent a corresponding monetary expansion and a possible upwards pressure on inflation rate. From the end of 2000 to the end of 2001, inflation rate had increased from 39 to 69 percent. However, the underlying reason for this increase was not monetary expansion but the extreme depreciation of Lira. Of course, the CBT had not initiated this operation alone. Simultaneously, very critical steps had been taken to discipline fiscal policy. Massive efforts had been paid to save the banking sector that had tumbled down the cliff. Macroeconomic program had been backed by international organizations via low-interest loans at substantial amounts. Moreover, important steps had been taken to alter the ill-devised institutional structure.

In order to preserve the value of the currency issued, central banks have to be attentive to the circumstances under which the currency is injected into market. Injecting currency generously into the market by purchasing the bonds of a country that constantly fails to discipline itself and therefore suffers from lack of finance not only fails to solve the problem but also harms the prestige and the credibility of that central bank. What is more, if the country in question is large and has large debt, the amount of currency to be issued will also be massive. In addition, if the mentioned bank is the central bank of a monetary union, the action sets a model for other countries of the union to demand the same action if they get into trouble.

Let’s assume that, some part of the excess liquidity generated this way was withdrawn by the ECB, as had been the case with Turkey during the 2001 crisis. And let’s ignore the loss the CBT will face as a result. Then, the action will not cause a significant inflationary problem for the ECB for a considerable period given that the level of production across the Eurozone is currently below the potential.

Under these circumstances, apart from the obsession of Germany about inflation, we can bring about two main reasons why the CBT is acting reluctant to taking such action. First, the ECB might be of the opinion that stepping in before effort is paid to overcome the problem creating the finance requirement will be useless. This can be accomplished with a comprehensive economic program. In addition, politicians to implement the program have to be credible. The replacement of prime minister in Italy should be read with this perspective. Second is about the bigger problem of the EU: the Union has a single central bank while each member state implements fiscal policies independently. This is a rooted structural problem and is the mother of all problems currently facing the Union. This structure leads to the coexistence of a number of diverse fiscal policies that might or might not be harmonious with the single monetary policy. No one can guarantee that such disharmony will not arise again. I believe that the ECB calls the Union for starting to discuss this issue, at least. We also should note that, despite its reluctance, the ECB has already made bond purchases at certain level in order to make sure that things will not turn disastrous.

This commentary was published in Radikal daily on 15.11.2011