Friday, June 25, 2010

The Euro and ECB

A couple days ago, The Washington Post had an piece by Ezra Klein on the ramifications of the European debt situation on the future of the European Central Bank (ECB). I found it particularly insightful on two counts.

The first was the institutional barriers that make the ECB so difficult to manage. Specifically, each of the member countries has different views towards inflation and unemployment, which means a single policy (which focuses on inflation), is going to be unpopular in many of the member countries, particularly if they are experiencing differing economic conditions. In that respect, it is not unlike the Federal Reserve, which must formulate policy across a geographically and economically diverse nation. The advantage the Fed has is that the U.S. view on those conditions has had more than two centuries to approach something like consensus. The ECB hasn't had that luxury, even for its oldest members.

The second insight was the ECB's reversion to buying debt. Like the Fed, it is basically restricted from buying debt in the primary market (direct from government). As a result, it resorted to buying debt in the secondary or open market (individuals and institutions that had already purchased government debt).

If you're interested in the functioning of central banks, I strongly recommend you read Klein's piece.

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