Are ECB’s Greek bond purchases really irrelevant for the private sector?

Motivated by the current discussions about the Greek debt problems, Paul De Grauwe and Yuemei Ji have a VoxEu column addressing “Why the ECB should not insist on repayment of its Greek bonds”. In a debate that currently is, and has been for a long while, marred by political idiosyncrasies and ethnic stereotypes of the worst kind, it is a sound and healthy contribution based on basic public accounting. In all fairness, however, the authors cannot help contributing to the nationalistic platitude by making snide remarks about “hard-working German tax payers”. Also, in an earlier VoxEu column on the same subject they almost question the intellectual sanity of German economics professors and central bankers.

Their message is simple. The ECB or the citizens in the Eurozone should not worry about Greece not paying back €3.5 billion worth of Greek government bonds which are due on July 20, 2015. Those bonds were acquired by the ECB under the now defunct Securities Markets Programme (where the rule is that these are held to maturity).

They present their idea by a simple one-country example which suffices here. The main thrust of their argument is that when a central bank has purchased a government bond, then at the consolidated public sector level, the government is paying interest to the central bank, which on the other hand rebates those interest payments to the government. I.e., the consolidated public sector has substituted some interest-bearing liabilities (bonds) with non-interest-bearing liabilities (money). From a consolidated public budget perspective one could without problems write off the bonds from the central bank’s balance sheet. It would merely stop the “circular flow” of interest payments back and forth between the public entities. The private sector would be completely unaffected by this. Hence, any fears in the public that, say, extending the maturities on these Greek bonds would necessarily cause more taxation are unwarranted.

This is in itself correct as I see it. But it seriously misses some dynamics. The seigniorage revenues that the consolidated public sector extract in their example (which is not what happened under the SMP which involved sterilized purchases, but let that rest), do not come out of nothing. As the authors make clear: They are saved interest payments on public debt. Well, let us extend the focus beyond the public sector: Look at the private sector. Prior to the purchase of the bonds by the central bank, these bonds were owned by the private sector. They have therefore since the purchase missed out on interest payments. Some call seigniorage an “inflation tax” for a reason. The taxation that is allegedly feared (e.g., by the “hard-working German tax payers”), has already happened—it is not just “an inflation risk” as the authors purport. Those lost interest rate payments are gone for good no matter how long or short time the central bank decides to keep the bonds (and at what value).

So yes, extending the maturity on the Greek bonds will all things equal not necessitate new taxation in the Euro area. The taxation has already occurred. This simple fact could be the reason why some economists (of whatever nationality) raise a flag regarding these types of policies. Adding to the nationalistic mudslinging, I paraphrase the authors (January 15, Conclusion) by saying that I would have expected that London-based economics professors would understand this (whether being a former member of the Belgian parliament is an asset or a liability, I honestly do not know).

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