DOES THE ECB GET IT WRONG BY A FACTOR OF SIX? NO, NOT AT ALL

Economics is not a precise science. After all, it deals with human behaviour. But economics still has to be based on facts rather than fantasy. It is sometimes astonishing by how much Euro-sceptics bend the facts just to find an argument for their views.

One of the key points discussed at the hearing of the German Constitution Court on the ECB’s readiness to buy bonds of reforms countries was whether this might theoretically burden German taxpayers with nearly unlimited risks. The ECB argues that it would buy only sovereign bonds with a maturity of 1 to 3 years. As a result, the maximum amount of potentially eligible bonds from Italy, Spain, Portugal and Ireland would be around €530 bn. according to the ECB. With a German capital share in the ECB of 27%, the maximum potential German risk would thus be €145 bn. That is a very hefty sum, yes. But it is not beyond the scale of the European support mechanisms which the German Bundestag has already passed.

I was not at the Court hearing. But according to newspaper reports, a prominent German academic claimed in front of the Court that the ECB’s restriction to bonds with a maturity of 1-3 years would be meaningless. Over time, all longer-term bonds would eventually have a residual maturity of no more than 3 years and thus become eligible for ECB purchases. As a result, the potential upper limit to ECB purchases would be around €3trn instead of €530bn.

What a claim. Has the ECB got its arithmetic wrong by a factor of almost six? Sounds logical, doesn’t it? It is true that, seven years after its issue, a 10-year bond has only a residual maturity of three years. So each long-term bond could become eligible for ECB purchases.

But wait a minute. That would not be the only thing to happen. Over time, shorter-maturity bonds already bought by the ECB would fall due. While the ECB could theoretically buy additional bonds whose residual maturity has fallen to below 3 years, it would pocket the redemption proceeds from the bonds that have fallen due. We have to set these redemptions against the potential new purchases. The ECB would only ever hold bonds in a certain section of the curve. And the ECB has vowed to only buy bonds if countries issue across the maturity spectrum and not just in the section in which the ECB might buy. The total upper limit of bonds theoretically eligible for the ECB’s OMT programme would increase only very gradually with the overall expansion of the size of the bond markets in question. Note that the ECB has vowed to only intervene for solvent countries. That is, it would not support any country not redeeming a bond in full.

To claim that the ECB got its arithmetic wrong by a factor of almost six is rather ludicrous. Just as ludicrous as the even more prominent claim in 2006 that Germany was turning itself into a “bazaar economy” when, in fact, Germany was already on its way to a spectacular industrial renaissance.