ECB should ignore Berlin, says leading economist

A BREAKDOWN of the financial markets and a “very, very strong recession all over Europe” will occur if the European Central Bank does not adopt “bold” measures to stabilise the euro crisis, one of Germany’s most senior economic advisers said yesterday.

Economics professor Peter Bofinger, one of the “five wise men” who advise German chancellor Angela Merkel on economic policy, said the ECB should ignore the views of the German government and became a lender of last resort, like other central banks.

Prof Bofinger said the ECB was independent of government and this meant it was as independent of the German government as it was of the Irish Government. He said it had a responsibility to ensure price stability, and that entailed preventing deflation as much as inflation.

He told RTÉ radio's This Weekprogramme that the German people had bad memories of inflation, which had caused two generations to lose a lot of money. Fear of central banks funding government deficits was "deep in our genes", he said.

The debate on the role of the ECB in the euro debt crisis was not a rational one in Germany, where the fear felt by the public was being fuelled by the media, he said.

Because of this, the euro was being endangered because the German government was not prepared to take the steps necessary to stabilise the situation.

He said he and other advisers had suggested a eurobond scheme – a debt redemption scheme that would build a bridge between the need to stabilise the system and German fears, but the idea had not yet been accepted by the chancellor.

The suggested scheme would involve a certain amount of a government’s debt having joint liability, but with that debt having to repaid over a period of 20 to 25 years.

It would be a kind of sinking fund, Prof Bofinger said, and would require strong safeguards, with collateral such as a country’s foreign exchange reserves.

It was clearly needed that the ECB would act as a lender of last resort, he said. If the bond run was not stopped, it would “endanger the European and global financial system. So bold action is definitely needed.”

Prof Bofinger said that if the ECB did not act boldly enough there was a risk of the “implosion of the financial system, and that will lead to deflation”.

If the ECB does not act, and if there are no eurobonds, “we will run into a real disaster, a breakdown of the financial markets, [we will] see a very, very strong recession all over Europe, a long period of very high unemployment, with banks that going bankrupt, and people losing [their] money.”

He said Europe would be facing “a real disaster” if the current muddling response to the crisis continued in the coming months.

Two weeks ago, in an interview in Germany, Prof Bofinger said the situation was similar to that of autumn 2008, when governments decided to guarantee the deposits of banks and then set new rules.