ECB research paper continues to deny that bond buying programmes essentially funded the Eurozone governments

The ECB recently published in their Occasional Paper Series the following report (No. 397) – Prohibition of monetary financing: an economic perspective – which purports to justify the current practice of central banks of not directly buying the debt issued by their governments, despite many central banks at various times since this practice became the norm, buying very large quantities of government debt in the secondary markets. The discussion really avoids the issue and just rehearses the usual guff: central bank independence, maintaining fiscal discipline, and hyperinflation myths – which when one digs more deeply have never stood up to scrutiny. And when one puts the class element into the discussion we see through the fictions. Governments and their central banks will always bail out large corporations with influence when the need arises and never talk about their ‘independence’ being compromised etc. The reality is that the large-scale bond-buying programmes in Europe by the ECB saved several Eurozone governments from insolvency during the GFC and after because they funded the government deficits at times when the private bond markets were pushing for unacceptably high yields on the government debt.

On the ruse that central banks are independent, please refer back to these blog posts:

1. The central bank independence myth continues (March 2, 2020).

2. ECB continues to play a political role making a mockery of its ‘independence’ (June 12, 2018).

3. Censorship, the central bank independence ruse and Groupthink (February 19, 2018).

4. The sham of ECB independence (October 24, 2017).

5. Trump might do us a favour – expose the myth of central bank independence (November 14, 2016).

6. The sham of central bank independence (December 23, 2014).

7. Central bank independence – another faux agenda (May 26, 2010).

The ECB paper concentrates on why the Treaty on the Functioning of the European Union, which defines the governmental and central banking roles in the Eurozone:

… forbids the ECB and the national central banks of the EU from granting credit to governments or purchasing their bonds at issuance.

It rehearses the usual line that monetary policy must be solely concerned with maintaining price stability and should not be contaminated by the decisions or aspirations of the fiscal authorities.

It also makes clear that the overwhelming motivation for this prohibition, which is really only a relatively recent protocol in the scheme of central banking history, forces governments to deny their capacity as the currency issuer (not the way the ECB frames it though) and pretend that they

In the Eurozone, the governments are not currency-issuers, having surrendered that capacity when they signed up to enter the Eurozone.

So the ECB plays a role that is somewhat different to the central banks where the elected national government is the currency issuer.

But the line has always been the same that by forcing the governments to borrow funds from the private bond investors to meet the difference between their spending and their tax revenue, those governments are:

… subject to the disciplinary forces of the market, much like private sector debt.

In other words, denying the very essence of the currency-issuing government and treating it as if it is a private corporation that can become insolvent.

That ‘fiscal discipline’ is then variously enforced depending on the situation.

When it comes to provide fiscal support for the poor the alarm bells sound – ‘we will run out of money’.

But when some large corporation needs bailing out because it has been poorly managed the cry becomes – ‘the national interest requires government support’.

Privatise the profits, socialise the losses – is the familiar short-hand expression to summarise that inconsistency.

This is the ‘class’ aspect that really renders the so-called ‘taboo’ (ECB calls it the prohibition) an ideological contrivance.

Think back to the GFC when the US Federal Reserve Bank immediately provided about $US3.3 trillion in emergency funds to the private sector which expanded into support that was ultimately much larger than that.

At the time, there were all sorts of misleading commentary on this large liquidity injection that confused several different fictions.

For example, remember the famous March 2009 interview on the US CBS programme, 60 Minutes, when the head of the US Federal Reserve Bank, Ben Bernanke explicitly denied the bailout funding came via tax revenue.

He told the interviewer (Scott Pelley):

It’s not tax money. The banks have accounts with the Fed, much the same way that you have an account in a commercial bank. So, to lend to a bank, we simply use the computer to mark up the size of the account that they have with the Fed.

Classic statement of how a currency-issuing government spends and exposes the myth that taxes fund government spending.

A year later (December 2010), after much hostility by the conservative money doomsayers about this action by the central bank being equivalent to the dreaded (in their eyes) ‘printing money’, Bernanke told the same programme that:

We’re not printing money. The amount of currency in circulation is not changing. The money supply is not changing in any significant way. What we’re doing is lowering interest rates by buying treasury securities and by lowering interest rates we hope to stimulate the economy to grow faster.

The ECB report wants to convince the reader that the:

… prohibition on financing public deficits is consistent with a range of macroeconomic theories, including monetarism and the fiscal theory of the price level, although this approach is not without its detractors, including proponents of Modern Monetary
Theory.

The point to understand is that this prohibition is a relatively recent phenomenon and parallels the political and ideological developments that we now refer to as neoliberalism.

Prior to that period, central banks, as part of government, would regularly buy government debt in the primary issuing stage.

For example, in Australia the shift towards depoliticisation accelerated in the 1980s (under a Labor government to boot).

Prior to 1982, the federal treasury (coordinating the central bank, the RBA) ran what was called a ‘tap system’ in relation to government debt.

The system saw the government determine how much debt it wanted to issue.

Then the government would set the interest rate (yield) and supply the bonds to investors at that rate according to the demand received.

Sometimes investors did not take up as much as the Government desired to sell because they thought the fixed yield was too low.

The government would then instruct their accounts to create contra entries in the RBA-Treasury accounts so that the shortfall was closed by the RBA sending dollars to the government and receiving bond assets in return.

It was unambiguously a case of the government borrowing from itself, which exposed the whole fallacy of the government deficits requiring non-government sector debt funding.

As the neoliberal era intensified, such leaks in the ‘story’ (the fiction) could not be tolerated.

The tap system was relentlessly attacked in the early 1980s by the conservative government, economists, and the financial community as they all developed their neo-liberal credentials.

What transpired was the development of the – Australian Office of Financial Management (AOFM) – which in its own words “is a specialised agency within the Treasury portfolio responsible for management of Australian Government debt.”

So Treasury moved a few desks around and then pretended that the debt-issuance infrastructure was now at arm’s length from the government.

The AOFM’s activities include the issue of Treasury Bonds, Treasury Notes, management of the Australian Government’s cash balance, and management of a portfolio of debt and investments.”

The AOFM replaced the tap system with an ‘auction model’ in August 1982 and claimed that it would prevent so-called funding shortfalls from occurring.

This was just a smokescreen to divert the public from asking the obvious question: How can the Australian government that issues the AUD ever have a funding shortfall.

It also was in denial of the way the Tap system had operated for years.

The AOFM hammered the ‘uncertainty’ of government funding to justify this decision, which was, of course, totally spurious and just played along with the neoliberal agenda – to limit government activities except when they helped the elites prosper, which was often.

Under the Tap system, if the private investors didn’t take up all the debt that was on offer, that simply meant that they had converted a desired amount of their wealth holdings into government bonds and were happy with their portfolios at the rate of return on the paper that the government was offering.

That is all it meant.

It just meant that the RBA bought the rest of the debt on offer that exceeded the desired government debt holdings at the time of the private investors.

The auction model cut the RBA out of the direct (primary) issuing process and allowed the bond investors to bid for government bonds at the yields they desired.

It gave the bond investors a path to set the yields as high as possible (with large profits) and still get their hands on the risk-free government bond, which they could then use as a benchmark to price its other riskier bets (the derivatives market exploded on the back of the risk-free debt provided by government).

Corporate welfare exemplified.

And many of those bond investors also led the neoliberal charge against government provision of welfare assistance to the poor, the unemployed, etc.

Ultimately, the shift to the auction system and the prohibition on direct central bank bond purchases was a ruse to prevent governments from spending on policies that the elites felt did not advance their own interests.

The AOFM speech I referred to above gave the game away.

The speaker (then a senior AOFM official) was talking about the so-called captive arrangements, where financial institutions were required under prudential regulations to hold certain proportions of their reserves in the form of government bonds as a liquidity haven.

… the arrangements also ensured a continued demand from growing financial institutions for government securities and doubtless assisted the authorities to issue government bonds at lower interest rates than would otherwise have been the case … Because such arrangements provide governments with the scope to raise funds comparatively cheaply, an important fiscal discipline is removed and governments may be encouraged to be less careful in their spending decisions.

The pressure to change the system was thus not only about corporate welfare but also about the conservative desire to force voluntary limits on what the Federal government could do in terms of fiscal policy.

All the talk about inflation was based on the assertions that governments were prone to go feral and spend wildly unless the bond markets maintained a discipline on their capacity to spend.

On September 18, 2012, the then Bundesbank boss, Jens Weidmann told an audience in Frankfurt that the classic German story – Faust (Act 1, Scene IV) – which recounts how the evil Mephistopheles tricks the Emperor into signing some paper to create money, was apposite to the way central banks were behaving during the GFC.

He was criticising the bond buying programs (more soon).

In the play, the Emperor is concerned with the ‘crime’ but the Treasurer assures him that with “a few strokes of the pen!” allowed for increased spending in the nation and “how well the folk have fared”.

He went on:

Behold thy town, half-dead once, and decaying,
How all, alive, enjoying life, are straying!

In other words, when new money is spent into an economy, which has been mired in recession and has plenty of idle capacity available, new commerce is stimulated and people are happier, presumably because unemployment is lower and incomes higher.

But in Faust, the Emperor and his supporters realise the advantages of fiat currency and start spending it without regard to the capacity of the economy to respond to the higher nominal spending by increasing output.

The result unsurprisingly is inflation.

What von Goethe’s example can tell us is that human folly leads to undesirable consequences.

What else is new?

However, the likes of Jens Weidmann thought that the message from von Goethe was more sinister, given that Mephistopheles is none other than the devil’s agent.

He thought that it tells us that money creation “degenerates into inflation, destroying the monetary system”.

If you think about this for more than a moment you will wonder why central bankers would keep pumping out liquidity for the government to spend once the economy was beyond full employment and was no longer able to increase output?

Are central bankers so irrational that they need to be placed in a straitjacket to stop their destructive tendencies?

These questions might seem ludicrous or crass but they are merely responding at the logic level that maintains the taboo.

The reality is that during the era when central banks did directly purchase government bonds there was not systematic relationship between that action and inflation.

Most great inflations are, in fact, supply-side events and have no direct relationship to the way that the central bank and the treasury departments interact.

What Jens Weidmann was critical of was the quantitative easing programs run by the central banks, including the ECB at various times including during the GFC, even within the context of the prohibition on direct bond buying.

The ECB paper cited at the outset discusses these various bond buying programs.

It says that while “direct purchases” are not allowed (that is, in the primary market):

Purchases of government debt on the secondary market are permitted if certain conditions are met …

Their argument is that:

1. “in the case of primary market purchases, the government receives newly created money directly from the central bank in exchange for newly issued debt.”

2. “In the case of secondary market purchases, another investor has already been paid at market prices, with the central bank transacting with the private investor, rather than with the government.”

Can you detect any difference?

In the second case, the private bond investors ‘make the market’ via the auction bids.

The issued debt is then traded on the secondary markets, which is where the central banks are allowed to purchase the debt.

But when the central banks are running large-scale public bond purchasing programmes, the primary dealers know that they can offload the debt they get in the primary auction to the central bank – and make a profit because the increased central bank demand pushes up the bond prices after issuance.

In other words, according to the mainstream narrative, the primary dealers are ‘funding’ the government deficits, but on terms that are based on the assumption that the central bank will immediately buy the debt issued.

In other words, the central bank is really just ‘funding’ the deficits using the mainstream language.

There is zero difference once we understand what is going on.

The ECB paper claims that in the direct case, the government runs the agenda, whereas in the secondary case, the central bank has the discretion.

Not a substantive point really.

The ECB and other central banks have also claimed (to defend their actions) that these large-scale bond-buying programmes were in fact not fiscal operations but served to allow monetary policy to transmit down through the ‘transmission channels’ to the private financial markets.

How?

The central bank bond purchases drive up demand for the bonds and push down yields.

The lower yields transmit through other financial assets are are meant to drive investment.

But during a crisis, everyone wants the risk free asset which drives up government bond yields and prevents the ‘channels’ from opening.

In short, the claim is that these secondary bond market purchases are pure monetary operations and have nothing to do with fiscal policy.

It is a false claim.

As I argued in my 2015 book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015) – the large scale bond buying programs that began in May 2010 with the – Securities Market Programme – and morphed into the more comprehensive – Asset purchase programmes – essentially saved the euro during the GFC and beyond.

Without the ECB support, several governments including Italy (in June 2012) would have probably become insolvent such was their capacity to sell debt to the bond markets at reasonable yields.

The ECB intervention drove up the demand for the government debt in the secondary market and as a consequence drove down bond yields and without doubt amounted to ‘funding’ the fiscal deficits of governments that did not issue their own currency.

The ECB, by default, became a fiscal agency in the Eurozone and filled in the gap left by the omission of a European-wide treasury or finance function in the architecture of the common currency.

Conclusion

The question I asked in that 2015 book was:

How can a relatively simple monetary operation between a central bank and its corresponding treasury department (both part of what we call the ‘consolidated’ government sector) possibly be considered a taboo?

That question remains.

That is enough for today!

(c) Copyright 2026 William Mitchell. All Rights Reserved.