The implications of absorbed but not eliminated risks

March 15, 2013 • Blogs, IUSY Spring Research Trip, Online Content • Views: 791

BY HAROULA GOTSI

What is the role of the European Central Bank for the future of the European Union? Did the crisis reveal any institutional problems that need to be addressed in order for the legitimacy of the union and its goals to be preserved and promoted? These are some issues we touched upon in our meeting with Lorenzo Bini Smaghi, former member of the executive board of the European Central Bank.

The first relevant point he wanted to clarify for us was that Central Banks are able to influence the market and absorb the risk in the financial system, but they are not able to eliminate it. This targeted reduction of risk has to be followed by appropriate political action in order to be of any relevant significance. Unfortunately though, politicians tend to act only when the markets are pressuring them and the relief CBs are providing ends up leading to exacerbated negative results in case the risk materializes and the taxpayers end up having to bear the burden.

The economic crisis many countries are going through in the Eurozone are exactly due to the materialization of such risks. The ability to transfer resources between the countries of the union has been proven crucial for overcoming the crisis. However, the common monetary policy set by the ECB is only marginally sufficient; a uniform fiscal policy is needed, one that would also demand a tighter political union. Times of crisis enable people to be rational and clearly see the alternatives they have. Such times are required in order for stronger models to emerge, even in the absence of unanimity. It is now clearer than ever that the EU needs to become a political union, but political integration takes time and requires crisis- and we have both.

By forming a union, nations undergo, in essence, a deprivation of power, since they are required to hand it over to a supranational body. It is therefore expected that the formation of a union on any level will be a strenuous process. Has the ECB gone beyond its mandate or is it about to do so in its attempt to address the economic crisis? Mr. Lorenzo Bini Smaghi says it has not and it does not need to. The ECB has a commitment for ensuring stability for the Eurozone countries. It has a commitment to reduce risk for solvent countries. But the ECB only absorbs risks as long as they are probabilistic risks and have not been realized.

 

 

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