Sir Mervyn King's message


Sir Mervyn King had two big messages in his latest press conference today, one for people here in the UK and one for the eurozone.

Sir Mervyn King

The message for the UK audience was "be patient": the outlook seems bleak, but rest assured, the government and the Bank have done more or less everything they can do to get the country back on track. It's just going to take longer than we thought - maybe a lot longer, depending on what happens across the Channel.

His message for the eurozone was "shape up": you should stop fooling yourselves that this is a simple cashflow problem, and France and others should stop thinking the European Central Bank (ECB) can get them off the hook.

I'm not sure which will be less popular.

Certainly, the new UK growth forecasts look as grim as expected. Only three months ago, the Bank's central forecast was that UK output would expand by more than 2% between the middle of 2011 and the middle of 2012. That has now been roughly halved, to about 1%.

The governor did not re-enter the argument about the reasons for Britain's slow growth in the first half of the year. But Sir Mervyn was in no doubt that the recent gloom, since the summer, is down to the eurozone. Whatever happens in the next few months in Brussels or Frankfurt (or Rome), the eurozone will face slower growth as a consequence of the crisis, and so will the UK.

Bank liquidity

Sir Mervyn's views on the eurozone - and the ECB - will not come as a surprise to those who have heard him speak privately and publicly on these issues over the past year. As I noted in the summer, he has never thought that central bank liquidity was a solution to the crisis - only a way to buy time. And he has never thought the ECB should or could be the saviour of the euro, by buying vast quantities of Italian - or Spanish - government debt.

Why? Because, as I have explained on too many occasions, to ask the ECB to step in, in these circumstances, is basically to ask it to take risks onto its balance sheet, on behalf of a fiscal union that does not yet exist.

Suitably designed, the ECB's balance sheet could perhaps be a temporary bridge to a full-blown fiscal union. But it's quite something to ask it to play this role in a vacuum, however convenient that might be for governments like the French. Apart from anything else, it's deeply undemocratic. No-one ever elected the ECB. It was expressly designed to be beholden to no-one in the pursuit of its mandate.

The governor has said all this before, but he has perhaps tried a little harder, in the past, to hide his frustration. Today he said, testily, that most of the people who thought the ECB should be a "lender of last resort" for the euro seemed not to understand what a lender of last resort actually was.

In a sense, he's right. The Bagehot definition of "lender of last resort" applies to financial institutions, and involves lending to solvent concerns, at good collateral, for a "penalty rate". That is what the ECB believes it has been doing, in the past few years, with its emergency lending to Greek and other eurozone financial institutions. It is not what it thinks it is doing when it buys Italian or Spanish sovereign debt, which it has always defended, very separately, as an element of monetary policy. The claim is that the ECB's low interest rate policy is not getting through to these countries because of what is happening to their sovereign debt. Though, of course, German and other critics see that as a smokescreen for deeper, political motives.

But you can see, even from this brief description, that the dividing lines are not nearly as sharp as Sir Mervyn implies, or the ECB would like to claim.

The governor said buying a lot of periphery debt would be tantamount to financing those countries' current account deficits: in effect, a transfer from surplus countries to creditor countries, which should more properly be the job of governments. You can see his point. But in many ways, all that emergency ECB lending to periphery banks has achieved exactly the same thing.

Greek banks can't borrow directly from German and other surplus country financial institutions any more. But the lending - that transfer from surplus country to debtor - has not stopped. It has simply been replaced by the ECB. The Greek banking system now has a massive negative balance with the ECB. The German banking system has a massive positive one.

Dividing line

For the ECB, there is an important technical difference between the emergency liquidity programmes for banks and any sovereign bond purchases: in the lending to banks, the ECB gets collateral. In the second case, the sovereign risk is simply taken directly onto the ECB's balance sheet.

But in both cases, the ECB is helping to finance current account deficits which the private sector is unwilling to finance at a reasonable rate. And in both cases, it is taking risk onto its balance sheet which will ultimately be borne by eurozone taxpayers, particularly, one has to assume, taxpayers in surplus countries like Germany.

The governor may be right to have doubts about the ECB taking on a role that should more properly be played by governments - or institutions such as the IMF. He may also be right that, if the ECB is to have a big role now in "rescuing" the likes of Italy, this needs to be explicitly designed and underwritten by eurozone governments. It can't be simply down to the ECB governing council, or Mario Draghi.

But one of the things that makes the crisis in the eurozone so fiendishly difficult is that you can't draw an easy dividing line between "ordinary monetary policy operations" and "extraordinary current account financing" in a single currency area with one central bank and 17 sovereign governments. Or if you can, the ECB crossed it a long time ago.

Stephanie Flanders, Economics editor Article written by Stephanie Flanders Stephanie Flanders Former economics editor

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  • rate this

    Comment number 1.

    Our message to Mervyn should be -GO!

    This person knew so little about how the economy works to think that all was well in the way he was running money up to 2008, when in fact his policies and misunderstandings created the bubble of debt that created the crash which he should have seen coming way back in the early 2000s.

    He always gets predictions quite wrong too!

    What of inflation!

  • rate this

    Comment number 2.

    I get the impression that Sir Merve actually is encouraging inflation, so that the debts the government has run up are eaten away. Unfortunately this impoverishes pensioners and savers. Also not a good example when he is relying on investors to buy gazillions in public debt in future. Be very afraid. We could well be in the position of the Eurozone governments quicker than you imagine.

  • rate this

    Comment number 3.

    And one more time the ECB's main point is to lend to PIGS, and most likely that other EU countries will borrow funds to do it. But when will PIGS be able to pay back, taking into account their current state and IMF forecast ( )? It will be a problem fo EU members to borrow long and lend short to PIIGS with such expectations.

  • rate this

    Comment number 4.

    Merve does not seem to get that most differences between monetary policy and fiscal policy are just illusions. Fiscal policy is also monetary policy.

  • rate this

    Comment number 5.

    "....... his policies and misunderstandings created the bubble of debt that created the crash which he should have seen coming way back in the early 2000s."
    I thought it was all Gordon Brown's fault. Perhaps Mervyn very cleverly feigned incompetence to discredit Labour, which worked brilliantly and would expalin why he's still got the job.

  • Comment number 6.

    All this user's posts have been removed.Why?

  • rate this

    Comment number 7.

    I think for last couple of years MK has tried to talk pound down and allowed inflation to happen in an effort to inflate away debts (public and personal) and encourage exports.

    Basically he is allowing us to get poorer in an orderly fashion without too much rioting and disorder - long way to go yet.

  • rate this

    Comment number 8.

    Wow, superb article. Thanks Stephanie.

    I can't help feeling that we are now beginning to see the failure of democracy in addition to the failings of capitalism. Afterall, Greece and Italy now have unelected governments and the ECB (equally unelected) are redistributing cash via the back door.

  • rate this

    Comment number 9.

    I find it rather strange that the BoE which presided over the printing of at least £275 billion and which has resulted in LOWER growth than in the Euro zone but DOUBLE the inflation rate now dares to lecture the ECB.
    Despite all the propaganda the 2011 UK government deficit will be higher than that of the Euro zone. If you read the UK media you would think the opposite is the case.

  • rate this

    Comment number 10.

    @5 - ihopethisoneworks

    Well, MK has been cutting his growth forecasts since the election & those earlier forecasts did help Osborne get his cuts package through by painting an optimistic outlook in the face of them.

    On the matter of Gordon Brown I am trying to figure out if you are joking. GB didn't create the bubble of debt - it was the people who issued the debt and those who took it on.

  • rate this

    Comment number 11.

    Merv was shamelessly party-political in the run up to the 2010 election openly lobbying for the Tories and their austerity "solution".

    He's not going to admit now that he was wrong.......

  • rate this

    Comment number 12.

    So is this all about Germany waging a war by other means - a debt loaded shot gun wedding to fiscal union under German terms. Dangerous if it is and what does Sarkozy think of this possibility of being financial Robin to Merkel's Batman (he has the right build!)

  • rate this

    Comment number 13.

    Memo to George Osborne

    One quango you should cut is the Office of Budget Responsibility, so far all of its forecasts have been wrong. Whats the point?

  • rate this

    Comment number 14.

    10. worldofsport

    Actually, it was the bloated Civil Service and mounting corporate waste that created the spending deficit. GB made the situation worse through his bumbling mistakes both as Chancellor and PM.

  • rate this

    Comment number 15.

    Unless they simply break EU and German law - which the eurozone has not been shy of so far - it is hard to see a way out of this for the eurozone

    Mervyn King is right, the ECB should not be doing covertly what politicians should through the ballot box. The eurozone should become a fiscal union but that will take a long time and a lot of - probably nationally repeated (think Ireland) - referenda

  • rate this

    Comment number 16.

    "On the matter of Gordon Brown I am trying to figure out if you are joking. GB didn't create the bubble of debt - it was the people who issued the debt and those who took it on."

    Playing devil's advocate more than joking. I'm sure there are those who will say it's still Labour's fault for not regulating. No crash=no recession=manageable (at least) deficit=no Osborne....

  • rate this

    Comment number 17.

    Another good article. However I might have misunderstood, but surely the ECB could take colateral against Greek assets rather than soveign bond. Afterall the Greeks own many valuable assets and these are planning to be sold as part of the IMF/ECB reforms. Therefore the risk to the ECB would be far less and more easy for the eurozone generally to accept.

  • rate this

    Comment number 18.

    14. nickburks


    I was, however, referring to private sector debt not the Government budget deficit. It is difficult to describe the Government deficit as the consequence of a bubble but quite easy to describe the market driven private sector debt in those terms.

  • rate this

    Comment number 19.

    The time for Mervyn and many other experts is up!
    So full of wisdom that they never find a solution.
    The UK economy has to trade with the world and let Europe be a small and diminishing part of this.
    The UK has only one road ahead-massive growth in Coal-Steel-Ships-Energy Manufacturing.
    Simple economics-We have this on tap!

  • rate this

    Comment number 20.

    Yes - just look at his smirking face.
    Mumbo Jumbo King's main response to an ongoing financial crisis has been to put £275 billion QE to - the protectionist City of London.
    No wonder the French & Germans are determined to bring UK FI to heel with a Tobin Tax.
    King is disgusting - he's put £275 billion + rest into the profit accounts of the most wealthy 1% of the UK population, nondoms, frgnrs


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