I wrote this paper just before the ECB announced its Quantitative Easing program. Due to the political quarrels between Member States, the ECB was late to saving the Euro Area and late to the QE-party that followed and drove up asset prices.
From the point of view of an individual Member State of the Euro Area, the question arises what it can do in case of a speculative attack against its government bonds when the central bank is unwilling to guarantee the value of the country’s government bonds? This situation is special to the Euro Area where Member States‘ central bank are unable to conduct sovereign monetary policy. With an unwilling or even politically hostile joint central bank, how much leeway does an individual Member State have during or on the eve of a speculative attack against its government bonds?
I explore a specific aspect of this question, namely the option of founding a public bank in such a Member State. This bank has access to ECB financing (just like a regular bank) and may use it to refinance governments bonds and thus influence their price to limit a collapse in their value. While the system could work in principle, there is a caveat. The rules governing the constitution of the ECB lead to the unavoidable fact that the ECB always has the last say about money creation in the Eurozone. Nevertheless, a slight change of the rules could enable a productive financing system for governments that is more restrictive and better targeted than the current quantitative easing.