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Gergő Motyovszki

@motyo6

, 9 tweets, 4 min read

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@ecb

@ecb

A. Orphanides has long been warning about the @ecb using external private credit rating agencies to determine collateral eligibility of € gov debt. Will this finally be changed, or is the Italian banking system really at S&P's mercy at the end of April?
voxeu.org/article/how-ec…

A potential downgrade of Italian sovereign debt would entail the ECB not accepting it as collateral any more in its normal monetary operations with banks. A large amount of IT gov debt is hold by IT banks, whose access to ECB liquidity would be curtailed, leaving only ELA.

Evaporating demand from banks would also put IT gov bond markets under stress. Thus, the problem under the current system is that market based assessments of debt-sustainability can be self-fulfilling, and might give rise to multiple equilibria.

A country with its own currency can avoid these self-fulfilling sovereign defaults only if the central bank guarantees the safe asset status of its bonds - not just by providing a monetary backstop and being a LOLR for the gov, but also by accepting them from banks as collateral.

The ECB should reclaim its discretion over deciding collateral eligibility of sovereign debt and, instead of using it as a fiscal disciplining device, rule out self-fulfilling market dynamics.

Further details in this paper of #Orphanides:
papers.ssrn.com/sol3/papers.cf…

And also here:
papers.ssrn.com/sol3/papers.cf…

Also: letting IT gov debt lose its collateral eligibility status is inconsistent with the monetary backstop role the ECB is (thankfully) fulfilling as buyer of last resort for gov bonds via OMT and PEPP, and it would put a much larger burden on those programs to contain IT spread

@gregclaeys

@gregclaeys