Why European repo policy is a cause of Europe's fiscal problems

From “Europe on the Brink,” Simon Johnson and Peter Boone, Peterson Institute for International Economics, July 2011

“Key rules regarding money creation in the euro area explain the current dangerous situation. Since its founding, the European Central Bank has used repurchase operations as a major tool of monetary policy. In practice, this means that the 7,856 banks (monetary financial institutions at the end of 2010) in the euro area are able to buy sovereign debt of any euro area member nation and then present these to national central banks, which act on behalf of the ECB, as collateral for new finance.

The ECB set collateral rules that made short–term paper more attractive than long–term paper (Buiter and Sibert 2005, 7-14). Initially the Bank also treated all nations equally, regardless of credit ratings. Later it adjusted collateral require- ments for nations to reflect their credit ratings, although these adjustments were minor.”

More at http://www.iie.com/publications/pb/pb11-13.pdf

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