The Bundesbank is right to remind us that the unprecedented monetary accommodation in the eurozone has produced undesirable side effects. In particular, the policy has reduced the pressure on politicians to pursue speedy budgetary consolidation and to implement structural reforms. In the summer of 2011, for instance, as soon as the European Central Bank intervened to purchase Italian and Spanish government bonds through the Securities Market Programme and the spread on interest rates decreased, the commitments made earlier by those two governments began to be diluted. The same thing happened two years later, after the announcement of the Outright Monetary Transaction by the ECB contributed to sharply reduced market tensions, but also structural reforms.
It is not clear, however, whether or how central banks should incorporate these effects into their own policy frameworks. In other words, should central banks try to calibrate monetary policy – in particular, by being tighter than would otherwise be the case – with a view to keeping a tight leash on governments and inducing them to play their own part? There may be some good reasons for doing so but on balance it would be a serious mistake. Here are several reasons why. Continue reading »