Fiscal Policy under Low Interest Rates by Olivier Blanchard

Author:Olivier Blanchard
Language: eng
Format: epub
Publisher: The MIT Press

Should Central Banks Write Off Their Holdings of Government Bonds?

As debt levels have increased, some have argued that central banks should simply write off their holdings of government bonds to give governments more fiscal space.39 I have argued earlier that there was a lot of remaining fiscal space, so there was no need for any kind of write-off at this point; but leaving this argument aside, this particular type of write-off would not achieve what its proponents believe.

The proposition is that the cancellation of the bonds held by the central bank would decrease the amount of interest payments and thus the debt service of governments. And indeed, it would. But it would have another effect—namely, to decrease the revenues of the central bank and thus the profits that the central bank turns in to the government. This second effect would be exactly of the same size as the first, and the net effect on the government budget constraint would be equal to zero.

Another way of stating the same conclusion is to look at the operation from the viewpoint of private investors. From their viewpoint, this is just an exchange of claims between the government and the central bank. The central bank gives up claims on the government; the government gives up claims on central bank profits. This has no implication for private investors. (Some proponents have argued that the decrease in the reported official debt of the central government—which indeed would happen—would lead investors and rating agencies to see this as an improvement and thus increase fiscal space. This is assuming too much stupidity on the part of investors.)

While the write-off has no direct effects, it is likely to have adverse political effects. As a signal, it may lead investors to question the central bank’s independence. And given the size of most central bank balance sheets, the cancellation of claims on the government is likely to lead to a negative balance sheet for the central bank. As I discussed earlier, while this is of no economic relevance, it may make it more difficult for the central bank to keep its independence vis-à-vis the government, leading to a higher probability of fiscal dominance. It is to be avoided.

A final remark about the ECB (as this is the context in which the French discussion has taken place). Because the ECB is not a national bank, cancellation of government bonds of one member country would indeed improve the fiscal situation of that country. The reason is that, given that ECB profits are distributed among all member countries (in proportion to their capital key), the decrease in profits for the country whose debt is written off will be much smaller than the decrease in its debt. In effect, the cancellation will lead to a transfer from all member countries to the country in question. This shows, however, the limits of the argument: It is very unlikely that other members will agree to it. And if the debt is canceled in the same proportion for

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