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Home Publications Blogs Beat the Press The European Central Bank: The Main Cause of the Debt Crisis

The European Central Bank: The Main Cause of the Debt Crisis

Thursday, 04 August 2011 04:43

The Post forgot to mention the role of the European Central Bank (ECB) in worsening the European debt crisis. The original crisis stemmed from the failure of the ECB to notice and respond to the huge housing bubbles that were driving the economies of countries like Spain and Ireland.Instead, it allowed these bubbles to grow to sizes where their collapse would inevitably sink the economy.

However, the ECB has compounded this damage by its limited response the downturn. It never pushed its overnight money rate below 1.0 percent, in contrast to the zero rate at the Fed. It also was more cautious in it quantitative easing policy and now is actually raising rates, ostensibly because it fears inflation.

Higher interest rates will worsen the debt situation for two reasons. First, it will tend to put upward pressure on the interest rates that countries must pay on their debt. Second, it will slow growth. Slower growth will mean reduced tax revenues for debt burdened countries and higher payments for unemployment insurance and other benefits.

Anyone reporting on the course of the debt crisis of the Euro zone countries has to give the ECB a starring role.

Comments (1)Add Comment
Interest rate adjustments are a farce.
written by Ralph Musgrave, August 05, 2011 2:04

Dean Baker highlights the excessive loan funded property boom in PIG countries, and then advocates reduced interest rates as a cure for the recession. Well low interest rates will just encourage more loan funded property speculation relative to other forms of economic activity!

There is a fundamental flaw in conventional economics here, which Dean goes along with, namely that interest rate adjustments are a good way of adjusting demand, inflation, and so on.

The rate of interest is the price of borrowed money, and that price should be determined by market forces: governments should keep their noses out of it. Where a governments / central banks want to raise demand, they should feed more money into household pockets. “Money”: that’s the stuff that enables people to “demand” more goods and services.

Conversely, if inflation looms and demand needs reducing, government can raise taxes and rein in money.

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About Beat the Press

Dean Baker is co-director of the Center for Economic and Policy Research in Washington, D.C. He is the author of several books, his latest being The End of Loser Liberalism: Making Markets Progressive. Read more about Dean.