Governments around the world have turned on the taps to deal with the pandemic, so far spending about US$14-trillion to help their citizens weather the economic consequences of COVID-19. Much of this spending has been financed by new debt that has gone on to be purchased by central banks, in what has seemed like a painless process; even the most indebted countries, such as Italy, have had no trouble borrowing money, thanks to expansive monetary policies that have seen central banks buy up government bonds soon after they hit the market.
More than one-third of all bonds issued by the government of Canada are now owned by the Bank of Canada, up from one-fifth before the pandemic. Over all, the central bank’s holdings of federal bonds have surged to $320-billion, from about $120-billion before it committed to weekly bond purchases last March, under a program known as quantitative easing, or QE. Those purchases have made it exceptionally easy for Ottawa to borrow record amounts of money.
The story is much the same in the United States and Europe, where the central banks have also been hoovering up government bonds. The U.S. Federal Reserve has increased its holdings of Treasury bonds and other government debt instruments by US$2.7-trillion since last March. The European Central Bank has bought up more than €800-billion ($1.24-trillion) since the pandemic began, bringing its total holdings of government debt issued by euro zone countries to about €2.5-trillion, or around 25 per cent of all such debt.
In theory, these central bank bond-buying programs are supposed to be only temporary. Bank of Canada officials have insisted that the federal government must reimburse it when the bonds it holds come due. The dollars created out of thin air would then be cancelled, preventing a permanent increase in the money supply that could lead to higher inflation. In reality, it may not work that way.
To retire the debt held by the central bank, the federal government would need to borrow from investors on the open market. Indeed, without dramatically raising taxes or cutting spending, Ottawa is expected to run large deficits for years to come, requiring it to borrow to finance new spending and to roll over existing debt.
More than 100 European economists on the left insist they have a better idea. Instead of forcing euro zone governments to repay the bonds held by the ECB, the central bank should just cancel them. That’s right – they say the ECB should wipe the slate clean so that governments can emerge from the pandemic freed of debt obligations in order to pursue a green recovery.
“Our solution is therefore simple: Let’s make a deal between the European states and the ECB,” the group that includes noted French economist Thomas Piketty wrote last week in an op-ed published in several leading European newspapers. “Let it cancel the debts that it holds (or transform them into perpetual debts with 0-per-cent interest rate) and let the European states commit the same amount to a widespread social and ecological recovery plan.”
The group has found plenty of support among left-leaning European politicians. Its suggestions echo those Riccardo Fraccaro, an aide to former Italian prime minister Giuseppe Conte, who in November called on the ECB to cancel “sovereign bonds bought during the pandemic or perpetually [extend] their maturity.” Italy’s sovereign debt is set to surpass 160 per cent of gross domestic product this year, but its government has been able to borrow at interest rates of just 0.6 per cent, largely because of the ECB’s massive bond purchases.
ECB president Christine Lagarde wasted no time shooting down Prof. Piketty’s idea, describing it as “inconceivable.” In an interview with France’s Journal du Dimanche, she said cancelling the debt “would be in violation of the [European Union] treaty which strictly prohibits monetary financing.”
In their op-ed, however, Prof. Piketty and his co-signatories argued that some monetary purists argued that QE also violated EU treaties when the ECB began its bond-buying program more than five years ago. “Let us not be distracted by legal fallacies; in the end only political will matters,” they wrote. “And history has shown countless times that petty legal issues fade away in front of robust political deals.”
Similar arguments have emerged on this side of the Atlantic as progressive economists worry that pandemic debts will hamstring governments in Canada and the United States for years to come. After all, debt cancellation sounds so much more palatable than austerity, doesn’t it?
QE was always bound to lead us to this place. The everlasting appeal of the free lunch lives on. But sooner or later, someone – or some generation – has to foot the bill.
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