The Lender of Last Resort: Is There a Role for the ECB?

5 Introduction Since the end of 2009 the European Union has been facing an emergency situation. Following the outbreak of the Greek Debt crisis, fears that it will rapidly evolve into a Eurozone debt crisis developed among investors fostered by a wave of downgrades by credit rating agencies. The origin of the debt problem varied across countries. In nations like Greece and Portugal, unsustainable public sector wage and pension commitments drove the debt to unsustainable levels; in Ireland and Spain, private debts arising from a property bubble were transferred to sovereign debt as a result of banks’ bailouts. Although investors’ concerns might well be rooted into fundamentals, it is worth noting that States outside the Eurozone with an analogous – and in some cases worse – debt situation, like the United Kingdom, Japan and the United States were not hit by the market distrust. Two of the most suggestive explanations of this different market sentiment are put forth by De Grauwe (2011) and Wyplosz (2012). The first argues that the structure of the Eurozone as a monetary union without a common fiscal system contributed to the crisis and harmed the ability of European leaders to respond; Euro area States cannot control the currency in which their debt is denominated, and are de facto downgraded to the status of emerging economies, lacking the possibility of providing liquidity to avoid default in case of a loss of confidence by the market. The second – but De Grauwe too – denounces a peculiar difference between the Eurozone and the other countries: the absence of a lender of last resort; an authority with potentially unlimited liquidity which stands guarantor for the borrowers with the ultimate intent of avoiding a collapse of the financial system. So far, the European Central Bank has refused this role and this thesis focuses on the possibility to become such a lender in the future. In particular, this dissertation tries to provide all the instruments for a deep and clear analysis of the theoretical assumptions and the practical implications of the role of lender of last resort.