Friday, April 6, 2012

The ECB has completely lost control over the monetary policy for Greece

The Bank of Greece balance sheet has expanded sharply this year. This of course is part of the ECB's balance sheet expansion on a consolidated basis. But the Greek central bank's balance sheet by itself is now almost €200 billion. That's an unprecedented amount for Greece and represents over 65% of the nation's annual GDP. It is also close to a 50% increase year-over-year.

Bank of Greece balance sheet ( €mm, source: BoG)

One would expect at least some impact on the monetary aggregates from such a dramatic expansion. Yet the money supply measures, both narrow and broad have collapsed. We've seen this before with other periphery nations such as Italy. But nothing on this magnitude.

Greece contribution to Eurozone's money stock year-over-year growth (source: BOG)

This trend shows a massive drain of liquidity out of the system that will result in a total seizure of credit. How can the ECB claim any control over the monetary policy when a 50% increase in the Greek central bank's balance sheet results in a 16% decline in M1 and nearly a 20% decline in M3 money stock?  Greece is now in a  permanent state of extraordinarily tight monetary conditions no matter what the central bank does. In such an environment there is absolutely no hope for any growth, let alone fiscal consolidation. It seems the only possible solution for Greece may be to take control of its own monetary policy, which would require abandoning the euro. An ugly outcome, but given the ECB's inability to stabilize Greece's rapidly shrinking money supply, there may be little choice.

Update: see some insightful comments below from Kostas Kalevras on the topic.
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