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German central bank says promissory note deal is 'problematic'

In its monthly report the Bundesbank says the deal illustrates problematic overlaps between fiscal and monetary policy.

Bundesbank governor Jens Weidmann, pictured with chancellor Angela Merkel last year.
Bundesbank governor Jens Weidmann, pictured with chancellor Angela Merkel last year.
Image: Michael Sohn/AP

GERMANY’S CENTRAL BANK has voiced its reservations about the deal to scrap Ireland’s promissory notes and replace them with long-term government bonds – theorising that the move may fall foul of European law.

In its monthly report for February, released today, the Bundesbank expresses unease at the way in which Ireland negotiated its way out of its promissory note burden – by liquidating IBRC so that the Irish Central Bank owned the promissory notes, and then agreeing a deal with the Irish bank to swap the notes for bonds.

This meant the European Central Bank was not ultimately needed – and allowed the Irish government to agree an arrangement with the Central Bank of Ireland which helped it to avoid the burdensome €3.1 billion annual repayments.

“The Irish central bank k ultimately pays interest on the new bonds to the rest of the Eurosystem at the main refinancing rate,” which currently at 0.75 per cent, “while the Irish government’s interest payments are collected as net income by the Irish central bank,” the monthly report notes.

This ultimately cuts the cost for the Irish government, however, as any profits accumulated by the Central Bank of Ireland are forwarded to the Exchequer at the end of the year.

The Irish government therefore effectively only pays an effective interest rate of 0.75 per cent on its government bonds for as long as the Central Bank of Ireland is their owner.

Though this could rise when the Central Bank sells the bonds on the public market, the sale of the bonds would also end up counting towards Central Bank profit – with the money from the sale also then returned to the taxpayer.

Blurring the lines

The Bundesbank sees the deal as blurring the lines between the roles of governments and central banks – with the latter, it believes, supposed to focus only on ensuring the availability of money but not to help governments out of difficult financial territory.

“This approach underlines the increasingly close and problematic ties between monetary and fiscal policy in the European monetary union,” the bulletin says, asserting:

Responsibility for providing any assistance to individual member states in servicing their sovereign debts should lie with the European Stability Mechanism (ESM), which was established for this purpose.

In other words, the bank believes that governments struggling to keep up with their financial obligations should not be helped out by central banks, but should instead have to turn to the Eurozone’s bailout fund for assistance.

Banks barred from funding governments

The EU’s founding treaties explicitly forbid central banks from printing new money and giving it directly to governments to help them out with running their countries. While the Irish arrangement did not result in the creation of new money, it did allow the Irish government to reschedule the repayments.

Bundesbank governor Jens Weidmann sits on the ECB’s Governing Council, which unanimously “took note” of the Irish arrangement at its meeting two weeks ago.

The ECB’s decision not to stand in the way of the deal suggested there was little agreement with the German bank’s argument that the Irish deal may have come close to breaching the European treaty.

Because Central Banks are governed and managed independently of national governments, it is unlikely that the Bundesbank’s reservations may be passed on to Germany’s finance minister Wolfgang Schauble for him to raise among his EU counterparts.

Aside from requiring some political liaison between the Bundesbank and the German government – which is precisely what the Bundesbank has opposed – it would also mean Schauble would have to raise questions about the Irish deal at ‘Ecofin’ meetings of the EU’s finance ministers, which are currently chaired by Michael Noonan.

Speaking on The Week in Politics yesterday, junior finance minister Brian Hayes played down the prospect of the Irish deal being unwound or reversed – saying the deal was “solid” and suggestions to the contrary were “fanciful”.

Column: Promissory note deal savings should be spent on relieving youth unemployment

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About the author:

Gavan Reilly

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