Monetary Policy Stretched to the Limit: How Could Governments Support the European Central Bank?

New-style central banking in many advanced economies, involving the use of unconventional monetary policy instruments and forward guidance at the effective lower bound for interest rates, has raised questions about the appropriate role of fiscal policy – also in the euro area, where a fiscal counterpart to the European Central Bank (ECB) and the Eurosystem is missing. This paper considers three areas where euro area governments could act as the ‘joint sovereign’ behind the euro and support the ECB in its task of maintaining price stability, staying within the boundaries of the Maastricht Treaty. First, member countries could coordinate a growth-friendly aggregate economic policy mix that is supportive of the single monetary policy, with the help of a central fiscal capacity subject to common decision-making. Second, they could introduce a safe sovereign asset for the eurozone without assuming common liability in order to anchor financial integration and facilitate monetary policy implementation. Third, the significant benefits for the Eurosystem from a lower burden on monetary policy and a reduced exposure to sovereign risk could make it acceptable for euro area governments to indemnify it against potential large losses on its much expanded balance sheet. The fundamental solution, however, lies in advancing with fiscal integration to address the ‘institutional loneliness’ of the Eurosystem with full respect for its independent status.