Eurozone: welcome to your currency board future

Citi’s Chief Economist Willem Buiter spent some time with FT Alphaville explaining why he believes Draghi’s concession on profit and loss sharing among ECB member national central banks turns, in all likelihood, the single monetary unit into nothing more than a glorified currency board.

Quick background: The ECB’s profit-and-loss sharing mechanism became a key negotiating point ahead of European QE. For the Bundesbank, QE was only viable if NCBs assumed most of the responsibility for losses on assets they brought into the consolidated balance sheet. In the end Draghi acquiesced by reducing risk-sharing to only 20 per cent of assets.

A currency board works by pegging liabilities (central bank reserves and currency) to an exchange rate target, rather than a CPI or employment target. The monetary authority managing the board achieves the target by ensuring all commercial entities served by the system can convert the authority’s liabilities into foreign currency at any point. In short, there’s a guaranteed FX convertibility promise at the central bank.