ECB Monetary Policy and Euro Area Governance: Collateral Eligibility Criteria for Sovereign Debt

Abstract

Since the beginning of the crisis, euro area governments have experienced greater fiscal stress than governments of advanced economies outside the euro area with weaker fiscal fundamentals. What has been the source of this fragility and how can it be corrected? The cause of the instability in euro area government bond markets can be traced to a discretionary decision taken by the ECB in 2005, in the aftermath of the failure of the Stability and Growth Pact. The decision effectively delegated the determination of collateral eligibility of euro area government debt to private credit rating agencies and eventually compromised the safe asset status of government debt for most member states. This paper examines how the ECB inadvertently planted the seeds of the euro crisis and discusses how the resulting tensions can be reversed.

Keywords: ECB, collateral eligibility, sovereign debt, euro crisis, credit ratings, cliff effect

JEL Classification: E52, E58, E61, G12, H63