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ECB must become lender of last resort, says Nobel laureate Krugman

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  • ECB must become lender of last resort, says Nobel laureate Krugman

GLOBAL - The European Central Bank (ECB) must become lender of last resort and adopt a more tolerant attitude to inflation if it hopes to improve the economic situation within the euro-zone, Nobel laureate Paul Krugman has argued.

Addressing delegates at the Union Investment Risk Management conference in Mayence yesterday, Krugman also said the UK should be facing greater difficulties than Spain - but that the Mediterranean country was suffering due to its membership in the single currency.

The Princeton University lecturer also debated the fate of the euro-zone with Otmar Issing, former member of the ECB executive board.

Issing was critical of several points raised by Krugman, who likened the role the ECB should assume to that of the US Federal Reserve (Fed) or the Bank of England (BoE).

"The comparison is, for me, somewhat misleading," the German economist said. "The Fed is not buying the bonds of Florida or California, the Fed is buying bonds for the US Treasury.

"You ask that the ECB should do the same, but we don't have Eurobonds. Hopefully, we will not get them."

The sentiment was shared by conference attendees - around 300 largely German investors representing €500bn in assets - who, when asked if they supported the notion of Eurobonds, rejected it with a 79.4% majority.

The overwhelming majority - 94.4% - also agreed that improved fiscal discipline of government budgets was the best way to address deficits, rather than attempting to increase economic output through higher levels of spending.

However, Krugman insisted that countries were in crisis independent of their debt level, saying that comparing the UK and Spain should leave the former in a worse situation than the euro-zone member.

"What we need to understand here is that, while this is a sovereign debt crisis, it's an oddly asymmetric one," he said. "You cannot predict who's in trouble by looking at debt levels of even debt projections."

He referenced a fellow academic's work comparing Spain and the UK's 2010 debt levels and their predicted debt over the next few years.

"The UK is in worse shape - and that is despite Cameron's austerity stuff," he said in reference to prime minister David Cameron's reduction in government spending since he came to power in May last year.

Krugman said this view was not reflected in the government's individual bond rates - moving in opposite directions over the past few months whenever a market shock occurred.

He further argued that the crisis was the result of lack of consideration about the impact of a liquidity shortage and the absence of a lender of last resort within the euro-zone - unlike the manner in which the BoE, Fed or the Bank of Japan can counteract such fears.

The academic later told attendees: "Not only does the ECB have to accept and take on the role of lender of last resort, but it also has to be more tolerant of inflation."

He argued that one way out of the current crisis would be for wages in peripheral euro-zone states to be eroded through inflation, but for this to happen, a central banker with a mindset similar to that of BoE governor Mervyn King would need to prevail - supplanting the ECB's current cautious approach to inflation.

Monthly euro-zone inflation in September was an atypically high 3%, while the lower of the two UK indices stood at 5.2% during the same month.

In absence of either the introduction of a lender of last resort or higher inflation, leaders solving the crisis would be faced with an irresistible force meeting an immovable object, Krugman said.

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