Asia Pacific
China and India: Strategies for Sustainable Growth
January 20, 2012

By Chetan Ahya, Derrick Kam & Jenny Zheng | Singapore

Backdrop: Have Both Nations Been Living on Borrowed Growth for Too Long?

Following the credit crisis, both China and India relied on aggressive tactical measures to revive growth quickly. Given the pace at which the external environment was deteriorating then, policy-makers in both China and India had to act quickly and decisively to boost domestic demand.

•           Specifically, in China, the key driver of domestic demand was an aggressive credit expansion - close to a 30pp rise in the ratio of bank loans to GDP (excluding non-bank loan lending by banks), in addition to some support from the expansion in the government's budget deficit. Bank loans to GDP has been maintained at these high levels of close to 130% until recently.

•           In India, the biggest driver was the doubling of the national fiscal deficit - from 4.8% of GDP in the year ending March 2008 to 10% in the year ending March 2009. By our estimates, the national deficit is likely to be 9.2% for the year ended March 2012 - implying that the government has now maintained this expansionary fiscal policy for four years in a row.

China's Fetish for Investment, India's for Consumption

As growth began to slip immediately after the credit crisis, China focused on supporting investment with the large rise in the ratio of bank loans to GDP. India focused on supporting strong consumption (particularly rural consumption) growth with its major fiscal stimulus. These stimulus measures were largely instrumental in helping China and India to recover quickly from the global recession. Indeed, this counter-cyclical response - a rise in bank loans in China and fiscal expansion in India, respectively - had also been employed during the 2001 US recession and global growth slowdown.

Macro Stability Risks - Only Symptoms of Low Productivity Dynamic

The stimulus measures helped to boost growth quickly - but they also brought macro stability risks. A major rise in property prices, inflation pressures and banking sector asset quality issues - symptoms which surfaced in China and India over the course of 2010-11 - are only a reflection of the low productivity dynamic of growth driven by tactical stimulus, in our view.

We believe that the aggressive policy stimulus was not based on what was truly needed for achieving a sustained growth trend in these countries. Rather, the stimulus measures were based on what both governments could do best in that short period in response to the sudden growth shock on account of the credit crisis. Given the sharp and rapid pace of the deterioration in growth conditions, we believe one can hardly question this move at the time the credit crisis was unfolding.

However, persistent reliance on tactical measures for such a long period (September 2008 to late 2010) was at the heart of the emergence of these symptoms of macro stability risks.

Deleveraging in DM - A Reminder to China and India

Following the 2001-02 global slowdown, low real interest rates and the rise in leverage in the US and Europe had supported strong growth in their domestic demand and overall GDP growth.

•           The expansion in US/European domestic demand meant that China benefited from strong growth in exports... In China, net exports contributed an average of 1.9pp to overall GDP growth of 12.1% between 2004-07. Strong growth in investment aimed at building capacity to feed exports demand was the other key anchor of GDP growth.

•           ...while the low real interest rate environment meant that India (along with many other emerging markets) gained from a major rise in capital inflows. For India, the sharp rise in capital inflows over F2005-08 meant that real interest rates declined to average just 2.1% even as GDP growth averaged 9.0%, led by strong growth in private investment.

We believe that this extremely favourable global environment, apart from structural domestic factors in both countries, played a big role during the 2003-07 period in lifting growth rates for China and India.

However, the credit crisis and the subsequent deleveraging in US and Europe have disrupted this benign global environment that had benefited China and India. We saw a short period of revival in exports and capital inflows into the region over the course of 2010-11, but the emergence of sovereign concerns in the developed world has again reminded us about the sustainability of these two drivers. Considering the major structural challenges that the developed world now faces, the external environment will likely be less benign than in 2004-07 - suggesting that policy-makers in China and India will have to seek sustainable sources for domestic demand engines of growth for their respective economies.

Growth Is Slowing Again

After recovering strongly from the credit crisis, growth in China and India is slowing again. The emergence of macro stability risks forced policy-makers to tighten monetary and fiscal policy to control domestic demand.

•           In China, tighter monetary conditions and the gradual withdrawal of fiscal incentives have curtailed domestic demand.

•           India is seeing a broad-based slowdown in domestic demand. Persistently high inflation has eroded purchasing power and has forced the government to slow down its expenditure growth, the major driver of rural consumption.

Just as domestic demand had begun to slow, external demand conditions turned less supportive as the sovereign debt situation in Europe intensified during the summer of 2011. Export growth for the region weakened; sequential growth (seasonally adjusted) had averaged close to zero since March 2011.

Moreover, the risks to the growth outlook for both China and India are skewed to the downside, in line with our global team's view on Europe and the US. Barring a quick recovery in the developed world, the external environment could again be a drag on the region's growth outlook.

Aggressive Tactical Easing Is Not an Option

We believe that there is growing recognition among policy-makers that the low productivity dynamic of growth driven by tactical stimulus had resulted in the emergence of macro stability risks. As such, if economic conditions evolve in line with our base case outlook, we do not expect policy-makers to engage the same old aggressive policy response, as it would quickly revive the macro stability risks. We do expect some policy easing in China and India, but the policy response would likely be less aggressive than in 2008-09.

In China, we expect policy-makers to proceed with further policy easing to cushion the moderation in growth. We believe that the PBoC will favour quantitative adjustment through RRR cuts, open market operations (OMO) and window guidance, while keeping the policy rate unchanged for now.

In India, we expect the RBI to initiate policy rate cuts by March-April 2012 when inflationary pressures start softening, delivering a cumulative 100bp cut in policy rates in 2012.  The RBI would also likely continue to inject liquidity via open market operations and/or via a reduction in CRR to prevent a sharp rise in inter-bank rates.

What Would Help Revive it on a Sustainable Basis?

Investors remain focused on the next round of tactical responses - but we believe it is essential to watch the efforts from policy-makers in China and India to revive domestic demand in a sustainable manner through strategic policy responses. We would also highlight that the source of domestic demand growth matters as well.

In this context, we believe that China should tilt the balance towards boosting consumption growth - while India needs to focus on lifting investment.

China Needs to Move Towards Higher-Value-Added Economic Activities, Boost Private Consumption

In China, a number of structural impediments have held back private consumption growth:

1)         Surplus labour in preceding years, as reflected in relatively low wage growth, has meant that a larger incremental share of income has been allocated to corporates rather than households. Hence, the growth in private consumption was held back by the relatively weaker growth in disposable incomes.

2)         There has been a lack of a comprehensive social security system and access to public healthcare, housing and education, particularly for migrant residents. This has fostered a strong desire to hold a high level of precautionary household savings.

3)         Until the late 1990s, China had several restrictions on ownership of private property. As a result, a large proportion of lower- and middle-income households were not able to tap the private housing market and thus experienced a lack of security on that front.

Hence, to address these impediments, we believe that China needs to initiate structural reforms: The ultimate goals: to transition towards higher value-added economic activities, to accelerate fiscal transfers towards social security, and to boost private consumption.

First, a sustainable rise in household disposable incomes (wages) would help to support consumption growth.

In this context, the government has been addressing this issue by steadily raising minimum wages. Indeed, in 2011, minimum wages have risen by an average of 22.0% in 22 of China's 31 provincial-level regions. Some provinces have already announced further plans to hike minimum wages in 2012. The government, in its 12th Five-Year Plan, has also set out to lift household disposable incomes (wages) at a pace that at least matches the nominal GDP growth.

We believe that demographic changes will mean that market forces will also warrant this rise in wage growth. According to UN projections, 18 million people will be added to China's working age population over the next decade, one-sixth of what it was in the last decade.

•           These significant demographic changes indicate that the social objectives (economic welfare) are changing from aggressive employment creation (creating enough jobs to absorb the rise in working age population) ...

•           ...to employment enhancement (moving employed workers up the value chain, thereby giving them the opportunity to earn higher wages).

Moreover, the CAGR in number of new graduates has been 21% over 2001-10, rising from 2.0 million in 2001 to 7.7 million in 2010. The rising number of graduates from higher education institutes will mean that the economy will need to generate higher value-added jobs to ensure that their skill sets will be fully utilised.

In order to move up the value chain, the government would need to reorient manufacturing investment towards higher value-added manufacturing. In its 12th Five-Year Plan, the government plans to raise the strategic emerging industries' share of GDP from 4% in 2010 to 8% in 2015. These industries include high-end equipment manufacturing, next-generation information technology, biotechnology and environmental protection (including alternative energy).

Moreover, the production structure of the Chinese economy is likely to shift gradually towards the services (tertiary) sector as the economy continues to mature in its developmental stage.

This process of industrial upgrading and movement towards the tertiary sector will likely bring with it more job opportunities which will be higher value-added in nature - thereby allowing for a virtuous cycle of sustainable growth in disposable incomes and therefore consumption growth.

Second, to address the issue of improving social security, the government could push for affordable social housing.

This would boost investment in the near term but would ultimately boost consumption, as households feel more secure. The government has announced plans to construct 36 million units of social housing from 2011-15. We believe that the government will likely accelerate its efforts to ensure that the construction of social housing projects proceeds smoothly and is completed as scheduled. The government has announced measures to ease the financial constraints of the local government financing vehicles, thereby indirectly supporting the construction of social housing.

Third, we believe that the government will work to extend the provision of social services such as public education, healthcare and housing for more residents.

This, we believe, will be the key to improving social security and will also free up disposable income for consumption of other goods and services. In this context, one of the possible measures that the government could consider is allowing the registration of migrant urban residents in a phased manner. According to the National Bureau of Statistics of China, as of 2011, 230 million residents are not registered under the hukou system in the city where they are currently residing. Registration of these residents would give them access to the above-mentioned social services of public education, healthcare and housing.

We believe that the goal of boosting household incomes to raise consumption will serve as a strategic complement to accelerate growth in the services sector, thereby raising the opportunity for higher value-added jobs.

We believe that fiscal policy is likely to play an important role in supporting this transition towards domestic demand. Indeed, China's government balance sheet is in a strong position to provide this support. The government's fiscal position, as measured both in terms of its fiscal deficit and public debt to GDP trend, has more than adequate room to play this constructive role. The government could thus increase its social spending and initiate tax reforms to lower the tax burden of households to boost consumption.

India: Revival in Investment Is the Key to Recovery in Growth

In India, structural measures are needed to help boost private investment. India will continue to have strong support from favourable demographic trends, as the age dependency ratio (proportion of non-working age population to working age population) will continue improving until 2040, according to UN projections.

This warrants a rise in investment to GDP, which would help to generate productive capacity, and is crucial to kick-start a virtuous cycle of faster growth in productive job creation - income growth - savings - investments - higher growth, without a rise in inflation challenges.

Unfortunately, investment sentiment in corporate India has remained weak... Currently, from an entrepreneur's perspective, several factors are adversely affecting corporate confidence:

1)         The slowdown in domestic demand growth;

2)         Weak global economy and slowing export growth;

3)         Weak global capital markets;

4)         Relatively high global commodity prices in rupee terms hurting margins;

5)         Slowing pace of execution by government machinery;

6)         Corruption-related investigations.

...and the government has little fiscal room for manoeuvre: Moreover, the already high starting point of the fiscal deficit (9.2% of GDP) implies that the government has very little room to pursue an expansionary fiscal policy to boost public investment.

Credit policy isn't enough on its own: We expect the RBI to start cutting policy rates from Mar-April 2012 onwards and cumulatively cut policy rates by 100bp during 2012 to 7.5%. Still, interest rate cuts are unlikely to be a sufficient driver to kick-start the investment cycle, in our view. Indeed, private investment has slowed even though real interest rates remain negative. As inflation moderates, real interest rates will need to be high for some time to ensure that India lifts savings enough to fund the eventual rise in investment.

We acknowledge that reviving capex in a counter-cyclical manner will not be easy: A typical capex recovery cycle involves cyclical policy stimulus reviving domestic demand (particularly consumption) and growth confidence. This is then followed by a gradual pick-up in private investment. However, with limited scope for cyclical policy stimulus this time and an otherwise adverse macro environment, we believe that reviving the investment cycle quickly will be challenging.

In our view, two key factors can help support the investment and therefore GDP growth recovery:

(a) Global capital markets: Global capital markets weigh on capital inflows into India and also tend to influence the risk appetite in the domestic markets. This factor is particularly important for India, because its corporate sector's investment funding is more dependent on capital markets compared to bank credit. Moreover, businesses of many of the companies are now linked to the global economy and their investment decisions are dependent on the global economic outlook.

Considering that the developed world is facing major structural challenges, support from the global economy and capital markets may not be forthcoming. Hence, to support investment growth, the government needs to focus on policy reforms to get the productive dynamic back, in our view.

(b) Government policy action: If global support is less forthcoming, we believe that the only way to revive investment will be a ‘campaign-style' effort from the government which should include major policy reforms and a focused approach to speed up the execution machinery of the government.

Thus, the government could use a two-pronged strategy - first, speed up implementation of major policy reforms...

•·         Strengthen institutional capacity to allocate critical national resources (land, minerals) to the private corporate sector in a transparent manner for rapid industrialisation.

•·         Enact the Goods and Services Tax Act (GST; value-added tax).

•·         Strengthen institutional capacity to manage the awarding of major infrastructure projects through the public-private route, which should increase transparency.

•·         Build a comprehensive plan for energy security along with a systematic programme for energy pricing reform.

•·         Initiate aggressive fiscal consolidation which aims to reduce the national government deficit and improve the mix of its expenditure towards development spending.

•·         Take meaningful steps towards divestment of the government's stakes in SOEs.

•·         Accelerate infrastructure spending, particularly for power: The government needs to systematically address institutional capacity to sustain a steady rise in infrastructure spending.

...second, identify 25-30 core infrastructure and industrial projects - and fast-track them: The government could either take up projects already underway or encourage new ones that can be taken up for execution quickly to ensure that investment is revived in a more timely fashion. These projects could be those with limited call on land/mineral resources.

We believe that the government should focus in particular on infrastructure investment, which can be taken up in a counter-cyclical manner, because weak global sentiment could weigh on manufacturing investment. For instance, many Indian cities need a jump-start in critical urban infrastructure facilities. The central government could provide a capital grant of about US$10 billion to initiate projects worth US$40-50 billion. We understand that in many cases the plans for such infrastructure projects are ready - but need a determined push from the central government.

We believe that such measures could also give a strong boost to foreign investor sentiment and would help to revive capital inflows as investors look for strong growth opportunities in an otherwise gloomy global environment. Among the large economies in the world, India's structural growth story remains the most compelling, in our view. However, policy support would help to keep faith in this growth opportunity intact.

Macro Imperatives Will Likely Force the Much-Needed Transition, Pace Is an Issue

We believe that policy-makers in both China and India have indeed embraced the view that aggressive tactical easing will bring the same old macro stability risks. This is also reflected in their calibrated approach towards monetary easing thus far in this cycle. Encouragingly, policy-makers have been indicating that structural measures are needed to support domestic demand on a sustainable basis. Indeed, according to press reports (China Daily), Vice Premier Li Keqiang had emphasised that "more priorities should be given to the areas related to improving people's livelihood, so as to boost the domestic demand and consumption" and stressed that "more expenditures should be made in areas such as social security, education and healthcare".

Similarly in India, Prime Minister Manmohan Singh admitted that the government had taken "a conscious decision to allow a larger fiscal deficit in 2009-10 in order to tackle the global slowdown". He stressed, however, that "like other countries that resorted to this strategy, we have run out of space and must once again begin the process of fiscal consolidation". Finance Minister Pranab Mukherjee has also indicated that, in the context of reviving investment and growth, policy-makers will "have to be alert to shape the required policy responses, reform systems, improve the regulatory framework of our institutions to make the most of the opportunities coming our ways".

We believe that policy-makers in China could surprise with more meaningful strategic measures in 2012.

In India, we believe that a window of opportunity for acceleration in policy measures could arise after the state elections in March 2012.

Global
G3 Central Banks: Constitutional Questions
January 20, 2012

By Spyros Andreopoulos & Sung Woen Kang | London

Debt, deficits and deleveraging imply a new, post-Great Moderation economic landscape. In this changed landscape, at least some societies' preferences are likely to shift - probably towards higher inflation, as: (i) with anaemic growth, the willingness to sacrifice some of it in favour of lower inflation will be diminished, especially when (ii) inflation would help at least a little to erode private and public debt. In democracies, policy institutions and their actions tend to - and indeed should - follow societal preferences. Central banks may prove no exception. Despite formal independence, monetary authorities do not operate in a vacuum. Rather, an important question for investors is how robust central banks' institutional insulation will prove to be. These are not least constitutional questions - i.e., they go back to central banks' constitutions, or statutes. Here, we examine the constitutions of the three major DM central banks along four crucial dimensions: mandate; target; prohibition of direct monetary financing of the sovereign; and how the central bank constitution can be changed.

I. Mandate

Mandates are relatively similar in that they focus on "price stability". The more interesting question is whether there are objectives other than price stability, and the relationship between price stability and the other objectives - essentially, whether there is an implicit or explicit hierarchy of objectives.

The Fed's mandate is clearly dual as the Federal Reserve Act does not provide a hierarchy of the goals of "maximum employment [and] stable prices".

The ECB, on the other hand, is commonly thought of as having a single mandate - price stability. This strikes us as inaccurate, since the treaty does make reference to other objectives; these are, however, clearly subordinated to price stability: "The primary objective...shall be...price stability. Without prejudice to the objectives of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community" [our italics]. These objectives, in turn, are "sustainable and non-inflationary growth...[and a] high level of employment". We would thus classify the ECB's mandate as ‘conditional dual', to reflect the existence of a second mandate which, however, is clearly subordinate to the achievement of the price stability mandate.

The Bank of Japan's mandate is somewhat different. Our Japan Economics team translates Chapter 1, Article 2 of the Bank of Japan Act as follows: "The principle of the Bank of Japan in carrying out the control of monetary and currency policy will be to contribute to the sound development of the national economy through the pursuit of price stability." We would call this mandate ‘conditional single': while the bank is being instructed to contribute to the economy - "development" could even be construed as synonymous with "growth" - it is meant to do so through the pursuit of price stability alone, with no other means being considered.

Thus, the central bank that comes closest to a single mandate is actually not the ECB, but the BoJ.

II. Target

Taken literally, the "price stability" mentioned in all mandates could imply zero inflation if one interprets "stability" as constancy of a price index. In practice, however, no central bank operationalises "price stability" to mean zero inflation, whether officially or unofficially. Rather, it is usually specified as something at or somewhat below 2% on a preferred price index.

The Fed's target of 1.7-2.0% PCE inflation (price stability goal) and 5-6% unemployment (maximum employment goal) emerge from the "longer-run" FOMC forecasts for these magnitudes - there is no specific time horizon.

The ECB Governing Council's own quantitative definition of price stability is "below, but close" to 2% HICP inflation "over the medium term".

The Bank of Japan's "current understanding" implicitly defines price stability as "2% or lower, centering around 1%" - there is no concrete time horizon.

III. Prohibition of Direct Monetary Financing of Governments

Buying at auction prohibited... The prohibition to provide direct monetary financing for their governments - by which we mean buying at auction - is explicit in all of the above central banks' statutes. According to the Federal Reserve Act (section 14) "bonds...or other obligations...of the United States...may be bought...but only in the open market" [our italics]. For the ECB, Art. 123(1) of the TFEU specifies that "any...type of credit facility...in favour of Union...central governments...or...other public authorities...shall be prohibited, as shall the purchases directly from them by the ECB or NCBs of debt instruments" [our italics]. A similar prohibition for the Bank of Japan is contained in Article 5 of the Public Finance Law of Japan.

...but QE comes naturally: Note that secondary market purchases are not prohibited, as this is how modern central banks conduct monetary policy. This is less trivial than it sounds if seen in the context of QE. Since purchases of government paper on the open market are something that central banks do naturally in the course of conventional monetary policy, there is plenty of space within central bank statutes for QE. Put differently, conducting QE does not require a central bank to exploit any legal loophole.

Buying sovereign debt: ECB versus the others: To our economists' eyes, the prohibition to buy at auction expressed in the treaty does not seem more stringently worded than the one for the Fed, and in any case concerns primary market purchases of government debt. And yet, the ECB - or at least an important segment of the Governing Council - seems uncomfortable with secondary market purchases of eurozone government bonds. The FOMC, on the other hand, considers such purchases as a natural extension of the monetary policy arsenal.

We have three explanations - one institutional, one historical and one tactical - for this fundamental difference in the attitude to government debt purchases. First, it is in the nature of the ECB as a supranational institution to want to be further away from - and to be clearly seen to be further away from - governments than the Fed. Second, hyperinflation caused, literally, by money printing is part of the collective memory in Germany and partly explains the inflation aversion of the German public (see also The Global Monetary Analyst: The Deep Divide, June 1, 2011). Last but not least, the ECB - rightly, in our view - insists that the eurozone crisis requires a fundamental, i.e., a fiscal, solution. It therefore fears that by providing too much monetary relief (through, inter alia, government debt purchases) it will take the pressure away from European governments.

In this context, it is worth pointing out that QE through granting the ESM a banking licence would, in principle, be entirely compatible with the ECB Constitution. Article 123(2) of the TFEU exempts "publicly owned credit institutions" from the prohibition of monetary financing contained in Article 123(1). Being such a credit institution, a putative ESM bank would "in the context of the supply of reserves by central banks...be given the same treatment by national central banks and the ECB as private credit institutions" - that is, it would be able to exchange bonds for central bank money. However, it is exactly in this context that ECB Governing Council President Draghi recently stated that "there should be no monetary financing of governments" and that the ECB should "respect the spirit of the treaty" as well as the letter.

IV. Changing the Constitution

How high is the hurdle towards changing the statutes? Would governments be able to, for example, change the inflation target or remove the prohibition of direct monetary financing - and how quickly would they be able to do so? The highest practical hurdle is for the ECB "statute". By their very nature, intergovernmental treaties are the most difficult to change. As we know from current discussions around Europe's "fiscal compact", treaty change involves a process of ratification once it has been agreed by the heads of state. The treaty change would then need to pass individual countries' parliaments in all 27 EU countries - including the EMU outs - and/or be put to a referendum, depending on local provisions.

Changing the Federal Reserve Act would require a simple majority in both House and Senate. However, changes could be vetoed by the president, which would require two-thirds majorities in both chambers to override. In Japan, changing the relevant legislation for the BoJ would require a simple majority in both Houses; if the Upper House were to reject, a supermajority would be needed in the Lower House to override this rejection.

Reflections on the Lender of Last Resort for Sovereigns

Our analysis demonstrates that if lender of last resort (LOLR) is understood to mean the (legal) ability to buy at auction, then none of these central banks could be a LOLR as their constitution prohibits primary market purchases - so the ECB is not in a materially different position from, say, the Fed. Why, then, does the market seem to perceive such a difference in the ability of the two central banks to perform the LOLR function?

One explanation could be that it is the ease with which a change of the constitution can be effected that drives market perception. As we elaborated above, a change in the ECB's statute would necessitate the change of an intergovernmental treaty to which all EU27 governments and parliaments and/or electorates would have to agree. It is almost certain that allowing the ECB to buy at auction would be deemed unacceptable by core European countries. In the US, on the other hand, while the institutional hurdles for changing the Federal Reserve Act are significant, they are at least in principle not insurmountable.

The other explanation goes back to the attitude of different central banks regarding secondary market purchases of government bonds. From an economics perspective, it seems to us that the ability to purchase government bonds in the secondary market is, for almost all practical purposes, sufficient for a central bank to be able to perform the LOLR role: recent experience demonstrates that buying five minutes either side of an auction can be almost equivalent to buying at auction. That is, a de facto LOLR role can be performed effectively even with the legal prohibition for buying at auction in place.

In this case, it is the fact that at least part of the Governing Council is reluctant for the ECB to assume even a de facto LOLR role that differentiates it from its central bank peers in the eyes of the market. While the reasons for this reluctance are sound, this attitude can be a double-edged sword. Eurozone governments issue liabilities in a currency they cannot themselves print. Much like banks, that makes them vulnerable to a self-fulfilling run, and in part it is to prevent such runs that central banks were historically created: to provide a lender of last resort. As we have said in the past (see Elga Bartsch, EuroTower Insights: Fiscal Union Needs Monetary Back-Up to Solve Crisis, September 22, 2011), even if a fiscal union was in place in the eurozone, a resolution of the crisis would likely still require the ECB to be able to act as a de facto LOLR for governments.

The corollary is that for the ECB to be able to play a de facto LOLR role, no treaty change would actually be necessary. Yet while this seems clear-cut from an economics perspective, legal complications may exist. This is because (i) if de jure LOLR requires the ability to buy at auction; and (ii) since the treaty forbids buying at auction and hence de jure LOLR, then de facto LOLR may be stretching the spirit of the treaty, in which case even de facto LOLR would likely require treaty change.

Conclusions

While there are subtle differences across central banks' mandates, the universal "price stability" mandate is inevitably very broad. While the operational definitions of price stability are specified by the monetary authorities themselves, they are not immutable (and in any case the vague time horizons allow very sustained deviations from target, as the case of the BoJ demonstrates). Further, changing the central bank constitutions themselves appears - with the exception of the ECB - not excessively difficult. In short, there is nothing hard-wired into central bank legislation that would prevent at least moderately higher inflation in the medium term. Soft constraints - i.e., the importance central bankers attach to their hard-earned credibility - may be more important.

The prohibition to buy at auction exists across the board but is practically not a very meaningful constraint on government financing, since the ability exists to buy in the secondary market.

Economically, this implies that a central bank could be a de facto lender of last resort to sovereigns even if it is de jure banned from buying at auction. In the case of the ECB, the legal prohibition of monetary financing is very similar to the prohibition the Fed and the BoJ face: it applies to primary market purchases only; and it seems not more stringently worded. While from an economics perspective the ability to buy in the secondary market is practically sufficient for the ECB to perform a de facto LOLR role for eurozone sovereigns, legal complications may arise if the treaty is interpreted as prohibiting a de jure LOLR.