They argue that in such cases it is vital for a central bank to come to a country’s aid, the rationale being that, just as its role in ensuring comprehensive liquidity provision or in acting as “lender of last resort” serves to safeguard financial stability, central bank intervention in the government bond market could fulfil the same purpose.
However, I beg to differ for a number of reasons. First, it is at times hard to determine the “correct” risk premium ex ante. Hence, it is not always evident to a central bank whether a government is merely illiquid or truly insolvent. Here, we need only look as far as purchases of Greek sovereign bonds under the Securities Markets Programme.