Of course, within the U.S., households and businesses can react to this wedge by choosing to locate elsewhere. And because the tax base of any jurisdiction depends on the level of local economic activity, this out-migration can lead to ever-higher tax rates or everdiminished services for those who still remain – typically those with fewer opportunities or resources to relocate. Today, there are several ways that states and localities can borrow to cover operating deficits; and the relatively slow economic growth since the financial crisis has increased pressure on their budgets, making such measures more appealing. One mechanism for doing this is to treat borrowed funds as revenues that can be used to balance the budget. Another form is asset sales. Here the jurisdiction receives cash today in exchange for a reduction in its future assets – sometimes physical like an office building, sometimes financial like tobacco settlement funds – and an increase in its future costs. Finally, and perhaps most importantly, is the practice of pushing the cost of current employment services into the future. Let me elaborate on this last method. Here I’m referring to the underfunding of public employee pensions and other post-retirement benefits for current employees. Both of these practices add to the indebtedness of the state and local governments with the employees playing the role of creditors. To be clear, while unfunded promises to cover retiree health insurance are very common, unfunded pension liabilities are probably much larger in aggregate magnitude.
Sustained buying of government paper by the central bank would only postpone problems and delay the necessary fiscal adjustments, ultimately resulting in a build-up of inflationary pressures. The ECB has never hesitated to reaffirm and remind all Member States, in very concrete terms, that compliance with the principles of budgetary discipline is absolutely fundamental. Naturally, since member states do not control their currency alone, they are vulnerable to liquidity episodes and multiple equilibria. Creditors’ assessments can change, e.g. via contagion effects, even when the fundamentals would not justify it. The high degree of financial integration within EMU means that, if left unchecked, contagion in the banking sector can spread rapidly via cross-border holdings of sovereign debt. For the sovereigns themselves, sudden shifts in market re-pricing of risk can lead to unexpected liquidity challenges. These dynamics underscore the importance of strengthening the mechanisms that prevent such risks – the SGP, surveillance of broader macroeconomic imbalances and stronger financial supervision. However, the liquidity dry-ups and the contagion risks also call for stronger backstop mechanisms, to provide significant, albeit temporary, liquidity assistance. The SMP aims to create a better functioning transmission mechanism of monetary policy to all parts of the monetary union and is therefore in full compliance with the prohibition of monetary financing. Also, we sterilise the impact of the SMP on our total liquidity provision.