Investors in financial markets are nervous all across the globe. There is great concern about the potential of another recession as asset prices have dipped substantially over the past few weeks. This concern can clearly be seen in the continent of Europe. Several European countries have faced the risk of defaulting on their obligations over the past few weeks and the European Central Bank has helped to avert those disasters.

TUTORIAL: The Industry Handbook: The Banking Industry

What Is The European Central Bank
The European Central Bank (ECB) is the governmental organization that is responsible for setting the monetary policy and regulating the money supply for the 17 different countries that make up the Eurozone. The bank exists to help ensure stability for the Eurodollar and to combat inflation. The responsibilities of the European Central Bank are strikingly familiar to those of its sister institution, the Federal Reserve.

During recessionary times, financial institutions and private sector companies conserve capital and are unwilling to make loans. Central banks like the European Central Bank often become the lender of last resort in order to keep money flowing. The European Central Bank is currently stepping in and helping countries like Italy and Spain avoid bankruptcy by injecting money into the financial systems. (For related reading, see What Are Central Banks?)

Role Of The European Central Bank
The European Central Bank bought the bonds of Greece, Ireland, and Portugal to help the governments of those countries avoid insolvency and to stabilize markets. Now the central bank has started buying the bonds of distressed nations Italy and Spain as well. The ECB believes that buying the debts of these countries will help to keep bond yields low. This should in effect, lower the borrowing costs for these countries which would unclog financial markets and allow them to get access to capital at lower rates.

The European Central Bank has spent the last two years trying to fight contagion. As the debt crisis hits one European country, it can quickly spread to a partner country that owes the bonds and financial obligations of the other country.

Flaws In The Bond Buyback Plan
While the European Union is hoping to squash the fears in the market, the union is pretty much admitting that countries are weak by bailing out nations to a much greater extent. Programs that were meant to be short term financial assistance plans, like the Greece bond buying plan, have turned into long term bailouts. Once the central bank has propped up a market, the government is finding it very difficult to exit that market.

Another issue is the health of the European Central Bank's balance sheet. The central bank is taking on a large amount of risk in buying the debts of distressed nations. Every assistance program implemented limits the bank's ability to get involved in the next major crisis and hinders its ability to deal with its primary job of keeping inflation in check. (For related reading, see Get To Know The Major Central Banks.)

Resistance To The Bond Buying Plan
The European Central Bank is already facing blowback from the stronger members of the European Union. Germany and France have expressed resistance to the continued bailout plans. Germany believes that the bank is putting the financial health of the other nations at risks with this bond buying plan. France fears losing its triple A credit rating because of the latest bailout plan.

The massive debt buys have put the future of the euro in question. This will cause the central bank to use a substantial amount of leverage thereby weakening its own balance sheet. The EU is in danger of a revolt as it is unclear how long stronger nations like Germany and France will tolerate these programs.

The Bottom Line
As you can see the European Central Bank has a dilemma on its hands. The central bank could sit back and do nothing while watching countries spend themselves into insolvency or the bank can assist these countries with bailouts which may in fact, be weakening the whole region. (For related reading, see The Euro: What Every Forex Trader Needs To Know.)

Related Articles
  1. Economics

    Investing Opportunities as Central Banks Diverge

    After the Paris attacks investors are focusing on central bank policy and its potential for divergence: tightened by the Fed while the ECB pursues easing.
  2. Economics

    Long-Term Investing Impact of the Paris Attacks

    We share some insights on how the recent terrorist attacks in Paris could impact the economy and markets going forward.
  3. Investing

    The Hunger Games Economy: 5 Unanswered Questions About Panem

    The Hunger Games's fictitious nation of Panem has technology, black markets, and government. But, we know precious little about Panem's economy and the reasons for its rampant inequality.
  4. Economics

    Understanding Donald Trump's Stance on China

    Find out why China bothers Donald Trump so much, and why the 2016 Republican presidential candidate argues for a return to protectionist trade policies.
  5. Economics

    Is Wall Street Living in Denial?

    Will remaining calm and staying long present significant risks to your investment health?
  6. Markets

    What Slow Global Growth Means for Portfolios

    While U.S. growth remains relatively resilient, global growth continues to slip.
  7. Economics

    Who Stands To Lose (And Gain) From The Paris Attacks

    For every major world event, there are those who stand to lose and those who stand to gain. A look at the short, medium, and long-term impacts of the Paris attacks.
  8. Investing News

    How the Paris Attacks Could Impact the Economy

    The horrific terror attacks in Paris will have a ripple effect on comsumer spending and tourism.
  9. Forex Strategies

    3 Simple Strategies For Euro Traders

    Euro traders can execute three simple but effective strategies that take advantage of repeating price action.
  10. Investing

    World Bank Data For Dummies

    Developing countries can't always afford to track the data crucial to setting the right economic policies and programs. That's where the World Bank steps in.
  1. How do you make working capital adjustments in transfer pricing?

    Transfer pricing refers to prices that a multinational company or group charges a second party operating in a different tax ... Read Full Answer >>
  2. Marginal propensity to Consume (MPC) Vs. Save (MPS)

    Historically, because people in the United States have shown a higher propensity to consume, this is likely the more important ... Read Full Answer >>
  3. Do lower interest rates increase investment spending?

    Lower Interest rates encourage additional investment spending, which gives the economy a boost in times of slow economic ... Read Full Answer >>
  4. Who decides to print money in Russia?

    The Central Bank of the Russian Federation (CBRF), like its peers in most countries, is the governmental entity responsible ... Read Full Answer >>
  5. Who decides to print money in Canada?

    In Canada, new money comes from two places: the Bank of Canada (BOC) and chartered banks such as the Toronto Dominion Bank ... Read Full Answer >>
  6. Who decides when to print money in India?

    The Reserve Bank of India, or RBI, manages currency in India. The bank's additional responsibilities include regulating the ... Read Full Answer >>

You May Also Like

Hot Definitions
  1. Turkey

    Slang for an investment that yields disappointing results or turns out worse than expected. Failed business deals, securities ...
  2. Barefoot Pilgrim

    A slang term for an unsophisticated investor who loses all of his or her wealth by trading equities in the stock market. ...
  3. Quick Ratio

    The quick ratio is an indicator of a company’s short-term liquidity. The quick ratio measures a company’s ability to meet ...
  4. Black Tuesday

    October 29, 1929, when the DJIA fell 12% - one of the largest one-day drops in stock market history. More than 16 million ...
  5. Black Monday

    October 19, 1987, when the Dow Jones Industrial Average (DJIA) lost almost 22% in a single day. That event marked the beginning ...
  6. Monetary Policy

    Monetary policy is the actions of a central bank, currency board or other regulatory committee that determine the size and ...
Trading Center