Why won’t Europe’s central bank save Europe?

With Italy’s debt crisis still smoldering, analysts are insisting that only the European Central Bank can quell the ongoing market panic over Europe’s troubled countries. “We think ECB needs to step up to the plate,” warned Barclay’s Capital. There’s just one teensy hurdle. In recent weeks, ECB officials have actually become less willing to embrace this savior role. “Clearly it is not the task of the central bank to intervene,” wrote board member Peter Praet on Thursday. So what gives? Can the ECB really stop the carnage? And if so, why won’t it?

New ECB President Mario Draghi (Geert Vanden Wijngaert/AP) Recall the reasons why markets are freaking right now. Members of the euro zone all issue debt in a currency they don’t control — i.e., the euro. So countries like Italy can’t always guarantee to bondholders that they’ll have enough money to pay up when the bills come due. At the moment, investors are fretting that they won’t get repaid and are demanding ever-higher interest rates to lend Italy money. That, in turn, makes Italy’s debt problems more unmanageable and causes markets to freak out further. Repeat until doomsday.

Fortunately, there is an entity with an unlimited supply of euros — the European Central Bank. All the ECB has to do, argues Paul De Grauwe, an economist at Belgium’s University of Leuven, is announce that it’s going to do everything in its power to intervene in the bond market and that it won’t stop until Italy’s borrowing costs settle back to manageable levels. (Right now, the ECB only engages in sporadic, temporary purchases, while harrumphing that it would prefer not to intervene at all.) In theory, that should calm the markets, giving Italy space to carry out longer-term reforms. So why doesn’t the ECB do this?

Those who oppose the idea that the ECB should act as a “lender of last resort” take several tacks. “One is purely emotional,” says De Grauwe. “We don’t want to do it. It’s bad. Period.” The ECB has always seen its job as preventing inflation from getting out of hand. Anything else simply goes against the bank’s culture (and, opponents complain, the euro’s founding treaty).

But there are also rational arguments against having the central bank intervene too heavily in the bond markets. Some officials worry that the ECB would spark greater inflation if it started buying up bonds en masse, injecting more and more euros into the economy. De Grauwe calls this fear “bogus,” citing Milton Friedman’s argument that the monetary base has plenty of room to expand during deep downturns.

There’s also the moral hazard argument — by bailing out a country like Italy, the ECB is providing European governments with incentives to take on too much debt. Maybe so. But the exact same thing occurs when central banks act as the lender of last resort in the banking sector, and yet most people — well, save for Ron Paul — still agree that this is an appropriate role for a central bank to play. (See this article for more detailed arguments for and against ECB intervention.)

Right now, says De Grauwe, European Central Bank officials are overly obsessed with moral hazard — to the extent that they’re trying to influence the behavior of countries like Italy. “They started buying Italian bonds; then Italy didn’t do what the ECB wanted, so they stopped,” he says. “They’re trying to put the screws on. But that’s not what a central bank should do. A central bank’s role is provide liquidity and maintain financial stability.” Questions about how to reform Italy’s government — or whether the prime minister should resign — should be left to Europe’s political institutions.

Even so, there’s little indication that the ECB is prepared to ramp up the printing presses. “To ask the ECB to become the lender of last resort to governments, it would mean that the ECB would immediately lose its independence,” said executive board member Jurgen Stark. One theory is that opponents of intervention — especially the Germans, who see a bailout as a wealth transfer to “irresponsible” states — are trying to extract as many concessions as possible out of Italy et. al. before the rescue mission begins. That’s the optimistic take. The gloomy view, offered by Tyler Cowen, is that ECB officials simply don’t believe they have the tools to salvage the situation — and so it’s not worth trying. An even scarier thought.