How do you solve a problem like Mario's?
Mario Draghi is facing a 1 trillion euro ($1.3 trillion) problem: expanding the European Central Bank's balance sheet toward 3 trillion euros from 2 trillion euros.
The fastest route, buying sovereign bonds, may be sealed off because it risks violating European treaties and infuriating a significant minority of his policy-making board.
One detour: Let financial alchemists invent an asset class that skirts the potential pitfalls.
Lucrezia Reichlin, the ECB's former head of research, and Luis Garicano of the London School of Economics say that with the right signal from the central bank, markets could create an instrument that mimics a collection of euro-zone government securities, what they term "safe-market bonds."
The paper would be backed by quality government debt and the weight each country's bonds have would be determined by its gross domestic product. The central bank would buy them, resulting in the easier liquidity and credit needed to revive inflation. And no sovereign debt would have been purchased.
The plan "would not only help the ECB attain its elusive inflation target, but would contribute to the financial stability of the euro zone," the economists wrote on the web site VoxEU.
It would also address some of the euro's defects by introducing the equivalent of pan-European bonds and reducing the direct exposure of banks to governments, they said.
The proposal is echoed by Carlo Bastasin of the School of Political Economy at LUISS University - Rome. He proposed a "silver bullet for the European crisis" by suggesting the creation of an asset-backed security reflecting the attributes of existing euro-zone debt that the ECB could then buy.
"The new ABS would not be an attractive innovation for the ECB only, but would greatly benefit private investors, both European and non-Europeans, who are longing for a European liquid and safe asset," Bastasin wrote in a Nov. 14 paper. "If the total amount of QE is estimated at 1 trillion euros, the market behind the new security would amount to one of the largest in global finance."
Another suggestion from Olivier Garnier, a former ECB adviser and now chief economist at Societe Generale SA, is for the ECB to intervene in the interest rate swap market.
"Its objective would be the same as in the case of large- scale purchases of debt securities with medium and long maturities: reducing long-term interest rates once short-term rates have reached the zero lower bound," he said.
Other advantages are that the swap market is both liquid and private so the ECB wouldn't be buying government bonds, while flattening the yield curve would curb financing costs for banks, companies and households.
"In other words, this policy would have greater target efficiency than government bond purchases if the true goal is to lower private sector funding costs," said Garnier.