ECB moves make euro collapse look more preventable
ECONOMICS:SINCE THE summer of last year, when Italy and Spain fell victim to the disease that has so afflicted smaller euro zone peripherals, it has been clear that the euro would fail without European Central Bank intervention.
At that time, Italy was perceived as being most at risk, and in August (2011) the ECB agreed to buy Italian government bonds in return for the introduction of a series of reforms. The bank duly started buying. The then prime minister Silvio Berlusconi promptly rowed back on reforms.
With a visceral hostility to central bank bond-buying already strong in northern creditor countries, Berlusconi’s breach of promise was a disaster. For Germany the blurring of monetary and fiscal functions was bad enough, but allowing a country with a high inflation history unconditional access to the single currency’s printing presses was an abomination. Berlusconi paid for his actions with his premiership.
But despite the price paid, the episode proved so damaging that it has taken more than a year for agreement to be reached on the design of a new and more effective ECB intervention mechanism that could help bring the two big Mediterranean countries back from the brink of default. The delay has made the recessions in the periphery worse, not least by curbing the supply of credit and raising its cost for those who can still get it.
But if the ECB delayed for far too long, it delivered yesterday. And it delivered in full.
Its new open-ended bond-buying programme ranks alongside the three biggest responses thus far to the crisis: the creation of a euro zone bailout mechanism and a (grudgingly limited) ECB bond-buying programme in May 2010; the ECB’s provision of €1 trillion in three-year liquidity to the financial system around the turn of last year; and the announced intention to Europeanise some of the costs of bank failures in the zone on June 29th of this year.
The new bond-buying programme is wider in scope and bigger in scale than before – crucially it is explicitly unlimited in the value of bonds it can purchase. It will not scare private investors from the market by telling them that they will get money back in the event of default only after the ECB has been repaid in full. And it deals with moral hazard and political risk – centred mostly on the outcome of Italy’s April 2013 election – by setting conditions and sanctions for countries who avail of the bank’s help in retaining and regaining market access (if there is a gap in yesterday’s measures it relates to the limited credibility of sanctions).
The new mechanism, formally christened “Outright Monetary Transactions”, is a huge step. Moreover, coming just 10 weeks after the last major advance, there is hope – and still hope only – that the euro zone’s institutions and governments may be moving towards a proportionate response to the crisis.
It is always risky to attribute too much to individuals in the closed world of central banking, and even more so in the case of the ECB – the Frankfurt bank, unlike its US and British counterparts, does not publish minutes detailing its decision-making committee’s discussions, so individuals’ contributions are hard to discern. Moreover, the bank’s governing council is much larger than those of either the Federal Reserve or the Bank of England so the role of single members, including even the president, Mario Draghi, is inevitably watered down.
All that said, it is hard not to conclude that Draghi has been more radical than his predecessor since he took the helm last year. One example is his willingness to highlight the Bundesbank’s isolation. Yesterday he again mentioned that only one governing member (of 23) opposed yesterday’s measures.
ECB actions have not gone down well in the country where Draghi now lives. He was reminded at a press conference yesterday (by a German) that only 18 per cent of Germans trust him, according to an opinion poll.
Draghi and the ECB have been tactically astute in playing up their anti-inflation credentials. Yesterday the bank neither cut interest rates nor embarked on quantitative easing (there was some speculation – though not an expectation – that it would do one or both). Draghi stressed that the new actions were designed always and everywhere to preserve price stability – a Teutonic obsession.
Preventing the euro’s collapse while maintaining cohesion and legitimacy will be difficult. It seems more achievable after yesterday.