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Will Mr. Draghi save the euro, again?

January 24, 2015

p.3Since yesterday, Mr. Draghi is the new superstar of the euro zone, and the Union as a whole. At least, he kept his July 2012 promise to do “whatever it takes” to save the Euro (and the EU). His statement was credited with changing the course of the euro zone’s crisis, and keeping the monetary union afloat for two years and a half, without the European Central Bank (ECB) actually having to purchase a single government bond – unlike a similar case in which, the Fed had to buy up to $85 billion treasury bonds per month in order to stabilize the US economy.

These two and a half years gave plenty of time for EU governments to take action: to carry out the much advertised structural reforms; to reinforce solidarity among member states of the Union and advance harmonisation of tax and fiscal policies; to start a serious investment programme in order to shore up economic activity. Well, nothing of the above really happened, making clear that Europe’s governments are stuck in their divergences and conflicting views of what has to be done. In this framework, the only remaining option to prevent the fragile eurozone economy from grinding to a halt was monetary policy, or more precisely, money printing–and here enter the ECB and Mr. Draghi. Let’s take a closer look at what was announced.

The president of the ECB has announced that he will pump a significant amount of money (around €1.1 trillion) into financial markets, through a government bond-buying program, at the rate of €60 billion per month, up to at least September 2016. That date isn’t mandatory though as, according to the ECB’s president, the operation would continue, “until we see a sustained adjustment in the path of inflation.” If everything goes according to plan, by September next year at least €1 trillion will have been created under quantitative easing, bringing the European Central Bank’s balance sheet to around €3 trillion, that was its level in 2012.

The purpose of this move is to increase the liquidity of the system in hope that commercial banks will boost their lending to the private sector, to push down the value of the euro in order to help exporters, and to drive up inflation, which has slipped below the 2 percent target of the central bank. But, above all, the move is intended to restore confidence in the euro zone’s sagging economy; to prove that, in spite of political divergences among European governments, the monetary union has a dynamic central bank, keen to take any steps necessary to support the common currency and to kickstart growth.

The move was in large part anticipated by the markets, as the discussion about quantitative easing started two years ago, at a time when practically all major central banks were using it in order to support a shy recovery in their respective economies. However, the size and projected time span of ECB’ action impressed the markets and had an immediate impact on euro’s rates. A recent move by the National Swiss Bank to ‘unpeg’ the Swiss Franc from the euro, in force since September 2011, in anticipation of ECB’s action, had prepared the ground for that.

Still, however euphoric the environment after Mr. Draghi’s announcement, it’s worth mentioning a few details of the European Central Bank’s decision. First, in an obvious concession to Germany, which has been strongly opposing the scheme, the ECB’s governing council decided that 80 percent of the risk of losses on the quantitative ease bond purchases will be assumed by the national banks. That means that the central bank of each member state will bear most of the risks of a potential default of their government, with the remaining 20 percent of the new bond purchases to be subject to risk-sharing. Critics say that this will introduce a fragmentation of the euro zone’s monetary policy and may have consequences on its overall effectiveness and credibility; at least, it proves that for the time being, euro zone countries may share the same currency but are not able to adopt a single monetary policy–a rather unique situation by any standards.

Moreover, Mr Draghi announced that “some additional eligibility criteria will be applied in the case of countries under an EU/IMF adjustment programme.” This is a clear warning especially to Greece’s future government, that its bonds might not be included in the asset-purchase programme, should this government not reach an agreement with its creditors on the continuation of reforms and the austerity measures. Yet, this is one more signal that the euro zone is not a unified economic space, and thus its monetary policy cannot be applied across the board.

Other more technical conditions imposed by Germany, such as the non inclusion of bonds yielding negative interest rates, or the disconnection of quantitative easing transactions from any effect on interest rate-setting on the primary market, may further complicate ECB’s task and even cast doubts about the real ability of the programme to reach the €1.1 trillion target.

All these limitations to Mr. Draghi’s ambitions are easy to understand given both the German government and the Bundesbank’s fierce opposition to the whole idea of quantitative easing. Whatever the efforts of the ECB’s president to convey an idea of consensus, the divergence of views is blatant. According to Mr. Draghi, the ECB’s governing council had been unanimous in agreeing that the decision to print money was legally sound. That unanimity became only a large majority on the need to trigger it now, (“so large that we didn’t need to take a vote” Mr. Draghi said), then a simple consensus on the risk-sharing scheme. Still, several key figures of the euro zone central banks, including the heads of the central banks of Germany, the Netherlands, Austria and Estonia, opposed the expanded asset-purchase plan–not a good signal for a start.

Whatever the downsides, and there may be many, of Mr. Draghi’s programme of quantitative ease, the bottom line is clear: through it the European Central Bank affirmed its willingness to support the common currency and the euro zone’s economy. It is certain that monetary policy alone, however successful, is not sufficient to revive the old-fashioned production structures of the European continent, nor to change the mentality of those resisting structural reforms. In the words of Mr. Draghi, “for growth to pick up you need investment, for investment you need confidence, and for confidence you need structural reforms.” Still, happily Mr. Draghi is here to buy the bonds!

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