The Tree and the Forest
What to do of yesterday’s decision of the ECB? The tree looks
very rather nice, the forest much less. First, a look at what Mario Draghi announced:
- “[...] the Governing Council today decided on the modalities for undertaking Outright Monetary Transactions (OMTs) in secondary markets for sovereign bonds in the euro area. [...] We aim to preserve the singleness of our monetary policy and to ensure the proper transmission of our policy stance to the real economy throughout the area. OMTs will enable us to address severe distortions in government bond markets which originate from, in particular, unfounded fears on the part of investors of the reversibility of the euro. [...] we act strictly within our mandate to maintain price stability over the medium term.” The technical note accompanying the decision explicitly states what markets wanted to know: “No ex ante quantitative limits are set on the size of Outright Monetary Transactions” In other words, bond purchases will be unlimited.The technical note also specifies the conditionality, the fact that the purchases will be on short maturities, and that they will be fully sterilized.
- Let’s go back to Draghi: “we decided to keep the key ECB interest rates unchanged. [...] inflation rates are expected to remain above 2% throughout 2012, to fall below that level again in the course of next year and to remain in line with price stability over the policy-relevant horizon.“
To summarize, the ECB will try to bring down the spreads, acting within its mandate, because speculation is perturbing the transmission mechanism of monetary policy and threatening stability. This can also help explain the decision to keep the rates unchanged: there is no point in using that lever, unless it is sure it works.
Why is the tree rather good? And what makes the forest more worrisome? The tree first.
The tree is good because of the word unlimited. This is what the ECB should have said a long time ago. The purchases will be uncapped, if needed. Draghi mark II seems to be very different from Draghi mark I. A few months ago I cited him, challenging his arguments:
In his first press conference as president of the ECB, Mario Draghi explicitly stated that “The Securities Markets Programme (SMP) always has had, and was meant to have – as it has been stated since the very beginning – three characteristics. First of all, it is temporary. Second, it is limited in its amount and, third, it is justified on the basis of restoring the functioning of monetary policy transmission channels [...].” The ECB has therefore managed to pick the worst equilibrium: it needs to actually buy large amounts of sovereign debt, while it is ineffective in contrasting speculation and yield increases. The contrast with the British case makes the point very clearly, as speculation is deterred by the role of LOLR played by the Bank of England, which therefore ends intervening less than the ECB.
Apparently, that was true. Contrasting speculation, to be effective, needs the committment to use the Bazooka. Draghi seems to have at last managed to get this simple concept through the ECB board. The tree is not perfect, nevertheless, because of the decision to sterilize OMTs: the fear of inflation in the current situation is simply ridiculous. But this, and the strong emphasis on conditionality, are the price paid to obtain the quasi-unanimity of the Board. In the current situation, it was hard to expect more from yesterday’s meeting. And this will most probably defuse speculation. Good.
The forest now. I see two reasons why the picture is much bleaker if we take a broader perspective.
- The first is that the ECB should not have intervened in the first place. A well functioning institutional framework, and a less ideological leadership would have seen the core countries react fast to the debt crisis, with a coordinated fiscal policy effort aimed at minimizing the recessionary effects of consolidation in the periphery. The ECB had to intervene because markets exploited the political (and policy) void, to bet against the weaker members of the eurozone. There has been too much talk about the possible complacency in the consolidation effort of countries saved by the ECB. There is an even greater risk that European leaders will use the ECB shield to prolong the sequence of useless summits delivering half-baked solutions. Curiously enough, that risk is never mentioned.
- The second reason is even more structural. The ECB intervenes because it has to, in order to avoid the otherwise inevitable implosion of the eurozone. But nowhere, both within the ECB and in the European policy circles, we observe(d) a discussion on why we got to that point. Draghi yesterday insisted once again on structural reforms, as do most European leaders. The crisis, the self-defeating consolidation of peripheral countries, but also the dismal performance of the continent in the past two decades, have not led to a serious debate about the obstacles to sustainable growth. Most commentators and policy makers are reluctant to leave their comfort zone, and repeat the mantra: structural reforms, now and forever. The conditions for countries to benefit from the OMTs closely resemble the (in)famous structural adjustment programs imposed by the IMF in the 1990s…
The forest problem is very serious. It seems increasingly clear to me that the recipe for sustainable (in a broad sense) growth needs to be found in a mix of well functioning institutions and efficient (but regulated and
sometimes often constrained) markets. The United States are a good case in point, with proactive policies and often virtuous interaction of the private and public sector (I know. Not very fashionable to say good things about the States nowadays).
European leaders and economists are stuck, unable to look at more than the typical and caricatured neoclassical prescription: austerity and flexibility.
Some trees may unexpectedly grow healthy. But at least for the moment, the forest is irremediably sick…