The ECB Umbrella is here to stay

On December 10th the European Central Bank Governing Council will likely announce new measures to support governments that have to reach to their wallet again to try to cope with the economic effects of the pandemic second wave. It would not be surprising that the ongoing asset purchase programmes will be extended in size and duration (currently, the Pandemic Emergency Purchase Program, PEPP, is scheduled to run until June 2021). There have been rumors in recent days that the ECB could use this increase in its firepower to put pressure on countries that do not wish to make use of loans from the Recovery Fund and the ESM. ECB board member Yves Mersch yesterday also suggested that the ECB walk that path.

For those who are not into the European debate, it should be recalled that using the loans from European programmes (the ESM covid line, the SURE, and the quota of the Recovery Fund that is not grants) yields savings in interests: the EU will borrow on the markets at more favourable costs than many Member States and redistribute the amounts. If market rates are low, the gain in interest from European loans is reduced and may not be sufficient to offset the fact that these loans come with terms and conditions (and further problems in the case of the ESM). By reducing its purchases of reluctant countries’ assets, the argument goes, the ECB would raise market rates and thus make it convenient, if not inevitable, for them to use financing from European programmes.
I believe that it is very unlikely, if not impossible, that the ECB would engage in such nudging. Its umbrella will remain open for all eurozone countries for a long time to come. Instead of worrying about the presumed unsustainability of the debt that all European countries are accumulating, we should focus on how to spend the money quickly and well. Sustainability depends more on this than on unlikely ECB pressures or unlikely sudden reversals of market confidence.

There are three reasons to doubt that the ECB will use its purchasing programmes to interfere in the financing choices of European Governments. The first reason is technical. Since the Quantitative Easing program started in 2015, purchases of each country’s securities have been proportional to the so-called capital key, the shares of EMU countries in the capital of the ECB, which in turn are linked to population and GDP. This self-imposed proportionality was the price to be paid to avoid that the purchases were concentrated on peripheral countries’ securities, allowing them to pass on their debt to the supposed frugals through the ECB. When last March the new emergency purchase programme was introduced, the ECB relaxed the capital key so that purchases could initially focus on the debt of countries subject to market pressure and (contrary to what Lagarde has suggested just days before) keep spreads under control. However, even in this case, the ECB did not embrace complete discretion, as flexibility was only temporary: at a later stage purchases will have to be rebalanced in order to respect the self imposed proportionality at the end of the programme. Deciding now to move away from the capital key to put pressure on countries that do not want European loans would most likely meet the opposition of the core countries, that feel protected by them. It is interesting that Mersch himself, a few days before suggesting proportionality were scrapped to nudge Member States into EU loans, argued in an interview that “We are bound not by self-imposed limits but by red lines which are of a constitutional nature and which are in the treaty. The self-imposed limits only serve to respect those constitutional limits, which are not at our disposal.”

The second reason why ECB nudging is unlikely has to do with the current macroeconomic situation. One might in fact argue that, pretty much as in the current PEPP, flexibility and nudging could happen in the short run to eventually restore the capital key. But contrary to what many believe, today the ECB necessary to keep rates low. The crisis has generated an enormous mass of savings which, given the economic uncertainty, has mostly been channeled into demand for public debt of all countries. In October’s auctions alone Italy, one of the most problematic EMU countries when it comes to public finances’ sustainability, placed debt at different maturities (with rates close to zero) for around 33 billion euros against a market demand of more than 55 billion euros . Of course, it would be foolish to neglect the role of monetary policy: the ECB’s umbrella has contributed to making public debt safe and therefore attractive. But it is certainly not the only factor; the abundance of savings is increasingly a feature (and a problem) of our economies.
Last, but not least, political reasons, that encompass all th others, reduce the risk of ECB interference in countries’ financing choices. Since 2012, while it has struggled to convince markets of its credibility in sustaining growth and keeping inflation close to its target, the ECB has been very effective in curbing speculation. Ever since Mario Draghi’s 2012 whatever it takes speech, all it took to stop market pressure on peripheral countries, was the certainty that the ECB was ready to do everything (whatever it takes) to prevent speculative attacks to keep markets at bay, make public debt attractive and reduce spreads. A sort of (imperfect) lender of last resort, in sum. Even the PEPP programme, after some massive initial purchases, has settled on limited flows and proportionality is already almost restored. It is frankly quite implausible that the ECB will deliberately risk to increase uncertainty and let spreads widen again, squandering an hard-earned credibility capital just to push hesitant countries to apply for loans from European programmes.

Long story short, the ECB’s umbrella is set to remain open for a long time to come and will contribute, along with the mass of savings in search of placement, to keep the cost of debt low. We should resist getting entangled in the debate on how to finance (and repay) public debt, and focus on the use of the resources available. European countries need to efficiently invest in tangible and intangible infrastructures that will enable us to set out on a path of sustainable and sustained growth. After all, a healthy economy is the best guarantee of sustainable public debt.

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