On 6 September 2012, Mario Draghi,
the Italian President of the European Central Bank (ECB)
announced something that no ECB official would have
thought possible.
ECB’s role has been very tightly defined since it
was set up in 1999 to be the central bank for the
euro area. Indeed, its location at Frankfurt defined
its main role, which was “to maintain the euro's
purchasing power and thus price stability in the
euro area.” Those words come straight out of the
German Bundesbank. Scarred by hyperinflation of the
Weimar Republic and fears of yet another one during
post-war reconstruction under Konrad Adenauer and
Ludwig Erhard, there was — and still resolutely
remains — a Bundesbank view of central banking: to
maintain price stability come what may.
It is not surprising then, that the Germans insisted
on a non-negotiable price for the common currency —
a totally independent and strictly inflation
targeting Bundesbank-like monetary authority located
in the heart of Frankfurt, where the President and
five other members of the Executive Board couldn’t
dare breathe anything but pure German air. Nor, too,
could the 17 governors of the national central banks
of the euro area. The ECB statutes clearly say,
“Neither the ECB nor the national central banks… nor
any member of their decision-making bodies, are
allowed to seek or take instructions from [European
Union] EU institutions or bodies, from any
government of an EU member state or from any other
body.”
ECB independence in enshrined. It is financially
independent of the EU, with its own budget and
capital paid up by the euro area national central
banks. Moreover, it cannot grant loans to any EU
body or national public sector entities.
Wim Duisenberg and Jean Claude Trichet, the two
past-presidents of the ECB, more or less adhered to
this Bundesbank view of the world. Eventually,
however, the current crisis forced Trichet to
deviate by buying government bonds of several member
states of the euro area, which prompted two Germans,
Axel Weber, President of the Bundesbank, and Jürgen
Stark, a member of ECB’s Executive Board, to resign
in protest.
This is the context which makes Draghi’s
announcement so historic. Super Mario, as he is now
called, managed to get the ECB’s Governing Council —
comprising the Executive Board and the central bank
governors of each euro area nation — to agree on
Outright Monetary Transactions (OMTs), which
basically allow the ECB to conduct open-market
purchases of euro area sovereign bonds from
secondary markets.
Draghi elegantly defended this volte face. He said
it was “to safeguard the monetary policy
transmission mechanism in all countries of the euro
area” and claimed that “OMTs will enable us to
address severe distortions in government bond
markets which originate from, in particular,
unfounded fears… of the reversibility of the euro”.
The decision was not unanimous. Responding to a
question, Draghi admitted, “There was one dissenting
view. We do not disclose the details of our work. It
is up to you to guess.”
What do these OMTs really mean? Quite simply, the
ECB has voted itself to buy sovereign bonds of such
euro area countries it feels necessary and in such
quantities as is needed to bring down the yield
rates. It has become, at last, a full-fledged lender
of the last resort — and has got itself the
permission to do what most other central banks take
as given.
The reasons are very clear, and Draghi said so in no
uncertain terms. I quote: “…you have large parts of
the euro area in what we call a ‘bad equilibrium’…
where you may have self-fulfilling expectations that
feed upon themselves and generate very adverse
scenarios. So, there is a case… to ‘break’ these
expectations, which, by the way, do not concern only
the specific countries, but the euro area as a
whole. And this would justify intervention of the
central bank.” Absolutely so. Yet, there are
questions worth asking.
Will this prevent the euro area from breaking up?
Probably not Greece, which is beyond redemption and,
in any event, accounts for only 2.5 per cent of euro
zone’s GDP. But it should thwart speculators from
shorting Spanish sovereign bonds — which is surely
the target if Greece exits, and a strain that the
euro area can ill afford. Are there sufficient
caveats to prevent uncontrolled monetisation of the
“feckless south”? Yes, there are in theory. Yet if
push came to shove, these will be almost surely
abandoned. Are we to see what the German press has
nastily called the “lira-isation” of the euro? Not
yet. Though it may be. But in today’s context the
ECB is better off being a no-holds-barred lender of
the last resort to major euro area nations, than
practising false parsimony of the Bundesbank.
So, maybe the ECB has woken up at last. We should
thank Super Mario for it.
Published: Business World, September
2012