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  Can He Save the Euro?  

Omkar Goswami


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


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