FOR ONCE, a central banker showed the politicians what to do. After two years of denial, dithering and brinkmanship at a series of high-profile summits, the leaders of the eurozone countries were given a lesson in decisive action by an unelected technocrat. All the ministers had to show for their summitry was a deteriorating debt situation and a macro-economic environment that spelled recession. But with the very real threat of contagion, the spread of the debt crisis spilling into Spain and Italy, the unlikely figure of Mario Draghi, the Italian economist, banker and academic who heads the European Central Bank (ECB), stepped in with his “big bazooka”.
What he proposed at the beginning of September was his twist on the quantitative easing adopted by the Federal Reserve in the US and the Bank of England. The problem for the likes of Spain and Italy was that markets believed either or both would need bailout packages and the increased risk was pushing up the cost of borrowing to unsustainable levels, thus making the problems even worse.
Draghi’s proposal was simple. The ECB would stand ready to buy any amounts of sovereign debt with a term of up to three years, thereby ensuring a government’s access to funding. It was, he claimed, “a fully effective backstop” for the affected countries, an insurance policy for the single currency. To make the scheme more acceptable to doubting countries and to markets, he said the ECB buying programme would be “sterilised” (what it spends would be matched by cuts elsewhere) and the bank would forgo “seniority” (having the first claim in any restructuring package over private investors).
The programme added to the alphabet soup of packages and is called Outright Monetary Transactions (OMT). Its purpose is to reduce the borrowing costs of the countries at risk to more affordable levels and early indications are that it is happening. Like all insurance policies, the holder hopes never to make a claim but its presence offers comfort. So it is with OMT. If markets are convinced the ECB will act, interest rates should fall and the “big bazooka” need never be used.
But it is not a soft option: conditions are attached and this is where Draghi’s good work could be undone by politicians, whose interests remain national rather than European. The plan was not unanimously accepted. There was one dissenting voice, thought to be the most important: the Bundesbank. The Germans’ opposition to debt-pooling and loose money supply meant they found OMT unacceptable, but Draghi over-rode the objections.
Other considerations could undermine the plan. Countries have to apply to the ECB, but Spain, for example, has denied it needs a bailout. A stand-off between a government, the ECB and markets is possible. There will, in addition, be conditions attached, which might not be as severe as those imposed on Greece but will still point to more austerity in countries already in recession and trying to cope with double-digit unemployment rates. Politically, this would be a hard sell for any government.
But what OMT offers above all is more time. The can has been kicked a long way down the street and governments have the breathing space to address the real issue. Debt is only the symptom. The issue is a lack of competitiveness in the debtor countries. There is a need for structural reform (of welfare systems, labour markets, tax structures) so the least efficient can become competitive. It will take years to achieve, but is essential, or further rounds of debt crises will emerge after these have been sorted.
Draghi said he would do what it takes, and he has done just that. The ball has been passed to the politicians who have to do what they should have been doing all along. The ECB president has not solved the problem but he has created the environment in which solutions can be applied. ?