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Euro-area bond-buying plan is progress despite flaws
By Clive Crook and Paula Dwyer |
September 10, 2012, Monday
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EUROPEAN Central Bank President Mario Draghi has announced his much-anticipated bond-buying plan. The short version: The bank will purchase sovereign bonds on the open market in unlimited quantities, but only after troubled countries request the aid and agree to fiscal conditions that other euro-area governments would impose.
It's not the shock and awe we called for, but it is an important move and could relieve the financial pressure on Spain, Italy and other distressed euro-area governments. However, we have a few reservations.
Before we get to them, give Draghi some credit for pressing on with his plan over the opposition of Germany's Bundesbank. Give Draghi credit, too, for the fact that his diagnosis of the problem is mostly correct.
The price of Spanish and Italian debt had begun to reflect not just solvency concerns but also the fear that the euro system might unravel. Guaranteeing the integrity of the currency system - which is how Draghi rationalizes his plan - is a proper and reasonable role for the ECB.
Draghi was also right to say that the ECB's interventions would be "unlimited." An arbitrary ceiling would have given the markets a target to shoot down. A similar logic applies to his decision not to announce a formal cap on borrowing costs for countries whose bonds the ECB will buy. That would have failed the credibility test and been one more hostage to fortune.
Damaging concessions
Unfortunately, the plan, forthrightly named Outright Monetary Transactions, makes two damaging concessions to the Bundesbank and its allies. One is that the ECB will sterilize its bond purchases - meaning that it will offset any effects they might have on the euro-area money supply. This is meant to reassure inflation hawks. At the moment, it would be better to ignore them.
The ECB's new forecasts point to a continuing euro-area recession. The immediate risk of higher inflation comes from planned increases in indirect taxes, part of Europe's overzealous austerity drive, not excess demand. Monetary stimulus through unsterilized bond-buying - quantitative easing, as it's called - is warranted for the euro area just as it is for the US. It's a shame the ECB ruled it out.
Granted, sterilization shouldn't stop ECB bond purchases from doing what Draghi wants them to do: lowering the cost of borrowing for countries thought to be at risk of insolvency or of being ejected from the euro system.
His other concession to orthodox central banking is his promise that the ECB won't buy bonds unless the countries concerned have a policy-adjustment program with the temporary bailout fund or its permanent successor, the European Stability Mechanism. Moreover, Draghi said, the ECB would suspend its bond purchases if a borrower fell out of compliance.
To serve effectively as a lender of last resort to governments - the role Draghi is reluctantly assuming - the ECB needs to act instantly and on its own initiative. Complex loan conditionality managed by other agencies introduces further delay and uncertainty into a situation already plagued by both. Rather than outsource the job, the ECB should have its own process to determine whether governments are acting responsibly.
Conditionality also creates the opportunity to game the rules. Once a country has a fiscal disciplinary program and the ECB is buying its bonds, could the bank credibly promise to stop the purchases and risk bringing the ceiling down on the entire euro system? We doubt it.
All this assumes, of course, that the German constitutional court doesn't simply strike down the ESM this week when it gives a provisional ruling on the program.
Draghi's plan is flawed, as it was bound to be, given Europe's tangled politics, opaque constitutional arrangements and opposing economic philosophies. It's progress nonetheless.
Clive Crook and Paula Dwyer are editors of Bloomberg View. The opinions are their own.
It's not the shock and awe we called for, but it is an important move and could relieve the financial pressure on Spain, Italy and other distressed euro-area governments. However, we have a few reservations.
Before we get to them, give Draghi some credit for pressing on with his plan over the opposition of Germany's Bundesbank. Give Draghi credit, too, for the fact that his diagnosis of the problem is mostly correct.
The price of Spanish and Italian debt had begun to reflect not just solvency concerns but also the fear that the euro system might unravel. Guaranteeing the integrity of the currency system - which is how Draghi rationalizes his plan - is a proper and reasonable role for the ECB.
Draghi was also right to say that the ECB's interventions would be "unlimited." An arbitrary ceiling would have given the markets a target to shoot down. A similar logic applies to his decision not to announce a formal cap on borrowing costs for countries whose bonds the ECB will buy. That would have failed the credibility test and been one more hostage to fortune.
Damaging concessions
Unfortunately, the plan, forthrightly named Outright Monetary Transactions, makes two damaging concessions to the Bundesbank and its allies. One is that the ECB will sterilize its bond purchases - meaning that it will offset any effects they might have on the euro-area money supply. This is meant to reassure inflation hawks. At the moment, it would be better to ignore them.
The ECB's new forecasts point to a continuing euro-area recession. The immediate risk of higher inflation comes from planned increases in indirect taxes, part of Europe's overzealous austerity drive, not excess demand. Monetary stimulus through unsterilized bond-buying - quantitative easing, as it's called - is warranted for the euro area just as it is for the US. It's a shame the ECB ruled it out.
Granted, sterilization shouldn't stop ECB bond purchases from doing what Draghi wants them to do: lowering the cost of borrowing for countries thought to be at risk of insolvency or of being ejected from the euro system.
His other concession to orthodox central banking is his promise that the ECB won't buy bonds unless the countries concerned have a policy-adjustment program with the temporary bailout fund or its permanent successor, the European Stability Mechanism. Moreover, Draghi said, the ECB would suspend its bond purchases if a borrower fell out of compliance.
To serve effectively as a lender of last resort to governments - the role Draghi is reluctantly assuming - the ECB needs to act instantly and on its own initiative. Complex loan conditionality managed by other agencies introduces further delay and uncertainty into a situation already plagued by both. Rather than outsource the job, the ECB should have its own process to determine whether governments are acting responsibly.
Conditionality also creates the opportunity to game the rules. Once a country has a fiscal disciplinary program and the ECB is buying its bonds, could the bank credibly promise to stop the purchases and risk bringing the ceiling down on the entire euro system? We doubt it.
All this assumes, of course, that the German constitutional court doesn't simply strike down the ESM this week when it gives a provisional ruling on the program.
Draghi's plan is flawed, as it was bound to be, given Europe's tangled politics, opaque constitutional arrangements and opposing economic philosophies. It's progress nonetheless.
Clive Crook and Paula Dwyer are editors of Bloomberg View. The opinions are their own.
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