European Central Bank President Mario Draghi has taken a bold step this week to contain the euro crisis. The ECB is now planning unlimited bond purchases in order to prevent an escalation of the euro’s woes. The step marks a fundamental shift in efforts to save the common currency — and comes with plenty of risks.
The big moment almost fell through at the last minute. Thirty minutes before Mario Draghi planned to announce a turning point in the two-and-a-half year drama to rescue the euro, the fire alarm in the Euro Tower in Frankfurt went off. The elevators in the entire European Central Bank headquarters were placed out of service and two fire trucks arrived at the scene. It turned out to be a false alarm and the emergency vehicles drove away a short time later.
It added a bit of tension that the central bankers could well have done without. There had already been enough pressure in the run-up to what may have been the most important meeting in the ECB’s history. The 22 members of the ECB’s Governing Council had to decide on a program that many experts believe is no less than the solution to the euro crisis — but which others are viewing as the greatest sin yet committed within the common currency zone.
Following Thursday’s decision, the ECB now plans to purchase sovereign bonds from crisis-plagued euro-zone countries in unlimited quantities. Given that the ECB can literally print money, it essentially has unlimited means to buy bonds, thereby, it is hoped, driving down yields on those securities and lessening the interest rate burdens of the affected countries. ECB President Draghi said the Governing Council had approved the plan with an “overwhelming majority”. Jens Weidmann, the head of Germany’s central bank, the Bundesbank, had opposed the move, but he was ultimately outvoted.
Draghi: ‘Euro Is Irreversible’
But what if it isn’t? Then the ECB will be forced to go down a path that is paved with risks. Europe has never seen a program like this before, and it is almost impossible to predict the consequences. Critics of the program are focussing on three main points:
- The ECB is relieving crisis-ridden countries of fiscal responsibility because the bond buying could threaten to eliminate pressure for them to reduce their deficits and control their spending.
- If it conducts mass bond buys, the ECB will flood the economy with money and risk causing a devaluation of the currency — in other words, inflation.
- The central bank will violate its mandate because it is effectively financing states, which it is expressly prohibited from doing under current European Union treaties. This, they argue, will make it the stooge of euro-zone governments, jeopardizing its independence.
On Thursday, Draghi attempted to refute all of these points. Indeed, the new program has been tailored in a way that it already addresses much of the criticism.
- In order to ensure that pressure for reforms is still applied to countries like Spain and Italy, strict conditions will be attached to the bond purchases. The ECB will only intervene in the first place if a country agrees to submit to a structural adjustment program administered by the European Stability Mechanism, the permanent euro bailout fund that is expected to begin operating soon. In other words, the central bank will only provide assistance if countries commit themselves to strict austerity.
- The ECB also countered fears of inflation with the announcement that money that is pumped into the economy will later be removed at other places — through the sales of securities or through regular lending to banks, for example. The problem here, however, is that the more money the central bank pumps into the system, the harder it becomes to get it back later.
- The arguments made by the ECB president to counter critics were perhaps weakest when it came to the claim that the bond-buying program is tantamount to providing direct financing to states. Draghi said the primary purpose behind the bond purchases is to make monetary policy in the euro zone functional again. “We are sure that we are acting within our mandate,” he said. The crisis, he said, has distorted the mechanisms the central bank generally uses to ensure that money gets pumped into the economy — and the “monetary policy transmission mechanism” needs to be repaired. To emphasize that, he said the ECB would only be purchasing short-term bonds with maturities of one to three years. He also said that European treaties explicitly prohibit the purchase of bonds on the primary market, but not on the secondary market, as the ECB plans.
Spiegel has the full article
