ECB: Growth measures even before the German elections

Benoît Cœuré, Member of the Executive Board of the European Central Bank (ECB), participating in the conference “Financial Stability and the Single Market – The Keys to Growth in Europe”. (EC Audiovisual Services).

Benoît Cœuré a French economist, Member of the Executive Board of the European Central Bank and former head of French public debt office, delivered a revealing speech on ECB’s programme for Eurozone state bond purchases in the secondary markets, known as Outright Monetary Transactions initiated in September 2012. Cœuré said that OMTs arrested and neutralised the catastrophic sequence and the disastrous eventualities of self-fulfilling predictions about euro area break-up which plagued the financial markets last summer. He insisted that this initiative was not only within ECB’s mandate but it constituted a fundamental obligation of Eurozone’s central bank. Cœuré was speaking at the Centre for Economic Policy Research, a German Institute for Economic Research and KfW Bankengruppe, last Monday 2 September.

In one word the OMTs are there to stay and, according to what the President of ECB Mario Draghi has left to be understood during this summer, the ECB will soon reinforce its long-term monetary easing with more extraordinary measures. Actually the central bank might introduce measures touching the limits of growth policies despite the German opposition. The coming elections in this country on 22 September do not constitute an impediment in this direction and probably the ECB is to announce its new policies prior to this date. The German voters should not go to polling stations without knowing.

But let’s return to Benoît Cœuré’s revealing speech, describing the devastating developments in Eurozone’s capital markets in the summer of 2012, and the dangerous culmination of this sequel until the ECB decided to intervene with its OMTs in August 2012. He said {A “bad equilibrium” of an adverse scenario was possible, triggered by self-fulfilling and reinforcing expectations. In this adverse scenario, the expectation of one or several countries exiting the euro would have driven public and private financing costs in these countries at such a high level that they would have had no other option than to actually exit}.

Fulfilling ECB’s obligations

Those countries were the third and the fourth largest Eurozone economies, Italy and Spain, to be accompanied to the exit by Greece, Portugal and Ireland. At that point the question which arose was whether ECB is within its mandate in doing whatever it takes to safeguard the Eurozone and the euro? The answer came with the famous speech of Mario Draghi, at the Global Investment Conference in London on 26 July 2012, when he said, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”. This was the first reference to what was to follow that is the OMTs.

One year later, Benoît Cœuré comes now to analyse, justify and actually include in central banking textbooks the OMTs. He did this last Monday when he said “First, the necessity of OMTs. Here, I will recall the circumstances that made OMT necessary. Second the effectiveness of OMTs. I will explain why OMTs were effective from a monetary policy perspective and finally the robustness of OMTs. I will show that the design of OMTs is robust to the criticisms that have been raised in the public debate”. Actually he delivered on all those accounts.

Today the necessity and the effectiveness of OMTs are already proven in action beyond reasonable doubt. Eurozone’s financial markets have calmed down and Italy and Spain can borrow at sustainable interest rates, without the ECB having spent not even one euro. What remains unanswered is the criticism whether the OMTs were within ECB’s mandate. In this respect the strongest argument against is that the central bank by buying government bonds even in the secondary market neutralises to a varying degree the pressures on politicians, governments and Parliaments alike, to take the needed but unpopular corrective fiscal and economic policy measures. According to this line of thinking, the ECB is actually following fiscal policies ways outside its mandate by accommodating the imprudent governments.

Strong answers

To this criticism the French economist answers that “one should not ignore the most important feature of OMTs, namely: its explicit link to policy conditionality”. At this point it has to be reminded that the OMTs were designed together with the European Commission. The EC undertook the task to draft a corrective economic and fiscal programme to be applied together the OMTs (purchases of the given country’s public debt paper) and make sure that the member state in question is effectively implementing it.

In this way the country in question would be given the time to correct its economic problems while being able to borrow at interest rates reflecting only its basic economic stance and shortcomings, but insulating it from the catastrophic ‘predictions’ for a potential exit from the euro area. In short “OMTs are not just words: the ECB is fully prepared to use them. But even if euro area member states comply with the conditions, there is no automatism to activate OMTs”.

Liquidity needs

Last but not least Cœuré referred to ECB’s fundamental obligation to secure the liquidity of the euro system, without making exceptions or introducing conditions. He explained that “the decision on the geographical allocation of liquidity across countries is not at the discretion of the ECB: it is essentially market-driven and depends on the liquidity needs of the banks”. Given that he concluded that “the transfer of risk is inevitable because a decentralised allocation of liquidity is a pre-condition for achieving our mandate of price stability. If we were to impose a specific distribution of liquidity across countries we would have to renege on our mandate”.

This is a direct answer to Berlin. The Germans insist that the ECB function and the use of the euro money by 17 EU member states should not act as a diffusion mechanism of specific country risk emigrating to the entire Eurozone. This speaker says that this is not possible. He proves here above that the very basic obligation of ECB to guarantee the liquidity of the euro system is by itself a built-in mechanism automatically defusing to some extend specific country risks to the entire money zone. In short Germany and the other surplus countries cannot have it both ways; ripping the benefits of a seamless monetary and product market environment without undertaking any risks inherent in Eurozone.

Cœuré and Draghi know how to answer the German grievances. Last July the ECB governing council, including the two and a half German representatives, decided unanimously to guarantee that there will be abundant and almost zero cost liquidity in the eurosytem, “for as long as it is needed”.