Last week, investors took less than a day to decide that the proposed assistance package for Spanish banks wouldn’t do. This week, the good news from Greece -- leftists who want to confront rather than cooperate with Brussels were defeated in the general election -- was discounted even faster.
With the EU’s politicians unable or unwilling to act, everything depends on the European Central Bank and its chief, Mario Draghi.
That may sound familiar. Once the fiscal stimulus of 2009 had passed, the U.S. Congress and administration fought to a draw, leaving the economy’s prospects in the hands of the Federal Reserve. With the recovery again losing momentum and U.S. politics stalemated, many investors expect that the Fed will soon announce a third round of quantitative easing, where the central bank buys bonds to drive down long-term interest rates. It is unorthodox, controversial and necessary. The government can’t act, so the Fed has to.
Constitutional DesignEurope’s fiscal paralysis has a different cause: an argument about the EU’s constitutional design. The consequence is much the same. The ECB has to step up. It wasn’t easy for the Fed to enlarge its role in this way, and it will be even harder for the ECB, which operates under tighter legal restraints.
There’s no alternative. We will know one way or the other within days. EU leaders have a summit meeting scheduled at the end of the month. Supposing they can ride out the next week or so, could that produce a breakthrough? Don’t bet on it.
The EU’s political leadership understands that a Spanish default would be a cataclysm -- including for Germany, the principal architect of the no-policy policy and a country already exposed to enormous losses if the euro system unravels. Few deny that forceful action could avert the danger. They have known this for months, and still just stand there.
Ahead of the summit, it is unclear whether they are even discussing the needed remedies -- first, a banking union that creates a single mechanism for financial regulation, deposit insurance and bank reorganization; and second, some measure of fiscal burden-sharing, perhaps through the issue of jointly guaranteed euro bonds.
There is high-level support for the idea of a banking union someday, eventually, but no real sense of urgency. It requires legislation, goes the prevailing view. You can’t rush these things.
As for debt mutualization, Germany and like-minded northern European countries remain opposed in principle. No fiscal union without political union, says Germany -- an unpromising approach, considering that political union is the last thing Europe’s voters want to see emerge from this mess.
Recently Germany’s leaders have seemed more receptive to an idea put forward last year by a council of German economic experts for a so-called redemption pact. This would provide a measure of fiscal risk-sharing tied to strict rules and penalties for noncompliance. Even if this were the right design (which it isn’t, as I explained last week), it might require months of talks and legislative action.
ECB ToolsThe most the summit seems likely to do is start official consideration of the idea. That is no good, because the market’s patience is used up. If Europe’s governments refuse to act decisively and soon, the ECB will have to. Like the Fed, the ECB has the tools.
This is a question of propriety and legality, not economics. With big parts of Europe falling back into recession, unemployment high, wages suppressed and inflationary pressures minimal, the argument for stronger monetary easing is open and shut. The ECB should engage in large-scale quantitative easing. At the same time it can guarantee the solvency of Spain and Italy by acting as lender of last resort to their governments.
The ECB can deliver monetary stimulus and restore confidence in the distressed governments’ solvency at a stroke, without further debate or delay, so long as it is forceful enough.
What’s stopping it? When Europe’s monetary union was being designed, this kind of intervention was ruled out because the legitimate need for it was never envisaged. Central-bank financing of governments was seen as a formula for fiscal excess and uncontrolled inflation. History shows the danger is real.
Restricting the ECB’s discretion so tightly, though, was a huge error, because the EU lacks any other collective macro- policy machinery. The Fed was right to resort to unorthodox stimulus when conditions demanded it. The ECB must do the same.
Can it act without breaking the law? The spirit of the law rules it out. The letter is more accommodating. Bear in mind, the ECB has already done it on a small scale. Under its Securities Markets Program, the central bank bought Spanish and Italian debt last year; previously it had bought Greek, Irish and Portuguese government debt under the same plan. The ECB said the purchases weren’t direct financing of governments. The idea was to safeguard the money transmission mechanism, a proper ECB function -- an interesting distinction that nobody else understood.
Later the ECB rolled out its much larger liquidity relief operation -- again, to many, a form of QE. Instead of buying government debt, the ECB lent to banks at very low rates in the hope that they would buy the sovereign bonds instead. The maneuver worked for a while, and the legally questionable debt- buying program fell into disuse.
The time for this stratagem has run out. Providing cheap liquidity can’t deal with insolvency. The Securities Markets Program must be revived -- urgently and at scale. It is fine if Draghi says he is safeguarding the money transmission mechanism. Let him deny the purpose is to assure the solvency of Spain and Italy. Investors won’t believe him, so it won’t matter. The main thing is that he acts, because nobody else seems willing to, and Europe is in grave danger.