Europe ac­cord­ing to Draghi

Financial Mirror (Cyprus) - - FRONT PAGE -

Cen­tral bankers are of­ten proud to be bor­ing. Not Mario Draghi. Two years ago, in July 2012, Draghi, the pres­i­dent of the Euro­pean Cen­tral Bank, took ev­ery­one by sur­prise by an­nounc­ing that he would do “what­ever it takes” to save the euro. The ef­fect was dra­matic. This Au­gust, he used the an­nual gath­er­ing of top cen­tral bankers in Jack­son Hole, Wy­oming, to drop another bomb.

Draghi’s speech this time was more an­a­lyt­i­cal but no less bold. First, he took a side in the on­go­ing de­bate about the ap­pro­pri­ate pol­icy re­sponse to the eu­ro­zone’s cur­rent stag­na­tion. He em­pha­sized that, along with struc­tural re­forms, support for ag­gre­gate de­mand is needed, and that the risk of do­ing too lit­tle in this re­spect clearly ex­ceeded the risk of do­ing too much.

Sec­ond, he con­firmed that the ECB was ready to do its part to boost ag­gre­gate de­mand, and men­tioned as­set pur­chases, or quan­ti­ta­tive eas­ing, as a nec­es­sary tool in a con­text in which in­fla­tion ex­pec­ta­tions have de­clined be­low the of­fi­cial 2% tar­get.

Third, and to the sur­prise of most, Draghi added that there was scope for a more ex­pan­sion­ary fis­cal stance in the eu­ro­zone as a whole. For the first time, he ex­pressed the view that the eu­ro­zone had suf­fered from the lower avail­abil­ity and ef­fec­tive­ness of fis­cal pol­icy rel­a­tive to the United States, the United King­dom, and Ja­pan. He at­trib­uted this not to pre-ex­ist­ing high pub­lic debts, but to the fact that the ECB could not act as a back­stop for gov­ern­ment fund­ing and spare fis­cal au­thor­i­ties the loss of mar­ket con­fi­dence. More­over, he called for a dis­cus­sion among euro mem­bers of the eu­ro­zone’s over­all fis­cal stance.

Draghi broke three taboos at once. First, he based his rea­son­ing on the het­ero­dox no­tion of a pol­icy mix com­bin­ing mon­e­tary and fis­cal mea­sures. Sec­ond, he ex­plic­itly men­tioned the ag­gre­gate fis­cal stance, whereas Europe has al­ways looked at the fis­cal sit­u­a­tion ex­clu­sively on a coun­try-by-coun­try ba­sis. Third, his claim that pre­vent­ing the ECB from act­ing as a lender of last re­sort im­poses a high price – mak­ing gov­ern­ments vul­ner­a­ble and re­duc­ing their fis­cal space – con­tra­dicts the tenet that the cen­tral bank must not pro­vide support to gov­ern­ment bor­row­ing.

The fact that Draghi chose to con­front the or­tho­doxy at a mo­ment when the ECB needs support for its own ini­tia­tives is in­dica­tive of his con­cern over the eco­nomic sit­u­a­tion in the eu­ro­zone. His mes­sage is that the pol­icy sys­tem as it cur­rently works is not suited to the chal­lenges that Europe faces, and that fur­ther pol­icy and in­sti­tu­tional changes are nec­es­sary. The is­sue now is whether – and, if so, how – con­cep­tual bold­ness will trans­late into pol­icy ac­tion. There is less and less doubt re­gard­ing the ben­e­fits of out­right as­set pur­chases by the ECB. What was long re­garded as too un­con­ven­tional to be con­tem­plated has grad­u­ally be­come a mat­ter of con­sen­sus. It will be op­er­a­tionally dif­fi­cult, be­cause the ECB, un­like the Fed­eral Re­serve, can­not rely on a uni­fied, liq­uid bond mar­ket, and its ef­fec­tive­ness re­mains un­cer­tain. But it will most likely take place.

At the same time, there is lit­tle doubt that fis­cal pol­icy will fall short of Draghi’s wishes. There is no agree­ment in Europe on the con­cept of a common fis­cal stance, and the back­stop that the ECB could pro­vide to sov­er­eigns can be of­fered only to coun­tries that com­mit them­selves to a ne­go­ti­ated set of poli­cies. Even this con­di­tional support within the frame­work of the ECB’s so-called out­right mon­e­tary trans­ac­tions (OMT) pro­gram has been op­posed by Ger­many’s Bun­des­bank and con­sti­tu­tional court.

Draghi’s ini­tia­tive on this front should thus be in­ter­preted not only as a call for ac­tion, but also – and per­haps even more so – as a call for re­flec­tion on the fu­ture ap­proach to eu­ro­zone pol­i­cy­mak­ing. The ques­tion is this: How can the eu­ro­zone de­fine and im­ple­ment a common fis­cal pol­icy with­out hav­ing a common bud­get?

In­ter­na­tional ex­pe­ri­ence shows that vol­un­tary co­or­di­na­tion is of lit­tle help. What hap­pened in 2009 was a rare ex­cep­tion; shocks like that which fol­lowed the Lehman Brothers bank­ruptcy – sud­den, strongly ad­verse, and highly sym­met­ric – come once in decades. At the time, all coun­tries faced es­sen­tially the same is­sue, and all shared the same con­cern that the global econ­omy could slide into a de­pres­sion. Europe’s prob­lem to­day, though se­ri­ous, is dif­fer­ent: a sig­nif­i­cant sub­set of coun­tries does not have fis­cal space to act and would there­fore be un­able to support de­mand. And, though Ger­many is do­ing much bet­ter than any­one else and has fis­cal space, it does not wish to use it to ben­e­fit its neigh­bors.

If joint fis­cal ac­tion is to be un­der­taken, a spe­cific mech­a­nism would be needed to trig­ger it. One could think of a joint decision pro­ce­dure that would, un­der cer­tain con­di­tions, re­quire bud­get laws to be ap­proved by the na­tional par­lia­ment and a majority of part­ner coun­tries (or the Euro­pean Par­lia­ment).

Or one

could

think

of

a

mech­a­nism in­spired by the “trad­able deficits per­mits” imag­ined by Alessandra Casella of Columbia Univer­sity. In this sce­nario, coun­tries would be al­lo­cated a deficit per­mit con­sis­tent with the de­sired ag­gre­gate stance, but would be free to trade them; a coun­try will­ing to post a lower deficit thus could cede its per­mit to another one will­ing to post a higher deficit. In this way, the ag­gre­gate stance could be achieved while ac­com­mo­dat­ing na­tional pref­er­ences.

Any mech­a­nism of this sort raises a host of ques­tions. But the fact that the of­fi­cial in charge of the euro is rais­ing the is­sue in­di­cates that the common cur­rency’s ar­chi­tec­ture re­mains in flux.

A few months ago, the con­sen­sus was that the time for re­design­ing the euro had passed, and that the eu­ro­zone would have to live with the ar­chi­tec­ture in­her­ited from its cri­sis-driven re­forms. Not any­more. It may take time be­fore agree­ment is reached and de­ci­sions are made, but the dis­cus­sion is bound to re­sume. That is good news.

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