06 May 2013

ECB/Draghi: The euro, monetary policy and reforms

In order to reassure banks that access to central bank liquidity would indeed be extended in line with their refinancing needs in the medium term, we extended the maturity of our credit lending from the standard three months pre-crisis, to six months after the collapse of Lehman Brothers, to one year by mid-2009 and, finally, to three years at the end of 2011.

From the second half of 2011, we witnessed the emergence of a new source of stress, which has been defined as the risk of “redenomination”, resulting from the potential exit of a country from the euro or even from the potential collapse of the single currency. A particular form of credit risk premium was associated with these possibilities, which was unrelated to the assessment of a borrower’s solvency but which, in fact, came about owing to unfounded concerns regarding a systemic breakdown in the euro area. The ECB therefore launched the OMTs (Outright Monetary Transactions), a monetary policy instrument aimed at eliminating the financial risk premium caused by this specific systemic risk.

OMTs allow the ECB to buy sovereign bonds with a remaining maturity of up to three years in the secondary market, where necessary in order to remove the risk of “redenomination” (i.e. the risk related to concerns about the end of the euro) from the financial markets. The bond-issuing governments which request the activation of OMTs agree, in conjunction with the European authorities and, if possible, with the International Monetary Fund, on a recovery programme to address macro-economic and structural weaknesses. This is a necessary, but not sufficient, condition as the ECB has full discretion to decide on the start, continuation or suspension of OMTs. Furthermore, the excess liquidity created by these purchases will be reabsorbed by the ECB.

The conditionality associated with the programme to which governments and the European authorities agree is a crucial element in being able to preserve monetary policy independence. It is important in providing the ECB with adequate assurance that interventions supporting sovereign debt bond prices do not mutate into financial subsidies for unsustainable national policies in the medium term.

By way of drawing a parallel between OMTs and our standard liquidity operations: as the credit provided to banking counterparties cannot be, and must not be, interpreted as an injection of capital into failing banks; in the same vein, under OMTs, in compressing the premium for the risk of “redenomination”, the ECB cannot and does not intend to provide financial support to governments which reinstate solvency conditions which have not already been approved ex ante.

In both cases, the ECB’s non-standard measures were triggered by the need to restore the functioning of monetary policy transmission channels, first by reducing liquidity premia and then by reducing the redenomination risk premium.

Fiscal policies must follow a sustainable path, separate and distinct from cyclical fluctuations. Without this prerequisite, lasting growth is not possible. Particularly for countries with structurally high levels of public debt, rather than temporarily high levels as a result of the current crisis, this means not slipping back from the goals already achieved. Let us not forget that, in an institutional context in which the solvency of sovereign states is no longer an established fact and the governance of the Union is still incomplete, when a country’s public finances lack credibility its banks are quickly cut off from the rest of the euro financial market in the absence of private sector credit in that country: this is what we are now seeing.

There are a number of tools governments can use to achieve this aim, but first of all social cohesion must be sought by removing the barriers which limit individuals’ opportunity to pursue their goals and which allow family background to dictate life choices. In eliminating vested interests in a non-competitive system, structural reforms are more than just a tool for growth creation. By encouraging everyone to be involved in the process of production, they ensure that the drive for a more equal income allocation is not the task of state-led redistribution alone. In this way, reforms aim to harness individual potential to the growth of the economy.

Full speech

© ECB - European Central Bank