04 April 2012

Bernard Delbecque: The ECB’s proportionate response to the eurozone crisis

This column reviews the criticisms against the ECB's longer-term refinancing operations, and assesses whether the ECB should have intervened directly in the sovereign debt markets instead of providing funding to banks.

Despite positive developments, three main criticisms have been made of the LTROs:

• Moral hazard: The liquidity injections in the banking system created moral hazard problems that are more dangerous than those resulting from direct ECB intervention.

• Excessive liquidity provision: Because banks channelled only a fraction of the liquidity they obtained from the ECB into the government bond markets, the ECB had to pour much more liquidity into the system than if it had decided to intervene itself.

• Limited chance of success: The austerity programmes imposed by the European Commission are pushing the peripheral eurozone countries into a deep recession that will exacerbate their fiscal problems and will create renewed distrust in financial markets. As a result, the sovereign-debt crisis will explode again.

Conclusion

The ECB’s banking liquidity operations have been instrumental in breaking the negative spiral, averting a credit crunch, restoring confidence and bringing risk premiums back down. This does not mean that the exit from the crisis has been reached. The ECB has just bought time for the weakest countries to carry on their adjustment efforts. In this context, it would be good if these countries would make best use of the window of opportunity to strengthen their economies.

In parallel, the eurozone leaders should be concerned about the warnings that too little efforts will be made by banks to become less dependent from ECB financing and that the austerity programmes could push the peripheral eurozone countries into a deep recession. They should also agree to boost the funding of the European Stability Mechanism – the successor of the European Financial Stability Facility – to make sure that the eurozone rescue fund is big enough to help countries like Spain or Italy, if need be.

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