13 September 2012

Paul de Grauwe: The ECB, the OMT and austerity

Last week Mario Draghi announced that the ECB would become the eurozone's lender of last resort by starting to purchase the sovereign bonds of the area's stricken economies. De Grauwe addresses two major criticisms of the plan in his article for Social Europe.

I have heard and read a lot of criticism against the decision of the ECB. I also have my share of criticism but more on that later. First I want to counter two of the most frequently raised points of criticism.

There was a lot of criticism to the effect that the bond purchases do not solve the fundamental problems of these countries, and therefore that the ECB is wrong to want to solve these problems by throwing money at them. The first part of this criticism is correct, the second part is wrong. It is true that the intervention of the ECB does not tackle the fundamental problems of these countries. But does this mean that the interventions of the ECB are not needed? Not at all. There is confusion between what is necessary and what is sufficient. The interventions of the ECB are necessary to prevent worse. Of course they are not sufficient to permanently save the Southern countries and to avoid a breakup of the eurozone. In order to prevent the latter, structural reforms will be necessary. The interventions of the ECB are necessary but not sufficient. An important distinction that to my surprise seems to have been forgotten by many critics.

A second criticism that I heard in Germany and other Northern European countries is that these interventions will lead to inflation. This criticism is based on a fundamental misunderstanding about what’s going on today. We are still in a financial crisis. This is characterised by the fact that after the excesses of the wild bubble years, financial institutions have become very risk-averse, and only sparsely grant credit to companies and households... The fear that in such an environment the interventions of the ECB will lead to too much inflation, reminds me of the generals who are preparing for the last war.

The absence of an inflation risk today is also apparent from the following. The liquidity created by the ECB (which economists call the “money base”) does not seep through into the real economy. The banks are piling up the liquidity without doing anything with it. The extra cash injected into the financial system does not lead to more bank credit or to an increase of the money supply. And it is the latter which is important for inflation.

I now come to my criticism of the ECB. The latter has made the purchase of government bonds conditional on further budgetary cuts in Southern countries. Most of these countries have made dramatically deep cuts. We now know that all too impetuous cuts are counterproductive, and can push countries into an economic and social abyss. Thus, one can hope that the ECB will use common sense and will not ask the Southern countries first to jump into the abyss before it helps them out with more cash.

Full article

© Social Europe