03 October 2012

Peterson Institute/Funk Kirkegaard: Protests, riots, rightists rage in Europe—But no ill effect

Funk Kirkegaard believes that concerns about the political stability of the euro area periphery are overblown, and that the main risk is that protests merely make governments less bold on needed reforms.

Two matters outside the euro area periphery have raised doubts that can be put to rest. First is the public scepticism voiced by the German Bundesbank and its president, Jens Weidmann, over the European Central Bank’s (ECB) new programme of bond purchases—known as outright monetary transaction, or OMF—to allay concerns about contagion... In reality, the Bundesbank’s criticism suits both Mario Draghi, president of the ECB, and Chancellor Angela Merkel of Germany very well. In their dealings with Prime Minister Mariano Rajoy of Spain, the role of “bad cop” falls to the Bundesbank. Indeed, the political benefits for all the German political establishment (not just Merkel) of the Bundesbank’s public defence of traditional German conservative monetary policies go further than helping to put pressure on the Spanish government to act. In practice, the Bundesbank’s opposition to the OMT programme is irrelevant, because the vote to adopt it at the ECB Governing Council was 22 to 1, over the Bundesbank’s dissent. In Congressional terms, the Bundesbank’s dissent is a “free vote” of no consequence, politically similar to the US House of Representatives Republicans’ 33 votes to repeal Obamacare.

But the Bundesbank’s lectures about printing money to help distressed banks and countries helps channel potential German conservative scepticism about European integration in a non-threatening direction. With the Bundesbank publicly lecturing the ECB (and the International Monetary Fund), there is less political space for other actors in Germany to make that case. Or put another way, the Bundesbank venting about ECB money printing preemptively takes the wind out of potential German populists by stealing some of their thunder as guardians of traditional German monetary policy virtues. This is important in a country where monetary and fiscal policy matters are never far removed from moral teachings. 

A second question relates to what the ECB might do if the OMT programme and a separate action revamping its collateral requirements fail to restore market confidence in the euro area. Will the creation of a credible backstop in the euro area prove sufficient? What happens if the divergent borrowing costs for businesses and individuals in the euro area persist because of backtracking in Spain and delays in the creation of the European banking union? Will such problems aggravate what Draghi has called “unfounded fears about the future of the euro area” on the minds of global investors?

Since early 2010, the ECB has shown that it has unparalleled coercive crisis management powers to nudge euro area governments in the direction it wants. But even if the ECB decides against unleashing the full force of the crisis to get euro area leaders to do their political homework, it retains a large arsenal of other measures. When the ECB launched the OMT programme, it said its goal was fulfil its original mandate and restore the monetary transmission mechanism—i.e. the setting of interest in a way that would let non-financial firms in every euro area country enjoy the same cost of borrowing. That day may be far off. But the ECB can lower financing costs for households and the non-financial sector in the euro area periphery by further loosening its collateral requirements to banks. This goal could be accomplished, for example, if it accepts highly illiquid collateral or buys more private financial assets, such as the €70 billion in covered bond purchases already acquired.

Full article

© Peter G Peterson Institute for International Economics