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True enough, when the ECB intervenes directly in the bond markets, moral hazard risk is created because governments may have fewer incentives to reduce budget deficits. However, this risk has been reduced significantly in the new institutional environment, which gives considerable power to the European Commission to impose austerity programmes. It is a power the Commission has happily embraced to impose excessive austerity in the eurozone and to drive it into a recession.
The LTRO programme has relieved the pressure in the sovereign debt markets of the eurozone. But this is only temporary. The peripheral eurozone countries are now pushed 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, forcing the ECB to make hard choices. Either it will stick to its indirect LTRO approach, giving cheap money to trembling banks with all the problems this entails. Or the ECB will become pragmatic and intervene directly with a steady hand in the government bond markets.
It is often said that Germany will never accept such direct interventions. Today this German opposition is difficult to overcome, and explains why the ECB reverted to the indirect LTRO programme.
It would help if these German opponents liberated themselves from the damaging dogma that it is a sin to create liquidity to buy government bonds when these bonds appear on the ECB’s balance sheet – while believing that the same operation is virtuous when these bonds appear on the balance sheets of banks.
What is politically impossible today may, in the end, be accepted when it becomes obvious that direct intervention is the only way to save the eurozone.
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