Eurozone Crisis Monitor: Update on the Debate
On September 6, Mr. Mario Draghi, President of the European Central Bank, announced an Outright Monetary Transaction programme (involving potentially unlimited bond purchases), in order to “address severe distortions in government bond markets” and to provide “a fully effective backstop to avoid destructive scenarios”. He stressed, by the way, that “the euro is irreversible”. [Press Conference Statement]
At about the same time, the Commission issued a proposal for a European banking union and the German Constitutional Court upheld the European Stability Mechanism, Europe’s bailout fund. To many, these developments signalled a turn in the right direction in the management of the euro-crisis. They also seemed to pacify financial markets, as Spanish and Italian bond yields fell.
Kemal Derviş, Vice President and Director of the Global Economy and Development program at the Brookings Institution, had already pointed out that for such a program to succeed “a decisive change in the macroeconomic policy mix throughout the eurozone” would be required. More recently, in an article entitled “Back to the Brink for the Eurozone?” (10/10/12), Derviş stressed that although “there has been some progress, albeit slow, toward agreement on the institutional architecture of a more integrated eurozone … there has been virtually no progress at all … in the recalibration of the macroeconomic policy mix”: Europe insists on a pro-cyclical strategy of excessive austerity and internal devaluation that is producing a “deflationary spiral”, thwarting the efforts to curb deficits and the debt/GDP ratio. He points out that the enormous combined current-account surplus that northern European countries are running at the same time “subtracts net demand from the rest of Europe and the world economy”. He warns against the fallacy of the rationale behind this (increased competitiveness in the global market), arguing that “surplus countries must contribute no less than deficit countries to global and regional rebalancing, because the world economy cannot export to outer space”. Insisting on such policies, he fears, could “bring about the end of the eurozone”.
Yanis Varoufakis, a Professor of Economics and one of the most vocal and eloquent critics of the Eurozone’s crisis management policies, has tried to assess the credibility and viability of the OMT scheme in a series of three brilliant posts on his blog under the general title “Europe’s Modern Titanomachy” (Part A, Part B, Part C). His view is that “all depends on whether bond market participants take a look at it and decide that it will not pay them to bet against its integrity”. His conclusion is that “the OMT conditionality constraints, if imposed, guarantee that the Eurozone’s Periphery will continue along its present path toward” catastrophe, because “Italy and Spain … will apply for an ESM-EFSF-OMT program only when their situation is so desperate that their commitment to deficit reduction … lacks credibility, in turn wrecking the ECB’s own credibility regarding the threat to discontinue an OMT program when deficit reduction falls through” (as a decision to withdraw OMT support might well be tantamount to suicide for the eurozone and “no ECB President can convince politicians that he will prefer to pull the plug on an OMT program, rather than find a rationale to continue with it, if their fiscal targets are continually missed and they relent in their implementation of increasingly harsh austerity”).
Wolfgang Munchau, the Financial Times columnist and associate editor, agrees that “trouble is already building that may soon destroy the OMT’s credibility”. (“QE would be right for Europe, too”, FT, 16/09/12). Is it just a “confidence trick”? Munchau thinks that “there are good political reasons that stop elected politicians from applying for the OMT”. And even if current leaders do apply, what happens if a newly elected government tries to “tweak the reform process”? Will the ECB be willing to withdraw its support? As Varoufakis says, “when I threaten my daughter that I shall stop breathing till I die unless she does her homework, she has every reason to ignore me, knowing that, if she does not do her homework, I will be far worse off if I carry out my threat”. Hence, Munchau worries that “we might be damned if the OMT works and damned if it does not”. He urges quantitative easing, as a monetary stimulus, to counteract the effects of pro-cyclical austerity policies and “halt a self-reinforcing crisis”.