The recent ECB Governing Council turned out to be something of an anti-climax. Mario Draghi created huge expectations when he stated one week before that the ECB would do ‘whatever it takes to save the Euro’. It was hoped that the ECB would finally step in from the sidelines and send a strong signal to markets: Euro Area member states and their finances would no longer be standing on their own but would be actively backed up by the ECB’s massive and unlimited liquidity, in the same way the sovereign debt of the United States, Japan or the UK is being supported by their respective central banks. Further speculation and intra Euro capital flight would become pointless since sovereign debt markets across the Euro Area would be effectively stabilized by the ECB.
What markets and the Euro Area actually got is a statement saying that the ECB may undertake open market operations of an adequate size provided a list of conditions are fulfilled: governments need to push ahead with fiscal consolidation, structural reforms and European institution building (and this with ‘great determination’). Moreover, governments need to ask the EFSF/ESM to buy sovereign debt and this, again, must be linked with ‘strict and effective conditionalities’.
It is difficult not to see this statement as an attempt to kick the ‘hot potato’ back to governments. After all, governments have already delivered, both on fiscal consolidation as well as on structural reforms. In fact, the Euro Area is back into recession, precisely because governments are sticking to excessively rapid fiscal consolidation and have opened up the wage race to the bottom by deregulating labour markets and wage formation institutions. If the ECB is still hesitating after governments have dismantled the social dimension to such an extent, then what else are they waiting for?
In any case, the ECB statement does not seem to be able to convince financial markets. Remember that , last week, markets had pushed up interest rates on Spanish and Italian sovereign debt to record highs of 7,5 and 6,5% and that spreads and interest came back down after Mario Draghi’s famous intervention claiming to do ‘whatever it takes’. Following Draghi’s press conference, yields on Spanish and Italian debt climbed up again reaching 7,2 and 6,2% respectively. If the ECB does not put up the money to back up its statement, then all that it achieved was to get exactly one week of respite from market turmoil.
Finally, it needs to be stressed that the single currency’s suffering will not end even if the ECB does start to massively buy sovereign debt. To get us out of the mess we are in, two additional actions are necessary. First, the policy of ‘austerity’ needs to be stopped so as to prevent the prospects for the real economy from deteriorating even further. Second, the economy needs to be kick- started into renewed growth by setting up a major European investment initiative. In this way Europe can, at the same time, grow out of unemployment, deficits, debt and imbalances.
However, this is clearly not what is on the ECB’s mind. On the contrary, it is the ECB’s explicit intention to continue with contractionary fiscal policy and social deregulation even in the midst of the recession. This will not work: Overly tight fiscal policy will still yield disastrous outcomes for the economy and the labour market, even if things would be much worse if the ECB was not buying up sovereign debt.
Moreover, with markets observing the continuing collapse of Euro Area economies – particularly in the periphery – the ECB’s program of open market purchases will be perverted and used by markets as a unique possibility to cash in on what have become risky investments in peripheral economies and invest instead in “hard” euro deposits in the core. Far from restoring what the ECB calls the transmission channels of monetary policy in the periphery, capital flight will continue and the peripheral banking and credit system will bleed to death. The ECB and financial ministers do not like it but the fact is that there is no way around the fact that growth and investment focused demand policies are essential to set the single currency back on track. Any attempt to save the euro that does not take the dimension of growth and adequate, counter cyclical demand policies into due account, is bound to fail.
 August 2012