Europe vs. the ECB: A high-stakes game of chicken
By Neil Irwin,
Efforts to resolve Europe’s debt crisis are, at their core, an exceptionally high-stakes game of chicken, pitting the continent’s central bank against its national governments. Hanging in the balance: the entire world economy.
If an economic calamity is to be avoided, some Europe-wide entity probably will need to funnel money to Greece and other troubled nations and jointly guarantee the debts of the continent’s governments in a we’re-all-in-this-together show of solidarity. The great debate in Europe right now is over what entity will be stuck holding the bag.
The European Central Bank, the Frankfurt-based equivalent of the Federal Reserve in the United States, has the authority to print euros, can make cash available to banks and is led by a small board of highly trained financial experts who can make decisions on a moment’s notice.
In other words, the ECB has the tools and ability to take the kind of dramatic actions that could address the crisis. But doing so could undermine its position as an independent central bank, risk inflation in the future, work against democratic principles and remove pressures on national governments to make needed economic changes.
On the other side are the governments of Europe — 17 of them that use the euro currency alone, each with its own unique political structure, national interests and idiosyncratic government officials.
Even the vehicles through which these nations are supposed to jointly shape policy — the European Commission and European Union — can each seem like a confusing morass of interrelated bureaucratic entities.
Although everyone acknowledges it would be preferable for democratically elected leaders to make the moves toward economic unity that are the most promising solution for the crisis, it would be much more politically convenient for politicians if the unelected technocrats at the ECB would take those steps and become the channel through which Europe’s losses are realized.
Somebody is going to have to blink.
The ECB’s efforts to hold the line were evident Thursday as it declined to cut interest rates to try to address a weakening European economy. By contrast, the Bank of England expanded a program of buying bonds to try to push money into the British economy, a move known as quantitative easing. The bank on Thursday announced 75 billion pounds in new purchases. (Two weeks ago the Federal Reserve also eased monetary policy in the United States, further illustrating the deep concern within the U.S. and European central banks about the economy.)
“The economic outlook remains subject to particularly high uncertainty and intensified downside risks,” ECB President Jean-Claude Trichet said Thursday, raising the possibility that the ECB will ease monetary policy sometime in the near future.
“A very thorough analysis of all incoming data and developments over the period ahead is warranted,” said Trichet, who completes his eight-year term as bank chairman Oct. 31 and will be replaced by Mario Draghi, governor of the Bank of Italy for the past five years.
Under Trichet, the ECB has already bought hundreds of billions of euros worth of debt from financially troubled European nations to try to ease the crisis, causing discomfort to many in the central bank and eliciting steep opposition from German central bankers; the purchases were a major factor in the decision by two German members of the bank’s policy committee to step down in the past six months.
“As much as you have a financial crisis in Europe, both sovereign and banking, you also have an institutional crisis,” said Nicolas Checa, a managing director at McLarty Associates, a consultancy. “The governments are saying, ‘The only strong institution we have is you, so you need to deal with this,’ even though doing so goes against the very essence of the ECB and the legacy that Trichet has built.”
The whole situation is reminiscent of the 2008 crisis in the United States, when there was a basic tension within the government on who would undertake expensive but unpopular bailouts of financial firms. The Federal Reserve had the ability to take rapid, decisive action, given its unlimited ability to print money and flexible legal mandate. But the Fed undertook the bailouts of Bear Stearns and American International Group with considerable reluctance — and with the blessing of the Bush administration — because it viewed it as not the proper role of unelected officials at a central bank.
Bush’s Treasury Department, by contrast, lacked the legal authority or financial resources to move on bailouts until conditions got so bad that Treasury Secretary Hank Paulson was able to persuade Congress to enact the $800 billion Troubled Asset Relief Program. The legislation gave Paulson the requisite authority to rescue financial firms through more democratic — if still wildly unpopular — means.
In many ways, though, Europe faces an even more complex situation now than the United States did three years ago. After all, whatever the complexities of the U.S. Congress, it is one legislature, not 17. And Congress was not being asked to make sacrifices on the same scale that Europe is.
Italy is a prime example. Investors began selling off the nation’s bonds this summer, causing the interest rates it must pay to borrow money to skyrocket. The ECB feared that the sell-off could cause the continent-wide crisis to spiral out of control, so began it buying Italian bonds to keep keep rates from rising too high. But, as a condition, Trichet and Draghi sent Italian Prime Minister Silvio Berlusconi a detailed letter explaining the actions needed to make the Italian economy more competitive over the long run and reduce its indebtedness.
Berlusconi initially agreed to the proposed actions, and Italy enjoyed the benefits of lower rates thanks to ECB buying. But the Italian government soon backtracked, refusing to pass some of the provisions earlier discussed. The ECB, in turn, backed away from its purchases, prompting a rise in interest rates, which in turn got the Italian government back on track.
“The ECB is worried that if it does too much, the Italians will backtrack on structural reforms,” said Joe Gagnon, a senior fellow at the Peterson Institute for International Economics. “It’s a game between the ECB and the Italians, ‘we’ll help you, but help yourself first’; ‘you go first,’ ‘no, you go first.’ ”
But the dynamic isn’t limited to Italy and other nations, like Spain and Portugal, that have faced difficulty funding themselves. Just as those nations have looked to the ECB to support their debt with as few strings attached as possible, nations with more sound finances, notably Germany and neighbors like the Netherlands and Austria, have looked to the central bank to bear the cost of bailouts, rather than their taxpayers directly.
The split is one reason why Chancellor Angela Merkel did not turn to any representatives of the German central bank, the Bundesbank, when a slot opened up on the ECB board last month. She opted instead for a German finance ministry official. Bundesbank officials were opposed to the bond purchases.
In theory, the ECB’s bond buying program is only temporary, to be supplanted by an expanded program created by the governments of Europe, known as the European Financial Stability Facility. But even once all 17 nations approve the expansion of that fund to 440 billion euros, it might not be enough to provide the backstop that will ultimately be needed to assure global investors that Europe stands together.
Some say the contributions by individual governments to the facility should be viewed as an initial investment, with more money then being borrowed to ensure that the fund has the trillions of euros available needed to guard against any new wave of crisis.
One way to do that would be for the stability fund to issue debt, which the ECB could buy. But the central bank is resisting those calls, reluctant to find itself in the position of permanently backstopping what the continent owes.