EAST WEST - SuperMario!
Europe is increasingly addicted to SuperMario.
- Tuesday, 21 April 2015
The most significant political objective the European integration process has achieved in the last three years has been to merge the roles of the president of the Central Bank and a European-level finance minister. Not formally, but in practice…
When an Italian was installed in the Eurotower in Frankfurt on 1 November 2011, a shiver of uncertainty ran down the spines of Europe’s foreign ministries. No one was sure whether the Italian would slavishly comply with Berlin’s wishes or instead shown signs of the incompetence that the press in Northern Europe often unfairly attribute to those in charge of institutions in Italy.
However, these doubts could only arise in the minds of those unacquainted with Mario Draghi. As representative for the Italian Ministry of Foreign Trade on the board of Italy’s Export Credit Agency (SACE), I had a chance to meet Draghi in 2000 when I served on various boards chaired by the then director general of the Italian Treasury. I can still recall the highly competent and authoritative way the meetings were handled and their extremely efficient use of time. One-hour meetings that always produced exemplary decisions. The same could not be said of meetings chaired by president Draghi’s director general colleagues when he was unable to attend. The length of the meetings doubled or even tripled and many thorny issues were left unresolved.
In fact, in keeping with his authority and reputation, the first meeting of the board of the European Central Bank (ECB) chaired by Draghi was marked by an historic and entirely unforeseen decision: a 0.25% cut in interest rates, even though annual inflation was running at more than 3% at the time, way above the ECB’s statutory target. This was a complete reversal for Eurotower policy compared to the interest rate hikes the institution had applied until as late as July 2011. But the results proved the decision was a good one! And the decision was even approved by Germany, adding kudos to Draghi’s political stature.
Let’s now skip from the first to the latest of his brilliant initiatives. On 22 January this year, he announced that Frankfurt was about to engage in a quantitative easing (QE) program. With interest rates close to 0% and thus no longer a weapon in the ECB's armoury, it has opted to use this unconventional tool to relaunch the economy. The purchase of sovereign bonds (and other assets, such as private sector securities) that would reduce the cost of borrowing and stimulate loans and investments. The overall figure for the bond-buying package (roughly 12% of Europe’s GDP) amounts to €1.1 trillion, divided into monthly purchases of €60 billion starting from March 2015 until at least September 2016.
Indeed, the ECB has committed to continuing this purchase package until there is a sustained adjustment in the eurozone’s path of inflation to reach the original target of just below 2%. In fact, the main aim of the plan is not to reduce the divergence between government bond yields – the Outright Monetary Transactions (OMT) Programme was launched almost three years ago to do that. Rather, it is to counter the risk of deflation in the eurozone by increasing aggregate demand. The use of this unconventional monetary policy tool (a complicated way of saying that Europe is finally adopting a centralised economy policy) will undoubtedly lead to a swifter and more decisive recovery.
What’s more, since QE leads to a rise in the price of public bonds, it should push investors to stop buying these bonds and move their money elsewhere, selling euros to buy other currencies. This produces a depreciation of the euro (the euro/dollar exchange rate should fall to around one dollar per euro during 2015) that should bring about a rise in exports, an increase in production and consequently a surge in employment.
More generally, it will lead to higher growth than originally forecast: 1.5% in 2015, 1.9% in 2016 and 2.1% in 2017, according to the ECB’s own estimates.
The fact that the ECB is successfully managing to stimulate virtuous growth processes proves that when European policies are entrusted to an independent and supranational institution, Europe is able to come up with strong responses that are effective for everyone.
In recent years, Draghi has done everything possible (perhaps overstepping his mandate even) to salvage the integrity of the monetary union and push European markets towards an inevitable integration. Before the aforementioned quantitative easing, it is worth recalling the now famous speech Draghi made in London in July 2012 (the notorious “whatever it takes” referred to the OMT programme): “The ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough!” The mere announcement of being ready to do whatever it takes, with the ECB not spending a single euro at the time, was enough to bring about a drastic reduction in the difference in sovereign bond prices within the eurozone. And you need someone with the kind of reassuring attitude like Draghi's if you are to obtain such decisive results.
But resolving the eurozone’s problems cannot be left solely in the hands of the ECB president and his unconventional monetary policies, justified though they may be by the exceptional circumstances. There needs to be a wider political plan that foresees greater European fiscal integration for the future.
And for that you need politics, baby!