Will the ECB bazooka follow the US example?
by Francesco Guarascio
The European Central Bank is ready to use its monetary bazooka, as the United States Federal Reserve does in emergency situations - but member states states first have to accept tighter and common fiscal rules, before this can happen
The first speech that the new ECB President Mario Draghi gave to the European Parliament last week, in Brussels, was by no means a strategic plan for his eight-year term. It was, instead, a landmark speech - full of key messages on the future role of the eurozone and the central bank - dotted with powerful historical references. The most important and far-reaching citation was the call for a "new fiscal compact", which would imply "a fundamental restatement of the fiscal rules, together with the mutual fiscal commitments, that euro area governments have made," Draghi said. "It is first and foremost important to get a commonly shared fiscal compact right," he added: "Confidence works backwards - if there is an anchor in the long term, it is easier to maintain trust in the short term. Other elements might follow, but the sequencing matters." He was clearly hinting at the helping hand that the ECB would offer, provided that member states do their homework.
Before assessing the possible ECB interventions embraced in the sibylline statement indicating that "other elements might follow", it is important to understand why Draghi used the old-fashioned expression "fiscal compact" to call for a tighter economic union among eurozone member states. He could instead have used dozens of other words, much more fashionable in these times - such as deal, pact, agreement, contract, compromise or even treaty. He could also have just referred to a new fiscal union, echoing the expression used on several occasions by German Chancellor Angela Merkel. Compact is an unconventional and rarely used word in political and economic circles, in recent decades. To find relevant precedents, we have go back deep into history. The word appears in the US Constitution, in the section outlining the limits of the member states. "No state shall, without the consent of Congress enter into any agreement or compact with another state, or with a foreign power," reads article one of section 10 of the American legal founding text. In short, this article reasserts the ultimate powers of the central federal government.
Another erudite reference to the word compact also comes from American, and notably from the father of US federalists Alexander Hamilton. "The origin of all civil government, justly established, must be a voluntary compact, between the rulers and the ruled," he wrote in 1775. It was the year when the American colonies joined together to fight against British rule – a move that later brought the birth of the US in 1789. Draghi's citation of Hamilton comes as the name of the first US Secretary of the Treasury is starting to crop up again and again in Brussels' debates. European Finance Commissioner Olli Rehn, at the end of November, referred to Hamilton when launching his long-awaited proposal on Eurobonds. Hamilton managed to pool together the debt of the original member states, therefore, strengthening the power of the federal government and - as Rehn remarked - composing "the foundations for the federal economic government of the US". Eurobonds can, then, be assimilated to Hamilton's move as they would partially "mutualise" the debt of eurozone members. Rehn believes in this historical parallel so much that he proposed it during the public deliberation of the council of European finance ministers meeting - held in Brussels last week. This caused ministers to debate Eurobonds, even though the topic was not formally on the summit's agenda.
By indirectly referring to Hamilton's compact, is Draghi making an overture about the idea of Eurobonds? Maybe this interpretation of his cryptic words is going too far, for the moment, but it certainly shows a very different approach to his predecessor Jean-Claude Trichet - who never missed an opportunity to rule out Eurobonds. Instead, Draghi spoke of the new wide-ranging "fiscal compact" during a debate in which he had to answer a number of MEPs questions about Eurobonds. "A new fiscal compact would be the most important signal from euro area governments for embarking on a path of comprehensive deepening of economic integration," Draghi said, making clear his intentions. And what more than Eurobonds can deepen the eurozone's economic integration? Whether Eurobonds are included or not, a tighter fiscal union is the prerequisite for the ECB to eventually use its so-called "bazooka" – which is what Draghi refers to when he says that "other elements might follow". This monetary bazooka would probably imply an unlimited purchase of sovereign bonds to stabilise their yields, as the US Federal Reserve did in 2009 - in the middle of the US sub-prime crisis. The Swiss Central Bank took similar steps recently by buying Swiss Francs to fix the value of its national currency, which has become overvalued as a reserve asset in the current crisis.
Both actions were dramatic, but successful. The ECB might do the same, given that its current limited bond-buying programme has clearly not been helping the eurozone's weakest members sufficiently. It is true that Draghi underlined in his speech that bond purchases were "not eternal and are limited" - but this seems more of a warning to member states, urging them to maintain the momentum of their reforms; rather than a pledge to end the controversial programme. When he was appointed as the chairman of the ECB, Draghi gave the impression of being a strange creature with Italian origins - but German inflexible attitudes. Now that he is based in Frankfurt, he seems to be doing the opposite and turning into a pragmatic Italian of German origins – finally.
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