The ECB is Open to Extending Its Role in Debt Crisis

Mario Draghi has become explicit about what it will take for the ECB to have a more active role in the European sovereign debt crisis. Addressing the European Parliament in Brussels, Draghi said:

“what I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.”

This statement is the clearest indication that the ECB will in fact take on a more prominent role in dealing with the crisis only if it sees meaningful fiscal consolidation and integration. Draghi also indicated that the ECB will cut rates later this month.

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On Tuesday, I said that the likely policy path for European sovereign debt crisis would be a deal whereby countries that have deficit problems would agree to allow European oversight of their future budgeting process in exchange for some kind of supranational support. Indications are that Germany and France are trying to hammer out an agreement on specifics but reports indicate that the two countries are still far apart.

In yesterday’s weekly, solutions in Europe figured prominently. At the moment there are five competing and complementary ideas that are being bandied about as short- and long-term fixes.

  1. Fiscal union. This is a must. The ECB will not act without some credible degree of fiscal integration. And the ECB has come to be critical in dealing with the banking sector where liquidity has dried up because of bank exposure to weakening sovereign debt.
  2. ECB liquidity. With banks now able to borrow for less than the sovereigns that have kept them from failing, it is clear that the sovereign debt markets have frozen. Once a credible form of fiscal integration or a path to integration is achieved, the ECB is expected to support euro area banks by taking on a lender of last resort role to unfreeze sovereign debt markets in Italy, Spain, Belgium and France. How any intervention would take place is unclear.
  3. Eurobonds. This subject is still taboo. In public all of the German coalition officials voice great opposition to collectivised European debt. However, behind the scenes nothing has been ruled out. In fact, leading politicians from a number of other countries are now jumping the fence on this issue. Outgoing Bundesbank head Juergen Stark explained his support for Eurobonds only after fiscal union. And Austrian daily Kurier reports that Austrian finance Minister Fekter now also supports Eurobonds only “when everyone is disciplined” in their public finances.
  4. Austerity: What is clear then is that any fiscal integration will require fiscal discipline aka austerity and this in turn is the prerequisite for any imminent ECB liquidity and for Eurobonds over the medium-term. Yes, budget cuts will deepen the recessions in the periphery. But, there is no way around it; politically, no solution in Europe will unlock the sovereign debt crisis without fiscal consolidation. All of the political leaders are aware that this is so.
  5. IMF: The talk of the IMF as a lender of last resort for sovereigns continues. I continue to see any imminent real IMF involvement as unlikely. The IMF simply does not have the funds to bailout large developed economies, nor is that their mission. Politics in the US would rule out any solution that required the US to contribute to the IMF to help bailout Spain or Italy. If any IMF-oriented solution comes into being, the IMF would only be used as a fig leaf, and the true paymaster would be the ECB.

What I see happening now is an attempt to cobble together a credible enough form of fiscal integration or a credible enough commitment to it to allow the ECB to intervene while a more permanent structure is implemented. If the Europeans get that far, only then would Eurobonds enter the picture.

All of this is still very much up in the air. Still, markets now expect some sort of reasonable solution within days. But will they be disappointed?

Also see: Draghi hints at eurozone aid plan in the FT

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8 Comments
  1. Oz says

    Ed,

    Its certainly true that fiscal union seems the only true solution.  But what’s really the chances of all nations agreeing to give up this much sovereignty if they truly understand the implications? 

    As an example I’ve been pondering – Greece has a big army.  Would it really cede its power to decide how much it spends on military?  This would of course be part of a true fiscal union – allowing the Germans etc to say “no…you’re not buying those new tanks”.  It all just seems impossible – maybe they agree for now…but it only makes the hatred of the Euro and its leaders worse in the longer term as individual nations reslise what they’ve done.

    1. Anonymous says

      Would the Greek army be willing to accept huge cuts imposed on it from some foreigner? How would they react? Next there will be the issue of who runs the budget and how they are picked. Then how will they force the cuts through? With German tanks on the streets of Athens? That will go down very badly, throughout Europe, because who will be next?

      1. Oz says

        Indeed – that’s my view.  This is a step in the wrong direction for social harmony – it could backfire in a major way…

        1. Anonymous says

          They are panicking so decisions are not being thought through properly. My concerns are with the 99% in Greece and elsewhere. They are paying for the mistakes of the elite and numerically that is unsustainable. It is the sort of policy making that makes revolutions and civil wars a higher probability. So I am not anti euro, it has some very good merits, but some system that allows rebalancing is essential. And impoverishing the Greeks to save a few germans a tax rise is not going to work. 

  2. Oz says

    Ed,

    Its certainly true that fiscal union seems the only true solution.  But what’s really the chances of all nations agreeing to give up this much sovereignty if they truly understand the implications? 

    As an example I’ve been pondering – Greece has a big army.  Would it really cede its power to decide how much it spends on military?  This would of course be part of a true fiscal union – allowing the Germans etc to say “no…you’re not buying those new tanks”.  It all just seems impossible – maybe they agree for now…but it only makes the hatred of the Euro and its leaders worse in the longer term as individual nations reslise what they’ve done.

    1. Anonymous says

      Would the Greek army be willing to accept huge cuts imposed on it from some foreigner? How would they react? Next there will be the issue of who runs the budget and how they are picked. Then how will they force the cuts through? With German tanks on the streets of Athens? That will go down very badly, throughout Europe, because who will be next?

      1. Oz says

        Indeed – that’s my view.  This is a step in the wrong direction for social harmony – it could backfire in a major way…

        1. Anonymous says

          They are panicking so decisions are not being thought through properly. My concerns are with the 99% in Greece and elsewhere. They are paying for the mistakes of the elite and numerically that is unsustainable. It is the sort of policy making that makes revolutions and civil wars a higher probability. So I am not anti euro, it has some very good merits, but some system that allows rebalancing is essential. And impoverishing the Greeks to save a few germans a tax rise is not going to work. 

  3. Dave Holden says

    Democracy looks like being revealed as a facade and in a way westerners are not used to. We’re used to the distortion of moneyed politics (particularly of the broken type practised in the US) but that usually moves in tandem with the electoral cycle. This seems like something very different, where apparently democracy is so subordinate to finance that elected heads of state can be removed in weeks if not days.

    Fundamentally my gut tells me this isn’t sustainable and that we are headed for a EMU split.

  4. Dave Holden says

    Democracy looks like being revealed as a facade and in a way westerners are not used to. We’re used to the distortion of moneyed politics (particularly of the broken type practised in the US) but that usually moves in tandem with the electoral cycle. This seems like something very different, where apparently democracy is so subordinate to finance that elected heads of state can be removed in weeks if not days.

    Fundamentally my gut tells me this isn’t sustainable and that we are headed for a EMU split.

  5. Norme says

    Does this mean Greece, Italy, and Ireland are out? France, too. Will the EC be monitoring only German and Finish budgets?

    If they need a quick first step to fiscal integration, the ECB needs to loosen the money supply. The emphasis on their “independence” we hear in speeches all the time sounds like the go ahead “wink wink.”

  6. Norme says

    Does this mean Greece, Italy, and Ireland are out? France, too. Will the EC be monitoring only German and Finish budgets?

    If they need a quick first step to fiscal integration, the ECB needs to loosen the money supply. The emphasis on their “independence” we hear in speeches all the time sounds like the go ahead “wink wink.”

  7. bena gyerek says

    competitiveness? trade imbalances? debt overhang? hello?

    1. Norme says

      Ah, oh that! Yea, so much has happened we seem to forget that. LOL

  8. bena gyerek says

    competitiveness? trade imbalances? debt overhang? hello?

    1. Norme says

      Ah, oh that! Yea, so much has happened we seem to forget that. LOL

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