The One-Two Punch to Put Europe Back on Its Feet
A year ago, Europe’s sovereign debt problem reached the crisis stage. Since then, troubled governments have had to pay interest rates on bonds that have pushed them to the brink of insolvency.
European banks, holding much of that debt, are woefully undercapitalized. The European Central Bank practically gave away $1.2 trillion to banks to prod them to lend again, which they mostly haven’t. Greece defaulted on its debt, forcing bondholders to accept heavy losses; it also had to beg for a second bailout, destroying an already weak economy in the process. Heads of state toppled in France, Greece, Italy, Portugal and Spain. Spain sought a rescue package; Italy might yet need one.
None of the steps taken by European officials have been big or bold enough to convince the markets that the crisis is contained. Meanwhile, Europe is crumbling. On Tuesday, unemployment hit its highest level ever at 11.2 percent, or nearly 18 million people, in the 17-nation euro area. Joblessness among those younger than 25 in the currency bloc is 22.4 percent.
Economic activity has ground to a halt. Euro-area banks report declines in corporate demand for loans. Savings and investment are fleeing Greece, Italy and Spain, where they are most needed, for the safer confines of Germany, where three-year notes pay below-zero rates.
This is the desultory scene facing the ECB’s governing council as it meets Thursday. A credible course correction is desperately needed. Various market analysts think the central bank will restart a moderate government bond-buying program that has been inactive for four months. The ECB had purchased about 210 billion euros ($258 billion) of sovereign debt on the secondary market, but resuming that program alone isn’t what we mean by big and bold.
What’s needed is a one-two punch, in which the ECB continues its bond buying, supplemented with purchases by the European Union’s temporary bailout fund, the European Financial Stability Facility, and its permanent successor, the European Stability Mechanism. The twin actions would help make borrowing affordable again for Italy and Spain. This would also solve a structural flaw in the euro area’s design: The ECB can’t intervene in primary bond markets, where governments finance themselves by selling bonds to banks and investment firms, and where borrowing costs are determined. The EU’s bailout funds, however, can step in -- they can buy government debt in the primary market and impose conditions on the countries that borrow.
The rescue funds are limited only by the size of their firepower, now about 500 billion euros ($615 billion). Access to ECB money could change that. All the central bank would have to do is grant the permanent rescue fund, the ESM, a banking license that allows it to borrow from the ECB, as other banks do.
This offers another side benefit. Acting together, the rescue funds and the ECB would make it possible for the central bank to better transmit monetary policy to corporations and consumers. The benchmark interest rate is a very low 0.75 percent, yet that cheap money isn’t seeping down to borrowers in Greece, Italy and Spain, where it would do the most good.
Previous ECB bond purchases were ineffective because they were “sterilized” -- that is, the ECB withdrew cash from the money supply in equal amounts to the bond purchases to keep inflation at bay. The need to sterilize purchases prevented the ECB from acting at times and limited its effectiveness when it did. The rescue funds can bypass this restriction.
In a highly publicized speech July 26 in London, ECB President Mario Draghi raised expectations by declaring that the central bank was “ready to do whatever it takes to preserve the euro.” His words may have been foolhardy, even if they did trigger a crowd-pleasing global market rally. German Chancellor Angela Merkel and French President Francois Hollande quickly signaled their support for Draghi, though it’s unclear exactly what he meant or what the French and German leaders were supporting.
Draghi added a big caveat by saying “within our mandate,” exposing a debate within the central bank over its powers. Some members, including the Bundesbank, the largest shareholder, oppose ECB bond buying, arguing that it amounts to government financing (contradicting euro-area law) and encourages recklessness.
But they are wrong. Giving the rescue fund a banking license would act like a rocket booster on the ECB. The fund could impose strict conditions on borrowers, including that Greece, Italy and Spain meet previously agreed milestones for fiscal and structural reforms, to assuage Germany’s moral hazard concerns.
We hope Draghi, in jetting around Europe to discuss his next move, is building support for more bond buying and granting the ESM a banking license. So long as elected leaders don’t neuter it with unnecessary delays and face-saving qualifiers, this would constitute the kind of big and bold plan the euro area needs.
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