On Wednesday, Mario Draghi, head of the European Central Bank, appeared before the German Bundestag to explain himself. In September the ECB announced a program of “Outright Monetary Transactions.” The bank will buy three-year member-state bonds in the secondary market, subject to what it delicately calls a “macroeconomic adjustment”—writing austerity into the member state’s budget. The program, the bank hopes, will lower the yields on these bonds, in turn lowering the state’s financing costs. Jens Weidmann, head of Germany’s Bundesbank, has said the action will just print money and even went so far as to compare it with an inflationary plan from the devil in Goethe’s Faust. This leaves Draghi with both an economic and a political problem. He has to save Europe from its sins. And still, even though the German Bundestag and high court have already nodded their approval of the ECB’s European Stability Mechanism, Draghi has to convince the Germans that he is not compounding Europe’s sins with more of his own.
The market, he explained in his prepared opening statement, is wrong. A central bank can’t just set market lending rates. It sets the few it can directly control, then hopes those rates seep into the market through what is called “monetary policy transmission.” In normal times, this transmission works, unseen; in interesting times, it can become blocked. Banks in Europe, Draghi said, aren’t passing on low interest rates equally to all businesses and households in the euro area. Here’s where a market purist would answer that investors perceive risk in Spain and are pricing it in. Not completely so, says Draghi. Investors, he told the Bundestag, are “charging interest rates to countries they perceived to be the most vulnerable that [go] beyond levels warranted by economic fundamentals and justifiable risk premia.” This fear, he said, is “unfounded.” The market is wrong.