Monday, 30 June 2014

The ECB and policy "blackmail"

Süddeutsche Zeitung has conducted a fun interview with French ECB Executive Board member Benoît Cœuré and two radical activists. Central bankers should sit down with people who think capitalism is doomed more often.

One of the activists recalled (slightly inaccurately) an incident from August of 2011.  At the time, interest rates on Italian and Spanish bonds were spiking, amid fears of a self-fulfilling prophecy about the sustainability of their debts.

Source: 10-year bond benchmark from Datastream; SMP purchases laboriously hand-compiled from ECB statements
On August 5th, ECB then-president Trichet sent secret letters to Italian PM Berlusconi and Spanish PM Zapatero with a list of measures that should be urgently adopted to “restore the confidence of investors.” The letters were immediately understood as specifying preconditions for the ECB intervening to buy bonds. The activist referred to this as "blackmail," as the ECB was threatening to ignore the bond market panic if the measures were not adopted.  Cœuré replied:
The ECB does not blackmail anyone. The case you have mentioned refers to the purchase of government bonds under the Securities Markets Programme (SMP). What the ECB wanted to make clear was that our monetary policy can only be effective if governments themselves carry out reforms that address the root causes of the crisis. No monetary policy measure can have the desired effect if that is not given.
Yes, well, if you believe that, I'm sure Monsieur Cœuré would welcome your expression of interest in purchasing the Pont d'Avignon

On July 11th 2011, Mario Draghi (who cosigned Trichet's letter to Berlusconi), praised a just-passed Italian austerity package and called for a push to balance the Italian budget by 2014.  Just over three weeks later, Trichet and Draghi, in their secret letter, called for the budget to be balanced by 2013. Would Cœuré care to argue that there was some change in the "root causes of the crisis" that required this acceleration? 

If the ECB had wanted to, it could have thrown its weight behind the measures Italy had already adopted. Trichet could have said that the bond markets were displaying "fear and irrationality" about the bonds of the country with the highest primary surplus in the Eurozone, and pledged to put a floor under bond prices. 

Instead, the ECB tried to use the panic to maximize its influence. The chart above--which shows aggregated ECB bond purchases for all countries--suggests quite strongly that the ECB stopped trying very hard to change prices when Berlusconi proved unable to get the measures in the letter through Parliament (for this argument, see Irwin's The Alchemists.) Blackmail is not an unreasonable term for this.  

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