Blog Post

Blogs review: the ECB’s new doctrine of explicit policy conditionality

What’s at stake: Last week was dominated by Thursday’s ECB Governing Council meeting and Mario Draghi’s subsequent press conference, where he clarified some of the statements made earlier in London. In particular, he gave a precise idea about what commentators had previously referred as “a grand master plan” or “the two-pronged approach” where ECB intervention on the secondary market would be conditioned on countries making first a request to the EFSF and accepting the strict conditions and supervision attached to it. While there is still uncertainty about how things will play out – the board gave “a determined guidance for the committees to design the appropriate modalities for such policy measures” over the coming weeks – the change of approach from implicit (illustrated by the now infamous letter to Berlusconi from last year) to explicit policy conditionality was important enough to generate surprise and excitement among several ECB watchers.

By: Date: August 8, 2012 European Macroeconomics & Governance Tags & Topics

What’s at stake: Last week was dominated by Thursday’s ECB Governing Council meeting and Mario Draghi’s subsequent press conference, where he clarified some of the statements made earlier in London. In particular, he gave a precise idea about what commentators had previously referred as “a grand master plan” or “the two-pronged approach” where ECB intervention on the secondary market would be conditioned on countries making first a request to the EFSF and accepting the strict conditions and supervision attached to it. While there is still uncertainty about how things will play out – the board gave “a determined guidance for the committees to design the appropriate modalities for such policy measures” over the coming weeks – the change of approach from implicit (illustrated by the now infamous letter to Berlusconi from last year) to explicit policy conditionality was important enough to generate surprise and excitement among several ECB watchers.

What Mario Draghi said

In the Q&A session following his Introductory Statement Mario Draghi said that “the guidance that we have given to the committees of the ECB differs from the previous programme” [since] “we have explicit conditionality here”. “The first thing is that governments have to go to the EFSF”, but “to go to the EFSF is a necessary condition, but not a sufficient one”. “When governments have actually fulfilled the necessary conditions, namely have undertaken fiscal and structural reforms and applied to the EFSF with the right conditionality. At that point, we may act, if needed.”

Karl Whelan points that the ECB would focus on the acquisition of short-term debt and, unlike in the past, would state how much it was purchasing. Finally, ECB will re-examine its policy of insisting on being treated as senior to private bondholders.

The new doctrine of explicit policy conditionality

Erik Nielsen argues that the ECB de facto introduced a new doctrine in central banking; namely that of explicit policy conditionality for its actions. Nielsen writes that he cannot recall another example of a central bank telling its democratically elected officials that there will be a threshold in terms of their policy stance below which the central bank will simply throw in the towel and accept that markets (dysfunctional or not) have made it impotent with respect to its ability to steer policies to fulfill its mandate. So, what, for Italy and Spain, used to be peer pressure or informal conditionality, will now become formal conditionality. If it leads to better policies by governments, if the EFSF/ESM appreciates those efforts and if this comforts the general public (and the media) in core Europe and therefore frees the hands of the ECB to do what they have to do to restore a proper transmission mechanism, then he can see not only the light of the end of the tunnel of this crisis, but the opening itself. But it seems that the ECB has seriously raised the stakes for the eurozone and might one day face a serious dilemma: In a future scenario where a government cannot reach agreement with the EFSF/ESM, do they stick with their new doctrine and refrain from intervening and accept what could well be sovereign default, or do they risk their credibility and reverse to their previous doctrine of intervention if the dispute is small enough (or the country big enough), thereby seriously challenging their own future?

Yanis Varoufakis (HT Simon Wren-Lewis) writes that Mr Draghi has, possibly unwittingly, undermined the principle that the ECB does not meddle in fiscal policy and stays well within its remit of maintaining price stability and a healthy monetary policy transmission mechanism. The issue here is not whether one agrees or not with austerity. The issue is that the degree of austerity, and the extent to which policies like privatization of the electricity grid of a nation must be pursued, was never supposed to be the business of the Central Bank. These were matters for democratically elected governments.

Antonio Fatas writes that this is not ideal but understandable. Some national governments would love to see the ECB intervening in financial markets to reduce their risk premium without having to involve any supervision from European authorities. But the political reality is that intervention by European institutions requires some risk sharing to be successful. And risk sharing requires some recognition that we are all in the same boat and as such the decision on the directions in which the boat has to go have to be made together.

The Economist’s Charlemagne argues that the ECB must perform a delicate balancing act: between its potential power to print vast amounts of money and its unusually narrow legal mandate to maintain price stability; between the interests of creditor and debtor states; and between maintaining market pressure on countries to reform and preventing them from being pushed into insolvency.

Lorenzo Bini-Smaghi writes that politicians and commentators cannot ask for more Europe, then complain about the loss of sovereignty. If the survival of the euro requires further political integration, as many suggest, then member states need not only to share more decisions at European level but also to accept more interference by EU institutions in areas previously held to be the preserve of national authorities. High quality global journalism requires investment. The real issue is the democratic legitimacy and accountability of the institution responsible for the relevant decisions – in this case, the Eurogroup. Either the Eurogroup is considered legitimate, or it should be made legitimate, as soon as possible.

The ECB as a LoLR to governments redux

Kevin O’Rourke writes that the reason why economists like Paul de Grauwe have been asking for ECB intervention is so that an Italian bailout becomes unnecessary; now it seems that Italy will only get ECB intervention if it enters a bailout programme. The whole thing seems upside down, and people are playing with fire here. Despite its large debts, Italy wouldn’t be having these difficulties on the market if it wasn’t in EMU: to ask a big, important country with a sense of its own dignity to give up sovereignty — and potentially enter the same death spiral as Greece, and now apparently Spain — simply so that it can remain in a single currency that isn’t working seems like a bit of a stretch.

Karl Whelan writes that there are two ways that the ECB could allow such a lender of last resort to come into existence. The first option is for the ECB to purchase bonds in the secondary market.  This allows primary bond investors to buy government bonds safe in the knowledge that a market for the bonds will continue to exist. The second option that can produce a sovereign lender of last resort in the euro area is the provision of a banking license to the ESM bailout fund combined with the ECB accepting this fund as an “eligible counterparty”. Karl Whelan disagrees strongly with the ECB’s current approach on the banking license issue. During the press conference, Draghi said he was puzzled people kept raising this question and pointed to this legal opinion from the ECB, which states that “Article 123 TFEU would not allow the ESM to become a counterparty of the Eurosystem”. However, this is a blanket statement rather than an opinion.  While part 1 of Article 123 rules out monetary financing of governments, part 2 states: “Paragraph 1 shall not apply to publicly owned credit institutions which, in the context of the supply of reserves by central banks, shall be given the same treatment by national central banks and the European Central Bank as private credit institutions.”

Sony Kapoor writes that this set of interventions does not constitute a game-changer. With a banking license for the ESM ruled out, the only real ‘bazooka’ option that has not been explicitly ruled out is something Re-Define suggested last year as a compromise: “The ESM could indemnify the ECB against any credit losses on its purchases of sovereign bonds”. Economically, this is similar to the ESM bank model as the credit risk is taken on by the ESM and the funding comes from the ECB. However, unlike the ESM bank idea, which has explicitly been ruled out by key political actors not least Draghi himself, this idea has not been vetoed, yet.

The impact on Target 2 balances

Gavyn Davies writes that Draghi’s latest idea – ECB purchases of short dated bonds under a reactivated Securities’ Market Programme – will not increase the scale of official capital inflows into Spain, since they will (mostly) be undertaken by a Spanish entity, the Bank of Spain. This means that reactivation of the SMP will not eliminate the need for Target 2 imbalances to continue rising, which ultimately could undermine confidence in the single currency still further. In order to prevent that, more drastic action to raise official capital flows into Spain, like providing a banking license for the ESM, would be required.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

View comments
Read article More on this topic More by this author

Blog Post

Silvia Merler

Big data and first-degree price discrimination

What’s at stake: first-degree price discrimination - or person-specific pricing, had until recently been considered a theoretical case with unlikely real-world application. Yet the increasing availability of big data could make this possible. We review recent contributions on this issue.

By: Silvia Merler Topic: Innovation & Competition Policy Date: February 20, 2017
Read article More on this topic More by this author

Blog Post

Pia Hüttl

Inflation's comeback

What at stake: After years of deflationary pressures and anaemic economic performance, inflation seems to be on the rise again, both in the US and the euro area. Does this comeback mark a return to target? Will it be sustained, and what should central banks be thinking? These are among the questions raised in the blogosphere.

By: Pia Hüttl Topic: Global Economics & Governance Date: February 13, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Is Germany a currency manipulator?

What’s at stake: the Financial Times reports that Peter Navarro, head of the US’s National Trade Council, has accused Germany of currency manipulation. He claims that the country uses a 'grossly undervalued' Euro to 'exploit' its trading partners. Angela Merkel replied that the Euro is managed by the European Central Bank, on which Germany does not exert influence. We review what the economic blogosphere thinks of this.

By: Silvia Merler Topic: Global Economics & Governance Date: February 6, 2017
Read article More by this author

Blog Post

Silvia Merler

Climate change and financial markets

What’s at stake: Ever since the 2016 Paris Agreement to reduce emissions was signed, researchers have been looking at the impact that moves towards a low-carbon economy might have on financial markets and financial stability. We review these contributions here. 

By: Silvia Merler Topic: Energy & Climate, Finance & Financial Regulation Date: January 30, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Tariffs and the American poor

What’s at stake: much has been said and debated — during the US election and beyond — about the distributional impact of free trade on the disadvantaged. But what would be the distributional impact of a new protectionism instead?

By: Silvia Merler Topic: Global Economics & Governance Date: January 23, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

The economic effects of migration

What’s at stake: migration is currently a very hot topic in both the US and the EU. Immigration issues have come to the forefront due to the problem of rapidly ageing populations, the refugee crisis, and growing anti-immigration political rhetoric. But what do we know about the economic effects of migration?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: January 16, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

Compensating the “losers” of globalisation

What’s at stake: According to some, 2016’s political turmoil shows that the so-called “losers” of globalisation are striking back. There is, however, little agreement on how government should respond to this challenge.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: January 9, 2017
Read article More on this topic More by this author

Blog Post

Silvia Merler

2016: The end

What’s at stake: 2016 is coming to an end. It will be remembered as an annus mirabilis and horribilis, at the same time. 2016 brought us some previously unthinkable political shocks, and admittedly took away some of our finest musicians. It also couldn’t help taking away Willy Wonka and Princess Leia, making this a much sadder Galaxy. This raises an obvious question: what are we in for, in 2017?

By: Silvia Merler Topic: European Macroeconomics & Governance Date: December 31, 2016
Read article More on this topic More by this author

Blog Post

Silvia Merler

The American dream

What’s at stake: historian James Truslow Adams, in his 1931 book The Epic of America, stated that the American dream is "that dream of a land in which life should be better and richer and fuller for everyone, with opportunity for each according to ability or achievement”. Few ideas have ever been as powerful as the “American Dream”, and many recent political events hinge on the fear that this “dream” may be dead. Meanwhile, researchers have been trying to measure the reality behind the dream.

By: Silvia Merler Topic: Global Economics & Governance Date: December 19, 2016
Read article More on this topic More by this author

Blog Post

Silvia Merler

The political economy of macroprudential policy

What’s at stake: the emergence of renewed interest in macroprudential policy has characterised the aftermath of the great recession. There is not yet full agreement on what the tasks of macroprudential policy is or how it should be carried out, but there is a clear understanding that there is an important political economy dimension to it. We review some of the recent contribution on this.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: December 12, 2016
Read article More on this topic More by this author

Blog Post

Pia Hüttl

Macroeconomics in the crossfire (again)

What’s at stake: After a first go at macroeconomics and its flaws a year ago, Paul Romer kicked off the debate again with a recent essay on how macroeconomics has gone backwards. The way that this debate, along with the debate of the role of economics in general, feeds into today's election woes, has also attracted attention in the blogosphere.

By: Pia Hüttl Topic: European Macroeconomics & Governance Date: December 5, 2016
Read article More on this topic More by this author

Blog Post

Silvia Merler

The Italian referendum

What’s at stake: on 4 December, Italy will hold a referendum on a proposed constitutional reform approved by Parliament in April. The reform, which was designed in tandem with a new electoral law, aims to overcome Italy’s “perfect bicameralism” by changing the structure and role of the Italian Senate. It also changes the distribution of competences between the state and regions. After the shocks of Brexit and the US election, polls are now drifting towards a defeat of the government’s position in Italy.

By: Silvia Merler Topic: European Macroeconomics & Governance Date: November 28, 2016
Load more posts