The ECB cannot remain on the sidelines

That would be a recipe for utter failure. Guido Tabellini has a good analysis:

The Eurozone core weakness has been known since the beginning – the separation of monetary and fiscal policy. This is the principle upon which the European monetary union was built, but the crisis made it clear – without a central bank acting as lender of last resort, highly indebted countries are too vulnerable to changes in market confidence. Unless this central problem is addressed, the crisis is unlikely to reach a turning point.

A turning point in the setting of monetary policy is needed to restore confidence. Financial stability should become at least as important as price stability as a guiding principle for monetary policy decisions.

Accordingly, the ECB should cut interest rates and announce the intention to sustain the price of the bonds of the Eurozone governments, unless their public finances are truly unsustainable. A depreciation of the euro would help relaunch the economy – something that would be welcome now that themain risk is a new recession and certainly not inflation. This is the current monetary policy of the other major economies. The economic situation would require the same approach in the Eurozone.

This turn in monetary policy is not necessarily incompatible with the European treaties, given the exceptional nature of the crisis, but it is surely against the prevailing opinion in Germany. And this is not only a political problem. Should the ECB challenge German public opinion, adopting a monetary policy deemed by Germany to be in contrast with the founding principles of the monetary union, the euro would be exposed to serious risks. Currencies, like debt, are based on trust. However, with deep contrasts on monetary policy, we do not know how long trust in the euro would last.

This is the underlying reason why this European summit has proven so difficult. Many realise that the contagion could reach France and that this crisis will not come to an end without a radical reset of monetary policy goals. Yet, the country that more than any other has foregone monetary sovereignty would consider this turn a betrayal.

Conclusion

If this analysis is correct, this outcome of this summit is unlikely to be decisive. The crisis will last for long. We have to wait for German public opinion to realise that the euro was built on imperfect foundations and that these imperfections must be corrected. Meanwhile, the Italian president of the ECB will need all his technical and political expertise to keep the boat afloat.

One thought on “The ECB cannot remain on the sidelines

  1. Boy, I would hate to be a guy opening up a business in Europe today. Your own central bankers are going to try to suffocate you.

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