Many economists are predicting that Europe will slip into recession because of the war in Ukraine and expensive energy. For the European Central Bank (ECB), this normally means being particularly cautious, raising interest rates cautiously if absolutely necessary.
But when the Governing Council meets on Thursday, more courage than caution is required. The credibility of the central bank is at stake. And not just in monetary policy: Their efforts to support the financial policies of highly indebted countries are about more than the good intentions of keeping the euro zone together.
In terms of monetary policy, the ECB should now move faster rather than slower. Instead of raising interest rates by a quarter of a percentage point, it is appropriate to raise interest rates by half a percentage point. This would mean that the interest rate currently applicable for commercial bank deposits at the ECB would at least be back to zero.
Let’s be honest: For laypeople and just as many professionals, the question arises as to whether those responsible are still in their right mind when interest rates are negative and inflation is over eight percent at the same time. Ultimately, monetary policy can only work if it is understandable and credible across the board. ECB President Christine Lagarde and her colleagues on the Governing Council must keep this in mind.
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Another tricky point is the hotly debated concept of supporting heavily indebted euro states with targeted purchases of government bonds if their interest burden threatens to get out of control. Italy is at the center of the discussion here. Because of the size of the economy and the high level of debt, government bonds from Rome have a significant impact on the entire capital market. Nobody wants anything to go wrong there.
Too involved in fiscal policy
Expectations are high that the ECB will make more than just general statements on this point on Thursday. She owes it to the public to make it clear exactly how she intends to proceed.
>> Also read the interview with top economist Brunnermeier: “Inflation requires aggressive action by the ECB”
Ultimately, the ECB is drawn far into European and national financial policy here. According to regulatory and legal requirements, that shouldn’t actually happen. Of course, it’s not her fault, it’s because there is a uniform monetary policy in the monetary union, but no coordinated financial policy.
That was clear when we were founded, and nothing will change that until we have a United States of Europe. The central bank should therefore be more careful not to give in to this pull too easily.
Two perspectives stand out. The first is likely to have a majority in the ECB Council: If the central bank gives a firm signal that it will help in an emergency, then the risk premiums (spreads) on Italian government bonds – i.e. the differences to German yields – will not even increase. In short: If you threaten effectively, you don’t have to strike. But there is also the second perspective: if you help too willingly, you will be exploited.
Ultimately, the ECB is drawn far into European and national financial policy here. Frank Wiebe, Handelsblatt financial correspondent
For many years, Italy pursued a thoroughly sound financial policy and generated primary surpluses, i.e. it was in the black before interest payments in the budget. At the same time, the country is suffering from tough structural problems that are slowing down growth and thus keeping relative debt at a high level.
Mario Draghi, who headed the ECB before Lagarde, has been trying to solve these problems since he took office as Italian prime minister. But the current government crisis in Rome shows where the real problem lies: in the notoriously unstable politics.
According to its own understanding, the ECB only wants to help individual countries against speculative attacks on the bond market, but not to cover up fundamental problems. And under no circumstances should it mitigate the consequences of government crises. Otherwise, it ultimately only contributes to instability because its support is taken into account by unscrupulous politicians.
Aid only within a narrow framework
Critics of the ECB are calling for bond purchases to be used only as part of a program known by the acronym OMT that is around ten years old. However, the government in Rome would then have to accept the shame of being de facto subject to the supervision of the European bailout fund.
>> Read also: Ukraine war and euro stability: What are the consequences of Italy’s government crisis for Europe?
Surely nobody wants that. And those who agreed to this would in all likelihood be very quickly ousted from power. Therefore, even if the crisis is overcome, OMT is unlikely to be an effective tool.
All of this shows how far the central bank has already become politicized – which most of the Governing Council are certainly not enthusiastic about. It is important to make it clear that aid is not only tied to certain conditions, but is also limited in time. In the background, the threat must be recognizable that only the strict OMT program will remain as a rescue if the aid purchases drag on too long.
Here, too, the credibility of the ECB is at stake: monetary policy can only work if it is reasonably independent.
More: What Princeton economist Markus Brunnermeier advises the ECB.