The eurozone crisis may have started out as a fiscal crisis but it is now most definitely also a monetary crisis. The eurozone’s monetary system has begun to fragment. No longer is the European Central Bank able to set interest rates for the eurozone as a whole. Paranoia about an eventual eurozone break-up has persuaded financial institutions – with some encouragement from national regulators – to keep their money at home. So, the cross-border interbank market is more or less shut and peripheral nations are suffering.
An Italian bank hoping to borrow money for a year or so has to pay an interest rate of 2.7 per cent. A Spanish bank pays 3.8 per cent. A German bank pays nothing at all (indeed, others are now paying Germans to look after their money). Something has gone horribly wrong. There may be a single currency but its constituent parts are in danger of slipping towards a messy divorce.
In earlier phases of the eurozone crisis, government bond spreads widened not so much because the euro itself was seen to be in terminal decline but, instead, because countries had their own idiosyncratic local difficulties: Greek government debt was spiralling out of control, the Irish banking system was heading to the rocks and Spain’s autonomous regions were, as it turns out, just a bit too autonomous. The choices were simple: austerity, bailout or default. These were specifically fiscal – indeed, political – options providing the perfect excuse for the ECB to take a back seat.
No longer can the ECB afford to do so. Mario Draghi, the ECB president, admitted as much when he observed last week that "these premia have to do more and more with convertibility ... they come into our mandate”. In other words, as the ultimate guardian of the single currency, the ECB has to act to avoid terminal fragmentation. The problem is simple. The ECB’s job is to deliver price stability in the medium term. It can do this only if its decisions feed through to the economy at large. Policies made in Frankfurt should trickle down to Barcelona, Berlin and Brindisi in roughly the same way. That no longer seems to be the case.
A central bank that can no longer set the monetary policy agenda is fairly useless. It is no surprise, then, that Draghi has dangled so many treats before investors. He talked yesterday about the ECB undertaking "outright open market operations of a size adequate to reach its [price stability] objective” while accepting the need to address bondholder seniority issues.
These are important developments. The ECB has accepted it is no longer properly in control of monetary conditions across the eurozone. It is happily considering a variety of measures to fix what has become a broken transmission mechanism for eurozone monetary policy. And it is increasingly focused on the interest rates traditionally determined by the actions of the central bank, not on those mostly influenced by the creditworthiness of individual sovereigns. All this begs the obvious question: if the ECB is doing the right thing – or at least planning to – why did investors take fright as its press conference drew to a close?
Five explanations stand out. First, the ECB’s proposals are very much a work in progress: the instant gratification investors hoped for – and which they thought Mr Draghi had promised last week – didn’t materialise. Second, ECB help appears contingent on actions from others: in Draghi’s words "the adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions”. Third, even with a bond-buying program, there is no guarantee of economic success. The US and UK experience in recent years, after all, has hardly been encouraging; both are once again hitting economic brick walls. Fourth, it is blindingly obvious that the Bundesbank is not on board.
Lastly, even if Draghi has correctly identified the nature of his monetary problem, that won’t be enough to solve the eurozone’s difficulties. The transmission mechanism is certainly worth fixing. But anyone who’s owned an unreliable car will surely agree that fixing the transmission mechanism alone provides no guarantee that the journey can be completed.
The writer is HSBC’s chief economist. Copyright The Financial Times Limited 2012.