Mario Draghi disappointed markets yesterday by not offering a clear commitment to any concrete policy action to resolve the turmoil in European financial markets. Nothing new: the inability of European policy makers to resolve the crisis continues as markets keep going back and forth between excitement and depression.
My reading of his statements (a few days ago) and yesterday is slightly different and possibly more optimistic. Mario Draghi has made very concrete statements about what the ECB is willing to do that go beyond what was said before. In particular, what I heard yesterday is that
“Risk premia that are related to fears of the reversibility of the euro are unacceptable, and they need to be addressed in a fundamental manner. The euro is irreversible.”
These are strong statements in support of the Euro (not that surprising) but also about mispricing of certain risks in bond markets (this is more surprising). Some are disappointed that he only talks about risks related to the reversibility of the Euro and not about default risks, but central bankers need to choose their words carefully. It would be difficult to expect from a central banker an explicit statement about specific country default risks.
He was also as explicit as one can be about intervention in bond purchases:
“The Governing Council, within its mandate to maintain price stability over the medium term and in observance of its independence in determining monetary policy, may undertake outright open market operations of a size adequate to reach its objective. In this context, the concerns of private investors about seniority will be addressed. Furthermore, the Governing Council may consider undertaking further non-standard monetary policy measures according to what is required to repair monetary policy transmission. Over the coming weeks, we will design the appropriate modalities for such policy measures.”
These are strong words and open the door for a more flexible discussion on seniority of debt. Less concrete than what some wanted but they clearly signal further actions in the coming weeks.
Some found it surprising that he established a connection between ECB actions to involvement of EFSF/ESM.
“The adherence of governments to their commitments and the fulfilment by the EFSF/ESM of their role are necessary conditions.”
This is not ideal but understandable. Fundamentally, the Euro/EU area has a very complex set of institutions. They might play a role in certain occasions but when it comes to reacting quickly to economic events they are slow (very slow!). The EFSF/ESM were created to deal with economic circumstances like the ones Europe is going through. 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. If the disagreements about these directions are that strong, then the Euro project is bound to fail.
Compromises are necessary on all sides. Some need to understand that sharing risks is the only way to move forward even if it exposes them to loses on debts originally accumulated by other countries. And those countries which are being helped need to acknowledge that the help comes with a price and certain amount of interference in internal political decisions. This has proven to be a very tough dialogue among all European countries where blame should be assigned to all parties involved (how much blame you assign to each party is another issue…).
I do not expect miracles going forward but I see progress on several fronts: the words by Draghi yesterday are reassuring and bond yields in Spain or Italy are under pressure but contained. To find an exit we are waiting for more actions and they will require additional dialogue between all governments involved and a sense of even larger compromise than what has been agreed so far. Progress will be painfully slow and costly but at least we are moving in the right direction.