What’s up with the new Draghi plan?

I won’t recapitulate my core views on the euro crisis (see this talk), but here are a few points:

1. The aggregate numbers are workable, but the eurozone needs a unified solution of some kind.  Putting any single country “in charge” would yield a solution, although the quality of solution would vary with the country.  Still, it would be a solution.

2. The danger is that quasi-solutions will appease all countries in the short run, not really solve the core problems, and thereby walk the eurozone further down the plank of doom.  This is the outcome I have been predicting, though it is not necessary in any logical sense.

3. The new plan puts the ECB in charge, and in fact gives the ECB semi-dictatorial powers over the weaker eurozone economies.  If Draghi says “jump,” you had better jump.  Many will consider this an untenable abrogation of democracy, see the remarks of Matt Yglesias and more generally ponder the Rodrik trilemma.  I don’t know how long this arrangement can last.  Up through now, and still, my view has been that at least one of these democracies will “crack” and pull the plug on whichever non-democratic dictatorial scheme happens to be in place at the time.   I don’t see that the chance of that has gone down.

4. Some portray this as a loss for Germany and the Bundesbank, but I wonder.  I tend to see the ECB as the new enforcer.  The more the ECB is responsible for the money it hands out, and the larger the role the ECB takes in governance of the weaker economies, the more the perspective of the ECB will approach that of Germany.  That the ECB can “money print” its way out of insolvency I don’t see as so important for the true incentives facing ECB leaders.

5. By the way, the ECB has renounced its senior place in line, at least for the new bond buying, how generally I am not sure from published reports.

6. Does the ECB have the stones to cut off or not start up with countries violating the terms of their bailouts?  Greece and Spain are already way out of line.  Yet it seems this new plan is directed at Spain, at the very least, so how credible can it be?  I say the ECB becomes even more of a fudger.

7. The notion of “unlimited” but “sterilized” bond-buying interventions is a problematic one.  How much “Dran-O” is there to remove the newly created money?  Surely the ECB can’t respond by selling from its current portfolio of periphery bonds.

8. The afflicted countries now have an incentive to load up on short-term debt.

9. The theory of bureaucracy suggests that Draghi has delivered somewhat different messages to Merkel and to the periphery nations as to what this scheme really will mean.

In a few words I would say “The ECB as Old Testament God.”  He wasn’t omnipotent either, and in Genesis you also will find intimations of henotheism.

Let’s see how good a job they do.


'but the eurozone needs a unified solution of some kind'
Almost as if the people who designed the euro intended the currency to lead to a unified solution, almost as if the words 'European Union' actually mean something.

'Many will consider this an untenable abrogation of democracy'
Or will recognize how the Bundesbank has worked for two generations in Germany - not that this is necessarily a contradiction, though most Germans do have a higher faith in the Bundesbank to make difficult decisions than in democratically elected representatives, who are prone to pandering while avoiding difficult decisions.

'Does the ECB have the stones to cut off or not start up with countries violating the terms of their bailouts?'
If this cost higher in one direction than the other? So far, pragmatism has ruled a lot of decision making involving things no longer mentioned in the Anglo-American press - Commerzbank takeover, or the 'nationalization' of HypoReal. The reaon they aren't mentioned possibly having something to do with how the shareholders paid for the losses, while management was replaced. Whether the EZB is equally pragmatic is difficult to know - but since point 4 caught the essence that the EZB is starting to look a lot like the Bundesbank, it is quite possible.

'The theory of bureaucracy suggests that Draghi has delivered somewhat different messages to Merkel and to the periphery nations as to what this scheme really will mean.'
No - the reality of how politics is done in the EU ensures that between the various languages, factions, cultures, and interests, all sorts of different messages have been sent and delivered - which will then be fashioned into a consensus. One that may be false or too weak, but still a consensus based in part on the flexibility required to manage a mix of nations. People talk about the American empire without noting that a new model has introduced itself - one which will fail as inevitably as any other, but one which works quite differently from the earlier versions.

Solid Analysis!

I guess I don't understand how "the numbers are still workable," regardless of a unified approach or people running in circles in the streets and waving their hands. The simplified version of how I see this crisis is this: for decades, every country in Europe has steadily imposed economic/social policies that lower growth, even while government spending has accelerated. As this pattern has developed, a larger and larger percentage of European economies has moved into the unproductive public sector and out of the more productive private sector. Since the U.S. has been paying for their militaries, we have propped the system up for a few more years, since military spending is probably the greatest waste possible, and various kinds of bond holders have been willing to bet that the European system will work, but now it's become apparent that the future holds only decelerating growth and rising interest payments on government debt. The issue is worse in the southern European economies (where so much of the economy is part of the corrupt public sector that people have forgotten how to be productive in the private sector) than in the north, but the same pattern holds everywhere in Europe. Disturbingly, the U.S. is on the same path, just a bit more slowly.

So, it doesn't matter whether the Bundesbank or the ECB or the IMF is in charge. It doesn't matter whether Spain or anyone else bails out the insolvent banks. It doesn't matter whether Greece defaults on their debt now or in a year. All that matters is whether the individual European economies can move from a system under which the unproductive public sector eats up an increasing percentage of the economy or if they move to a system under which the ECONOMY ACTUALLY GROWS! This movement is made all the more unlikely by the fact that Europe faces a demographic time bomb since they haven't been having any kids for the last couple of decades, so their years of highest productivity and entrepreneurship are almost certainly behind them. Regardless of their current fiscal situation, every country in Europe faces this last problem. The U.S. at least has some hope because our population is at least growing.

The numbers aren't workable. It's just easy to imagine a way to put off the inevitable for a few months. But what then?

"Sterilization" - why didn't we think of this before?

If your bonds are tanking because it turns out you don't pay as much taxes as you say you do and your public sector is full of featherbedding and crackpot social engineering schemes, just have the ECB print up money and buy them. Then have the ECB "sterilize" the transaction by stashing all that fancy engraved toilet paper on a balance sheet somewhere. Hey presto--economists can do anything!

Instinctively, something tells me this can't go on, but I'm not an economist. Maybe it can.

I'm not sure it's correct to say the EU is growing slower than the US. I thought if you run the numbers on a per capita basis (US pop growing much faster), the growth between the EU15 & US are statistically the same for the last 40 years. Of course that still leaves Europe with problems in the long run with a shrinking population, but that's not likely to be an issue for decades.

Andrew Wise is right. The euro is a monetary union faced with a political crisis, not a financial or a liquidity crisis. It's a crisis of demosclerosis, where democracies, esp. in the south, have put themselves in thrall to special interests that refuse to give up their privileges -- overpaid unions, protected public employees, too generous pensions, banks subsidized to hilt and run by politicians, too many restrictions on competition and markets, etc. etc. That is why Germans and the other better run countries are balking. Why should they support the Rube Goldberg political machines of the Garlic Nations? I think Tyler abstracts from this in his discussion, which suffers from being too macro-simplistic. The required solutions are political, and the correct analysis must begin with public choice theory, not macro.

The notion of “unlimited” but “sterilized” bond-buying interventions is a problematic one. How much “Dran-O” is there to remove the newly created money? Surely the ECB can’t respond by selling from its current portfolio of periphery bonds.

No, but it can tighten policy just as easily by raising the rate paid on cash in its deposit facility. Indeed, this is part of its usual operating procedure: the headline "repo rate" lies at the center of a corridor, with the deposit rate at the bottom. Already there are enough excess reserves sloshing around that the deposit rate is arguably the true risk-free short rate. There are currently 350 billion euros in the deposit facility (so this is the marginal rate paid on cash for a lot of banks!), and the EONIA overnight rate is at 0.1%, far closer to the 0% deposit rate than the 0.75% repo rate.

As long as this continues, the ECB can just follow its normal operating procedure, keeping in mind that the "true" rate is 75 basis points below the rate it's announcing. There's no real effect from having greater or fewer excess reserves outstanding; in my view, the "sterilization" program is a meaningless way of appeasing people who still hew to some kind of crude monetarism and don't understand how the ECB's policy actually works.

The critics are right about one thing, though; the taxpayers are the residual claimants here. If the ECB buys lots of Italian and Spanish debt and then they either default or leave the Euro, a hole will be blown in its balance sheet, and if insolvent it will require a taxpayer bailout. (And even if it's not insolvent, profits that would otherwise have been remitted to taxpayers will disappear.) This is a fairly likely scenario.

"The notion of “unlimited” but “sterilized” bond-buying interventions is a problematic one."

Yep !
That's the most interesting questions: how does he intend to sterilize ? Buy selling other bonds ? Fair enough but how can this be unlimited then ?

As I hear it, they're going to package the sterilized bonds and sell them in slices. The computer model says that this should be enough to get a AAA rating.

5. By the way, the ECB has renounced its senior place in line, at least for the new bond buying, how generally I am not sure from published reports.

By promising to do so, Sillyhead!

Seriously, the ECB should (and will, in the end) only take on only senior status, but the truth is that Draghi knows acknowledging this gives up the game he is trying to run which is convincing private investors that Spanish bonds are still worth buying. I don't know how many suckers will take him up on this.

The ECB seems to want to do anything but implement proper monetary policy...

god let the euro just fail.

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