Sunday, 9 September 2012

ECB Announcement and Criticisms

On Friday, markets around the world were soaring as a result of the European Central Banker's announcement on late Thursday.  This came as a surprise to many, and they rushed to rejoice by raising stock market worldwide. Soon after the announcement, critics of the decision began to appear. Their criticism was expressed in three points:
1. The ECB is removing responsibility for fiscal reforms and austerity measures from the crisis-ridden countries because the bond buying program threatens to relieve the pressure of cutting expenses and deficits.
2. The ECB will flood the economy with money and risk higher inflation and a devaluation of the currency.
3. The Bank will violate its mandate because it will be effectively financing states, something which it is prohibited from doing under current European Union treaties. This would as a result endanger the ECB's independence.

Point 3 is, in my opinion, a matter of technicalities concerning EU Law. The ECB is not allowed to finance Member-States through the primary market, however, the treaty does not forbid it to do so in the secondary market. As for the independence? Well, the ECB did not have much to begin with. If by linking to the ESM the Bank will be made vulnerable to Member-State pressure, then all the ECB has to do is stand its ground and not allow any deviations from what was originally planned. Pressure will not mean a thing if the ECB does not succumb to it. And it has what it needs not to do so. Besides, the Federal Reserve in the USA has been pumping money into the economy over the last 70 years and no one has ever questioned its independence.

Point 2 is an overall policy issue. Fact: If the ECB issues money then inflation will rise. Thus, what the Bank has to do is issue money now and retract it later on. Or, issue money now and delay further issuing in the future until a sustainable, low level of inflation is achieved. I will not be the one to propose anti-inflationary policies to the Central Bank. That is what they are supposed to do better than anyone else. They have done good so far and I suppose we should allow them to do so in the future as well.

Point 1 is the most important of them all. By buying bonds directly, the ECB does promote some sort of moral hazard. Countries will not be so inclined to promote austerity measures and reforms if their bonds will be bought by the ECB. Nevertheless, the ECB has clearly stated that the plan will only assist those nations which have already applied for a bail-out and reforms as well as austerity packages are already on their way (and their bonds are not considered as "junk" by the three rating agencies). The ECB must make a strong point that without reforms and spending reductions no such help will be issued. Otherwise the critics will be right: nations will not do anything to fix what is broken. 

The announcement was a relief to both markets and nations. The ECB will, after a long waiting, play its card and assist in rebuilding confidence in the markets. As Draghi has stated: "The Euro is Irreversible"

No comments:

Post a Comment