“Without the euro, the ECB ceases to exist. That is true of no other eurozone institution. It gives it the incentive to act. It is also acting on a large scale.”
– Martin Wolf, December 28, 2011
Regular readers of this blog are well-acquainted with the thoughts of Martin Wolf, the Financial Times’ chief economics commentator. Wolf has long been among the most vocal critics of the European Central Bank, charging that its refusal to act as the eurozone’s lender of last resort has worsened the currency union’s crisis and made it impossible to resolve that crisis.
It is therefore with considerable interest that, as suggested by the above quote, he seems to have changed his mind regarding the intentions and efficacy of the ECB’s policies and actions. Simply stated, without the euro, the ECB has no raison d’être. Like any and all institutions, it will do whatever is necessary to ensure its survival.
Wolf seems to have been greatly influenced by Mario Draghi (the ECB’s new president) who, in his interview with the FT on December 18, argued that the ECB had taken important actions during the previous week:
“We cut the main interest rate by 25 basis points. We announced two long-term refinancing operations, which for the first time will last three years. We halved the minimum reserve ratio from 2 per cent to 1 per cent. We broadened collateral eligibility rules. Finally, the ECB governing council agreed that the ECB would act as an agent for the European Financial Stability Facility (EFSF).”
Wolf’s interpretation is as follows:
Thus the ECB is determined to fund banks freely, at low rates of interest, thereby subsidising them directly and the governments they lend to, indirectly.
Why lending to banks that use the money they borrow to lend to governments is good, while lending to governments directly is bad, is hard to understand. The only obvious difference is that in the case of lending via banks, the intermediaries may themselves go broke. That makes them unavoidably unreliable conduits. Yet if this complex procedure gets round theological objections to direct financing of governments, those who believe some financing of governments is now needed should be content.
In short, the recent decisions of the ECB look like a clever way of relieving the funding constraints suffered by banks and vulnerable sovereigns. This does not redress solvency concerns directly, though the subsidy may be large enough to make a difference even here, particularly for the banks. But it should mitigate – if not eliminate –liquidity constraints, which have proved of rising importance over the last year and half.