The ECB bonanza - Irresponsible risk or still not enough?

Commentary by Michael Menhart

For years, economists in banks and insurance companies were the only people who discussed the policies of the European Central Bank. Now practically everyone follows the ECB’s activities, some viewing them with concern, and others with hope.

The sums of money involved are staggering, even after four years of crisis in which we had become used to aid packages and deficits amounting to billions. For example, the ECB has bought up government bonds worth over €200bn on the secondary market. On top of this, European banks have received €1,000bn in “cheap money” since December 2011. And many experts are pointing to further risks running into the billions in the Target2 balances of the European Central Bank.

For many people it fell well short of what was required. They called on the ECB to send a much clearer signal to the markets that it would be prepared to intervene at any amount to avoid an escalation of the crisis. Others have condemned the buying up of government bonds, even using the indirect route of the secondary market, and the generous concessions made to the banks, as unforgivable cardinal sins. They warn of the risk of inflation and the possible loss of the ECB’s independence as possible results of the present policy.

In many respects, the critics are right. Even if a weaker economy keeps consumer prices more or less stable, an undeniable risk of asset-price bubbles remains. And even if the discussion on Target2 balances is more of an academic argument among economists: if one country abandons the euro, or even if the entire eurozone breaks up, it is an indisputable fact that this will trigger risks running into the billions. So is the ECB not running irresponsibly high risks? We do not believe so, because if it manages to stabilise the eurozone through its measures, the above-mentioned risks will not materialise in the first place. However, it would be irresponsible not to make a timely exit from the current “crisis mode” if we were to see a sustainable improvement in the situation.

There are two basic requirements for the stabilisation process to succeed: firstly, the countries affected must introduce the necessary measures to get their state finances back on a solid footing and help their economy remain competitive on the global market. Secondly, they need to adhere strictly to this course, possibly for years, because they will not be successful from one day to the next.

If the ECB had followed the American model and sent an unmistakeable signal that it would buy up any amount of government bonds in an emergency, it would certainly have had the effect of calming the markets in the short term. But in this case, what incentive would there have been for the crisis states to tackle the Herculean task of implementing substantial structural and financial reforms? None whatsoever! The precondition for long-term stabilisation would not have been met.

If the ECB did not intervene, the peripheral states would soon have little or no access to the capital markets. At the same time, there would be the serious risk of the banking market drying up, and the entire eurozone suffering the additional burden of a severe credit squeeze in Europe. In such a climate, the chances of political survival after a long period of painful reforms would be virtually zero.

In fact, there is no pain-free or risk-free path to achieving a eurozone that can be stable in the long term. This is also true for the ECB. Without doubt, all it has managed to do with its strategy is to buy some time for Europe. But it is precisely this room for manoeuvre that is needed in order to introduce the measures required for stabilisation.

The greatest challenge for the Central Bank is yet to come: how to choose the right moment for a return to a normal liquidity supply and interest-rate policy. For some time now, we insurers in particular have been feeling the pinch from the low interest-rate environment. If the ECB’s crisis policy were to become “business as usual”, the long-term consequences would be painful for everyone, even for those caught up in the current crisis, whose pain the Central Bank is trying to alleviate.