Covid-19 is make or break for the euro. The only way the European Central Bank (ECB) can convince markets that it will do whatever it takes to save the single currency in the current crisis is to abandon the self-imposed political constraints on the assets it can buy under its Quantitative Easing (QE) programme. These encompass the so-called “issue limits,” which dictate that the ECB cannot buy more than one-third of a country’s eligible debt, and the “capital key,” which insists that the central bank’s bond purchases are in proportion to the share of capital held by each country in the ECB.
Not only would relaxing the constraints convince markets that there truly are no limits on ECB bond buying but also that the governing council stands ready to use its ammunition fully.
The emergency aid package of 750 billion euros ($808 billion) adopted last week by the council — dubbed the Pandemic Emergency Purchase Program — goes part of the way by pledging to consider relaxing the political constraints if necessary. But it will take a further intensification of the coronavirus crisis for the ECB to put a true “No Limits” bond-buying policy into effect. When the pandemic programme passed, six
holdouts on the ECB council were opposed to the pledge to even consider dropping the issue limits and capital key measures.
That Europe needs unconstrained QE to save the euro was brought home with a vengeance last week when the Austrian member of the ECB governing council, Robert Holzmann, cast doubt on both the ability and willingness of the central bank to do the requisite bond buying to stabilise markets in the face of the Covid-19 attack. The Italian sovereign debt market tanked after his reckless remarks and the cost of borrowing for Rome to fight the virus crisis skyrocketed. The ECB was well aware afterward that Italy couldn’t stay in the euro for long had it not come to the rescue again with the emergency aid package.
The Holzmann affair makes perfectly clear the fundamental incompatibility of the German model of limited ECB bond buying (supported by Austria and other fiscally conservative European states) with the survival of the euro.
This has been the history of reform in the ECB. The hawks are always on the losing side when there’s a crisis because Europe is simply unwilling to give up the single currency. The erosion of the German position is so inexorable that it seems to be independent of the man or woman who’s heading the central bank. The new ECB president Christine Lagarde came into office with the idea of tilting to Berlin to make her institution more popular in Germany and to create more unity on the governing council.
But Lagarde’s hawkishness was short lived, after she caused a market panic with her comment that it wasn’t the job of the ECB to “close the spreads” between German bunds and Italian bonds in response to the coronavirus outbreak — a shock departure from her predecessor Mario Draghi’s 2012 promise to do “whatever it takes” to save the euro. The subsequent selloff in European bonds, and particularly Italian debt, was so alarming that she backtracked immediately and apologised to her colleagues.
In less than one week Lagarde went from dumping Draghi’s whatever it takes mantra to conceding that “extraordinary times require
extraordinary actions.” Now she’s saying there are no limits to ECB asset buying and Europe’s bonds are soaring.
Yet there’s something surreal about the current battle over QE’s political constraints in that it could all be made irrelevant as early as May, when a German court is due to rule on the constitutionality of QE. Many expect the judges to vote that it’s unconstitutional. European governments would then be faced with a possible choice of abandoning the euro or coming up with real reform that takes the monetary union a step further, say through the issuance of a Eurobond.
Again, a crisis that threatens the euro’s very existence would lead to a reform that secures its future.
Melvyn Krauss is an emeritus professor of economics at New York University and senior fellow at the Hoover Institution, Stanford University