Europe According to Draghi

Aug 31, 2014 Jean Pisani-Ferry

A few months ago, the consensus was that the time for redesigning the euro had passed, and that the eurozone would have to live with the architecture inherited from its crisis-driven reforms. Not anymore.

PARIS – Central bankers are often proud to be boring. Not Mario Draghi. Two years ago, in July 2012, Draghi, the president of the European Central Bank, took everyone by surprise by announcing that he would do “whatever it takes” to save the euro. The effect was dramatic. This August, he used the annual gathering of top central bankers in Jackson Hole, Wyoming, to drop another bomb.

Draghi’s speech this time was more analytical but no less bold. First, he took a side in the ongoing debate about the appropriate policy response to the eurozone’s current stagnation. He emphasized that, along with structural reforms, support for aggregate demand is needed, and that the risk of doing too little in this respect clearly exceeded the risk of doing too much.

Second, he confirmed that the ECB was ready to do its part to boost aggregate demand, and mentioned asset purchases, or quantitative easing, as a necessary tool in a context in which inflation expectations have declined below the official 2% target.

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John Morgan Sep 3, 2014

"....his claim that preventing the ECB from acting as a lender of last resort imposes a high price – making governments vulnerable and reducing their fiscal space..."

There is another factor which is reducing fiscal space. European Governments (and Argentina and Venezuela) are raiding accumulated State Pension funds or Social Security funds to hide deficits. This is done by internal government fiscal transfers, as was the case in Cyprus, where I live. The previous Cyprus government bankrupted the Social Security fund, borrowing from it by issuing Treasury Bills and rolling them over.

Sadly, the Cyprus private sector pension and social security premiums went into providing a backstop (guarantee) for the pensions of state employees. (State employees did not contribute to either Social Security or Pensions, hence the need to raid private sector inflows).

It was only during the Cyprus bailout by the Troika, that this irregular fiscal transfer, amounting to an accumulated €7 bn (40% of GDP), was discovered.

As is well known, the same strategy of transferring Social Security and Pension contributions to the current account, led to Greece's bankruptcy. In the case of Greece, a law was passed that all private pension funds had to invest in sovereign bonds.

€110 was wiped off the value of Greek bonds (PSI), because, like Cyprus, the Greek Government ran a Public Pension and Social Security Ponzi scheme. The private sector was robbed to pay the outrageous salaries and pensions of state employees. This was done to counter trade union blackmail and avert continuous strikes by militant public service trade unions.

My point is that these massive multi-billion Social Security and State Pension fund black holes exist throughout Europe and have to be filled so that governments can meet current and future liabilities to pensioners and the unemployed.

The Greek-style black hole in the state finances of Poland, which is not a Eurozone country (yet), is estimated to stand at €250 billion. In September 2013, PM Donald Tusk nationalised 50% of the private pension industry, worth €30 billion, to try and plug his Public Pension shortfall.

Tusk is now President of the European Council, which means that he will support other European leaders who wish to raid the private sector pension industry to give themselves fiscal space.

In summary, OMT or QE will be used as another source of funding to fill the black holes in State Pension and Social Security obligations that indebted European governments are hiding off their books, like Greece was doing.

As a consequence, there will be limited fiscal expansion with OMT or QE. Undeclared government obligations must first be met. If not, the state will have to resort to mass-firing of state workers, as demanded by the Troika for Greece. This in turn leads to political instability and the loss of electoral prospects for the governing parties who perpetrate false accounting.

As long as economists believe the false accounting provided by European governments, the Eurozone crisis will defy rational analysis.
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Paul Peters Sep 2, 2014

Admirable but such macro-economical measures cannot control the multi-faceted economical landscape of the Euozone. Several sorts of partial Eurobonds are needed for more precisely targeted linkage between disparate but interdependent economic sectors. Turning the volume dial on the currency is simply too inaccurate when it is more profitable for most investors to do speedy investments in emerging economies, however unsustainable that may be in the long run.
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John A Werneken Sep 2, 2014

This is terrible news. The uncompetitive should be relatively impoverished unless they wish to abandon egalitarian policy and become competitive. Debt is a good measure of action: high debt means no action as yet.
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Joshua Ioji Konov Sep 1, 2014

To say the least, quantitative easing combined with austerity measures will accelerate inequality, because the social expenses and governmental employment in EU has been a natural market tool for balancing the deteriorating private employment salaries with the best example has been China, but not the least Japan fir the last 10-15 years. Even so the governments lack market flexibility, at the moment they are the only market tool for helping markets equilibrium..., what EU is doing and planing to do is going to create more imbalance..., raising inequality, moreover economic stagnation.
Mr. Draghi is planing to pour new wine in the old wineskins...
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Val Samonis Aug 31, 2014

Not too little, too late?

The EuroZone (EZ) banks are almost totally out of any control or any macro prudential regulation because they decide some 97% of money creation (some 80% in the USA) and the directions of money flows. The ECB already admitted its impotence within the current set-up. The EZ banks earn their money the EZ way (pun intended!) mainly by financing the governments of the EuroZone, which is a rather unproductive use of capital resources in the longer-term. I see no productivity breakthrough in the EZ, so we might see a euro collapse sooner than later when Russia corners the EU energy market before this winter.

Val Samonis
Vilnius U
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