2

The ECB’s Lethal Inhibition

BERKELEY – Last December, with Europe’s financial system on the brink of disaster, the European Central Bank stunned the markets with an unprecedented intervention, offering banks across the eurozone essentially unlimited liquidity against any and all collateral for an exceptional period of three years.

The ECB’s surprise liquidity operation put the continent’s crisis on hold. But now, just fourth months later, matters are again coming to a head. The big southern European countries, Spain and Italy, battered by austerity, are spiraling into recession. The deterioration of economic conditions is casting doubt on their governments’ budgetary arithmetic, undermining political support for structural reform, and reopening seemingly closed questions about the stability of banking systems.

Once again, the eurozone appears to be on the verge of unraveling. So, will it be once more into the breach for the ECB?

The hurdles to further monetary-policy action are high, but they are largely self-imposed. At its most recent policy meeting, the ECB left its policy rate unchanged, citing inflation half a percentage point above the official 2% target. Board members may have also been concerned by evidence of cost-push inflation in Germany. The leading German trade union, IG Metall, has called for a 6.5% wage increase in the next annual round of negotiations. And German public-sector workers obtained an agreement at the end of March that boosts wages by 6.3% in the coming two years.