January 2012
Heroes and zeroes
For all European countries, the daunting task facing policymakers in 2012 is to find ways of alleviating their respective debt burdens while trying not to impact economic growth prospects too detrimentally when doing so. This is a regional conundrum with global implications. The damage done by any single national failure within the eurozone will not only be felt Europe-wide, thanks to the potential for domino-effect contagion, but also well beyond European shores, due to the unprecedented interconnectedness of the global economy.
The role of the European Central Bank may prove vital as 2012 progresses. The ECB has done its utmost to come to the aid of financially distressed eurozone states. It has intervened directly in government bond markets, participated in internationally co-ordinated central bank initiatives to ease liquidity conditions, cutting interest rates despite an inflation level of 3% and, most recently, introduced three-year long-term refinancing operations (LTROs) to banks – not bad for an institution whose core mandate is solely to contain inflation. The last of these measures is perhaps the most significant, since the hope is that banks will use the LTRO loans to buy sovereign debt issued by their respective governments to help themselves and their countries. But that hope may be misplaced, since most banks (except smaller Italian and Spanish ones) are more likely to prefer to shore up their capital ratios to help comply with new requirements.
Long on concepts, short on credibility
Sadly, the ECB’s efforts have not been matched by those of EU politicians. Their latest offering, a “fiscal compact” agreed (with the notable exception of the UK) in early December, failed to impress. Instead, the compact’s aim of pressuring fiscally profligate countries to put their house in order merely prompted credit-rating agencies to warn of further eurozone downgrades. There seems to be a lack of understanding among Europe’s political elite as to what is required to calm the financial markets’ fears; and there is an air of pathos each time a new agreement is hailed by politicians, only to fall considerably short of market expectations. For the future, this is a crucial mismatch that urgently needs to be reconciled.
There is also a growing sense of impatience at the ECB with the ineffectual attempts of its political counterparts to act decisively, and the central bank’s public reluctance to confirm it will buy unlimited amounts of government bonds if necessary could be interpreted as a signal to EU leaders to improve their efforts. For now, however, in the absence of a central institution (such as the US Treasury) to implement and oversee regional financial policies, the EU’s fortunes remain at the mercy of its elected heads of state.
