Time and again throughout the crisis, investors have called on the European Central Bank to provide more of a financial backstop for troubled countries, thus limiting the risk of a eurozone break-up. In the words of Mario Draghi, ECB president, the central bank’s new bond-buying scheme, announced on Thursday, should do just that.
The stakes could not be higher. The eurozone’s financial market is fragmenting. The wide divergence in rates between different countries is raising fears that the monetary policy mechanism may be broken. This is filtering through to the underlying economy. Both the ECB and the OECD slashed their growth forecasts on Thursday.
Elements of the “outright monetary transactions” – the name Mr Draghi has given his brainchild – offer hope that the scheme may be more effective than past attempts to drive down rates in peripheral eurozone countries. The size of the programme is uncapped lending credence to Mr Draghi’s remarks that he will do “whatever it takes” to save the euro. The ECB has dropped any claim to seniority, which should reassure investors that any purchases will not subordinate their own holdings of peripheral bonds.
Mr Draghi stressed that any purchases under the OMT will be subject to “strict and effective conditionality”. This is an important statement. Given the uncapped nature of the programme, the central bank could suffer politically and financially were governments in trouble to renege on their promises after receiving help.
This commitment, while welcome, does not eliminate the risk of moral hazard. Mr Draghi may claim that the ECB will stop buying the bonds of countries which are not compliant with their agreed programmes. But doing so after the central bank has stuffed itself with a country’s bonds is like putting a gun to one’s own head and threatening to pull the trigger.
Enforcing conditionality is also crucial politically. The Bundesbank and the German public remain opposed to any bond-buying programmes. While Mr Draghi is right to do what he feels is necessary to save the currency bloc, he has to ensure that Europe’s largest economy remains on board.
Markets have applauded the ECB’s move. But European leaders should not get carried away. Spain and Italy still have to decide whether to apply for help. The process of closer eurozone integration remains uncertain.
For all Mr Draghi’s bravery, his audacious gamble remains just that.