How Draghi Got Divided ECB To Say 'Yes' To Money-Printing
When Mario Draghi announced the European Central Bank's trillion-euro scheme to buy government bonds, he acknowledged that in the round of strategies to revive inflation and boost the economy, the bank had just played its last hand.
Asked by reporters what would happen if the plan to purchase 60 billion euros of assets a month for 19 months failed, Draghi answered: “We have Plan A. Period.”
In fact, the money printing scheme known as quantitative easing is already a plan “BBB” in the words of former European Economic and Monetary Affairs Commissioner Olli Rehn, who termed it a “Belated Big Bazooka.”
For more than a year now, economists and central bankers have pressed for dramatic action to halt tumbling inflation, sagging price expectations and a stagnating economy.
But fierce resistance from German politicians and the influential Bundesbank meant Draghi could not move until he had slowly and painstakingly built overwhelming support in the ECB's policy-making governing council for his monetary gamble.
This report shows how the ECB went from being deeply divided over QE to launching a bolder and more open-ended version than most investors had expected.
It is based on interviews with half a dozen persons involved in the decision. All spoke on condition of anonymity because of the confidentiality of ECB deliberations. Other policymakers have chosen to speak publicly in the aftermath.
The Italian ECB chief's first tactic was to chop the decision into separate questions, a strategy he thought most likely to construct as broad a consensus as possible for QE.
He first sought agreement on the principle that buying sovereign bonds of all euro zone member states in the secondary market in proportion to their share in the central bank's capital was a legitimate tool of monetary policy.
This not only built a vital foundation, but also neutralized official German opposition.
“For me, the most important thing was we all agreed it was legal – including the Germans on the council,” one participant said.
Having secured unanimous support for the principle, debate could then move to the timing and modalities of bond-buying, notably how much risk was shared among national central banks.
Here, crucially, Draghi offered a compromise — one that some central bankers and analysts have said could weaken not just the impact of QE but also the bank's credibility.
He suggested that only liability for jointly issued EU and European Investment Bank bonds be mutualised, and that the default risk on the other 80 percent of government debt to be bought should fall on national central banks.
“Draghi argued that while many of us want to see a European fiscal and political union with mutualised debt issuance, this requires a political decision, and unelected central bankers should not do this through the back door,” one participant said.
This most disputed aspect of the decision — to ring-fence most of the risk — was a concession to German Chancellor Angela Merkel and the Bundesbank “designed to allay German hysteria”, said another source. The source added that it was of little practical relevance since risks would inevitably be shared among Euro system central banks if a euro zone country defaulted.
Draghi briefed Merkel on his intentions at a private meeting in Berlin on Jan. 14. Despite her stated concerns about the “sweet poison” of easy money causing speculative bubbles and loosening pressure on governments to carry out painful reforms, Merkel indicated she would respect the bank's independence, a source briefed on the conversation said.
“The purpose was to let her know what was in the pipeline so she would not negatively surprised,” the source said.
“SHOCK AND AWE”
Once debt mutualisation was taken off the table, the governors were able to agree on a bigger and more front-loaded bond-buying drive than was initially proposed.
After initially exploring a 500 billion euros program, the formal proposal circulated to governors on Jan 21 was for 50 billion euros in monthly purchases over 22 months or a final bill of 1.1 trillion euros.
In the meeting, they raised the amount to 60 billion euros a month for at least 19 months — a total of 1.14 billion.
“The main change was more front-loading to try to achieve a sense of 'shock and awe' in the markets,” another person involved in the decision said. “And the program is semi-open-ended. We subtly kept the door open for more if needed.”
The euro, which had fallen from a high of near $1.40 last May to around $1.15 just before the decision, slipped below $1.12 afterwards in a move that will make European exports more competitive and may eventually help revive inflation.
In building his case, Draghi was supported by a welter of evidence that downward pressure on prices and on inflation expectations was accelerating.
The plunge in oil prices, while potentially a boon for purchasing power in the euro area, risked depressing wage growth and accelerating a price-cutting war, while making it harder for households and governments to work off their debt. Market indicators closely watched at the ECB's Frankfurt headquarters suggested inflation might not recover before 2020.
And just a week before the ECB's final decision, Draghi was greatly helped by an opinion issued by the legal adviser to the European Union's highest court giving him a virtual green light.
Advocate-general Pedro Cruz Villalon rebuffed a German legal challenge to a previous, as yet unused, bond-buying scheme. He found overwhelmingly in the ECB's favor.
That was a much-need counter to a drumbeat of hostile comment from German politicians, economists and media, accusing the ECB of robbing German savers with negative real interest rates and transferring credit risk from profligate southern states to German taxpayers.
“That opinion made things much easier. It was very helpful in the process. It made it much harder for the Germans to argue against QE,” an ECB policymaker said.
CLEARING THE AIR
Draghi also got his way in part because he had reassured council members that he could work collaboratively with them.
Last October, seven members of the 24-strong council voted against the policy of expanding the bank's balance sheet without resorting to full QE, and a couple more voiced reservations about the ECB chief's perceived secretive leadership style.
That led to a clearing of the air in which Draghi promised closer consultation and more debate with governors outside his Frankfurt inner circle.
“We decided to show our unity, and Mario has been more forthcoming since then,” a person familiar with the discussion said. “Since November, the meetings have been better directed and there has been more transparency.”
No formal vote was taken on the QE decision. Instead, Draghi summed up after each question, gaining agreement to announce the council's unanimous support for the legitimacy of QE within the bank's mandate.
An ECB official said the fact that executive board member Yves Mersch from Luxembourg, a monetary hawk close to Germany, changed his mind and ultimately backed the decision was helpful.
Yet several governors, including some who voted for the policy, harbor doubts about whether it will work.
“We were trapped, both by market expectations and by the fact that we couldn't leave this tool in our toolbox unused as we slid closer to deflation,” said one person involved in the decision.
Five members — the German, Dutch, Austrian and Estonian national central bank governors and the German member of the ECB's executive board — opposed the timing.
“I personally would have suggested thinking about this program but waiting a bit (to see) if we really need it,” Austrian ECB council member Ewald Nowotny said on Austrian television, while Dutchman Klaas Knot said in another television interview he was concerned the ECB was using “such a powerful drug with considerable side-effects.”
By upholding the ECB's independence and refraining from public criticism, Merkel has blunted German dissent against the decision, which will be reviewed in September 2016.
Asked what would happen if the goal had not been achieved by then, ECB executive board member Benoit Coeure said at the World Economic Forum in Davos: “If we haven't achieved what we want to achieve … then we'll have to do it for longer.”