The EconomistOctober 12th 2019 Finance & economics 79N
ot long ago it was hard to find anyone with a bad word to say
about Mario Draghi, the Italian boss of the European Central
Bank (ecb). He is credited with saving the euro by pledging, in the
depths of a crisis in 2012, to do “whatever it takes” to stop the cur-
rency from breaking up. He seemed certain to leave office at the
end of October to gushing tributes and an assured place in the pan-
theon of Europe’s great leaders. Instead, his critics are out in force.
Their fury was aroused by the stimulus package Mr Draghi un-
veiled on September 12th, which included cutting interest rates
from -0.4% to -0.5% and resuming quantitative easing (qe), the
purchase of bonds with newly created money. In the hope of reviv-
ing inflation, the ecb has pledged to keep rates low and continue
buying bonds until underlying inflation returns to its target of
“close to, but below, 2%”. At least seven members of its 25-strong
rate-setting body, including the central-bank governors of France
and Germany, opposed restarting qe. Klaas Knot, the head of the
Dutch central bank, called it “disproportionate”.
On October 4th the old guard joined the fray. Six former Austri-
an, Dutch, French and German central bankers released a memo
criticising the ecb’s direction under Mr Draghi. The bank mis-
interprets its job of maintaining price stability, they say, and its
policies have become entangled in politics. One of the signatories,
Otmar Issing, the ecb’s first chief economist, was its intellectual
leader for its first eight years. If Mr Draghi is the euro’s preserver,
Mr Issing is one of its creators. How to interpret the strife?
To make the single currency palatable to the inflation-phobic
Germans, the ecb was modelled on their central bank, the Bundes-
bank, with control of inflation at the heart of its mission. (In 1992
Jacques Delors, then the president of the European Commission,
joked that “not all Germans believe in God, but they all believe in
the Bundesbank.”) On Mr Issing’s watch, the ecb began life with a
“reference value” for growth in the money supply and a flinty view
of inflation: anything below 2% counted as price stability. But the
reference value fell by the wayside. Mr Draghi views the bank’s in-
flation target as symmetrical, not an upper limit, and has said he
would tolerate prices growing faster for a spell.
Teutonic toughness was necessary to tame high inflation in the
1970s and 1980s. But that world is gone. Inflation has exceeded 2%in only 29 of the past 120 months; core inflation, not once. In this
environment the memo’s worry that the ecb’s symmetrical target
might stoke runaway inflation seems absurd. It confirms what Mr
Draghi told the Financial Timeson September 30th: that he inherit-
ed a “very conservative” institution. This rankles with old-timers,
but it is true. On the eve of the great recession in 2008, the ecb
raised interest rates as other central banks were loosening. In 2011,
as the euro zone’s economy teetered on the brink of a double-dip
downturn, it raised rates twice. Those mistakes, and its slowness
compared with America and Britain to start qe, left it struggling to
convince investors that it would act speedily to head off deflation.
Critics of negative interest rates fear that they do more harm
than good by reducing bank profits, thereby deterring lending. But
in June the ecb’s economists concluded that banks were passing
negative rates on to their borrowers and depositors, thus avoiding
a squeeze on their margins and providing an economic stimulus.
Even some of the hawks on the ecb’s governing council think in-
terest rates can safely be pushed even further below zero.
A fear often heard in the northern countries of the currency
bloc—and one implied by the memo—is that qe, by lowering the fi-
nancing costs of indebted southern governments, allows them to
avoid painful reforms. It is true that loose money has benefited
highly indebted countries the most. But the old guard are wrong to
say that the ecb is deliberately cosseting the southerners. North-
erners, too, have enjoyed lower debt-service costs—the German
state, for instance, to the tune of €368bn ($402bn), or 11% of a year’s
gdp, according to the Bundesbank.
Now the ecb is wading into deeper political waters. It has set a
limit of 33% on the share of a government’s public debt that it will
buy. That ceiling will soon be reached in countries, including Ger-
many and the Netherlands, with little debt relative to their size.
The bank will then face an unpalatable choice. If it raises the limit
it could become such a significant creditor that it might one day
have to decide whether or not to veto a country’s debt restructur-
ing—a highly political question. If it keeps the limit where it is, it
will be able to buy more assets only in those countries where the
limit has not yet been reached—making it even clearer that the
main beneficiaries of qe are indeed the southerners.North-south divide
The ecb’s critics tend to miss the underlying cause of low interest
rates: weak demand across most of the rich world. Ironically, the
problem is particularly acute in the euro area, precisely because of
fiscal reforms by its southern members. For the euro’s first decade,
growth and inflation trundled along because excess savings in the
north were matched by excess spending in the south. But wage re-
straint and improved competitiveness in the south since the
zone’s sovereign-debt crisis has turned those countries into sav-
ers, too. The northerners have never adjusted. Their governments
remain preoccupied with paying down debt. Their companies gain
from a weak euro, but hoard cash rather than investing more or
paying higher wages. The result is huge current-account surpluses
in Germany and the Netherlands of 7-10% of gdp. The euro area as a
whole runs a surplus of 3%.
The critics’ timing seems calculated to influence Christine La-
garde, the former boss of the imf, who takes over from Mr Draghi
on November 1st. She has promised to review the ecb’s strategy. Ms
Lagarde must listen to northerners but also tell them some unwel-
come truths. Quelling the dissent would be the first step towards
an eventual legacy as significant as that of Mr Draghi. 7Free exchange Clash of the titans
What to make of the strife at the European Central Bank