Mario Draghi has become explicit about what it will take for the ECB to have a more active role in the European sovereign debt crisis. Addressing the European Parliament in Brussels, Draghi said:
“what I believe our economic and monetary union needs is a new fiscal compact – a fundamental restatement of the fiscal rules together with the mutual fiscal commitments that euro area governments have made.”
This statement is the clearest indication that the ECB will in fact take on a more prominent role in dealing with the crisis only if it sees meaningful fiscal consolidation and integration. Draghi also indicated that the ECB will cut rates later this month.
On Tuesday, I said that the likely policy path for European sovereign debt crisis would be a deal whereby countries that have deficit problems would agree to allow European oversight of their future budgeting process in exchange for some kind of supranational support. Indications are that Germany and France are trying to hammer out an agreement on specifics but reports indicate that the two countries are still far apart.
In yesterday’s weekly, solutions in Europe figured prominently. At the moment there are five competing and complementary ideas that are being bandied about as short- and long-term fixes.
- Fiscal union. This is a must. The ECB will not act without some credible degree of fiscal integration. And the ECB has come to be critical in dealing with the banking sector where liquidity has dried up because of bank exposure to weakening sovereign debt.
- ECB liquidity. With banks now able to borrow for less than the sovereigns that have kept them from failing, it is clear that the sovereign debt markets have frozen. Once a credible form of fiscal integration or a path to integration is achieved, the ECB is expected to support euro area banks by taking on a lender of last resort role to unfreeze sovereign debt markets in Italy, Spain, Belgium and France. How any intervention would take place is unclear.
- Eurobonds. This subject is still taboo. In public all of the German coalition officials voice great opposition to collectivised European debt. However, behind the scenes nothing has been ruled out. In fact, leading politicians from a number of other countries are now jumping the fence on this issue. Outgoing Bundesbank head Juergen Stark explained his support for Eurobonds only after fiscal union. And Austrian daily Kurier reports that Austrian finance Minister Fekter now also supports Eurobonds only “when everyone is disciplined” in their public finances.
- Austerity: What is clear then is that any fiscal integration will require fiscal discipline aka austerity and this in turn is the prerequisite for any imminent ECB liquidity and for Eurobonds over the medium-term. Yes, budget cuts will deepen the recessions in the periphery. But, there is no way around it; politically, no solution in Europe will unlock the sovereign debt crisis without fiscal consolidation. All of the political leaders are aware that this is so.
- IMF: The talk of the IMF as a lender of last resort for sovereigns continues. I continue to see any imminent real IMF involvement as unlikely. The IMF simply does not have the funds to bailout large developed economies, nor is that their mission. Politics in the US would rule out any solution that required the US to contribute to the IMF to help bailout Spain or Italy. If any IMF-oriented solution comes into being, the IMF would only be used as a fig leaf, and the true paymaster would be the ECB.
What I see happening now is an attempt to cobble together a credible enough form of fiscal integration or a credible enough commitment to it to allow the ECB to intervene while a more permanent structure is implemented. If the Europeans get that far, only then would Eurobonds enter the picture.
All of this is still very much up in the air. Still, markets now expect some sort of reasonable solution within days. But will they be disappointed?
Also see: Draghi hints at eurozone aid plan in the FT