Tuesday, August 7, 2012

Welcome to the ECB & Risk

by Don Alexander, MBA

Associate, RSD Solutions Inc.

www.RSDsolutions.com

info@RSDsolutions.com 

 

The current ECB President, Mario Draghi has said in his latest statements that the ECB is now determined to act as lender in last resort to governments by offering the services of the ECB’s unbounded purse.  In effect, the ECB head is willing to backstop public debts to restore the effectiveness of monetary policy as the markets continue to test its’ resolve.  This could indeed bring the euro zone close to the end of the crisis.  This is part of a recent discussion by Charles Wyplosz in Welcome to the ECB (VOXEU, 30th July).

 

By stating that preservation of the euro is an ECB obligation, he indicated that he will have no choice but “to do whatever it takes”.  This means optimism may be justified – if only because it suggests that the Eurozone has a great central banker who is both a serious economist and an astute politician.  Draghi made an implicit commitment to act as lender of last resort to Eurozone governments. 


Draghi has political cover: every single summit since 2010 has repeated – and this quite formally and explicitly – that Eurozone leaders are ready to do whatever it takes to preserve the euro.  The time to deliver is coming.  This will be a gigantic political challenge for Merkel, but in many cases she has already changed her position in front of pressing danger to the euro zone.

 

On 11 December 2011, Mr. 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.” A fiscal compact was initiated and the Treaty on Stability, Coordination and Governance in the EMU, is now under ratification. The ECB delivered starting its massive liquidity support for Eurozone banks – the LTRO (Long Term Refinancing Operation).

 

Secondly, On 31 May 2012, Mr. Draghi famously called for a banking union, pointedly noting:  "We can have a big pot of money, but if people can't touch it, it's like we don't have it."  Although the term is vague and therefore open to much watering down, the prospect of a single European bank supervisor, a long-rejected yet indispensable element of a monetary union, is now on track.

 

The latest statement signals that the ECB is now determined to act as lender in last resort to governments.  The Draghi method is becoming clear: offer the services of the ECB’s unbounded purse, but require what it takes to alleviate the moral hazard that it entails.  Put differently, Draghi is willing to backstop public debts to restore the effectiveness of monetary policy. This would indeed bring us close to the end of the crisis.  The question is can he deliver.

 

Optimism may become justified now, if indeed the ECB is in the hands of serious economists and astute politicians.  But then, Wyplosz worries that there always is a risk of reading too much in a central banker’s unavoidably cryptic statements.

 

The lesson for risk management is not just the discussion, but what is actually delivered.

For more on this follow the link: http://www.voxeu.org/article/welcome-to-the-ecb

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