Last Thursday, Mario Draghi, the President of the European Central Bank (ECB), said that “within [its] mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The statement lifted market sentiment and sent Spain’s 10-year government bond yields back below 7%.
Media and market commentators have interpreted Mr. Draghi’s remarks as an indication that the ECB is willing to do more to support pressurized euro area sovereigns, for example by expanding the securities markets program (SMP) with further government bond purchases.
In fact, the statement was a supportive but very general one that contained no specific proposals and offered no firmer prospect of the crisis being resolved quickly. It reaffirms our view that the ECB will ultimately do all it can to support policy makers’ efforts to resolve the crisis. However, that is a necessary but not a sufficient condition for the euro area authorities’ current strategy to succeed.
The assumption of ECB support is central to the credibility of the authorities’ ‘muddle-through’ strategy for resolving the crisis – a reactive and gradualist approach that makes periodic shocks inevitable. The ECB’s willingness to act in a way that, by bolstering investor confidence in peripheral sovereigns, temporarily supports those countries’ continued access to debt markets, is a crucial element of the strategy. The ECB’s capacity to provide such support was amply demonstrated with the introduction of the three-year long-term refinancing operation in December 2011. Were the ECB unwilling to act in this way, the authorities’ muddle-through strategy would be unlikely to succeed.
However, the ECB can do no more than buy time: its actions alone will not resolve the debt crisis. Resolution will ultimately rest on achievement of fundamental changes to member states’ budgetary positions and debt stocks, on structural economic changes required to stimulate growth, and on institutional reform to the economic and fiscal governance of the euro area. Each change will take years to accomplish, and support from the ECB will be essential to the preservation of the euro in the meantime.
The timing of Mr. Draghi’s statement is significant. With the July Summit having failed to reassure euro area sovereign investors, and Spanish and Italian government bond yields having risen substantially over recent days, Mr. Draghi’s statement indicates the level of concern among euro area policymakers. It illustrates the extent to which current financial market conditions are credit negative for issuers across the euro area.
The views and opinions expressed herein are the author’s own, and do not necessarily reflect those of EconMatters.
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