The week when Mr Draghi greatly diminished the office of ECB President and sacrificed the fiscal-monetary policy distinction

First came the impressive declarations: The ECB will do whatever is necessary to ensure that those who go short on the euro, who bet on its disintegration, will lose. “And, believe me”, he added “it will be enough”. He also, rather significantly, uttered the term ‘convertibility risk’ (code-words for the risk that funds kept in some part of the Eurozone will be forcefully converted to some new, devalued, currency) and pledged to eradicate it. No wonder, the markets responded with considerable enthusiasm.

Then came the moment to put up or forever lose his credibility. Alas, probably under incredible pressure from the Bundesbank, he opted for the latter. Citizens and investors felt a wave of desperation hit them and all the gains from the grand declarations fizzled out. Since then, some analysts went back to what Mr Draghi said during the Thursday press conference and read between the lines some evidence of actions-to-come that may offer relief to the struggling Eurozone. They are clutching at straws, I am very much afraid.

What was the ECB’s position before Draghi’s heroic declarations? It was that it cannot arrest the crisis unless member-states act as part of a Grand Deal on how to effect a Eurozone-wide fiscal policy. Then and only then, the ECB would bolster their efforts through its own monetary operations. Clearly, that position led markets to believe that the Eurozone had no credible plan for dealing with the Crisis, as the cart (fiscal union) was being placed before the horses (serious ECB-centred intervention to stop the death embrace between insolvent banks and insolvent nations).

And what is the Draghi position after Thursday’s crucial ECB board meeting? That the ECB is ready to buy bonds in the secondary market once member-states act as part of a Grand Deal on how to effect a Eurozone-wide fiscal policy. In other words, no change whatsoever. None! In this sense, the ECB’s position which was initially deemed inadequate was reiterated as fresh policy a few days after its President pronounced himself ready to implement a radically new policy. The end result is, simply, the loss of the ECB President’s credibility. Or, to put it differently, if Mr Draghi were once again to make a similarly large pronouncement (along the lines “we shall slay this dragon, whatever it takes”), there is no doubt that the market fillip that will follow will be much weaker than that we experienced last week. Thus, the office of ECB President has been diminished.

As if that were not enough, Mr Draghi has, possibly unwittingly, undermined one of the ECB’s cherished principles, without replacing it with some fresh (possibly more appropriate) principle. Which principle? The principle that the ECB does not meddle in fiscal policy and stays well within its remit of maintaining price stability and a healthy monetary policy transmission mechanism. Consider this statement by Mr Draghi:  The “…guidance that we’ve given to the committees of the ECB differs from the previous program because … we have explicit conditionality here. And as a necessary condition, an adherence by governments and by euro area governance to its commitments.” Let’s unpack this. The previous program he refers to is the flurry of purchases of Greek, Portuguese and Irish bonds during 2010/11, the purpose of which was to stabilise these countries’ spreads and avert their insolvency. That program failed miserably, in the end, even though it did manage to slow down for a while the rate of increase of these interest rates. What Draghi is now saying is that, unlike those purchases which the ECB made without imposing conditionality on the three countries involved, any new purchases will come with strings attached; i.e. with a Memorandum of Understanding between the ECB, the EE and the member-state whose bonds the ECB will be purchasing in the secondary markets. This is, in my view, the end of any pretense to keeping monetary policy separate from fiscal policy. In effect, the ECB gives itself the task of enforcing into member-states particular (and highly austerian) fiscal policies.

The issue here is not whether one agrees or not with austerity. The issue is that the degree of austerity, and the extent to which policies like privatisation of the electricity grid of a nation must be pursued, was never supposed to be the business of the Central Bank. These were matters for democratically elected governments. During 2010/11, when the ECB was purchasing stressed bonds, it did so on the basis that the debt crisis of these member-states was threatening the ECB’s capacity to determine interest rates in places like Greece and Ireland. Thus, it intervened in the secondary bond markets in order to repair these monetary policy transmission mechanisms. Meanwhile, whatever conditionality was imposed on Greece, Ireland and Portugal was imposed by the troika in the context of the loans provided to these countries by means of guarantees backed by the taxpayers of the surplus countries. In short, the principle of keeping fiscal policy and monetary policy separate was, more or less (and despite Axel Weber’s protestations), intact.

Now, however, Mr Draghi is proposing to scrap this principle by tying up his impending intervention in the secondary market for Italian and Spanish debt to particular austerian fiscal policies by Rome and Madrid. This abandonment of the formal divide between fiscal and monetary policy may not be a bad thing, per se. But let us be honest about it and call a spade a spade. The reason why a smidgeon of honesty is necessary here is because, now that the ECB has decided to go boldly into the realm of fiscal policy, it might as well push for fiscal policies that work; as opposed to the austerian ones that do not.

For example, given its new boldness, there is nothing to stop the ECB from declaring that it will set a limit of 3.5% to all spreads within the Eurozone, promising to buy however many bonds of any member-state whose spread from the bund exceeds 3.5%. What stops it now from making this declaration? The answer is: the myth that this would amount to crossing the Rubicon that divides monetary policy (the ECB’s tool) from fiscal policy (the area of responsibility of elected governments). But surely this argument holds no longer now that this Rubicon has been passed by an ECB President who says that he will use the ECB’s power to print in order to impose particular fiscal policies on the member-states that will be favoured by the ECB’s intervention!

In summary, in a few days, the hapless Mr Draghi managed to diminish the power of his office and permanently to blur the divide between fiscal and monetary policy without even opting for a foray into fiscal policy that may help the euro survive. Infinite are the ways in which Europe’s leaders manage to injure our common European home. May they cease and desist before it is too late.


  • Is it disputable that the majority of people in Greece, Ireland and Portugal would be better off today in real terms if they had chosen to go out of the EZ rather than accept bail-out loans?

    • Yes it is. While the periphery would have been better off had it not entered into the euro, getting out of it would be a calamity.

    • If your prediction of conditionality proves true, and harsh MoU are imposed on future “bailouts”, it will provide a plausable excuse for “proud” sovereigns to exit the Euro.

    • Yanis, I have undeterredly said the same thing from the start, i. e. that getting out of the Euro would be a calamity for a country like Greece. I am still saying that but I have to admit that “alternative thoughts” are entering my brain. Why? I read so many views expressed by Greeks that all they ever want is to return to is financial/fiscal self-determination, regardless of the possible costs involved. I can’t tell whether this has become a majority view in Greece or not. Presumably, someone would have to do a lot of explaining of the consequences before they take a decision emotionally. But, if after due consideration of all the consequences, the majority view would still prefer total self-determination, one ought to think about that. And if one were to go down that route, one would have to negotiate with the EU a very substantial support program to make the transition as orderly as possible.

      Again, I still view a Grexit as a calamity for Greece but Greek writers/commentators seems to be suggesting that, for the electorate, no calamity could be so great as to justify not being fiscally and
      financially self-determined.

    • Germans (not the owner of the export companies) would also be better off had it not entered the Euro.

      Since the Euro is causing symptoms like a virus. It needs to be killed. That might be a painful therapy, but there will be light at the end of the tunnel.

    • @klaus
      Nice analysis. Indeed the mood is changing in Greece especially since the cost for keeping the euro is increasing and no end is in sight. The hard reality of the latest 11,5 billion worth of cuts (that’s “structural reforms for you”..) is sinking in. I would like to point out that people do not care so much about fiscal sovereignty as much as getting out of a hopeless situation. One out of six Greeks is now unable to even pay the first tranche of this year’s tax according to reports. People need a way out of this horror show. I imagine the voices pushing for a stop to this madness will only grow although the damage is now done. Could it be that this was the plan all along? Break the economy past the point of no return so that it would be impossible for Greece to stay in the EZ and be forced to beg for a way out? My answer would be yes.

    • Tasos – I think Greeks will agree, the Troika can now be accused of propping up an oppressive regime.

  • Great analysis. Does the Bundesbank or any other central bank have veto rights in any decision the ECB might want to take? Let’s say for arguments sake that mr Draghi wants to pursue the course of action suggested here, does he need a unanimous decision or a majority of the board is simply enough?

    • No. BUT, yes capital but! Draghi always stated that the ECB is in the footsteps of the Bundesbank, which was a lie of course, since the ECB is not close to being as independent as the Bundebank was. Latin law has its difficulties with “autonomous entities”.

      If it becomes even more evident that the ECB is nothing else than a ClubMEd style central bank, all Europhiles in Germany have to face opposition. In Germany we have always looked down on the ClubMed butter in the sun currencies. So it is dangerous for politicians wanting us to use stuff like that.

      The ECB cannot survive without the support of the German public and you should include the public of Northern Italy too! They have the money and as soon as they are not long on the Euro anymore its game over.

  • Yianis – “May they cease and desist before it is too late.” – Don’t you want to put more power in the hands of the ECB? Doesn’t your plan entail cutting the local politicians out of the equation? Isn’t Draghi’s/the ECB’s involvement in fiscal policy an inevitable consequence of cutting the local government out of the equation?

    • I have never wished for the ECB to intervene in order to accelerate the current death spiral that drags both banks and states into a black hole. I wished for the sort of ECB intervention that ends the death spiral. (This is why I wrote that I have no qualms with the end of the pretense that the ECB ought to stay clear of fiscal policy; and that my gripe is with its espousal of toxic-austerian fiscal policies that lead to Europe’s disintegration).

    • The situation has morphed from a banking crisis to an economic crisis to a political crisis and now to a crisis of democracy. I agree completely that it would be economic suicide for Greece to leave the euro (although it should never have entered); however, if the EU cannot provide an acceptable level of democratic accountability for the handling of this mess, then maybe Greece should quit the euro. The biggest danger with that is that there is a political and legal opinion that Greece should also quit the EU: the implications of this are so big, that it is difficult even to speculate.

  • The ECB had some very enlighting experiences with bond buying w/o strings attached. So it is perfectly understandably that it won’t repeat this mistake. From The Economist:

    A YEAR ago this week Italy’s prime minister, Silvio Berlusconi, received a terse letter from two men who held his country’s fate in their hands: Jean-Claude Trichet, the-then president of the European Central Bank (ECB), and the man who has since taken over the job, Mario Draghi (then governor of Italy’s central bank). It contained a list of measures Italy had to adopt urgently, from budget-cutting to structural reforms, to regain the trust of investors who were dumping Italian bonds. Mr Berlusconi began to comply and, though the bargain was never explicit, the ECB began buying its bonds to bring down Italy’s borrowing costs. But no a sooner had market pressure on Italy relaxed a bit than Mr Berlusconi started to backtrack.

    The experience of August 2011 goes some way to explaining Mr Draghi’s caution this week, when he declared the ECB was ready to resume buying bonds in the coming weeks – but only if vulnerable countries asked for help first from the official euro zone rescue funds and submitted to a reform programme […]

    As for Draghi did this “possibly unwittingly” I think you underestimate this guy: I loathe him, but one has to acknowledge he is extremely intelligent and klnows perfectly well what he is doing. Which is: to serve the interests of the finance sector. Whoever came up and through with the idea of making of all people a Goldman Sachs alumni the head of the ECB, earned the huge bonus he certainly got from this industry.

    For instance that Draghi has forked over more than one trillion Euro (via the bloody LTROs) which guarantee the banks an absolutely secure additional profit of 40…70 billion Euro per year over the three years the LTROs are running was a brilliant move by the masterminds who drafted the script for Draghi.

    • Well….. the LTRO scam came and went but I don’t remember you, as the implicit “guardian” of the the German taxpayer, being outraged. Quite revealing.

  • I don’t agree with your interpretation of “conditionality”. I don’t see anything that would hint that the ECB will require the countries to make commits to the ECB (i.e. sign some MOU with the ECB) to benefit from the restarted SMP. Instead what Draghi refers to is that countries willing to benefit from SMP have to apply to EFSF/ESM. The commitments will be between the country and the ESM/EFSF.

    In my view, a very significant announcement and a great way forward towards a solution to the government debt crisis. The new SMP will not be limited in size and only be open to countries that adhere to austerity. This is something the Northern States should be able to live with.

  • Germany faces a massive downgrade which will have all German pension geezers spinning their heads off, if something as much as tiny happens to Greece.

    Even a wrong look by German tourist with smelly, sweaty socks (hiding premature fungus growing organisms) would be enough to trigger the greatest avalanche ever to befall Bundeslandia without mercy.

  • Mr. Varoufakis, thank you for your very informative blog. I read it regularly. I am wondering whether your Vital Space page might be back up and running anytime soon? I have a project in mind. Thank you.

  • @yanisv

    Why getting out of it would have been a calamity? Can we go objective in predictions of consequences of past not done choices?

  • “Jullie premier speelt een verderfelijke rol tijdens de EU-toppen”

    (Your prime minister his role is very bad during the EU summits)

    “Het probleem is niet dat Nederland dwarsligt, het probleem is dat Nederland bijna altijd dwarsligt.”

    (The problem is not that Holland makes problems, the problem is that Holland always makes problems)

    Of het nu over de noodleningen voor Spanje of Griekenland gaat, over de meerjarenbegroting van de EU, het banktoezicht, de regels voor de pensioenfondsen, het asielbeleid, de Hedwigepolder of het opheffen van de grenscontroles met Roemenië en Bulgarije, Ruttes antwoord is steeds: nee, nee, nul, nul.’

    (It does’t matter what, the answer from Holland is no, no, zero, zero.)

    “Alsook het feit dat nergens anders in de EU de eurohaat zo intens en zo wijdverbreid is als in Nederland. ‘Nedergif’, noemt een hooggeplaatste EU-ambtenaar het. ‘En we appreciëren het nog minder dan de nederwiet.”

    (Nowhere in the EU there is such a tremendous hate against the EU like in Holland)

    Why is everybody looking to the other site, looking to Germany, to the Bundesbank and don’t see were the REAL bomb is???

    Holland will blow the euro, not Germany. We are better of without the euro. Like Finland.

    Best regards, Martin.

    • Yes, that´s great! Hollland can do it, their politicians are not pussies like in Germany where htey still think they need to be careful due to the last war.

      Did you see the great new website the Wilders set up? Only purpose is to get people angry about the Eurocrats. Smart move.

  • There is no doubt a very insightful analysis by Yannis there . I am not an Economic Expert on the plans other than to say but I feel that the plans won’t work because at it’s essence Germany is , to mostly suit itself and it’s voters , completely failing to realise that if they want the Euro and EU project to continue for the long term they will ultimately have to decide to pay for the Dinner . All the other talk and debate and idea thrashing is just that , talk . If I could Gordon Gecko for a minute ” It’s about the Bucks Buddy , the rest is conversation . ” It is clear the Germans are too mean to pay for the dinner and are Completely underestimating the seriousness of what they are inflicting on the rest of Europe especially the weakly Quisling Traitor Governments in most of the Periphery . These Governments have completely lost their way and perspective about what the purpose of joining the EU was . The Germans seem to think that the periphery lived it up at their expense and can suck up Austerity for a bit and that the crisis isn’t that serious really . In fact they think that the “crisis” is being talked up by Speculators looking to profit . Ordinary People aren’t suffering at all . If this is the sum total of EU solidarity after 50 years then it’s time it was binned or greatly reduced in it’s costs, grandiose notions about itself to some sort of a simple trading agreement . The solidarity that exists is I’ll throw you a few Euro for now to save the system and keep the value of the Euro down for German Exporters. All bills to be dumped on to current and future taxpayers . Keep promising them that glorious future in the future through good works and sacrifice . You know sort of “Abracht mac Frei” for slow learners , with the backing of the overpaid career politicians and state class to sell the snake oil to the Dump Serf Sheeple public . It won’t last because as Yannis said Austerity ain’t working and people will leave, especially the youth in the Peripheral Countries , rather than see a future constrained by lack of opportunities as the Debt mountain is worked off . The only question is what triggers the end if things dont change from the current approach soon . when that gets triggered unexpectedly it will be too late for real solidarity . Yours Sincerely Peter Pipesmoker .

    • The key for the prison gates is right there. You just need to take it.

  • It is pretty well accepted in Ireland that ‘bailing out the banks’ had a devastating effect on the economy, and the government’s ability to pay for running the country.

    Would there have been serious negative consequences in not paying bondholders?
    (but guaranteeing deposits)

    Someone told me for example that Anglo Irish Bank had very little systemic importance. Yet the government sent tens of billions its way.

    It occurred to me that the many billions in the pension reserve fund could have been used to augment annual government expenditure and for job stimulus had it not been spent on repaying bank debt, (and then national debt…part of the
    eu/imf ‘bailout fund’ is pension reserve money…22.5 billion)

    Cheers for reading.

    • I am completely with you. The alarmist actions to save the finance sector, may it cost the taxpayers what it wants, is one of the core causes of the desaster we are facing now (how it could and should have been done can be seen in Iceland).

      That’s why nothing will change, no matter how many more money you pump into the system, as long as the banks continue to control the rules of the game.

  • Now its getting really nice. The Euro brings peace and prosperit to Europe is what the Europhiles told us all the time. Some samples from Markus Söder (Finance Minister (CSU) of Bavaria) this week end:

    “Greece needs to exit the Eurozone. Sending more money to Greece is like pooring water in the dessert”
    “Some day everybody has to move out from mommy. It is time for Greece now”.
    “When mounting climbing you have to cut the rope if there is someone that will cause you to fall”
    “Somehow Mr. Draghi always gets active ans wants to buy governement bonds when the situation in Italy is escalating.”

    • It’s gettting even better. Today, the Goldman Sachs alumni Monti, an unelected technocrat like the Goldman Sachs alumni Draghi (also Italian. By accident?) demands that national governments should ‘educate’ their parliaments.

      His idea seems to be that elected bodies (parliaments) don’t interfere with the doings of unelected ones (governments, ECB, EU Commission…)

      So much about the understanding of democracy entertained by Mr. Monti. Seems to be pretty much in line with what Merkel, Schäuble, Draghi, Hollande, Barroso, Samaras… and the rest of the ‘elites’ would prefer.

    • VSS, this is what it is coming to. The common belief that people are too stupid to vote, the problem is I think populations in Europe are on the brink of agreeing.

  • I think you may be underestimating the end game for the majority at the ECB. It is one man one vote, and Draghi has a Latin led majority that is going to drag the ECB, like the US during the Vietnam war, into a battle they hate to imagine. Markets will force them to keep buying more and more peripheral debt. Spain is the line in the sand, else next would be Italy and no one at the ECB wants that. Spain and Italy can and will give up on their austerity programs, and even so Draghi’s ECB majority will still buy their bonds because those ECB governors otherwise will each go down in history as failures. So austerity is not the outcome here, it is instead what the Germans fear.

    • They will soon not only have a majority but close too 100%. After the Netherlands leave, the rest of the paymasters will leave too.

  • Yes it is. While the periphery would have been better off had it not entered into the euro, getting out of it would be a calamity.

    But Greece has already suffered a calamity, and will continue to. The only way forward for them in any realistic scenario is leaving the Euro.

    • Just when you think things cannot get worse, they do. (This is something I learned in the UK in the late 1970s.)

    • And we should respond with another campaign, promoting travel to Germany as: “Visit your deposits.”

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