09 December 2011

Douglas J Elliott: The Euro Summit only worked if it convinced the European Central Bank

In his article for CNN, Elliott comments that in the short run, the ECB remains the only institution with the financial capacity to stop a future round of market panic that could lock Italy or Spain out of the bond markets.

ECB President Draghi spoke quite positively about the summit outcome, but it is very unclear what this pronouncement would actually mean for future ECB actions. After all, on Thursday he went out of his way to pour cold water on the idea that it would be the ECB's role to intervene in bond markets in a big way -- as opposed to working around the edges. 

The ECB remains wary of taking bold action that might take pressure off the government leaders to truly solve the underlying problems, leaving the ECB with all the risk. ECB leaders feel they already lived through this in a smaller way this summer, when they stepped up purchases of Italian bonds only to see Italian President Berlusconi try to backslide on his reform promises as market pressure eased.

Europe needs solutions in three different time-frames:

Short-term: Markets need to know that someone has the money and the will to fund Italy or Spain if private markets become too scared to do so. This is a real possibility at some point, given the serious economic difficulties that both face and the very tricky politics their governments need to navigate.

Medium-term: Eurozone institutions need to be strengthened so that governments, not the central bank, can provide the funds a troubled Member State might need. In return, there needs to be an assurance that all Member States will run their budgets responsibly. The summit made real progress in both of these regards.

Long-term: Finally, the summit did little to address the long-term issues of competitiveness.

Unfortunately, the existing ways to reduce relative costs are extremely painful, and therefore politically very difficult. Answers need to be found, but they certainly did not come out of this summit, which was understandably focused on the immediate problems.

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