AS CRISIS MOUNTS, EUROPE´S CENTRAL BANK STANDS BACK / THE NEW YORK TIMES NEWS ANALYSIS ( VERY HIGHLY RECOMMENDED READING )

November 25, 2011

As Crisis Mounts, Europe’s Central Bank Stands Back

By JACK EWING

FRANKFURT — To some people, the European Central Bank seems like a fire department that is letting the house burn down to teach the children not to play with matches.

The E.C.B. has a fire hose — its ability to print money. But the bank is refusing to train it on the euro zone’s debt crisis.

The flames climbed higher Friday after the Italian Treasury had to pay an interest rate of 6.5 percent on a new issue of six-month bills — more than three percentage points higher than a similar debt auction on Oct. 26. It was the highest interest rate Italy has had to pay to sell such debt since August 1997, according to Bloomberg News.

But there is no sign the E.C.B. plans a major response, like buying large quantities of the country’s bonds to bring down its borrowing costs. The E.C.B. “is not the fiscal lender of last resort to sovereigns,” José Manuel González-Páramo, a member of the executive board of the bank, told an audience at Oxford University on Thursday, a view that has been repeated by members of the bank’s governing council in recent weeks.

To many commentators, the E.C.B.’s attitude seems so incomprehensible that they assume the central bank is just putting pressure on politicians to make sure they keep their promises. Rather than let the euro break apart, the thinking goes, the bank will eventually relent and drench the economy with cash as the United States Federal Reserve and Bank of England have done.

But another possibility is that when the E.C.B. says “no,” it in fact means “no.”
“I think markets are going up a blind alley thinking there’s going to be a common euro bond or thinking that the E.C.B. is going to act as a lender of last resort,” Norman Lamont, the former British finance minister, told Bloomberg on Friday. “I think Germany would rather leave the euro than see the E.C.B.’s integrity affected.”

Instead, the E.C.B. insists, euro area governments must amend their errant ways. “Governments need to ensure, under any circumstances, the achievement of announced fiscal targets and deliver the envisaged institutional and structural reform programs,” Mr. González-Páramo said in London on Friday.

E.C.B. policy makers have been consistent in arguing that huge purchases of government bonds would violate the bank’s mandate and not solve the crisis.

Mr. González-Páramo even accused investors of cynical self-interest when they pleaded for a European version of quantitative easing, the use of large purchases of securities to encourage economic growth.

“Market participants that call for the E.C.B. to play this role may care only about the nominal value of their assets and the need to avoid losses,” he said in Oxford.

To outsiders, it may seem that the E.C.B., based in Frankfurt and steeped in the conservative culture of the Bundesbank, would rather let the euro go up in smoke than compromise its principles. But policy makers do not see the choice in those terms.

To them, the best way to address the crisis is to stick to principles, the most important of which is preserving price stability. That is set out in the first sentence of the statute that defines the E.C.B.’s tasks. “The primary objective” of the European system of central banks “shall be to maintain price stability,” the statute reads.

E.C.B. policy makers also believe that their charter forbids them from using bank resources to finance governments. If they expanded the money supply to provide debt relief to Italy, policy makers believe, they would be breaking the law. They would also effectively be transferring the debt burden from countries like Greece and Italy to countries like Germany or the Netherlands.

The E.C.B. has been buying Italian government bonds and debt from other troubled countries, but in relatively modest amounts and always on the ground that intervention was needed to maintain control over interest rates and prices.

Mr. González-Páramo argued this week that the restriction on E.C.B. action, far from a handicap, was a good thing. It helps policy makers resist the temptation to print money rather than make painful changes.

“The monetary financing prohibition, in this way, is a spur towards better policies and better governance — in other words, a closer economic union,” Mr. González-Páramo said in the Oxford speech, which encapsulated arguments made by other top E.C.B. officials.

But there might be a situation in which the E.C.B. would intervene significantly in bond markets. If there were credible signs that inflation was coming to a standstill and that deflation threatened, the bank would have a strong justification for pumping up the money supply.

“Things would be very different if the E.C.B. started to think there is a risk of deflation,” said Eric Chaney, chief economist of the insurer AXA Group. “In that case, there would be a good reason to buy bonds, to lower interest rates. Then it would be done for price stability objectives, not for saving Country X or Y.”

Inflation in the euro area is 3 percent on an annual basis, still above the E.C.B. target of about 2 percent, though the central bank has forecast that price pressures will ease as the economy slows.

The E.C.B., though formally immune from political influence, would in practice need the approval of European governments, especially Germany, to intervene. Any move would have to be tied to new treaty provisions to enforce greater spending discipline on governments in the future, said Daniel Gros, director of the Center for European Policy Studies in Brussels.

For now, opponents of greater bond buying on the E.C.B. governing council appear to hold sway. Jens Weidmann, president of the German Bundesbank and an influential council member, has been particularly vocal.

If there are members of the 23-member council who favor some form of quantitative easing, they have been quiet about it. But Mr. Gros said support could grow as borrowing costs soar in more countries.

Despite acute tensions on markets, policy makers argue that the crisis is not as acute as it seems, and they refuse to be rushed into making decisions they might later regret.

If the E.C.B. miscalculates, though, the result could be breakup of the euro area. Mr. Gros said it was reassuring that Mario Draghi, president of the E.C.B. since the beginning of the month, seemed to have an impressive grasp of market dynamics.

“He has a lot of experience in the markets,” Mr. Gros said of Mr. Draghi, an economist who worked briefly at Goldman Sachs before becoming governor of the Bank of Italy and then E.C.B. president.

“I presume Draghi has all the market information in real time at his disposal,” Mr. Gros said. “What can we do but trust him?”