The European Central Bank is trying to navigate a vortex of hostile forces. Thursday’s decisions – steady rates, a small programme to buy covered bonds and the provision of as much as one-year bank funding as needed through all of 2012 – will not get it out.
If the ECB had dictatorial powers over both monetary and fiscal policies, the crisis could be surmounted fairly easily. The central bank would promise to provide unlimited liquidity as needed and merited. It would also mandate fiscal balances, banishing fears of sovereign restructurings after Greece.
But the central bank’s powers are limited. It must appease governments which refuse to try to persuade voters that the euro zone is more than worth the relatively small sacrifices required to maintain it. It cannot force member governments to create a debt-buying and liquidity-providing facility – the sort of monetary support central banks in other countries can and do offer, but which are legally out of reach for the ECB itself.
The ECB must also run scared of the German Constitutional Court, which could well prohibit any particular solidarity arrangements. The need to keep the inflation-fearing Germans sweet may lie behind Thursday’s decision not to cut the key policy interest rate. In any case, lower rates would probably do little to stimulate lending in the middle of a crisis of economic confidence.
While governments are not pulling their weight, investors are hyper-charged. They are ready to see insolvency lurking everywhere, and willing to make it happen with sudden withdrawals of funds. The ECB was unable to persuade investors to put pressure on reckless sovereigns when times were good. It seems incapable now of persuading them that defaults, other than for Greece, will be avoided.
The ECB has done less than many investors hoped, but has already bent its rules and pressured governments as much as was politically possible. It remains the leader in the European muddle-through approach to the crisis. That effort is falling short; the vortex is still swirling. But the central bank is moving in the right direction. It could eventually wriggle out, if banks get more capital and governments and investors don’t add to the pressure.