The Ecb has Done Its Part. Now It is Time to Press on

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10-2-2012 | Economic news

Sentiment on financial markets has improved sharply in recent weeks. This is primarily thanks to the European Central Bank (ECB) that introduced a new long-term financial facility for banks in December. This move eliminated fears that less strong, but still solvent banks would encounter liquidity problems. The glut of liquidity in the money market has also led many banks to begin buying French, Italian and Spanish government bonds again. The ensuing easing on the financial markets has produced universal relief. Stock markets are rebounding and some voices are even saying this recession may not actually be that bad.

There are naturally people who keep emphasising the risk of inflation that assumingly ensues from all this liquidity. But inflation only arises when households and businesses turn the extra liquidity into spending. And that is still a way off. This is because much of the extra liquidity is held at the ECB itself. So it does not all translate into a substantial increase in the amount of money in circulation. Lending will, in fact, remain under pressure for now due to a combination of a more robust supervisory regime and some other government measures. Should lending pick back up, the ECB will possess sufficient instruments to once again reduce the excess bank liquidity. I am not too concerned about that.

I do see a greater risk of policymakers now thinking the greatest danger has subsided and that they can let off the gas. The success of the ECB’s steps cannot conceal the reality that much work still has to be done. The ball is now in the politicians’ court. But I do expect the pieces of the puzzle to gradually fall into place this spring. The tighter budget rules will be anchored in law. Each policy plan must be approved by the European Commission. This will involve scrutinising all the countries, not just the weaker ones. The Netherlands will consequently also be included and the lack of reform policy will undoubtedly receive criticism. All the good policy plans must also actually be implemented. After that the positive effects of the policy must still become visible and politicians will have to demonstrate their staying power. It will all take a lot of time.

There is naturally a chance that the financial markets will not give the politicians the required time. While the ECB can continue to parry this with interventions, this is not generally a very elegant approach. So I want to once again make a stand in favour of introducing eurobonds and more specifically for employing a temporary programme of short-term eurobonds. Obviously with a disciplining mechanism (countries must pay a risk premium) and a mutual guarantee. This programme would then only be open to solvent countries that have established strict budget rules in law and have passed the European Commission’s critical assessment. So the countries that receive support (Greece, Portugal and Ireland) and those that do not want to sign the new budget pact (Czech Republic) will not be allowed to participate. The European bailout fund will not have to be expanded and the ECB can end its bond buying programme and once again focus fully on monetary policy. For more information, consult the ELEC website that contains full details of the proposal, including a discussion on all the pros and cons of such a programme.

And once budget policy begins moving in the right direction and the eurozone has stabilised with the help of eurobonds, a much tougher task will still lie ahead: structurally strengthening the European growth potential. A lot still has to be done.

News Source : The ECB has done its part. Now it is time to press on.