After a quiet few weeks, political pressures are rising again in Europe. Pictures of petrol bombs exploding among riot police officers in Athens have returned to global television and Bloomberg screens, and news reports suggest mounting support for the rightist Golden Dawn party, bringing back questions about the durability of the summer stabilization in the euro area. Yet there is little to indicate that these developments change anything of significance in the euro area crisis response. Greek protesters invariably fight with police, but so what? The Greek government is likely to agree on a further austerity package, despite the violence and the first strike by (mostly) public sector workers since the new coalition government took office. As for Spain, the government in Madrid presented its fifth fiscal austerity and consolidation package last week, despite a few thousand protesters in Madrid. In fact the only example of public outrage having an impact in the euro area recently has come in Portugal, where protests have spread spontaneously against the government’s new proposal to shift social security contributions from firms to workers. The furor forced the government to withdraw this step, which had been aimed at increasing competitiveness by an “internal devaluation.” Thus concerns about the political stability of the euro area periphery are overblown. Indeed the main risk is that the protests merely make governments less bold on needed reforms.
Two matters outside the euro area periphery have raised doubts that can be put to rest. First is the public skepticism voiced by the German Bundesbank and its president, Jens Weidmann, over the European Central Bank’s (ECB) new program of bond purchases—known as outright monetary transaction, or OMF—to allay concerns about contagion. As I have noted before, this is largely German political kabuki theater. In reality the Bundesbank’s criticism suits both Mario Draghi, president of the ECB, and Chancellor Angela Merkel of Germany very well. In their dealings with Prime Minister Mariano Rajoy of Spain, the role of “bad cop” falls to the Bundesbank. Indeed, the political benefits for all the German political establishment (not just Merkel) of the Bundesbank’s public defense of traditional German conservative monetary policies go further than helping to put pressure on the Spanish government to act. In practice, the Bundesbank’s opposition to the OMT program is irrelevant, because the vote to adopt it at the ECB Governing Council was 22 to 1, over the Bundesbank’s dissent. In Congressional terms, the Bundesbank’s dissent is a “free vote” of no consequence, politically similar to the US House of Representatives Republicans’ 33 votes to repeal Obamacare.
But the Bundesbank’s lectures about printing money to help distressed banks and countries helps channel potential German conservative skepticism about European integration in a nonthreatening direction. With the Bundesbank publicly lecturing the ECB (and the International Monetary Fund), there is less political space for other actors in Germany to make that case. Or put another way, the Bundesbank venting about ECB money printing preemptively takes the wind out of potential German populists by stealing some of their thunder as guardians of traditional German monetary policy virtues. This is important in a country where monetary and fiscal policy matters are never far removed from moral teachings. For the German establishment it is better that a known quantity like Weidmann is articulating such traditional concerns in the public, rather than having them come from a populist platform of the maverick politician Thilo Sarrazin and others. Allowing the Bundesbank to dissent is reminiscent of Lyndon Johnson’s famous quip about keeping J. Edgar Hoover at the FBI—that it was better to have someone inside the tent relieving himself toward the outside, than outside the tent facing in.
A second question relates to what the ECB might do if the OMT program and a separate action revamping its collateral requirements fail to restore market confidence in the euro area. Will the creation of a credible backstop in the euro area prove sufficient? What happens if the divergent borrowing costs for businesses and individuals in the euro area persist because of backtracking in Spain and delays in the creation of the European banking union? Will such problems aggravate what Draghi has called “unfounded fears about the future of the euro area” on the minds of global investors?
Since early 2010, the ECB has shown that it has unparalleled coercive crisis management powers to nudge euro area governments in the direction it wants. But even if the ECB decides against unleashing the full force of the crisis to get euro area leaders to do their political homework, it retains a large arsenal of other measures. When the ECB launched the OMT program, it said its goal was fulfill its original mandate and restore the monetary transmission mechanism—i.e., the setting of interest in a way that would let non-financial firms in every euro area country enjoy the same cost of borrowing. That day may be far off. But the ECB can lower financing costs for households and the non-financial sector in the euro area periphery by further loosening its collateral requirements to banks. This goal could be accomplished, for example, if it accepts highly illiquid collateral or buys more private financial assets, such as the €70 billion in covered bond purchases already acquired. (A covered bond is fully collateralized.)
The political and economic implications of purchases by the ECB of covered bonds or other even riskier private asset classes is different from what they would be in the United States. Because euro area countries retain their fiscal sovereignty and because the European Union treaty bans monetary financing of sovereign bonds, the Securities Market Program (SMP) and potentially the OMT are more politically difficult for Frankfurt than buying more private assets. Recall that not even German monetary hawks paid much political attention to the ECB’s two covered bond purchase programs in 2010. It is the sovereign bond purchases that carry the political risks in the euro area, whereas more covered bond purchases and the like would probably be more acceptable.
By contrast, the US Federal Reserve has bought large amounts of Treasuries and Treasury-guaranteed mortgage bonds. But it has shied away from US municipal bond purchases and—apart from bailout related programs like the Maiden Lane Special Purpose Vehicles in 2008—generally not bought many private assets. This reticence likely reflects the legal constraints on the Fed and also the alarm bells that go off in the United States when the government is seen to be “picking winners” in the marketplace.
In the euro area, however, the politics work just the opposite. The threshold for further ECB actions to secure the reinstatement of the monetary transmission mechanism through such non-standard measures as the purchase of private assets is lower than in the United States.
Finally, coming back to Spain, there are some danger signs surrounding the recent events in Catalonia and the cynical attempt by the Catalan government to exploit long-standing nationalist sentiments to divert attention away from the region’s deep economic problems. The decision by Artus Mas, the Catalonian leader, to call a new election on November 25—two years ahead of schedule—to move toward a referendum on Catalan independence, must be seen as driven by the longer-term constitutional process in Spain. In 2010, the Spanish Constitutional Court rejected parts of a new Statute of Autonomy for Catalonia, which would have devolved more powers to the Catalan region, effectively granting it nationhood within Spain. Beyond the legal issues, Catalonia, a relatively prosperous part of Spain, objects to the subsidies for other parts of Spain through regional fiscal transfers within Spain.
Yet, despite all this and despite the largest separatist march in decades, which happened in Barcelona recently, the risk of secession by Catalonia is virtually zero. It is far from obvious that most Catalans would back such a step. Mas’s political gambit is likely to be seen for what it is—an attempt to divert attention away from a tough economic situation and to secure more powers for the region within Spain. It is also not obvious that the Spanish constitution can accommodate a move towards independence. Moreover, other euro area countries would not welcome a highly destabilizing move towards Catalan independence. They can be expected to play hardball and demand that an independent Catalonia would have to requalify for euro area membership without being grandfathered in with the privileges enjoyed by Spain as a member of the European Union and the euro area. Like Scotland, Catalonia can dream. But there is no persuasive economic case for secession.