Power & Market

After Draghi, Europe Needs a Hawk To Head the ECB

On November 1, Mario Draghi’s tenure as governor of the European Central Bank (ECB) will expire, and the European Council will appoint a successor for the role. Moreover, it is now known that northern European countries are pushing for replacing Mr. Draghi — widely recognized as a “dove” — with a “hawk” — less accommodating toward the loose monetary policy being demanded by southern European states.  Most especially, Italy.

On the other hand, there are plenty of economic considerations — besides the historical and political ones blaming the alleged excessive (but totally sensible and legitimate) German fear of hyperinflation — which support the northern European preference for a less accommodating governor, and a tighter monetary-policy stance. Let’s look at three of them, which are the most prominent amongst several others:

One: From March 2015 onwards, the Quantitative Easing program (QE, officially known al the Asset Purchasing Programme, APP) implemented by the ECB has been distorting the relative prices of European private and public bonds, delivering a perfect textbook-case of how Cantillon-effects distort the economy. Indeed, for instance, the current difference between the yield of American 10-year government bonds and Italian ones is much lower than the same difference between German 10-year government bonds and American ones, in spite of the total absence of macroeconomic fundamentals to account for this fact. Moreover, as figure 1 and 2 show, the Asset Purchasing Programme has been highly biased towards its public-sector branch (PSPP, Public Sector Purchasing Programme, painted in blue). This also distorts the relative prices of private and public securities, and brings about a crowding-out effect damaging private investments;



Two: From a historical and political perspective, Italy has been blatantly breaching the deals — i.e., the 1992 Maastricht treaty and the 1997 Amsterdam treaty — requiring limits of its public debt over a GDP ratio to the 60% level. In practice, this has reached a historical post-war peak of more than 132%. Hence, it is evident that Italy has been only reaping the benefits stemming from European integration. This includes lower public expenditure for debt-interests (from 12.2% in 1993 to 3.7% in 2018), monetary stability, low inflation, and commercial integration. Of course, northern states are no longer willing to let Italy have everything it wants, and are perfectly aware that Italy has been the country gaining the most in terms of lower interest on its public debt brought about by Mr. Draghi’s monetary policies;


Three: The central bank has been claiming these inflations are “justified” by the alleged empirical evidence entailed by the Phillips-curve. The central bankers have been lamenting excessively low inflation within the Eurozone, and Mr. Draghi has expanded the Eurozone’s monetary base up to a level equal to 28% (3.217-trillion euros) of its GDP. Meanwhile, the American monetary base has been reduced to a level lower than 17% of American GDP. This, combined with a stable — even though low — growth in the Eurozone, with a macroeconomic outlook close to its full potential (even Italy, the weakest of all European economies, is predicted to have an output gap equal to -0.3% of GDP in 2019 and -0.1% of GDP in 2020, thus practically reaching its full potential output) and the fear of an economic slow-down caused by trade-wars, has convinced north-European politicians that the current monetary-policy stance is no longer what Eurozone — as a whole — needs. (Even Italy, the weakest of all European economies, is predicted to have an output gap equal to -0.3% of GDP in 2019 and -0.1% of GDP in 2020, thus practically reaching its full potential output.)

Lastly — and subsuming the three aforementioned bullet-points — a “hawkish” ECB-governor would be also in the interest of Italy itself. After all, Mr. Draghi’s monetary-policy stance has allowed Italian governments to keep implementing unsustainable fiscal policies without sustaining the associated economical and political costs, such as higher public expenditures for debt-interests and lower bank-lending. The latter is being caused by the huge exposure of Italian commercial banks to Italian sovereign risk.

Ultimately, northern-European savers, the stability of the monetary union and — especially — Italy itself do not need a lovely, charitable and “dovish” mother at the central bank. We need, rather, a stark, strict and “hawkish” tutor.

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