The European Central Bank, with the support of Germany, is putting immense pressure on euro-area governments to do something about their finances. To that end, it would be helpful if central bankers more clearly defined what they want done.
By refusing to intervene as investor jitters send government borrowing rates to euro-era highs, the ECB has become the primary agent of political change in Europe. In recent days, market pressure has pushed Greece, Italy and Spain to install new governments focused on the painful measures needed to stabilize their debts and make their economies more competitive.
Now France is in the crosshairs. The yield on the government’s 10-year bonds has surged beyond 3.5 percent, from 2.5 percent in September, as investors process a litany of concerns: the effects of slowing growth on France’s yawning budget deficit; the potential costs of bailing out French banks; and the increasing possibility of a euro breakup. To prevail in elections next year, President Nicolas Sarkozy may have to promise more and deeper austerity measures.
No matter what governments do, their efforts may fail without the ECB’s help to support growth and keep borrowing costs down. France pays an average of about 3 percent interest on its debt, according to data from the International Monetary Fund. At that rate, the government would need to get its primary budget deficit (excluding debt-service costs) down to about 0.5 percent of gross domestic product to stabilize its debt burden - - something it has pledged to do by 2013. If France’s borrowing costs rise to 5 percent, and its growth prospects decline by a percentage point, the target would move to a primary surplus of 2 percent of GDP. The difference: about 50 billion euros ($69 billion) a year, or approximately what the French government spends on research and higher education.
The crucial question, then, is what, if anything, governments can do to gain the ECB’s backing. For all its talk of non-interventionism, the ECB has become a political actor -- most notably by withholding support for the Italian bond market in the crucial week before Silvio Berlusconi’s ouster as prime minister. ECB President Mario Draghi never specified why. Nor did Draghi or German Chancellor Angela Merkel ever say what would qualify as behavior worthy of support, other than to pledge allegiance to the euro while insisting that the central bank won’t act as a lender of last resort.
The lack of a clear signal may be intentional -- a way to maintain the ECB’s power and freedom. It’s also dangerous. At any moment, investors can assume the worst and refuse to lend at any price to European sovereigns, banks and companies. In one ominous sign, Germany had trouble placing 10-year bonds at a Nov. 23 auction, selling only 3.6 billion euros of a 6 billion-euro issue.
We believe the right approach would be to allow insolvent governments to go through an orderly default and for the ECB to put up enough money -- at least 3 trillion euros -- to ensure the recapitalization of Europe’s banks and to guarantee solvent governments’ access to financing at reasonable interest rates.
In the absence of such a bazooka, the ECB could at least provide some rules of the game. This would involve going beyond a narrow focus on inflation and explicitly stating that it will support the financial stability of solvent governments. It might also include some definition of what the word solvent means. Are austerity and labor-market reforms enough? Or must governments give up some sovereignty to a pan-European fiscal authority, with the power to step in and take over if budget-balancing measures fail?
If the requirement is such a fiscal union, we wish Europe’s leaders the best in achieving it before markets lose faith. If that doesn’t work, we hope the ECB stands ready to do whatever it takes to hold the euro together.
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