ECB: What it would have cost without Trichet
6 October 2011
Accused at times of excessive timidity, at times of trespassing on the preserve of states, the governor of the European Central Bank has, on balance, been able to hold the euro steady and, so far, to avoid getting swept away by the crisis.
The opportunity cost of a decision is the cost one would pay for not taking it, or the costs that would be involved in making an alternative decision. This reductio ad absurdum formulated in 1914 gained in popularity following the Single European Act of 1987, which opened the way to Europe's single market without borders in 1992, thanks mainly to the famous report from the great Paolo Cecchini, The cost of 'non-Europe'.
Following his eight years in office, the president of the European Central Bank, Jean-Claude Trichet, will dictate his testament today: one can only wish fervently that he will announce lower interest rates, given that core inflation is under control at around two percent; or at least, to lay that out as the marker buoy that his successor, Mario Draghi, will be guided by.
What would it have cost not to have Trichet? What would it cost if Draghi were to squander his inheritance? The mistakes of the ECB under the aegis of the former governor from France have been two. The first came in July 2008, when the bank raised the interest rate just after inflation topped out and on the eve of the Great Recession disaster triggered by the collapse of the Lehman Brothers two months later in September.
The second mistake has been its apathy and timidity in orchestrating the policy for buying up government bonds from peripheral states: twice, once in early May 2010 and then in August of 2011, when the turmoil multiplied the spreads between the Italian and Spanish debts and Germany debt. They have been the mistakes of orthodoxy.
On the other side of the ledger, the ECB under Trichet has offered wide-open liquidity to banks and diversified its terms, thus avoiding total paralysis in the financial system; it has bought up peripheral bonds in the secondary market to the tune of more than 156,500 million euros (not a lot to those who compare it with the Federal Reserve, but too much for the purists), thus preventing some countries from going bust; has supported these sovereign debts and the holding entities by accepting as collateral the dubious bonds provided by banks requesting credit; and has led three operations in coordination with other central banks to provide dollar liquidity to European banks: after Lehman and in February and September of this year.
By the virulence of his critics one can grasp the cost of not having had Trichet: the two main backers of a radical approach, both Germans, have departed the picture this year. Axel Weber, the Bundesbank president destined to succeed Trichet, broke taboos by publicly criticising the ECB's buy-up of vulnerable countries' bonds, in a celebration of austerity (for others) that paved the way (his own) to a golden throne as the next chairman of Switzerland's UBS bank – such Lutheran virtue!
Abandoning the ECB seemingly for the same reasons, the ineffable Jürgen Stark, former vice-president of the Bundesbank, did the same thing. Both criticised the ECB governor for straying from his mandate to keep inflation under control – and for worrying too about economic stability and growth, objectives that are, apparently, blasphemous.
Trichet has been the key architect
Some researchers, like [IMF economist] Pau Rabanal, argue that Trichet has not only "maintained a relatively expansionary monetary policy," but even "sacrificed the ECB's inflation target for the sake of greater economic growth and jobs creation, and not the other way round.” Trichet's reluctance to lower rates too far, all the same, has brought him head to head with some politicians, including the French President.
Trichet has fiercely defended his independence from Sarkozy in urging that automatic sanctions be included in the new Stability Pact. And he has resisted Chancellor Merkel tooth-and-nail over German insistence that private investors absorb part of the Greek losses.
If the euro crisis has not quite left Europe for dead yet, it's because the ECB has acted as lender of last resort and as an arbitrator respected by the markets. Trichet has been the key architect of the rescue fund, resounding in his criticism of the downgrading by the agencies and clear in his defence of a European Treasury. That's not a bad legacy!
Translated from the Spanish by Anton Baer
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