President Draghi of the European Central Bank (ECB) got investors all excited last week when he said that the ECB would do all it could to support the euro. Perhaps investors should have listened to the rest of his statement where he added, “within its mandate.” Today’s policy statement from the ECB was perfectly consistent with what President Draghi said: The ECB left its benchmark interest rate unchanged at 0.75% and its deposit rate (the interest rate paid on bank reserves) at 0%. There was no new stimulus announced.
The ECB is not lending money to eurozone-area governments, nor should it. That would be outside the ECB’s mandate. Instead, President Draghi said in the press conference following the release of the policy statement that the governments should be ready to activate the EFSF (the European Financial Stability Facility) which could lend directly to the governments.
This is not to say the ECB cannot do more stimulus, but there is likely little the ECB can do to directly drive down the borrowing costs of eurozone-area governments. The ECB is solely focused on price stability and is prohibited by law from lending directly to governments. It can intervene in the secondary market and buy government debt, which it has in the past and may do again in the future, as President Draghi said today. It can lend to banks. It can even buy private-sector debt securities. But the ECB is not a “lender of last resort” for governments. And that is not an accident. That is by design. Lending by central banks directly to governments is toxic for inflation and undermines any fiscal discipline. Such lending might temporarily ease pressures on governments, but it would likely have much more dire long-term consequences.
President Draghi stated that monetary policy is not having the desired effect on the eurozone economies, but primarily due to “demand factors.” In other words, it’s not because there isn’t enough monetary stimulus being supplied; it’s because borrowers don’t want to borrow: Households and businesses are trying to clean up their balance sheets, as are governments. President Draghi focused his comments on the need to implement structural reforms to improve the competitiveness of eurozone economies. Effectively, in the press conference, President Draghi told investors to look to the governments, not the central bank, for solutions.