Excellent analysis, and I agree across the board. Most interesting for me is how the Eurozone is trying to address an obvious moral hazard problem: As you say, fiscal solidarity and the ECB "protection" have been extended to weaker EZ members in exchange for fiscal and structural reforms that have never materialized. To mitigate this, we now have the requirement that, in order to benefit from ECB support in case of market pressure, a country should be in compliance with the EU fiscal framework. Of course, if financial market pressure were to threaten the financial stability of a non-compliant member, I believe a way will be found for the ECB to step in anyway. As you correctly suggest, this would however take more time and uncertainty, creating buying opportunities as markets get spooked. It would however then make the moral hazard problem worse, and reduce chances of reform even further -- and I'm not sure I can see a way out of this problem. The result would seem to be an outlook of "fragmented fiscal dominance" where ECB policy is to an extent hostage to the fiscal irresponsibility of some large member states.
I think saying that no reforms were ever done is a bit harsh, even for some large economies 😉
But I take the point on moral hazard – probably in the end the ECB is likely to “blink”. Couple of things here.
What I find interesting is that, with all the talk of fiscal dominance, so far the ECB hasn’t really been forced to choose between its mandate and financial stability. I.e. during OMT and QE inflation was too low, not too high. Inflation now rose due to extraneous reasons (granted, the ECB was late to move, but it wasn’t QE or low rates that triggered the inflation). So things will get interesting if an obvious conflict arises between the monetary policy stance required to achieve the target and its ability to backstop bond markets. (The deeper point goes back to Tinbergen: are bond market interventions an independent enough tool with which to pursue financial stability without compromising price stability?)
My suspicion is that before we get there, what gives is the politics, which is to say the appetite of voters in some countries to help others. We almost got to that point in the 2009-12 crisis.
Thank you Spyros, very good points. I feel my take on reforms is harsh bit not far from the truth -- but on the fact that fiscal dominance has not yet been an issue, I fully agree. And maybe in the case of the ECB it's unfair to even talk of fiscal dominance in the first place, in the sense that the ECB does have a built-in responsibility to try and keep the Eurozone intact, which is quite different from feeling the pressure to help out a spendthrift Treasury. I also think your last point is spot on.
Thank you Marco. What you say is exactly the ECB's predicament: as the central bank in a very incomplete monetary union, it is always forced to pick up the failings from other policy areas, as the consequences from not doing so could be existential for the euro area. Which as you say is quite different from wanting to "bail out" the fiscal side.
Excellent analysis, and I agree across the board. Most interesting for me is how the Eurozone is trying to address an obvious moral hazard problem: As you say, fiscal solidarity and the ECB "protection" have been extended to weaker EZ members in exchange for fiscal and structural reforms that have never materialized. To mitigate this, we now have the requirement that, in order to benefit from ECB support in case of market pressure, a country should be in compliance with the EU fiscal framework. Of course, if financial market pressure were to threaten the financial stability of a non-compliant member, I believe a way will be found for the ECB to step in anyway. As you correctly suggest, this would however take more time and uncertainty, creating buying opportunities as markets get spooked. It would however then make the moral hazard problem worse, and reduce chances of reform even further -- and I'm not sure I can see a way out of this problem. The result would seem to be an outlook of "fragmented fiscal dominance" where ECB policy is to an extent hostage to the fiscal irresponsibility of some large member states.
Thank you Marco.
I think saying that no reforms were ever done is a bit harsh, even for some large economies 😉
But I take the point on moral hazard – probably in the end the ECB is likely to “blink”. Couple of things here.
What I find interesting is that, with all the talk of fiscal dominance, so far the ECB hasn’t really been forced to choose between its mandate and financial stability. I.e. during OMT and QE inflation was too low, not too high. Inflation now rose due to extraneous reasons (granted, the ECB was late to move, but it wasn’t QE or low rates that triggered the inflation). So things will get interesting if an obvious conflict arises between the monetary policy stance required to achieve the target and its ability to backstop bond markets. (The deeper point goes back to Tinbergen: are bond market interventions an independent enough tool with which to pursue financial stability without compromising price stability?)
My suspicion is that before we get there, what gives is the politics, which is to say the appetite of voters in some countries to help others. We almost got to that point in the 2009-12 crisis.
Thank you Spyros, very good points. I feel my take on reforms is harsh bit not far from the truth -- but on the fact that fiscal dominance has not yet been an issue, I fully agree. And maybe in the case of the ECB it's unfair to even talk of fiscal dominance in the first place, in the sense that the ECB does have a built-in responsibility to try and keep the Eurozone intact, which is quite different from feeling the pressure to help out a spendthrift Treasury. I also think your last point is spot on.
Thank you Marco. What you say is exactly the ECB's predicament: as the central bank in a very incomplete monetary union, it is always forced to pick up the failings from other policy areas, as the consequences from not doing so could be existential for the euro area. Which as you say is quite different from wanting to "bail out" the fiscal side.