The financial crisis faced by the vulnerable economies of the Eurozone (e.g. Greece and Italy) with rising inflation, the widening of various bond yields (spreads) from their German counterparts and the reduction in the rate of growth, is very more serious and dangerous case to deal with only the old tools of monetary policy. The recent intervention of the European Central Bank is more reassuring than deterrent in the long run. It sends a clear signal to the markets that the ECB is here, but how long it will “be here” is far from certain.
More specifically, there is no doubt that the expansion of borrowing costs in a National economy can become the cause of its destruction. Initially the public and banking system and very soon, the entire economy. The destruction is chained. The state itself is unable to service its loan obligations and cover its needs. Rising borrowing costs reduce the value of government bonds held by banks. The reduction in their value is decisive because it greatly limits the ability of banks to borrow and obviously to lend. The next link in the chain is the horizontal and vertical spread of panic both in the money markets (the national money market and the international money markets) and among the citizens of the country. In theory and in practice the game ends here.
To avoid the zero point, therefore, the ECB needed to step in and protect the most vulnerable economies of the euro area. For this reason, after the jump in Greek ten-year bond rates from 1% to 4.5% (and corresponding increases in Italian bond rates), the ECB announced the activation of a “new anti-fragmentation tool”, with which will buy bonds from the countries of the South, reinvesting capital from the maturing bonds of strong economies such as Germany, France and the Netherlands. With this policy, it aims to achieve two goals at the same time:
- in containing the rise in borrowing costs in vulnerable economies,
- while, it will be able to proceed at the same time with interest rate increases as inflationary pressures impose.
With these measures the tyranny of bond spreads is temporarily brought under control, but fiscal stability has not been ensured for vulnerable economies such as Italy. The reasons are many and complex. The ECB’s program may require huge capital depending on the duration of the crisis. But we must not forget that the availability of funds is never unlimited. Therefore, the duration of the new program must be considered limited by definition. The return to normal levels of inflation will also mean the end of this policy.
What must also be clarified is that the viability of the Italian and Greek economies respectively, in the long run, do not depend only on the sustainability of their debt. It is necessary and necessary to maintain a relatively high growth rate. This is not always possible. The ECB, what it gives with one hand, partially at least, takes with the other hand. In the next period and especially until the end of the year, the ECB is expected to raise interest rates as a measure to contain inflation. This automatically implies a reduction in investment growth prospects. ECB policy may send the message that the safety net has been extended, but the investor, big or small, experiences the uncertainty of tomorrow which makes him more conservative and cautious in his movements.
This results in anemic growth. In recent months, growth forecasts have been continuously revised downwards. This is an ominous sign for long-term debt reduction, because a key driver of debt reduction is GDP growth, given that the absolute value of debt is indeed important, but more important is the debt-to-GDP ratio. This is where a paradox comes in if a significant increase in GDP is maintained. Inflation in this case may have a beneficial effect on debt, at least in the short term, provided of course that inflationary pressures are brought under control before they fuel persistent price-wage inflation.
Given that the economic problems are real and ever-worsening, a number of Europe’s political leaders are calling for further integration of the Union, but there are also economic leaders such as Germany’s central banker Joachim Nagel, who strongly oppose the “anti-fragmentation tool”. During the ECB’s emergency meeting on June 15, he expressed his opposition to the new policy aimed at lowering the various bond yields in the vulnerable economies of the Eurozone with the logic that the borrowing costs should be decided by the markets, so as to send the real messages to their recipients. He further claimed that such policies lead governments to become complacent and fail to understand that they are in mortal danger of fiscal collapse and must bring drastic measures regardless of the level of interest rates and bond yield spreads. This has its own logic. He also emphasized that this program may constitute monetary financing from the central bank to the governments of the specific member countries, which financing is prohibited by the European treaties.
