Greece’s Former Finance Minister Defends Super Mario


George PapaconstantinouGreece’s former Finance Minister George Papaconstantinou defends European Central Bank chief Mario Draghi’s Outright Monetary Transactions plan. Photo by Louisa Gouliamaki/AFP/Getty Images

Earlier today, we featured Boston University economist Laurence “Ask Larry” Kotlikoff on the European crisis and his skepticism with regard to the current solutions. Taking issue is George Papaconstantinou, Greece’s former Finance Minister and current Minister for the Environment, Energy and Climate Change,

Larry Kotlikoff’s article “Mr. Draghi’s Dangerous Confidence Game” bucks the current trend of commentators praising European Central Bank chief Mario Draghi for his recent announcement of the Outright Monetary Transactions (OMT) plan, namely ECB unlimited (but conditional) purchases of government bonds of countries in trouble. The gist of Kotlikoff’s article is that a) the ECB is single-handedly attempting to bail out the GIIPS (Greece, Italy, Ireland, Portugal and Spain), b) that it is dangerous c) that it will not work, and d) that it is a second-best solution. I believe he is wrong on a, b and c, and partly right on the last point.

To understand the ECB’s latest move, it is important to go back a few years and look at how various EU institutions reacted to the European crisis. When the new Greek government in 2009 announced that the public deficit was at least twice as large as the previous government was claiming, it set in motion a chain of events that are currently reshaping the institutional architecture of the Eurozone. In a nutshell, the design faults and compromises of the original Eurozone construction were now laid bare for all to see and required immediate action.

Yet in complicated institutional environments, change is difficult and it takes time. So it took time for European governments to understand that whatever Greece did, a stopgap was necessary, which inevitably would in one way or another breach the “no bailout rule” enshrined in the Treaty establishing the Euro. It took time to realize that this crisis was not confined to one errant member, but was in fact systemic, even though it did not manifest itself the same way in every affected country (in all countries but Greece, the banking sector was the main conduit and therefore there was to be no solution without addressing the banking sector). And it took time to realize that maybe this was not just a liquidity crisis and that issues of debt sustainability would need to be addressed as well.

While politicians initially entered fire-brigade mode, and until they eventually started designing something more durable, the only institution with the capacity to act and with the firepower to do so effectively was the ECB. With the market having woken up from its decade-old slumber and now clearly overreacting and overpricing risk in peripheral countries’ debt, the ECB entered the fray. From the initial buying of government securities in secondary markets, to relaxing its eligibility requirements for collateral from commercial banks, it played a clearly stabilizing role. Reluctantly? No doubt. With a delay? Probably. But would the May 2010 decision of the creation of the initial €750 billion mechanism have made an iota of difference, were it not for the direct intervention of the ECB in markets the next day?

Is the recent OMT announcement then a repeat of the same? Are we just muddling through some more? No it is not, and we are not. 2012 is not 2009 or even 2010. The pieces of the puzzle are slowly (too slowly) falling into place. There is now a permanent mechanism (the European Stability Mechanism, or ESM) which if allowed to operate properly is the first step to debt mutualization (but let’s not say this too loudly). The first decisions on a true banking union have been taken with the creation of the Single Supervisory Mechanisms (SSM) by year-end and the eventual move to a Europe-wide guarantee of deposits — the only tool to make sure that the outflow of deposits from the south to the AAA countries does not starve the economies in trouble of liquidity and does not keep them in a vicious cycle of austerity with deepening recession. And the “closer fiscal union” with some ceding of sovereignty over national budgets is also making its way, with many difficulties; it is after all the necessary prerequisite for all the rest.

Let’s be clear: there are no guarantees that all this will work or that it will work in time. Accidents can and will happen. But in this arduous and politically charged process, which is dotted with complicated national strategies and electoral calendars, the ECB can clear the ground and buy the time for EU governments to act. This is what Mario Draghi has done, by going to the limit of his mandate (which needs to change, but this is for later) and against non-negligible opposition.

Is what he is doing dangerous? At a certain level of course it is, but simple cost-benefit calculations of assets and liabilities fail to consider the much higher potential losses if the whole system falls apart. Could it ignite inflation? Hardly, except in the minds of those in Germany that want to see all this as the “expropriation of the Euro” (to quote a recent Der Spiegel title). Will it work? Probably yes, as long as the time it buys is put to good use and is not taken to be another reason to delay and procrastinate (as the current Spanish government seems to be doing). After all, this is no blank check; it is accompanied by strict conditionality criteria.

Finally, is it a second-best solution? Of course, but then again there are no first-best solutions realistically available today. Ideas such as “limited purpose banking,” interesting as they may be to debate and refine, are a gleam in the eye of academics. Eventually, they may provide the blueprint for a wholesale reinvention of the financial system — and one is most definitely sorely needed. But for the time being, our best bet in the Eurozone is Mario buying some time for European governments to finally repair the bicycle — not an easy feat, as we are actually riding it.

George Papaconstantinou is Greece’s former Finance Minister and the current Minister of Environment, Energy and Climate Change.