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Article / 25 November 2014 at 16:15 GMT

Questions we should ask Mario Draghi

Blogger / MoreLiver's Daily
Finland

  • Germany objects to everything so what can be done about it?
  • How will the ECB manage higher capital requirements of the banks?
  • Is there any future for the euro area in its current form?
By Juhani Huopainen

The European Central Bank’s president Mario Draghi will be speaking in Helsinki, Finland on Thursday. Bloomberg wrote that this is his “final opportunity to signal his intentions for policy next week after a series of public comments seeming to prepare the ground for fresh stimulus”.

I will be attending the event as a member of the press and have been thinking long and hard about what I should ask him. The trick is asking him a question that he is both willing and able to answer. Draghi will not say anything that is confidential, could undermine current and future policies, anger certain countries (read: Germany) or lead to panic in the financial markets.

It is thus not worth asking the questions that really matter because they will not be answered. In the following I present a couple of questions that matter but would be futile to ask. If you have any good ideas of what to ask him, leave a comment below.

When will the banks be fixed and how?


Why even the stressed scenario in the comprehensive assessment did not include deflation or restructurings of sovereign debt?

Why did the ECB allow discretion on a national level to accept things such as goodwill and tax-deferred assets as bank capital?

The Peterson Institute for International Economics calculated that if banks had to adhere to the fully loaded CET1 capital ratio (to become mandatory in 2017), the banks would be required to add EUR 126.2 billion of new capital. European banks have raised approximately 50 billion in new capital in 2014 and sold off their assets in preparation for the comprehensive assessment. How will the ECB ensure that the banks will be willing and able to raise capital during the next two years to meet the tighter requirements?

As banks will probably continue raising capital and selling off their assets, how will the ECB plan to compensate the expected decrease in bank lending?

Bank tests
 Chart source: PIIE

Why are you keen on inflation?

Higher headline inflation in 2011 made the ECB raise rates twice. The higher inflation was caused by higher energy and food prices and thus it was cost push inflation, and not demand pull inflation. When inflation fell, it was originally explained away as a temporary fall due to lower energy and food prices. Why is the ECB being inconsistent on its stated inflation goal? Doesn't such an asymmetrical approach guarantee that the ECB will consistently fail to reach its policy goals?

There are several problems associated with a relatively low inflation target of 2% – the most important being that when facing a serious financial crisis, there is not much room to lower rates. What thinking or economic research backs the 2% target, or is it just a number chosen arbitrarily, just like the Maastricht criteria were?

The financial market consensus worries, given the history of the ECB’s decision-making, Germany’s oversized influence and its opposition to easier monetary policy, that the ECB would tighten monetary policy at the first sign of inflation picking up. The easiest way to deal with this would be through forward guidance: stating explicitly that the ECB would allow the inflation to overshoot during the eventual recovery phase and that any cost-push inflation would be ignored. Why this has not been done? Are the investors correct and will the future ECB remain a tight central bank, even under an existential threat of becoming obsolete after a breakup?

Do your stated goals and presented policies fit?

If the diagnosis is that Europe suffers from lack of demand, low inflation and debt overhang, how will the ECB’s balance sheet expansion by purchases of government debt help, especially when interest rates are already low and legal debt and deficit limits are in place?
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ECB president Mario Draghi has said the bank's bond buying would provide a degree of support to a region dented by weak confidence and low investment. Photo: Getty

If the balance sheet size is not a policy goal in itself but rather a tool, it becomes uncertain if asset purchases would help in meeting the ECB’s goal. If lack of demand is the real problem, why isn’t the ECB presenting more direct criticism towards EU’s official austerity line and the German rhetoric? Division of duties is not an acceptable answer, since ECB’s actions are widely debated in politics and courts, and at the end of the day both fiscal and monetary policy are directly linked.

What would be an optimal asset purchase mix to increase the aggregate demand?

What are you going to do with Germany?

It is widely known that Germany has resisted the interest rate cuts and almost all unconventional policy measures. Can the ECB be a credible conductor of monetary policy if, in reality, all the key decisions are made by Berlin and the Bundesbank?

Should push come to shove, in what situations could the Bundesbank argue that articles 10.3 and 32 of the ECB statutes allow the use of capital-weighted voting procedures – which would give Germany 26% of the vote – and require a two-thirds majority for a proposal to pass a vote and thus guarantee that Germany can veto anything it wants as long as it gets one or two countries on its side?

If the leaders of EU institutions are willing to oust Italian or Greek prime ministers, is it not reasonable to say that those very same leaders also try to accommodate the political needs of the core countries, namely Germany's Christian Democratic Union and its leader Angela Merkel?

What actions are taken to improve the reaction time and the credibility of the ECB, including but not being restricted to limiting Germany’s influence over the central bank's decision-making?

If Germany has a hard time being in a currency union, would it not be in everyone’s interests to let Germany go, thus allowing a more optimal policy mix for the rest of the euro area?

When will you accept Russia is here to stay?

The Ukrainian crisis and sanctions against Russia seem not to be short-lived. At what point will the ECB accept that the crisis is not a temporary event, and will in all plausible scenarios have a prolonged negative effect on the growth outlook? When the ECB accepts this, will it also act appropriately? Isn't economic weakness something that promotes instability and encourages adversaries?

Why so many secrets?

Why the ECB has declined to disclose how Greece used derivatives to hide its debt?

Why were the so-called Trichet-letters to Ireland not made public before the Irish Times published them? Would it not have made sense to publish such communication so that other countries would have had an additional incentive to get their finances in order? How much else is there that the public or the governments do not know about?

Do you see any viable future for this construct?

Internal devaluation (lower wages, unemployment, lack of demand) seem to be necessary in many euro area countries to suppress internal imbalances of the euro area. This is unsustainable because it causes deflation and debt-deflation, not to mention political unsustainability and external imbalances of the euro area. How can we escape this catch-22?

After all that you have seen, would you still consider the European Monetary Union a good idea that was implemented well? If not, would you say that the euro was a mistake?

In your opinion, is there a viable future for the European Monetary Union unless sovereign debts are mutualized and there are much larger fiscal transfers between the member states? Is such a union realistic, and if not, what will be done instead?

Membership in a monetary union without a backing federal union is economically risky to a single country. Would it not be prudent to prepare a two-way system where countries that want closer integration will proceed, and those countries that do not want further integration are allowed to exit the monetary union?

If given free hands and not being bound by existing treaties, what would you think would be the three things that the ECB would do now?

Why haven’t the changes required to do those three things already been made, and do you think they will ever be made?


Thank you for your time, President Draghi.


-- Edited by Kevin McIndoe

Juhani Huopainen is a blogger and a macro analyst at More Liver’s Daily.
4y
Dimitrios Tamvakas Dimitrios Tamvakas
Fantastic article, all the best for 27/11 and get answers
4y
fxtime fxtime
Perhaps ask if he has formed the bank equivalent of a ''living will'' incase the euroland needs to lose a country from its current coterie? After all the current mainstream Banks are trying to form (as ordered ) a ''living will'' to foreclose themselves in an orderly manner should the situation be required. Also what stress test was done for this situation? Just how many countries or size of country is he willing to lose? Draghi should after all know the stress test remit thoroughly and it would perhaps be remiss not to apply to the ECB??
4y
James Picerno James Picerno
Great article. Puts the key issues in perspective--well done. Now we have a benchmark to evaluate Draghi's next round of comments.
4y
Juhani Huopainen Juhani Huopainen
fxtime, Draghi earlier answered that "there is no plan B" of euro exits. Which is funny, because at the exact same time they had a task force called "plan Z", Draghi and the then-commissioner Olli Rehn being some of the members, that had the responsibility to look after a possible Grexit.

When van Rompuy suggested even closer and more stringent fiscal straitjackets for the euro members, the prime minister of Netherlands told him "sure, go ahead, but we would leave the euro if you do that". The Netherlands central bank had an exit plan ready.

So, if I were to repeat the question, and ask "do you have living wills", he would say no. If I reminded him that he lied on this earlier, he would say "but I'm not lying now". That is the problem with any position of power nowadays. You can ask the questions, but you will not get a proper answer.
4y
Juhani Huopainen Juhani Huopainen
Instead of wasting the opportunity by asking a really good question that will not get a proper answer, I think it is better to ask something irrelevant, like "how will you develop the ABS-market so that the ECB's purchase programme would be as effective as possible".
4y
thewickedwiz thewickedwiz
Is the only way to cure the debt problem in Europe a 10 per cent levy on all wealth regardless of how it is denominated.
Would this solve the problem or would it cause even greater deflation?
4y
thewickedwiz thewickedwiz
For levy I mean wealth tax....
4y
Juhani Huopainen Juhani Huopainen
Thought experiments are always fun. Assume that the governments tax all deposit accounts by 99% and use this to pay off government debt, recapitalize banks and so on. Household demand would plummet when people lose their savings, lower demand would lead to lower prices, thus deflation. Would banks be more willing to lend money to households when the households are broke, or lend to corporations when there is no demand for their products - no. The money supply and velocity of money would plummet, lowering inflation. As gross domestic production is money supply x velocity, GDP would plummet, and both governments and households would be in debt deflation.

So it would not solve anything. Such measures can be done locally, but the damage is still real, even though it is local. In a healthy economy businesses and households are expected to fail and go bankrupt, and people to become unemployed. But it should not be let to happen to the whole economy.
4y
Adam Courtenay Adam Courtenay
It's a dream Q&A, Juhani - I mean that in the best sense. I wish I could ask questions like that and expect an answer, but central bankers the world over - and their finance ministers above them - are, at heart, bureaucrats. Reform and transparency? It's all about not saying and not doing, not telling, not opening, not showing.
4y
Juhani Huopainen Juhani Huopainen
I know. I just had to get this out of my system, so that I can ask something polite and almost meaningless. The damp cellar with "bring out the gimp". Or a big bottle of Jameson - followed by something like this: http://www.theonion.com/articles/drunken-ben-bernanke-tells-everyone-at-neighborhoo,21059/
4y
thewickedwiz thewickedwiz
It is being discussed in some very high circles , sadly , but instead of making it selective and taxing lets say bankers salaries that are paid from subsidised profits I have a feeling that there is a plan to fleece the masses. If we look back at Spain, and the way that small investors were sold subordinated "riskless" debt it would seem that nobody in government has any morality in this respect.
In fact the last years proved that you could put your deposits in any bank (if debt was not subordinated ) and not lose money, caveat emptor was suspended.
Would it not be ironic if suddenly now that the smart money has exited the really dangerous institutions a new method would be found to finally cash in on the public's savings....
4y
Juhani Huopainen Juhani Huopainen
There's a bill to be paid, and those who ate and drank from the table are not going to pay it. Those who have funds and who have no political power will pay it. Bye bye, middle class. That's the twisted logic of internal devaluations and deposit bail-ins.
4y
Juhani Huopainen Juhani Huopainen
Couple of questions from readers: Does the ECB consider the increased home-bias of distressed countries' banks a systemic risk and does it intend to address it?

Does the ECB consider the rapidly changing political landscape in the EU as a threat to the euro?
4y
Juhani Huopainen Juhani Huopainen
Thank you / spasibo!

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