Wednesday 12 December 2018

Decisive Draghi secures place in history books

ECB President confounded critics with bold action to help rescue the eurozone

Mario Draghi. Photo: Reuters
Mario Draghi. Photo: Reuters

Sean Crowe

Mario Draghi may not quite be a household name for many European citizens, yet his decisions as ECB President have a had significant impact on our lives, largely determining what our mortgages cost and what our savings return.

Over his eight-year term he has been a steadying influence in these often turbulent times. When he steps down in October 2019, he will leave behind a legacy of decisive crisis management and a long shadow for his successor to fill.

The next ECB President will face a different set of challenges, but will need to display the same levels of mastery that Draghi exemplifies.

A tricky inheritance

Draghi became ECB President in October 2011. The previous incumbent, Jean-Claude Trichet ,had hiked interest rates twice that year despite a deteriorating growth outlook. Europe was on the verge of a recession due to oil prices increasing to over $110 and the escalating sovereign debt crisis.

Draghi also faced a degree of scepticism over his inflation-fighting credentials. Many northern Europeans had reservations about an Italian at the helm of the ECB due to serial Lira devaluations and a history of relatively high Italian inflation.

The German Newspaper Bild gifted Draghi a Prussian spiked helmet to remind him to be "German" in his stance towards inflation and money printing.

While Draghi faced pressure from northern Europe to deal with inflation, Ireland and Greece were already in bailout programmes.

The problems in Italy and Spain were also becoming more apparent with bond markets under intense pressure, massively increasing the cost of credit for businesses and consumers across Europe.

The ECB needed to get ahead of the crisis.

Building concensus

Draghi took bold and decisive action right from the start of his tenure, cutting interest rates at his first ECB meeting.

The challenge for Draghi and the ECB Governing Council then became how to respond to a once in a generational crisis when conventional policies were exhausted.

It is here that Draghi's abilities to deftly build consensus despite strong opposition came to the fore.

The German public remains scarred and haunted by the hyperinflation of the 1930s. The German central bank (Bundesbank) spent decades post-war building a track record of fighting inflation to preserve a strong and stable Deutschmark.

For this reason it has long been one of the most trusted institutions in Germany. Germany and other northern European countries have always feared an ECB that would run easy money policies to facilitate fiscal laxity in southern Europe so selling quantitative easing to the general public was a daunting task.

The ECB needed to buy bonds in troubled countries to harmonise the cost of borrowing across the eurozone. Draghi argued successfully that this policy was required to ensure the transmission of monetary policy.

He built a consensus that this decisive and untried course of action was necessary to ensure price stability while not giving profligate governments a free pass.

German ECB members resigned in protest at the direction of policy. While these policies contained the crisis, they did not end it.

Draghi's commitment to do "whatever it takes" at a speech in London in July 2012 marked the apogee of his verbal intervention and proved to be the inflection point of the crisis.

Draghi had attained enough credibility that speculators switched sides and stopped believing in a eurozone break-up.

Bild was unimpressed and demanded its Prussian helmet back.

The quantitative easing policies enacted have fostered the conditions for European exporters to lead the initial recovery, with the baton now taken up by domestic demand.

Legacy

Draghi bequeaths his successor a much strengthened economy and banking system. The unemployment rate is reaching levels last seen pre-crisis. Growth has been above trend for three years. Despite the worst fears of many monetary hawks, inflation has remained moderate, allowing the ECB to maintain policy stimulus.

On the other hand, more time will need to pass before we can judge how effective Draghi's policies have been. This is because the unwinding of quantitative easing and negative rates is a new challenge and will undoubtedly cause volatility in financial markets.

Policymakers must always keep an eye on the long-term picture. Many institutions such as the BIS have urged central banks to use this period of calm to build resilience for the next downturn by hiking interest rates so that they have the ammunition to respond to the inevitable future recession.

The US Federal Reserve is well through that process and the worry from a European perspective is that the ECB will be trying to exit unconventional policies around the time the US may be expected to fall into recession.

Many commentators are concerned that US interest rate hikes and President Trump's pro-cyclical fiscal stimulus means the US will face a challenging period in 2020-21.

Leadership Lessons

Draghi's courage and innovative solutions have secured his place in the history books. Even Draghi's detractors would admit he has called the really big moments correctly and he did not blink or waver in his resolution to maintain eurozone cohesion.

His actions contributed to ensuring that we never found out what a eurozone break-up and the associated turmoil would mean for 300 million citizens. Draghi's skills at building a consensus to take seemingly unpalatable actions while bringing opponents on board will be hard to replace.

His leadership fostered the conditions for a necessary adjustment to occur in many European countries that now sees them better positioned for the future.

Sean Crowe, chief executive, Markets and Treasury, Bank of Ireland

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