Saturday, March 3, 2012

ECB Finally Acts, Saves Banks not People

500 Billion Loaned to Banks - Draghi Overlooks Real Economy
At the beginning of March, the ECB finally acted to address the current financial and economic situation via expansionary monetary means. Europe’s central bank issued 500 Billion in loans.

At the same time, Mario Draghi stated publicly his intention that not only was the use of monetary powers to foment economic growth, reinforce Europe’s recovery, create jobs out of the question, but that Europe’s 27 member nations not use their sovereign fiscal powers to do so either.
Central Bank Independence: Role of the Central Bank
While I am a reluctant believer in the in the independence of the central bank, it must be said that central bank independence swings both ways. The role of the central bank is purely to provide the best monetary policy possible for the economy which the central bank serves. This is the reason that most central banks have policy independence.

In Europe, the ECB’s role of is even narrower: It’s primary role is to ensure price stability. While I do not agree with this narrow focus, Draghi should understand that politics is not in his job description. Involvement in the political debates from which fiscal policy emerges will never be part of the ECB director’s job. Central bank independence means the strict separation of the monetary policy from the political debate. If  Draghi  cannot manage that, then he should resign.

What’s Wrong with Bailouts?
To boil it down to two words, Moral Hazard. While we do need to keep banks afloat, if only to keep the entire European economy from disintegrating,  we should not do it by giving away free money and allowing the failed bankers to retain their posts. Both Hayek and Smith would agree that this will just lead to further disasters down the road. Rather bailout funds should come with strings attached. strings such as corporate governance standards and a partial public-sector stake in several of the economy's key strategic banks and firms. 

On the other hand, while we are busy worrying about the banks we are ignoring the broken part of the real economy. This is a capital mistake because we worry ostensibly about the banks because they affect the real economy. Its in the real economy that job are held or lost. Its in the real economy that tangible goods and services are produced or not. If we are going to use monetary action to save one sector, we should use it to save more than one sector. 

What we Need
While monetary expansion in the Eurozone was long overdue, more attention needs to be played to the real economy where jobs and production of tangible goods and services takes place. At the same time, banks who receive public support, should get it with strings attached. Higher supervisory standards, better risk prudence (in terms of both loans and portfolio), public stake, and the dismissal of incompetent managers are good strings to start with. Otherwise, we have printed the banks some free money and will end up compelled to do it again in two-year's time.
Max Berre is an economist at the EDHEC-Risk Institute (Ecole Des Hautes Etudes Commerciales du Nord) who has worked as a sovereign debt expert at the Inter-American Development Bank in Washington and has taught financial economics at Maastricht University in the Netherlands.

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