The European Central Bank is under pressure to open the money taps to help Italy, which is struggling to fund its debts through the private markets. Every day private lenders demand that Rome pays a higher interest rate. Without loans from the eurozone’s central bank, Italy could go the way of Greece, Portugal and Ireland, which rely on loans supplied directly from the treasury departments of eurozone countries.
Mario Draghi, the bank’s new boss, has refused to offer more than limited support. He said the job of a central banker fell short of extending support to individual countries. But there is a problem with his stance: the European Financial Stability Facility, the successor to the hotchpotch of loan packages for Lisbon, Athens and Dublin, cannot cope with funding a country as big as Italy.
What has the bank done so far?
The central bank for the 17 eurozone countries has lent €183-billion since the beginning of the financial crisis. About €110-billion of that has been directed at Italy and Spain since August. Capital Economics, a London-based consultancy, said it was likely that 80% of the lending was directed at Italy.
How much can the bank lend?
Unlimited amounts. A central bank can print as much money as it likes. The total so far is small compared to the €9.2-trillion income of all eurozone members. In practice, the amount depends on the reaction of banks, businesses and households with a policy that floods the economy with extra currency. More cash in the economy should lead to inflation. As people and businesses spend the extra funds, so demand rises in relation to supply and inflation takes off.
Are there restrictions on the bank?
Draghi said rules adopted at the birth of the single currency prevented him from favouring one country over another. The former head of the Italian central bank said his hands were tied. But analysts believe there is plenty of wriggle room and Draghi could be forced to carry out the wishes of eurozone finance ministers, should they agree.
What is needed for Italy?
The Italians have run up debts of €1.8-trillion, equivalent to 120% of the country’s annual income. The yield on 10-year Italian bonds is still unsustainable. Rome will begin to spend more than 20% of its income on debt interest in a few years if its rates stay at the current 7% level. It would need a commitment from the central bank to lend about €700-billion, said Capital Economics, to reassure the private markets.
Who is blocking central-bank lending to Italy?
A group of countries headed by Germany. Berlin fears that giving the green light to the bank will trigger the hyperinflation that ruined Germany in the 1920s. French president Nicolas Sarkozy, worried about the knock-on effects for France, argues that inflation worries are a red herring. The eurozone is heading for recession and inflation is falling. The supply of money is contracting as companies and households save their cash. Loans to Italy would have no impact, he said, on the wider economy.
What else can the bank can do?
It has two main options. It could cut interest rates. At the last monthly meeting it shaved 0.25 percentage points off the previous 1.5% rate. This left euro rates higher than the 0.5% base rate in the United Kingdom and 0.25% in the United States. Draghi could ease the debt burden on the entire eurozone, not just to help Italy, but also to prevent a recession that is inevitable without a change of policy.
And the second option?
Draghi could follow the Bank of England and the US Federal Reserve with a programme of quantitative easing. This involves printing money to buy government bonds from European banks. Increasing the demand for government bonds — the name given for the thousands of loans each government has built up from years of overspending — increases the price and depresses the yield, leading to lower interest rates.
Why not carry out these policies?
Draghi said there was no mandate to start quantitative easing. He may cut interest rates further, though it is difficult to know what the bank council is thinking because it refuses to publish minutes of its meetings. —