Ecstasy Of The ECB In The Lagarde Era Of Alignment

As Christine Lagarde turns one year as president of the European Central Bank (ECB) this Sunday, she has reason to celebrate. The entity, re-founded by its predecessor, Mario Draghi, has reached the ecstasy of its history. Due to the size of its balance sheet, 6.3 trillion euros at the end of July, 53.3% of the GDP of the euro area, higher than the 32.3% of the Federal Reserve on the US economy.

For his influence on EU policies. For the practical absorption —or alignment— of the European Banking Authority. For his impulse to use all expansionary tools, well loaded, in strategies against the pandemic recession. 

When Lagarde took over the house a year ago, she promised herself a quiet era: managing the latest stimulus package to beat German anemia. Draghi ordered it in September, recovering the quantitative expansion canceled at the end of 2018. Now it would be 20,000 million euros a month in purchases of public and private bonds.

And calmly approach the strategic review of monetary policy: establish a different inflation target (still today “close to, but below” 2%), hopefully more flexible and technically less biased towards restrictiveness.

And with the addition of purposes such as flanking the reorientation of the economy to green and digital. 

The pillars raised by the Italian would thus culminate in “the hanging arrangement of the ceiling”, it was commented in Frankfurt. Which would facilitate, perhaps, lower the souffle to the rebellion of the hawks led by Jens Weidmann, the rigid head of the Bundesbank.

Fortunately, Lagarde’s first mistake was multiplied with a lethal gaffe: “We are not here to reduce debt spreads,” the new boss answered at her first key press conference, an original phrase by the German Isabel Schnabel . It would ignite the markets, which knew better than she how the disparity in prices of the southern bonds with the German bund triggered the crisis of 2011.

So, alert and swift, she corrected the course on CNBC (“I am committed to avoiding any fragmentation” of the eurozone). The chief economist, the Irishman Philip Lane, and the governors of Spain —Pablo Hernández de Cos— and French —François Villeroy de Galhau— assisted her with simultaneous declarations, assuring that all peripheral bonds would be bought as appropriate.

That fiasco prompted a more substantive change: a week later, the ECB was lighting a resounding bazooka of 750,000 million, the gigantic monetary program against the pandemic recession. Spiced with an apparent technicality, revolutionary: bonds would be bought “flexibly over time between different asset classes and between [different] jurisdictions”.

In silver, without being enslaved to the distribution keys of each one in the bank’s capital. Success: Frankfurt has purchased 34.2% more Italian bonds than its share by the end of August; 25.1% more from Spain; and almost 10% more than that of France. Double success: if the Italian premium reached the peak of 2.43% on March 18, it fell to 0.65 in mid-October; and the Spanish was reduced from 1.28% to 0.13%.

Inflation target

The spectacular commitment of the ECB had been increased on June 4 by 600,000 million “to support the economy during the gradual reopening”, a total of 1.35 million. And it infected the political institutions (Commission, Council), which embarked on the recovery plan – finally fiscal policy! – launched on July 21 for another 750,000 million.

It remained to be executed. And foresee the exact date for another turn of the screw. But in that wait, the governor of the Federal Reserve, Jerome Powell, who came forward on August 27 from Jackson Hole to the execution of the mandate left by Draghi and still pending: modify the inflation target.

 “An appropriate monetary policy should aim for inflation moderately above 2% for some time,” which implies the zenith of flexibility, expansionism and support for the real economy.

There Lagarde erred again, and twice, after the government council of September 10. Asked about Powell’s move, which strengthened the euro and decreased European competitiveness —the Commission calculated that the dollar depreciated 7.5% between February and August—, she replied, perhaps to avoid Trump’s quarrels:

“Our objective is not the exchange rate ”. It is true that it is not directly, but it does condition monetary policy.

And he gave another sign of rigidity by disdaining the immediate expansion of the purchasing plan: “We haven’t even discussed it.” Inaccurate, since the minutes reveal that several councilors proposed it. Again Philip Lane and other advisers had to calm the markets on both issues. And so on, until next December .

Communication failures are due to pactism with the tough

The almost unanimous benevolence towards Lagarde has manufactured a legend: her mistakes are communication failures. But that is inexplicable in an accomplished artist using the word. This is how he fought against the interference of the German Constitutional Court on May 5, which questioned the quantitative expansion.

Factors such as his limited mastery of the technicalities of monetary policy, a pending issue, as well as the vice president, Luis de Guindos, weigh in on the failures. The ECB is headed by seasoned politicians, but pays the deferred price for its limitations.

Thus, his career was influenced by dialogue with ministers and deputies. And they haven’t yet taken the pulse of the fifty fund experts and other interest rate rabies, who scrutinize every semicolon of a statement in Frankfurt with their crooked fangs. An infinitesimal error costs millions.

It also computes the purpose of tame beasts: hawks . That is why Lagarde, being a pigeon , sometimes uses expressions used by them in internal meetings, without calculating that they carry a code and will have their impact on the market. Harmful, as seen in March and September.

The executive committee includes the openingists Philip Lane and the Italian Fabio Panetta, fervent of expansive politics. 

And the tough, restrictive ones, the Luxembourgish Yves Mersch – recently replaced by Frank Elderson, from the Dutch central bank but who studied in Zaragoza – and Isabel Schnabel, a German academic more tractable than the black legged ones from the ultra-rigorous Bundesbank.

The tie sometimes paralyzes, as Lagarde tries to compose. And Guindos, surfing, unlike his Portuguese predecessor, Vítor Constáncio, an intellectual heavyweight of the bank and more draghista than Draghi.

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