Mario Draghi has just passed the halfway mark of his term in office. You don’t have to be a prophet to predict that the events of the past week will cast a long shadow over the rest of his presidency of the European Central Bank.
Mr. Draghi, the great interpreter of markets, has miscalculated. Deliberately or not, he fueled expectations that he was unable to fulfill. Even though the ECB’s quantitative easing program was beefed up on Thursday to €1.5 trillion ($1.63 trillion) and the negative interest rate on deposit accounts was increased, the euro shot up by almost 5 cents in an otherwise sluggish foreign currency market, while stock markets plummeted.
Some would argue that making investors happy is not the goal of monetary policy. But it was Mr. Draghi who, with the introduction of “forward guidance,” tried to take the markets by the hand and give them the most precise guidance possible over the future direction of monetary policy. It was Mr. Draghi who had developed the reputation of being a sort of magician of the markets.
The days of impending financial collapse are long gone, and yet Mr. Draghi is still acting in emergency mode.
But this time he has failed miserably with his management of expectations, which is a key qualification for central bankers, not only from Mr. Draghi’s perspective.
It was more than a misstep on the part of the magician. For the first time since he came into office in 2011, the limits of his power are becoming visible – in several respects.
Mr. Draghi’s strategy of presenting the ECB decision-making governing council – made up of 25 members including the heads of national central banks – with a fait accompli by making announcements without prior consultation isn’t working anymore.
The strategy has worked in the past, such as when he gave his legendary “whatever it takes” speech in London, which amounted to a guarantee of the euro’s continued existence. A few months later, the council hardly had a choice but to follow his grand promise with significant actions. The unlimited Outright Monetary Transactions (OMT) program was born.
The same strategy worked even more spectacularly with his announcement in the fall of 2014, also without prior consultation, that he wanted to increase the ECB’s total balance sheet by a trillion euros. Everyone knew this meant quantitative easing was coming. And indeed, in March of this year the ECB began a massive program to buy up government bonds, based on the example set by the U.S. Federal Reserve.
But Mr. Draghi’s method of taking far-reaching decisions for the central bank in consultation with no more than his closest associates, his so-called “kitchen cabinet,” and then merely securing the ECB governing council’s blessing, is increasingly giving rise to resentment.
Far more tragic than his fellow council members’ skepticism is the fact that he is also increasingly hitting a wall with his monetary policy.
Now that the extension of the QE program has been approved, the central bank’s total assets will likely increase to the astonishing total of €3.6 trillion, or more than one-third of the euro zone’s entire economic output.
Not even the United States, whose monetary policy is traditionally more forceful than Europe’s, has ever reached such levels.
Despite all of his spectacular actions, Mr. Draghi has not managed to bring inflation even close to the ECB target of just under 2 percent, let alone put a self-sustaining recovery in motion.
But Mr. Draghi keeps running, faster and faster, without asking himself whether the direction he has taken is even the right one.
He consistently turns a deaf ear to criticism, citing his inflation mandate.
But mechanistically invoking the mandate is no substitute for self-reflection, or for balancing the costs and benefits of his actions.
The economic risks of a monetary policy dedicated and determined to keep the cost of money near zero in the long term, or even to push it below zero, are well-known: the wrong incentives for politicians and businesses, zombie banks that are artificially kept alive and the formation of bubbles in financial markets that could trigger the next, even bigger crisis if they burst.
These risks are all the more serious when we consider that there is no truly discernible benefit to Mr. Draghi’s monetary policy.
Yes, he saved the euro. With creativity and drive, he made the central bank Europe’s most important authority on economic policy. Meanwhile, the policy became rigid in the face of massive problems, and the German Bundesbank did little more than level criticism at the ECB, criticism that seemed so trite because it failed to offer any realistic alternatives.
But the days of impending financial collapse are long gone, and yet Mr. Draghi is still acting in emergency mode, as if he could forcefully achieve recovery in the ailing economies. However, there is no correlation between the size of the central bank’s balance sheet and economic growth.
The markets’ drastic reactions to Mr. Draghi’s latest monetary feel-good package show that their faith in the magician’s power is disappearing.
The magician has been demystified.
To contact the author: email@example.com.