Eighteen of the nineteen Eurogroup finance ministers met Saturday night to discuss what to do about Greece. What they agreed – according to both their official statement and to the press statement released by Eurogroup president Jeroen Dijsselbloem a couple of hours later – is ‘to complement any actions the ECB will take in full independence and in line with its mandate.’ They also agreed, on behalf of ‘the institutions’, ‘to provide technical assistance to safeguard the stability of the Greek financial system.’
The ECB met today (Sunday, 28 June) to decide what this means in practice. It could opt to extend a lifeline to the Greek banks until this problem works itself out. Given the phrasing of the Eurogroup statement, however, that was unlikely. Instead, it began to act in a manner that would safeguard its own position. The Eurogroup made it clear that the ECB had full room for manoeuvre. The Eurogroup will provide political cover so long as the ECB acts ‘within its mandate’. The Eurogroup will also help the Greek authorities manage the consequences of the ECB’s actions.
There were four options on the menu for the ECB’s Governing Council. None of them is exclusive; each is problematic for the future of Greece participation in the euro. The ECB could decide to cap Greek access to emergency liquidity assistance (ELA), it could raise the haircuts required for the use of Greek government backed assets as collateral for access to liquidity, it could announce the end of Greece’s ELA program for one or financial institutions deemed to be at risk of insolvency as a result of Greek government actions, and it could take measures to restrict the access of the Bank of Greece to the real-time gross settlement system (Target2) used to redistribute liquidity among central banks within the single currency.
For the moment, the ECB has opted to maintain the level of ELA that it agreed last Friday. The official statement makes it clear that the ECB can reconsider its actions and this decision will obviously continue to evolve during the coming days. The point to underscore is that any of the actions sketched above would be within the mandate of the ECB – which is the same mandate that Mario Draghi used in July 2012 to frame his commitment to do whatever it takes to safeguard the euro. The problem is that these actions would have precisely the opposite effect of the ECB’s program for ‘outright monetary transactions’. Rather than eliminating ‘convertibility risk’, which is ECB speak for the risk that a country could be pushed out of the single currency, the Governing Council would be acting to ensure that market participants recognize that participation in the single currency is not irrevocable. If we eliminate the double-negative, that means that the ECB would be teaching market participants that the euro is a fixed exchange rate regime. Governments can leave once it becomes too inconvenient to stay.
The contradiction here stems from the Janus-faced mandate of the ECB. In turn, that mandate stems from the single-minded focus of the ECB on the goal of price stability. The tension was already apparent in the original ‘whatever it takes’ commitment. When Draghi introduced the program for outright monetary transactions, he made it clear that the purpose of buying ‘unlimited amounts’ of distressed-country sovereign debt instruments was not to become a lender of last resort for banks or sovereigns but to restore the monetary transmission mechanism. Hence governments could only qualify for ECB assistance if they retained access to private capital markets and agreed to enter into a program. Anything outside of those conditions would be outside the ECB’s mandate. Europe’s political leaders could decide to support a government in extremis, but the ECB’s Governing Council would not take the lead on any such decision and it would support political action only insofar as that was consistent with the goal of price stability.
The conflict that arose between the Governing Council and the Government of Cyprus in March 2013 underscored the tensions within the ECB’s mandate. The Governing Council threatened to cut off emergency liquidity assistance to the small island nation’s two largest banks because it judged them to be insolvent. The Government of Cyprus could not afford to resolve the two institutions without bailing in the banks’ creditors. When the Cypriot Parliament balked at putting a tax on small depositors, there was a brief moment when it looked like the Bank of Cyprus might have to pull the country out of the euro in order to provide the banks with necessary liquidity until a resolution plan could be put into place. That moment passed quickly – almost instantly – because the cost of leaving the euro was disproportionate to the cost of finding another arrangement for resolution financing. Nevertheless, the ECB defended its decision to run this very small but still noticeable risk of pushing Cyprus out of the euro by pointing out that it was acting ‘within its mandate‘.
The situation in Greece is different only in terms of quantity and not in terms of quality. The risk that Greece will leave the euro cannot be discounted as easily as the risk that Cyprus would do so in March 2013. But the principle remains the same. Within its mandate the ECB can act to create the conditions where Greek policymakers would have to weigh the costs and benefits of leaving the euro and then choose to act accordingly. Should they choose to leave the single currency rather than accept whatever constraints the ECB chooses to impose on relations between the Bank of Greece and the country’s main financial institutions, then the euro will be forever changed.
The architects of the single currency made a fundamental mistake. They designed the ECB to be a monetary policy authority. In doing so, they forgot that first and foremost central banks are supposed to be banks. A single currency cannot survive without a lender of last resort facility. A lender of last resort has to act to stabilize the financial system in moments of crisis without regard to the longer-term implications for price stability. Of course those longer-term implications cannot be ignored entirely. Over time some reconciliation has to take place. But the hierarchy of needs places the ‘bank’ above the ‘monetary authority’ in moments of crisis. Europe’s monetary union was not designed to respect that hierarchy. That is why the ECB’s mandate is Janus-faced.