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ECB Bond-Buying Program a Balancing Act Between Leverage and Rescue

The Wall Street Journal has more confirmation that the European Central Bank will consider rate targets to keep the spreads on bond yields manageable for its member states.

The central bank wants to help bring down government financing costs through targeted purchases of government bonds, while preserving their flexibility to change course when needed and to maintain pressure on governments to rein in budget deficits and revamp stagnant economies.

To achieve that delicate balance, officials are moving in the direction of informal, flexible yield objectives for shorter-maturity bond yields of Spain and other at-risk countries, according to the person familiar with the matter.

The central bank is unlikely to finalize anything before its Sept. 6 policy meeting, at the earliest. Yet the basic contours are starting to take shape.

This looks like a “have your cake and eat it too” kind of policy effort. The ECB still wants to use is power as a lever to force Spain and Italy into labor market changes that would break unions and stagnate wages. But they also want to save the euro. So they’re trying to thread the needle by agreeing to bond purchases, but making them uncertain enough so they can still apply pressure. This turns the ECB into a fiscal policymaker by using the leverage of the monetary instrument. I don’t know why that should be seen as promising; the ECB has a very particular viewpoint, and little in the way of fiscal policy expertise.

Meanwhile, another part of this effort to hold down yield spreads concerns Greece. Over the weekend, Germany and France both let the Greek leadership know that they would not budge on the need for the troubled sovereign to meet budget targets immediately. It appears that Greece will not be able to get to a mid-October EU summit without a reckoning. The troika (EU, IMF and ECB) plans to spend the whole month of September in Athens auditing the Greek books. One German politician said he expected a Greek exit next year, which caused harsh admonitions from the German Foreign Minister and Chancellor Angela Merkel.

If Greece is pushed into exiting, this would undermine the case against capital flight in Spain and Italy. If Greece can shift back into its old currency, so could Spain or Italy. So the bond-buying seems intended to serve the purpose of settling the nerves of investors and preventing a capital run. But given how the ECB still wants to hold the trump card and exercise leverage, they may not allow enough firepower to leak out in the event of a Greek exit.

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David Dayen

David Dayen