Mario Draghi’s term at the ECB

Last week, Mario Draghi’s 8-year term as President of the European Central Bank came to an end. He served as head of the ECB from November 2011 to 31 October 2019.

Given the significant developments that took place over the past 8 years, it is good to look back at the main events that shaped and characterised Mario Draghi’s presidency.

The eurozone crisis was in full swing when Mr. Draghi took over in November 2011. The global financial crisis of 2008/9 had precipitated an existential crisis in Europe, fuelled by debt, banking and government bailouts, austerity and civil unrest.

Mr. Draghi immediately left his mark shortly after being appointed as President. Within two months, he reversed the controversial two interest rate rises actioned by his predecessor Mr. Jean-Claude Trichet in the midst of the aftermath of the global financial crisis.

Although Mr. Draghi had to deal with the prospect of Greece being forced to leave the euro area (which many believed that the eurozone as a currency bloc could have survived given the small size of the Greek economy), the market became increasingly concerned in 2012 about the debt situation of other eurozone economies, especially two of the largest – namely Italy and Spain. A default or exit from the eurozone by either of them would have possibly been a fatal blow to the entire eurozone project. The yields (borrowing costs) of the government bonds of both countries soared to what many believed to be unsustainable levels reflecting the fear that Italy and/or Spain might leave the euro and repay their debts in a restored national currency that would lose value. The 10-year Italian government bond yield had surpassed the 7% level in November and December 2011 and remained above the 5% for most of 2012. Likewise, the 10-year Spanish government bond yield had also momentarily breached the 7% level during summer 2012.

Mr. Draghi is probably best remembered for a speech delivered in London in July 2012. The euro crisis was at its peak at the time with Greece, Ireland and Portugal having already been bailed out and the government bond yields of Italy, Spain and other so-called peripheral countries ran at persistently high levels. Against this background, the 17 members of the single currency agreed to provide up to €100 billion to rescue Spain’s banking system through what later became the European Stability Mechanism.

Mario Draghi had stated in this famous speech that the “ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” Following the speech in London, the ECB designed a programme called outright monetary transactions (OMTs) which involved the possibility for the central bank to buy the bonds or debts of eurozone governments if their borrowing costs reflected fears of a eurozone breakup. The plan was designed to protect governments from speculative attacks by buying their bonds if they accept fiscal discipline.

The statement seemed to have convinced market participants immediately as the high borrowing costs of the ‘peripheral’ countries came down to more manageable levels. The ECB did not even need to buy any debts of distressed governments since the convincing statement made by the ECB President at the time persuaded financial markets and forced yields lower.

Mr. Draghi is widely known for having transformed the ECB “into a modern central bank” by “using a broad, innovative, efficient and flexible toolkit of unconventional policy measures”. The well-known US economist Paul Krugman described Mario Draghi as “[arguably] the greatest central banker of modern times”.

Apart from shoring up faltering support for the euro in various countries, Mr. Draghi’s legacy also extends to the expansion of the ECB’s policy toolbox to include generous lending facilities to banks to help shore up their balance sheets and boost liquidity, negative rates to lower borrowing costs and stimulate economic activity in general, as well as sovereign bond purchases to bring down the market interest rates faced by the bloc’s most troubled economies. The various measures over the years were effective in bringing down the unemployment rate which soared after the financial crisis, topping 12% across the eurozone in 2013 to a current level of 7.5% – the lowest level in more than a decade.

Following the important statement in London in July 2012, the next remarkable milestone of Draghi’s term was in July 2014 when the ECB introduced negative interest rates. Inflation and economic growth in the eurozone were still struggling so the ECB introduced negative rates thereby forcing European banks to pay interest on deposits held with the central bank. The measure was an attempt to boost bank lending thus helping economic growth. The ECB was the first major central bank to introduce negative interest rates.

A few months later, in January 2015, the ECB replicated the measures used by other major central banks (most notably the Bank of Japan, the US Federal Reserve and the Bank of England) and introduced quantitative easing which involved the buying of government bonds of euro area countries to keep yields lower and boost spending. The ECB’s QE programme was amended in subsequent months by first increasing the amount of monthly purchases and initiating the purchases of corporate bonds as well, and then reducing the amount of stimulus as the eurozone began to experience higher and more sustained economic growth. The QE programme came to an end in December 2018.

However, in his penultimate monetary policy meeting in September 2019, as global trade tensions worsened, and amid a marked slowdown in Germany as well as the ongoing Brexit uncertainty, economic growth in the euro area was once again faltering so the ECB reintroduced quantitative easing by launching a bond-buying programme of €20 billion per month and pushed interest rates further into negative territory.

Although Mr. Draghi was successful in stemming the eurozone crisis, bringing down bond yields and also reducing unemployment, many critics argue that he did not deliver on the ECB’s main objective which is to maintain price stability. This is defined as a year-on-year inflation rate of below but close to 2%. The rate of price growth remained below this level for most of Mr. Draghi’s tenure. The ECB President did however avert the risk of deflation, which would have been extremely dangerous and damaging to the eurozone.

Unfortunately, there is currently very little hope that inflation will pick up and approach the ECB’s target of 2%. The latest reading for inflation data for September 2019 indicated a rate of 0.8% (a three-year low) and the ECB forecasts that it will remain subdued for the foreseeable future.

In its statement following the monetary policy meeting in September, the ECB remarked that the “Governing Council expects them [the net purchases] to run for as long as necessary to reinforce the accommodative impact of its policy rates, and to end shortly before it starts raising the key ECB interest rates”.

The decision was reportedly not favoured by several heavy-weight members of the ECB who spoke openly about the negative impact of the interest rate environment on savers, asset prices and the banking sector. Some opponents argued that the ECB will run out of eurozone bonds to buy by the end of 2020 which could then force the central bank to exceed its self-inflicting limit of buying no more than a third of outstanding bonds of the same country or turn to other assets such as bank bonds and equities.

However, Mr. Draghi defended the latest stimulus package by warning that the eurozone’s economy remains vulnerable and continued measures are required due to the weak economic dynamics. The President had stated that the ECB was concerned that the economy faced “protracted weakness” going into 2020. Mr. Draghi also indicated that it will “take quite a bit of time” before the ECB comes up against limits on bonds it can buy.

In his last speech as the ECB President, Mr. Draghi once again highlighted the importance of fiscal policy measures to complement monetary policy. Although he had begun advocating for governments to resort to fiscal policy measures since 2014, he argued that now it is more urgently required. Mr. Draghi explained that monetary policy will continue to do its job, but he admitted that the negative side-effects will become more visible as time passes. Negative rates, in particular, place a heavy burden on banks’ profitability, challenging their traditional business models, while forcing savers to take additional risks in their search for a positive income stream.

Other critics opined that the ECB has little firepower left to respond to a new recession in the eurozone leaving his successor Christine Lagarde with little options. Some stated that Ms. Lagarde “will find her hands pretty much tied by Draghi’s last big policy package”.

The ECB has now entered a new era under incoming President Christine Lagarde – the former head of the International Monetary Fund. Following the discontent among several council members on the recent policy decisions, Ms. Lagarde must decide how aggressively to pursue Mr. Draghi’s goal of bringing eurozone inflation to close to 2% and whether this is indeed the right target in today’s world.

The new ECB President may also be judged on her ability to generate support for greater fiscal stimulus. The aim is to encourage looser fiscal policy from Germany, the eurozone’s largest economy, as well as other countries that have the credentials to implement such measures to boost economic growth. In fact, Mr. Draghi had recently stated that “governments with fiscal space should act in an effective and timely manner.”

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