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Wed, 20 Nov 2019 11:44 GMT

Draghi’s Legacy


Ben Mueller

Wed, 06 Nov 2019 07:21 GMT

The European Central Bank’s President’s second term came to an end on the 31st of October. After he was first welcomed by some as a German-style central banker, his reputation noticeably changed over the years – how will history judge him? 

At a time of economic stagnation and mounting recession fears, ECB President Mario Draghi passes the baton on to Christine Lagarde, hitherto the head of the International Monetary Fund (IMF). The Italian central banker leaves after eight memorable years marked by uneven economic growth, the near collapse of the currency area and a fundamental transformation of the ECB’s monetary policy.

“Whatever it takes” – Draghi and the Eurozone’s Sovereign Debt Crisis 

When Draghi commenced his first term, the Eurozone had already gone through the first phase of the sovereign debt crisis. Seeking to bring down the borrowing costs for Eurozone countries, the ECB had started to purchase Greek and later also Italian, Spanish, Portuguese and Irish sovereign bonds on the secondary market. This programme was controversial back then because some argued it breached the Maastricht Treaty, which prohibits the ECB from directly financing Eurozone governments.

 Draghi nonetheless chose to double down and lowered the ECB benchmark rate as a first act in office, thus kicking off the rate’s downward slide into negative territory. This soon proved insufficient when, just over a year into his term, borrowing costs reached unsustainable levels for the Italian and Spanish governments. With national leaders unable to mount a concerted effort to resolve the crisis, the Eurozone was teetering on the brink of collapse. Draghi then stepped into this void left by politics and in a historic speech in London in July 2012, he told his audience “within our mandate, the ECB is ready to do whatever it takes to preserve the euro.” 

These words were soon followed by the announcement of a bond buying programme called “Outright Monetary Transactions” (OMT). In contrast to the previous bond purchases programme, OMT allowed for unlimited secondary market purchases of sovereign bonds. Curiously, the ECB’s willingness to use this instrument alone was enough to calm investors and the programme was ultimately never used.

Quantitative Easing and Negative Interest Rates 

By 2015, it appeared that the ECB’s intervention had helped contain the sovereign debt crisis. This, however, did not mean that the Eurozone as a whole had returned to good economic health. Besides low GDP growth rates and falling inflation, several countries were struggling with stubbornly high unemployment. 

Taking inspiration from central banks elsewhere in the world, Draghi’s ECB embarked on its first asset purchase programme, better known as quantitative easing (QE), in an attempt to pump liquidity into the economy to stimulate growth and inflation. Not everyone was impressed – veteran bond investor Bill Gross dismissed it as “too little too late”, while Bundesbank president Jens Weidmann considered it an effort to buy time for Eurozone members to avoid reforms thanks to lower borrowing costs. Despite growing resistance in the ECB’s governing council, Draghi ultimately persevered in this policy direction and his last act in office was the launch of yet another round of QE.

Set the ECB’s path for the years to come

With the launch of further stimulus measures, Draghi is believed to have set the central bank’s policy course for the years to come. James McBride, Andrew Chatzky and Christopher Alessi from the Council on Foreign Relations noted that “many observers expect Lagarde to follow along the path laid out by Draghi, noting that she has praised central bank stimulus measures in the past.” At the same time, they warrant that “interest rates are already below zero, [...] meaning borrowers are being paid to take out loans—an unconventional policy [...] that also hurts Europe’s banks, because negative rates cut into their profits.” 

From German-style Central Banker to Draghila... who saved the Eurozone after all? 

The negative impact of the ECB’s policies on banks and savers has possibly been the main reason why Draghi’s image changed considerably over time. “When Draghi’s term [...] started he was welcomed by mainstream media. [...] In interviews back then, Draghi emphasised how much he admired the legacy of the hard-nosed Bundesbank,” wrote Henrik Mueller, professor of economy policy journalism at the Technical University of Dortmund, in 2014. 

This initial perception indeed stands in stark contrast to some reactions to his latest policy measures in September, a particularly extreme example being the coverage of German tabloid Bild with its “Count Draghila sucks our accounts dry” headline. 

Nevertheless, this might not be what Draghi will be best remembered for in the long term. Olivier Blanchard, former chief economist at the IMF, thinks “he will probably be mostly remembered for three words, which, on their own, and without having to take any action, saved Europe from tragedy.”