And that was it. Although the Draghi era at the European Central Bank (ECB) is not over in nominal terms (that will take another week), it is already in real terms. The last policy meeting and press conference with Italian President Mario Draghi took place on Thursday, October 24.
Draghi will definitively go down in the monetary history books as the first ECB president who never raised official interest rates. He did lower that interest rate, no less than 8 times. And there were many announcements of quantitative easing (money creation), an expansion or reduction thereof and many more expansionary measures. The ECB board decided not to change monetary policy. Not surprising, after the decisions taken last month. That did not mean that there were no noteworthy things to hear at the press conference.
Exit shifted
One of them was when Draghi referred to the International Monetary Fund (IMF) report on financial stability, which was published last week. In it, the fund warned of the negative consequences of long-term negative and very low interest rates. Interest rates appear to remain very low for longer, which, according to Draghi, means that an exit from the current monetary policy environment has been pushed further into the future. It is not surprising if by the time his successor Christine Lagarde leaves the ECB (in October 2027), that policy has still not been fully normalized.
What was important was Draghi's answer to the question of what we should be most concerned about. “About economic downturn,” said the Italian. The reason is obvious: all the resources the central banks have to mitigate such a downturn have run out or are almost gone. Economic downturn in the future is inevitable, as is another recession. Then this statement is a clear warning for anyone who will listen. Coming from none other than the President of the ECB.
Bank against the limits
Draghi was most sophisticated when he addressed the question of how long the new round of quantitative easing can continue without the bank running into the limits. After all, the ECB has drawn up rules about how many bonds per issue and issuer it can buy and what the distribution key is per country. How long that can be possible depends largely on the supply of government bonds, according to the cunning Italian monetary fox.
Why is that cunning? The expectation is that the ECB will fairly quickly reach the point where it cannot buy enough German government bonds. The bank can extend that period slightly by issuing slightly more money on debt securities from other countries. But that offers temporary relief. If the ECB cannot buy enough German government bonds and therefore has to stop, this will de facto lead to a forced stop on monetary expansion. Something like this can lead to chaos and panic in the markets.
Transferring responsibility
By pointing out that the supply of (German) government bonds plays an important role in this, he subtly transferred responsibility for concerns and uncertainty about how long the ECB's quantitative easing can continue from the bank in Frankfurt to the government in Berlin .
The German government can extend the moment when QE reaches its limits by pursuing more expansionary fiscal policy. This means that more German government bonds will be offered and the ECB can therefore continue with QE for longer. If Berlin does not provide additional supply in time, then Germany and not the ECB will be responsible for any monetary chaos and panic on the markets. Draghi knows very well that Berlin does not want to have that on his conscience.
Nip uncertainty in the bud
It is therefore expected that the very likely recession in Germany will result in the German government pursuing a much looser budget policy next year than it currently advocates. That could boost growth in the eurozone and push up long-term interest rates. As well as, and crucially for the markets, nipping concerns and uncertainty about the ECB's policy in the bud.