Right now, Italian 10-year bond yields have passed the 7% mark – a figure thought to be unsustainable by many analysts. The European Central Bank (ECB) may be forced to step in and buy up massive amounts of Italian government debt in order to prevent the country from turning, like Greece, Ireland and Portugal before it, to the EU/IMF for a formal bail-out. Worryingly, it remains to be seen whether there will be enough money in the EFSF (the EU’s “bail-out fund”) to prop up the third largest economy in the Eurozone.
In our last post, we had a comment come in from Patrick Leneghan arguing that more attention should be paid to movements such as “Los Indignados” and “Occupy Wall Street”, which are protesting against the current status quo in the global financial system:
Again, [there has been] no discussion as to what ideology or economic system to adopt and worse, the propaganda that there is only one set of economic rules available. This is fiercely disputed around the globe, the ‘occupy’ movement being one example. As many citizens have correctly identified, it is this current financial system (aka ideology) that is the cause of all of these problems.
Debating Europe recently spoke to some of the protestors from Spain involved in the Indignados movement. These movements have been criticised in the past for failing to suggest any specific solutions to the crisis, instead advocating “protests over policy”, but the common theme when speaking to the protestors was disillusionment with the current political and financial system. One protestor, for example, wanted to see an end to professional politicians, instead suggesting that politics could become a voluntary activity with everybody participating part-time.
We took some of these sentiments to Peter Praet, a Belgian economist and a member of the six-person Executive Board of the European Central Bank. The Executive Board is responsible for the monetary policy of the Eurozone, and so the board members are currently right at the centre of the Eurozone crisis. We asked Peter Praet: “Are we seeing a crisis of democracy in Europe?”
If you look at sovereign debt, checks and balances in our democracies have not performed sufficiently well. Future generations are not sufficiently defended in our current system. They cannot vote. We have shifted risks to future generations: many difficult challenges can be pushed into the future in the form of debt. We saw weaknesses due to ineffective public governance and market failures. In a number of countries there were budget rules such as the “no bail-in rule”, the balanced budget rules, etc. But these rules obviously were not strictly followed. Also, everybody knew before the crisis that measures were needed to maintain the sustainability of public debt in many advanced countries because of the ageing population in these countries. But these measures were too often postponed.
One protestor we spoke to, however, expressed his frustration at precisely this. He was angry about politicians agreeing to put a constitutional limit on public debt in Spain:
If we accept that future generations cannot vote on national budgets, but nevertheless have an important stake in them (because they will be paying off any debts accrued), then we are faced with a dilemma. Should there be constitutional rules to stop democracies from borrowing too much and passing the problems on to future generations? Let us know what you think.
Speaking of “rules”, of course, is the ECB now breaking them? Is it overstepping its mandate by buying up government bonds in Italy? Here’s Peter Praet’s response:
No. We are in a context with a lot of market disruptions, where market liquidity can evaporate quickly because of panic reactions. As a result, monetary policy transmission mechanisms do not work sufficiently well. You give an impulse on an interest rate and it’s not passing through the whole financial sector.
That’s why we intervene in the market with unconventional measures, to restore the monetary transmission. However, this cannot become a chronic situation. If it becomes a chronic situation, it would mean that it is not related to a situation where markets are in a panic mood, but to more fundamental issues about doubts of stability in some countries. And that’s absolutely clearly beyond the mandate of the central bank. It’s one thing to accept interventions to facilitate better transmission where there’s a lot of noise in the market. It’s another thing when there are fundamental doubts about the sustainability of some countries. Clearly, it is not the task of the central bank to intervene in the latter case.
If you accept the analysis that bond market discipline didn’t work, then it is not by intervention of the central bank on a continuous basis that you would solve the problem.
What can be done, then, to improve the situation?
Any solution is going to be tough. It should be [implemented] as smoothly as possible and avoid something that would be too damaging. Action is needed in both the private and the public sector. Important measures are being taken. You have the whole regulatory package at the G20. You have to define well the rights of equity holders versus debt holders in the financial sector and banks in particular. In the public sector, you need an improved rules-based system. If you accept that future generations cannot impact national budgets, then you have to put some rules that are really binding for those budgets. This was missing, and so needs to be achieved.
It is something that was long due. Unfortunately, it comes in a very harsh way – but you must remember that even before the crisis there were concerns. At that time, decision makers thought they had ten years to prepare for an aging population. Now, with the economic slowdown because of the crisis, we have lost, in many countries, those ten years. Reforms have to be pushed faster than what was planned. It had to happen anyway, but now it has to happen faster. The problem was already there before the current crisis.
What do YOU think? Do you agree with those protestors that want to see a radical new approach to democracy, with more direct participation from citizens? Or will more direct democracy mean future generations (who cannot vote) must pay for our mistakes? Has the ECB broken the rules by intervening in Italy? Or is the crisis so serious that they had no choice? Let us know in the form below, and we’ll take your comment to politicians and experts for their reaction.