The ECB has released a letter from its former President, Jean-Claude Trichet, to the Spanish Prime Minister in August 2011. It is excruciating reading.
The letter starts with a reminder about the Spanish government's responsibilities:
“We recall that the Euro area Heads of State or Government summit of 21 July 2011 concluded that "all Euro countries solemnly affirm their inflexible commitment to honour fully their own individual sovereign signature....."
Well, ok, this letter is about the threat to the Euro caused by spiking Spanish bond yields and the fear of default and redenomination at that time, so it is probably reasonable of the ECB to ask for assurance that the Spanish government intends to honour its debt obligations. But that's not all:
“...and all their commitments to sustainable fiscal conditions and structural reforms.”
And the letter then goes on to explain in some detail exactly what "structural reforms" the ECB expects Spain to undertake. There are three groups of changes:
· changes to the labour market, including decentralising wage bargaining, ending indexation of wages and "reviewing other regulations" in order to make it easier for the unemployed to find jobs. Apparently making it cheaper for firms to sack people and eliminating restrictions on the rollover of temporary contracts makes it easier for the unemployed to find jobs. I am not quite sure how this logic works.
· additional "structural fiscal consolidation" (i.e. permanent spending cuts and/or tax rises) of 0.5% of GDP, apparently to "convince markets" that the 6% deficit target could be met. This was to be coupled with strict control of sub-sovereign budgets, new rules enforcing transparency in sub-sovereign accounts and a "spending rule" restricting spending increases to the trend growth of GDP.
· product market reforms, mainly to improve competition in key sectors and promote housing rentals.
I am not in this post going to discuss the wisdom or otherwise of these proposals. I am interested in the fact that it was the ECB that made them. In what insane world is fiscal policy the responsibility of a central bank? Which EU treaty gives the ECB the right to dictate policy to a sovereign government, even one subject to the "excessive deficit procedure"? It is very hard not to conclude that the ECB strayed far beyond its mandate. But why did it do this?
The final paragraph gives the game away:
“Overall, we trust that the Spanish government is aware of its very high responsibility for the smooth functioning of the Euro area at the current juncture and will decisively undertake all necessary measures to regain market confidence in the sustainability of its policies again.”
The impression that this gives is that restoring market confidence in the Euro was the responsibility of the Spanish government, not the ECB. An emasculated ECB was desperately trying to persuade the Spanish government to do whatever was necessary to prevent a disorderly breakup of the Euro. Poor thing.
We now know that this is total nonsense. What markets really needed to restore confidence was not Spanish structural reforms or fiscal consolidation. It was a guarantee from the ECB that it would stand as "buyer of last resort" for Eurozone sovereign debt. And when the ECB finally gave that guarantee - though admittedly hedged around with conditions - calm was restored to the markets and bond yields fell to normal levels.
So it was not the Spanish government that needed to act. It was the ECB.
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