Following the various announcements of President Draghi in July and August, most analysts were expecting further clarification of the modalities of the sovereign debt purchase programme at today’s ECB meeting. They will not be disappointed.
In his press conference President Draghi recognized that the old programme, known as the Securities Market Programme (SMP), had not worked, and announced that it will as being replaced as of today by a new programme called Outright Monetary Transactions (OMT). The new programme differs from the old one in four main respects:
· Activation and continuation of OMT with respect to bonds issued by a euro area country is subject to “strict and effective” conditionality. No such requirement existed, at least formally, for the SMP.
· No ex ante quantitative limits are set on the size of OMT. By contrast SMP interventions were de facto subject to limits.
· The Eurosystem will be treated pari passu with other creditors for bonds purchased through OMT. This was not the case for the SMP and President Draghi announced that Eurosystem seniority for existing SMP holdings would remain in place.
· There will be much greater transparency on OMT than SMP holdings, including the breakdown by country on a monthly basis.
The new programme reflects two fundamental departures from previous ECB attitudes made explicit by President Draghi during his press conference. One is the admission that some euro area countries are trapped in a bad equilibrium caused self-fulfilling expectations. This is essentially the argument for having the ECB act as a lender of last resort to governments that a number of economists have been putting forward. This admission is reflected in the absence of ex ante quantitative limits on the size of OMT. The other is the conviction that sovereign debt purchase by the ECB can only be effective if there is recognition by governments that the reason why their country finds itself in a bad equilibrium is due in the first place to their own earlier economic policies. This recognition translates into a strict and effective conditionality attached to an EFSF/ESM programme which, however, need not be a full macro-adjustment programme. A precautionary programme could be sufficient but a sectoral programme like the EFSF/ESM programme for Spanish banks is not.
The OMT is no doubt a great improvement over the SMP. The notion that solving the crisis requires a two-legged approach, as President Draghi insisted several times during his press conference, involving both the ECB and governments, and the creation of a mechanism of conditionality meant to ensure that each leg moves in the right direction is a great step forward. Indeed one of the tragedies of the euro area crisis so far has been the lack of an authority capable of providing the necessary coordination between the various actors, mainly the national governments and the independent central bank resulting in a game of chicken among governments and between governments and the central bank.
Whether or not the OMT succeeds in solving the euro area chicken game will soon been known. The only question for now is whether Spain and its euro area partners will go for a full macro-adjustment or a precautionary EFSF/ESM programme. The next question will be whether Italy can do without the ECB’s OMT and its conditionality. A happy outcome for Spain would certainly be good news for Italy as well.