“You…. start your term with … a system in need of reassurance that Outright Monetary Transactions (OMT) are ready to be used, if need be.” This is what we said in July 2019 when we wrote the memo to the incoming ECB president. What we did not know back then is just how quickly she would have to contemplate the need.
The COVID19 virus that has affected Italy the worst, is now pushing the country in that direction.
For OMT to be activated it requires both for the country to ask and for the rest of euro area members states to agree. And it comes with conditionality, Greek style. OMT was always meant to be the nuclear option. The kind of thing you put in place so that you do not have to use it.
The question now, and for a little while longer, is not whether the ECB should apply OMT. The question is what can be done instead, so that it does not have to.
Olivier Blanchard argues, among others, for a “light” pre-emptive application of OMT. In the case Italy finds itself right now, “… conditionality should be very limited, and easy to define: Spend what you must on crisis containment and commit to wind down everything once the crisis is over. Full stop. No stigma.” he said in a twitter thread on the 13th of March.
A light OMT might be interesting from the euro-area perspective. If Italian spreads get the jitters others will follow. A readily available tool like OMT can help contain spreads and with them contagion. And it will give members states a handle on Italian economic choices through conditionality. It would be a good measure to protect the euro area convincingly.
But light or otherwise, OMT requires a temporary surrender of one’s economic sovereignty. Italy is hit by possibly the worst crisis aside of wars. It was the first in Europe that bore the human cost of the pandemic and the first to take drastic measures that entail severe economic costs. What do Italians think about “limited conditionality”, “commitment to wind-down”, and importantly “No stigma”? As medical resources are stretched, doctors are asking for guidance from the state on how to prioritize lives. Is this the right time to relinquish any sovereignty?
But beyond that there is also the issue of protecting the euro area. If OMT is a way of managing contagion and protecting the euro, why should the Italians bear the cost of doing so alone? All this changes if Italy is cut out of the markets. But till they are, incentives are not aligned and Italy will exercise its sovereign right to protect its own interests, first and foremost. It would not be reasonable to ask of anything less.
For the moment therefore we should look at other options. Italy still has access to the markets and is, as Blanchard says, “behaving extremely responsibly - more so than many”. Phillip Lane’s ECB blog on the 13th, provided a very clear description of the policy space that ECB has to help the euro area and, in the process, also Italy.
But the real elephant in the room is the perennial lack of centralised fiscal capacity. Euro area ministers will be discussing a coordinated response at the start of the week. It will require funds for direct medical assistance, like the solidarity fund the European Commission has just activated. But it will also require area-wide macroeconomic assistance to cushion the inevitable hit that comes from having to bring all economic activity to a halt.
If they do not rise up to such unique circumstances, demonstrate the level of solidarity that is truly needed, then ECB communication mishaps of last week will pale into insignificance.
 Preparing for Uncertainty: Memo to the President of the European Central Bank, Claeys, Demertzis and Papadia (July 2019), Bruegel.