The future of Europe hung in the balance at the battle of Waterloo in 1815. The British, led by the Duke of Wellington, held Napoleon’s Grand Armeé to a standstill, waiting for General Blücher and his Prussians to add their weight to the battle. Without his Prussian allies, the best the Duke could expect was an inconclusive outcome that would prolong the fighting. With them, Wellington could end Napoleon’s dreams of empire. As it turned out, Blücher arrived toward the end of the day and tipped the scales against the French. Europe could look forward to peace and stability.
The future of Europe again hangs in the balance, not because of the forces of empire but because of the threat of financial chaos, and all are looking for a latter-day Blücher. The European Central Bank (ECB) could and should play this role. It is the only party with the necessary financial resources to reliquefy markets and calm them. But the bank’s leadership shows remarkably little commitment, certainly less than the Prussians and the British did that Sunday in June 1815.
But after this sudden burst of effort, Europe’s central bankers stepped away again. ECB President Mario Draghi announced earlier this spring that the bank had “done enough.” Market concerns intensified almost immediately. Without that reliable source of liquidity, investors and traders worried about Spanish bank capital and the political backlash against austerity that was so apparent in Europe’s recent elections. Spanish bond yields retraced their earlier fall, rising to exceed 7%, and Italian bond yields reapproached the highs of last summer. Although markets are reacting to more than the ECB’s renewed aloofness, an active bank with the willingness to provide needed liquidity would have helped quiet markets. That fact was evident last month, when Draghi’s comment that the ECB stood ready to support the relief offered by the eurozone’s governments brought on a temporary rally. Moments after he made his remark on June 15, Spanish and Italian bond yields fell more than 15 basis points.
Given Europe’s needs and the ECB’s critical importance, it is a wonder the bank has not been more active. Sometimes ECB officials reference legalisms to explain the bank’s reserve, but from a policy standpoint, there is nothing that should hold it back. Even its mandated focus on inflation offers no impediment to an easier stance. Consumer prices in May registered only a 2.4% rise over the previous 12 months, down from the 2.6% increase recorded in April, which itself was hardly a threat to the ECB’s 2% target. Since money growth in the zone is miniscule and liquidity continues to shrink, policy makers have no reason to worry that liquidity injections would lead to future inflation. The zone's narrow M1 definition of money has risen less than 2% during the past 12 months and expanded hardly at all over the last six months. On this basis, there is a greater threat of disinflation or even deflation than that of inflation. Yet the ECB remains aloof.