Paul Taylor, a contributing editor at POLITICO, writes the “Europe At Large” column.
PARIS — Christine Lagarde was supposed to be The Great Communicator. But the European Central Bank president sent markets into a tailspin Thursday when she set out her emergency stimulus measures to protect the financial system from the crippling shock of coronavirus.
The problem was not the measures themselves — flooding the banks with cheap money and increasing bond purchases — although investors had expected a more radical response. The U.S. Fed and the Bank of England had, after all, already slashed interest rates.
It was what she said and failed to say that triggered the panic sell-off, forcing her to walk back those comments in a subsequent television interview. Lagarde’s chief economist, Philip Lane, had to dig her out of a hole on Friday in a blog post by promising further action as required.
Facing her first big test after replacing Mario Draghi in November, Lagarde sent the wrong message about the ECB’s determination to preserve the eurozone through this crisis, even if she was right to press EU governments for ambitious fiscal action
Since the coronavirus crisis began to spread from China, Lagarde has shown mounting frustration at what she sees as the complacency and inability of EU governments to formulate a joint economic response.
With several eurozone countries already in lockdown or on the brink, and swathes of economic activity frozen for weeks and possibly months to come, markets and governments were looking to Lagarde for a reaffirmation of Draghi’s market-soothing 2012 statement that the ECB would do “whatever it takes” to preserve the currency area.
Lagarde pointedly refused to send that signal, saying she did not seek to be “whatever it takes, number two.”
“We are not here to close spreads,” she said, referring to the difference in borrowing costs between, say, coronavirus-struck, debt-ridden Italy and Germany, which was in healthier economic shape even before Rome took extreme measures like shutting down shops and restricting movement.
“There are other tools for that and other actors to deal with those issues,” Lagarde added, passing the buck implicitly to governments. Her comment immediately raised the Italian government’s borrowing costs.
Hidebound view
As Thursday’s biggest sell-off of Italian assets in history showed, central bankers can fuel crises with words as well as calm them.
If Lagarde’s remarks were a carefully reflected policy statement on the limits of central bank responsibility, they constitute an alarming step back from her Italian predecessor’s willingness to stretch the ECB’s mandate to the limit to keep the currency area together.
Draghi was widely credited for turning the tide of the eurozone crisis by effectively declaring the ECB would be a lender of last resort, ready to buy unlimited numbers of bonds from any eurozone government that implemented an agreed adjustment program. He never needed to make good on the commitment. His word was enough to calm the markets.
Lagarde has since tried to correct her mistake by making clear that the central bank does indeed have a responsibility to combat fragmentation in the currency zone, saying that “high spreads due to coronavirus hamper the transmission of monetary policy.”
But her comments suggest she takes a much more limited, legally hidebound view of the ECB’s treaty mandate to uphold price stability.
If true, this is music to the ears of conservative German guardians of central banking orthodoxy, who accused Draghi of exceeding his powers and lurching toward the illicit monetary financing of governments. But she drew rare public criticism from both the Italian and French presidents.
Tactical pressure
It is also possible, however, that the Frenchwoman, who by her own acknowledgement is a lawyer, not an economist by training, was making a tactical statement to pile political pressure on divided European governments to act more boldly, rather than drawing a definitive line under the limits of central banking.
Lagarde made clear in her European Parliament confirmation hearing in September that monetary policy could no longer be “the only game in town” to support the eurozone economy. Draghi issued similar warnings in his last months in office, venting his impatience at the reluctance of Germany and the Netherlands — the eurozone countries with the biggest current account surpluses — to invest far more in public infrastructure to stimulate the economy.
Since the coronavirus crisis began to spread from China, Lagarde has shown mounting frustration at what she sees as the complacency and inability of EU governments to formulate a joint economic response. Diplomats said she was blunt in conveying that view to the 27 EU leaders during their emergency summit by videoconference on Tuesday.
President of the European Central Bank Christine Lagarde | John Thys/AFP via Getty Images
Before she was hit by an unexpected crisis that economists would call an “exogenous shock” (a bolt from the blue that impacts the economy massively), Lagarde had made a promising start in the hot seat. She had used her charm and management skills to heal bitter divisions in the ECB’s governing council, making national central bankers feel their voices were being listened to and practicing a more collegial style of leadership.
Her corona blunder exposed one of her vulnerabilities — a weaker understanding of market psychology than Draghi’s. The Italian was a master at managing down market expectations, then exceeding them to amplify the impact.
The ECB could and should have done more before Thursday to lower the wilder market and media expectations of a cut in the bank’s record low interest rate, which would anyway have taken 18 months to produce a stimulus.
But above all, Lagarde must learn the lesson that public and market faith in the central bank’s willingness to do “whatever it takes” is crucial. By casting doubt on that determination, she is sawing the branch on which she, and the eurozone, are seated.