A wake up call for Europe

The coordinated intervention by the major western central banks, aimed at improving liquidity management can be, from at least three points of view, an excellent wake up call for Europe. Firstly, while waiting for political decisions on fiscal discipline, it strengthens the doves of the ECB who favor a more resolute financial stability policy, in the absence of inflationary risks.

Then, it can make the EBA come to its sense before its absurd banking recapitalization policy becomes one of the reasons for the next liquidity crisis. Finally, it indicates that European stability policy could become even more effective if coordinated with the other central banks; for example, finally the Fed could do something good by buying European sovereign bonds. This summer, in the face of growing instability on global financial and banking markets, we urged (Il Sole 24 Ore, August 20th) the creation of a G-5 of central banks with the aim of coordinating liquidity.
Also then it was clear that the uncertainty and lack of confidence that markets were once again assuming had to be faced with an effective and global liquidity policy. Forgetting for two decades the importance of a managing liquidity with discipline was the main cause of the crisis, along with bad financial regulation.

The US central bank is the great culprit for what happened. Monetary policy completely neglected what was happening on financial markets. The price thermometer was flat: the excess of liquidity, in a situation of positive growth expectations, pumped financial markets, in terms of size, complexity and interconnection. The risk of a financial explosion was ignored; we all know what the result was.
Today the ECB has to avoid making the same mistakes, in a situation that is symmetrical to the one in 2007-2009. A disciplined monetary policy in these years obtained an enviable result: price stability and expectations of price stability. In a similar context, however, the ECB has to look at financial markets and realize that, in a context of growth expectations that are steadily negative, the worsening of the sovereign debt crisis is bringing to a liquidity crisis.

That's not all: the ECB has to watch out for friendly fire represented by the decisions of the EBA in terms of banking recapitalization. This author finds it difficult to explain to his students the logic that pushed the European supervisory authority to take measures on recapitalization and accounting of sovereign bonds that are useless in terms of stability and that without a doubt will increase the risks of a liquidity crisis for banks. Since the traditional economic analysis is of no use we need to resort to political economics, explaining that rules often follow cost-benefit analysis of politicians and bureaucrats and not the general interest.

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