by Neil Irwin
In other words, if investors are selling off Spanish or Italian bonds not because they fear they won’t be repaid, but because they fear the eurozone will collapse, it is the ECB’s job to intervene.
“So we have to cope with this financial fragmentation addressing these issues,” Draghi said. “I think I will stop here; I think my assessment was candid and frank enough.”
• • •
When Merkel appointed Jens Weidmann president of the Bundesbank a year earlier, he had seemed to have a more flexible approach to central banking than his predecessor, Axel Weber. He’d spent his career in public policy navigating between the doctrinaire, hard-money sensibility of the German central bank and the more adaptable approach of the nation’s government. Within Merkel’s government and beyond, he was expected to be a different kind of Bundesbank leader, one who would simultaneously honor its traditions and find ways to do whatever was required to rescue the eurozone.
But once ensconced in the brutalist concrete headquarters of the Bundesbank fifteen minutes north of the Eurotower in Frankfurt, Weidmann quickly made clear that he was just as committed to principle and purity as his forerunners. And he was livid over Draghi’s apparent promise to print up a potentially unlimited amount of euros. “This is a political problem that in my view needs a political solution,” Weidmann told Draghi that July day in a phone call, according to one report.
At a dinner on August 1, the evening before a Governing Council meeting, over baked goat cheese, roast beef, and caramel mousse, Draghi laid out his ideas. It would, of course, violate the founding treaty of the ECB for the central bank to monetize debt, he said. The ECB must not print money to fund governments. But when interest rates rise in a country like Spain or Italy because investors are betting against the continued existence of the euro, would it not be appropriate for the bank to intervene to get interest rates in that country in line with its target rate? Would that not be consistent with the ECB’s mandate—all the more so if the central bank eschewed longer-term bonds, those whose prices most reflect markets’ views of a nation’s fiscal prospects? For good measure, the ECB could insist that before buying any bonds, the nation involved formally request the assistance and submit to conditions from the IMF.
Draghi found his colleagues in a more receptive mood than he might have expected, given the multiple dissents to previous ECB interventions. Only Weidmann was dead set against the notion. Even as he voiced his reservations, opinion was shifting against him, with central bankers from the Netherlands, Finland, and Austria all supportive of Draghi’s argument that it was within the ECB’s mandate to deploy euros to combat speculation that the eurozone will fall apart. Draghi had asked German finance minister Wolfgang Schäuble to back the ECB’s proposed bond buying publicly, which he did. Angela Merkel’s government was essentially giving Draghi cover in Germany. Through some skillful diplomacy, Draghi succeeded in isolating Weidmann and the Bundesbank.
The morning after the dinner, the ECB had its usual interest-rate-setting meeting, and after a quick lunch, Draghi again stood before the press. Although the night before had made it clear that there was widening support for a new bond-buying program, the bank needed another month to prepare the details. Markets were initially disappointed that there was no grand announcement, falling worldwide. And then traders took another look at Draghi’s statement to the press. The ECB “may undertake the open market operations of a size adequate to reach its objectives,” he’d said. The details would be decided “over the coming weeks.”
As Draghi and his allies worked on their plan, Weidmann was on the outside looking in. The German made the voyage to Jackson Hole, traveling eighteen hours each way from Frankfurt at the very time the ECB’s inner circle was sorting out what to do. He gave an interview to Der Spiegel, published on August 29: The framework for European unity, Weidmann said, “has been stretched and, in some cases, disregarded,” and bond buying by the central banks was “too close to state financing via the money press for me.” The cover of Germany’s most influential magazine featured Weidmann staring out, his fists clenched together, under the headline “Aufstand der Bundesbank”—“Rebellion of the Bundesbank.”
It didn’t matter. Draghi’s campaign had succeeded. The next Governing Council meeting, on September 6, was almost anticlimactic. Draghi and Asmussen presented the plan they’d spent the previous weeks cooking up. Weidmann again stated his objections. Then a vote was held. It was twenty-two to one.
Draghi took the stage in Frankfurt that Thursday afternoon amid a bit more press corps murmuring than usual, and with the central banker’s standard practice of understatement he announced that “the Governing Council today decided on the modalities for undertaking ‘Outright Monetary Transactions’ in secondary markets for sovereign bonds in the euro area.” It was yet another new abbreviation, OMT, replacing the SMP of the earlier Securities Markets Programme.
The program would focus on medium-term securities of nations in trouble—three- to five-year bonds, not longer-term securities. The theory was that this would ensure that markets continued to exert pressure on profligate countries by demanding high interest rates for longer-term debt. Governments receiving the help would also be subject to strict fiscal conditions. Asked if the decision to enact the program was unanimous, Draghi impishly told reporters, “There was one dissenting view. . . . It is up to you to guess.”
Less than two weeks later, Weidmann spoke at an institute devoted to financial history in Frankfurt. He started at the beginning, telling the story of money from its ancient origin as shells or salt or furs used as a means of exchange to its present-day status as a “social convention” no longer backed by tangible assets and issued on paper by central banks. Speaking in the hometown of Goethe, Weidmann examined Faust as an allegory of economics. “Mephistopheles stirs up the general elation even further,” he said, “by saying, ‘Such paper’s convenient, for rather than a lot / Of gold and silver, you know what you’ve got. / You’ve no need of bartering and exchanging, / Just drown your needs in wine and love-making.’ Those concerned are so overjoyed by this apparent blessing that they do not even suspect that things could get out of hand.”
Weidmann didn’t mention the ECB’s new program explicitly, but given the timing and location of the speech and his open opposition to bond purchases, there was no escaping the obvious metaphor: Mario Draghi was Mephistopheles, and Europe had just made a deal with the devil.
But Weidmann’s opposition was confined to words. He and his colleagues at the Bundesbank were unwilling to take the ultimate step of refusing to follow the ECB’s orders to carry out the program, an action that would put him at odds with the German government and likely create a constitutional crisis. At his press conference announcing the new plan, Draghi was asked about the pressure placed on him by Weidmann. “I think that, in my job as president, I have been blessed by almost having unanimity on the very important and fundamental decisions that we have taken in the last few months. There is nothing I would wish more than to have total unanimity, of course. So I am looking forward to having that,” Draghi said.
“I am what I am, really,” the Italian said. “I think one thing that is required for this job . . . is that you have to think with your head, and external pressures do not really have a role to play in your decision making.”
Three hours before Woodford presented his paper in Jackson Hole, Bernanke spoke. As always, his speech was more carefully considered than most that he gave, calibrated with the knowledge that the world was looking to the Explorers Room for guidance.
Quantitative easing and the other tools the Fed had been using since the end of 2008 to support growth had helped, Bernanke argued, and the downsides some had warned of hadn’t materialized. But the U.S. economy was growing too slowly, unemployment was too high, and inflation seemed barely a threat. “We must not lose sight of the daunting economic challenges that confront our nation,” the chairman sa
id. “The stagnation of the labor market in particular is a grave concern not only because of the enormous suffering and waste of human talent it entails, but also because persistently high levels of unemployment will wreak structural damage on our economy that could last for many years.”
Against that backdrop, Bernanke continued, “Taking due account of the uncertainties and limits of its policy tools, the Federal Reserve will provide additional policy accommodation as needed to promote a stronger economic recovery and sustained improvement in labor market conditions in a context of price stability.”
And that was it.
The speech was notable for what it didn’t say. Bernanke set the table for new easing, but he didn’t reveal exactly what dish would be served. Would the Fed start yet another round of bond buying, a QE3? Would it expand Operation Twist to longer-term bonds, or pledge to keep interest rates even lower for even longer than previously promised?
Bernanke’s lack of specificity was no accident.
Privately, the chairman had decided weeks earlier that the Fed needed to do more than continue its series of temporary, one-off measures. In the days after Jackson Hole, Bernanke began trying to steer his fellow members of the Federal Open Market Committee toward the same conclusion. He placed phone calls, sent e-mails, and, in the case of his colleagues on the Fed Board of Governors in Washington, arranged in-person meetings.
The FOMC had a number of members already committed to decisive action, among them Bernanke’s inner circle of Janet Yellen and Bill Dudley and emerging thought leaders such as Charles Evans of the Chicago Fed and John Williams of San Francisco. Then there was the committee’s more hawkish wing, the people who couldn’t be swayed to vote for more monetary easing no matter what, including Jeffrey Lacker of the Richmond Fed and Charles Plosser of Philadelphia. Bernanke concentrated instead on the swing voters. They weren’t the flashier members of the committee, whose public utterances attracted the most attention. But if he could bring all or most of them on board with a new policy, he knew that it would have staying power.
Bernanke spoke with Dennis Lockhart of the Atlanta Fed and James Bullard of the St. Louis Fed and e-mailed with Narayana Kocherlakota of Minneapolis. He met with Jeremy Stein and Jay Powell, two new Fed governors who were still feeling their way around the organization and wary of some of the risks attached to unconventional easing. He worked with Governor Elizabeth Duke, a banking expert with an independent streak who was a reluctant proponent of new easing, to adjust the language of his proposal with an eye toward reaching a compromise with any holdouts. In these conversations, Bernanke was partly seeing what his colleagues might be willing to do, partly trying to persuade them that the FOMC need not simply look at its options in isolation but make a Woodford-style commitment to boosting the U.S. economy until it returned to health.
On September 12, less than two weeks after the Jackson Hole speech, the committee gathered around its mahogany table in the Eccles Building where the results of Bernanke’s handiwork were evident. The group agreed that it would be a good idea to do something like what Woodford had advocated, pledging to keep easy-money policies in place until a specific unemployment or inflation rate had been reached.
But there was disagreement on, among other things, what those numbers would be. So the committee settled on buying more bonds—$40 billion of them a month, initially. Combined with the Twist policy already in place, that meant the Fed would be pumping an extra $85 billion into the financial system every thirty days. And, the FOMC pledged, “If the outlook for the labor market does not improve substantially, the Committee will continue its purchases of agency mortgage-backed securities, undertake additional asset purchases, and employ its other policy tools as appropriate until such improvement is achieved in a context of price stability.” It added that it expected that “a highly accommodative stance of monetary policy will remain appropriate for a considerable time after the economic recovery strengthens.”
Translation: We’ll keep pushing money into the system until the job market really starts to improve or inflation starts to become a problem. And we will act on whatever scale we need to until we achieve that goal. We’re not going to take our foot off the gas, that is, until some time after the car has reached cruising speed.
Markets had been eagerly speculating about the possibility of QE3. Instead, they got something bigger: QE infinity.
Bernanke didn’t stop there, however. For more than a year, he and the committee wrestled with the notion, first advocated by Charles Evans, of pledging to keep pushing money into the economy until either unemployment fell to some specific level or inflation rose above some specific level. Bernanke and many others on the FOMC saw the theoretical appeal of Evans’s approach. It would clearly tie the future of the Fed’s interest-rate policies to what happens in the economy. Perhaps the mere act of offering clarity of what levels of unemployment would coax the Fed to start raising rates—and how much inflation it could tolerate in the course of getting there—would make businesses and consumers more confident about the future. It was a practical way to apply the Woodford critique of Fed policy. There were quite a few things standing in the way. Fed leaders didn’t want to send a signal that they were making policy based only on two numbers and didn’t want people to confuse their “thresholds,” as the strategy was known internally, for their longer-term targets for inflation and joblessness.
On December 12, 2012, following another FOMC meeting, Bernanke held his usual press conference. “The conditions now prevailing in the job market represent an enormous waste of human and economic potential,” he said that Wednesday afternoon. The FOMC said it would keep ultra-low-interest-rate policies in place as long as the unemployment rate remained above 6.5 percent, so long as its forecast for inflation does not surpass 2.5 percent. Bernanke had pulled another rabbit from his hat, guiding his committee toward yet another novel tool to try to help bring the U.S. economy out of its doldrums. He had come full circle. The professor who preached to the Japanese more than a decade earlier about the need for experimentalism and resolve in the face of economic catastrophe was now making it happen, for better or worse. His was a lifelong war against economic policy defeatism. And in 2012, he was winning it.
• • •
Mervyn King was feeling Shakespearean when he took the stage at the South Wales Chamber of Commerce in October 2012. He discussed the state of the “sceptered isle,” a reference to Richard II, acknowledging that given the global forces walloping the British economy, “this precious stone set in the silver sea seems more like a storm-tossed vessel.”
But while the ECB and the Fed had undertaken bold new policies late in the summer of 2012 to try to combat those waves, the Bank of England had once more chosen inaction. The British economy was by many measures in worse shape than the United States, in part because of the tightening of fiscal purse strings that had started in 2010. King estimated that economic activity in Britain was 15 percent lower than it would have been had its pre-2007 trajectory held. The U.S. economy, by contrast, was functioning at about 6 percent below its potential.
Two weeks earlier, King had in another speech cited an exchange between John Maynard Keynes and Josiah Stamp, a great British industrialist. “Is not the mere existence of general unemployment for any length of time an absurdity, a confession of failure, and a hopeless and inexcusable breakdown of the economic machine?” asked Keynes in 1930, soon after the onset of the Great Depression. “Your language is rather violent,” replied Lord Stamp. “You would not expect to put an earthquake tidy in a few minutes, would you? I object to the view that it is a confession of failure if you cannot put a complicated machine right all at once.”
As King surveyed the British economy that autumn day in Cardiff, he saw a broken machine—but also one that was in the process of slowly repairing itself. “After a period of lopsided expansion, with growing trade deficits and debt levels, and a collapse of their banking syst
ems, advanced economies across the world are facing a huge adjustment. Such is the scale of the global adjustment required that the generation we hope to inspire may live under its shadow for a long time to come,” King said. He didn’t rule out a return to quantitative easing, should conditions warrant it. But his tone was a far cry from that of Draghi or Bernanke, who offered open-ended pledges to return their economies to stability.
“Printing money is not . . . simply manna from heaven,” King said. “There are no shortcuts to the necessary adjustment in our economy. . . . We shall have to be patient.”
Every reign must end, and for the King of Threadneedle, that day was approaching. His term was to end in June 2013, and on November 26, 2012, chancellor George Osborne stood up in parliament to announce King’s successor. Betting was so strong that Paul Tucker, King’s respected deputy governor for financial stability, would get the job that bookmakers had stopped taking wagers. Osborne instead shocked the world, however: The 120th governor of the Bank of England wouldn’t be British at all. Canadian Mark Carney, who headed the Bank of Canada, was the government’s pick to follow King. Over twenty years, King had been a dominating force at the bank, and in the British economy. The selection of Carney was the clearest sign yet from the government that it was time for a rethinking.
• • •
The fifth year of the crisis, then, looked a lot like the first.
The Bank of England again stood by as others went into action as Mervyn King was convinced that the economy was finding its own way forward, difficult as that might be.
