The European Central Bank’s Bond Buying Program: Is Berlin the Greatest Beneficiary?

Editor’s note: This piece is translated and adapted from Domenico Lombardi’s bimonthly column Pennsylvania Avenue in the Italian daily Il Foglio.

The euro crisis has just entered a new stage. The European Central Bank’s establishment of the Outright Monetary Transactions program, the new bond buying program, has been greeted by Italy and Spain as manna sent from heaven. However, the real political beneficiary of the program is the government of German Chancellor Angela Merkel, just as she prepares to enter the battleground for reelection.

It became clear over the past few weeks that Spain was about to request another program of assistance, in addition to the one needed for recapitalizing its banks— a request that would have put the German chancellor in a politically fragile situation. Since the European rescue fund, officially known as the European Financial Stability Facility, only has €150 billion, net of existing commitments, a new program with Spain would have forced Merkel to ask the Bundestag for an increase in the financial capacity of the fund itself. Should Spain’s difficulties have spilled over into Italy, the Italians would have most likely also needed to request a program of assistance. Even assuming that the Bundestag had, in the end, given the green light, the political cost for the German chancellor would have been huge. It was still uncertain only a few days ago whether the European Stability Mechanism, the permanent rescue mechanism for Europe, would be ratified by Germany with a pending decision by the constitutional court on the matter.

With the ECB’s new bond buying program, Merkel is now able to translate onto the ECB the financial burden of any assistance to Italy and Spain. This puts her relationship with the Bundestag and the German electorate on a better footing. In fact, under the assumption that the mere introduction of the OMT program continues to keep interest rates in Italy and Spain in check without these countries even requesting to use it, the German chancellor might even succeed in completely avoiding the domestic debate about what such a request would entail. This would further strength her position on the domestic front. Internationally, by accepting the ECB’s engagement in potentially unlimited transactions, she meets a key request made of her insistently by the U.S. administration, which has since the beginning emphasized the need for the ECB’s proactive involvement in the European crisis.

Lastly, by making the ECB’s intervention conditional on a formal request for assistance to the EFSF/ESM by the country in difficulty, Berlin has achieved a two-fold objective: first, it maximizes its control by subjecting the range of unconventional monetary policy interventions to formal political scrutiny; second, it minimizes the costs and the risks of its financial exposure to future programs of assistance to the systemic debtors in the eurozone, rendering the financial role of the EFSF/ESM entirely ancillary to the unlimited fire power of the central bank.

As for relations with Greece, the ECB’s new program protects Germany from pressures by the Greek government, which deprives Athens of its most important playing card: the potential ability to destabilize Spain and Italy in the event of an uncontrolled Greek default. With a hint of satisfaction, already some German sources note that the OMT program represents the most powerful line of defense for Spain and Italy in the event of an implosion of the Greek crisis. Not by chance, Greek Prime Minister Antonis Samaras returned empty-handed to Athens after his recent visit to Berlin, and it is likely that his subsequent visits will not produce any better results over the course of the next 12 months, roughly the amount of time left before the German elections.

In the upcoming days, Samaras will try to get the green light from his parliament for a program of spending cuts and revenue increases of €11.5 billion, equal to 6 percent of Greece’s GDP. However, despite expectations in Athens, this provision will not pave the way for a second restructuring of the Greek debt, which is currently mostly held by the ECB, EFSF and IMF. Yet again, Samaras will be forced to bide his time and wait for the reconfirmation of Angela Merkel in her third mandate as chancellor next fall. The White House also finds itself in a similar position although the time horizon is much shorter; it has been reported that U.S. officials have already recommended freezing any action or decision on the Greek crisis until after the U.S. presidential elections in November.

In the meantime, the ECB will help.