Monetary Policy Is Not Impotent, Yet

As a quick follow-up to my posting of September 5, in which I argued that the important economic policy challenges​ in the world are now fiscal, not monetary, it is nonetheless interesting to note the "Mario Draghi" effect from last Thursday.

On that day, as was widely expected, the European Central Bank announced​ another sovereign bond-buying program (technically called "outright monetary transactions")  designed to lower governments' cost of financing the debt and current public expenditures in countries like Spain, Greece and Italy. The effect was immediate: Spanish long bond yields, for example, which had begun to decline early last week in anticipation, fell further on Thursday and Friday, to as low as 5.6% (compared with a record-high 7.6% in July). Similar drops were evident for other bond maturities, and in other southern European countries.

These are welcome moves, but hardly sufficient by themselves to "save the Euro", Mr. Draghi's expressed goal. Stopping, then reversing, the public debt/deficit spirals in Europe (and, of course, elsewhere)​ is the fundamental fix required. This is fiscal policy, over which only elected governments, not central banks, have direct influence. Lowering the financing cost of debt provides time - a breather - but as Paul Ryan noted on Thursday, "there is no substitute for good fiscal policy - we cannot expect central banks to go on bailing out their respective economies".

Watch for my upcoming postings on the progress (or lack thereof) of fiscal re-balancing. ​