Mario Draghi: The policy and the role of the European Central Bank
during the crisis in the euro area
Speech by Mr Mario Draghi, President of the European Central Bank, at the Katholische
Akademie in Bayern, Munich, 27 February 2013.
* * *
Excellencies,
Ladies and Gentlemen,
I am delighted to be here in Munich at the Catholic Academy and thank you for this kind
invitation. As befits this setting, I would like to begin my remarks by noting the momentous
nature of the current period for the Catholic Church, on the eve of the last day of the
pontificate of Benedict XVI.
Pope Benedict, a great son of Bavaria, used his eight years at the helm of the Church to
address a variety of pressing concerns of the modern world. Among them was an emphasis
on ethical concerns in the economic relationships of our globalised world.
Those concerns have become more relevant than ever during the economic and financial
crisis that now extends into its fifth year.
The crisis has dented people's confidence in the capacity of markets to generate prosperity
for all. It has strained Europe's social model. Alongside the accumulation of staggering
wealth by some, there is widespread economic hardship. Entire countries have been
suffering from the consequences of misguided past actions - but also from market forces
that are sometimes beyond their control.
In a sense, the "social question" of the 19th century, which inspired the Catholic Social
Doctrine, has re-emerged - but today it transcends national borders: what is the right
framework for reconciling free enterprise and individual profit motives with concerns for the
common good and solidarity with the weak?
In recent decades, this question seemed to be approached from a purely economic
perspective. The invisible hand of the market, if only left unconstrained, would eventually
generate better outcomes for all. The rational actions of "homo oeconomicus" were seen as
divorced from ethical concerns about compassion, charity and decency. It seemed forgotten
that Adam Smith, the philosophical father of market economics, saw his "Wealth of Nations"
as inextricably linked to his "Theory of Moral Sentiments".
Thankfully not everywhere. At the Jesuit school in Italy where I was educated, we had a
fundamental guiding principle: our striving for excellence had to be paired with integrity and a
moral message - an ultimate sense of purpose in the service of social justice and fairness.
I have previously noted that "without ethics, there cannot be a genuine development". We
cannot have an economic model that allows excesses to go uncorrected, which relies
exclusively on self-regulation of markets and in which individuals believe that "anything
goes".1 Ultimately, we must be guided by a higher moral standard and a profound belief in
creating an economic order that serves every person.
Here I find myself in the company of Marx. Not Karl, but Reinhard. Cardinal Reinhard Marx
has rightly insisted that "the economy is not an end in itself, but is in the service of all
mankind."
And caring for the welfare of our neighbours is not only an ethical principle of the Christian
faith: it also makes eminent economic sense. No-one knows this better than the successful
entrepreneurs of Bavaria. Interdependence is not just a catchword. The economic health of
the countries around you affects us here and now.
So these are the challenges facing European policy-makers today: how do we recreate
confidence in the capacity of our economies to grow and generate prosperity so that they can
ultimately serve the people? How do we shape our economic model so that it reconciles
individual freedom and social justice? And how, as the European Union, do we strike the
right balance between the responsibilities of individual countries and those of the Union as a
whole?
How the ECB plays its part
Let me begin by focusing on the role of the European Central Bank (ECB).
We have been given a special responsibility by the people of the euro area to ensure price
stability. Price stability is the foundation of a functioning economy. It is also the basis for a
just and fair society. It is a common good for all Europeans.
As Walter Eucken, the philosophical father of ordoliberalism, noted, "all efforts to establish a
liberal order are futile unless a certain monetary stability is guaranteed. Monetary policy
therefore has a primary importance for the liberal order."2
Price stability ensures that the market mechanism works properly, which is the best way we
know to create growth, jobs and prosperity for all. It preserves the purchasing power of our
money and the value of our savings.
And it has profound social implications. Stable prices support the weakest members of our
societies - including pensioners and the unemployed - who depend on fixed incomes to live.
In that sense, a stability-oriented monetary policy is a key component of the Social Market
Economy.
I do not say this based on theory: the history of this country has taught us that inflation
undermines not only economic wealth but also political stability. The deep-seated fear of
inflation is therefore more than understandable. Your own national experience is at once a
powerful reminder and steadfast obligation for the central bank.
The challenges of the crisis
But preserving price stability today requires different actions than it did in the past. We have
required new tools to ensure that our monetary policy decisions are able to reach firms and
households.
This is because the crisis has severely fragmented the euro area's financial system. It has
disrupted the way our interest rate changes are passed on by banks to the wider economy.
As a result, our low interest rates have simply not been getting through to people in some
parts of the euro area.
This may sound like a technical matter. But the transmission of interest rates is fundamental.
The euro area is a bank-based economy. Around three quarters of firms' financing comes
from banks. So if banks in some countries will not lend at reasonable interest rates, the
consequences are dire.
Perfectly healthy companies would be forced to close. Credit for new investment would not
be available. Not because business models are flawed or because investment projects are
too risky, but because firms happen to be located in the wrong place.
Worse still, in the first half of last year fragmentation in the euro area had become so serious
that some investors were questioning the future of our currency. Fears of a potential
break-up were sending capital fleeing from the periphery to the core. For some in the
financial markets, the most fundamental notion of confidence in a currency - that a euro is a
euro regardless of where you are - was no longer a given.
But a currency whose integrity is in doubt cannot be a stable currency.
So we had to decide: do we passively let events take their course and accept severe risks for
price stability? Or do we assume the responsibility, within our mandate, to defend the stability
of our currency and our monetary union?
Those were difficult and existential decisions. They required deep reflection, a proper
assessment of risks in the short and long term, and a clear-headed judgement of possible
alternatives. They also required the courage to face the inevitable criticism and engage with
those who disagreed.
But we chose to act - because we judged this to be right and necessary to safeguard price
stability.
Defending the transmission of monetary policy
First, we acted to remove blockages that were stopping banks from passing on our low
interest rates to borrowers.
We allowed banks to take as much liquidity as they needed from our operations. We allowed
a wider set of collateral that banks could use to access this liquidity. And we extended the
maturity of our operations, going up to 3 years.
Second, we acted to remove the unfounded fears about the future of the euro area that were
undermining the stability of our currency.
We launched a new measure called Outright Monetary Transactions (OMTs) to provide a
fully effective backstop in the sovereign bond market.
We focused on this market because it has a "knock-on" effect on other markets. Fears in the
sovereign bond market were seeping into the banking system. They were paralysing the
economy, and ultimately threatening price stability. By putting in place a credible backstop,
we were able to remove those fears at the source.
Those fears were unjustified by economic fundamentals. They were the result of market
failure: a situation where investors seem to act rationally, but collectively they create
destructive outcomes. Countries that were fundamentally adjusting were being driven to the
wall by panic. And the result would have been unnecessary hardship and suffering.
Much has been written about this measure, especially in this country, and some fundamental
questions have been raised:
 Is the ECB still independent?
 And will the ECB stay focused on fighting inflation?
The answer to both these questions is a categorical "yes".
First, we always protect our independence.
We take all our monetary policy decisions in full independence. And we have designed the
OMTs so that these decisions could never be dominated by fiscal policies. This is why a
pre-condition for access to the OMTs is a strong economic adjustment programme. It
ensures that we would only ever intervene in situations where fiscal discipline is firmly
ensured.
Second, we keep a permanent watch on inflation.
We understand and take very seriously people's concerns about possible inflationary threats.
But it is a fallacy to make a mechanical connection between the creation of central bank
liquidity and a rise in the money supply. The liquidity we provide to banks is used in the
markets where banks lend to each other. It does not automatically increase credit or money
in the economy - and so does not automatically lead to price pressure in the economy.
Indeed, money growth is currently well below an inflationary level. Credit provision to the
private sector is overall weak, and contracting in large parts of the euro area. And inflation
expectations are firmly anchored. So risks of inflation down the road are firmly in check.
The euro area dimension to our actions
It is also important to understand that our measures are designed not only to help the people
in countries under stress. In fact, in line with our mandate, they serve the citizens of the
whole euro area.
Many of the financial developments that concern people in this country - such as meagre
returns on their savings or large imbalances in the Target-2 payment system - are really only
the mirror image of fragmentation in the rest of the euro area.
As money flows out of stressed countries and into safe-haven countries like Germany, it
pushes up interest rates in the stressed countries, and pushes down interest rates here.
These flows cause Target-2 imbalances to increase.
What has not been sufficiently acknowledged, however, is that these imbalances would only
affect German taxpayers in the event of a break-up of the euro area. This means that actions
by the ECB that protect the euro area against such outcomes - like the OMTs - also reduce
hypothetical risks for German taxpayers.
And this is exactly what we have seen. Since the announcement of the OMTs, the
Bundesbank's Target-2 exposure has decreased by more than 100 billion euros.
In sum, the ECB has acted, and will continue to act, to fulfil its mandate. We are committed
to preserving the integrity of our currency, in the interests of all people of the euro area.
We do not act to help banks. We do not act to help governments. We act to help maintain the
flow of credit to real firms and households. We act to preserve price stability.
Incidentally, while some in this country are wondering whether the ECB does "too much",
elsewhere in the euro area I am asked why the ECB does not "do more". I just returned from
the Spanish Parliament in Madrid - and the concerns expressed there are very different from
what I hear in Germany. People worry that a stagnating economy will lead to the emergence
of a "lost generation", where young people have no jobs, and even worse, no hope.
But our answer - both to those who want us to do less and to those who want us to do more
- is the same: we will preserve price stability. This is our mandate.
How governments play their part
It is important to stress that the ECB's mandate only extends so far. There are clear limits to
what monetary policy can and should aim to achieve.
We cannot repair unsound budgets. We cannot clean up struggling banks. We cannot solve
deep-rooted problems in the structure of Europe's economies.
Our monetary union was deliberately constructed so that these policies would be the
preserve of elected governments in each Member State. Sharing a common currency would
only be sustainable if each country assumed its own responsibility.
This reflects the subsidiarity principle embedded in our European Treaties. And in that sense,
it also echoes a central tenet of Catholic Social Doctrine. As Pope Pius XI wrote in 1931, "It
is a fundamental principle that one should not withdraw from individuals and commit to the
community what they can accomplish by their own enterprise and industry."3
Individuals have to do what they can to help themselves before they seek help from the
community. The same is true for the countries in the euro area.
Fortunately, this is what we are seeing across Europe today.
Governments have already done a lot to tackle the imbalances that accumulated in previous
years.
Progress in implementing economic reforms has been extraordinary. Deficits are being
reduced. Current account imbalances are being unwound. Wide-ranging structural reforms
are underway.
Particularly impressive is the scale of the adjustment that has taken place in countries
receiving financial assistance.
In many countries these efforts have largely removed the underlying drivers of the sovereign
debt crisis. But while sovereign debt markets have improved, bank lending is still very
fragmented across the euro area. Credit in some countries is still difficult to obtain. The
benefits of the painful actions undertaken so far have not yet materialised.
And this means that economic adjustment is coming at a heavy social cost. Economists often
speak about "inevitable adjustment costs", which to some sounds cold, heartless and lacking
compassion. But we are fully aware of the human dimension that lies behind it.
Euro area GDP is currently lower than it was in 2008. Almost 19 million people are
unemployed - more than the population of the Netherlands.
Unemployment is a tragedy. It squanders the vitality of our workers. It prevents people from
playing a full and meaningful part in society. It induces a sense of hopelessness, which
drains the inspiration from our young.
Reform as the path to growth and fairness
Reducing unemployment is therefore a pressing challenge.
Governments need to address the structural problems in their economies. They need to
enact fundamental reforms that boost the potential of their economies to grow.
We need reforms that make doing business easier. That guarantee that those who owe taxes
actually pay taxes. That ensure that public services actually serve the public.
And these reforms should aim not only to create more growth and jobs, but also to make
society fairer.
Fairness starts within countries.
In one country in the euro area, more than fifty percent of young people cannot currently find
jobs. Is it fair that, as a result, this generation has to bear the bulk of the burden in the
downturn?
In another country, an estimated 55 billion euros of tax revenue remains unpaid. Is it fair that,
as a result, other people who are taxed on their salaries have to make up the difference?
This is why I say that reforms that make economies work better also make them fairer.
And fairness also matters between generations.
Many countries have to think hard about how they can support ageing populations and
generous welfare states. The unsustainable option is to keep increasing debt. But this means
nothing else than passing the burden onto future generations. There is no real equity through
debt.
The sustainable option is to generate the higher growth that is needed to maintain Europe's
social model. And this is only possible by walking the path of determined reform.
There is no doubt that this is the hard path. But it is also the courageous path. It is the path
that will create jobs; that will support our social model in the future; and that, in the end, will
contribute to a fairer society.
For this reason, it is wrong to claim that countries are undertaking reforms only to please the
markets or to satisfy the demands of technocrats in Brussels, Frankfurt or Washington. They
are doing it for their own benefit. And it is time that this message gets more emphasis.
The place for mutual support
But what if countries cannot succeed on their own?
The ethical imperative when we see others in need is to help. It is to do what we can to limit
their hardship.
Should this not also apply within the euro area? Should countries support those in difficulty?
The answer is yes. Catholic Social Doctrine makes absolutely clear that subsidiarity has to
be paired with support. But what binds these together is trust.
Trust that each will put its own house in order - even if it is politically difficult.
Trust that each will play by the rules - even if this imposes unpopular choices.
Trust that each will constrain its sovereignty - even if this means making a break with the
past.
Such trust has to be built through actions, which is a further reason why the process of
reform across the euro area is so important. It shows that countries are ready and willing to
be full members of the community. And this makes mutual support between them possible.
Certainly, countries in Europe are already doing a lot to help each other. They are providing
generous financial assistance on condition that underlying problems are fixed. But in my
view, once trust is established, we should go further still.
We should take stronger collective responsibility over national economic and financial
policies, to ensure that countries do not get into trouble in the first place. We should make
better use of common resources, to encourage reforms and restore the dynamism of our
economies.
In other words, we should aim to build a strong and deep economic and political union in
Europe, which would be to the benefit of all members of the single currency.
As I said at the beginning of my remarks, today's social question is not just a national one. It
transcends borders. And this path - building a stronger union based on mutual trust - is the
way to answer that question for Europe.
Let me conclude by returning to the theme of Cardinal Reinhard Marx - that the economy
should be in the service of humanity.
Our common currency exists not as an end, but as a means. As Nobel Prize winning
economist Amartya Sen has reminded us, our "instrumental objectives - like the single
market and monetary union - should not overshadow our social commitment to the
well-being and basic freedoms of the people."4
The euro is a means to foster peace between nations; and a means to further our collective
prosperity.
In many ways, we have already achieved this. War among the countries of Europe is
unthinkable. We have integrated our nations and our markets. The ECB has overseen the
longest period of price stability in post-war history.
But there are also important ways in which we have not succeeded. The terrible economic
hardship in some parts of the euro area is testament to this.
So what we cannot afford now is to stay where we are.
Federal President Joachim Gauck recently called upon all of us to have more courage for
more Europe: "What Europe needs now are not doubters but standard-bearers."5
We need to reinvigorate our social models by reforming our economies.
And we need to harness the market mechanism in the service of humanity.
In this way we can safeguard our primary capital, which is the human person in his or her
integrity.
Thank you for your attention.