Skip to main content

The concept of euro zone unity promises to be tested Thursday when the European Central Bank unveils a stimulus program that will almost certainly be tailored to meet Germany's demands.

The quantitative easing (QE) program, coming years after the United States, Britain and Japan launched their own versions, is expected to see the ECB buy between €500-billion ($693-billion) and €1-trillion of sovereign and corporate bonds in effort to kick-start stalled inflation and help restore economic growth.

The details of the asset-buying program – size, what exactly will be bought, when and under what conditions – are unknown at this point.

What is known is that ECB chief Mario Draghi is under enormous pressure from Germany's central bank, the Bundesbank, to make concessions. Germany is no fan of using the mass purchase of bonds to try to pump up the economy.

Reportedly, one of those concessions would see the ECB transfer the risk of any purchased sovereign bonds to the national central banks across the 19-country euro zone. If there were to be a default, the cost would be absorbed by those central banks (or the national treasuries), not the wider euro system. German taxpayers, in other words, would not be directly exposed to losses on any purchased Greek sovereign bonds if Greece were to default.

While QE has not even been formally announced, its expectation continued to rock the European markets. Last week, in advance of QE, the Swiss National Bank abandoned the franc-euro peg, triggering a lightning quick, 20-per-cent rise in the franc that day. On Monday, it was Denmark's turn to try to prevent its currency, the krone, from rising as QE speculation pushed down the value of the euro. It did so by cutting its deposit rate to minus 0.2 per cent while vowing to keep the krone-euro currency peg intact.

Denmark's Saxo Bank admitted it will likely suffer losses from the currency turmoil and Alpari (UK) Ltd., a foreign-exchange broker, has filed for administration.

The likelihood of forcing the central banks to take on the bond risks has triggered strong reactions from euro watchers, who argue it would end the one-for-all-and-all-for-one philosophy that typically drives euro zone monetary policy. Quoted in the Financial Times, Marcel Fratzscher, a former ECB official who is now president of the Berlin economic research institute DIW, said "it would signal the end of monetary union. It would mean less risk sharing and less common effort."

Writing for Bruegel, the European think tank, Bruegel director Guntram Wolff said that foisting any bond losses onto the national banks would undermine the ECB's credibility as an institution.

"Buying sovereign bonds but leaving national central banks to take on the risk of default would be a strong signal that the ECB is no longer a 'joint and several' institution," he said. "It would effectively be a declaration that the ECB cannot act and purchase government bonds as a euro-area institution in the interest of, and on behalf of, the entire euro area."

The views may be extreme. If the euro zone were ever to fall apart, it might do so for political reasons, not because of a flawed QE program (note that all three of Italy's main opposition parties want to yank Italy out of the euro zone). Still, a departure from the concept of shared risks would not help the monetary union, which is the glue that holds the region together.

Mr. Draghi is likely to insist on the national banks' role in the QE program not because he wants to, but because he is trying to buy peace with the Bundesbank and the German representatives on the ECB's governing council. The Germans are not convinced that QE is the answer to the euro zone's slow growth, high unemployment and low inflation problems – the region slipped into outright deflation in December, year-on-year. They think QE in a euro zone that is already soaked in liquidity could be inflationary. They also think that the falling price of oil, while disinflationary, will spur growth because it acts effectively as a tax reduction.

They are equally convinced that QE would act as an economic reform disincentive. Their view: If the ECB does all the heavy lifting, why would the national governments insist on tough, and always politically unpopular, reform and austerity measures?

Economic laggards such as Greece, Italy, Spain and Portugal don't need more free money, Germany would argue; they need to buckle down and overhaul their fundamentally uncompetitive economies. QE would be made worse if the bond-purchase risk were spread among taxpayers of the member countries.

To get QE launched, it appears that Mr. Draghi will have to bend to Germany's demands or find a compromise solution. One option might see the both ECB and the national banks buy bonds, with the risk to the ECB limited by the "capital key" – each national bank's subscribed capital at the ECB (the Bundesbank's, for instance, is 18 per cent).