Merkel’s Placet

Building a Smarter German-American Partnership

Remember the saying it takes two to tango? In the case of the European Central Bank, that phrase could prove rather fitting for its President Mario Draghi, who will need the tacit support of German Chancellor Angela Merkel if he wants to introduce new unconventional policies, especially during an election year.

What Draghi got on Thursday, April 25th was more than just tacit support. He received an explicit green light for a new ambitious program that the ECB is on the verge of launching, perhaps as early as next week but no later than June.

Merkel gave her consent while speaking in front of an audience of representatives from the German savings banks association. For the many observers that are exclusively focused on interest rate cuts as the primary tool capable of injecting life into a faltering European economy, what they heard was alarming. Merkel dismissed the idea that the ECB should lower interest rates. If anything, she believed that rates should even go up for Germany. It sounded like a warning shot across the ECB’s bow.

Nothing could be further from the truth. Pouring cold water on the idea of lowering interest rates was not Merkel’s main argument. More importantly, she stressed that what is currently needed is a way to get cheap credit to those SME’s in the periphery of Europe that are having a hard time accessing funds.

For weeks, Draghi and fellow members of the ECB’s executive board have argued along the exact same lines. They have repeatedly stressed that as long as low interest rates are not successfully transmitted to all of the euro zone’s banks (and this is presently the case), it does not make much sense to be tinkering with them. What is needed, they have argued, is a set of new instruments designed to get credit flowing again.

Based on public and private remarks made by representatives of the European Commission, the European Investment Bank and the ECB in Washington during the recent spring meetings of the International Monetary Fund (IMF) and World Bank, I have concluded that this time the ECB is working on a plan that would involve all three European institutions. Needless to say, no details were offered. And of course, it is difficult, if not impossible, to imagine how the ECB could lend directly to SME’s. Hence, this time it is the EIB, under its head Werner Hoyer, that could play a central role.

The main aim of the new program would be to encourage the securitization of loans made to small and medium sized companies. The central part of the concerted action undertaken by the ECB, the EIB and the EU Commission should be to provide a guarantee for those securities and reduce the risk to banks.

Whatever shape the program might take, the ECB will continue to remind politicians that they are not off the hook and that most of the homework still rests with them. They need to address the underlying structural reform backlog that is hampering a recovery. However, once again Mario Draghi seems prepared to act in a moment of need. We now know that Merkel will give her placet to the new experiment.

As long as interest rates are left untouched for a little longer, I would even expect the President of the Bundesbank, Jens Weidmann, to tolerate the new ECB program. In the end he might even join the tango. We are about to find out.