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Regardless of ECB Bond Purchases, Conditionality for Eurozone States is a Myth

The debate about European Central Bank (ECB) purchases of distressed sovereigns’ bonds is potentially relevant to the outcome of the sovereign debt crisis in the Eurozone, as these purchases might ultimately be the Eurozone’s last defense. However, the substance of the debate is somewhat less relevant. Specifically, one key sticking point in the debate between those in favor of extending ECB purchases of the sovereign bonds of troubled Eurozone states, and those opposed, is the question of whether states can be pressed to see through difficult structural reforms when they know that ECB financing offers an alternative to the bailout funds that are conditional on such structural reforms. In other words, Jens Weidmann, head of the German Bundesbank and one of the loudest voices against ECB bond purchases, argues that indebted Eurozone members will have no incentive to reform their economies to enhance long-term sustainability as long as non-conditional financing from the ECB is on offer. A clear example in support of this argument is Italy, where then Prime Minister Silvio Berlusconi halted structural reforms in response to purchases of Italian sovereign debt by the ECB last summer. The question of whether the Eurozone would still exist had the ECB not intervened in the bond markets when Spanish and Italian bond yields were approaching unsustainable levels might be raised to counter such an example, but this is strictly hypothetical and so difficult to defend. A far more convincing rebuke to Weidmann’s line of reasoning would be to point out that, if bailouts extended thus far were actually conditional on the completion of certain structural reforms, then Greece would have stopped receiving funds, and defaulted on sovereign debts some time last year, if not earlier.

Thus, while I sympathize with the case against non-conditional financing of formerly profligate Eurozone states, especially in light of the colorful analogy of providing drugs to a former addict, I also think it misses the point, and ignores a crucial feature of the Eurozone crisis. That is, it ignores the fact that creditor states have been looking, throughout this crisis, for a way to enforce conditionality in the face of unacceptably high costs surrounding the effective imposition of conditionality, i.e. exit of one or more members, and potential dissolution of the Eurozone. This is why the ECB has been able, and even encouraged, to intervene in the bond markets in support of troubled sovereigns and why Eurozone members have received bailouts, conditional or not, both of which can be argued to violate the Maastricht Treaty governing European Economic and Monetary Union. It is not the case, then, that ECB President Mario Draghi genuinely believes the purchasing of Spanish sovereign bonds will help the cause of politically suicidal reforms that the government is trying to implement, but that the alternative of national leaders solving the crisis to prevent a catastrophic breakup of the Eurozone is no more likely now than it was last summer.

This is not to come down on one side or the other of the debate over ECB sovereign bond purchases, which would be, at best, a short-term solution to the current debt crisis, though irrelevant to the wider design flaws of the Eurozone. Rather, what I wish to highlight is how this debate over the potential threats to structural reform and to pushing the issue of structural reform through conditional bailouts, as tied up with ECB bond purchases, demonstrates the continued refusal to acknowledge that no EU country, not least Germany, wants responsibility for breaking up the Eurozone. To be sure, there are politicians from the right and left wings of the political spectrum, in creditor and debtor states alike, who profess a willingness to leave the single currency rather than compromise further, but these are not mainstream parties and, perhaps tellingly, voters have not yet given them the power to follow through on such pledges. Thus, for the time being, it is not a decision to purchase the bonds of indebted sovereigns that risks destroying the myth of conditionality, but rather the decision to forge a single currency for purely political reasons, with all of the economic interdependence that nonetheless entails.

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