Mario Draghi can leave one last monetary gift

Mario Draghi has worked nothing short of monetary miracles over his eight-year term as European Central Bank (ECB) President through a sequence of unconventional policy interventions. As we count down the days to Draghi’s departure, expectations are building once again that he will be able to pull one final rabbit out of the hat.
Whether long-term loans to banks, a conditional safety net underneath sovereign bond market, negative rates or quantitative easing, Draghi coaxed and cajoled his colleagues on Governing Council into delivering it. The naysayers in financial markets might say it has all been for naught. Try telling that to the near 11 million people who found work since the trough in 2013.
Still, here we are approaching Draghi’s end of term and once again there is a clamor for Draghi to cut interest rates further into negative territory and to launch another round of asset purchases. There is no crisis demanding an immediate response. But global headwinds threaten to stall the recovery and the outlook for inflation remains a cause for concern. Inflation is stuck below, but not close to, the ECB’s target and with every passing month it becomes more likely that households and companies will expect it to remain that way. Another dose of monetary stimulus is clearly required if the central bankers are serious about achieving their mandate.
However, it is not that simple. The economy is not in dire straits, and without a crisis many, if not most, of Draghi’s colleagues may remain unpersuaded of the case for action. And Draghi’s capacity to convince them to act sooner might finally be fading as his date of departure approaches.
At some point cutting rates can become counterproductive. When it comes to buying bonds, the ECB has imposed constraints upon itself, which would soon bite if quantitative easing was restarted on a meaningful scale. Those constraints can be lifted, but not without a a degree of soul searching over whether the ECB would be in breach of rules for bailing out governments.
So what should Draghi do? Perhaps he will be able to work his magic one last time and convince his colleagues to act. But that looks a tall order unless there is some significant change in the global outlook. There is a sensible alternative: Extract a credible commitment today from his colleagues to act in the future if certain conditions are met. Draghi’s latest speech suggests he is moving in this direction.
Draghi’s colleagues will be uneasy about having their hands tied in this way. But this form of words does nothing more than commit them to respect their existing mandate. Economic theory suggests that a far more aggressive ambition could be very effective but it is hard to imagine Draghi convincing his colleagues to make that commitment, and even if they did so, it is hard to imagine them sticking to it. This brings us to credibility.
If Draghi is to convince investors that his colleagues will deliver on the commitment even when he is no longer in the room then he will need to remove the institutional and intellectual impediments that might delay or derail action once he is gone. If investors and economists worry that the ECB is running out of room to cut rates, then Draghi should commission research from his staff to estimate where the true lower bound lies and publish the results.
For the moment, these would merely be options. Rates would remain where they are and the reinvestment policy as bonds mature would respect the existing issue limits. The point is that policy space would have been clearly established. And ideally Draghi could secure unanimity within the Governing Council on these decisions. Of course, Draghi would probably prefer to act sooner. But a credible conditional commitment for the future is a lot better than doing nothing at all.
—Bloomberg