New ECB chief Draghi faces tussle over bank's role

October 31, 2011 - 9:50 AM
European Central Bank Draghi

FILE - In this Oct. 19, 2011 file photo outgoing European Central Bank (ECB) President Jean-Claude Trichet, left, hands over a bell to his successor Mario Draghi from Italy at the end of a farewell ceremony at the old opera house in Frankfurt, Germany. Draghi officially takes over as head of the ECB on Tuesday, Nov. 1, 2011, in a high-pressure struggle with eurozone government leaders over how far the bank should go in rescuing indebted governments. (AP Photo/Arne Dedert, pool)

FRANKFURT, Germany (AP) — When Mario Draghi takes over as head of the European Central Bank on Tuesday, he faces a high-pressure struggle with eurozone governments over how much the bank should do to rescue indebted countries.

Where he can draw the line will go far in determining the outcome of Europe's government debt crisis and the future of the euro.

Like his predecessor Jean-Claude Trichet, Draghi is a consistent defender of the ECB's tough and sometimes unpopular anti-inflation stance. But he's also a skilled backroom negotiator who knows how to forge agreement and compromise.

He will need both attributes — principle and flexibility — as the ECB tries to keep financial disaster from engulfing the 17-country currency zone.

Under Trichet, whose eight-year term expires Monday, the bank reluctantly eased its resistance to bailouts and started buying government bonds. That lowers the rates at which governments borrow and kept Italy and Spain from being driven to insolvency the way Greece, Ireland and Portugal have been.

The bank's purchases since August have kept Europe from meltdown — but it now wants to hand off the rescue mission to elected governments. They would handle the crisis through their newly-strengthened bailout fund, the European Financial Stability Facility. Yet the fund, at euro440 billion ($623 billion), is considered too small to do so convincingly, and new measures meant to increase its firepower to euro1 trillion still lack detail.

Draghi warned Italy last week to fix its budget problems itself, decrying "the hesitancy and delay with which steps to correct imbalances have been taken and measures to correct growth have been adopted."

He said that the "extraordinary measures" the bank has taken — such as the bond purchases — were "temporary."

Draghi will get his first public chance to start defining "temporary" when he holds his first news conference after the ECB's rate-setting meeting Thursday.

Halting the purchases risks disastrous debt defaults that could topple banks, choke credit to the economy, cause a deep recession, and in some scenarios lead to the break up of the euro.

Continuing the purchases risks sending the message that politicians can sit back and let the central bank bail them out.

The markets' lack of confidence in states like Italy was evident on Monday, when the country's bond yields rose sharply and stock markets fell, unwinding some of the optimism generated last week by Europe's grand plan to save the euro.

Economist Marco Valli at Unicredit says Draghi's job will be to use the carrot and stick, supporting markets in the short term while "making sure any kind of support is perceived as temporary and therefore there is no government addiction to ECB action. That would be extremely dangerous."

While the crisis has shown the need for the bank to act, Draghi will quickly have to draw a clear line over what it will do and for how long.

"The central bank must cut for itself a piece of this objective, financial stability, and be responsible for it with a specific list of instruments and a specific strategy," said Franco Bruni, an economist at Milan's Bocconi University.

Draghi, 64, brings long experience as a crisis manager and discreet, behind-the-scenes negotiator to the task of dealing with eurozone leaders.

He served as a World Bank director for six years, and as a top official at the Italian Treasury from 1991 to 2001, including a period in 1992 when Italy teetered on the edge of default with high debt and deficits. The country was knocked out of the European Exchange Rate mechanism, the prelude to the euro.

But Italy recovered through tough measures including pension cuts and new taxes. Draghi, a veteran of international and European finance minister's meetings, helped negotiated Italy's way back into the euro project in time to join at launch in 1999. He also oversaw a program to sell off much of Italy's bloated state sector.

He served as head of the Bank of Italy from 2005 and steered the banking system through the crisis of 2007-2009. Italy's banking system came through in relatively good shape, in contrast to the bank bailouts in Germany, Britain and Belgium.

As Bank of Italy head, he sat on the ECB's 23-member governing council but has remained one of the quieter members. He lets others give interviews or make statements to signal rate policy.

As a result, his views on monetary policy are less known than others'. That may give him more room to maneuver in office.

Economists say his record shows he clearly supports the ECB's mission as defined in the Maastrict Treaty: fight inflation first before lowering rates to help growth, and a no-bailout culture in which governments are pushed to balance budgets.

Yet like Trichet he has a flexible streak and a cool character that clearly set him apart from Axel Weber, the Bundesbank head who was originally favored to succeed Trichet. Weber quarreled publicly with the council majority over the bond purchases. Isolated and unwilling to yield ground on his positions, Weber dropped out of the running.

Bruni, who attended graduate school with Draghi at the Massachusetts Institute of Technology in the 1970s, used the word "serene" to describe his character.

Draghi also retains many habits from his days as a top Italian civil servant. He's practical, discreet and focused on serving the institution, not ideology, said Paul Furlong, a scholar on Italy at the University of Cardiff School of European Studies.

"His interest has usually been that of the classical high ranking civil servant whose job is to promote and protect the institutions he is responsibile for," said Furlong. "It's more about those kinds of values than about specific adherence to economic schools of thought."

When it comes to defending the ECB, "he'll do what it takes," said Furlong.