What did Mario Draghi mean?
Update: graph replaced by new, longer term as well as more recent graph included
from Merijn Knibbe
At this moment there is a lot of ado about this speech of Mario Draghi. The crucial passage is this one:
Then there’s another dimension to this that has to do with the premia that are being charged on sovereign states borrowings. These premia have to do, as I said, with default, with liquidity, but they also have to do more and more with convertibility, with the risk of convertibility. Now to the extent that these premia do not have to do with factors inherent to my counterparty – they come into our mandate. They come within our remit. To the extent that the size of these sovereign premia hampers the functioning of the monetary policy transmission channel, they come within our mandate.
This sentences mean that, in a situation of capital flight (as is the case in ‘club Med’ and Ireland), very high interest rates of government bonds (as is the case in ‘club Med’ and Ireland) and problems with ‘rolling over’ the debt because the government bonds are rapidly loosing value as collateral (which is the case in ‘club Med’ and Ireland), problems which cause the average interest rate on government bonds in the Eurozone to escape the ‘transmission channel (see the blue line in the reposted graph from Erwin Mahe)’, the ECB will buy bonds.
If the thin white line escapes the ECB-interest rate channel, the ECB is even forced to buy bonds because if it doesn’t, monetary policy will become defunct’. There are by the way good reasons to assume that at least the short- medium term influence of central bank interest rate cuts on household and company loans is limited: see this blogpost from J.W. Mason: Does the Fed control interest rates?).
By the way – Draghi also states that financial fundamentals (the average current account, the average government deficit, average government debt, average productivity) in the Eurozone are so much better or at least at par with the USA and/or Japan (Draghi does not mention unemployment), which leaves him puzzled about why people are shunning the Euro. I vaguely recall this story of a man who drowned in a river which was, on average, one meter deep. Or was it this story about somebody drowning – and nobody helped?
It’s what happens when countries have tax systems that are not robust and/or have a heavy deadweight cost ie GNP is substantially lower than what it would be in the absence of the tax, due to the built-in disincentives. The estimate for the UK is in the range -12% and -30%.
Why don’t the experts understand this?