The role of the European Central Bank in the European debt crisis

European Central Bank

Role of European Central Bank in the current European Financial Crisis

The Great Financial Crisis of 2008 has impacted the western world in an unprecedented way and has left many countries in the European Union scrambling to manage their debts. The impact is more evident in the European Union, mainly because it is a conglomerate of different countries that gave up their currency to accept the common Euro. Some of the most affected countries include Spain, Italy, Greece and Ireland, though its impact has spread to other stronger economies such as France and Germany as well.

Since the beginning of this year, the bonds of Italy, Spain and France have been sold in batches at much lower rates and for the first time in recent history, the Standard & Poor downgraded its AAA rating for France. Many countries in this region are looking at another recession that is expected to be more severe than the previous one. Moreover, the strong austerity measures in these countries are not public-friendly as is evident from the recent election results in France and Greece where the public have supported the anti-austerity candidates. In the light of these happenings, the European Central Bank's role has become crucial because most governments look to it for bail-out.

To counter this crisis, the ECB has taken many steps. In late December last year, the bank began to provide emergency loans to numerous European Banks spread across different countries to the tune of hundreds of billions of euros to help them to rescue their respective national governments. Most of these loans are interest-free and it was done in an attempt to prevent another financial crisis of the same magnitude. It flooded the markets with euros and hoped that this will ease out the problem to some extent (Kulish, 2012).

By doing so, the ECB has followed the steps of its U.S. counterpart, the Federal Reserve. Though most countries in the EU criticized the U.S. For its reckless bailout and the resultant inflation problems it posed, they realize that it has worked wonders for the U.S. economy and has helped it to bounce back slowly and steadily. So, they followed a similar strategy and the results have proven to be fruitful. Currently, Spain's 10-year bonds have an interest of around 5.5% which is way less than the 7% it touched in November while Italy has reduced its interest rates from 8% to around 5%, thanks to these efforts by the ECB (Kulish, 2012).

Moreover, the ECB reduced the interest rate to 1% in December to further boost the European economies. These measures have increased the inflation rate to above 3% while the ECB's mandate is to keep it to 2% or less. Mr. Draghi, the President of the ECB, believes that these measures are essential to accelerate the economies and said that a weaker economy could bring down the inflation rates (Blackstone and Gauthier-Villars, 2011).

This infusion of cash into the market has provided a much-needed breathing time for the national governments and they have to work on ways to repay these bonds when they become due in three years. At least for now, this measure taken by the ECB has helped to prevent a financial collapse and has given another chance for these struggling economies to get back on their feet.

However, the role of the governments to put their finances in order have taken a new twist with the recent election results where the anti-austerity candidates have won with a sweeping majority. This has put the ECB in the spotlight again because the bank wants the governments to make tough choices to reduce its debt. ECB wants Greece to implement its agreed restructuring plan because it does not want to intervene again until the governments take steps. The ECB does not want the banks and governments to get addicted to the funding it receives and wants them to do their role in the debt crisis as well (Buell, 2012).

The ECB cannot mandate governments to act in a certain way because of the limitations that come with the European Union Treaty. The role of the ECB is highly limited because it does not have over-reaching powers like the Federal Reserve in the U.S. For example, the bank cannot issue ECB bonds and so, they can try to revitalize the ailing economies only through other means such as pumping in billions of euros to the financial system and hope that the governments take the action necessary to fix their debt problems like implementing strict austerity measures.

Despite all this coaxing, what the ECB does not want is Greece's exit from the euro zone because its total exposure to this country alone is at around EUR 152 billion. In such a scenario, the ECB may have to pump in more funds with little or no collateral to avoid another crisis (Buell, 2012).