Almost three years after Europe started to experience a credit crisis that threatened to unravel its monetary union, the European Central Bank today announced a program that has the potential to turn things around. Its president, Mario Draghi, said the central bank would begin an open-ended sovereign bond purchasing program to help those countries still in crisis, like Spain and Italy.
Jacob Kirkegaard of the Peterson Institute for International Economics says the plan is not a band-aid and "really does have the potential to be a game changer."
Here's how it will work: The ECB will buy unlimited government bonds so long as that euro zone government complies with an economic reform program approved by the euro zone leaders. The ECB, in turn, will offset those purchases by taking an equal amount of money out of circulation, keeping its mandate to maintain stable prices.
The ECB announced the program after the European Union said euro zone GDP fell 0.2% in the second quarter. ECB staff projected that growth in the euro zone will decline 0.2-0.6% this year. Despite this outlook, the ECB left interest rates unchanged.
The euro currency retreated after the news was announced.
Kirkegaard explained that the ECB was previously the buyer of last resort for European bank bonds and is now extending that role to become the buyer of last resort for European government bonds. He called it "a big step forward."
Does this mean Greece will remain a member of the euro zone? Possibly, says Kirkegaard. "Ultimately, whether Greece stays or leaves is really up to Greece…..what is critical is that the (Greek) government makes a credible effort at reforms that has so far been lacking in Greece."
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