"ECB will do everything to save the Euro," said the ECB President, Mario Draghi. With the extensive public indebtedness, the worlds confidence in the second largest currency of the world, Euro, is traumatized. And questions marks still hang over whether the European institutions will be able to combat this crisis and rescue the Euro zone.
Causes of this crisis varied across the zone. In some countries, private debt arising from property bubble led to the blast of sovereign debt catastrophe. On the other side of the picture, public sector wage and pension commitments became the calamity drivers, and the list goes on and on. Holistically, the structure of EU as a monetary entity and not as a Fiscal entity has led to this fiasco.
With the Euro zone on the verge of mayhem, ECB has come up with a unique scheme of facilitating the floundering economies given that they agree to launch fiscal austerity measures and apply for a bailout to the Euro zone emergency fund. The ECB plan proposes to rescue the countries using four effective measures.
Firstly, outright monetary transactions will be incurred, whereby ECB will purchase the bonds of highly indebted countries. Bond purchases will push the prices up and bond yields down. The government could then take the advantage of lower yields when they sell the bonds to pay off bonds reaching maturity.
The second measure involves the indirect relief whereby ECB will offer an unlimited amount of cheap loans to the banks of the struggling economies. The banks will use the money to buy high yield government bonds. The purchase of bonds will give a rise to bond prices and consequently push down yields resulting in lower borrowing cost.
Other measures are the slashing of reserves countries reserves with ECB by half freeing some 100 billion Euros to be used elsewhere, and ECB rate cut that would encourage banks to lend among themselves and to other business rather than parking their funds with ECB.
Whether or not the plan works out is still unclear. However, following the ECBs announcements, the Spanish 10-year bond and Italian 10-year bond declined by around five percent and 2.7 percent respectively in their yields. While stock exchanges improved by 4.9 percent in Spain, 4.3 percent in Italy, three percent in France, 2.9 percent in Germany, and 2.1 percent in the UK. Thus, with these immediate optimistic results, there are reasons to believe that ECB plan has the potential to turnaround the Euro zone.
The shoddier side of the ECB plan is that the unlimited purchase of bonds financed by money printing might trigger brawny inflationary pressures in the Euro zone. Moreover, whereby ECB becomes the lender of the last resort for the national governments, the economies might revert to the same extravagant fiscal behavior that caused this crisis in the first place.