Bailout of First Resort

Editorial do WSJ

Europe's central bank can't save spendthrift governments

Mario Draghi must wonder what he's signed up for. Only weeks into his new job as president of the European Central Bank, the Italian is being portrayed along with German Chancellor Angela Merkel as the main—the only—obstacle to saving the euro zone. If only the ECB would print a few trillion euros to buy the debt of spendthrift European countries, all will be well.

Hang in there, Mr. Draghi, and you too, Chancellor. Don't let the French, the British and the Yanks, the euro-pundits and the other blabbering bullies for bailouts get you down. Someone needs to defend the principle of central bank independence and price stability. The ECB has been by far the most effective part of the euro system since its founding. It shouldn't squander that legacy now by taking on the debts of spendthrift governments that are the real cause of this crisis.

It's true that the ECB has already become a little bit pregnant in buying sovereign bonds, first taking on Greek, Irish and Portuguese debt, and this summer Spanish and Italian bonds. A week ago Friday, the ECB held €187 billion worth of country bonds.

Jean-Claude Trichet, Mr. Draghi's predecessor, made this concession amid earlier rounds of political brow-beating. This was supposed to scare the sovereign-bond vigilantes and reduce soaring national bond yields. But how well has that worked? Greece is still a wreck and Italian bond yields reached 7% last week.

The ECB bailout brigade now says this is because the bank simply hasn't bought enough bonds. Like Keynesian spending stimulus, if bond-buying doesn't work the buy must have been too small. It can never have been the wrong idea. So the ECB must do like the Federal Reserve, buy four trillion euros or so, and the sheer financial firepower will crush bond spreads and end the crisis.

This assumes that the Fed's experiment has been successful, though it's more accurate to say the verdict is still out. The U.S. housing market still hasn't recovered, despite nearly $1 trillion in Fed mortgage-backed securities purchases, and the economy remains in low gear despite nearly three years of near-zero interest rates. Rather than slowly extricating itself from its crisis programs, the Fed has felt obliged to sustain or expand many of them, including MBS purchases. Whether the Fed emerges from its frantic crisis-management with its monetary credibility intact is an open question.

At least the Fed has statutory power granted by Congress as a lender of last resort, while the ECB has no such legal authority. The ECB was established with a sole mandate of maintaining price stability, not as a fiscal savior. This was done deliberately to shield the bank from political influence and to maintain the credibility of the euro as a currency that would retain its value over time.

So far, the ECB's bond purchases have been limited enough that the central bank has been able to "sterilize" them, meaning they are offset by withdrawing money elsewhere in the banking system and haven't added to the overall supply of money. But a multitrillion euro program would make sterilization impossible and would become a money-printing exercise.

And what if even that doesn't work? The ECB would have squandered its monetary credibility, and shattered its charter, to buy the worst debt in the euro zone at the expense of the countries with the best fiscal policies and the lowest interest rates. It will have abandoned any semblance of market discipline in favor of a panicky rush to defend the ability of spendthrift governments to borrow. Price stability will move from the ECB's sole mandate to its third or fourth priority.

Europe's real problem now, as at the euro's founding, is that the currency zone lacks a mechanism for enforcing fiscal discipline. The Stability and Growth Pact was an attempt, but it lacked teeth and was violated early. All of the fixes in the current crisis lack credibility with markets because they too lack any discipline that would show creditors that Europe's problems of overspending, cradle-to-grave middle-class entitlements and slow growth are being fixed.

The voices now pleading for greater "fiscal union" are really pleading for the Germans and the ECB to write their governments blank checks. But if they want them to pay this bill, then the French, Italians and the others should be prepared to let the Germans and the central bank approve their budgets, their pension systems and other fiscal policies. We don't recommend such a grant of extra-national democratic authority—it would lead to all kinds of intra-Europe feuding—but at least it would be a form of financial discipline.

If the Germans and ECB do write a blank check, then the balance of power within the euro zone will shift markedly, and perhaps irreversibly, in favor of the spenders. Even if this prevented short-term panic, it would merely postpone the day of reckoning and leave Europe worse off in the medium and long term. Without a system that can enforce spending restraint, borrowing discipline and economic reform, all the ECB bond-buying in the world won't save the euro, and the independence of the ECB itself will become another casualty of the crisis.