Mario Draghi: A breath of the fresh air at the ECB

May 12, 2011

It looks all but certain that the next head of the European Central Bank (ECB) will be Bank of Italy Governor Mario Draghi. He has received the crucial backing from Germany’s Chancellor Angela Merkel and is likely to be voted in, bar a major shock, when the EU leaders meet next month.

With a PhD from the Massachusetts Institute of Technology, Draghi  has a resume as long as your arm:  a one-time economics professor at Harvard University, a former Vice President at Goldman Sachs, the head of the Italian Treasury that oversaw Italy’s transition to the euro as well as being Italy’s central bank chief since 2006.

His experience and credibility to be the leading candidate are in no doubt, but it is his style that will be the focus of much attention. As the first head from a Mediterranean nation (Trichet is French and the first President Wim Duisenberg was Dutch) all eyes will be on Draghi to see firstly, whether his sympathies lie with the weaker peripheral nations and secondly, to determine how hawkish he is.

It’s worth looking at the second point first. Draghi has a reputation as one of the more hawkish members on Europe’s rate-setting committee, akin to former Bundesbank President Axel Weber. In a speech about the economic outlook back in February, Draghi sounded the alarm bell over rising prices.

During this speech he mentioned that although inflation expectations remained well-anchored over the medium-term “the appearance of inflationary tensions does require that we carefully assess the timing and methods for restoring normal monetary conditions and interest rates.”

Interestingly, Draghi also said that negative real short-term interest rates In the Eurozone “have not improved the growth prospects of the less dynamic economies” and that “as economic policies reach the end of their expansionary phase, this will not necessarily endanger growth.”

This is the type of talk that won over Merkel’s heart. On this basis he is likely to carry the mantle from Trichet and normalise interest rates over the medium-term. Even with one rate hike in the bag, interest rates in the currency bloc would need to be at least 3 percent before they are in positive territory in real terms. So there could be a lot more “normalisation” to come under Draghi.

Added to this, he seems convinced that rate hikes won’t hurt the weaker peripheral nations.  Back in February he said that the cost of borrowing may fall for the peripheral nations of Greece, Ireland, Portugal and Spain if, along with fiscal consolidation, inflation expectations are kept under control with rate hikes.

On the second point regarding any sympathies he may have for the weaker states, we can assume that his credentials as an economist have left him a pragmatist, and free from any bias. But, if we need evidence there is plenty.  In a speech at the Universita Cattolica del Sacro Cuore last month entitled “The euro: from past to the future”, Draghi sounded a defiant tone that EU fiscal rules have to be obeyed – without any exceptions.

In the penultimate section of the speech he focuses on two areas of improvement: a strong fiscal surveillance policy to stop members from running unsustainable deficits and the commitment of member governments to implement measures to boost competitiveness.

Trichet had to approach the sovereign debt crisis with a sticking plaster solution and re-capitalise Europe’s banking system even if it meant accepting collateral from the weakest nations that was of dubious quality in return for ECB funds. However, Draghi is likely to take a harsher approach: “We must not forget a golden rule: increasing the economy’s growth potential and consolidating the public budget are national priorities first of all. Governments should pursue them even independently of the European rules,” he said in April.

While Draghi needs to get the peripheral nations in shape, Germany may not escape criticism either. Public debt reached a record high last year of 80 percent of GDP, exceeding the EU’s 60 percent rule.

Draghi seems to be advocating a private sector approach to the public purse strings within the Eurozone, one where each individual member is responsible for their own finances. This may be just the breath of fresh air the Euro zone needs to survive.

Kathleen Brooks is research director at The opinions expressed are her own.

Image – Italy’s Central Bank President and Financial Stability Board Chairman Mario Draghi speaks during a news conference at the G20 Summit in Seoul November 12, 2010. REUTERS/Jo Yong-Hak

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