Saturday, December 13, 2014

Monetizing Eurozone's Sovereign Debts: it is now or never

So, Mario Draghi said that an inflation much lower than 2% is against his mandate. And it is! If you ask me, early 2015 is the right time, if not too late, to buy sovereign bonds. Let me, please, tell you what I think.

First of all, given that Eurozone economy is below its potential, inflation risk will remain low, and the zero lower bound will prevent monetary policy to be "hazardously" inflationary. But, this is an argument why we should not fear of inflation, if the ECB decides to take bold action. True! For now...

Moreover, given that we remain below our potential output, member states have begun to deviate from austerity and call for more expansionary budgets. Sooner or later, they will start creating budget deficits as a mean of expansion. And this has two implications. The first one, which relates to my previous argument is that budget deficits will boost expansion, and, hence, the return to the potential output. Therefore, the later the ECB decides to act, the more probable the inflation becomes. Following this scenario, should the member states decide to move to budget deficits, this will increase the cost of their funding. Especially for the periphery, the effect would be disproportionate to that in the rest of the Eurozone. So, an intervention of the ECB would lower this cost, and would make budget deficits, i.e. recocery, cheaper. In other words, ECB and Eurozeone members will share, so to speak, the costs of tackling deflation.

Finally, monetizing sovereign debt without triggering hyperinflationary pressures would be ideal. Eurozone's overindebted economies will be able to take a breath, and continue with structural reforms without the necessity of more painful budget cuts. Structural reforms can be more easily pursued when economic activity flourishes.

Overall, since member states will start diverging from the austerity dogma, ECB will have to act before its policy risks becoming inflationary, to make budget deficits cheaper, to reduce debt burden, and to make structural reforms easier. All while tackling deflation as its mandate demands.

P.S.: Real GDP of the US (red line) and the Eurozone (blue line) in the following graph; yet another reason why bold action is needed...