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With Italian borrowing costs at dizzying highs, Goldman Sachs strategist Dominic Wilson says the European Central Bank should take a leaf out of the Swiss book.An unlimited commitment by the ECB to purchase Spanish and Italian sovereign bonds may actually end up being less expensive for the bank than its current policy of periodic bond-buying that is struggling to keep borrowing costs down.
This commitment would mirror the Swiss National Bank’s commitment in August to impose a floor on the price at which euros can be traded for francs. This policy has actually been cheaper and more effective for the SNB than earlier reserve purchases:
The success so far in the SNB strategy indicates that credible commitments backed up with the threat of unlimited action are likely in general to be much more effective, and cheaper, than vaguer intervention strategies. This lesson is one that is familiar from economic theory (a fully credible commitment will not in fact be tested) but the recent Swiss experience is a clean reminder.
However, a few key differences complicate a similar move by the ECB to buy unlimited quantities of Spanish and Italian bonds—at least for now.
– Such a commitment would alter incentives for national governments, and potentially ease the pressure to make effective reforms.
– A commitment by the ECB to unlimited bond-buying lacks political support.
– It is unclear that the ECB would actually be able to defend such a policy, whereas the likelihood of the SNB making good on its promises—amid economic data pointing to downside price risks—was always much more certain.
Even so, Wilson argues, more transparency about bond-buying could still mitigate the ECB’s expenses:
On that front, more clarity about the strategy of SMP purchases – and the circumstances in which tensions are “severe” enough to justify serious interventions – might still help to limit these risks, even short of a more radical commitment.