Christine Lagarde's gifts to populists

ATHENS — Christine Lagarde’s three blunders as president of the European Central Bank (ECB) did not cause the revival of right-wing populism across Europe; but they have reinforced it mightily.

The first gaffe cost Italy billions, and the ECB many of the reputational gains that Mario Draghi, Lagarde’s predecessor, previously worked so hard to secure. Recall March 2020: The world was gripped by pandemic-induced anxiety and markets were panicking, especially about the solvency of Italy, a country with gigantic debts and no central bank of its own to print money the way the US Federal Reserve, the Bank of Japan, and even the Bank of England could do.

When asked at a scheduled press conference if the ECB would stand by Italy’s debt to contain interest-rate spreads (the difference in borrowing costs between member-state governments) within the eurozone, Lagarde did not reassure markets and the public by repeating Draghi’s famous promise to do “whatever it takes”. Instead, she did the opposite, declaring: “We are not here to close spreads.” Within seconds, Italy’s debt-servicing costs skyrocketed. While Italy’s government was apoplectic at this, populist opposition leader Giorgia Meloni, who has since become prime minister, was undoubtedly delighted.

The second blunder was less visible but has had deeper, longer-lasting effects. Ever since the crash of 2008, the ECB has been pushing a wall of money toward Europe’s permanently fragile banks in the hope that they would lend it on to businesses and thereby revive Europe’s flagging economy. After 2014, when official interest rates were negative, the ECB was essentially paying bankers to accept hundreds of billions of euros in their ECB accounts. But instead of lending that money to businesses, the bankers simply kept it in their ECB accounts and continued collecting the bribes the ECB was paying them in the form of negative interest rates.

Now that inflation has returned with a vengeance, the same bankers have kept billions parked in their ECB accounts to collect on the higher interest rates, while continuing to pay their depositors minuscule interest. Yet instead of using the ECB’s powers to put the fear of the divine into these bankers, Lagarde has let them run rings around the institution at the expense of small businesses and depositors.

Once again, this has played right into the hands of populist politicians like Meloni, who is benefitting politically by calling for a windfall tax on bankers. As if that was not bad enough, Lagarde and the ECB have responded to this proposal by taking the bankers’ side. I, for one, cannot imagine a more efficient way to boost the appeal of right-wing populists in Italy and beyond.

Lagarde’s third blunder was her slow reaction to rising inflation, reflecting a long sequence of spectacularly disastrous ECB forecasts. In fairness, Draghi, too, had presided over terrible forecasts while consistently failing to hit the ECB’s 2 per cent inflation target. But the dragon that he could not slay was deflation, negative or very low inflation, which forced him to cut interest rates first to zero and then to minus 0.5 per cent.

These ultra-loose policies made him an object of hatred among German savers, particularly the proverbial “Swabian housewives”. Still, most workers in Germany and beyond took little notice, because their real (inflation-adjusted) wages were unhurt by deflation, and because they had precious few savings.

That all changed under Lagarde, when inflation turned positive — and in a big way. Unlike deflation, inflation hits the entire population, especially workers and middle-class households struggling to make ends meet. Any central banker who fails to anticipate it is thus guaranteed opprobrium from all walks of life. We saw this in the 1970s, and we are seeing it again now — except that this time is even worse.

In the 1970s, trade unions were strong enough to claw back workers’ inflation-driven losses through higher wage bargains. Moreover, since women’s labour-market participation was still low, households managed to maintain their living standards by dint of women entering the workforce.

Today, by contrast, trade unions are a shadow of their old selves, and most women are already in paid employment. Unemployment may be low, but as prices have continued to rise over the last two years, the average working-class household’s spending power has taken a beating unlike anything seen in the 1970s.

In this sense, Draghi was lucky, at least compared to Lagarde. His policy toolbox worked reasonably well under deflationary conditions because the ECB at least could pretend that the aim of its unlimited money-printing was not to save Italy (which the ECB’s charter formally prohibits), but to ensure that the low (often negative) interest rates were reaching every part of the eurozone.

Lagarde’s luck ran out early on in her tenure when pandemic-induced supply-chain disruptions triggered inflation, which Russian President Vladimir Putin later turned into an even bigger problem by invading Ukraine and causing a nightmarish energy-cost crisis. Before long, Lagarde was saddled with a cruel dilemma. She could keep interest rates below 5 per cent, let inflation run away from her, and unwittingly do the bidding of the right-wing Eurosceptic German opposition party, Alternative für Deutschland (AfD). Or, she could raise interest rates to levels that would quell inflation but bankrupt Italy and many European banks and corporations in the process. In the event, she chose to delay until falling between these two stools.

Could Lagarde have done something different? As I argued at the time, yes: She could have increased interest rates earlier to burst the housing bubble while buying (or merely promising to buy) bonds issued by governments, the European Commission, the European Investment Bank, and even private companies, with the proceeds going exclusively to finance a green public investment drive. Instead, she wasted her energy and political capital on calibrating the ECB’s collateral policy to favor phony ESG (environmental, social, and governance) commitments, which did nothing to increase the supply of clean energy just when it was most needed.

Moreover, instead of advocating EU Treaty changes that would spare the ECB from always having to keep our governments solvent, she gave misguided speeches foreshadowing the impending replacement of the dollar as the world’s reserve currency.

Where are we now? Lagarde’s rare blend of ineptitude and conceit has helped revive the political fortunes of the AfD in Germany, Meloni in Italy, the right-wing Vox Party in Spain, and so forth. All we can do now is hope that these parties’ own incompetence will lead them to squander their gains.

Yanis Varoufakis, a former finance minister of Greece, is leader of the MeRA25 party and professor of Economics at the University of Athens. Copyright: Project Syndicate, 2023.

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