ECB President to Italian Prime Minister, Super Mario understands crisis management.
Draghi is one of the most distinguished academics, bankers and politicians for a generation. His perspectives are strongly influenced by family and academia and he possesses a broad knowledge of the financial system alongside a firm centrist Keynesian ideology. However, his likeability stems from implementing 'whatever it takes' to satisfy market participants; therefore, his long-run monetary and fiscal impacts are unknown and may prove calamitous.
Draghi's strong 'Caffè'
Carlo Draghi, Draghi's father, had a career at the Bank of Italy, the Banca Nazionale del Lavoro and the Institute for Industrial Reconstruction (IRI), the latter is a public holding firm responsible for restructuring insolvent private and financial institutions subsequent to the Wall Street Crash. In the late 1950s and early 1960s, it used the 'IRI formula' forcing its subsidiaries to compete on private markets but its finances and inventories were still controlled by Parliament - leading to strong economic growth in Italy. His father's pragmatic approach to work and understanding of the IRI's history credibly formed Draghi's disposition: an appreciation of the state, a willingness to revive fallen firms and the belief that growth is necessary to improve living standards.
Attending the Sapienza University of Rome under Federico Caffè's guidance Draghi was exposed to Keynesian ideology. A lover of Nordic democratic socialism and despiser of greed, Caffè promoted class mobility to maximise the workforce's productive capacity. Furthermore, he argued for the use of generous welfare states as a mechanism to bolster the jobless' permanent incomes during recessions. Parallels can be drawn with this and several of Draghi's policies. For example, persistent structural unemployment is a resounding feature of the Italian economy, particularly in young women. The youth gender unemployment gap reached a low during the Eurozone Debt Crisis and has widened since. Two months after taking office Prime Minister Draghi executed, with the aim to increase social mobility, €220bn in reforms to aid the less innovative South, the youth and women to rebound from the 2020 8.9% GDP contraction. Caffè's stance for quick, decisive policy action is an undeniable influence on Draghi.
In addition, his doctoral advisors at the Massachusetts Institute of Technology (MIT) were Modigliani and Solow, two more academics who had respective full and partial beliefs in the Keynesian ideology. Solow's growth-orientated theories and his extensive mathematical proofs alongside Samuelson, the father of Neo-Keynesian economics, may have tainted Draghi's predictably leftist Keynesian view with classicism. The Solow growth model emphasises the larger marginal productivity of capital in less developed economies enabling catch-up growth (until long-term trend convergence), a Italian feature Draghi is now attempting to exploit.
Conflicting classical beliefs of professors, his New Keynesian peers Paul Krugman and Maurice Obstfeld likely fostered Draghi's moral views. Moreover, their advocation for globalisation over a trade strategy policy, contradicting Caffè, possibly enhanced Draghi's belief in support of the European Currency Union which he had previously disliked. Thereafter, Draghi taught macroeconomics and financial/corporate policy for two decades - an advocate for privatisation but favourited regulating financial institutions.
Confidence reviver
Draghi joined Goldman Sachs in 2002 as a Managing Director focussing on client relationships with European governments and corporations which then led him to take office as ECB President in November 2011. He reshaped animal spirits reinstalling waves of optimism in the Eurozone through targetted long-term refinancing operations (TLTROs); preventing a bond market collapse after S&P downgraded several euro-denominated bonds.
TLTROs were used in the order of €1tn to aid 800 solvent banks that faced harsh liquidity problems, facilitating temporary injections of central bank reserves to repair credit conditions and stimulate growth. The first €489bn repo operations were assigned a 3-year maturity with 1% interest and TLTRO 2 was worth €530bn in additional cheap loans, in both cases the largest loans were auctioned to banks who would have the largest impact on real economic lending. The ECB also hoped the repo expenditure entailed leveraged private bond purchases to drive down yields as the outlook improved. Expansionary support initiated by Draghi draws several commonalities with the IRI.
Although QE did not officially occur during the first three years of Draghi's tenure, the ECB attacked bond markets of fiscally unstable economies using the Single Market Programme purchasing $250bn during the Great Financial Crisis and Outright Monetary Transactions. Indicating liquidity sterilisation through auctioning one-week deposits the central bank refused to agree they were undertaking QE, arguably a weak response given the lower default and inflation risk associated with one-week deposits.
PwC indicated $1.22tn non-performing assets were mixed into the banking system following the Great Financial Crisis. Debtholders were unlikely to sell high-yielding assets for a devaluing currency and a negative ECB deposit rate. Draghi used his academic views to argue a complementary fiscal and monetary response was necessary. In 2015, international bond markets capitalised the European Investment Bank for Juncker's €315bn plan, more attractive high-yielding debt used for supply-side improvement. In this way, the ECB's €80bn monthly purchases truly suppressed sovereign yields. In this case, Draghi had fulfilled his role of stabilising the crisis but the permanent damage to the Eurozone is immeasurable.
Moral hazard concerns caused by Draghi were raised by Stiglitz; financial institutions were responsible for overlending and were 'bailed' through TLTROs and fiscal support. On the contrary, Draghi and now Lagarde have allowed the ECB to gain responsibility to regulate and test bank compliance. Draghi comprehends the costs of his decisions resulting in zero interest rates and a consequent liquidity trap but he also understands that without the reinitialization of confidence European bond markets would have remained in turmoil and followed with policy to prevent a similar future scenario.
Next moves
Draghi successfully campaigned for the prioritisation of Italy in the vaccine queue by leveraging the poor state of Italian finances, utilising the relationships previously founded with the EU officials and withheld 250,000 doses from Australia.
Famous for the "Draghi effect", the bullish market reaction when uptaking his ECB presidency, he now faces the EU austerity threat as Prime Minister. Grey-sky forecasts only project €4bn per annum in EU net transfers to Italy, not denting the €160bn Italian negative output gap caused by the pandemic. Although, following the intial crisis management stage Draghi argues Schumpeterian creative destruction is needed, highlighting his economic school of thought of efficient free markets during recoveries and expansions.
Draghi's role as Prime Minister is in jeopardy, despite an uptick in support. A structural flaw in the Italian parliament due to local devolution and several vote-splitting political parties causes the creation of short-tenured discontented coalition governments. He is likely considering the Italian President's role which is not so influential in creating policy.
Always prioritising crisis management in his policy regime even if it is at the expense of the public finances or foreign relations, Draghi successfully stabilises markets via restoring confidence. However, given he has only created policies for the last decade, his long-term credibility and whether he has exacerbated the threat of euro destabilisation, moral hazard or increased personal welfare is a mystery. Draghi has perfected his policy by using his balanced morals of class mobility and government intervention during crises from his father and Caffè alongside stressing the importance of economic activity learnt from Solow, both are necessary to have prosperity and a fair societal structure.
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