I have been trying to understand what might motivate Germany to give permission for the European Central Bank unequivocally to don the mantle of “lender of last resort” and allow monetary policy to complement fiscal austerity in the hope of avoiding disaster.* What follows is just a speculative thought that you can dismiss if it seems like nonsense.
A metaphor that makes sense to me is one in which Germany is determining whether the purchase of another market-moving call option is cheaper than the cost of inaction. Imagine that aggressive action by the ECB is an at-the-money call option the purchase of which would keep the eurozone afloat at least until that call expires. By pushing for deeper and more permanent austerity measures, Germany is trying to ratchet down the premium and lengthen the duration of this call contract, on the view that if debtor countries substantially lower their deficits, the call will be more powerful and will last for longer as citizens bear budget cuts in lieu of creditors taking haircuts. The medium-term implications of punitive and anti-democratic fiscal austerity on the economic growth of debtor countries are actually irrelevant for the moment, since the question is not whether what Germany believes is true, but whether the perceived premium to be paid for the ECB call option is lower than the perceived loss to Germany of a unified eurozone.
It is as though Germany owns 100 equity shares representing the current and future value of its assets and economic output. The price of those shares is plummeting, and the only remaining decision is whether to use its last remaining cash (i.e. the sanctity of bunds and of its credit rating) to purchase the only call option that exists in this metaphorical market. Buying the delta and especially the gamma of this option would force equity short-sellers to cover, but at the risk of leaving Germany exposed after expiration. If the premium paid for the call is low enough – if structural and ratified treaty reforms are heavy enough – Germany will not have to give up quite as much, and the likely gain from the call purchase will offset the risk of its being ineffective or of having a too-soon expiration date. On the other hand, if France and the debtor countries reject reforms, agree to too little, or are unable to convince onlookers that they can actually implement their promises, the perceived cost of the ECB call option will be too high for Germany, such that a cheaper route will be to let its shares continue to fall, perhaps to the “book value” of Germany’s export power in a depressed global economy.
At some point we will find out whether the optionality of ECB action is perceived by Germany to be less dear than the prospect of a fractured eurozone. My suspicion is that Germany fully intends to be an option buyer, and is merely working its order at a too-low price with seconds remaining before the “Functioning Global Economy” market closes. Assuming that France and the other European countries are competent market-makers, and assuming that Germany is a rational and non-akratic agent, we will see Germany lift the offer before the closing bell.
* Let’s just ignore for now the fact that fiscal austerity to the extent proposed practically guarantees revolt and noncompliance and possibly worse on the part of debtor countries. Riots in Greece and Italy are almost no longer newsworthy; see this excellent post from Crooked Timber thinking through the “exit, voice, and loyalty” situation as it stands for Ireland.