Recent developments in Europe have caused a rush of adrenaline to political leaders’ heads across the continent. The dramatic expansion of the European Central Bank’s (ECB) program of asset purchases, coupled with the landslide victory of Syriza, the anti-bailout and anti-austerity party, in the Greek elections, have once again called into question Europe’s crisis management policies. Overall, it is fair to say that the waters are choppy, and there is certainly a risk that Greece might once again push the monetary union off-balance.

However, it is primarily Chancellor Angela Merkel’s ability to keep the union clear of a veritable storm that is being put to the test. The new government in Athens is a break with continuity and will resist attempts by European partners to continue to muddle through. The partners’ ability to play their cards well will depend on the Syriza government recognizing that it doesn’t hold many of its own. Indeed, it will be impossible for Athens to ask its European partners for a clean slate—debt forgiveness in its most extreme form. But debt forgiveness can take many forms. And Merkel will be the deciding factor for whether a compromise is possible.

The Dangers of Renegotiation

The conundrum European leaders are facing is that any substantial debt renegotiation will reverberate across the monetary union—no matter how many times politicians repeat that Greece is a unique problem and that, this time, the crisis can be contained.

Boiled down to the very essence, this time is no different:

  • If Greece manages to win significant concessions from its creditors, then other countries weighed down by excessive debts could ask for a similar treatment.
  • If Greece chooses a hardline approach, it could very well eject itself from the euro zone, simply because the ECB would be forced to shut down the liquidity tap that has kept Greek banks afloat. Absent this liquidity, Greece’s financial system would no doubt collapse.

If the euro is reversible in one country, it can be in others, too. The taboo would be broken and the euro would become a fixed exchange rate regime backed by a “foreign” central bank. Let’s not fool ourselves. It is true that the monetary union is better equipped today than it was three years ago to withstand a credit event and a potential exit—it has a better institutional framework and the powerful promise of its central bank “to do whatever it takes.” But that does not mean that euro zone members would be immune to contagion. In addition, this time the social and economic fabric of many euro zone countries is much weaker than just a few years ago. They simply can’t afford another bout of uncertainty.

There is another factor that puts the onus more squarely on politicians’ shoulders. Merkel has lost the staunch support of an important ally: the ECB. In recent months its president, Mario Draghi, has made a very simple cost-benefit analysis: How big is the damage to the central bank’s and its monetary policy’s credibility if it continues to be the fig leaf for policies that political leaders are not willing to sell directly to their own domestic audiences? The answer to this question is the announcement that Draghi made on January 22. In its political essence, the message of euro quantitative easing (QE) is that it is a pure monetary policy tool launched in order to meet the ECB’s only mandate: price stability. QE is a declaration of independence from politicians. German Finance Minister Wolfgang Schäuble, who takes the Bank’s independence very seriously, recognized this. He may have different views about the merits of QE, but he respects the ECB’s independent decisions. Judging from Merkel’s public restraint in past days, it seems that Schäuble convinced her to hold fire. Merkel strongly opposes QE.

But she, too, had to realize that ultimately it is not up to the ECB to enforce fiscal austerity or structural reforms, especially if this puts a constraint on monetary policies and jeopardizes the central bank’s mandate of price stability. As of January 22, meddling with the Frankfurt-based institution has become just a bit harder. The ball, as the saying goes, is squarely in the politicians’ court. This is only one of the reasons why Draghi’s latest move is a defining moment in the history of the ECB:

1) He managed to reassert the role of the ECB as a modern, independent central bank, despite the legal and political constraints of the monetary union. This program of asset purchases is open-ended in all but name. Furthermore, he managed to awe investors with a big number. By September 2016, the ECB will have pumped more than €1.1 trillion into the economy by purchasing €60 billion worth of securities, mostly government bonds, every month. These figures exceed market expectations. In the past weeks, investors got overly distracted by the last-ditch efforts of QE adversaries, primarily the Bundesbank, to limit the size and scope of the program.

2) He managed to silence those, like me, who thought that without risk sharing, asset purchases would not be able to reverse fragmentation in the euro area. Draghi defined these concerns as “futile.” The bulk of the risk will stay on the balance sheets of national central banks (NCBs). In the case of a real crisis, however, Draghi reassured his audience that outright monetary transactions (OMT) would still be available for individual countries that need support. Under OMT, risks are fully shared, but the program comes with strings attached. The euro QE is purely a monetary policy instrument—and was confirmed as such by all members of the governing council. Draghi argued that the decision to purchase assets through NCBs was made in order to make QE more effective, especially given the large size of QE and the expertise of the NCBs. I would argue, however, that the decision is a nod to QE opponents in Berlin, who were increasingly isolated, as well as a warning to those (including many in Draghi’s home country of Italy) who believe that given the size of their sovereign debt, it may eventually become necessary to ask for some kind of debt forgiveness—perhaps to be achieved through the backdoor of the ECB’s monetary policies. We now know that this is not going to happen. Let’s just say that if QE works and the economy starts to grow again, Germans will realize that they will not be stuck with the bill. At the same time, others will have to accept that while they remain on the hook for their own debt overhang, they should be able to take care of it, albeit slowly and not without some additional pain.

3) The euro will become a carry trade currency. This will put further downward pressure on the euro, help European exporters, allow for some inflation to be imported into the euro area and, last but not least, allow central banks in other jurisdictions—the Fed—to exit their own ultra-loose monetary policies gradually and increase nominal interest rates without causing dramatic disruptions in financial markets. Indeed, real interest rate increases in the United States would be partially offset by the ECB because many investors will use cheap euros to purchase higher-yielding assets in stronger currency jurisdictions, such the as the U.S., thus pushing bond yields lower.

Will Euro QE Work?

Does this mean that QE is a silver bullet? By no means—and this not primarily because of the uncertainty caused by the situation in Athens. Indeed, it still remains to be seen how effective QE can be in a bank-based financial system, such as the euro zone. It took the United States six years and multiple rounds of QE to see bank lending increase again. The Fed’s QE worked in part because it was transmitted to the real economy through capital markets. Furthermore, banks in the United States underwent dramatic changes. In Europe’s monetary union, this process is far from complete. In many countries, the consolidation of the sector has not even begun. Furthermore, structural reforms in many member countries are still not sufficient to create a growth-friendly environment.

Despite these caveats, I have to admit that Draghi’s announcement exceeded my expectations. The ECB needed to send a strong message; it has done so. As for the Germans, they must find a way back to the mainstream. Runaway inflation is not the greatest danger in Germany or in the euro zone today.

Letting the ECB do its job is in everyone’s interest. Draghi has always kept the door open for Berlin. German politicians should more openly give him the credit he deserves. Solving the Greek crisis will be a test for politicians, not central bankers. How they pass it will have repercussions on the whole of the monetary union.