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IAI Actuarial Core Principles · Business Economics · Recent macroeconomic history

In 2012 the European Central Bank president said the ECB would do 'whatever it takes' to preserve the euro, later backed by the Outright Monetary Transactions (OMT) programme. What was the main effect of this announcement on the crisis?

The announcement and OMT backstop narrowed peripheral bond spreads by removing fears of euro break-up and disorderly default. The effect worked through credibility and expectations, since the ECB did not actually need to buy bonds under OMT, which was never activated.

  1. AIt lowered peripheral government bond spreads by reducing fears of forced exit and default, largely without the ECB having to buy bondsCorrect
  2. BIt immediately raised the ECB policy rate to curb inflation in Germany
  3. CIt caused Greece to leave the euro within the year
  4. DIt replaced national fiscal rules with a single Eurozone budget
  5. It required banks to raise equity by selling sovereign bonds

Explanation

The credible backstop acted as a lender-of-last-resort signal. Investors judged that redenomination or disorderly default risk had fallen, so spreads over German bunds narrowed sharply. OMT was never actually used, showing the effect came through expectations. The other options describe events that did not occur.

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