War, Inflation And Disaster Didn't Come From Nowhere

In 2012, the eurozone was mired so deeply in crisis that investors worried that the euro might collapse. Mario Draghi, president of the European Central Bank at the time, stepped in and gave a speech, uttering three words that provided much-needed stability.

“He famously calmed markets just by saying the ECB is ready to do ‘whatever it takes’ to preserve the euro,” said Robert Pozen, a former vice chairman of Fidelity Investments and a senior lecturer at MIT Sloan.

In a June 7 forum at which Draghi was awarded the Miriam Pozen Prize in recognition of his leadership in international financial policy, Pozen drew a laugh from attendees when recounting that Draghi’s rescue of the euro earned him the nickname “Super Mario.”

“And he didn’t actually have to do anything,” Pozen said, alluding to the fact that Draghi’s pledge alone was sufficient to stabilize the markets.

The event was sponsored by the MIT Golub Center for Finance and Policy and included remarks from MIT Sloan professors Deborah Lucas and James Poterba, who said Draghi’s tenure as ECB president set a precedent for transparency that markets now take for granted. 

“He, Ben Bernanke, [and] Mervyn King were very important in contributing to this nudge toward greater transparency in what the banks were doing,” said Poterba, president and CEO of the National Bureau of Economic Research. “From today’s perspective, this notion of central bank transparency [and] clear communication — we take that for granted.”

Draghi, who earned his doctorate degree in economics at MIT, also served as prime minister of Italy, chair of the Financial Stability Board, and governor of the Bank of Italy.

“The fight against inflation is not over”

In his address, Draghi focused on the war in Ukraine and the persistent battle with inflation, predicting that a prolonged war between Russia and Ukraine, along with continuing geopolitical tensions with China, will continue to weigh on the rate of potential growth of the global economy.

These two momentous events — the war and inflation — didn’t come out of nowhere, and they’re not disconnected.

The war in Ukraine has contributed to the rise of short-term inflationary pressures, but it’s also likely to trigger lasting changes that herald higher inflation in the future, Draghi said.

“With the benefit of hindsight, I will argue that these two momentous events — the war and inflation — didn’t come out of nowhere, and they’re not disconnected,” Draghi said. “They’re rather both a consequence of a paradigm shift which over the past two and a half decades has quickly moved global geopolitics from competition to conflict.”

This paradigm shift may lead to lower potential growth and require policies leading to higher budget deficits and, possibly, higher interest rates. “The fight against inflation is not over,” Draghi said.

Addressing inflation will probably require a cautious continuation of monetary tightening, either through still-higher interest rates or by maintaining current rates for a longer period of time before bringing them back down.

“Eventually, central banks will succeed in bringing inflation rates back to their targets, but as the long-term consequences of the war become visible, the economy will look very different from what we’ve been used to,” Draghi said.

Draghi also commented on current banking troubles in Switzerland and in the United States, where three banks — Silicon Valley Bank, Signature Bank, and First Republic Bank — collapsed earlier this year. He said that those problems are “not systemic” and are “in no way comparable with the financial crisis” and should be addressed with “ad hoc measures, as has been done so far.”

“Given the limited size of this crisis, governments should finance [banks] when needed,” Draghi said. “In other words, they should avoid contagion at all costs and should undertake any necessary intervention to avoid creating a conflict for central banks between pursuing the objectives of monetary policy and those of financial stability.”

The $200,000 Miriam Pozen Prize is awarded biennially and is sponsored by Robert Pozen in honor of his late mother, recognizing outstanding financial policy research or practice.

See Draghi's speech and award ceremony here.