07/30/2012 08:08 am ET Updated Sep 29, 2012

A Tale of Two Central Bankers

Federal Reserve Chairman Ben Bernanke has been desperately trying to levitate a sinking economy, by buying government and commercial bonds in whatever quantities it takes to keep interest rates at record lows. This policy has kept the Great Deflation from being even worse, but it hasn't produced a robust recovery.

The reason: Consumers are suffering from rising unemployment and declining wages, and aren't eager to spend. Still wounded banks, meanwhile, aren't eager to lend. Business is sitting on about two trillion dollars in cash, and isn't eager to invest when it doesn't see customers.

Even 30-year mortgages at record lows of 3.5 percent interest have not revived the sagging housing market. The government, despite a token program of mortgage relief known as HAMP, has not been willing to get serious about reducing the principal of mortgages where the debt exceeds the value of the house.

Prospective buyers, no longer confident of whether housing is a good investment, continue to rent, waiting for housing prices to bottom out. But prices are still falling in most metropolitan areas.

Bernanke, under fire from conservatives in Congress and in his own Federal Reserve System for courting inflation (also at near-record lows), keeps sending the politicians delicately coded messages: The Fed can't do it all. He warns that things will be even worse if the economy goes off a "fiscal cliff" in January, when the Bush tax cuts expire and automatic budget-cut triggers go off unless Congress reaches a budget deal.

Bernanke means that all this would worsen the slump by producing an ill-timed fiscal contraction. What he almost says, but not quite, is that the economy needs a big dose of fiscal expansion -- more public spending even at the cost of a short run increase in the deficit, so that faster growth will bring the deficit down over time.

The Republicans would crucify him if he said that.

Bernanke's warning on the fiscal cliff, if anything, has been ill-used by the right as demonstrating the need for more tax cuts and more stringent budget balance, even though those two goals are at odds with each other and this is the opposite of what Bernanke meant.

Bernanke has also discretely prodded the administration to get more serious about solving the mortgage mess, since the Fed can't succeed on that front by itself either.

This message is also unwelcome, especially to the Obama Treasury, where Secretary Tim Geithner is determined to protect prettied-up bank balance sheets from booking any losses on underwater mortgages.

Bernanke is torn between protecting his institution and getting more aggressive about prodding the other branches of government to do their part. He defaults to protecting the Fed. Give him an A for effort, but a D for too much discretion.

Meanwhile, Mario Draghi, Bernanke's counterpart at the European Central Bank, lifted hopes and markets last week when he said that he would do whatever it takes to rescue the euro. Markets took this as a sign that the ECB would get a lot more serious about buying the government bonds of nations under attack by speculators in money markets.

So far, the ECB has bought less than $300 billion of European government bonds, while the Fed has bought around $3 trillion of securities to keep U.S. interest rates low.

But Draghi is under even more constraints than Bernanke. When the ECB was created in 1993, the treaty establishing the euro explicitly included a "no bail-out" clause. The Germans wanted to be certain that Europe would not become a "transfer union" and that stronger nations would not be responsible for helping weaker ones. As Europe has sunk back into recession, German Chancellor Merkel has appointed herself enforcer of this policy.

That in turn has led to utterly perverse responses to the speculative attack on the bonds of Europe's weaker peripheral economies. Just when Europe's financial markets are about to go off their own cliff, Merkel relents just enough to allow a temporary stopgap. The ECB gives Europe's banks a jolt of cheap loans. Or it buys government bonds on the secondary market, which does not technically violate the bailout clause and Mrs Merkel discretely looks the other way. Or the Europeans set up a jury-rigged facility with a clunky name (the European Financial Stability Facility) to buy the bonds that a real central bank should be buying.

To compensate for her lapse into monetary sin, Ms. Merkel then imposes even deeper fiscal penance on Greece, Spain, Portugal and Europe generally. Markets then rally briefly, borrowing rates for nations like Spain and Italy temporarily subside. But then it becomes clear that austerity is only driving Europe deeper into recession and that the European Central Bank lacks the will to prevent the next round of speculative attack. The same cycle has been repeated at least four times since the attack on Greek bonds began in late 2009.

What doomsayers about the euro forget is that Europe was on path to a (too-slow) recovery until hedge funds began betting against Greek bonds. But because of the Merkel austerity policy and the limits on its own authority, the ECB was not able to decisively take the other side of the bet and didn't even try until the fire spread to larger nations.

You can be confident that markets will slump again and Spanish and Italian borrowing costs will rise again as soon as investors realize that Draghi, despite his best intentions, can't quite deliver. His bank's board is due to meet Thursday, and the Germans remain adamantly opposed to allowing Draghi to get serious about bond purchases.

Draghi, like Bernanke, keeps warning that central bankers can't fix the economic mess by themselves. Europe needs to reverse its austerity policies, to take shared responsibility for dealing with the legacy debt of its weaker members, and to turn the ECB into a true central bank. None of this is likely to happen.

Draghi has done better at resisting the austerity hawks than his predecessors. He is certainly a breath of fresh air compared to the Bundesbank official who was in line to head the ECB, Axel Weber, who withdrew in protest against the pressure from other European governments to at least let the central bank make bond purchases on the secondary market. But Draghi does not have the leverage or the will to reverse Europe's larger economic folly and slide into deeper recession.

Draghi is a relative hero amid a very sorry lot. Like Bernanke, he puts the health of his own central bank first. Give him an A for effort and a D for too much discretion.

Robert Kuttner is co-editor of The American Prospect and a senior fellow at Demos. His latest book is A Presidency in Peril.