The claim that the European Central Bank was independent of any political interference was always a little difficult to substantiate. Membership of its governing committee was rigidly tied to nationality even though members were expected to vote in the general European interest. Recently, French President Nicolas Sarkozy insisted that Italy retire one of its members in order to avoid there being two Italians – and no Frenchmen – within the upper echelons of the ECB. Neutral indeed. Nevertheless, the ECB’s creation was perhaps the best expression of the belief that short-termist and self-serving politicians need to keep their hands out of the monetarist policy pot. In the monetary policy jargon, this is all about ensuring that central banks can issue ‘credible commitments’ to the markets. So when they say they are going to be tough on inflation, everyone believes them.
Recent events have suggested that the ECB’s independence is being steadily mined by the ongoing Eurozone crisis. One reason is because of the faultlines exposed by the crisis, with the ECB being firmly located on one side of the growing gulf between creditor and debtor interests across Europe. The ECB, and particularly its out-going director, Jean-Claude Trichet, has consistently argued against anything that might look like default on the part of those countries signed up to an EU bail-out package. In so doing, the ECB has put itself forward as the leading defender of the private creditor interest in Europe. Neutral indeed. Most recently, the ECB declared its intention to raise Eurozone-wide interest rates 0.25%, from 1.25% to 1.5%. This is in order to quell inflation, the result of food and energy price-hikes, which some think will provoke higher wage claims in the Eurozone’s bigger economies. The response from Ireland, Greece and Portugal was immediate: does the ECB not realize that in raising rates it is making it even more difficult for these countries to repay their loans?
The second reason is more subtle but also more important. Whilst being officially a non-political body authorized to deal exclusively with Eurozone monetary policy, the ECB has been getting steadily more involved in fiscal policy, notably in providing cash-stricken Eurozone members with much needed liquidity. The ECB, like any central bank directed by political concerns, has been acting as lender of the last resort. It has for some time been keeping the Greek banking system afloat. To date, the ECB has provided about 100bn Euros in loans to Greek banks, in exchange for Greek government bonds classified as junk by the markets.
The official reason why Trichet declares himself so fervently against any default by Greece is that it will create “contagion” in the markets: if Greece defaults, will private investors not believe that Portugual and Ireland will also do the same? But there is another reason why a Greek default would be a problem for the ECB. It would force it explicitly out of its independence shell and into the terrain of political choice. With Greece in default, the ECB could abandon the country’s banking system by ending its loans. Or it could make its role in fiscal policy explicit, providing finance to governments shut out of international markets. This is a choice both Trichet and national governments would rather avoid as it would force them to reveal their cards about whether they support closer political union within the Eurozone. Whilst central bank heads and member states may disagree on this point, they all seem to agree that they’d rather not be forced to have a public debate about it. A Greek default would make that debate increasingly difficult to avoid.