The end of independence

11 Jul

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.

4 Responses to “The end of independence”

  1. Art July 11, 2011 at 1:08 pm #

    I don’t disagree with your analysis, but Trichet’s concern with “contagion” goes beyond the fact that default in Greece might heighten investor concerns about other sovereign debt. As a banking technician, he’s also worried that a “default event,” which, depending on the legal language, might also include restructuring short of actual default, might trigger credit default swaps held by many players in the financial system, weakening or breaking the capital positions of the CDS issuers, which include many European private banks and insurance companies. In short, he’s worried about a Lehmann-like event, which would have consequences that cannot be calculated in advance, given the murkiness of the CDS market.

    In any case, I’m not sure that the ECB is any less legitimate as a political actor than the EU Council of Ministers or the European Commission. All are “emanations,” as the US Supreme Court might say, of the will of the people, but only in the most indirect sense. The democratic deficit afflicts them all.

    The banking function was separated out because of the credible commitment problem you emphasize, but if it remains quite insulated from popular rumblings, so do the other EU executive institutions. The difference is not so much political as philosophical: the ECB’s mandate is not a dual mandate like the Fed’s, and that is because it was necessary to placate German fears of inflation in order to get consent to a single currency.

    Dividing interests as you do between “creditors” and “debtors” allows you to avoid the more difficult question of what a “democratic” adjudication of the question would yield. Given the strong opposition to any bailout of the PIGS among rank-and-file voters in Germany, the EU’s most populous country, I’m not at all sure that a “democratic” result would be any more “debtor-friendly” than current policy. Indeed, it might conceivably be less so. The surge of right-wing populism in many northern countries is driven in part by an unwillingness to assist the allegedly “lazy and shiftless” PIGS (never mind that Greeks work longer hours than Germans). A populist electoral verdict might well prove more punitive to both creditors and debtors than the kinds of “technical” solutions coupled with “auserity” policies currently being pushed by “elitist” EU institutions, including the ECB.

    • Chris B July 11, 2011 at 3:20 pm #

      I agree that Trichet’s concern also is about a Lehmann-scenario in Europe though I think there is something self-fulfilling about the ‘contagion’ argument: it posits the risk of a complete unravelling in a way that makes that more likely. On the problem of the ECB and the democratic deficit, I also agree. I don’t think the ECB is necessarily in a worse state; the difference is that its mandate is explicitly technical and yet it is being drawn into political decisions today. Other institutions, like the European Council, are more obviously places where political decisions can be made, even if leaders shy from doing that very openly. On the final point, I think you concede too much. I wouldn’t give up German democracy to the populists just yet. And in any case, the merit of democratic adjudication at the national level is that we can get involved, argue our case, and try to influence the result. Such involvement is much more difficult at the EU level and takes the form of lobbying and consultation rather than public debate.

  2. davidbick01 July 11, 2011 at 2:35 pm #

    Talking of fiscality and the BCE, a point that’s struck me has been the way the BCE, IMF, finance ministers of the EU et al have been imposing rigorous fiscal policies on countries like Ireland and Greece, to the point of ruination of large sectors of the population. That is not being politically “neutral” in any sense of the word either.
    The case of the UK going through intense austerity, a devalued currency and a painful resurgence of manufacturing is surely a good source of comparisons with other parts of the world? It would be good to bring Great Britain into the picture from time to time.

    • Chris B July 11, 2011 at 3:22 pm #

      The austerity packages attached to the bail-outs are certainly not neutral, that’s a good point. The ECB’s problem seems to stem from the fact that the Eurozone as a whole is fundamentally unbalanced: different rates of growth, different labour market institutions, varying levels of competitiveness. Under those conditions, no policy can ever be neutral and monetary policy especially hits savers and borrowers differently.

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