The ECB was modelled on the German Bundesbank. As a result, it is one of the world’s most politically independent central banks; its mandate is focused narrowly on price stability; it does not take broader economic goals like unemployment into account in the way other central banks, such as the Fed, do; and it is de facto more restricted than other central banks, since controversial measures can lead to complex political and legal struggles, involving 18 (soon to be 19) countries. Its setup and philosophy are therefore ‘German‘, that is, conservative and cautious.
In terms of the ECB’s conduct of monetary policy, it is worth distinguishing between the pre- and post-crisis periods. A wide range of studies have so far failed to establish a firm consensus on the influence of various countries on the ECB during the euro’s first decade. However, most studies have found that the ECB behaved like a multinational central bank, in which each country has a weight proportional to the size of its economy. This gave Germany a higher weight than other countries because it is the largest economy in the eurozone. But it is hard to argue that there was a German bias at the ECB before the crisis.
In the post-crisis period, the ECB has failed to stabilise the economy, and inflation has fallen to just 0.3 per cent. It is tempting to see this as the product of a German bias, because the German economy has suffered least from the ECB’s hesitation to do more. But it is hard to argue that German pressure prevented the ECB from lowering rates faster during the last two years, for example, or managing the inflation expectations of consumers and investors more aggressively. Rather, the ECB’s misjudgement of the economic dynamic in the eurozone prevented a more timely and aggressive stance.
However, now that the ECB has to move further into unconventional territory to correct its previous errors – potentially by buying government bonds – Draghi has taken German resistance into account and delayed quantitative easing (QE). German policy-makers and commentators argue that further monetary easing will not stimulate the eurozone economy much, but risks encouraging excessive risk-taking and asset price bubbles that could breed future crises. They also claim that buying government bonds would lower the pressure on governments to reform, and adjust their economies and budgets.
This raises the question of why German approval is needed at all. In the governing council of the ECB, all relevant monetary policy decisions are taken by simple majority, with the smaller countries having one vote each, and the larger countries traditionally two (because of the additional votes of executive board members). Some of the more fundamental decisions, like recapitalising the ECB, need a two-thirds majority, based on the ECB’s capital shares, but even then Germany has no veto. What is more, there is currently a clear majority for more aggressive ECB action in the council, which Draghi can draw upon whenever he decides that the time is right. Formally, there is no need for German approval, either from Berlin or from the Bundesbank.
Why, then, is Draghi waiting for German approval? There are two possible reasons. First, he might consider it unwise to conduct monetary policy in the face of opposition from the largest eurozone country. There is some merit to this view but it loses validity when the ECB is failing to fulfil its inflation mandate by a wide margin, as it is now. Not only is inflation below the target of 'just below, but close to 2 per cent inflation'; expectations of future inflation have fallen steeply – a source of alarm even to conservative central bankers. Expanding the scope of monetary policy is therefore a matter of urgency, regardless of which country is opposed. It is with good reason that the statute of the ECB is not limited to a narrow definition of monetary policy but allows the purchase of ‘marketable assets’, including government bonds in the secondary market.
In such circumstances, Draghi should not let himself be bullied by the macroeconomic views of a single, if powerful country – views that few share outside Germany. Even the relatively cautious OECD has now come out in favour of further monetary stimulus, and the IMF has been urging the ECB to do more for a while. Given that the Fed and the Bank of England have bought government bonds on a massive scale, the ECB would be well in line with consensus views on monetary policy if it did the same.
The second reason why Draghi might want to get Germany’s backing is that he may fear losing the German government’s consent for the ECB’s other operations, which are not strictly monetary policy. The most important of these, of course, is the OMT programme, which was announced during a panic-driven run on eurozone government bonds in the summer of 2012. The ECB declared that it intended to buy unlimited quantities of these bonds if the panic did not subside – which it then duly did. This programme makes the ECB the implicit guardian of the eurozone as the lender of last resort to governments, but the OMT is in part a fiscal operation. Without the support of Germany, the country with the deepest pockets, the OMT might fail. Draghi therefore does not need the Bundesbank’s support but that of Merkel and the German government – which has backed him on the OMT.
However, Germany’s attitude towards the OMT should not be misunderstood. The German government understood very well that the eurozone might collapse if the ECB did not intervene in the summer of 2012. In fact, one could hear a collective sigh of relief (some say the sound of popping champagne bottles) in Berlin after the ECB took on the de facto role as lender of last resort to sovereigns – despite shrill German press coverage warning against such a step. Regardless of whether the German government approves of further easing of monetary policy, it would still back the OMT. Draghi should therefore not be overly concerned that further, unconventional monetary easing would threaten his role as guardian of the eurozone.
The outstanding legal challenges to the OMT do not change this. Even if the German constitutional court were to forbid the Bundesbank to take part in such a programme in the end – a drastic but conceivable outcome – the basic idea behind the OMT would still survive. The question that the OMT has answered is how far Germany would go to save the eurozone from breakup. Germany has tacitly approved the nuclear option, using the very deep pockets of the ECB as a backstop for government bonds. Even if the legal details of the OMT programme turn out to be tricky, this answer is still the same: Germany and the ECB are determined to avoid a break-up of the eurozone and a panic-driven run on eurozone government bonds. The history of the euro crisis shows that if there is a will, European policy-makers remove the legal roadblocks that might stand in the way. The market will therefore not bet against Germany’s and the ECB’s resolve to keep the eurozone intact.
Waiting for German consent has been Draghi’s biggest mistake in office, since waiting imposes considerable costs. The most important task of a central bank is to keep the expectations of consumers, firms and investors about the future state of the economy on a reasonably optimistic path. Waiting for German approval in the face of a weakening economy undermines these expectations, making the job of lifting expectations that much harder, once the central bank does decide to act. Draghi has wasted precious time – the ECB should have started to act aggressively in spring 2013 – and is now being forced to use controversial measures on a large scale to turn the economy around. Whether those measures will succeed is still uncertain.
Draghi is not the only one to blame, however. The Bundesbank enjoys huge credibility in the German public. It could easily stand publicly behind the ECB and thus foster an environment in which the ECB can act more aggressively, which most economists agree is desperately needed. At the very least, Jens Weidmann, the head of the Bundesbank, needs to stop undermining the ECB in the eyes of the German public. Likewise, Wolfgang Schäuble, Germany’s finance minister, and Angela Merkel should back the ECB openly, and pressure the Bundesbank to do likewise. After all, one reason for the weak state of the eurozone economy is Germany’s reluctance to accept more expansionary fiscal policies in the eurozone and at home.
Christian Odendahl is chief economist at the Centre for European Reform.
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