Wednesday, January 12, 2011

Has the ECB's Independence Gone Up or Down?

. Wednesday, January 12, 2011

The question in the title refers to the fact that central bank independence usually refers to the isolation from the political process that a central bank has in setting policy. Traditionally, the ECB has been considered to have a lot of independence. But it has also had a very narrow, strict mandate: to promote price stability in the eurozone. It did not have a mandate to promote full employment. It did not regulate the European banking system. It was not a lender of last resort. So the ECB's freedom to pursue the goal of price stability was very high, but pre-crisis its freedom to pursue other goals was very low. Depends on what you mean by independence.

That's all changed over the past few years. The Financial Times' stupid, self-hurting TOS prevent cutting, which means (among other things) that I've been linking to them a lot less frequently than I used to, but this article is worth highlighting. Who would have thought in 2006 that the ECB would be intervening in bond markets to prop up Portugal's debt auction? Portugal says it does not need a bailout, but this is a bailout. It's just a monetary bailout rather than a fiscal bailout. The ECB intervened so the auction wouldn't fail.

At this point the ECB looks like the main thing holding EMU together. And it's able to do it because, unlike national governments, it doesn't have to face an election following a fiscal transfer to the PIGS. It can just intervene when necessary, serving as the "lender of last resort" that it claims not to be. In other words, its scope of authority has been greatly expanded since the crisis began, without (as far as I know) any new statutory authority being given to it.

The ECB is still not pursuing employment-boosting monetary policies, but by buying the debt of needy countries it is in effect subsidizing fiscal policies that could boost employment. The alternative is austerity, either self-imposed or demanded by the EFSF/IMF, which involves major internal contraction. And while the ECB is not regulating banking sectors, it is doing whatever it can to prevent a banking collapse, especially in Spain. If the ECB hadn't overstepped its official mandate back in 2007-8, there is little question that the entire European banking sector would have melted down by now.

So the ECB is now acting more like that Fed than it had pre-crisis. I would consider that an increase in the ECB's independence, because it can act in more ways to promote the economic well-being on Europe. The difference is that the Fed has a political mandate to act the way it does. The ECB does not. By intervening in bond (and other) markets, the ECB is essentially spreading the credit risk of the eurozone's riskiest governments across the entire union. If this were properly understood in Frankfurt it would be deeply unpopular. Perhaps it is; my thumb isn't enough on the pulse of Euro domestic politics to know.

There are political battles on the horizon in the eurozone. It will be interesting to see the fate of the ECB in the coming years. My guess is that Europe's leaders will see that a stronger, more flexible ECB would make fiscal union less necessary; given that, I expect the ECB to retain its new-found authority, and perhaps get some more. We'll have to see.


Has the ECB's Independence Gone Up or Down?




Add to Technorati Favorites