1.3 The arrival of the Euro and the European Central Bank
The ECB (founded in 1998) is a formally independent body charged with defining and implementing monetary policy for the EU. It holds the reserves of the national banks of those participating in the Euro-zone, and also has responsibility for the Euro exchange rate (see Section 1.5). This independence is ensured by the fact that the ECB does not have to ‘take instructions’ from any EU government or institution and it does not act as the ‘banker’ to the EU or its governments by granting them credit or managing their debt (a task undertaken by national treasuries or finance ministries). But its overriding goal is delivered to it by the Maastricht Treaty: to achieve price stability, though exactly how this is defined and how to achieve it is left up to the Bank to decide. Thus what the ECB has is not ‘goal independence’ but ‘instrument independence’ since it can only independently decide on how to best achieve the goal of price stability.
The most important role in the ECB is that of the president; and it was over the appointment of its original president that the first of what will no doubt be many battles between member states, in respect to the actual operation of the ECB, was fought. Two rival candidates emerged in 1999: the Dutch central banker Wim Duisenberg (favoured by the Germans and others) and the French candidate Jean-Claude Trichet (particularly favoured by the French). After several months of deadlock and fierce infighting, Duisenberg was appointed in a messy compromise that saw uncertainty about whether he would serve a full eight-year term or only a four-year term, giving way to Trichet in October 2003. However in October 2003 Trichet did take the helm, somewhat controversially, after being indicted by a French court for a banking scandal in 2002 (he was cleared).
The central problem encountered by the Bank in its management of monetary policy, almost since its inception, has been to balance its main concern with inflation – which implies a ‘conservative’ and restrictive stance vis-à-vis interest rates (i.e. keeping them high) – with the fact that the EU economy has been performing relatively badly in real terms, implying the need to keep interest rates low to stimulate business and commercial activity. By and large, and as might be expected, it has opted for caution in its interest rate and money supply policy, although it did drive interest rates down to 2 per cent during 2004–05. However, the bank reluctantly lowers interest rates only when under extreme pressure to do so, and has maintained a generally ‘tight’ monetary stance overall; although, as we shall see in the following paragraphs, one perhaps not quite tight enough to ameliorate all of its critics (European Commission, 2005a).
In the initial phase after the Euro was established there was understandably great uncertainty over the way in which the ECB should operate and the reaction of the financial system to its policies. But the bank may have added to this uncertainty by adopting a dual approach to monetary policy: neither a pure-inflation targeting approach nor a monetary-aggregate approach, but a combination of both of these. First it established its definition of price stability as a ‘year on year increase in the index of consumer prices in the Euro area of below 2 per cent’. Then it proposed to keep inflation rates to ‘below or close to 2 per cent over the medium term’ (usually understood as about three years). This was taken as a lack of a precise point target (‘below or close to’, and ‘over the medium term’ express the ambiguities). Furthermore, to achieve this it would monitor a money growth aggregate in the economy (termed ‘M3’) and take this ‘money supply growth’ as another indicator of possible inflationary pressures. It would also look at other relevant aggregates (various asset prices and macroeconomic measures) in making final decisions about interest rate changes. So, there is a range of possibly conflicting measures and aggregates that the Bank was to concentrate on in making its decisions about monetary policy, which was thought to have added to the confusion over what was actually being measured and monitored.
All of this was thought to offer a somewhat imprecise set of signals to the financial system about the Bank's policy stance. It does not rule out deflation (negative price changes) as an acceptable policy outcome, and 2 per cent or under is not the same as a zero inflation rate. In addition, Euro-zone actual inflation has been above 2 per cent over most of the operational period of ECB activity so far, though it has not acted to explicitly suppress this. These points are independent of the controversial link that the ECB establishes between growth of the money supply (M3) and inflation (that the growth of the money supply leads to inflation – a classic ‘monetarist’ position), although in its actual operational environment the reference money supply growth target of under 4.5 per cent per year has in practice been continually overshot. All this has gone towards raising concerns over the adequacy of its capacity to meet the goal commitment to defeat inflation.
During 2004–05 the EU economy was in a recovery phase, so the question of inflationary pressures moved up the Bank's agenda. In addition there was an increase in international oil prices and those of other raw materials (predicated on China's enormous demand for energy and raw materials), which could eventually feed back into domestic prices. But here the dilemma appears again, since the EU recovery was very weak (with unemployment at 9 per cent across the EU as a whole). Pressure for interest rate rises was acknowledged, however, confirming the suspicions of those opposed to the ECB's whole strategy in dealing with economic management and the governance regime imposed upon it by the Maastricht Treaty.
A further issue for the ECB has been the way it is governed internally. Apart from the importance of its president, already mentioned, there is a Governing Council made up of a six member Executive Board and the governors of the national central banks of those member states who participate in the Euro-zone. This Council makes the decisions. Thus, monetary policy decision making is centralised, but monetary policy operations are left to the participating national central banks to implement on the instructions from the Board – they are decentralised. It is this functional centralised and decentralised structure that is thought to impart another level of uncertainty and potential conflict into the overall running of monetary policy. In addition, if all the current EU members were to eventually participate in the Euro-zone the decision-making Council could have expanded to a possible thirty-two members, making it almost impossible to reach ‘sensible’ decisions. To address this, the ECB Council has been restricted to a maximum of twenty-four members with a rotating membership, but this is still a very large number for decision making.
The final issue circulating around the ECB concerns the transparency of its decision making and its political accountability. The bank is formally independent, as outlined earlier, though it must meet its externally imposed ‘political’ objective of controlling inflation. In addition there is the inevitable political wrangling over the appointment of its president. But to whom does the bank report on its conduct of monetary policy? Unlike several other central banks (including the Bank of England) the ECB does not publish the minutes of its meetings that decide monetary policy. This is thought to undermine its transparency. And it is only through a rather ill-defined process of ‘dialogue’ with the European Parliament, for instance, that the ECB can be formally called to account for its actions. Thus the political accountability and transparency of the ECB is weak and lacks comprehensiveness.