Arguably, the seeds of future conflict were already sown when the European Central Bank, the monetary lynchpin of the euro zone, opened its doors with great fanfare on June 1, 1998. The first president was a Dutchman, Wim Duisenberg. The second was a Frenchman, Jean-Claude Trichet. The third and current one is an Italian, Mario Draghi. And all three have resolutely stood their ground against the demands of Europe’s self-serving politicians.
Yet the euro has always been a political project, beginning with a softening of the EU’s debt criteria in the early 2000s to enable iffy candidates to join the euro club, and to keep its more profligate spenders happy. (Germany, though fond of preaching financial restraint, has for years exceeded the EU’s limits on outstanding debt of 60 percent of GDP.)
Now, in the final stages of his presidency, Mr. Draghi faces a daunting challenge. With the election of a populist government, his native Italy is moving even further away from the financial discipline laid down by Brussels to preserve the euro’s stability. Talk of creating a sort of parallel currency to the euro has alarmed fellow EU members, wary of a Roman ploy to extract debt relief in exchange for keeping the euro zone intact. Against this troubled background, the question arises how the ECB can maintain its independence.
Officially, the ECB has only one mandate: price stability. But Massimo Rostagno, its director general of monetary policy, says the bank also sees itself as the guardian of the euro. When Mr. Draghi vowed in 2012 that the ECB would “do whatever it takes” to defend the euro zone, it was a legitimation of this unofficial task.
For the ECB, its commitment to the euro is both a strength and a weakness. The institution is bolstered by the assumption — or mere hope — that the euro zone’s 19 members will stick together to preserve the single currency. But this also undermines the ECB because the financial markets and even German politicians, among the ECB’s most vocal critics, rely on it to save Europe when crisis strikes.
In contractual terms, the ECB’s independence is better secured than that of the US Federal Reserve, which is ultimately “a creature of Congress,” said Peter Hooper, chief economist of Deutsche Bank Securities in New York. But treaties are no bullet-proof guarantee against political pressures.
Otmar Issing, the conservative former chief economist of the ECB, warned in an interview with Handelsblatt that central banks now face a de facto loss of independence. Gerhard Schick, fiscal spokesman for the Green Party in the Bundestag, Germany’s lower house of parliament, expressed a similar view. If two such politically different personalities are worried about the ECB, then there must be something to it.
Granted, the ECB has performed well under the circumstances. Since the ECB was founded, inflation in Germany has been consistently lower than in the half-century under its beloved Deutsche Mark, a delight to stability-minded Germans. More recently, the ECB has also made progress in staving off deflation. In May, inflation in the entire euro zone rose to 1.9 percent, reaching the ECB’s target of “below, but close to two percent” for the first time since February 2017.
Supporters believe the ECB’s stimulus — best exemplified in the controversial mega-purchases of EU sovereign bonds — stopped Europe’s economy from going over the brink after the financial and euro crises. But the cost has been staggering, ballooning the ECB’s balance sheet to 40 percent of euro-zone GDP (see chart below). The Fed’s assets, by contrast, have never exceeded one-quarter of US GDP, even after the meltdown of Wall Street banks and subsequent rescue packages in 2007-08.
Structural reforms and smarter, more harmonized fiscal policy are sorely needed to ease the burden on monetary policy. But coordinating this goal in 19 euro countries is like herding cats. Sweden’s finance minister, Magdalena Andersson, raised eyebrows recently by suggesting that the Riksbank, the national central bank, cede some of its independence to financial policy in the event of a crisis. To Ms. Andersson’s backers, it was a sign of deepening cooperation for the greater good, both within Sweden and the EU; to defenders of the independence faith such as Mr. Issing, it set off the alarm bells.
What does all this mean for the ECB’s future? “In the long term, central banks cannot control their own reputation and independence,” says Mohamed El-Erian, chief economic advisor to German insurance giant Allianz. Much depends on whether governments are willing to free central banks from burdens to stimulate the economy, implementing growth-oriented policies themselves.
In the short term, the ECB is likely to come under renewed political pressure when, as many analysts expect, it ends its bond-buying program later this year and raises interest rates from the current zero percent. And it will have new gadflies in Rome. Italy’s ruling populist parties both have records of anti-euro views and comments. Governing a chronically over-indebted country, the new Italian government will howl in protest as borrowing costs rise.
Under one scenario doing the rounds, Rome could threaten to leave the euro unless the ECB writes off some or all of the €250 billion in Italian bonds it holds. At that point, the ECB could come under concerted pressure, not just from Brussels but from those nations that profit most from the euro, to make its most unpleasant choice.
Jan Mallien covers monetary policy for Handelsblatt in Frankfurt. Jeremy Gray is an editor for Handelsblatt Global in Berlin. To contact the authors: firstname.lastname@example.org, email@example.com