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Monitoring
the ECB The
inaugural MECB report was
published in October 1998. Entitled The
ECB: Safe at any Speed?, the report was written by David
Begg (Birkbeck College, London, and CEPR), Paul De Grauwe (Katholieke Universiteit Leuven and CEPR), Francesco
Giavazzi (Università Bocconi, Milan, and CEPR), Harald
Uhlig (CenTER, Tilburg University, and CEPR) and Charles
Wyplosz (Graduate Institute of International Studies, Geneva, and
CEPR). The authors argue that the ECB is not yet fully prepared to meet
its responsibilities and challenges and that many operational issues
remain to be settled. Even in a benign global climate, these
shortcomings could prove problematical; a deteriorating climate could
well expose the flaws in the design of the institution and undermine its
ability to manage a major financial crisis. The
report notes that the design strategy for the ECB intentionally sought
to emphasize its similarities to the Bundesbank. Despite a decade of
planning for EMU, however, many crucial decisions have been left
unresolved; and among the decisions actually made, a number contained
compromises that have weakened the Bank from the outset. Five basic
difficulties exist. First, much of the relationship between the ECB and
the European System of Central Banks has been left unclear. With the
existing central bank governors remaining in charge of their own
national institutions, but simultaneously controlling the ECB Council,
national perspectives are likely to persist and lines of authority to
remain ambiguous. Second, the monetary-policy strategy also has been
left (deliberately) ambiguous, which means that the transparency
necessary for accountability will be difficult to accomplish. Third, the
process by which monetary policy will be conducted – whether via
money-stock or inflation targets – has still to be determined. Fourth,
who is to speak for the ‘EuroXI’ in global institutions (such as the
G-7) in which both fiscal- and monetary-policy coordination issues may
arise both within Euroland and between Euroland and other major actors?
And fifth, like any central bank, the ECB will have substantial
discretionary powers – for example, in its regulatory and its
lender-of-last-resort roles. Yet the basis on which discretion will be
exercised is unclear. In
short, as with most previous moves to integrate European markets, and
contrary to the ECB’s own expressed beliefs, the monetary integration
process has led to weak central institutions reflecting national
disagreements and political compromise. In the authors’ view, its
flawed and incomplete design leaves the ECB both weak and unprepared,
especially where the flaws and incompleteness are symptomatic of deeper
disagreements. They therefore urge that steps be taken to strengthen the
ECB in relation to national central banks, whose governors will
otherwise retain too much power, inhibiting development of a truly
European perspective. Ideally, there should be more centralized
operating procedures, and the balance of voting power between the
ECB’s executive board and the national central bank governors should
be tilted in favour of the former. The
report acknowledges that such changes cannot happen immediately. None
the less, without them, there is a danger that the ECB will simply
repeat the mistakes made by the early Federal Reserve as a result of its
(the Fed’s) decentralized and disputed authority. Two early practical
steps could mitigate some of the danger. First, the resources available
to the ECB should be increased, so that it can develop its own research
and other support services in healthy competition with its national
counterparts; and second, a number of national central bank governors
should relocate to Frankfurt rather than continue to be based in their
national institutions. Turning
to the monetary policy issue, the authors argue that in seeking to prove
its mettle, the ECB will do itself no favours if it embarks on its role
in ‘foggy’ conditions. On the contrary, the Bank would benefit from
helping its many constituencies to watch and appraise its conduct. In
this respect, the report seeks first to debunk the myth that central
banks do care (or should care) about price stability to the exclusion of
all other goals. There is ample evidence that, in practice and on
average, most central banks follow a ‘Taylor rule’, in terms of
which interest rates are changed whenever either inflation or output
depart from set targets. Ex post,
it is clear that not even the Bundesbank has assigned a zero weight to
the output gap. There is thus no need for the ECB to display total
stubbornness in relation to price stability in order to establish its
reputation. Furthermore,
because monetary policy affects prices with a long lag, there is
considerable latitude in interpreting a mandate to pursue price
stability. For the same reason, the ECB cannot be held instantly
accountable for inflation. Consequently, it will have some discretion
about how quickly to achieve inflation targets. On the assumption that
the ECB inevitably will end up behaving like other responsible central
banks, economists will, in due course, uncover from the data its average
behaviour. In the interim, the ECB will gain nothing from seeking to
hide its normal behaviour. The
Bank should therefore adopt and announce the rule that it intends will
govern its normal behaviour towards interest rates when inflation and
output deviate from their target or trend paths. This would have three
advantages: it would help ensure systematic and consistent internal
decision-making; it would act as an important external communication
device; and it would act as a commitment device in the Bank’s
strategic interaction with both fiscal authorities and wage setters in
the EuroXI. The authors reject, as ‘unconvincing’, the three
arguments that have been advanced to justify reluctance to announce a
policy rule, namely that secrecy offers scope for ‘creative
ambiguity’; that, since the launch of the euro represents a ‘break
in history’ and a change in the policy environment, the consequent
structural uncertainty will render it more difficult for markets to
extract information signals from the Bank’s actions; and that the
world is ‘too complex’ for simple rules. Nor would there be any
danger that, in announcing the rule, the ECB would be limiting its
capacity to exercise discretionary powers in response to specific and
temporary circumstances that warrant departing from the rule. The public
would expect no less, just as it would expect the ECB to avoid
capricious or erratic behaviour. Announcement
of a rule would thus provide a benchmark against which to check that
discretion had no hidden systematic components. Since policy takes time
to work, however, announcement would also involve making public the
ECB’s forecast inflation and output growth rates for Euroland, which
would indicate in turn the expected deviations of these variables from
their targets. But the report also suggests that, on the basis of the
published forecasts, the ECB should go one step further and explain what
its normal rule would then imply for interest rates, and whether or not
it considered that any deviation from this normal reaction was required. In
essence, the report contends that there is no serious conflict between
transparency and effectiveness. On the contrary, transparency would
assist markets, and improve both the ECB’s accountability and the
quality of its decision-making. Changes in interest rates should be
accompanied by a public explanation of why rates were changed, including
any evolution in the forecasts of economic conditions. Votes cast by
individual members of the Governing Council should be made public after
a short time. On the question of the policy rule itself, the report
comes down firmly in favour of an inflation-rate, rather than a
money-stock growth-rate target. Whatever the chosen target, however, the
imperative of communicating the strategy to the public remains. The
report also deals at some length with some of the more specific
challenges that will face the ECB in its first year under two
alternative scenarios: (1) if the economic climate in Europe remains
relatively benign; and (2) if the global environment deteriorates
significantly. The authors note first that the ECB will face two
problems not encountered by the US Fed: labour markets are more rigid,
potentially giving rise to more persistent recessions; and fiscal policy
is in the hands of 11 uncoordinated authorities, giving rise to
potential free riding by each fiscal authority. The ECB should strive to
avoid hard landings, but it cannot succeed if any monetary tightening
becomes the excuse for fiscal expansion by individual member states.
Since politicians care even more about recession than the ECB, labour-market
rigidities may actually enhance the Bank’s threat to create recession
if fiscal discipline breaks down. It may be possible to sustain some
cooperation between fiscal and monetary authorities. The EuroXI
committee would then play a key role in coordinating fiscal policies
among EMU members. Second,
there is no guarantee that the expensive TARGET payments system will
actually be used for large-value transactions. Alternative private
settlement systems will be vulnerable in a crisis, however, and may
force the ECB to act as lender of last resort. More generally, financial
regulation within EMU is at present unsafe. No secure mechanism exists
for creating liquidity in a crisis, and there remain flaws in proposals
for dealing with insolvency during a large banking collapse. Asymmetric
national exposure to risky foreign loans may lead to conflicts about the
appropriate response. In the longer run, centralization of regulation is
essential. Third,
a global crisis would set off the deflation already evident in Japan.
Although deflation is a symptom of deeper causes, such as failures in
bank regulation, it is also damaging in its own right since it escalates
the real burden of debt repayment. It is therefore important that the
ECB should pay as much attention to avoiding undershoots of its target
inflation range as it pays to avoiding overshoots. The
ECB: Safe at Any Speed?, Monitoring
the European Central Bank 1 ISBN 1 898128 39 1 |