European Central Banking
Lessons from the US

Many important questions concerning the structure and operations of the proposed European Central Bank (ECB) remain unanswered. In Discussion Paper No. 585, Research Fellow Barry Eichengreen argues that the founding and early operations of the Federal Reserve System in the US may provide lessons for policy-makers in Europe today. The district banks initially retained control of their discount policies, which gradually transferred to Washington when the problems this entailed became apparent. The new institution did not overcome the remaining interregional conflicts and implementation problems, however, until the Board of Governors and the Federal Open Market Investment Committee took full control. Eichengreen notes four general lessons that will be relevant to Europe in the 1990s.
First, once monetary unification has been achieved, any attempt to control monetary policy at the national level will endanger the ECB's stabilization function, since no national central bank will have an incentive to internalize all the spillovers its actions create. There is broad agreement on the need for central control once the ECB comes into operation, but policy-makers have largely ignored the dangers of continued national autonomy in Stage Two. Second, if policy-makers allow controversies over the role of national central banks to remain unresolved when the ECB comes into operation, they will act independently to demonstrate their autonomy and the ECB will respond strongly to assert its authority. Such a process led to disastrous delays in implementing policy in the early history of the Fed. Third, the draft statutes of the ECB leave open major politically-charged issues of autonomy and control that require explicit answers before it comes into operation; the attempts of the drafters of the Federal Reserve Act to circumvent such issues led directly to the disputes that disrupted policy for two full decades. Fourth, the ECB's draft statutes stress its role in maintaining price stability; but it is not clear that policy will respond to new requirements if the main problem at some future date is not inflation but bank insolvency or some other source of financial instability. Nor will the adoption of explicit rules and restrictions necessarily help in the long run. The centralization of the Fed's authority in the 1930s allowed an institutional structure to emerge that increased the influence of the factions who least appreciated monetary policy's potential to counter the Great Depression. The Fed's architects' failure to anticipate the importance of open market operations and the problems created by the gold constraint should serve as the ultimate warning to European policy-makers today.

Designing a Central Bank for Europe: A Cautionary Tale from the Early Years of the Federal Reserve System
Barry Eichengreen

Discussion Paper No. 585, October 1991 (IM)