Draghi’s Go-to ECB Seen Risking Credibility Through Overload
The European Central Bank president is taking on more and more responsibility to keep the currency bloc afloat, from propping up bond markets to monitoring fiscal policies and assuming supervision of the region’s 6,000 banks. Economists, academics and officials past and present say the ECB is at risk of becoming overloaded, which could erode the credibility it needs to achieve its primary goal of price stability.
“The ECB saved the euro,” says Andrew Bosomworth, managing director at Pacific Investment Management Co. in Munich. “But the extra responsibilities, in particular its supervisory role, put additional burdens and risks onto its mandate.”
The ECB has been the euro area’s go-to institution during the sovereign debt crisis, filling the void as governments procrastinate and squabble over how to fight the turmoil. Unencumbered by the need to win votes, the ECB’s ability to act quickly has seen it steadily accrue new roles and made its president at least as powerful as Europe’s elected leaders.
Draghi yesterday left interest rates at a record low and said the ECB stands ready to intervene in bond markets if governments sign up to fiscal and economic reforms.
Draghi won international praise -- from Bank of England Governor Mervyn King to U.S. Secretary of State Hillary Clinton -- after his promise of unlimited bond purchases reassured investors that the euro has a future.
Earlier this year, bond yields in countries like Spain and Italy soared amid fears of a euro breakup, driving up borrowing costs for those governments in spite of the ECB’s historically low rates.
Yields plunged after Draghi first hinted at his bond-buying plan in late July. The rates on Spanish and Italian 10-year debt have fallen by more than 200 basis points, and Greece’s has almost halved to 15 percent.
Under Draghi, the ECB has recognized that “keeping the euro zone intact is part of its mandate,” French Finance Minister Pierre Moscovici said last month. “The ECB is doing what is needed to fill its role.”
Still, the ECB’s primary role is to keep prices stable, and it knows that its credibility is key to achieving that.
While inflation expectations, as measured in the ECB’s survey of professional forecasters, on average remain consistent with the central bank’s 2 percent target over the medium term, skepticism has risen consistently since the outbreak of the global financial crisis in 2007.
In the latest ECB survey, economists assessed the probability of inflation being over 3 percent in the medium term at 8.8 percent. That’s up from 3.4 percent five years ago.
“The ECB is generally seen as a good institution that is credible and professional,” says Nick Kounis, head of macro research at ABN Amro in Amsterdam. “If the new duties are not carried out properly though, that credibility is put at risk.”
The next job for the ECB is supervision of all 6,071 banks in the euro area. The single supervisor is a key pillar of the banking union proposed by European Union leaders in June and a precondition for Europe’s bailout fund to start recapitalizing ailing lenders in countries like Spain. The reasoning is that joint liability has to be matched by joint supervision.
The ECB expects to gradually assume its new role over the course of next year, with full implementation by the start of 2014. The move may give it the power to withdraw banking licenses, approve or reject mergers, fire bankers and set their bonuses, draft documents show.
European finance ministers face an end-of-year deadline to have the legal framework finished, with Germany suggesting it may try to limit ECB oversight to only the biggest lenders. Ministers, who failed to reach agreement this week, will hold an emergency meeting Dec. 12 before a leaders’ summit the next day.
“I’m very confident we’ll reach an agreement,” Draghi said yesterday. “The benefits of having one single supervisor for the euro area are not disputed.”
Even as governments wrangle over the exact configuration of the ECB’s role, some politicians are asking whether there are enough mechanisms in place to hold the independent central bank to account.
The European Parliament’s Committee on Economic and Monetary Affairs, which questions the ECB president four times a year, may need to be given more teeth, says chairwoman Sharon Bowles.
“It is a fine line,” says Bowles. “You want central banks actually to be free from political interference, but when you start taking on additional powers and you are going beyond price stability, then maybe there is a question -- does the same independence cover you?”
Further complicating the issue, the supervisory role could create a conflict of interest for the ECB that compromises its ability to fight inflation.
Policy makers risk having their monetary policy judgment clouded by supervisory concerns, such as whether raising borrowing costs could endanger the health of an individual bank, says Klaus Baader, the former co-chief European economist for Societe Generale in London who now covers the Asia-Pacific region.
For that reason, Draghi has said the roles must be strictly separated. Yet the EU treaty states that the Governing Council is the central bank’s primary decision-making body, meaning it may be impossible to fully split the two in the current framework.
The dilemma illustrates the kind of pressure the ECB is under as the monetary union is forced to rapidly evolve to prevent the debt crisis from tearing it apart.
“It completely overburdens the central bank,” says Juergen Stark, who quit the ECB’s Executive Board last year. “What’s worse is the ECB is actively helping to make itself into the scapegoat for governments if something goes wrong.”
Draghi’s so-called Outright Monetary Transactions program is another example of the risks posed by ECB activism. While the plan has again hauled Europe back from the brink, it has also fueled inflation fears in Germany, Europe’s largest economy.
The Bundesbank, whose iron grip on prices after World War II helped to soothe German memories of 1920s hyperinflation, was the only national central bank in the euro area to vote against the latest bond-buying plan, saying it is tantamount to printing money to finance governments.
‘Out of Mandate’
Stark, a former Bundesbank vice president, calls Draghi’s OMTs “Out-of-Mandate Transactions.”
According to a Stern magazine survey published Sept. 6, only 18 percent of the German public view Draghi favorably.
Draghi has countered German concerns with the argument that the ECB has to regain control of interest rates to maintain price stability and fulfill its primary mandate. The OMT program also commits governments to making reforms and the ECB says it will stop purchases if the conditions are not met.
“The design of the OMT is so cleverly done,” says former ECB board member Jose Manuel Gonzalez-Paramo. “I understand the concerns, but the ECB has shown it will stop when it makes no sense to continue. The ECB is very responsible.”
The risks inherent in the ECB’s growing power may not have escaped Draghi, who has stepped up his communication efforts and sought to limit the central bank’s involvement in fiscal matters.
He explicitly backed German Finance Minister Wolfgang Schaeuble’s call for a beefed-up EU economic and monetary affairs commissioner who could reject national budgets if they’re judged to be too lax. He also wants the International Monetary Fund to police whether a government is meeting the conditions it agrees to in return for bond purchases.
At the same time, Draghi has pointed out that the ECB is probably the only European institution immediately capable of solving some of the region’s problems. In a speech in Frankfurt on Nov. 23, he confronted concerns about overloading the ECB with supervision duties head-on.
While those concerns “must be taken seriously,” building a single supervisor around the ECB “is the only pragmatic” option “in the present circumstances,” Draghi said.
At the end of the day, there will always be unease about the enormous power of a central bank, says Gonzalez-Paramo.
“This is always the debate that surrounds independent institutions,” he says. “Legitimacy means a central bank is faithful to its mandate. Central banks are natural scapegoats, and this is part of the job.”
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