The ECB's New Boss

Will Jean-Claude Trichet be able to make the substantive changes needed to support the euro and get growth going?

It's not the heavy antique desk or centuries-old, gilt-framed portraits visitors notice when they enter Jean-Claude Trichet's elegant first-floor office at the Banque de France, where he has served as governor since 1993. What immediately catches the eye is a brightly colored abstract painting -- a prewar work by Hungarian-born, Paris School artist Emile Lahner -- hanging behind Trichet's chair. "It represents modernity," says the incoming head of the European Central Bank. "You sometimes need reminding of that in an institution that is more than 200 years old."

Trichet says he may take the painting with him when he moves to Frankfurt in November to take charge of the five-year-old ECB. As president of the complex, multinational organization that sets interest rates for the 12 countries using the euro, he will need all the inspiration he can get. In his new job, he will oversee monetary policy for the world's second-largest economy, home to 305 million people, and will head the only institution with a mandate to set economic policy for the entire euro zone. Trichet notes that there is no European counterpart to the U.S. Treasury that sets and manages a euro zone budget. In other words, the ECB, in its unique power to shape Europe, is on its own.

Trichet may give Europe's young central bank a powerful, politically savvy president. He will replace Wim Duisenberg, a towering, white-haired Dutchman known for his hawkish monetary policy and, early in his term, glaring gaffes. The latter shouldn't be a problem for his successor, who is famous for his savoir faire. But will Trichet also make more substantive changes at the ECB, whose four-year-old euro has the potential to become a global reserve currency? Other central bankers, along with business executives, politicians, and pundits, have been trying to read Trichet's tea leaves ever since it became clear he would be exonerated in an investigation of his role in an old scandal involving the Crédit Lyonnais bank. "The questions are, first, whether he will be more of a hands-on president than Wim and, second, whether he will favor a more flexible approach to monetary policy," says one official at a non-euro zone European central bank.

Trichet is not tipping his hand. Admirers assert his appointment will have a big impact. "Here we have the largest central bank in the world after the Fed, and one of the planet's greatest central bankers will now head it," says Daniel Bouton, chairman of France's Société Général bank. "The whole weight of the ECB is going to be seriously increased."

Trichet has run France's central bank with aplomb and hasn't shrunk from driving interest rates sky-high to protect the franc or from confronting powerful politicians he deemed too fond of public spending. That toughness indicates to some that Trichet will be a much more activist ECB head than Duisenberg. They think he will try to convince his fellow ECB governors to spur growth and fight inflation more aggressively with interest-rate moves. They also think he will try to influence overall euro zone economic policy. A lifelong civil servant, he's known as much for his razor-sharp political instincts as for his polished, diplomatic demeanor. "To have real power [at the ECB] you need to be persuasive and win people over," says Alexandre Lamfalussy, the former head of the Bank for International Settlements and also the European Monetary Institute, the precursor of the ECB. "And Trichet has shown that he has the ability to get ideas across." One area where observers say he may seek to make his mark early: pushing to raise the ECB's 2% ceiling on inflation tolerance to promote faster growth.

Trichet takes over at a particularly challenging time for the bank and the $7.7 trillion euro zone economy. Europe is underperforming, pulled down by sluggish growth in Germany, France, and Italy. The French and Germans are squabbling with other European Union ministers, who are irked that the euro zone's two largest economies are breaking the rules governing the size of their budget deficits. In addition, the ECB's mandate will soon expand dramatically, with 10 new nations scheduled to enter the EU in May. All of them are expected to seek admission to the 12-nation euro club within five years. "The ECB's structure is already cumbersome, and it will be even more so when the 10 new countries join the EU," says Martin Essex, an ECB watcher at Capital Economics Ltd. in London.

To address these issues, many think the ECB needs a hands-on, Alan Greenspan-type president. Over the past five years, Greenspan's Fed has clearly acted more aggressively than the ECB. While the Fed's benchmark rate peaked at 6.5% in May, 2000, and fell to 1% in June this year, ECB rates rose to 4.75% in October, 2000, falling to 2% in June, 2003. The affable Duisenberg, who likes the ECB to reach decisions by consensus, won plaudits for keeping a steady hand on the tiller during his five-year tenure. But critics say Duisenberg's shop moved too slowly and timidly over the past two years to fend off recession.

Proponents of change want the ECB's new president to forge closer ties with EU finance ministers and encourage a more flexible, Federal Reserve-style approach to monetary policy that bases rate movements on growth as well as inflation. True, under the terms of the Maastricht Treaty, which paved the way for economic and monetary union in Europe and laid down the ground rules for the ECB, the bank's primary mandate is to ensure price stability. But there is some wiggle room: It's up to the ECB to define just what price stability encompasses. Besides, support for an actual overhaul of the bank's mandate appears to be building. The French government commissioned two studies last year that argued for a Bank of England model, meaning the ECB should adopt a slimmer administration and have an inflation target set for it by the EU. "The markets expect significant changes under Trichet," says Austin Hughes, chief economist at IIB Bank Ltd. in Dublin.

If Trichet wants to engineer such change, his knack for turning detractors into allies should serve him well. In 1995, for example, as head of the Banque de France, he enraged then-Paris Mayor and presidential candidate Jacques Chirac by taking him to task in public for pledging to spend heavily on jobs programs. Shortly afterward, Chirac, as president, retaliated by putting an opponent of Trichet's tight money policies on the Banque de France board. Trichet riposted by commissioning opinion polls that showed broad public support for his policies. He did not publish the findings but showed them privately to Chirac. Chirac was convinced and became a Trichet fan.

Trichet, though, can also be fussy and demanding, which might trip him up as head of a collegial institution. He also does not shrink from confrontation if he deems it necessary. His plan to cut the number of Banque de France branches from 211 to 96 led to strikes by bank employees earlier this year. But that doesn't mean he can dominate the ECB, which, unlike the Banque de France, grants its president no authority to override fellow members of its top policymaking body. "Perhaps there's an exaggerated sense of what one man can do," says Hughes.

What makes the ECB unique among central banks is that it's a grouping of equals rather than a board run by a chief executive. Of its 18 governing council members, 12 are there as governors of the euro zone's national central banks; the other 6, including the president, are executive board members appointed by the EU Council, which is made up of heads of government. On the governing council, the chief of the Central Bank of Luxembourg has as much power as the governor of the Bundesbank, and both are considered equal to the president.

Even Greenspan would be daunted by such a setup. The ECB president must cope with 12 countries, 9 languages, and myriad political and economic systems. There isn't much of a bully pulpit for the ECB chief, either. Duisenberg's quarterly testimony before the Committee on Economic and Monetary Affairs of the European Parliament was widely ignored by the local press -- nothing like the media excitement that often follows Greenspan to Capitol Hill. "The president's hearings in Parliament are as frequent but perhaps not as visible as they are in the U.S.," says Trichet.

Trichet may be able to charm fellow governors into seeing things his way. But he could also exercise more clout over the ECB's powerful staff. Trichet is known for his technical expertise -- something that cannot be said of many colleagues. In the runup to the creation of the ECB, for example, Trichet showed interest in the technical aspects of the repo market, the key lever for managing overnight interest rates. Trichet could easily become actively involved in the monthly economic reports presented to the ECB by Chief Economist Otmar Issing. Insiders say Issing, a former Bundesbank economist, probably now has as much sway as the president over monetary policy. "A new chief economist would probably have a bigger impact on the bank's policies than a new president," says Hughes.

Is a clash between Trichet and the powerful Issing likely? Insiders note that they get along well, and share the same commitment to sound monetary policy and price stability. "Still, they will both want to stamp their authority on the bank as quickly as possible," says a seasoned ECB watcher. The sparring may have started already. In May, the governing council issued a "clarification" on the bank's inflation policy, which had been that price rises should be held to 2% a year or less. The clarification defined price stability as inflation close to 2% rather than down to zero. The move allayed any market fears that the ECB would trigger a price collapse by getting too tough on rates. But there's a slightly Machiavellian interpretation as well: Some observers think Issing and other monetary hawks in the bank wanted to undercut Trichet's ability to raise the inflation target above 2%. Trichet himself pooh-poohs speculation about such skulduggery, saying he fully participated in the clarification.

The son of a literature professor, the Lyons-born future ECB chief started out as a mining engineer; he first got a taste of that work laboring at a mine in northeastern France at age 19. Trichet quickly switched to economics, earning a master's degree from the Institut d'Etudes Politiques de Paris in 1966, and later attending the elite École Nationale d'Administration, which trains most French business and political leaders. As a youth, he dallied with left-wing politics -- Trichet earned the nickname Justix for his earnest lectures on workers' rights. Then he drifted to the center. "I became interested in how to get the best out of the market economy," he recalls. He was assigned to work as an Inspecteur des Finances at the French Finance Ministry in 1971 and rose up the hierarchy. In 1987, he was appointed head of the French Treasury, and was later heavily involved in negotiating the Maastricht Treaty, which paved the way for monetary union.

After arriving at the central bank in 1993, Trichet maintained a tight monetary policy and adhered to the "franc fort," keeping the franc stable against Germany's mark, squeezing inflation out of the French economy, and helping French growth outpace that of Germany and Italy. Since then, France has gone on a spending spree and is dragging its feet on important structural reforms. "The government doesn't seem to be listening to Trichet now," says one European central banker.

Yet it's a testament to Trichet that the conservative Chirac and ex-socialist Prime Minister Lionel Jospin both backed his appointment to the presidency of the ECB in 1998. The top job went to Duisenberg, who was a compromise candidate strongly supported by Germany, on the understanding that Duisenberg would step down to make way for Trichet before his eight-year term expired.

Can Trichet help create a public psychology for change? He seems ready to accept the challenge. "The fact is, we all live in democracies and have a lot of homework to do in terms of explanation so that ordinary people understand the need for change," Trichet says. Europe should soon expect some forceful lectures on economic reform from this most skilled of bankers.

By David Fairlamb, with John Rossant, in Paris

— With assistance by John Rossant

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