The remarkable
stability of the exchange rates of the EMU countries in a sea of
financial turmoil has led to complacency among European policymakers.
That is the view expressed in a new Report, entitled The
ECB: Safe At Any Speed?, published by the Centre for Economic
Policy Research on 15 October 1998. The authors, David Begg, Francesco
Giavazzi, Paul De Grauwe, Harald Uhlig and Charles Wyplosz argue that
this complacency presents serious risks for the European Central Bank.
These risks result from three factors. First, the ECB suffers from a
series of faults in its design. The consequences of these design
problems are likely to surface if the world financial crisis hits
euroland. Second, just a few weeks before the start of EMU important
decisions about the operational procedure of the ECB have still to be
made. Third, even under normal economic conditions the ECB will face
problems that originate from Europe’s rigid labour markets and from
the existence of 11 independent fiscal authorities.
The report argues that:
- The ECB suffers serious faults in its design that sooner or later
will surface. This is likely to happen when large shocks, such as
the world financial crisis, hit euroland. These design faults are
due to a failure to put sufficient decision making power at the
centre of the system.
- National central banks maintain too much power, which weakens the
ECB. This will be particularly troublesome when quick decisions have
to be made. National governors, who will make up a large majority in
the ECB Council, are likely to be driven by national perspectives
and will find it difficult to come to coherent decisions when
economic conditions diverge in euroland. Moreover, the lack of
centralized banking supervision, together with the absence of clear
responsibilities in crisis management, risk making the financial
system in euroland fragile. 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.
- To deal with these problems more power and responsibilities should
be shifted to the ECB at the expense of national central banks.
Supervision should also be centralized, and the responsibilities to
manage the system in crisis situations should be clearly spelled
out. There is very little time left to do so.
- The ECB will, by virtue of its mandate, pursue price stability.
The procedures it will want to use to achieve this objective are
still unclear at this late stage. More importantly, close to nothing
is known about its other responsibilities. And yet these are also
important to acquire credibility. Central banks with good
reputations pay attention not only to price stability but also to
output fluctuations and financial stability. The ECB should be
transparent about those other responsibilities, which in no way
conflict with its mandate to pursue price stability. In addition, at
the moment in which world-wide deflation has become more than a
scary dream, the ECB should pay as much attention to avoiding
undershoots of its target inflation range as it pays to avoiding
overshoots.
- Transparency implies that the ECB should preannounce its monetary
policy rule and discuss the circumstances in which it will exercise
its discretion to depart from its normal behaviour. Each meeting of
the ECB Council should be seized as a chance at communication. The
Council can either publish its minutes or announce not merely its
expectations for Euro–11 inflation and output, but the range for
current interest rates implied by its rule and the reasons for any
discretionary departures from the rule.
- Even if the global financial crisis recedes, the ECB routinely
will face two problems not encountered by the US Fed: more rigid
labour markets, potentially giving rise to more persistent
recessions, and fiscal policy in the hands of 11 uncoordinated
authorities, giving rise to possible free riding. The ECB should
strive to avoid hard landings, which in the European context of
rigid labour markets quickly translate into permanent unemployment.
The ECB, however, cannot succeed in this if any monetary tightening
becomes the excuse for fiscal expansion by individual member states.
Since finance ministers care even more about recession than the ECB,
paradoxically labour market sluggishness reinforces the ECB's threat
to create recessions if fiscal discipline breaks down. It may
therefore prove possible to sustain some cooperation between fiscal
and monetary authorities within Euro–11. The Euro–11 committee
would then play a key role in coordinating fiscal policies among EMU
members.
Notes for Editors:
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Monitoring the European Central Bank: A new series of Reports from
CEPR
Europe has a new central bank. It must develop its version of
accountability and public debate over monetary policies. It is natural
for CEPR, as a network of policy-oriented academic economists, to
contribute to the establishment of a new tradition. The response is
Monitoring the European Central Bank (MECB), an initiative that brings
together a group of economists internationally known for their work on
macroeconomics and monetary policy. MECB will monitor the European
economy and the work of the ECB. Its analyses will be presented to the
broader public, including the European Parliament and the media, in an
annual report plus a later commentary on the ECB's own annual report.
Underlying financial support for this research is provided by
Citibank N.A. and Monte dei Paschi SpA. The views expressed in the
Report are the authors’ own and do not reflect the views of CEPR or
the funders. CEPR takes no institutional policy positions.
The Authors:
David Begg is Professor of Economics at Birkbeck College, London,
and a Research Fellow in CEPR’s International Macroeconomics and
Transition Economics programmes.
Francesco Giavazzi is Professor of Economics at Università
Bocconi, Milan, and a Research Fellow in CEPR’s International
Macroeconomics programme.
Paul De Grauwe is Professor of Economics at Katholieke
Universiteit Leuven, and a Research Fellow in CEPR’s International
Macroeconomics programme.
Harald Uhlig is Professor of Economics at the University of
Tilburg, and a Research Fellow in CEPR’s International Macroeconomics
Programme.
Charles Wyplosz is Professor of Economics at the Graduate
Institute of International Studies, Geneva, and a Research Fellow in
CEPR’s International Macroeconomics and Transition Economics
programmes.
The
ECB: Safe at Any Speed?
Monitoring the European Central
Bank Vol. 1
David Begg, Francesco Giavazzi, Paul De Grauwe, Harald Uhlig and
Charles Wyplosz
ISBN 1 898128 39 1 – £20/$30/30 €uros
Available from
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