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When the Chancellor of the Exchequer announced that the Bank of England would become independent, a monetary policy committee was created to decide interest rates. And the responsibility for banking supervision was to be transferred to a newly created Financial Service Authority; though Governor Sir Edward George only read the bill once the ink had dried.
The European Union has decided to do things differently when reforming the European Central Bank (ECB) ahead of enlargement to as many as 25 countries. If the proposal is passed the outcome will be a bad system that could undermine the credibility of the euro.
Under current rules, the central bank governor of each new euro area member would get a vote on the ECB’s key decision-making body, the Governing Council. The size of the Council could thus increase from its current 18 members to 30 or more – too many for efficient decision-making. The need to reform the ECB ahead of enlargement was recognized by the Nice Treaty. Article 5 assigns the EU Council the authority to modify the voting rules of Governing Council ‘acting on a proposal by the ECB itself or by the European Commission.’ The Commission forgot about this. So, when the Nice Treaty was finally ratified in the second Irish reading last Fall, the ECB put forward its own proposal: a rotation system in which not every central bank governor would have a right to vote at each meeting.
Under the ECB plan, euro area members would be divided into 3 groups. The first would include 5 countries (Germany, France, Spain, Italy and the UK, if/when it joins) and would have 4 voting seats. Group 2 would include one half of all euro area members and would have 8 votes. All remaining countries would share 3 votes. Thus the number of Council members with a vote will be capped at 21, the number it would reach if the UK, Sweden and Denmark decided to join before enlargement.
The proposal has three major flaws. First, it violates the spirit of the ECB statutes, which stipulate that national central bank governors sit on the Governing Council in a personal and independent capacity, not as representatives of their own countries. Rotation will emphasize their national origin. Second, it caps the number of Council members with the right to vote at a level that is far too high. One of the problems experienced in the current Council--which includes 18 members, 12 national central bank governors plus 6 Executive Board members--is its size, which tends to produce a status quo bias: interest rates are sometimes kept unchanged simply because it proves difficult to gather consensus in favour of a change. Third, the composition of the voting team will vary– how frequently depends on how long some Council members will remain without a vote, something the ECB has not yet explained.
It is obvious that the ECB plan was the outcome of a compromise between current Governing Council members. The number of votes assigned to Groups 1 and 2, twelve votes, corresponds to the current number of euro area members. The problem of tiny Luxembourg, which might have fallen in Group 3, was solved by stipulating that the dimension of a country will be measured not only by its GDP, but also by the size of its financial system. Thus Luxembourg will be in Group 2, Poland in Group 3.
Best practice in central banking strongly argues in favor of delegation of interest rate decisions to an independent committee. This is the Bank of England model, after the bank was made independent, but it is also the case in Sweden, Australia, Canada, and New Zealand. Delegation to a committee is consistent with the ECB statutes. It is also consistent with EU decision-making in other areas. The Union has clear supranational executive power in two areas only: competition policy and monetary policy: in the area of competition power is delegated to a committee – the Commission.
In the US the Federal Reserve takes monetary policy decisions by the operation of a partial rotation system, but the number of members with the right to vote is limited to 11 and among them the majority, 7 out of 11, rests with members of the Board of Governors. In the ECB the Executive Board currently has 6 votes out of 18; under the ECB plan it will eventually fall to 6 out of 31. The Federal Reserve, moreover, is dominated by the personality of Alan Greenspan. This is not the case in the ECB Governing Council, where national central bank governors are the strongmen, largely because many maintain the important function of national financial market supervisors.
Delegation of monetary policy decisions to independent bodies, such as the ECB, is appropriate. What is not is that such bodies are left to design themselves. National central bank governors should not have been given the power to propose new voting rules for the ECB. It was inevitable that they would come up with rules designed to protect their own interests. EU leaders should think hard before accepting the ECB plan.
Francesco Giavazzi
Bocconi University, Milan and Centre for Economic Policy Research, London
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