In our blog in December we provide a quick critique of the ‘fiscal compact’ for the Economic and Monetary Union (‘euro area’) (now to be embodied in the Treaty on Stability, Coordination and Governance). The fiscal compact is more rigorous in terms of the constraints on budget deficits of the member states in relation to those that were contained in the Stability and Growth Pact and the requirement for a ‘structural balanced budget’. The proposed Treaty (signed by all the European Union members with the exception of the UK and the Czech Republic, and currently under a process of ratification by national parliaments) makes no mention of the role of the ‘independent’ European Central Bank.
This is not at all surprising in view of the sacrosanct nature of the current ‘most independent’ role of the ECB, and also given that ‘fiscal consolidation’ and calls for ‘structural reforms’ (which also feature in the Treaty) have been constantly on the agenda promoted by the ECB. But the position of the ECB lies at the heart of the euro crisis through its ambivalence over supporting the fiscal positions of national governments, and in a failure to provide the support to those governments which national central banks generally provide.
Some politicians have begun to question aspects of the current operation of the ECB. During the recent French Presidential campaign, Nicolas Sarkosy “called for the European Central Bank (ECB) to take a radically different role by lending directly to troubled eurozone states rather than to banks, and by keeping interest rates low”. He was quickly rebuked by a German government spokesman Steffen Seibert who said, “It is the core belief of the federal government…that the role and office of the ECB be independent of encouragement and assistance from politics. And that’s well known in Paris”. Nicolas Sarkosy’s opponent in the run-off election for the Presidency, Francois Hollande called for the ECB’s refinancing operations to bypass banks and lend directly to states. He added “I know that Germany is totally hostile, so this is another topic for discussion” (Interview, Europe 1 19th April 2012).
Many have long argued that the mandate of the ECB should be more akin to the dual mandate of the Federal Reserve with regards to growth and inflation, rather than the obsessional focus on price stability. This would be a modest small step and could perhaps be achieved by a sufficiently broad interpretation of ‘without prejudice to the objective of price stability, the ECSB shall support the general economic policies’ of the European Union contributing the objectives of economic growth, full employment etc. (Treaty of Lisbon). However, such a modest change would have little effect.
As we have often argued (see, for example, Arestis and Sawyer, 2008), the current inflation targeting does not deliver, and crucially within the Economic and Monetary Union does not and cannot address inflation differential between countries, which have contributed to changing relative competitiveness and to the yawning current account imbalances between the countries of EMU. It can further be doubted whether monetary policy itself can have much effect on the pace of economic growth; though the failures to support fiscal policies and financial stability do have considerable damage on economic prosperity.
Major and basic changes in the roles of the ECB are required. The first change would be to end the independence of the ECB, and to have it integrated with the policy-making arrangements of the Economic and Monetary Union to facilitate the co-ordination of economic policy-making.
The second change should be for a shift away from its sole focus on inflation (for which in any event they are not equipped through interest rate policies to influence inflation) and to view the major focus of the activities of the ECB being financial stability. It should be self-evident that financial instability and crisis impose substantial costs (much more than might come from inflation).
The third change should be to ensure that the ECB provides support to the fiscal policies being pursued. As we have often argued this should be a Federal level fiscal policy with expenditure and tax revenues of the order of 10 or more percent of GDP with ability to run budget deficits or surpluses as appropriate to the economic conditions.
We have also advocated that fiscal policy should not focus on some notion of balanced budget but to using fiscal policy to achieve high levels of aggregate demand, economic activity and employment (whether or not deficits are involved). But in near term until a Federal fiscal policy is developed, national fiscal policy should be conducted along similar lines. There is always the need that the ECB gives support to the democratically determined fiscal policies by, where necessary, providing funds and always accepting member-governments debt in open-market operations and provision of funds to the banking system.
We may conclude by suggesting that unless fundamental changes are introduced in terms of the way the ECB functions and the policies pursued by it, no hope is there for the current euro crisis to be resolved satisfactorily. Nor would it provide confidence for the future of the euro area.
Arestis, P. and Sawyer, M. (2008), “A Critical Reconsideration of the Foundations of Monetary Policy in the New Consensus Macroeconomics Framework”, Cambridge Journal of Economics, Vol. 32, No. 5, September.
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