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The Independence of the European Central Bank

, by Pietro De Matteis

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One of the results of the Treaty of Maastricht was the creation of the European Monetary Institute (EMI) chaired by Wim Duisenberg. In 1998 when the third stage of the Economic and Monetary Union began, the EMI was replaced by the European Central Bank (ECB) whose primary objective, according to the treaties, is to maintain price stability.

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In order to do so, 2% target inflation has been settled (i.e. below but close to 2%). Several issues have been raised regarding both the 2% target itself and, on a wider perspective, whether inflation should be the main ECB target.

ECB’s competences

Until now the ECB has exclusive competence for Monetary Policy and work in concert with the European System of Central Banks ( composed by the 27 EU National Central Banks) and with the Eurosystem (composed by the National Central Banks of the countries that adopted the Euro) to achieve its price stability objective.

Without prejudice to this first objective the ECB defines its policy in order to boost employment and growth. The main reasoning is that since the European Union does not have a federal budget and has within its borders economies under both different economical cycles and stages of development, the main result that can be achieved is to promote price stability. This is a necessary condition for both job growth and job creation (although not sufficient on its own) and allows a higher degree of certainty for the economic operators as well as lower interest rates.

These days the ECB is in the spotlight for two reasons: its important role in order to avoid a financial crisis in the EU following the lack of liquidity in the bank system and the development linked to the draft Reform Treaty.

ECB’s independence undermined

As for the latter issue the Portuguese presidency has rephrased the articles regarding the ECB with respect to what was proposed during the 2004 Intergovernmental Conference. In particular the ECB has been listed together with other EU institutions and the sentence “The European Central Bank is an institution” has been removed. President J.C. Trichet is clearly concerned about these developments and especially sees that this could lead to a lower degree of independence of the ECB from other European institutions and especially from national governments.

French President Nicolas Sarkozy has already shown on several occasions his wish to have an ECB taking more into account the European economic situation while setting its monetary policy objectives, and in particular would like to have a bigger say on the setting of the exchange rate with the US dollar and on the inflation target.

Conclusion

Of course lowering the degree of independence of the ECB is a serious risk as it could lead to a less credible monetary policy. Moreover, if political pressure was to be allowed, smaller countries might end up with an EU monetary policy more synchronized with the cycle of the biggest EU economies instead of a neutral pro-EU development one. In the worst scenario the ECB could be even pushed to follow the political or electoral cycles of the biggest EU countries.

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P.S.

Image € by MaxCere, source: Flickr

Further reading:

- Turmoil in financial markets: Two cheers for the ECB and one question mark on financial supervision; source: Eurozone Watch

- Trichet concerned over EU treaty change, source: EUobserver

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Your comments

  • On 16 August 2007 at 15:11, by Morrison Bonpasse Replying to: The Independence of the European Central Bank

    The independence of the ECB is crucial to the continuing success of the European Monetary Union. Not only is this important for Europe, it’s important for the world as we look forward to a Single Global Currency managed by a Global Central Bank within a Global Monetary Union. The Global Central Bank also will need to be independent of immediate political winds and keeps its focus on price and monetary stability. The Single Global Currency will bring huge benefits to the world:
    - Annual foreign exchange transaction costs of $400 billion will be eliminated.
    - Worldwide asset values will increase by about $36 trillion.
    - Worldwide GDP will increase by about $9 trillion.
    - Global currency imbalances will be eliminated.
    - All Balance of Payments problems will be eliminated.
    - Currency crises will be prevented.
    - Currency speculation will be eliminated.
    - Currency fluctuations, and the need for hedging, will be eliminated.
    - The need for foreign exchange reserves, now over $4.3 trillion, will be eliminated and these funds can be used for more productive purposes than maintaining an inefficient foreign exchange system. If a monetary union in Europe works well (still an issue for a number of economists) for 13 countries, soon to be 15 and then 22, then why not plan now for a monetary union for 192 countries? For more information, please visit the website of the Single Global Currency Assn. at www.singleglobalcurrency.org. Our goal is implementation by 2024 and we published the book, “The Single Global Currency - Common Cents for the World” and invite comments, suggestions and criticisms.

  • On 5 September 2007 at 02:44, by Damien R. Replying to: The Independence of the European Central Bank

    A single world currency would also put thousands of people into unemployment. Everywhere money is lost on currency trading fees and exchange fees, money is made by firms working in that domain. In every country in the world, there are bureau de changes, which are big employers.

    More importantly, a single world currency, assuming it could be brought about, would unbalance the world economy significantly. European markets were not hit as badly as the US by the sub-prime mortgages crisis only because it happenned in dollars and because the euro is strong. More problems would come from developping countries that speculate on their currency to boost their living standards, and where crises always occur eventually, such as Argentina. In a world with a single currency, the rest of the world would effectively bail out such countries as their incredible inflation rate would be paid for by the rest of the world.

    The only reason the euro is working is because European economies, single currency or not, are all solid, relatively stable first-world economies, which the ECB can pressure to keep inflation low, and that is only working because of the stability and growth pact, which could not exist at an international level. European economies can work with a single currency because economies in the european union are the most interconnected in the world. The French and German economies are the biggest joint venture on earth (I think I read somewhere that Germany owned about 40% of France and France about 30% of Germany. I’m not sure the figures are still true, but that gives you an idea).

    And I haven’t even started about the utopia of getting 192 countries to agree on this. Sheer idealism.

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