The European Central Bank at Ten

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Tax Policy and the Economy, Volume World Economic Outlook, October The Merits of Flexible Exchange Rates. Challenges in Central Banking. Crisis Management and Resolution: Early Lessons from the Financial Crisis. Financial Markets and Institutions. Financial Supervision in the 21st Century. The History of the Bundesbank. Conversely, financial instability endangers price stability. The idea that the central bank should only care about price stability had to be thrown into the garbage bin. Second, a central bank of a monetary union should extend its lender of last resort function to the government bond markets.

The ECB found out during the sovereign debt crisis of that the government bond markets are inherently unstable. As none of the sovereigns is backed by its own central bank, these sovereigns can easily become victims of self-fulfilling panic that leads investors to dump the government bonds deemed risky and to buy safe-haven bonds in the monetary union. This leads to massive destabilising capital flows within the union that only the ECB can stop.

It took the ECB some time to understand this, but in it stepped into the fray and announced its OMT-programme that saved the Eurozone from collapse. Third, the political independence of a central bank is fine in normal times. In crisis times when the existence of the sovereign is at stake, the independence of the central bank is limited. That is certainly the case in standalone countries, like the UK.

There can be no doubt that when the UK government experiences an existential crisis the government will and should prevail over the central bank which will be forced to provide liquidity. This should also be the rule in the Eurozone.

But here there is a complication: This creates uncertainty about the willingness of the ECB to support the sovereigns in future crisis situations. And these are coming for sure. This uncertainty will continue to be a major source of fragility for the Eurozone.

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The ECB at Not like its boring older brother. The ECB was the brainchild of an intellectual fashion. The brainchild was expected to be conservative and aloof like its boring older brother, the Bundesbank: In its early years, the ECB seemed to live up to these expectations of a prematurely ageing posterchild of monetary conservatism. Yet, the ECB has grown up to be an agile, boisterous teenager. Like all youth, it is at times inconsistent and devious in its behaviour. But it has also been a necessary challenge to its conservative progenitors.

The Eurozone crisis forced the ECB to challenge the original understanding of independence as separation from fiscal policy on which influential German commentators publicly insisted.

During the crisis, the ECB noted that it needed cooperation from fiscal authorities or else it would have to throw a permanent lifeline of liquidity to insolvent zombie banks. The ECB thus insisted on institution building that would enshrine a new division of labour. It requested the creation of an emergency fund in return for the first bond-buying programme and a banking union in return for the announcement of Outright Monetary Transactions that put it on par with private holders of bonds should they default.

These quid-pro-quos provided time for democratically elected governments to come to agreements that cannot be taken over night. Yet, this puts the ECB at loggerheads with the old disciplinarians. The response of the German government has been to politicise the succession of Mario Draghi and send Bundesbank President Weidmann into the campaign. There is a precedent to this politicisation: One lesson of the first 20 years of the ECB is that the foremost supporters of central bank independence are also its greatest threat.

The confrontation with these disciplinarians made the ECB a much more interesting central bank than anybody had feared or hoped for. I believe that it will stay that way. The next 20 years will be no less interesting as German policymakers will continue to interfere. But this interference will ultimately meet with limited success. The next ECB President, be it Weidmann or not, will have to lead an institution of the future, not of an outdated past. When Lehman Brothers filed for bankruptcy in September , the deceptively calm waters of the first decade of monetary union soon made way for a protracted financial crisis that embroiled large parts of the Eurozone.

The commitment itself — to not let the Eurozone be torn apart by diverging government bond spreads — is often said to have calmed panicking markets with near-magical efficacy. Rather, the ECB is in need of credible and cooperative counterparts. In the first instance, this requires not merely the creation of an outright supranational fiscal authority, as is often argued, but also a readiness among monetary and fiscal authorities to cooperate: While the upcoming June summit of European heads of state and government is unlikely to produce anything beyond a Eurozone budget line that hardly deserves its name, the ECB might eventually run out of time to obtain meaningful support.

After the formative period of its childhood and teenage years, Eurozone governments now need to ensure that the European Central Bank benefits from an independent adulthood, but within a cooperative European family, if the monetary union is to strive for another 20 years or more. The next 20 years may see the Eurozone become a federal economic state. The rules-based approach to economic policy that was created in order to support the functioning of the single monetary policy showed its weaknesses early on, with the failure to discipline France and Germany for infringing the Stability and Growth Pact.

In the Eurozone crisis, the full consequences of this disjunction of sovereignty emerged and the monetary union entered an existential crisis. The ECB then stepped in and acted as if its mandate was the political stability of the Eurozone rather than the much narrower price stability mandate. In doing so, the ECB reintegrated monetary and political sovereignty and supplied the radical assurance that the markets needed at the time: In the process, some of the core normative principles rationality of markets, rule of law of the EMU were, at least temporarily, suspended.

But the ECB did not act entirely on its own. The Member States similarly moved to centralise and strengthen public powers to regulate not only financial markets and banks but also the economic structure of the constituent states.



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While this process is incomplete, it points to what we might expect the Eurozone to look like in 20 years. We might, in other words, expect the Eurozone to become a federal economic state. Hopefully it will also be democratic. The Eurozone crisis unearthed profound flaws in the architecture of the euro area that make reviewing the design and operations of the ECB a necessity. Coming out of its teenage years, the European Central Bank could be happy about its emergence from a violent teenage crisis and entry into adulthood.

But the reality is somewhat more concerning. The ECB, while a beautiful construct in the abstract, still rests on a shaky economic, institutional and political structure. The issues that arise from having a currency without a State, described by Tommaso Padoa Schioppa as the central problem of the single currency, have become all the more visible in the last few years and have not been properly addressed.