Blog Post

How to restore trust in the ECB

When Mario Draghi takes office on November 1, he will face tough choices. Should he be more “German” than the Germans or more “Italian” than the Italians? Should he increase or lower rates? More fundamentally, should he continue or discontinue the European Central Bank’s bond purchasing programme? Failure to steer the right course amid formidable […]

By: Date: November 1, 2011 Topic: Macroeconomic policy

When Mario Draghi takes office on November 1, he will face tough choices. Should he be more “German” than the Germans or more “Italian” than the Italians? Should he increase or lower rates? More fundamentally, should he continue or discontinue the European Central Bank’s bond purchasing programme? Failure to steer the right course amid formidable obstacles could very well lead to the end of the euro; to a melt-down of the financial system and a severe recession; or to an end of German support for the ECB and the euro. The new ECB president will have to square the circle.

Regaining trust in debtor and creditor countries will be of central importance. Public trust in the ECB and the euro has drained away in the last three years: Eurobarometer data show it has fallen by more than 40 percentage points in Germany, Greece, Ireland, Portugal, Spain and the Netherlands. In France, it was and remains low. In countries under financial assistance programmes, trust has fallen because of the role the ECB played in their formulation. In Spain, the combination of fiscal austerity and rate increases has added to a sense of desperation about growth prospects. In creditor countries, trust has fallen because the ECB is seen as departing from its core mandate. In Germany in particular, the ECB’s bond purchasing programmes and the tough stance on restructuring have been deeply unpopular. A number of steps should be taken.

First, a significant rate cut is needed to help stabilise activity in the euro area as a whole and ease the impact of the necessary fiscal austerity in the eurozone periphery. Economic activity is cooling and inflation measures are falling, with inflation swap spreads at 1.9 per cent on a two-year horizon. Core inflation has been even lower in the euro area as a whole. In addition, growth in monetary aggregates has been very weak. The incoming president should lower rates rapidly once more negative figures become visible. In doing so, he needs to communicate clearly and openly, in particular to the German public, that the rate cut is a response to falling euro area inflation expectations. Such a step will also help to regain trust in the so-called periphery countries as it will help to boost growth and adjust balance sheets.

Second, the new president must find the right middle ground as regards the bond purchasing programme. While it is true that only the ECB can ultimately stabilise the bond market when there is a run on large countries, the conclusion cannot be that the ECB buys bonds without rules. Financial markets have focused on some countries for a reason and market pressure is indeed helping to foster much delayed reforms. The best way forward would be to clearly anchor market expectations by announcing a rate at which the ECB would intervene. Moreover, a clear policy rule is needed that divides the work between the European Financial Stability Facility, which has primary responsibility for stabilising the bond market after Thursday’s decision, and the ECB.

Third, the ECB will have to continue monitoring the implementation of reforms. The bold reforms promised are necessary, and the Commission has been given prime responsibility for monitoring them. But as long as the ECB is part of the game, it will also have to monitor and push for action. Only a clear message from national and European policymakers can stop the current dangerous capital outflows. However, the ECB has only limited time to do this, as it will lose trust and support if it is too involved in national policies. Ultimately, conditionality cannot be imposed by the common central bank. The incoming president must therefore advance Jean Claude Trichet’s calls for a eurozone finance ministry with democratic legitimacy, that is in a position to follow up on structural and fiscal reforms.

Trust in the ECB will return with a successful resolution of the problems. The last European summit has laid the foundations for a resolution of the main Greek problem, and the ECB is contributing to a solution. The incoming ECB president must further restore trust by stabilising the bond market, where the EFSF’s firepower reaches its limits, while avoiding moral hazard. A combination of clear rules for intervention as regards interest rates, and tough conditionality, will be needed as long as the eurozone lacks the necessary institutions, in particular a eurozone finance ministry, to ensure its survival.

Guntram Wolff is the authors of the policy contribution Changing of the guard – Challenges ahead for the new ECB president

A version of this column was also published in the Financial Times


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint. Anyone is free to republish and/or quote this post without prior consent. Please provide a full reference, clearly stating Bruegel and the relevant author as the source, and include a prominent hyperlink to the original post.

Read article Download PDF
 

Parliamentary Testimony

European ParliamentInclusive growth

Understanding the socioeconomic effects of the COVID-19 pandemic on women

Testimony before the European Parliament's Committee on Economic and Monetary Affairs (ECON) on the consequences of the pandemic on women.

By: Maria Demertzis and Mia Hoffmann Topic: European Parliament, Inclusive growth, Macroeconomic policy Date: October 27, 2021
Read about event More on this topic
 

Upcoming Event

Nov
4
14:00

European monetary policy: lessons from the past two decades

This event will feature the presentation of “Monetary Policy in Times of Crisis – A Tale of Two Decades of the European Central Bank."

Speakers: Petra Geraats, Wolfgang Lemke and Francesco Papadia Topic: Macroeconomic policy
Read about event More on this topic
 

Upcoming Event

Nov
9
11:00

Phasing out COVID-19 emergency support programmes: effects on productivity and financial stability

How can European countries phase out the COVID-19 support measures without having a negative impact on productivity and financial stability?

Speakers: Maria Demertzis and Laurie Mayers Topic: Macroeconomic policy
Read article More by this author
 

Opinion

European governance

Can EU fiscal rules jump on the green bandwagon?

By and large, setting a new green golden rule would be a useful addition to the existing EU fiscal framework.

By: Guntram B. Wolff Topic: European governance, Green economy, Macroeconomic policy Date: October 22, 2021
Read article
 

Blog Post

European governance

Germany’s post-pandemic current account surplus

The pandemic has increased the net lending position of the German corporate sector. By incentivising private investment, policymakers could trigger a virtuous cycle of increasing wages, decreasing corporate net lending, which would eventually lead to a reduction of the economy-wide current account surplus.

By: Lionel Guetta-Jeanrenaud and Guntram B. Wolff Topic: European governance, Macroeconomic policy Date: October 21, 2021
Read about event
 

Past Event

Past Event

Monetary policy in the time of climate change

How does climate change influence monetary policy in the eurozone? What potential monetary policy measures should be taken up to address climate risks?

Speakers: Cornelia Holthausen, Jean Pisani-Ferry and Guntram B. Wolff Topic: Green economy, Macroeconomic policy Date: October 20, 2021
Read article More by this author
 

Podcast

Podcast

Rethinking fiscal policy

A look at the past, present and future of fiscal policy in the European Union with Chief economist of the European Stability Mechanism, Rolf Strauch.

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: October 20, 2021
Read article
 

External Publication

European Parliament

Tailoring prudential policy to bank size: the application of proportionality in the US and euro area

In-depth analysis prepared for the European Parliament's Committee on Economic and Monetary Affairs (ECON).

By: Alexander Lehmann and Nicolas Véron Topic: Banking and capital markets, European Parliament, Macroeconomic policy Date: October 14, 2021
Read article More by this author
 

External Publication

Global Economic Resilience: Building Forward Better

A roadmap for systemic economic reform calling for step-change in global economic governance to increase resilience and build forward better from economic shocks, prepared for the G7 Advisory Panel on Economic Resilience.

By: Thomas Wieser Topic: Global economy and trade, Macroeconomic policy Date: October 14, 2021
Read article More on this topic More by this author
 

Opinion

Letter: Declining investment may explain why rates are low

Perhaps an analysis of the causes of the declining investment rate would bring us closer to explaining why real interest rates are so low.

By: Marek Dabrowski Topic: Macroeconomic policy Date: October 1, 2021
Read article More by this author
 

Podcast

Podcast

A green fiscal pact

How can the European Union increase green public investment while consolidating budget deficits?

By: The Sound of Economics Topic: European governance, Macroeconomic policy Date: September 29, 2021
Read article More on this topic More by this author
 

Blog Post

Monetary arithmetic and inflation risk

Between 2007 and 2020, the balance sheets of the European Central Bank, the Bank of Japan, and the Fed have all increased about sevenfold. But inflation stayed low throughout the 2010s. This was possible due to decreasing money velocity and the money multiplier. However, a continuation of asset purchasing programs by central banks involves the risk of higher inflation and fiscal dominance.

By: Marek Dabrowski Topic: Macroeconomic policy Date: September 28, 2021
Load more posts