Opinion

The ECB is much too stodgy

The euro fuelled a leveraged bet that went bad. The ECB is best positioned to orchestrate the painful sharing of losses. If the ECB does not reinvent itself for the times, it will be hobbled by its obsolescence and by increasingly acrimonious politics. And the flawed euro project will be further damaged.

By: Date: February 13, 2014 Topic: European Macroeconomics & Governance

See also blog posts by Guntram Wolff ‘The ECB should be more aggressive on monetary policy‘ and ‘OMT ruling: Karlsruhe says no, refers to ECJ and suggests ECB should always be preferred creditor, by Marcel Fratzscher, Michael Hüther, Guntram B. Wolff ‘Taking the mandate of the ECB seriously‘.

This piece was published by BreakingViews on January 29th 2014.

The euro area’s incomplete monetary union arose from a political compromise in which the member states ceded monetary authority to a supranational agency while retaining their fiscal sovereignty. Because a banking union is ultimately a fiscal union, the latest "banking union" predictably comes without a meaningful centralised pot of money. Once again, the decision to "muddle ahead" has produced a muddle: costly delays and half measures, with cumbersome governance structures.

Unfortunately, the European Central Bank has also chosen to stay behind the curve. Disregarding its unique credibility, mandate, and means to heal and protect, the ECB has too often invoked worn euro area prejudices while exhorting the national authorities to act. It is past time for the central bank to be proactive on monetary policy, banks and sovereign debt.

The ECB’s tight monetary policy explains why the weakest of the advanced economies has the strongest currency and faces the greatest threat of deflation. The widespread surprise at its Nov. 7 decision to belatedly lower the policy rate is a testament to the ECB’s stodginess.

The other major central banks have had near-zero policy interest rates for much longer. Moreover, through early and aggressive quantitative easing (QE) – buying assets to lower long-term interest rates – the United States has achieved an effective policy rate of about -2.0 percent. In turn, the QE has served to weaken the dollar relative to other currencies. The Japanese yen bore the brunt of this pressure early on, until the Japanese engineered their own QE, which promptly caused the yen to depreciate. The consequence is a strong euro.

With its single-minded commitment to maintain annual price inflation below 2 percent, the ECB has felt no urgency in responding to euro-area economic weakness or to countering other central bank actions. With market expectations of inflation at about 1 percent a year over the next two years, the ECB’s insistence on waiting for more evidence of deflation is a dangerous gamble.

The ECB must push conventional and unconventional policy buttons to help a more robust euro-area recovery. Today, when the distressed periphery faces a painful and extended "internal devaluation" – more plainly, a large real wage reduction – a weaker euro is their best hope for a jump start.

The shrill German commentators who criticised the ECB’s Nov. 7 decision ignore that an aggressive monetary policy – and a weaker euro – offer Germany the least-cost option for restoring the euro’s economic and political viability. Unwilling to make large fiscal transfers for fear of being sucked into an open-ended commitment, Germany also has no simple way to engineer domestic inflation, even if its traditional anxieties could be set aside.

Stressed banks remain the euro area’s Achilles heel. Without centralised funds for recapitalising banks, the creditors will need to bear significant losses, ideally through debt-to-equity swaps. The ECB’s hesitations – allegedly due to the contagion bugbear – risk diluting and prolonging the process.

We are long past the moment when several banks should have closed down. Zombie banks weigh on the economy. The ECB could expeditiously force losses on bondholders of insolvent banks, since it is well-positioned to deal with contagion risk by providing liquidity to solvent institutions.

The taboos are greatest with regard to sovereign debt. The ECB has insisted that it will not engage in monetary financing – that is, it will not buy sovereign bonds on an open-ended basis; instead, sovereigns must preserve their bonds as risk-free assets. By making its support conditional on promises of good behaviour, the Outright Monetary Transactions (OMT) programme conflates solvency and liquidity.

The euro area needs unconditional ECB bond purchases alongside selective sovereign default. With default risk rendered more believable through, for example, sovereign "CoCos" (contracts that specify debt restructuring at pre-agreed levels of distress), the ECB should stand as a lender of last resort to solvent sovereigns. This is not monetary financing: it is maintaining financial stability.

The ECB’s political independence and technocratic goals have accorded it deference on controversial and fast-moving matters. Despite its flaws, the OMT was endorsed by German Chancellor Angela Merkel, over the fierce opposition of Jens Weidmann, the Bundesbank president and ECB governing council member.

Five years into the crisis, with the worst seemingly over, the temptation is to declare victory and improvise when new challenges emerge. That would be a mistake. The ECB must harness the deference it enjoys.

The euro fuelled a leveraged bet that went bad. The ECB is best positioned to orchestrate the painful sharing of losses. If the ECB does not reinvent itself for the times, it will be hobbled by its obsolescence and by increasingly acrimonious politics. And the flawed euro project will be further damaged.


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to [email protected].

Read about event More on this topic
 

Upcoming Event

Sep
23
14:00

How to strike the right balance between the three pillars of the pension system?

In this event panelists will discuss the future of European pension schemes.

Speakers: Elsa Fornero, Svend E. Hougaard Jensen and Suvi-Anne Siimes Topic: European Macroeconomics & Governance
Read article More on this topic More by this author
 

Podcast

Podcast

Unboxing the State of the Union 2021

In this Sound of Economics Live episode, Bruegel experts look at the State of the Union address delivered by Ursula von der Leyen, President of the European Commission.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 15, 2021
Read about event More on this topic
 

Past Event

Past Event

The Sound of Economics Live: Unboxing the State of the Union 2021

In this Sound of Economics Live episode, we look at the State of the Union address delivered by Ursula von der Leyen, President of the European Commission.

Speakers: Grégory Claeys, Maria Demertzis, Alicia García-Herrero and Giuseppe Porcaro Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 15, 2021
Read article Download PDF More on this topic
 

Policy Contribution

A green fiscal pact: climate investment in times of budget consolidation

Increasing green public investment while consolidating deficits will be a central challenge of this decade. A green fiscal pact would address this tension, but difficult trade-offs remain.

By: Zsolt Darvas and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: September 9, 2021
Read about event More on this topic
 

Past Event

Past Event

Conference on the Future of Europe: envisioning EU citizens engagement

Bruegel Annual Meetings, Day 3 - Panellists will discuss different options and what they may entail while revisiting the debates on the future of Europe at national and EU-level that have been conducted thus far.

Speakers: Caroline de Gruyter, Kalypso Nicolaïdis, Niclas Poitiers and György Szapáry Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1 Date: September 3, 2021
Read about event More on this topic
 

Past Event

Past Event

The role of the EU's trade strategy for an inclusive and sustainable recovery

Bruegel Annual Meetings, Day 3 - We are delighted to welcome Valdis Dombrovskis, Executive Vice President of the European Commission for An Economy that Works for People to talk about Europe's trade strategy.

Speakers: Valdis Dombrovskis, Alicia García-Herrero and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1 Date: September 3, 2021
Read about event More on this topic
 

Past Event

Past Event

An in-depth look at the Italian Recovery and Resilience Plan

Bruegel Annual Meetings, Day 2 - A discussion of the largest national recovery plan.

Speakers: Carlo Altomonte, Declan Costello and Zsolt Darvas Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1 Date: September 2, 2021
Read about event More on this topic
 

Past Event

Past Event

Blending physical and virtual: shaping the new workplace

Bruegel Annual Meetings, Day 2 - This panel will cover the changes the COVID-19 pandemic made to our workplaces, and what to expect in the near future.

Speakers: Nicholas Bloom, Michael Froman, Mario Mariniello, Sara Matthieu and Luca Visentini Topic: European Macroeconomics & Governance Location: Academy Palace Date: September 2, 2021
Read about event
 

Past Event

Past Event

European banks: under global competitive pressure?

Bruegel Annual Meetings, Day 2 - European banks have lost stature and remain generally low-profitability, low-valuation in comparison to their global peers. Is that a problem? If so, what can EU policymakers do to address it?

Speakers: José Antonio Álvarez Álvarez, Mairead McGuinness and Nicolas Véron Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Palais des Academies, Rue Ducale 1 Date: September 2, 2021
Read about event More on this topic
 

Past Event

Past Event

Conversation on the recovery programmes

Bruegel Annual Meetings, Day 2- In this session, we discuss the recovery programmes.

Speakers: Maria Demertzis, Henry Foy and Tadeusz Kościński Topic: European Macroeconomics & Governance Location: Palais des Academies, Rue Ducale 1 Date: September 2, 2021
Read article More on this topic More by this author
 

Podcast

Podcast

The EU recovery fund - state of play and outlook

Live from the Annual Meetings: Bruegel Director Guntram Wolff discusses the EU recovery fund, its state of play and outlook with Nadia Calviño, First Vice-President and Minister for Economy and Digitalization of Spain and Professor Karolina Ekholm of Stockholm University.

By: The Sound of Economics Topic: European Macroeconomics & Governance Date: September 1, 2021
Read about event More on this topic
 

Past Event

Past Event

The EU recovery fund - state of play and outlook

Bruegel Annual Meetings, Day 1- In The Sound of Economics Live session we will discuss the EU recovery fund, its state of play and outlook.

Speakers: Nadia Calviño, Karolina Ekholm and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: September 1, 2021
Load more posts