Tuesday, 23 December 2014

The dangerous ambitions of the European Central Bank

Last week the European Central Bank published the letter it sent on August 5, 2011 to the then Prime Minister of Spain, Mr Zapatero. That was at a time of intense crisis in the Eurozone. Many thought that the Eurozone would implode.
The ECB’s letter to the Spanish government is not the only one the ECB sent to Member States' governments. A similar letter was sent to the Italian Government. The letter is of great significance because it reflects the ambition of the central bank to determine macroeconomic policies in the Eurozone. This ambition should be checked, for two reasons.
First, the letter illustrates the intensity of  the micro-economic management the ECB intends to apply in crisis countries. The letter contains a detailed list of what according to the ECB needs to be done in the labor market. Thus, collective agreements should be abolished and should be organized at the level of the individual firms. In addition, these agreements should not contain indexation clauses, even when these are entered into freely. Two things stand out here. First, there is the detail of the measures that the ECB would like to impose. In doing so, it substitutes itself to national governments in the formulation of national economic policies.
Second, it is striking to find that these policy prescriptions are based on an economic theory for which there is actually no serious empirical evidence. On the contrary, there is a strong empirical research suggesting that the degree of decentralization of wage bargaining should not go too far. The consensus among economists is that wage bargaining at the level of individual companies harms the economy, because it can easily give rise to a wage-price spiral when an external shock such as an oil price increase occurs. Yet extreme decentralisation of wage bargaining is what the ECB wants to impose in member-countries of the Eurozone. The policy that the ECB seeks to impose is not based on evidence but on ideology.
The second reason why the ECB’s ambitions in setting the policy agenda in the Eurozone must be checked has to do with governance. The ECB is a public institution, which has been given a strong status of political independence. The latter implies that politicians should abstain from interfering in monetary policy. They should certainly not give instructions to the central bank on how to conduct monetary policy. The reverse, however, is equally true. The political independence of the ECB can only be safeguarded if that institution keeps itself aloof from the political process and abstains from giving instructions to governments about how economic policies should be conducted. The ECB sins against this principle. In doing so, she puts her own independence at stake.
The ECB has set itself the target of keeping inflation close to 2%. It is failing spectacularly in reaching that objective and as a result, creates a risk of deflation that today increases the debt burden of national governments. An institution that fails to achieve its own objectives cannot afford to impose its ideas on national governments, lest these governments will turn themselves against the ECB.
The instructions the ECB gives in its letter to the Spanish government lead to an even more fundamental governance problem. The ECB consists of civil servants who bear no political cost of the decisions they try to impose on national governments. The latter bear the full political costs of these decisions. They risk to be thrown out of office when they implement policies forced upon them by the ECB. The civil servants of the ECB go home unharmed. This is a governance structure that is unsustainable and that will be rejected. It is important that the ECB realises this and reduces its ambition to rule the politicians. Failure to do so will greatly harm the ECB.


  1. Haven't heard of a CB of a EZ member state that participate in numerous conferences about public finances and fails successively in its mission of banks supervision?

  2. Dr. De Grauwe, thank you for bringing this issue to the attention of your readers. I would like to add that Mr. Tritchet's letter to Mr. Zapatero was tantamount to blackmail. In essence he was saying: "make this reforms or the ECB will not buy your sovereign debt". In essence the Euro and the ECB have killed democracy. This is extremely serious and questions the convenience of having a shared currency unless the rules change drastically.

  3. Well, there was a Democratic revolution started in Portugal, Ireland, Greece and Spain back in 2001. Within 7 years nominal unit labour costs had risen as follows (2008 over 2001) :
    Germany 0,69%
    Ireland 30,64%
    Greece 27,06%
    Spain 25,74%
    Portugal 14,61%
    Current account in 2008 stood at :
    Germany 5,8%
    Ireland -6,3%
    Greece -16,3%
    Spain -9,2%
    Portugal -12,6%
    It is pretty clear that democracy can lead a country into pricing itself out of the world market. Whether it can stay there for long is another matter. But I doubt Trichet or anyone else, outside those countries that take that self-destructive option, can be blamed.
    Even today, unit labour costs, relative to the start of the euro are as follows (2014 over 2001) :
    Germany 14,08%
    Ireland 17,74%
    Greece 21,53%
    Spain 21,11%
    Portugal 13,23%
    So, the Greeks do not seem to have had it so bad. Once those figures get known a bit more widely, we can wonder about the Democratic revolution starting in Germany.

    1. Interesting analysis. From the assumption of labor market dominant explanatory power of current accounts to the omission of how much labor costs weight in total costs

    2. Well, capital costs in the said countries seem to have been at their lowest ever, so much so as to facilitate a trend in investment away from tradeables and into nono-tradeables, thus further worsening the current account. Here are two references, one more technical, the other more readable :
      Another important factor that led to the present ruin is the sharp rises in spending on (mainly social) transfers in the said countries (2008 over 2002).
      Germany 4,7%
      Ireland 53,7%
      Greece 61,4%
      Spain 41,5%
      Portugal 29,8%
      that cannot be reversed much, given the present humanitarian crisis (2014 over 2002) :
      Germany 17,2%
      Ireland 59,8%
      Greece 38,2%
      Spain 56,0%
      Portugal 40,8%
      Thre were, also, reforms to reduce inequality :
      drawn from here :
      that do not seem to have exactly succeeded.
      It is too easy to blame the "dangerous ambitions of the European Central Bank" for all this.