Tuesday, July 05, 2005

Reforming the ECB

The Financial Times leads today that:

The ECB is not the main cause of Europe's economic malaise. Its effectiveness is constrained by inflexible labour markets, weak public finances and underdeveloped retail financial markets. But it is part of the problem.
By responding too slowly to shocks the ECB has allowed output to drift away from potential. By taking an extreme position on central bank independence it has prevented effective co-ordination of monetary and fiscal policy, and structural reform. We have seen this before - in Japan - and it resulted in a decade of stagnation.
To carry on regardless, relying on its formidable legal independence, would be unwise. Sooner or later change - probably of the wrong sort - would be imposed from outside. What Europe needs is leadership from within the ECB to make it part of the solution to the continent's economic woes.

Making the bank part of the solution
So far so good, and one can even agree with the FT when it states that “Consensus-based decision-making by national central bank governors at a time of persistent economic divergences is a formula for inaction.”

However they then go on to suggest that the ECB should engage in closer dialogue with Eurozone governments and move towards majority decisions. This sounds good in theory but closer dialogue with governments could lead onto sticky ground – governments are not allowed to attempt to influence the ECB and such dialogue could give rise to charges of influence or favouritism. As for majority decisions - the divergences between member states as to what is a suitable interest rate for the Eurozone are now so wide that I imagine this approach might do more harm than good. And, those who lose out might be bitter enough about it to indulge in more of the kind of posturing that Italy and Germany have recently engaged in – with conferences on the risks of break-up and noises about having a referendum on withdrawal etc. etc.

Then there is the small matter of enlargement of the €uro area and the implications this has for monetary policy ....... Currently there is no political authority to back up the single currency and with gradual enlargement of the Eurozone that lack of political authority will become more and more apparent. The longer there is no political authority behind the €uro, and the ECB, then the greater the risks of instability and possibly eurozone break-up.