The powers of the EU are horizontally divided in accordance with the principle of the separation of powers. Each European institution, every EU entity tasked with a cardinal function, enjoys operational independence. Neither the other institutions nor national governments can interfere with their internal affairs.
The European Central Bank, also known as the ECB, partakes of this principle. Its independence is commensurate with its role as the ultimate authority over monetary policy in Europe’s Economic and Monetary Union, the euro area in particular.1 Being independent allows it to conduct its operations with a medium-to-long-term horizon. Electoral cycles do not affect it, nor can a new EU policy agenda force it to adjust its monetary stance.
European leaders have designed this institutional arrangement under the impression that a central bank can only be effective when emancipated from the short-term temptations of the political process. Price stability presupposes consistency and that requires long term planning and execution. Monetary policy trickles down to the economy in an incremental fashion. The transmission mechanism is not immediate. Macroeconomic changes reflecting the impact of the central bank’s actions take time to materialise. To this end, the monetary authority cannot be bound by the will of politicians, whose role forces them to focus on the short term. A money supply that would be tailored to the needs of politics, would risk becoming erratic and, hence, ineffective at achieving price stability.
This is, in outline, the rationale underpinning the institutional standing of the ECB. Opinions on the particularities of economic policy notwithstanding, the notion of insulating an authority from the ups and downs of politics is not specific to central banks. It applies equally to other functions of the polity where holistic thinking is needed. The military is a case in point. The same is true for the courts, albeit for slightly different reasons.
Legitimacy and accountability
The point is that the underlying principle is sound. What matters is the modal features of its instantiation and how these impact the institution’s legitimacy and accountability. These democratic qualities go hand-in-hand: a state entity cannot be legitimate while remaining unaccountable and vice versa.
Legitimacy in the normative fundament of an official entity’s authority. Powers granted to an institution must be sufficient and proportional to the task, limited in scope, aligned with the will of the demos, and consistent with its stated ends.
Let us take a closer look at this claim:
- Sufficiency. The institution must be in a position to deliver on its mandate, otherwise it cannot be judged as ineffective in the task of pursuing its policy objectives;
- Proportionality. The authority it wields needs to be commensurate with the task at hand. Never in excess. A disproportionate use of power implies abuse, and that may entail an authoritative practice.
- Limited in scope. The mandate of a specialised institution can only be evaluated if it is specific. The broader it is the more divergent the interpretations can be, and hence the greater the difficulty to determine whether the institution is operating within its remit.
- Will of the demos. Given that the legal status is protected by the constitution, and since that is based on democratic legitimation, the institution must not deviate or in any way contradict the practical morality of the polity. Doing so could create tensions, raising questions about the appropriateness of various policies.
- Consistency of ends. A mandate is given to a specialised institution so that it may deliver on it. For as long as it meets its objectives it is evaluated as adequate for the task.
Legitimacy is further divided in two classes: (i) input and (ii) output. The former concerns the mandate given to the official entity. Legitimacy of this sort exists only when the demos offers its input within the framework of the legal order. As for output legitimacy it is about the outcomes of the institution’s measures and whether they comply with its mandate.
The European Central Bank has no direct input legitimacy. It is a technocratic entity whose members are appointed in office by national governments. At best that makes it indirectly legitimate in terms of input.
The ECB draws legitimacy from its output. It has a precise objective that is enshrined in the European Treaties: to ensure price stability. It has been endowed with sufficient powers to pursue that end, and, it enjoys operational independence which further guarantees its capacity to act.
The very mandate of the ECB is legitimate. It partakes of the legality of the EU Treaties. As such, the criterion for measuring its success or indeed its compliance with its role rests in price stability. For as long as the ECB delivers on that front, it qualifies as legitimate in terms of output.
The obscurity of “price stability” over the “medium term”
The justification for output legitimacy is plausible and clear. It may even be the optimal legal arrangement for specialised institutions. Where complexity and indeed obscurity is introduced is on the precise meaning of certain key terms, or rather on which entity gets to attach a signification to them. More concretely, the Treaties do envisage “price stability” as the ultimate telos of monetary policy. In doing so they provide the legal cornerstone of the ECB. What they fail to clarify is the exact meaning of that concept. They do not provide for either a methodology or indeed a rate (or range) of fluctuation in the aggregate price level.
Anyone who has ever followed the news on the European Central Bank has come across the much-vaunted objective of price stability, which manifests as a policy of targeting an annual inflation rate that is, in the words of the ECB, “below, but close” to 2%. This definition, the quantification of the Treaty provision, is provided by the ECB’s Governing Council.2 Put differently, the institution to be held accountable defines the criteria for its accountability.
The European Treaties have completely omitted the horizon over which a stability of prices is to be measured. This too is defined by the ECB and encapsulated in the otherwise vague notion of the “medium term”. It is never talked about in terms of years. We cannot know for sure whether the ECB has delivered on its mandate since we may not tell where the evaluation is supposed to start and end on the time axis. Given that the inflation rate is somewhat clear (close to 2%, but how close?), one would expect some more specificity on the temporal magnitude of the method.
What we infer from the above is that a flaw of the Treaties contributes to a rather awkward institutional arrangement where the ECB is in the advantageous position of both defining the criteria for its accountability and making the judgement call on whether they are met. Output legitimacy can be a sound justification for institutional independence provided there exists a precise legal basis that ensures the aforementioned aspects of legitimacy, namely, sufficiency, proportionality, limited scope, democratic consent, consistency of outcomes. In the absence of a clear method for measuring the deliverable results, it is impossible to determine in any objective way whether a technocratic institution is fit for its task.
Open-ended inflation targeting
To illustrate the point, the ECB cannot be questioned for having failed to maintain an inflation target of below, but close to 2%. The euro area has been consistently far below the ECB’s target. From July 2012, when Mr. Mario Draghi (the ECB chief) stated his famous “whatever it takes” claim for saving the euro, up until March 2016 the average inflation rate is 0.8%.3 That is near 1%, i.e. far below target.
Perhaps though we have just used the wrong time frame. Maybe it is too short to qualify as “medium term”. But how are we to settle this issue in some objective way? Our best guess would be to infer a temporal horizon from the ECB’s own policy initiatives.
In its March 10, 2016 meeting the ECB’s Governing Council approved of a new set of monetary measures for injecting liquidity in the financial system. The programme goes by the technical designation of Targeted Longer-Term Refinancing Operations II (TLTRO II). What is of interest to our inquiry is the maturity of these loans to the financial sector (the time until they expire). That is four years long, while the entire programme is conducted in the interest of price stability according to the ECB’s words:4
TLTRO II will contribute to a return of inflation rates to levels below, but close to, 2% over the medium term.
This is our most reliable indicator under the circumstances. The ECB is tacitly admitting that it will meet its target at around the year 2020. If we stick to July 2012 as a starting point—and there is no reason why we can’t start earlier—that would be about eight years. So, may we conclude that the ECB’s medium term is at least an 8-year-long period? The answer is negative. All we are doing here is making an educated guess, or rather, we are probing into the flaws of the European Treaties as concern the accountability structure of the European Central Bank.
Output legitimacy based on benchmarks
For output legitimacy to function as intended, the mandate of the ECB will need to be evaluated against a set of objective criteria. Based on the above-mentioned loopholes or omissions in the Treaties these could encompass the following:
- the Union’s primary law would have to render specific the meaning of “price stability”;
- the time frame for targeting inflation should be explicitly defined in months or years;
- whatever quantification of the Treaty provisions should be ancillary and supportive of the main task enshrined in primary law, without anyhow endowing the ECB with additional discretionary power.
In the absence of at least those three items, the independence of the European Central Bank does not really contribute to its legitimacy. Furthermore, the basis for its accountability is rather feeble and ineffective. This is one of the cases where the European Treaties exhibit a major flaw. One of the main EU institutions falls short of satisfying the normative democratic criteria of legitimacy and accountability.
A deeper fiscal-monetary disconnect
No central bank is omnipotent. Monetary policy cannot be a panacea for weaknesses on the fiscal front nor a substitute for sound budgetary planning. Europe’s Economic and Monetary Union is already based on the harmonisation of monetary affairs but remains far from homogenised on fiscal issues. The EU, in particular the euro area, has a single monetary function headed by the institution of the ECB, yet it lacks a counter-party treasury. There is no EU-level entity responsible for economic coordination, for raising and directing resources in an orderly fashion, and for drawing linkages between finance and the real economy on a system-wide scale.
Against this backdrop, the ECB can indeed face insurmountable obstacles in its task to ensure price stability. It may then be true that we have misplaced expectations for the monetary authority. We may be labouring under the erroneous assumption that the inflation rate is solely a function of monetary decisions. That the central bank can fine-tune it at will. The truth is that the demand curve is equally important. For instance, disinflation or deflation can also be reversed by activity on the fiscal side such as in the form of investment spending that would, ceteris paribus, put an upward pressure on prices.
The EU is in the process of completing its Economic and Monetary Union. The fiscal and financial aspects of it are still incomplete. In particular, there is no EU-level economic policy that could contribute to the ECB’s efforts for an average rate of 2% inflation. The European Central Bank continues to be the only supranational entity that can directly influence the average price level.
Whatever the case, economic policy is at its optimal when it is holistic, where there is concerted action between the various branches of the polity that deal with those issues. The European Central Bank may not be delivering on its mandate because it is trapped in an inefficient or incomplete institutional framework. Even so, that policy constraint would not detract from the normative fact that the effective arrangements for its legitimacy and accountability are far from adequate.