I have been reading through the statute of the European Central Bank (ECB) and the European System of Central Banks (ESCB), as well as the related articles in the Treaties. What I have yet to find is some sort of an “accountability clause”, a provision on the procedures that would be set in motion once a certain limit is exceeded. I am referring to a derogation from the rule of the ECB’s institutional independence, which would enable some legislative institution to exert influence over monetary policy.
It is readily apparent that the ECB has not met its stated inflation target of “below, but close, to 2%”. If we look at the data from July 2012, when Mr. Draghi delivered his famous “whatever it takes” speech, until December 2015 we see that inflation has been steadily declining (it was already falling from 2011). It now stands at 0.2% while the average rate over this period is 0.9%.
The vagueness of the medium term
The ECB maintains a medium term orientation. The rationale is that the medium term provides for a more calculated approach. It allows sufficient time for monetary policy decisions to be felt in the real economy through the transmission mechanism, while it leaves the market with a sense of stability.
Whereas trying to fine-tune price variations over weeks or months can be detrimental to the economy. It also is methodologically more demanding, since a short term view may fail to account for some key factors that are only rendered discernible once a phenomenon matures.
It therefore is understandable that the ECB’s inflation target is not measured on a short term basis. What is not clear though, indeed what is questionable, is the way in which the meaning of the “medium term” can be stretched to suit whatever policy the ECB is implementing. In fact, there is no specific definition of what it amounts to. One would assume that it is around 3 years. That would mean that the ECB has failed spectacularly since July 2012. But suggesting such a time range is just a hypothesis, albeit a plausible one, not some fixed target that legislators could appeal to in their effort to scrutinise the ECB.
To further complicate things, the 2% inflation rate is not part of the Union’s primary legal corpus. It does not have a “constitutional” status. It instead is a quantification of the Treaty provisions on “price stability” that has been determined by the ECB’s Governing Council. As per their own website (emphasis is theirs):
While the Treaty clearly establishes the primary objective of the ECB, it does not give a precise definition of what is meant by price stability. The ECB’s Governing Council has announced a quantitative definition of price stability: “Price stability is defined as a year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%.”
To put it in plain terms, by the much-vaunted “price stability” the Union’s primary law is only referring to predictable year-on-year changes in the general price level. There is no real inflation target since the ECB does not specify an objective time range. It has just given us a number to be met within some vague temporal horizon in an effort to place a check on speculation over its expected monetary policy.
Of course, the argument can be propounded that it would be an exaggeration and potentially a self-defeating practice to bestow constitutional status on a macroeconomic index. The peculiarities of the economy are such that what may be considered normal in one place or time appears as an irregularity in another. Primary law is not meant to be amended very often or indeed easily to accommodate for such relativity.
The problem with this line of reasoning, and in spite of its theoretical validity, is that European leaders have already added constitutionality to several macroeconomic indices, such as the budget deficit and the public debt. Indeed the entire architecture of economic governance is premised on such constitutionalised economic targets.
It follows that there is no “technical” reason as to why the inflation target cannot be enshrined in primary law. It simply is not there because of a political decision to set rigid fiscal rules while offering a very broad mandate to a disproportionately independent central bank.
Making the ECB accountable
Even though the current arrangements concerning the ECB’s independence could enjoy some serious reform, one can be modest in their demands by merely asking for an “accountability clause” to be inserted in the Treaties and/or the statutes of the ECB and ESCB. The clause would only be activated in cases where the monetary institution would fail to deliver on its mandate. The decision should be semi-automatic, judged against a benchmark such as an average 2% inflation rate over a three year period.
To enhance the interoperability of fiscal and monetary policy in the Economic and Monetary Union (EMU), it would be prudent to deprive the ECB of the power to provide its own definition of “price stability”. This should be trusted with the Council of the EU, which would decide on the nominal growth rate following consultations with the European Parliament and the Commission.
Apart from the experts in those institutions, the Council can always draw on expertise from its vast pool of talent, by bringing together economists and policy-makers from the Member States. It is a disservice to European citizens to pretend that only the central bankers in Frankfurt can understand money.
As for the immediate policy effects of the concomitant “accountability procedure”, they could range from limited to far-reaching. Here is a non-exhaustive list:
- policy control: the institutional independence of the ECB would temporarily be suspended, with the Council being the one to decide on the specifics of monetary policy, especially on such operations as quantitative easing that actually amount to implicit wealth transfers;
- a multi-annual monetary framework: similar to how the EU manages its own budget, a medium term inflation target could be established, while envisaging the specification of the expected yearly price level, so as to offer legislators a better indication of the effectiveness of monetary policy and whether it remains consistent with its mission;
- broadening of the mandate: in exceptional cases, such as in a period of excessive joblessness, the Council could decide that “price stability” is not sufficient for ensuring the unencumbered operation of the economy, since the fall in aggregate demand creates deflationary pressures that stand outside the central bank’s purview; and would thus instruct the ECB to prioritise a minimum target of average structural unemployment over the entire duration of the multi-annual monetary framework.
To these one could add such provisions as dismissing the ECB’s executive board, though the truth is that other things constant a change in faces cannot be enough to overcome institutional limitations.
Treaty change and political constraints
The aforementioned would require a change in the EU’s primary law, albeit a modest one. Under the current order, the “accountability” of the ECB amounts to a mere briefing session before the European Parliament’s Economic and Monetary Affairs (ECON) committee. While better than nothing, the “monetary dialogue”, as it is known, is nothing more than just that: a dialogue.
One of the reasons the ECB is practically exempt from democratic control is that European nations did/do not trust one another over monetary affairs. The fear was/is that “democratising” monetary policy would eventually lead to erratic money supply fluctuations, featuring rampant inflation, radical uncertainty in the markets, and so on.
The truthfulness of such concerns need not be examined herein. What is of relevance is that the “accountability clause” would not, in principle, alter the institutional standing of the ECB. It would only be the exception to the rule, and would only be activated in accordance with an objective criterion. It is best to think of it as the “failure clause”, the fallback option for when nothing else works.
As with everything related to economic policy in the Union, political leaders need to be reassured of the primacy of a rules-based approach over the deliberative method. While we may not be among the most fervent exponents of the EMU’s dominant mindset, we might as well try to think of ways it can be improved, in particular by making democratic control over monetary policy a semi-automatic procedure that is contingent on a clearly-delineated legal framework centered on an objective economic criterion.
This kind of arrangement would (i) strike a balance between the opposing views on the method of economic governance, (ii) bring the ECB in line with the expectations of citizens regarding the accountability of officials, and (iii) ensure interoperability between monetary and fiscal policy and, hence, guarantee the singleness of Europe’s economic governance.