ECB and democracy: The traps of debt monetization

2011-11-14

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Sooner or later the European Central Bank will have to monetize debts to pacify markets, who see the illiquidity of Italy and Spain as an underlying risk that might make their public finances unsustainable within the few years ahead or even sooner, depending on the overall conditions in the Eurozone first and the global economy second. What should be made clear is that the ECB is already buying sovereign bonds from the secondary markets, via its Securities Markets Programme (SMP), though the quantities it purchases are relatively insignificant to shape interest rates and send a clear message to international investors that there is a determined final backstop in the Euro Area. Having already stated on several occasions my belief that the ECB should take a more active role in combating the disintegrating dynamics of the crisis, I now need to point out some issues relating to democracy, transparency and equality with respect to euro member-states, that are often neglected by the vast majority of analysts, for whatever reason that may be.

First of all, the ECB has been given the unique task to issue and control a currency (the euro) without the existence of a counterparty treasury with jurisdiction over the exact same area. The eurozone is a currency union, an area with a single monetary policy (together with all the rest Community acquis), which lacks a unified fiscal policy, or in other words a single authority that would have the power to raise money from its constituent states, by imposing taxes or issuing bonds of its own. Regardless of what was the rationale behind this setting, the gist is that there is a significant institutional gap in the architecture of the euro that makes the management of the crisis ever more challenging. This currently leaves the whole euro with only one policy leg, implying that any efforts to introduce the missing “leg” would either require a cumbersome Treaty change that will take years to be concluded, given the complexity of law-making in the EU and the need for any Treaty change to be ratified by 27 parliaments, making the labor unfeasible within the rigid time frame of the crisis; or alternatively the introduction of ad hoc measures that would give the missing powers to some mechanism that would lack credibility and would most probably be undemocratic, just like the EFSF, or ultimately to assign to the ECB itself the twin task of monetary and fiscal policy.

Given that a credible Treaty change is practically impossible within the time frame available (what Merkel is saying all the time about changing the treaties is mostly to exert pressure on certain governments to pass the necessary reforms), the only real choice, should full scale monetization be allowed, is to either resort to half-measures undertaken by ad hoc mechanisms, or to give all power to the ECB. In either case we are dealing with an issue of democratic illegitimacy and most probably with the over-concentration of powers to unelected bureaus/bodies/agencies/institutions with basically little to no accountability. The ECB for instance is completely independent and no power can tell it what to do. This derives from Article 130 of the Treaty which states the following:

When exercising the powers and carrying out the tasks and duties conferred upon them by the Treaties and the Statute of the ESCB [European System of Central Banks] and of the ECB, neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body. The Union institutions, bodies, offices or agencies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the European Central Bank or of the national central banks in the performance of their tasks.</p>

Given this legal framework, the transfer of considerably more powers to an institution that cannot be controlled by anyone, is certainly not a prudent choice. The institutional gaps of the euro make the ECB a supranational entity, not a federal one, like the Fed in the US, which is from a qualitative perspective quite different since the ECB will in fact be above any state and will therefore have the power to impose its own conditions for monetization and discriminate among the states it wishes to support. This might sound overstretched to some, yet there already exists an instance of such coercion back in August, when a letter dated August 5 was sent from the ECB to the Italian government demanding austerity measures to be taken prior to the intervention in the secondary markets that took place during that time. Who can guarantee that similar actions may not be repeated in the future, especially in the case the ECB is asked to perform the dual task of being the treasurer and the issuer of the currency imposing rules and conditions and making discriminations? This democratic deficit is indeed an important issue, one that needs be considered prior to any steps towards such a direction.

On the flip-side, one might argue that the EU as a whole is already suffering from a similar democratic deficit which of course exists from the national level and it increases as we move higher in the institutional hierarchy. For instance the European Commission is unelected, yet the powers it commands are impressive. The point now is not to raise the issue of democracy in the EU, but to add to the discussion the argument which suggests that since Europe already suffers from a structural democratic deficit and since all measures that have been taken so far to combat the crisis are in most cases democratically illegitimate (excessive powers to the monitoring mechanisms in bailed out countries, democratically illegitimate mechanisms such as the EFSF etc.), why not move deeper in to the hole by adopting in full the sort of Faustian policies that are already exercised?

Regardless of where one stands regarding the argument, the point remains the same. We as Europeans are found in a situation where we have restricted our selves by designing a flawed monetary union and we now come to the point where the ECB will, sooner or later, have to monetize debts to prevent the implosion of the whole project. Democratic or not, this seems to be the only path to safety (combined with a series of other measures of course). Given that our leaders have proven to be quite creative when it comes to devising all sorts of complicated plans and bizarre mechanisms, an optimist might suggest that we should expect them to come up with a way to circumvent the democratic issue that has been raised above. Failing to do so in an effective manner, might well lead to unpleasant consequences, suggesting that this issue requires carefully taken decisions, with full agreement by all parties involved. At any rate we are already walking on a very thin diving line between virtue and vice. Alas we brought our selves to this position.