Has the European Central Bank lost its independence?

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In light of Mr Draghi’s latest press conference on the approach the European Central Bank will maintain in addressing the ongoing economic crisis in the euro area, prolific Greek economist Dr Yanis Varoufakis argues that the ECB has now lost its much-vaunted independence. Dr Varoufakis notes:

What Draghi is now saying is that, unlike those purchases which the ECB made without imposing conditionality on the three countries involved, any new purchases will come with strings attached; i.e. with a Memorandum of Understanding between the ECB, the EE [EU] and the member-state whose bonds the ECB will be purchasing in the secondary markets. This is, in my view, the end of any pretense to keeping monetary policy separate from fiscal policy. In effect, the ECB gives itself the task of enforcing into member-states particular (and highly austerian) fiscal policies.

This is an intriguing interpretation of what the ECB plans to do. At first it is indeed crystal clear that no easy money will be provided to stressed sovereigns as strict conditions will always accompany any kind of financial assistance. Towards that end it could indeed be said that this is a political decision tailored to the agenda of the German government and other net contributor countries to bailout funds; or it could perhaps be argued that the ECB remains in captivity thanks to the obstinacy of Mr Jens Weidmann, the Bundesbank chief, to cling on to the hard money approach that characterizes German central banking since the end of WWII. Along these lines skilled authors could provide a series of explanations on how the ECB has become a powerful weapon in the hands of governments who wish to impose a particular regime of measures in dealing with the crisis. Without monetary easing, stressed sovereigns like Spain and Italy will come to the need of a bailout earlier than expected, which will force upon them stringent conditions on fiscal issues and internal economic policy. Doing so, it is alleged, is a way of indirectly dictating fiscal policy; hence the ECB has lost its independence because it clearly facilitates a particular agenda.

To some extent this view is correct, at least on the surface. Yet as plausible as it may be, it leaves much to be desired. If it is true that the ECB has aligned its policy with the stratagems of core euro zone countries (net payers) by the mere fact of abstaining from massive bond purchases, then it can be deduced that if Mr Draghi had announced a massive bond buying programme, he would still violate the independence of his institution; this time by conducting monetary policy in accordance with the immediate needs of the periphery. If the short term conditions on the borrowing costs of Spain and Italy were improved, by means of monetary easing, that would still constitute an indirect influence on fiscal policy as it would temporarily alleviate the pressure for reforms and internal readjustments. In other words we would have to conclude, along the lines of this argument, that if Mr Draghi had announced the exact opposite of what he did, he would have still thrown to the wind the cherished independence of his institution, as he would have favored a particular fiscal agenda.

Understandably the argument can run both ways, which may only mean two things under the current conditions:

  1. the ECB will always be political in the sense of forwarding the agenda of a particular group of countries at a given time (remember that nonsense about the “winners” and the “losers” of the last European Council summit?), or
  2. the ECB retains its independence, by conducting monetary policy in accordance with its mandate, regardless of the fact that this may seem to serve the occasional interests of certain governments.

Given that point (1) is subject to the values, beliefs, prejudices, interests and political views of each individual, I think that any argument along those lines will ultimately be based on arbitrary, ad hoc definitions of value and theories that will be refuted by the very inferences that may be drawn out of them. Any discussion based on point (1) will eventually create confusion and arid controversies, while obfuscating the real issues at stake.

Whereas point (2) states the fact that the ECB has institutional independence, which means that being the monetary function of the broader institutional apparatus of the EU, it retains the discretion of conducting policy in ways that will best serve its mission, which is price stability (I say that the ECB is broader than the euro zone because it belongs to the European System of Central Banks, but this is a technicality that may be ignored). Whether one agrees or not with the current mandate of the ECB is irrelevant to the issue of independence per se.

Much has been said about the role of the ECB and sometimes the very notion of its independence has been challenged by heads of states, politicians, opinion-makers etc. (to avoid any misunderstanding, Dr Varoufakis has never challenged the independence of the ECB and I do not imply anything against his views). Yet there seems to be a fundamental and egregious error of these vociferous critics in conflating the current monetary policy with institutional independence as such. What the fervent detractors of the ECB are saying when they scornfully contest the independence of the ECB, is that it should not be freed from the machinations and short-term opportunism of some or all governments and that it should “support” governments in need of funding in order to promote “growth”. In a nutshell they fallaciously think that independence equals a rigid monetary policy.

As a corrective of this erroneous perception, it must be stressed that the current policy approach of the ECB does not stem from its independence qua independence, but from the mandate it has been assigned to uphold. If this mandate is wrong or undesirable, the blame should fall on all those who signed and ratified the relevant Treaties, as anything else would be a perversion of reality and a denial of recognizing the source of the alleged or real problem.

It also needs to be noted that the independence of the ECB does not mean that it can do whatever it wants, as is often thought. It only means that it has the discretion to discern between a number of tools and means at its disposal to fulfill its role. Anyone aware of basic legal principles, of constitutional and administrative law in particular, knows that “discretion” does not mean omnipotence, but only offers a scope of flexibility to enforce the given mandate, in accordance with established principles and customs. This is perfectly in line with the democratic principle of the separation of powers, as was originally practiced in the early parliamentary system of Britain and as was later theorized by Montesquieu, eventually becoming a central feature of modern democratic states.

In economic terms, institutional independence of the ECB, means that the power to manipulate the money supply will not be abused by politicians who, in face of declining popularity, will go asking for easy money so that they may avoid politically costly measures, by offering blank checks to their voters (see analysis: Should the European Central Bank give money to states at 0% interest?). Instead of that, monetary policy is determined mainly by the Governing Council of the ECB, where all heads of National Central Banks together with the members of the Executive Board express their views and take decisions. Monetary policy under the given economic order of fiat money, should always be independent from short-term politics, because it must be conducted with the long term perspective in mind; otherwise erratic expansions or contractions of the money supply, will heavily distort relative prices and have a chilling effect on everyday commerce by making the business cycle ever more volatile. A healthy economy is one where prices are not influenced by the arbitrariness of officials. Within the context of modern monetary policy this may only be achieved through the complete independence of the central bank.

Finally if the main argument of the ECB’s critics against its independence were to be taken as a universal axiom, then we would also have to question the institutional independence of supreme courts, or the separation between the executive and the legislative functions; ultimately challenging the very foundations of a democratic institutional order of checks and balances, by sacrificing it to a groundless conviction in the metaphysical benevolence of the occasional government or certain bureaucrats in office. The logical extension of this view is that it is right to offer unlimited power to some individuals, if this happens to serve “our” definition of the good and appropriate policy at the time it best serves “our” needs. Such a principle may only provide the excuse to “enlightened” and philanthropic despots to shape society in accordance with their caprice always in the name of the public good, without any institutional constraints to impede their plans. If democracy is to mean anything at all, the institutional independence of the democratic functions must always be preserved, regardless of conditions. The stability of institutions is essential if we are to have a transparent and just political order. For if rules are to be violated anytime it seems convenient to do so, then their credibility will be shattered, throwing us back to the era of demagogy, charlatanry and chaos.

Picture credit: Wikipedia