On the institutional independence of the European Central Bank

This post is archived. Opinions expressed herein may no longer represent my current views. Links, images and other media might not work as intended.

Update May 9, 2016: For the most up to date analysis, see my free book Little Guide to the European Union, in particular the chapter about the accountability and independence of the ECB.

The European Central Bank (ECB) is the institution of the European Union tasked with conducting the monetary policy of Europe’s Economic and Monetary Union (EMU). To fulfil its mandate, the ECB enjoys a very high degree of independence. In the present article, we reflect on the specifics of “independence” in the context of Europe’s sui generis political order.

A model for democratic rule is the separation of powers, which entails the institutional independence of the state’s powers. Notwithstanding the theoretical question whether monetary policy is a cardinal state function, this principle is typically applied to the central bank. The idea is that politicians should not be in a position to influence monetary affairs, for that would provide the incentive to introduce short term measures for boosting economic activity at the expense of longer term sustainability.

While monetary policy ought to be protected from opportunistic interference and must have a longer term continuity, the general perception of politicians as abusive and the concomitant aversion to the possible fluctuations of democratic conduct, if universalised, will usher in a robust technocracy. To avoid such pitfalls, it is of paramount importance to distinguish between institutional independence and independence from democratic control. The former is good, the latter is not.

The institutional independence of the central bank is a prerequisite for the optimal, unencumbered conduct of monetary policy. It amounts to operational independence and the necessary freedom from external control. To that end, Article 130 TFEU (pdf) is more than sufficient:

When exercising the powers and carrying out the tasks and duties conferred upon them by the Treaties and the Statute of the ESCB 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.

Modal features of independence

Though the degree of independence as well as the scope of authority always need to be proportional to the task, there is a certain qualitative aspect to be considered: the modal features, the modalities of independence.

In the EU’s unique brand of supranational politics, the modalities of ECB independence exhibit certain unique qualities that would not be found in genuine republics:

  • quasi-permanence: no given parliament, neither the European nor any national one, can amend the ECB’s mandate; unanimity among Member States is required to change a single iota in the Treaties;
  • tokenistic accountability: given that the European Parliament has no means of altering the ECB’s legal basis, the democratic accountability of the ECB is effectively tokenistic, with the monetary dialogue between the two institutions being mostly ceremonial;
  • euro statelessness: the euro is a currency that belongs no state, there is no European republic underpinning the EMU and, a fortiriori, the ECB has no counter-party European Treasury from which to receive guidance on the specific requirements of economic policy.

Couched in those terms, I would contend that the modal features of institutional independence actually render the ECB independent from democratic control. It is important to stress that this does not stem from the monetary-policy-related articles in chapter 2 of the Treaty on the Functioning of the European Union. What insulates the ECB from democratic control is an unintended consequence that necessarily emerges from the particularities of the EU as an incomplete, quasi-confederal, inter-governmental order.

Furthermore, this claim is based on a specific, albeit not idiosyncratic, understanding of accountability: the obligation of an unelected institution to render things concrete before the people’s representatives and remain subject to the consequences thereof. Since there exists no European Ministry of Finance to frame the ECB’s conduct and given that the European Parliament has no real power to act on the ECB’s briefings, communications, policies, no entity can hold the ECB democratically accountable in any meaningful way.

Output legitimacy is insufficient

A justification for the ECB’s unique kind of independence is that its clear mandate enables it to achieve “output legitimacy”. The ECB, it is argued, delivers on its expected objective of price stability and is therefore legitimised by the result.

While plausible, the claims on output legitimacy are dubious at best. How can we truly verify that the citizens are satisfied with the results when their representatives have no power of bringing the ECB into question? What if they would like to modify the ECB’s mandate? A Treaty amendment may require decades to be realised, while inter-state-treaty changes in general can be no reliable way of reviewing or tackling the central bank’s shortcomings.

As for the ECB’s mandate, there is a more subtle point to be considered: price stability concerns the medium-term outlook of monetary policy. However, there is no clear definition of what “medium-term” amounts to. It is open to interpretation: it can be 3-5 years or perhaps 5-7. Such vagueness opens up a broad sluice gate for the introduction of all sorts of justifications to any policy. To that end, accountability to the people’s representatives is reduced to a process of “explaining” decisions, so obscure language can always be employed to obfuscate or beautify the actual outcomes.

Still, even if the ECB were to consistently deliver on price stability, that would not be enough to legitimise its actions, for it clearly acts on issues that do not pertain to inflation targeting, such as the decision not to maintain an accommodative stance vis-à-vis the Greek banking system. Instead of being a clear benchmark for measuring performance and, hence, for attaching the corresponding output legitimacy, the narrow mandate of the ECB provides the means for circumventing democratic control, notwithstanding the afore-mentioned modalities of institutional independence.

The importance of central banking

There is a certain view that a central bank’s institutional independence should mimic that of a supreme court. Given that both entities are made up of unelected experts in their fields, this appears to be a sound proposition.

Yet such thinking seems to underestimate the qualitative differences between a court of law whose decisions tend to have a gradual and progressive impact on the social fabric, and a central bank with the power to make an entire economy go boom or bust in a very short amount of time.

It is in the nature of central banking to be the cornerstone of a financial capitalist system. “Financial capitalism” and “central banking” are inextricably bound up together. A failure to maintain the money supply will grind the banking system to the ground, just as a prolonged period of disinflation or outright deflation will severely damage economic activity while making nominal debt burdens heavier. In other words, a central bank is powerful, especially if it rules over a significantly large economy.

As concerns the reach of monetary policy, take Quantitative Easing as a case in point: a policy instrument with which the central bank shapes interest rates throughout the yield curve. This effectively represents the capacity to redistribute resources across the economy. If the central bank can achieve the same or similar results as those of an elected government’s fiscal and social policy, then it follows that it must also be subject to strict democratic control: citizens have to be able to review, reject or approve of wealth transfers.

The gist is that the central bank needs to be closely monitored, be subject to thorough scrutiny, and be held fully accountable for its decisions precisely because its day-to-day operations can change the material conditions of entire classes of economic actors.

ECB reform

As I am of the view that critique entails action and without prejudice to more ambitious proposals, I hereby furnish the outline of a reform to the ECB’s institutional character within the framework of a constitution-based European Democracy:

  • concerted action: just as with the Bank of England, make the rate of inflation an annual target placed in the hands of the Minister of Finance, the European Chancellor of the Exchequer, who will also be responsible for formulating the economic policy of the federal, European-level government;
  • dual mandate: like the Fed, the ECB has to pursue price stability and full employment, with no priority given to any one of them—it is preposterous to witness record levels of unemployment and have the central bank do nothing about it;
  • full transparency: ensure that records of all General and Executive Council meetings are kept, and that they are available to Members of the European Parliament within the context of the monetary dialogue, following a formal request from the Economic and Monetary Affairs committee;
  • parliamentary control: provide the bicameral European Parliament/Congress with the right to propose an amendment to the legal basis of the ECB through qualified majority voting in both chambers, subject to approval by the executive.

In such a context the ECB will indeed be empowered to promote the general good. It will be tasked with managing a currency that is socially-sustainable and with overseeing a monetary union that is part of a fully fledged democratic order.

Alas, the institutional independence of the ECB is embedded in a European Union that is anything but a genuine republic, with all the downsides this creates regarding its openness to democratic control. As for the EU being transformed into a European Democracy, founded on a codified constitution, that is highly unlikely, at least in the prevailing circumstances.