- institutional independence
- sufficiency of output legitimacy
- accountability based on the inflation target
- incoherence of European economic policy
- EU301: The economic governance of the European Union.1
One of the constitutional principles of the European Union is the horizontal separation of powers. This is achieved through the operational independence of the institution tasked with a state function. For instance, the European Commission, which is the Union’s
deciding implementing executive, is independent from the European Parliament and vice versa.2
The European Central Bank or else ECB partakes of this principle. It enjoys institutional independence commensurate with its role as the supreme monetary authority in the Economic and Monetary Union. Its status as independent is protected by the European Treaties and, therefore, is as permanent as any legal provision can get.3
European leaders have agreed to this arrangement under the assumption that a central bank ought to be protected from the short-term temptations of elected officials. The idea is that monetary policy has a longer term perspective. Price stability can only be achieved where there is a degree of continuity and consistency in monetary affairs. A central bank, it is claimed, cannot operate effectively if it receives direction from politicians. It will be forced to adapt its policy to the electoral needs of the government or the ruling parties, with whatever detrimental effects that will have over its outlook.
Views on economic policy notwithstanding, the notion of protecting an institution from shorter-term politics is not peculiar to central banks. It also applies to other branches of the state where strategic thinking is necessary. Military institutions are a case in point. Put differently, the principle of operational independence is sound. What really matters, and where evaluative judgements may be passed, is in the specific arrangements for the normative and legal standing of the authorities concerned. It is about their legitimacy and accountability. These are connatural qualities: an institution cannot be genuinely legitimate yet remain unaccountable, or be illegitimate while standing as accountable.
Legitimacy consists in the normative underpinnings of an authority’s mandate and in the appropriateness of its policy objectives and results thereof. It is about whether the powers conferred to an official entity are just, sufficient, proportional to the task, limited in scope, in line with the consent of the demos, and whether the authority is delivering on its stated ends.
Legitimacy is thus divided in two classes: (i) input and (ii) output. The former applies to the mandate given to the official entity, while the latter concerns the outcome of the measures it adopts. In the case of the European Central Bank, its input legitimacy is indirectly drawn from the European Treaties. This is true for a couple of reasons: firstly, there has been no direct participation of European citizens in the drafting and ratification of that corpus of law; and secondly, this indirectness is further amplified by the peculiarities of the European Union as a federal system, where intergovernmental politics play a central role, as we discussed in a previous seminar. 4
The ECB is therefore judged in accordance with its output legitimacy. It has been given a clear objective: that of ensuring price stability. It has sufficient powers to pursue that end, and, given its operational independence, it remains unhindered in its task. Given that the ECB’s mandate is legitimate, courtesy of the legality of the European Treaties, this institution shall enjoy output legitimacy for as long as it delivers on price stability.
The rationale is clear and rather straightforward. Where things get a bit more complicated and nuanced is on definitions and on who gets to make them. The European Treaties do indeed establish the fundament on which the ECB operates. What they do not provide for, is an explicit reference to what the notion of “price stability” amounts to. We have all heard of the ECB’s inflation target of “below, but close” to 2%. What we often neglect is that this value is not enshrined in Treaty law. It is, as a matter of fact, a quantification of “price stability” provided by the ECB’s Governing Council.5
To further add to the nuance of the matter, the inflation target is not evaluated on a year-by-year basis, but only over the “medium term”. This concept is somewhat problematic as it entails no fixed time horizon. There exists no specific commitment to, say, a range between three to five years, or even five to seven. In practice the “medium term” is whatever the ECB wants it to be, as the Treaties offer no further guidance.
The point is that by taking a closer look at the ECB’s institutional status, we have moved from what seemed to be a clear objective—price stability—to an effectively vague, open-ended mandate. Given this, we ought to question whether the criterion for output legitimacy is met. As we noted earlier, this is all about the policy results. The outcome of “price stability” ought to be an almost 2% inflation rate over the span of a few years. The ECB is judged on that. So does it deliver?
If we examine the data on inflation in the euro area from August 2012 to the present, we see that inflation has failed to remain in sync with the target. The average rate over this period is 0.8%.6 It is far lower than what we would come to expect. Perhaps then, this period is too short to qualify as a “medium term”. How are we then to proceed in our inquiry? Our best chance is to draw inferences on the implicit time horizon from the ECB’s policies.
In its latest meeting of March 10, 2016, the ECB’s Governing Council agreed to a new set of measures meant to inject liquidity in the system. The technical term is Targeted Longer-Term Refinancing Operations (the TLTROs). It is the second time such instruments are being utilised. What is of interest to us is their duration. They have a four year maturity and the reason they are introduced is, according to the ECB’s own words, and I quote:7
TLTRO II will contribute to a return of inflation rates to levels below, but close to, 2% over the medium term.
We must therefore conclude that this elusive “medium term” may extend to the end of this decade, with the possibility that inflation will remain at an average point well below its intended rate.
To be clear, we are not delving into the specifics of the inflation target for the sake of understanding some methodology in statistics. We are examining the subject to comprehend whether the ECB’s legitimacy is at the appropriate level and its powers are clearly delineated.
Speaking of checks and balances, there is, of course, the so-called “monetary dialogue”, where representatives from the ECB must regularly attend hearings at the European Parliament’s Economic and Monetary Affairs (ECON) committee. While European deputies get the chance to pose all sorts of interesting questions—something valuable in itself—the fact is that this exercise is nothing more than what its name signifies: a dialogue, a nearly inconsequential exchange of views.
How can legislators hold the ECB accountable when there is no fixed criterion with which to measure the effectiveness of monetary policy? Reliance on output legitimacy is sufficient when the results are gauged by an objective benchmark. The problem with the ECB’s mandate is that its medium-term orientation represents a moving target. It is, in other words, subject to broad interpretations and arbitrariness.
The implication then is that legitimacy based on deliverable outcomes has to be contingent on indices that can be measured with the highest possible standard of objectivity. For our purposes this would have to mean that:
- the European Treaties should render explicit the notion of “price stability”;
- the temporal magnitude of the inflation rate should be made specific;
- the quantification of any aspect of the ECB’s mandate should only be complementary to any Treaty provision and should in no way confer additional discretionary powers to the central bank;
- legislators should have a fallback option to impose conditions on the ECB in those cases where it fails to deliver on its mandate. In other words, central bank independence should be preserved as the default but remain open to political guidance whenever necessary.
These would, ceteris paribus, make the notion of central bank independence more appealing and, furthermore, would have reinforced the effectiveness of output legitimacy. In their absence though, we might as well conclude that the ECB stands to enjoy a disproportionate degree of power and virtual immunity to democratic control.
Which brings us to our final point, that of the disconnect between the various facets of economic policy in the European Union. We said in the previous seminar that Europe’s economic governance operates within a rules-based framework. There is no supranational authority to conduct a system-wide fiscal policy. The Economic and Monetary Union does not have a common treasury, nor is there a European finance ministry that could take the initiative to direct resources wherever these are needed the most. Economic policy is dependent on a process of coordination between national governments and is guided by a common set of rules and macroeconomic indicators.
In this context, the ECB has to meet its inflation target without there being a counter-party authority that could stimulate aggregate demand and, hence, put an upward pressure on prices. Instead of concerted action, the Economic and Monetary Union as a whole is characterised by disconcerted efforts to reach a minimum of area-wide coherence. This approach is rather suboptimal and ineffective. Part of the problem as we discussed is the excessive independence of the monetary function. The other is the lack of a European government, even if that were limited to economic policy.
For this order to be reformed, amendments to the European Treaties are necessary. That is no simple task. Changing the Union’s primary law will require extensive and multifaceted deliberations between policy-makers from all the Member States. Even then, it is not at all clear that there would be enough effort put on this particular set of issues.
Any reform of the Economic and Monetary Union will most likely be limited to areas of policy on the fiscal front. If monetary affairs are to be affected, it will most likely be for the sake of further enhancing the role of the ECB, such as on how the emerging banking union will manage and distribute authority within its jurisdiction.
At any rate, institutional independence is a given. It is the particularities we examined that truly matter. It appears that these will remain in place for quite some time to come, with whatever implications that may have for the proper functioning of the Economic and Monetary Union.
Update Mar 17, 2016 at 04.23 CET: In the original version the European Commission was described as the “deciding executive”. It should be the implementing executive, as I have explained in previous seminars. The audio of this seminar preserves the error. [^]