Capturing the ECB

The ECB Grows Up

European Central Bank (ECB)

Is the ECB Doing Enough?

The ECB and Its Critics

Ecb Is Now Europe s Anchor

Germany s Case Against the ECB

Helping the ECB Cross the Rubicon

Why the ECB Should Buy American

The ECB Picks Up The Pace

Trichet Takes Control At The ECB

Who Next at the ECB Helm?

In an effort to promote diversity and gender equality in the ECB, the European Parliament in 2012 blocked the appointment of Luxembourg s Yves Mersch to the bank s executive board. But MEPs then failed to propose a plausible female alternative, leaving the ECB understaffed for weeks during the eurozone sovereign debt crisis.

ECB President Mario Draghi has said much the same. Indeed, the upcoming summit is missing an important agenda item a European Fiscal Authority (EFA) that, in partnership with the ECB, could do what the ECB cannot do on its own.

To fund these redemptions on behalf of some member states, the ECB would issue bonds in its own name, guaranteed solely by the ECB, but repaid, in full, by the member state. Upon the issue of such an ECB bond, the ECB would simultaneously open a debit account for the member state on whose behalf it issued the bond.

That is what the ECB is now throwing away.

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For all these reasons, purchasing private sector securities alone will not enable the ECB to achieve its stated goal of expanding its balance sheet by 1 trillion ( 1.2 trillion). Unable to vanquish the specter of deflation, ECB President Mario Draghi will need to continue working to build a consensus even better, unanimity within the bank s governing board for purchases of government bonds.

There will also be potentially dangerous consequences for the ECB itself. The use of the Lisbon Treaty clause means that the ECB must be given these additional responsibilities.

E commerce and Development Report 2003, UNCTAD SIDTE ECB 2003 1.

The use of the Lisbon Treaty clause means that the ECB must be given these additional responsibilities. But it is impossible to create a separate bank supervision entity within the ECB, as has been done in France, for example, with the Prudential Control Authority, or in the UK with the new Prudential Regulatory Authority, which has its own board and accountability arrangements within the Bank of England.

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Now the ECB is reacting with force, but, as Japanese policymakers have found, exiting from deflation is far from easy. ECB President Mario Draghi may fail to bring inflation back to 2 .

Most recently, German Chancellor Angela Merkel has backed ECB President Mario Draghi, leaving Bundesbank President Jens Weidmann isolated. This will enable the ECB to put a lid on the borrowing costs of countries that submit to an austerity program under the supervision of the Troika (the IMF, the ECB, and the European Commission).

If savers in Portuguese banks start moving their money to Germany, the ECB will recycle these euros back to Portugal through interbank deposits. Again, there is no limit to how much money the ECB can recycle, provided Portuguese banks remain solvent which they will, so long as the ECB continues to buy Portuguese government bonds.

So far, the social partners, as ECB president Jean Claude Trichet likes to call the unions, have been quiet. Should this change, the ECB will have to raise rates even if Europe s economic growth remains slack.

So, why is the ECB set on a tougher course? There are three plausible reasons.

Finally, after a good start, the ECB has now placed on hold the additional monetary stimulus that the eurozone needs. Indeed, ECB officials are starting to worry aloud about the rise in inflation due to the oil shock.

Together, the ECB and the EFSF could do what the ECB cannot do on its own. This would provide temporary relief from a fatal flaw in the euro design s until the member countries devise a more permanent solution.

With European interest rates up 200 basis points since late 2005 and the euro near a record high, Sarkozy wants the ECB to stop raising rates now. ECB president Jean Claude Trichet and the Governing Council strongly disagree.

Like it or not, the ECB is effectively financing the sovereigns. German leaders have frowned on this, and the ECB has felt uncomfortable, limiting its purchases and saying that political leaders, not central bankers, should save the euro.

Although the ECB does not have to deal with direct legislative oversight, it is now clear that there are members of its governing board who would oppose higher interest rates, and that there is political pressure from government leaders and finance ministers to keep rates low.

By contrast, were the ECB to adopt decisive measures, it could reflate the entire eurozone and obviate the need for countries to act unilaterally. But, while the ECB has the capacity, the question remains whether it is has the will.

Tensions at the ECB and between the euro zone countries do not bode well for the stability of the common currency, both externally, vis à vis other currencies, and internally, in terms of inflation. The ECB will be scapegoated for that.

In addition, the ECB could purchase EIB bonds on secondary markets, which would help to keep funding costs low or even reduce them. More important, purchases of EIB bonds would enable the ECB to undertake quantitative easing without triggering the degree of controversy implied by intervening in 18 separate sovereign bond markets, where concerns that ECB purchases would affect the relative pricing of sovereigns are very real.

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Maastricht treaty or no Maastricht treaty, loss of public support for the ECB will diminish its independence.

Indeed, the ECB will soon have to confront the fact that structural reforms and fiscal austerity fall far short of being a complete solution to Europe s debt problems. In October and November, the ECB will announce the results of its bank stress tests.

According to a knowledgeable ECB source, however, Europe s finance ministers regularly meet in secret with the ECB leadership for a mutual and frank exchange of views on monetary policy and other issues. The dialogue already exists though the public does not know it.

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In short, the ECB bond buying program has transformed the ECB from a passive observer of the euro crisis, paralyzed by the outdated legalistic constraints of the Maastricht Treaty, into a proper lender of last resort. With powers to monetize government debts similar to those exercised by the US Federal Reserve, the Bank of Japan, and the Bank of England, the ECB can now guarantee the eurozone against financial contagion.

From this perspective, the proposal to use the IMF as a conduit for ECB resources (thereby circumventing restrictions imposed by European Union s treaties), while providing the ECB with preferred creditor status, would exacerbate the Fund s exposure to risky borrowers. This arrangement could be seen as an unwarranted abuse of Fund seniority that, in addition, unfairly frees the ECB from the need to impose its own conditionality on one of its members.

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