Capturing the ECB

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.

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?

Increasing tensions between the euro countries on economic policy are likely, as are growing rifts within the ECB governing council in the coming years. We might get a sneak preview this year and in 2011, when European leaders must select a new ECB president and vice president.

The voting rules unanimously approved by the Governing Council and adopted by the European Council in early 2003 have prepared the ECB well. All Governors, whatever their voting rights, will continue to attend meetings of the Governing Council and to participate fully in its discussions.

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.

LONDON Mario Draghi, the president of the European Central Bank, has repeatedly claimed that the ECB will do everything necessary to save the euro. Nothing has been formally agreed yet, but the ECB is expected to announce a new government bond buying program following next week s meeting of its Governing Council.

That is what the ECB is now throwing away.

A legal vestige of the original plan may offer an easy path to a greater ECB supervisory role today. According to Article 25 of the Maastricht Treaty, the ECB may offer advice to and be consulted by the Commission or the Council on the scope and implementation of legislation relating to prudential supervision.

Ecommerce and Development Report 2003, UNCTAD SIDTE ECB 2003 1.

The last thing Europe needs now is an interest rate cut, says one influential member of the ECB Governing Council in a candid assessment of the current situation. Capitulating to outside political pressure is no one s definition of an anchor of stability. The euro would collapse, and the ECB finished as a creditable central bank.

Furthermore, and contrary to common belief, the ECB president need not be very diplomatic, but should be able to unite all members of the ECB s Governing Council. As political pressure on central banks, including the ECB, increases, its president must not hesitate to criticize European politicians and, if necessary, publicly name and shame them.

The ECB governing council has already agreed, in principle, to use the first of these policy tools. But monetary expansion alone will be inadequate to lift the eurozone out of stagnation.

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 main question now is whether the ECB will be able to sustain its hard won reputation following enlargement of the euro zone in coming years. Indeed, when the ECB was established, some observers raised concerns even then about possible inefficiencies resulting from its supposedly outsized Governing Council and about possible distortions in its deliberations due to national considerations.

This is not the first time communications has been a problem for the ECB. On more than one occasion, under both Trichet and former ECB chairman Wim Duisenberg before him, press leaks and the tit for tat responses they engender, made the Governing Council sound more like a cacophony of discordant voices than a serious deliberative body.

Indications that Trichet s communicative skills were slipping already had become evident last September, when the Governing Council could not follow through with the rate increase the ECB president had promised the previous month.

Encrypt an input value with TripleDES under 2.2.x in ECB mode

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).

At the ECB press conference in early July, Trichet signaled at least one more rate hike either in September or October. Some Council members are known to support two more rate hikes before year end.

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.

Ironically, the October meeting of the ECB s Governing Council will take place in Paris this year. French politicians have been the most aggressive in putting political pressure on the ECB to relax its interest rate normalization policy.

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.

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.

In Germany, Axel Weber resigned as President of the Bundesbank and member of the Governing Council of the ECB last January, reportedly because his statements opposing the Banks purchases of troubled eurozone countries bonds reflected his political naivety. The press could not imagine that a technocrat might voluntarily relinquish a sure shot at a position of great power successor to Jean Claude Trichet as ECB President on a matter of principle.

But, for the ECB's plan to work, its QE must be robust and that will require broad support. After all, eurozone monetary policy is the product of joint decision making within the ECB governing council, where Germany's influence is strong.

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.