The Bank of Japan and the ECB were, characteristically, the slowest to react, keeping their policy rates higher for longer, and not undertaking QE and other extraordinary liquidity measures until late in the day. Indeed, it required new leaders in both institutions Haruhiko Kuroda at the BOJ and Mario Draghi at the ECB finally to set monetary policy right.

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.

More than the usual blame game is at work here. Pressures are mounting on the ECB to raise interest rates and Berlusconi and Co. s attacks are as much as an attempt to forestall future rate hikes as to get the ECB to loosen its monetary policy.

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.

So long as the ECB does not acknowledge the doubts now hovering around Europe s economies, there is a risk of a crash. The ECB is convinced that benign neglect is the right exchange rate policy, and that the G7 is the right place to address currency volatility.

A Yes vote, on the other hand, would encourage a reassured Chirac to continue his policy of no reform and scapegoating the ECB. External political pressure on the ECB and its president, Jean Claude Trichet, to lower interest rates and talk the euro down surely would increase.

Capturing the ECB

The ECB has never claimed that its strategy is the ultimate solution to the challenges monetary policy is confronted with. But, it has recognised the need to include monetary analysis in a very broad sense into its policy considerations.

The necessary transfers are not being made to make the common currency bearable to regions that lose out and are already in recession when the ECB tightens policy. The institutional foundations of stable long run fiscal policy are being eroded.

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

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.

Ironically, the inflation targeting advocated by Greenspan s nominated successor, Ben Bernanke, lies closer to ECB monetary policy than to the discretionary activism that the Fed has practiced during Greenspan s long tenure.

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?

Will Germany agree to such a relaxation or, for that matter, to Hollande s implicit demand that the ECB follow Japan s example and loosen monetary policy to drive the exchange rate back down?

Meanwhile, in Germany, the elections this September may have surprising consequences for ECB monetary policy. Angela Merkel, the Christian Democrats candidate, is a reformer, holding out hope for Germany s future and that of Europe.

But the ECB, whose only mandate is to maintain price stability, cannot pursue this policy without fundamental changes in legislation. Moreover, this scenario cannot take place before the slump has turned into a boom.

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.

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.

At a time when political processes are stalled on both sides of the Atlantic, the US Federal Reserve and the ECB have been engaging in a series of policy innovations, feeling their way toward a solution that could promote and sustain economic recovery. On this basis, the ECB is recasting itself as the incubator of a new intellectual and philosophical synthesis.

That is what the ECB is now throwing away.

As the Fed normalizes its monetary policy and the ECB doubles down on extraordinary measures, we certainly should hope for the best. But we should also be planning for a substantial rise in financial and economic uncertainty.

In Europe today, reunified and reinvigorated Germany is the only country capable of assuming this role. It could agree to swift bank recapitalization, a banking license for the European Stability Mechanism, and a more expansionary ECB policy.

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.

True, adopting the appropriate policy would require the ECB to articulate its rationale with great care. Here it can take lessons from its British and American counterparts credibility does not require dogmatism, but rather clarity of purpose.

Approval of fundamental changes in the currency union must be agreed by all members, and so will not be forthcoming. Nor will ECB President Jean Claude Trichet be intimidated by French pressure to pursue a softer monetary policy.

Moreover, unlike its counterparts, the ECB does not face a single interlocutor, and none of the governments that hold it accountable is or feels in charge of the eurozone as a whole. This is a deeply unfavorable situation, which explains why the ECB, once obsessed with the risk that governments would coalesce to assail its independence, has turned into the staunchest advocate of fiscal policy coordination.

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.

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

How the euro would be able to depreciate, given that it is a floating currency with very little intervention that is, the exchange rate is largely market determined depends on monetary policy. If the ECB agreed to loosen monetary policy or provide enough liquidity to support various bailouts, investors would fear inflation, weakening the euro.

Of course, everyone would prefer it if the line between monetary and fiscal policy had not become blurred as a result of the crisis. But blindly sticking to principle would have been a highly risky option for the ECB.

What is at stake is too important to ignore. On its current policy path, unless oil prices fall, the ECB risks being forced to commit to substantially higher interest rates, and thus to a further increase in Eurozone unemployment.

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

Second, it was hoped that the euro would become a major international currency (particularly given how few countries are equipped with the necessary legal, market, and policy institutions). And, according to recent ECB statistics, this hope has been largely fulfilled.

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 making it clear from the outset that it did not trust its own policy, the ECB practically guaranteed its failure. If it so evidently lacked confidence in the very bonds that it was buying, why should investors feel any differently?

Frankfurt is a divided city, policy wise the Bundesbank opposes quantitative easing and negative policy rates, while the European Central Bank is ready to do more. But Germany s thrifty savers households, banks, and insurance companies are furious about ECB policies that tax them (and others in the eurozone core) to subsidize the eurozone periphery s alleged reckless spenders and debtors.