Mario Draghi took over from Jean-Claude Trichet as president of the European Central Bank (ECB) earlier this week. It will be interesting to see whether he will make a difference.
Will he continue Trichet’s stubborn drive for large-scale bond market interventions in support of failing south European governments, including his own? Or will he courageously return to a more modest monetary policy course that avoids overstretching the ECB’s mandate? Only by pursuing the latter path can the ECB gradually regain the favourable reputation it once enjoyed among the German public.
The ECB has lost face with Germans. This is not because they are dreaming of a return to the deutschmark, but because, in German eyes, the ECB has taken measures that appear to run counter to the Bank’s claim of adhering closely to the mandate of preserving the internal value of the euro.
The infamous hyperinflation of the early 1920s is deeply embedded in the German psyche. It destroyed citizens’ monetary wealth and weakened their willingness to defend democracy. This hyperinflation was fuelled by the monetization of sovereign debt.
In principle, the process could have been stopped by the German Reichsbank at an early stage. But the tragedy was that the governor at the time, though formally independent from government, was convinced that it was his personal mission to rescue the country by preventing sovereign insolvency at any cost.
The ECB can be proud of having achieved and maintained price stability over a period of 12 years. But the recent innovation of the securities programme has weakened the long-run foundations of monetary stability in the eurozone. An open-ended programme of sovereign debt acquisition is an invitation to investors to care less about sovereign risk, and a hidden invitation to governments to continue with loose fiscal policies.
The longer the programme is kept open, the larger the ECB’s future debts will become. Given the lessons of Germany’s monetary history, it should be no surprise to anyone that the major opposition parties are closing ranks in rejecting the idea that a European reserve fund, be it the current European Financial Stability Facility (EFSF) or the future European Stability Mechanism (ESM), should have unlimited access to refinancing by the ECB.
Apart from the danger of laying the ground for lasting inflation, there is justified concern that the ECB’s security program may be misused to undertake a covert redistribution of resources between nations.
In contrast to other central banks, the ECB’s capital is held by 17 nations instead of one. Consequently, losses are distributed among the shareholders according to the quotas of paid-up capital. Should the ECB council decide not to hold to maturity the Greek, Italian, Portuguese or Spanish bonds acquired, but to sell them at a loss at an earlier date, this loss will have to be covered by all shareholders. The same applies if one of the debtor countries is declared insolvent.
As a final observation, it is to be noted that the ECB’s support of selected sovereign debt is in deep conflict with the rules of democratic representation.
In contrast to members of parliament, central bank governors are not elected by the people. For this reason they have no right to effectively tax citizens by running ill-designed public debt policies. All decisions on public debt are the responsibility of elected politicians, hence the existence of parliaments.
Moreover, a majority in the ECB council is able to inflict losses on the taxpayers of other nations whose governors do not support the securities programme. This calls into question the legitimacy of the current distribution of voting rights.
Manfred J.M. Neumann is emeritus professor of economics at the Institute for Economic Policy at the University of Bonn