Bursting the Bubble

The Politics of the ECB

19 December 2016 | by

The European Central Bank (ECB) is the central bank for the euro and administers the monetary policy of the eurozone, which consists of 19 EU member states and is one of the largest currency areas in the world. It is one of the world’s most important central banks and is one of the seven institutions of the European Union (EU) listed in the Treaty on European Union (TEU).

The primary objective of the ECB, mandated in Article 2 of the Statute of the ECB, is to maintain price stability within the Eurozone. Its basic tasks, set out in Article 3 of the Statute, are to set and implement the monetary policy for the Eurozone, to conduct foreign exchange operations, to take care of the foreign reserves of the European System of Central Banks and operation of the financial market infrastructure under the TARGET2 payments system and the technical platform (currently being developed) for settlement of securities in Europe (TARGET2 Securities). The ECB has, under Article 16 of its Statute, the exclusive right to authorise the issuance of euro banknotes. Member states can issue euro coins, but the amount must be authorised by the ECB beforehand.

The ECB is governed by European law directly, but its set-up resembles that of a corporation in the sense that the ECB has shareholders and stock capital. Its capital is €11 billion held by the national central banks of the member states as shareholders. The initial capital allocation key was determined in 1998 on the basis of the states’ population and GDP, but the capital key has been adjusted. Shares in the ECB are not transferable and cannot be used as collateral.

 

Goals of the European Central Bank

The goals, functions and organisation of both the European System of Central Banks (ESCB) and the European Central Bank (ECB) have been established by the Treaty on European Union (1992) and the accompanying Protocol on the Statute of the European System of Central Banks and of the European Central Bank.

The inspiration for the monetary policy framework to be implemented under EMU is the German system, and there are strong parallels between the statutes of the ECB and ESCB and the Bundesbank acts. In addition, the mandate given to the ECB and the ESCB owes much to German influence, in that it stresses price stability. This is, primarily, set out because at inception of the EMU and the ECB compromises were struck between the German authorities and the rest of the EU in that Germany could be reunified with a strong German currency, replaced by a strong European currency. The other countries had no independence of monetary policy because of their currency peg to the German Mark. Secondly, German authorities do not want to strong meddling of central banks in the economy because of their experience in the 1920s and 1930s with the super inflation as a consequence then.

Article 105 sets this out:

‘The primary objective of the ESCB shall be to maintain price

stability. Without prejudice to the objective of price stability, the

ESCB shall support the general economic policies in the Community

with a view to contributing to the achievement of the objectives laid

down in Article 2.’

 

Control of the ECB

The ECB is to be independent of control by elected politicians. That is enshrined in the

Treaty. Not only will the ECB be independent but elected politicians are, by the terms of the

Treaty, debarred from even attempting to influence the ECB as Article 107 makes clear:

`When exercising the powers and carrying out the tasks and duties conferred upon them by this Treaty … neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body. The Community institutions and bodies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the ECB or of the national central banks in the performance of their tasks.’

Central banks have to be independent at all cost to set out a monetary policy. Before their independence, and the ECB is one of the most independent central banks of the world, politicians set out monetary and inflation targets ad hoc to influence their prospects to reelection: that is a low inflation target at the beginning of their mandate to combat inflation and a high target to achieve full employment but high inflation at the beginning of the elections. To combat this European law clearly states the ECB independence.

 

Practice of the ECB independence in combating the euro crisis

The ECB’s response to the eurozone sovereign debt crisis, in which it stepped outside of its traditional role by repeatedly purchasing government bonds, has generated an intense debate over the bank’s mandate. Unlike the U.S. Federal Reserve, the ECB does not have a mandate to pursue full employment, and the Maastricht Treaty prohibits it from directly financing national governments. At the same time, the absence of a fiscal union, including a eurozone-wide treasury to pool debt, has made the ECB’s potential role as lender of last resort more complicated. The ECB as lender of last resort is necessary to provide liquidity to banks under stress.

After the January 25, 2015, election of the anti-austerity Syriza government in Greece, the ECB was once again thrust into the center of Europe’s debt drama. Despite Greece’s troubled financial sector, its banks had received liquidity from the ECB at the same rate as all other eurozone countries since 2010, as long as Greece complied with its bailout requirements. After newly elected Prime Minister Alexis Tsipras put Greece’s cooperation in doubt, however, the ECB limited this cheap access to capital. Beginning on February 4, Greece’s banks could only receive ECB funds through Emergency Liquidity Assistance (ELA) at the ECB’s discretion and at higher interest rates.

Though the ECB is an avowedly nonpolitical institution, Greece’s reliance on ELA gave the bank an unavoidable role in the fraught negotiations over a new Greek bailout. As the crisis intensified, more people withdrew their money from Greece’s banks, making them increasingly reliant on the ECB, whose emergency liquidity support surpassed 88 billion euros ($97 billion) by June 2015. In the 2010 Ireland and 2013 Cyprus bank crises, the ECB effectively forced compromises by threatening to cut off ELA altogether. But as Greece has come to the brink of exiting the eurozone, the ECB has so far sought a balance. It capped ELA, forcing Greece to impose capital controls, but it has not halted its support. This questions the role of the ECB as independent institution in the still ongoing eurozone crisis.

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