Too Little, Too Late? How Central Bankers' Beliefs Influence What They Do Daniel F. Schulz Thesis submitted for assessment with a view to obtaining the degree of Doctor of Political and Social Sciences of the European University Institute Florence, 06 June 2017 European University Institute Department of Political and Social Sciences Too Little, Too Late? How Central Bankers' Beliefs Influence What They Do Daniel F. Schulz Thesis submitted for assessment with a view to obtaining the degree of Doctor of Political and Social Sciences of the European University Institute Examining Board Professor Sven Steinmo, European University Institute (Supervisor) Professor Mark Blyth, Brown University Professor Philipp Genschel, European University Institute Professor Leonard Seabrooke, Copenhagen Business School © Daniel F. Schulz, 2017 No part of this thesis may be copied, reproduced or transmitted without prior permission of the author Researcher declaration to accompany the submission of written work Department of Political and Social Sciences - Doctoral Programme I Daniel Frederik Schulz certify that I am the author of the work "Too Little, Too Late? How Central Bankers' Beliefs Influence What They Do" I have presented for examination for the Ph.D. at the European University Institute. I also certify that this is solely my own original work, other than where I have clearly indicated, in this declaration and in the thesis, that it is the work of others. I warrant that I have obtained all the permissions required for using any material from other copyrighted publications. I certify that this work complies with the Code of Ethics in Academic Research issued by the European University Institute (IUE 332/2/10 (CA 297). The copyright of this work rests with its author. Quotation from it is permitted, provided that full acknowledgement is made. This work may not be reproduced without my prior written consent. This authorisation does not, to the best of my knowledge, infringe the rights of any third party. I declare that this work consists of 87,095 words. Statement of language correction: This thesis has been corrected for linguistic and stylistic errors. I certify that I have checked and approved all language corrections, and that these have not affected the content of this work. Signature and date: 3 April 2017 Chapter overview: 1. INTRODUCTION .................................................................................................... 1 2. HOW DID WE GET HERE? THE ROAD TO EMU AND THE FIRST DECADE ............................................ 21 3. POLICYMAKING INSIDE THE ECB: WHO GOVERNS? ................................................................................................. 35 4. WHAT CAN CENTRAL BANKERS DO? CONTROVERSIES IN MONETARY THOUGHT .............................................. 55 5. WHAT DO CENTRAL BANKERS THINK THEY CAN DO? ECONOMIC BELIEFS AND HOW THEY MATTER FOR POLICY ................ 95 6. WHAT CENTRAL BANKERS DID AND DIDN’T DO: KEY MONETARY POLICY DECISIONS, 2007-16 ......................................... 123 7. HOW THE WORLD WORKS: CLASHING IDEAS AND THEIR POLITICAL SIGNIFICANCE .................... 161 BIBLIOGRAPHY ....................................................................................................... 175 APPENDIX ...................................................................................................................... I Detailed table of contents PREFACE AND ACKNOWLEDGEMENTS 1. INTRODUCTION ........................................................................................................................... 1 1.1 The puzzling persistence of ECB conservatism ....................................................................... 2 1.2 The conventional explanation: Germany! ............................................................................... 7 1.3 Institutions: The incomplete contract of Maastricht ............................................................... 8 1.4 National interests in a world of radical uncertainty ............................................................. 10 1.5 The argument in brief: taking policymakers’ ideas seriously ............................................... 13 1.6 Gaps in the literature ............................................................................................................ 15 1.7 Plan of the dissertation.......................................................................................................... 18 2. HOW DID WE GET HERE? THE ROAD TO EMU AND THE FIRST DECADE ................................................................... 21 2.1 The Road to Maastricht ......................................................................................................... 21 2.2 Who joins the club? ............................................................................................................... 26 2.3 The ECB’s birth and carefree childhood (1999-2007) .......................................................... 30 3. POLICYMAKING INSIDE THE ECB: WHO GOVERNS? ........................................................................................................................ 35 3.1 Formal and informal decision rules ...................................................................................... 35 3.1.1 Governing Council Decisions: one head, one vote? ...................................................... 36 3.1.2 The agenda-setting power of the Executive Board ........................................................ 39 3.1.3 The role of staff ............................................................................................................. 41 3.1.4 Channels of influence for national central banks .......................................................... 43 3.2 The long legacy of Otmar Issing ........................................................................................... 46 3.3 ECB Presidents and their styles of leadership ...................................................................... 48 4. WHAT CAN CENTRAL BANKERS DO? CONTROVERSIES IN MONETARY THOUGHT ..................................................................... 55 4.1 What is money, who creates it – and how? ........................................................................... 56 4.1.1 Who ‘makes’ monetary policy?..................................................................................... 58 4.1.2 Central bankers’ instruments ......................................................................................... 60 4.1.3 The transmission mechanism ........................................................................................ 61 4.1.4 Rational expectations and money illusion ..................................................................... 63 4.2 What monetary policy can and cannot do: views on central banks’ objectives .................... 66 4.2.1 Controlling inflation ...................................................................................................... 67 4.2.2 Supporting growth and employment ............................................................................. 73 4.2.3 Providing financial stability: to lean or not to lean? ...................................................... 77 4.3 Monetary policy in hard times: experimenting in uncharted territory .................................. 83 4.4 Conceptualizing monetary paradigms: orthodoxy and revisionism in flux ........................... 88 5. WHAT DO CENTRAL BANKERS THINK THEY CAN DO? ECONOMIC BELIEFS AND HOW THEY MATTER FOR POLICY ........................................ 95 5.1 Central bankers’ economic beliefs: why and how to measure them ..................................... 96 5.1.1 A survey-based measure of economic beliefs ............................................................... 98 5.1.2 Institutions covered and their response rates ............................................................... 102 5.2 Central bankers’ beliefs: do they differ at all? ................................................................... 106 5.3 What role for paradigms? ................................................................................................... 110 5.4 Do beliefs matter for policy preferences? ........................................................................... 113 5.5 Beliefs and preferences across institutions: is the ECB really a special case? .................. 117 5.6 Policymakers matter! .......................................................................................................... 120 6. WHAT CENTRAL BANKERS DID AND DIDN’T DO: KEY MONETARY POLICY DECISIONS, 2007-16 ................................................................. 123 6.1 When disaster strikes: the response to the financial crisis (2007-09) ................................. 124 6.2 Worlds apart? Europe’s special path 2010-2012 ............................................................... 135 6.3 Too little, too late? The ECB’s catch-up policies 2012-2016 ............................................. 143 6.3.1 ‘Whatever it takes’: economic theory in court ............................................................ 144 6.3.2 A long time coming: European QE ............................................................................. 146 6.4 Not just what, but when: sticky ideas and the importance of timing ................................... 156 7. HOW THE WORLD WORKS: CLASHING IDEAS AND THEIR POLITICAL SIGNIFICANCE ............................................ 161