DIRECTORATE GENERAL FOR INTERNAL POLICIES POLICY DEPARTMENT A: ECONOMIC AND SCIENTIFIC POLICIES ECONOMIC AND MONETARY AFFAIRS Changing of the guard Briefing Note Abstract The enlargement of the European rescue fund EFSF should be part of a comprehensive approach of strengthening the Stability and Growth Pact both in terms of its corrective arm by using automatic sanctions and in terms of the preventive arm by introducing the European fiscal semester. The consequence would be that the Securities Markets Program could be terminated and the ECB’s portfolio of government bonds (presently around EUR 100 billion) could be transferred to the EFSF for the ECB’s book value. This would reduce the tensions within the ECB Governing Council and enable the ECB to focus on its direct mandate for monetary stability and its indirect responsibility - through the European Systemic Risk Board - for financial stability. This would result in a clear separation of responsibilities between the ECB and ESRB for monetary policy and macro-prudential supervision and the EFSF for fiscal policy and structural reforms in the Member States facing austerity measures. The ECB will certainly be confronted with possible trade-offs between monetary and financial stability. This problem could be solved by changing the ECB’s mandate for price stability from the medium term to the longer term (longer than two years) as financial stability is prerequisite for monetary stability in the longer term. Consequently, the two-pillar strategy of the ECB could be adapted in such a way that its economic analysis focuses on price stability in the medium term and its monetary analysis (e.g., credit and money growth) on financial stability in the longer term. The Bank of Japan’s analysis and strategy could be taken as an example to merge the responsibilities for monetary and financial stability in the medium and longer term. The two-pillar strategy offers an excellent framework for a time-consistent approach of preserving monetary and financial stability. It is up to Mr Draghi as the new President to give guidance to the ECB through this terra incognita. IP/A/ECON/NT/2011-03 September 2011 (Part of the compilation PE 464.446 for the Monetary Dialogue) EN This document was requested by the European Parliament's Committee on Economic and Monetary Affairs. AUTHOR Sylvester C.W. EIJFFINGER, CentER and EBC, Tilburg University and CEPR RESPONSIBLE ADMINISTRATOR Rudolf MAIER Policy Department Economic and Scientific Policies European Parliament B-1047 Brussels E-mail: [email protected] LINGUISTIC VERSIONS Original: EN ABOUT THE EDITOR To contact the Policy Department or to subscribe to its newsletter please write to: [email protected] Manuscript completed in September 2011. Brussels, © European Parliament, 2011. This document is available on the Internet at: http://www.europarl.europa.eu/activities/committees/studies.do?language=EN DISCLAIMER The opinions expressed in this document are the sole responsibility of the author and do not necessarily represent the official position of the European Parliament. Reproduction and translation for non-commercial purposes are authorised, provided the source is acknowledged and the publisher is given prior notice and sent a copy. Changing of the guard _____________________________________________________________________________ CONTENTS CONTENTS ................................................................................................3 1. INTRODUCTION .................................................................................4 2. THE TRICHET PRESIDENCY ..................................................................5 3. SUCCESSION BY MR DRAGHI ................................................................7 4. MORE FIRING POWER .........................................................................8 5. CONCLUSION...................................................................................11 REFERENCES ...........................................................................................12 Policy Department A: Economic and Scientific Policy ___________________________________________________________________________________________ 1. INTRODUCTION1 On 31 October 2011, the eight years term of Mr. Jean-Claude Trichet as ECB President will end. Mr. Mario Draghi will succeed him in office. This change of leadership in the ECB comes at a pivotal time for the euro area and the European Union as a whole. Furthermore, the ongoing crisis in the euro area may exacerbate the impact of this change in monetary leadership. As he will take office Mr. Draghi will face many challenges, the most important of which is probably maintaining ECB’s independence during the crisis. To see how he should do this, I shall first review the performance of Mr. Trichet as President of the ECB. Then, I will look at the challenges Mr. Draghi faces and how he should deal with them. Finally, I will argue that the enlargement of the European rescue fund EFSF (European Financial Stability Facility) is of paramount importance to make it possible for Mr. Draghi to properly do his work as an independent central banker. 1 The author gratefully acknowledges the very helpful comments of Professor Lex Hoogduin and Mr. Edin Mujagic, Msc. and the excellent research assistance of Mr Rob Nijskens, Msc. 4 Changing of the guard _____________________________________________________________________________ 2. THE TRICHET PRESIDENCY Jean-Claude Trichet has proven to be a good crisis manager, who has managed to safeguard the ECB’s independence during both the financial crisis of 2007-2009 and the current Euro crisis. He has operated in a pragmatic way: he did what was necessary to protect the euro, but always kept in mind the independent position of the ECB. The 2007-2009 banking crisis is a very good example of this. When the crisis broke, the ECB provided virtually unlimited liquidity to keep the European banking sector afloat. However, this long liquidity position was soon decreased as soon as inflationary pressures were appearing again in 2010. Personally, Mr Trichet has always assured the public that the ECB would put inflation stability above anything else. By acting in this way, the ECB has been able to maintain both monetary and financial stability while only having one official instrument (the interest rate) at its disposal. Balancing these two goals will be only more difficult since the ECB is now also officially responsible for financial stability (through the ESRB). I will elaborate upon this in the next section. During the ongoing Euro crisis Mr. Trichet has been under fire, especially in Germany and the German press, for putting the ECB’s independence in jeopardy. After the first large- scale buying of government bonds in May 2010 he faced massive criticism, not in the least from his German colleague Axel Weber. However, there was no other option: the ECB is the only European institution that can react with enough speed and firing power to resolve a crisis as large as this one. Additionally, through his appearances in the media Mr. Trichet has managed to ensure the public that the ECB did not cave in to political pressure, that its monetary policy was unchanged and that its actions would not spur inflation2. For instance, in an interview with the Frankfurter Allgemeine Zeitung he emphasized again that the ECB’s “line is price stability”, and that its “credibility is derived from achieving this objective over the medium term”3. As the effectiveness of the monetary transmission mechanism was severely hampered by the problems on the sovereign bond markets, the ECB’s actions were only to restore this effectiveness. Furthermore, Mr. Trichet insisted that, in contrast to the actions by other major central banks (notably the Fed), the ECB’s actions were sterilized and thus did not lead to an increase in money supply. In speeches he has also resolutely maintained the position that the ECB is “fiercely and totally independent”4, despite all allegations that it has become increasingly a political institution. Another example of this is the increase of ECB interest rates over the last year. Despite market pressures (both from Europe as well as from the US), to keep interest rates low to stimulate economic recovery, Mr. Trichet saw inflationary pressures mounting and has pushed for higher interest rates. This has led to an increase of 25 basis points in April 2011, and another one in July. The ECB has stuck to this policy even though the Fed has insisted it will keep interest rates low for the coming two years, and despite the ongoing crisis in the euro area. This course of action shows that the ECB is still independent from market and political pressures. 2 The Economist, After the Fall, 20-05-2010 3 Frankfurter Allgemeine Zeitung, Interview with Jean-Claude Trichet, 13-05-2010, available at http://www.ecb.int/press/key/date/2010/html/sp100521.en.html 4 The Economist, The Price of Pragmatism, 11-05-2010 5 Policy Department A: Economic and Scientific Policy ___________________________________________________________________________________________ Finally, last July it turned out that the ECB again had to buy government bonds, also from Italy and Spain this time. In this case, Mr. Trichet showed how clever and forward-looking he is: he emphasized strongly that this ECB action should be temporary. He has convinced Mrs Merkel and Mr. Sarkozy that the European rescue fund EFSF has to be ratified and implemented, after which