Last May, the European Central Bank (ECB) faced one of its most difficult decisions since its founding in 1998. As European capitals squabbled over how best to deal with the Greek debt crisis, the central bank was forced to decide whether to continue buying Greek paper.
If the bank decided to purchase the debt — which was worthless at the time because of lack of confidence in Greece’s ability to repay the bank — the ECB was essentially printing more money, an expansion of its limited powers and an unpopular choice in fiscally conservative corners of Europe. If it decided against purchasing the paper, Greece would be left to the mercy of hostile markets and European leaders who couldn’t agree on precisely how to save it.
It was a tough choice, but on May 9 the ECB decided to buy Greek paper. The markets responded positively, and the Greek economy was pulled back from the brink.
Yet the Frankfurt-based central bank’s decision to buy Greek paper was not universally applauded. Since its formation more than a decade ago, the primary role of the bank has been to maintain price stability by keeping euro zone inflation rates low. Its secondary objectives have been to implement EU monetary policy as defined by the European Union and to maintain foreign exchange markets.
Charles Wyplosz, professor of International Economics at the Graduate Institute of International Studies in Geneva, thinks the ECB badly overstepped its powers. “To me, the decision to buy Greek debt was a mistake,” Wyplosz told The Fiscal Times. “Right now I see them as fairly defensive on the issue.”
Is it the ECB or the Federal Reserve?
Unlike the Federal Reserve, which oversees U.S. financial institutions, the ECB has no formal power over European banks. In the U.S., the Fed took decisive action throughout the recession to prop up the U.S. economy and financial institutions; but the ECB was supposed to sit on the sidelines and wait for instructions from Brussels. Under its charter, the central bank is supposed to maintain independence from European political leaders at all times.
Wyplosz contends that the ECB violated this independence requirement by directly intervening in the Greek crisis. This involvement has undermined the credibility of the bank, he said, which caved to political pressure to rescue the Greek economy when European governments could not agree on the right course of action.
“The way credibility is earned is by being stubborn in tough times. The ECB has not been stubborn in tough times,” Wyplosz said. “I understand why they agreed to buy Greek treasurys, but that was the time to show that they care about the higher principles of independence.”
Now, the ECB is bracing for another potential major crisis, with trillions of dollars in short-term loans to private banks due in the coming months and growing skepticism about the results of recent stress tests that all but a handful of European banks passed.
Controversy over ECB’s Expanded Role
Wyplosz’s comments reflect one side of a growing debate over the future role of the ECB. His view is shared in Berlin, where German Chancellor Angela Merkel backs decentralized fiscal policy — with each country making independent fiscal decisions while the ECB reverts to its historical role of keeping interests rates low.
On the other side are leaders like French President Nicolas Sarkozy, who has said the bank needs to play a greater role in promoting economic growth, should be more susceptible to political influence and create policies that promote job creation.Erik Jones, professor of European Studies at Johns Hopkins’ SAIS Bologna Center, said the EU currently lacks mechanisms to promote economic growth at the euro zone level. The bank, he said, could be given expanded powers to take on this role. “What concerns me most is that with all of the bank’s various roles, it still lacks a competence for insuring economic growth,” Jones said.
The struggle over the bank’s mission is now taking place at the highest level of leadership. Jean-Claude Trichet of France, the president of the ECB, has called for an expanded role for the bank, reflecting the position of Paris that the bank should act more like the Federal Reserve. However, Trichet’s eight-year term ends next year. His replacement is rumored to be Axel Weber, president of Germany’s Bundesbank and a proponent of a more limited role for the ECB.
Jones said he worried that Weber could scale back the ECB’s role just as the euro zone shows signs of recovery. “The ECB is locked in a situation where as growth begins to accelerate, it will have to tighten monetary conditions [to control inflation] and will take the blame for taking the punch bowl out of the party,” Jones said.
Despite Role in Rescue, ECB Popularity Down
While it is acknowledged that the ECB played a significant role in preventing the Greek crisis from worsening, its action did little to win the bank public or political support. At a time when anti-EU feeling is high and nationalistic fever is growing, polls show public opinion for the ECB is declining. At the same time, the ECB is unpopular in many European capitals. Across the continent, European leaders are struggling to maintain popularity. The ECB presents an easy scapegoat. “No head of state or government is going to rush to the ECB’s defense,” Jones said. “For Berlin or Paris, it’s convenient to blame the ECB” for financial troubles at home. Jones said this blame is misplaced and that the ECB deserves more credit than is has received for preventing the financial ruin of Europe. “But you don’t win political points for saying things would have been really awful if we hadn’t acted.”
Wyplosz said that even with these successes, rebuilding credibility in the coming months and during the next year’s leadership transition will be the ECB’s greatest test. “When credibility is hurt it is hard to rebuild,” he said. “They have a very long haul ahead of them.”