European Central Bank

The European Central Bank (ECB) was designed to be the monetary policy bridge from which the euro - the leading symbol of European unity and supposed guarantor of just that - is controlled. The ECB and the European System of Central Banks (ESCB) were established in Frankfurt am Main, Germany, in June 1998 in accordance with the "Maastricht Treaty" on European Union (EU). The ESCB comprises the newly founded ECB and the pre-existing national central banks (NCBs) of all EU member countries (currently 27). The subset of EU member countries that have actually adopted Europe's "single" currency (currently 18) together with the ECB form the Eurosystem, which is governed by the decision-making bodies of the ECB.

While still young, the ECB is a peculiar central bank both by its statutory set-up and actual policy practices. Modelled after the Deutsche Bundesbank, the ECB has tried hard to emulate the "stability-oriented" policy approach and successes of its German archetype and original inspiration - which itself became part of the Eurosystem with the euro changeover and is supposedly subservient to its new European master today. Accordingly, its mind-set and policy approach features a peculiar asymmetry: the ECB is quick to hike in view of perceived inflation risks but reluctant to ease in support of the economy.

The ECB's multi-faceted peculiarity shone through strongly in energetic efforts to distance itself from the anything-but-impressive economic performance of the area under its monetary reign even in the largely smooth-sailing pre-crisis period. Thoroughly misreading the signs of the oncoming perfect storm until running the ship aground, the ongoing crisis savaging the euro area since 2010 has forced the ECB to depart from its stability-oriented rulebook and improvise along more venturous lines. As if chased by a curse, with the euro's future hanging in serious doubt, stepping outside the Bundesbank's towering shadow with the declared intention of saving its entrusted currency has brought the ECB into direct conflict with its very model.

The ECB's decision-making bodies are the Governing Council (GC) and the Executive Board (EB). The former is the principal policy-making body, which meets twice a month, while the latter is responsible for day-to-day policy execution. The GC includes the presi- dents of the euro member countries' NCBs and the six EB members: that is, the ECB president, a vice-president, and four other members, all selected by the euro member countries' heads of state or government. As all GC members are voting members, the policy-making body is very large. Also, following the one-person, one-vote principle, NCB representatives from across the monetary union enjoy an over-strong position vis-à- vis the Frankfurt-based EB. However, all GC members share a common mandate focused on the euro area aggregate situation.

By its statutes and constitutional position, the ECB is probably the most independent central bank in the world (Bibow, 2006). Any instructions from national or supranational political bodies are strictly banned. The ECB is not held to account on its performance by any political authority. Transparency about its policy conduct includes numerous publi- cations, press conferences, presentation of its annual report to the European Parliament, and quarterly meetings with a subcommittee of the European Parliament, but little is revealed about internal policy debates and decision making (Buiter, 1999). As changing the ECB's statutory position would require unanimity among euro-area member states, the ECB is legally in an unchallengeable position. To make the euro as "hard" as the Deutschmark, if not harder, the ECB was designed to be super-strong.

By its statutes the ECB's tasks were largely confined to the monetary policy domain of central banking. In the financial stability domain, the ECB's role as "bankers' bank" remained largely undefined. For fear of fiscal dominance, the other traditional central bank role as "government banker" was very tightly constrained. In particular, any loans to governments, including purchases of government securities in primary markets, are strictly prohibited. Additional fiscal safeguards (as the Stability and Growth Pact) were put in place to protect the currency and its guardian from government abuse and fiscal profligacy. Governments are also highly constrained regarding euro exchange-rate policy, which historically presented the Bundesbank's soft flank.

At the core of the ECB's monetary policy is setting a target for euro overnight money market rates of interest and making the policy rate of interest effective in the market through operating procedures that feature an interest-rate corridor (set by marginal lending and deposit facilities) and the use of open market (repurchase) operations with a large circle of banking counterparties applied to manage liquidity conditions in the interbank market.

While the euro area's pre-crisis performance was unimpressive overall, the ECB's most consequential policy blunder relates to thoroughly misjudging persistent divergences and the related build-up of grave imbalances inside the monetary union. As Germany lastingly undershot the 2 per cent stability norm, which should anchor unit labour cost trends in the monetary union, intra-area competitiveness positions ran seriously out of kilter. Also, the ECB's "one size fits all" policy stance became too tight for Germany but too easy for other member countries. As protracted domestic demand stagnation made Germany "the sick man of the euro", bubbles built up elsewhere. Regional bubbles burst and imbalances started to unravel with the outbreak of the global financial crisis of 2008-09.

The ECB has been challenged to the utmost in dealing with the consequences of the euro shipwreck, which the bank contributed to by its own misguided and negligent poli- cies. The ECB has proved uncharacteristically flexible in meeting the liquidity needs of the euro-area banking systems. In the fall of 2012, Mario Draghi famously promised conditional liquidity support for government bond markets through "Outright Monetary Transactions". ECB crisis management has enabled German banks to sharply cut back their exposures to euro-area crisis countries (migrating onto the Bundesbank's balance sheet in the form of TARGET2 imbalances as a result). But the Bundesbank has openly opposed the ECB's euro-area crisis management.

The ECB may be legally unchallengeable but its protection falls well short of the "untouchable" status that the Bundesbank derives from public backing in Germany. With public opinion in the euro area's key creditor country being vital for any fiscal support for the euro, the euro's fate remains highly uncertain - as the ECB emperor may be exposed to have no clothes (Bibow, 2013).

See also:

Bubble; Central bank independence; Corridor and floor systems; Deutsche Bundesbank; Draghi, Mario; Euro-area crisis; European monetary union; Financial crisis; Open- market operations; Outright Monetary Transactions; TARGET2 system.