The Bank that rules Europe? The ECB and Central Bank Independence
The idea that central banks should be independent from political influence
has deep historical roots and featured in the discussions leading to the
establishment of many 20th century central banks (Toniolo, 1988). The
historical desire to impose limits upon the government's ability to fund
itself through seignorage merges with the orthodox contemporary argument that
politicians manipulate monetary policy to win elections; thus policy tends to
exhibit a stop-go nature, reflecting an excessive concentration upon
short-term macroeconomic fine tuning (Swinburne and Castello-Branco, 1991).
Consequently it is argued that long-term economic efficiency requires the
removal of monetary policy from the sphere of democratically accountable
politics, and its delegation to an independent central bank with an
effectively designed constitution and internal reward system that imposes
price stability as the overriding policy objective.
Few institutional reforms recommended by economists have gained such rapid,
widespread acceptance as the demand to grant central banks independence from
political control. Countries of the North and the South, the post-communist
nations of Eastern and Central Europe as well as established capitalist states
have all been affected by the debate on the appropriate role and status of the
central bank (Posen, 1993). Thus the notion of central bank independence has
taken on the character of a panacea, a quick institutional fix, producing
desirable macroeconomic results in a wide variety of national contexts. The
search for such a beneficial institutional framework has taken shape within
the European Union (EU) through the position accorded by the Maastricht Treaty
to the European Central Bank (ECB) and the European System of Central Banks
(ESCB) at the heart of Economic and Monetary Union (EMU).
There is, however, an interesting division of views between the EU, where
an internal integrated monetary order is frequently perceived as a necessary
complement, perhaps even a prerequisite, for the successful completion of the
single internal market, and the North American Free Trade Area (NAFTA) where
there has been no call for, nor consideration of, any agreement on monetary
inter-relationships to support free trade. The difference is in objectives;
the EU saw the single internal market as a stepping stone to a single
currency, and thence to political integration. By contrast, NAFTA is focused
solely upon the economic advantages derived from a free trade area.
Of the economic consequences flowing from the single currency, the
attainment of the Maastricht convergence criteria and the Stability and Growth
Pact have received considerable attention. However, the crucial role to be
played by the ECB within the euro zone is becoming increasingly apparent to
politicians and citizens alike. Therefore this Occasional Paper examines the
EU's preoccupation with establishing a new monetary authority for
The concept of 'independence' is generally perceived to be obvious; it
means simply that the government possesses no formal mechanism to influence
central bank decisions over monetary policy (Wood, 1993). However, one of the
earliest analyses of the various possible dimensions covered by such a concept
was made by Friedman (196 2), whose broad definition of independence was that
monetary policy is entrusted to some separate organisation which is subject to
the head of that agency. In that sense the Bank of England was always
independent. Alternatively, on a more rigorous definition, the Bank of England
was not independent of the government during the post-war period, except in
regard to those functions where the Treasury explicitly or implicitly granted
it discretion. Section 4(1) of the Bank of England Act 1946 provided the
Treasury with the power to give directions to the Bank on any aspect of
policy, whilst the Crown, in effect the Prime Minister, appointed the Governor
and the members of the Court. This practice still occurs even under the more
'independent' Bank of England created in May 1997, demonstrating that
government retains the desire and ability to influence Bank policy, albeit on
a long-term rather than a short-term operational basis.
In practice, however, the Bank traditionally possessed considerable
managerial freedom and exercised a degree of discretion in deploying its
resources to support the banking system when it comes under threat. Moreover,
it has tacitly been allowed considerable scope in the field of banking
supervision, which was given statutory form in the Banking Acts of 1979 and
1987 (Hopkin and Wass, 1993). However, whilst the Bank of England always
enjoyed substantial freedom of manoeuvre, these links between government and
the central bank imposed severe limits on its potential independence. For
example, it does not influence the exchange rate for sterling, nor over
long-term interest rates, whose levels are affected by fiscal policy and by
market expectations as well as by short-term rates. Neither does it control
either the liquidity or the maturity of government debt, which significantly
influence the degree to which such debt can be monetised by being placed in
the banking system. Moreover, the appointment of the Governor and senior
members of the Court will presumably remain under any institutional reform, in
the hands of the Prime Minister. The power of appointment normally carries
with it the power to dismiss. Therefore governors could find their position
untenable, if they pursued policies that the government disapproved, even when
they enjoyed the statutory freedom to do so.
It should be noted that some commentators prefer to use alternative
expressions to that of 'independence'. Hetzel (1990), for example, adopted a
terminology of central bank 'autonomy' or 'autonomy with discretion' because
of the risk that 'independence' could be taken to imply a lack of constraints.
Similarly Fair (1979) referred to 'independence within government' rather than
'independence from government', even equating this preferred definition to the
provision of independent, professional advice by the central bank, possibly
combined with the ability to publicise or at least signal a policy
disagreement with government. Such a position could be seen as the minimum
level of central bank independence.
Alternative forms of central bank independence are as numerous as the
number of 'independent' central banks; the memoranda submitted by nineteen
OECD central banks to the Treasury and Civil Service Committee (1993) provide
abundant evidence. Consequently, this section concentrates upon a limited
number of blueprints. These are the German Bundesbank, the Federal Reserve of
the United States of America and the Reserve Bank of New Zealand, which are
often cited as models for an independent Bank of England, whilst they
influenced the ECB framework outlined in the Maastricht Treaty.
Until recently, most discussion of central bank independence centred on the
German Bundesbank, which was widely regarded as being successful in delivering
consistently low inflation, with its objectives defined in statutes which
insulate it from governmental interference. Moreover, it was not formally
accountable, either to the Federal Government or to the Bundestag, for the
discharge of its statutory functions (Marsh, 199 2). The Bundesbank Act of
1957 required it to "regulate the quantity of money in circulation and of
credit supplied to the economy with the aim of safeguarding the currency" and
also to "support the general economic policy of the federal Government, but
only insofar as it can do so without prejudice to the performance of its own
functions". While it is sometimes argued that these objectives may result in
conflict, a hierarchy of goals was established in its statutes where price
stability was clearly stated as the priority.
In contrast, the United States of America's Federal Reserve maintains its
independence 'within' government, regarding itself as an integral component in
the interlocking federal structure. The Federal Reserve's integration into
government is secured by its regular accountability, whilst its Chairman and
Board are appointees of the President, subject to the consent of the Senate.
Furthermore, the objectives of the Federal Reserve are more widely defined
than those of the Bundesbank, with no single objective, such as price
stability, specifically laid down.
Another model of central bank independence is that instituted by the 1989
Reserve Bank of New Zealand Act. It assigned the Reserve Bank a general
responsibility "to formulate and implement monetary policy directed to the
economic objective of achieving and maintaining stability in the general level
of prices". A second, unique feature of the Act required the Minister of
Finance and the Bank's Governor to establish "precise and agreed policy
targets consistent with the Act, and to publish these without delay". Such
arrangements have been described as devolving 'operational autonomy', rather
than independence to the Reserve Bank, because the government retains the
power to authorise a departure from the statutory objective of price
An alternative framework for central bank independence is provided by the
Maastricht Treaty. The EU's view on central bank independence is defined by
the provisions contained within Article 107 of the Treaty, which states that,
"when exercising the powers and carrying out the tasks and duties conferred
upon them by this Treaty and the Statute of the ESCB, 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 and of the national central banks in the
performance of their tasks" (European Communities, 1991). However, the legal
framework, institutional arrangements and emerging operating practices of the
ECB are increasingly coming under closer scrutinisation and criticism (Buiter,
A central issue arising from these alternative models is the extent to
which international experience is applicable to either the UK or the EU.
Indeed, Eddie George, the Governor of the Bank of England has conceded the
problematical aspect of transposing overseas institutions within a different
constitutional context. A fundamental difficulty is that the UK is a unitary
state, so that its economy and constitutional traditions differ from those of
many foreign countries, such as Germany and the USA, whose federal systems of
government reinforce the independence of the central bank and its board
members. In contrast, Parliament is the focus of Britain's political structure
with all legitimate power derived from it. Given that no Parliament is capable
of binding its successors, it follows that every political decision can be
reversed, which appears incompatible with the principle of an independent
central bank (Busch, 1994).
Although the apparent success of the New Zealand model made it a candidate
for imitation by Britain, reflected in New Labour's changed relationship to
the Bank of England, a number of reasons exist for doubting its relevance.
First, the New Zealand reforms were introduced in response to an inflationary
crisis, second, its economy is much smaller than the UK and less prone to
currency speculation, and third, the reformed arrangements have operated
primarily in a period of recession; so that it is too early to evaluate their
lasting effectiveness (Evans, et al., 1996).
Moreover, the UK is almost unique amongst developed economies in the
importance attached to variable short-term interest rates, because of its
method of financing house purchases and small business operations
(Miles,1994). Additionally, the British economy is vulnerable to international
developments and to associated changes in the external value of sterling
(Taylor, 1995). These factors demonstrate that overseas models of central bank
independence are less than wholly appropriate to the UK.
The conceptual case for central bank independence is primarily based on the
view that arrangements which raise the credibility of monetary policy will
increase its effectiveness in pursuit of price stability. Although this view
has long been held, only in recent years has the concept of policy credibility
been defined and analysed rigorously (Cukierman, 1986; Blackburn and
The establishment of an independent central bank with strong
anti-inflationary preferences is seen as a way for the state to bind its hands
against the electoral temptation of inducing unanticipated increases in the
price level. As commitment increases credibility, orthodox theory predicts
that divergences between the central bank's policies and people's expectations
will be smaller. Therefore lower costs and fewer delays are incurred when
adjusting to monetary policy shifts. It is from this theoretical perspective
of monetarism and rational expectations that the ECB was launched. However,
just months after its inception, the ECB faces intense pressure from European
politicians to cut interest rates. Given the levels of inflation and
unemployment, the case is strong, but the ECB fears the danger of being seen
as open to persuasion. It argues that an independent central bank must guard
its credibility. If the financial markets suspect that the bank is susceptible
to political influence, long-run inflation and the cost of controlling it
would be higher.
This argument has recently been challenged. If central bank independence
increases credibility, it should be associated with greater rigidity in the
setting of nominal prices and money wages, reflecting the fact that the bank's
promise to keep inflation low is believed. However, a study of OECD countries
by Posen (1993 & 1998) indicated that neither effect occurs. Indeed
independence, not merely fails to reduce the cost of dis-inflation, but rather
seems to increase it. Getting inflation down takes as long and calls for a
larger short-term sacrifice of output and jobs, on average, in countries with
relatively independent central banks.
Most of the contemporary support for central bank independence stems from a
partial and frequently historically naive view of West German experience. Any
one item that helped to promote rapid post-war German growth, such as the
independent Bundesbank, was part of a structural totality defining its role.
Accordingly it is unlikely to be effective if transferred by itself to other
countries or onto the broader EU stage (Dowd, 1989 & 1994). It may be more
appropriate to reverse the fashionable view; the structural conditions that
produced the strength of the German economy, allowing it to grow while
maintaining a low inflation rate also enabled it to afford the luxury of an
independent central bank concentrating on monetary stability. For example, the
wage negotiations system in Germany has generally produced a less inflationary
outcome than in many other countries over the post-war period, thus not
requiring intervention from the Bundesbank. Therefore it must be open to
question whether the creation of a more independent central bank is
significant in containing inflation, or whether the existence of an
independent bank merely reflects a political economy in which price stability
is a widely-shared objective and where governments, as well as the central
bank, regard low inflation as an over-riding objective (Mitchell, 1993).
Consequently, the possibility of 'reverse causality' is accepted by economists
as a significant constraint when interpreting the experience of countries with
independent central banks.
The theoretical case for independence is based on two analytical
assumptions that have become generally accepted by economists over the last
decade: (a) the 'no-trade off' vertical long-term Phillips
curve, which implies that price stability can be achieved at no long-term cost
of unemployment; (b) the political business cycle. However,
both rest on insecure foundations. First, the vertical Phillips curve analysis
rests upon the concept of a natural rate of unemployment, about whose
frequently changing determinants economists remain largely ignorant (Davidson,
1998; Karanassou and Snower, 1998; Madsen, 1998; Nickell, 1998; Phelps and
Zoega, 1998). Second, repeated studies indicate that relatively little
evidence exists for the occurrence of any systematic political business cycle
(Kalecki, 1943; Breton, 1974; Nordhaus, 1975; MacRae, 1977; Wagner, 1977;
Frey, 1978; Alesina, 1989).
These theoretical difficulties are compounded by the empirical evidence
concerning central bank independence and lower-than-average inflation which
again draw heavily upon the German Bundesbank, although counter-examples
exist. For instance, the USA with an independent central bank has not enjoyed
such a phenomenon. Moreover, German experience since reunification
demonstrates that an independent central bank is unable to guarantee low
inflation, whilst the Bank of Japan, no more independent than the Bank of
England, frequently presided over falling rates of price increase.
The dominance of monetarism led to the widespread conviction that low
inflation is an essential, or at least a very important, condition for high,
sustained growth, so that its achievement should be the priority for
government economic policy. The importance attached to low inflation as the
prerequisite for high employment and rapid growth is central to the case for
an independent central bank, which pursues price stability as its major, or
sole, objective. However, the belief that low or zero inflation produces
sustained growth is not supported by the available evidence, with many studies
indicating that no significant relationship exists between low inflation and
higher rates of growth, until double-digit rates of price increase occur,
which do retard economic development (Thirlwall and Barton, 1971; Brown, 1985;
Stanners, 1993). Thus, the consensus of research fails to support the
advantages of low inflation, so that a key element in the case for an
independent central bank remains unsubstantiated.
Until the 1980s the corner-stone of British economic policy was the pursuit
of four policy objectives, namely high levels of employment, stable prices,
balance of payments equilibrium and an expanding economy. However, if
responsibility for the second objective rests solely with an independent
central bank, while the other three remain with the government, economic
management potentially becomes more difficult due to the separation of
monetary and fiscal policy (Blake and Weale, 1998). Hence, an advantage of a
non-independent central bank is that budgetary and monetary measures can
complement each other, forging a co-ordinated strategy of economic management.
A failure of policy co-ordination was demonstrated by Germany's problems in
the aftermath of reunification, when the failure of the Kohl administration to
raise taxes for financing reunification generated a historically large budget
deficit, which in turn triggered the Bundesbank into setting high interest
rates. Such policy inconsistency highlights the ambiguous nature of
'independence' itself. The Bundesbank could not be seen to succumb to
political pressure, which may damage its credibility, but was unable to avoid
a political role; for instance, it regularly lowered interest rates before G7
meetings to avoid criticism from its trading partners. Analysis of the role of
a central bank confirms that, in a world of external shocks, the case for
delegating monetary policy is weak and that a co-ordinated approach is more
likely to achieve the electorate's objectives (Rogoff, 1985a&b).
Furthermore, if eliminating inflation is all-important and elected
politicians cannot be trusted to give it priority, the logical conclusion is
that all economic instruments, including fiscal policy, should be taken out of
their hands. The assertion often made is that monetary policy is different,
because it is a technical operation with a single objective and
well-understood, reliable techniques. Such a belief is questionable, since
monetary policy impacts upon employment and living standards, as vitally as
does fiscal policy. Moreover, periods of high inflation have not occurred
wholly, or even mainly, due to lax monetary expansion, whilst there is greater
international evidence of fiscal, rather than monetary, policy being
manipulated for electoral ends (Alesina, 1989). Despite this, few economists
advocate placing fiscal policy in the hands of independent functionaries,
because such a course of action would be obviously undemocratic.
When assessing the impact of central bank independence upon price stability
economists have mostly utilised imputed 'degrees of independence' to evaluate
the heterogeneous character of central banks. These are based upon factors,
ranging from the level of political control exerted upon the bank to its
operational role with the economy. A large body of literature focusing upon
single or multi-country time-series studies has accumulated, with an
additional series of studies attempting to rank independence for a
cross-section of countries. The majority of this research draws attention to
the inherent difficulty of defining, let alone measuring, the concept of
independence (Mangano, 1998).
The initial method of imputing degrees of independence, based solely on
legislature arrangements, found no relationship between inflation performance
and independence (Bodart, 1990). The index was refined by subsequent studies,
which constructed a measure of central bank independence that reflected both
'political independence' and 'economic independence' (Alesina and Grilli, 1991
and Grilli et al., 1991). The former relates to the ability of the monetary
authorities to choose the goals of policy, whilst economic independence is
defined by their capacity to choose the instruments with which to pursue
policy objectives. The main conclusion from such analyses is that the average
rate of inflation, and occasionally its variability, is significantly lower in
countries that possess independent central banks. However, the value of such
evidence is problematic, as the authors usually acknowledge, because
measurement of 'degrees of independence' possesses serious weaknesses, which
cast doubt upon the validity of any purported association between central bank
independence and the attainment of price stability. The main failings are:
- A limited spread of rankings inevitably restricts sensitivity across a
wide number of inherently different countries, which raises difficulties
concerning the index's analytical usefulness.
- Many of the studies cover overlapping time periods, opening up the
possibility that they have found a result unique to that particular set of
data. Therefore it becomes crucial to test a hypothesis on data sets other
than those which suggested the hypothesis (Friedman and Schwartz, 1991).
- The time periods covered by some studies increase concern over the
reliability of their findings; for instance, the participation of countries
within the EMS could be viewed as a potentially important determinant of
inflation rates. Consequently, if all countries in a pegged exchange rate
system are compelled to possess the same rate of inflation over the long-run,
whatever the various influences are on that rate, the status of national
central banks cannot be amongst them.
- Disregard for non-economic factors that shape fiscal and monetary policy
choices is a consistent feature of these studies, illustrated by their
assumption that electorates always prefer low inflation to the possible
trade-off of higher economic growth and employment (Muscatelli, 1998).
However, even casual observation of Swedish public opinion refutes this
perspective; it has consistently favoured full employment over low inflation
as the central objective for economic strategy.
- Even after analysing the role of political factors, other potential
sources of differences in inflation rates are often neglected. For instance,
even if EU countries were subject to the same exogenous shocks in the post-war
period, structural differences-labour relations systems, wage indexation
mechanisms, vulnerability to raw material price changes, varying preferences
for inflation versus unemployment - between them may explain their different
- The position of the government in the political spectrum and various
proxies of social consensus offer some explanation of inflation rates in
different countries (Hansson, 1987). Likewise, the size of the public sector
appears to be another significant factor (Alesina, 1988). Moreover, lower
inflation in Germany and Switzerland could result from the presence of 'guest'
workers during periods of economic growth, who absorb part of the unemployment
costs of disinflationary policies by having to return to their country of
origin when the work is no longer available (Burdekin and Willett, 1990).
- In an attempt to compare monetary regimes, many studies focus exclusively
on institutional characteristics disregarding behavioural indicators, such as
the average rate of growth of the money supply or the level and variability of
- New research rarely possesses at first the reliable database it requires.
Therefore greater attention should be devoted to improving databases and to
recording any national specificity that may exist or has occurred.
- These studies suffer from the omission of indicators not identified as
potential explanatory factors, so that influences other than central bank
independence may be important, but as yet unidentified, determinants.
In this section we examine the issue of central bank independence within
those EU members states (excluding Luxembourg which at the time did not
possess its own central bank), who were original signatories to the 1991
Maastricht Treaty. Although this reduces the number of countries in comparison
to several of the previous studies, it offers a logical basis for the
subsequent analysis. Little analytical precision is gained, when examining the
likely impact of the ECB, by including those countries which will never enter
EMU (for example, Australia, Canada, Japan, New Zealand and the USA).
Moreover, few previous studies offer a rationale for the countries they
include, for instance, whilst focusing upon industrialised economies, they all
fail to incorporate every member of such a representative grouping as the
A further aspect that differentiates this analysis is that it disaggregates
central bank independence into its constituent features of political and
economic independence. The approach is further developed by dividing these
principal features into sixteen individual components. Such a procedure
enables a detailed examination of the separate elements that comprise a
central bank's independence, alongside an evaluation of the aggregate level
analysis pursued in previous research. Finally, in addition to the now
traditional comparison of central bank independence and inflation, an
additional GDP growth variable is introduced to evaluate the proposition that
independence carries no detrimental consequences for output (Eijffinger et
Table 1 shows the correlation results between the series of measures of
central bank independence and both the rate of inflation and growth. An
association between a particular indicator of independence and either
macro-economic variable is demonstrated by the use of an asterisk to represent
alternative significance levels of one (††), five (†) and ten (*) per
Table 1: Correlation between central bank
independence and macroeconomic variables for EU member states
|Indicator of central bank independence: ||Rate of
inflation ||GDP growth|
|Governor not appointed by government ||0.20
|Governor appointed for > 5 years ||-0.51
|All the board not appointed by government ||0.52 ||0.31|
|Board appointed for > 5 years ||-0.63† ||-0.13|
|No mandatory government representative on board ||0.07 ||-0.10|
|No government approval of policy formulation required ||-0.55* ||-0.23|
|Statutory requirements that bank pursues goal of monetary
stability ||-0.39 ||-0.01|
|Legal provisions that strengthen position in conflicts with
government ||-0.20 ||-0.02|
|Cumulative index of political independence ||-0.48 ||-0.12|
|Direct credit facility-not automatic ||-0.34
|Direct credit facility-market interest rate ||-0.52* ||-0.57*|
|Direct credit facility-temporary ||-0.32 ||-0.15|
|Direct credit facility-limited amount ||-0.13 ||0.34|
|Central bank does not participate in primary market for public
debt ||-0.84†† ||-0.53*|
|Discount rate set by central bank ||-0.32
|Banking supervision not entrusted to central bank at all ||-0.16 ||0.10|
|Banking supervision not entrusted to central bank alone ||-0.42 ||-0.35|
|Cumulative index of economic independence ||-0.81†† ||-0.62†|
|Cumulative index of political and economic independence ||-0.81†† ||-0.45|
With regard to the relationship between central bank independence and
inflation, Table 1 indicates that only the factors of the 'board appointed for
> 5 years' and 'no government approval of monetary policy formulation is
required' are significant from the series of political features, whilst
'direct credit facility at market interest rate' and 'central bank does not
participate in the primary market for public debt' are the sole significant
economic characteristics. Hence only four of a possible sixteen features of
central bank independence contribute to lowering inflation. Such results
hardly support the contention that an independent central bank is an effective
Although these findings partially support the conclusions of previous
studies (Alesina, 1989; Grilli et al., 1991; Alesina and Summers, 1993), there
are several important caveats. First, the analysis of the individual features
of political and economic independence indicates that only a limited number
are statistically significant, raising difficulties concerning the necessity
for all such characteristics to be present simultaneously within the ECB.
Second, the index of political independence is insignificant, indicating that
such criteria proved historically inconsequential to EU member states'
inflation rates. Third, although the indices of economic and combined
independence are inversely related to inflation, only 66% of the variation of
inflation is 'explained'. This surely is insufficient evidence from which to
launch such a fundamental institutional reform, or to expect it persist over
the medium- to long-term, particularly if negative externalities are
associated with greater independence.
The relationship between central bank independence and output is also
examined to evaluate the orthodox hypothesis that the former constitutes "a
free lunch" (Grilli et al., 1991:375), because it carries no detrimental
consequences for GDP growth. The final column of Table 1 shows the correlation
results for the individual features and the three indices of independence in
relation to growth. With respect to political independence, neither the
individual factors nor the index are statistically significant, whilst three
of the economic independence criteria are significant: 'direct credit facility
not automatic', 'direct credit facility at market interest rate' and 'central
bank does not participate in the primary market for public debt'. Of
particular interest, however, is the negative association between these
features and GDP growth, which contradicts the previously established
proposition that central bank independence has no "costs in terms of
macroeconomic performance" (Grilli et al., 1991:375). The probability
therefore is that independent central banks exert a negative impact on the
rise in their citizens' standards of living. Such a research finding
constitutes an ominous background to the actual operation of the ECB.
The ECB, which started running the monetary policy of the eleven countries
adopting the euro on January 1st 1999, is a creation of the Maastricht Treaty,
which designed it to be the most independent monetary authority in the world.
The Maastricht Treaty established the ECB as the only institution possessing
the right to issue the single currency. Its sole aim is to pursue price
stability. Article 3A makes the latter goal legally explicit, and
therefore binding, whilst stating that other objectives may be pursued only
'without prejudice' to price stability. Furthermore, the ECB is forbidden by
its founding charter to balance the goal of price stability against other aims
such as growth and job creation.
The ECB's architects at Maastricht sought to insulate it completely from
political pressures, both at the national government and at the EMU-zone
level. By contrast, the US Federal Reserve, for instance, is required to take
into account output and employment objectives alongside inflation targets,
whilst being subject to fierce, regular scrutiny by Congressional committees
with wide powers of investigation and review.
The position of the ECB under the Maastricht Treaty permits no clear
accountability to any national nor EMU institution. It stipulates that the ECB
Council's deliberations remain confidential, although Wim Duisenberg, the
ECB's President, suggested that minutes of Council meetings could be made
public after a time lag of sixteen years! The only method of questioning the
ECB's policies is through periodic reports to the ineffective European
Parliament. Consequently, in an EU structure of decision-making widely
acknowledged to be suffering from a 'democratic deficit', the powers handed to
an unaccountable ECB will exacerbate the shortcoming. Charles Dumas of Lombard
Street Bank recently argued, "the ECB's 'excessive' independence was the price
paid for persuading German voters to give up the mark" (The Times,
3rd March 1999).
In Britain, the USA, Canada, Australia and a growing number of smaller
countries, monetary policy is used to control both inflation and unemployment
by managing aggregate demand. For example, the UK government and the Bank of
England's Monetary Policy Committee have recognised (as was implicit in the
Chancellor's specific 2.5% inflation target) that moderate inflation may
generate growth and a greater number of jobs. By contrast, within Euroland any
suggestion that monetary policy could be used to increase living standards and
reduce unemployment is a heresy not to be contemplated. The ECB's legal
responsibility is to maintain price stability, but that target has not been
attained in France and Germany for the past five years. However, the ECB
consistently ignores the success of the UK and the USA in achieving low
inflation, whilst simultaneously deploying monetary policy to reduce
unemployment. The explanation of this conundrum lies in the ECB's origins and
the macroeconomic theory it has adopted.
From its monetarist background, the ECB argues that the majority of
Euroland's historically high unemployment (currently around seventeen million)
originates from structural deficiencies on the supply side of its member
states economies. Consequently it denies responsibility for increasing
aggregate demand to lower unemployment, believing that there is no further
room for expansion in the Euro-11 economies. In support of this thesis,
another impeccably orthodox economic institution, the OECD, has published
estimates for the natural rate of unemployment, below which inflation is
believed to accelerate, for all industrialised economies. The estimated
weighted average for Euroland is 11%, where the actual average was 10.6% in
January 1999. On this reasoning, no scope exists to reduce unemployment
without accelerating inflation. Such a view emphasises the grip that the
natural rate of unemployment hypothesis exerts over ECB policy makers.
Contemporary EMU monetary policy is dominated by the view that inflation
inevitably increases once unemployment falls below a critical level (the
non-accelerating rate of unemployment). Therefore the focus of monetary policy
becomes to ensure, in practise, that unemployment is sufficiently high to
reduce price and wage increases. This theory is the clue to ECB strategy.
However, if the sole objective of policy is to maintain a constant rate of
inflation, wide variations in output and employment may be required. In so far
as a potential conflict exists between steady inflation and full employment,
the latter should enjoy priority, because the consequences of fluctuation in
employment are more serious than those in the rate of inflation. Apart from
the human costs of lower income, job insecurity, loss of skills, poorer mental
and physical health, and higher crime rates, the industrial cost is enormous,
since lost capacity cannot subsequently be made good when demand recovers.
These problems do not deflect Europe's establishment from its objectives.
As Strauss-Kahn, the French Finance Minister, said in a speech to the Centre
for Economic Policy Research on 9th November 1998: "We have made the choice of
having an independent central bank. Its autonomy vis-"-vis national
governments and the EU institutions, which results from an international
treaty, is more soundly guaranteed than anywhere else in the world...We have
clearly enshrined in our treaty a fiscal policy that emphasises the need for
fiscal responsibility and we have drafted secondary legislation that will make
sure that member states will deliver on this commitment". On the change from
an international economy dominated by the fear of inflation, when the
Maastricht Treaty was signed in 1991, to today's deflationary climate,
Strauss-Kahn remarked: "Our task is to make this system work in a context
which is clearly different from the one the architects of Maastricht had in
mind when they drafted the Treaty". The more effective alternative of changing
the policy decision-making framework as circumstances change is self-evidently
not on the agenda.
Strauss-Kahn does, however, accept the "need for institutions that can
deliver effective co-ordination between the eleven governments of the
euro-zone, and between them and the independent ECB", because "in the absence
of effective co-ordination, doubts about the other players might well lead the
euro-zone to adopt a less than optimal policy-mix". However, difficulties
arise when Strauss-Kahn claims that "the efforts made since the late 1980s
have created conditions for a long EU cycle of growth". Such a claim flies in
the face of all the evidence; the EU was a low growth area over the last
decade, when these 'efforts' were undertaken, expanding at 1.7% per annum
between 1991 and 1997 compared to 3.5% for the rest of the world. Consequently
unemployment in the EU was 5 million in 1979, 14 million in 199 2 and is now
nearly 19 million. Similar increases have not occurred in other OECD
Nonetheless the ECB's monthly bulletin of February 1999 asserted that
monetary and fiscal conditions "are favourable for sustained output and
employment growth in the euro-zone in line with price-stability" (ECB, 1999).
The ECB has consistently said that it would have to see clear signs of
deflation before reducing interest rates. However, Robin Aspinall, chief
European economist at National Australia Bank, argued on 16th February 1999
that, "the ECB will have to cut rates eventually because there is no sign of
any inflationary danger. However, the ECB is resisting a cut because it
distrusts the fiscal discipline of Europe's politicians. The ECB deliberately
keeps its inflation target vague, at simply below 2%, so that it would not be
beholden to the bidding of politicians once it meets its objective. The ECB
also that interest rate cuts will not have much effect on unemployment. It
favours structural reform to reduce unemployment" (The Times, 17th February
1999). However, the attainment of a 2% inflation target has not been achieved
by any major economy in recent times; the USA figure over the last decade was
3.3% and that of Germany 2.8%. Therefore an unaccountable institution has
assigned itself an exacting inflationary goal, with ramifications for other
dimensions of economic policy. Furthermore, the ECB argues that Germany's
current troubles are structural not cyclical, but even if correct, embarking
upon structural change and realising its results, is a lengthy process.
However, distancing itself from democratic demands to emphasise its
independence is a crucial tactic for building ECB credibility.
Following the Second World War, British economic policy was directed to the
simultaneous attainment of four policy objectives; high levels of employment,
stable prices, balance of payments equilibrium and an expanding economy.
Within Euroland, responsibility for the second lies solely with the ECB,
whilst the other three remain with national governments. An obvious danger is
that economic management will become more difficult through the separation of
budgetary and monetary policy. It was demonstrated by the shortcomings of the
Reagan-Volcker era in the USA and Germany's problems following reunification;
in both cases lax fiscal policy resulted in high interest rates. By contrast,
with a non-independent central bank, budgetary and monetary management can
complement each other, forging a co-ordinated strategy of economic
Since the EU Heads of Government met at Maastricht in 1991 to finalise the
blueprint for EMU, their political complexion has changed beyond recognition.
The centre-left now controls or shares power in thirteen of the fifteen EU
governments, Ireland and Spain being the exceptions. The majority won
elections by promising job creation. Therefore a new European consensus is
emerging which prioritises the need to reduce unemployment.
Consequently the theoretical possibility of a division between the conduct
of budgetary and monetary policy has become a reality within months of the
launch of the euro, far more rapidly than even sceptics anticipated. A
crevasse has opened up between centre-left governments focusing upon
unemployment and the ECB operating from a monetarist, natural rate of
unemployment perspective. Moreover, the bankers insisted in advance, via the
Stability and Growth Pact, that governments should be deprived of the ability
to spend their way out of recessions. The battle between the ECB and European
politicians was thrown into sharp focus by the resignation of Oscar
Lafontaine. However, the underlying structural conflicts within Euroland lie
deeper then the career of any individual, so that the danger of divisions
between fiscal and monetary policies remains. Moreover, the gloomy economic
prospects for the EMU-zone ensure that such pressures will intensify; for
instance, the German economy contracted by 0.5% in the last three months of
1998, whilst in France industrial output declined by 1.6% in December
The euro-11 countries, even without the UK, do not constitute an optimum
currency area (see Baimbridge et al., 1998). Consequently for many years to
come, persistent national divergences in growth and unemployment are likely to
recur. This nightmare scenario has not taken long to unfold; Wim Duisenberg
felt obliged to concede on 4th March 1999 that the economies so painfully
corseted together by meeting the convergence criteria are already diverging
(The Times, 6th March 1999). While Ireland appears likely to overheat due to
large reductions in interest rates at a time of unprecedented high growth,
Germany appears to be drifting ineluctably into recession. Whatever happens in
the future, it is plain that one key argument of the eurosceptics is correct;
no single interest rate is suitable for the euro-zone. Therefore any action of
the ECB will cause trouble for some parts of Euroland, whose economies are
destined to diverge over the foreseeable future. Thus, in the last quarter of
1998, Germany's GDP fell by 0.5%, yet Spain's rose by 0.8%, whilst Ireland's
increased by 8.0% over the whole year. Such sharp divergences in economic
performance will make the ECB's stewardship a difficult task.
The weight of theoretical and empirical evidence surveyed in this paper
suggests that, the creation of an independent central bank in an established
national economy, is an enterprise with certain costs and with only dubious
prospects of the anti-inflationary benefits so frequently claimed. To
transpose such a hazardous undertaking to a supranational framework such as
the EU, whose constituent national economies experience varying economic
cycles and possess divergent economic structures, is fraught with
The decisions taken by the ECB are amongst the most sensitive actions
deployed in a modern economy. Determining interest rates influences the growth
of living standards, the level of unemployment and the amount that people pay
for their credit and their mortgages. However, nobody votes for the ECB, which
is unaccountable for its actions. It does not publish its forecasts nor the
minutes of its deliberations. ECB members cannot be removed from office by the
European Parliament, by the Council of Ministers nor even by the European
Court. Therefore the move to ECB control reduces the amount of democracy,
increasing disillusionment and grievance with democratic institutions.
The ECB's problems arise from its lack of democratic accountability, its
arbitrary objectives, its outdated economic philosophy, and its potential for
intermittent conflict with the national governments whose destinies it
possesses considerable influence over. Therefore the ECB as currently
constituted is an anti-democratic, economically inept institution. Its lack of
accountability, transparency and democratic legitimacy makes clear that no
British government concerned for the efficiency of the UK economy and capacity
for self-governance could submit to the ECB's monetary authority. Therefore it
is crucial that the British people, if and when consulted, steer clear of this
ill-defined, bureaucratic nightmare.
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Dr. Mark Baimbridge is Lecturer in Economics at the
University of Bradford and EERU's Director of Research. He co-authored
What 1992 really means: single market or double cross? (1989),
From Rome to Maastricht (1992), There is an alternative
(1996) and A price not worth paying: the economic cost of EMU (1997)
for the Campaign for an Independent Britain. He has published over 100
articles, primarily concerning Britain's relationship with the EU, in learned
and current affairs journals in economics, politics and social policy. He is a
frequent contributor and commentator on economic issues to radio and in
newspapers, including The Sunday Times, The Sunday
Telegraph, The Financial Times and The Guardian. In
addition to the economics of European integration, his research interests
include trade unions, higher education, economics of professional sports and
Dr. Brian Burkitt is Senior Lecturer in Economics at the
University of Bradford and Director of EERU. He wrote two widely
quoted reports, Britain and the European Economic Community: an economic
re-appraisal, and Britain and the European Economic Community: a
political re-appraisal at the time of the 1975 referendum on EEC
membership. He is also author of Trade unions and wages (1975 and
1980), Trade unions and the economy (1979), Radical political
economy (1984) and over 150 articles in learned journals. He has
previously co-authored What 1992 really means: single market or double
cross? (1989), From Rome to Maastricht (1992), There is an
alternative (1996) and A price not worth paying: the economic cost of
EMU (1997). He is a frequent contributor, and commentator on economic
issues, to television and radio programmes, including Newsnight and
A Week in Politics. In addition to the economics of European
integration, his research interests include unemployment & crimes of racial
violence, cost of unemployment & inflation, disequilibrium economics and
Dr. Philip Whyman is Lecturer in Economics at the
University of Central Lancashire and Honorary Research Fellow of
EERU. He co-authored There is an alternative (1996) and
A price not worth paying: the economic cost of EMU (1997). He has
published widely in learned journals and a number of policy papers, including
submissions to the House of Lords Select Committee on The European Communities
(1996) and the House of Commons Treasury Select Committee (1998). His research
interests include the impact of European integration upon labour markets,
fiscal federalism, international monetary developments and the UK's future
relationship with the EU. In addition, he has written extensively on the
economic development of Sweden.
Their edited collection The impact of the Euro: debating Britain's
choice will be published by Macmillan later this year, whilst Britain
and Europe: the great divide by Dr. Baimbridge and Dr. Burkitt will be
published by Pinter next year.
For The Bruges Group they have previously written Is Europe ready for
EMU? Theory, evidence and consequences, Occasional Paper No. 31.
The European Economies Research Unit (EERU) specialises in the application
of critical policy orientated research in relation to the economies of Europe.
The major focus of this research is directed towards the development of the EU
with respect to economic and monetary union and a key objective of EERU is the
dissemination of its research output to the widest possible audience. EERU can
be contacted at:
European Economies Research Unit
Department of Social and Economic Studies
University of Bradford
Tel: 01274 234792 / 234802
Fax: 01274 235295