The Bank that rules Europe? The ECB and Central Bank Independence

Linked with Mark Baimbridge – England, and with Labour Market Flexibility and Foreign Direct Investment.

Paper No. 37, by Mark Baimbridge, Brian Burkitt, Philip Whyman / paper not dated. (Read the whole very long text on Bruges Group).

Issues in Central Bank Independence … (paragraphe 2 to 4) – Excerpt:

… 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.

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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 difficulties.

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.
(Read the whole very long text on Bruges Group).

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