Last week’s „discovery“ of the secret Agreement on Net Financial Assets (Anfa) that seemingly even ECB President Mario Draghi was not quite aware of (or he was ad subsequently was embarrassed by being caught), showed that matters at the core of the Eurosystem are rotten.
Anfa shows three things: First, some people in the ECB Council must be explained that public trust and transparency are modern central banks only working instruments; second, the decision-making process in the ECB council is in effect worthless; and last, even technocratic expert gremium need either checks and balances or must be greatly curtailed in their freedoms.
Modern Fiat Money currencies are backed by nothing more than the trust, that my trading opponent finds these funny, colourful little sheets of paper just as valuable as I do. A central bank that issues Fiat Money, (read: all of them) must be very protective of that trust since it is the only thing that gives money its value – and the central bank the subsequent power to steer it and thus prices, which is in the case of the ECB the foremost objective.
If now my opponent believes that the bill I give him is not really worth its nominal value, he will either charge more or give me less of my desired product. The loss of trust in a money’s value will greatly hamper the mechanisms of markets by distorting prices – which is true in cases of more-than-moderate in- or deflation.
It is not only the fact that the ECB Council cannot control monetary policy, since Anfa allows the National Central Banks monetary policy relevant operations that undermines trust in the Euro. It is also that these Anfa-operations were conducted in secrecy, hence distorting prices and relative scarcities without public knowledge of it.
That the NCBs can through Anfa basically overturn the monetary policy decisions of the ECB Council and conduct their own monetary policy, by printing money in their own cellar without the control of the Council renders common monetary policy in the Euro Area absurd and naught. To be frank, this is a disaster and any such scheme that allows the NCBs to conduct monetary policy relevant operations must be revealed and ended at once. There must be no possibility whatsoever for parallel monetary policy, since the treaties (and common sense) clearly stipulate that the sole body conducting monetary policy for the whole of the union is the ECB Council.
Note that this stipulation does not go against the possibility for NCBs to invest in financial assets for things like pension obligations. However, since any financial operation of a central bank is by definition monetary policy relevant, such operations must be conducted publicly and of course be sterilised by an according counter-effective fine-tuning operation.
The ultra-independent ECB has proven that it is not able to control itself. While it is very prudent to organisationally disentangle monetary and fiscal policy to limit the possibilities of monetary government financing (which the ECB is expressis verbis barred from doing), the Anfa operations by the Banque de France and the Banca d’Italia look exactly like this. Obviously, the Council was not able (or even worse not willing) to put an end to these operations, which is no surprise given that the council itself consists of the NCB governours. Interestingly, not even the Bundesbank, usually very fond of rules, transparency and orderly conduct of monetary policy, has objected to the plans of something like Anfa, but silently agreed on a secret(!) tool able to be abused for parallel monetary policy operations without control, transparency and accountability. This in turn means, that peer pressure among the NCBs does not work as well.
From this Anfa calamities follow some straightforward policy implications. First, Anfa and anything like it must end now. The monetary policy effects must be sterilised immediately for the ECB Council to regain some of the foregone trust – yes, this amounts to tightening of roughly half a trillion Euro.
Second, all that is known of Anfa and the likes must be published for both research into the effects and also for legal scrutiny, that is the ECB President must explain everything Anfa-related to the European Parliament. Still, the Parliament is not able to remove the President from office or even call for the European Court for Justice to remove him. Only the ECB Council can go before court to do that. I find this rather unlikely to happen. Perhaps the right to call the Court to investigate possible misbehaviour of the Council and its members should also be granted to the Parliament. The power to remove members of the Council including the President should remain at the Court, however.
Third, the institutional set-up of the Eurosystem needs an overhaul, which may prove difficult to implement without treaty change. Since the Council is unable to control itself and peer pressure is also toothless, its powers must either be curbed or put under greater democratic oversight.
Curbing the powers could be done by stipulating that the ECB’s monetary policy may only follow some interest rate rule or money stock rule, that is making monetary policy perfectly foreseeable and leaving only the powers to counteract interbanking-market distress at the discretion of the Council. Such curtailing however would of course greatly diminish the “independence” of European monetary policy – still the question remains what independent monetary policy is worth without controls. Exerting stronger democratic control could be done by giving the Parliament the power to replace the members of the ECB directorate by means of a vote-of-no-confidence, similar to the Bundestag’s power to remove the Federal Chancellor from office. Usually I am a fierce opponent of legislative interference in monetary policy due to the dangers of abusing the central bank’s power, but since the European Parliament’s budgetary powers are rather small compared with the national parliaments, this could be a worthwhile compromise. Lastly, Europeans should consider establishing a more American set-up of “National” Central Bank (see Burda, 2013) to further limit the incentives to try anything related to monetary government financing.