This post offers a short note clarifying the dynamics of the asymmetric relationship between the ECB and the governments of the Euro-area, its disparity with the USA and the UK and how this explains the lip service that is being paid to this institution. I conclude that given the misgivings of nation state oriented intergovernmentalism, the solution to this problem is delegation of larger fiscal powers to the European Commission.
Central Bank independence and Fiscal Policy accommodation
Central bank independence is a fundamental insight of macroeconomics and political economy that show it ensures credible monetary policy commitments to price stability, which politically motivated governments are not able to provide. Of course it is arguable whether delegation ensures independence. As Woodford 2003 and 2010 point out, monetary policy plays an important role in facilitating and amplifying the effect of fiscal policy. When it is said to “lean against the wind” it can facilitate fiscal policy by reacting less to potential inflationary pressures. The operation of monetary and fiscal policy tools and their interaction will depend on the prevailing institutional balance of power.
Monetary Vs Fiscal Policy Makers
The relationship between Monetary and Fiscal Policy makers matters a great deal for the functioning of an economy, particularly during a period of contraction during which policy makers are called upon to mitigate the effects of such negative movements. Clearly the relationship is somewhat asymmetric in the USA and in England, where the BoE and the Fed, enjoying no (democratic) political legitimacy and having a flexible and balanced mandates, can accommodate fiscal policy. In these countries, the governments have the upper hand.
The same cannot be said of the ECB, which has traditionally taken very conservative approaches to its already relatively rigid mandate, while enjoying an unrivaled level of political independence, enshrined in treaty law. Moreover, it faces the incoherent and disparate lobbying attempts of 17 different fiscal policy setters, with different agendas and leverage. In the Euro-zone, the balance of power is tipped in the opposite direction, giving the ECB the upper hand.
The ECB’s Identity and Reputation
All of this matters in the present Euro-zone setting because in the game of chicken that is being played between the ECB and the Euro-zone governments, questioning the identity of the ECB as an independent and conservative monetary policy setter could damage its reputation and through expectations feed inflationary back pressures on the economy, thereby jeopardizing its primary mandate of price stability.
Paying your Monetary Homages
This explains why the member states have, literally, been “put in their place” by the ECB and have gone to pains to stress central bank independence (see under “European Central Bank” heading) and ended their recent calls for it to intervene and do quantitative easing. At the same time, the ECB has spoken directly and indirectly as loudly as it can about the integrating, coordinating and moral hazard avoiding conditions necessary for such an intervention. Although the conditions are not the preferred ones, they are the feasible “second best” ones, which the ECB is likely to accept.
The Democratic costs of the Nation State
The notion that democracies are nationally bounded is well embedded in our collective civic minds. However, it can be argued that these two elements cannot be pursued simultaneously in a globalised economy, where movements in an economy’s balance of payments have become increasingly large, common and endogenised. In this case, an insistence on pursuing democracy at a national level will effectively devoid policy makers of alternatives, instead casting them in a golden straight jacket, and setting them on a race to the bottom in the taxation of (mobile) capital and financial resources that decreases the scope of their intervention. Of course I’m not saying we should live in autarky, but clearly globalisation creates costs as well as benefits, both of which should be managed. The question of course is: “How do you manage them”?
The Democratic Costs of Intergovernmentalism
Intergovernmentalism as an international relations process intended to manage these and other negative externalities through cooperation suffers from a large number of problems, as I mentioned before. First, bargaining equilibria will not be symmetric as countries with different demographic, geographic and economic sizes will have proportional influence. As Chang 2005 describes and Thornhallson 2006 explains, Germany and France are clearly more equal than the rest of the Member states.
Secondly, this process cannot generate credible commitments, given that the rules are set by the players, who themselves judge whether the rules are being followed. The conflict of interests should be apparent to everyone. It’s like judging whether you’ve committed a crime. In principle you’ll always be more lenient than an unbiased judge.
Thirdly, and at least partially flowing from the second, defection from cooperation cannot be avoided with certainty. This may be due to a number of reasons, such as moral hazard caused by imperfect monitoring, incomplete contracts, limited and uncertain interactions implied by the political cycle, strongly held priors and uncertainty about “the truth”, etc.
Democratic Implications of Intergovernmentalism
The, first cost of intergovernmentalism implies an unfair bargaining outcome. The second explains the irrelevance of rules that are not monitored and enforced by unbiased delegated authorities. Finally, the third, explains why the EU governments cannot stand up to the USA, to China or even to the ECB, because they are governments; plural not singular. The process of intergovernmental cooperation does not free you from your original political straightjacket. As an individual voter, by impeding sustainable agreements it doesn’t add any value to your vote, which continues to matters less in this globalised world. Intergovernmentalism only gives an impression of democratic relevance because the process is indeed democratic. However, the cacophony it creates imposes too many veto players which are unable to project the influence necessary to create and take the necessary policy alternatives and opportunities. Basically it’s the equivalent of many people in “golden straightjacket” bumping into eachother, not able to use their hands to do anything.
Delegation as a Solution
This is why I believe that we will see a large delegation of (fiscal) powers to the European Commission in the next 20 years. Of course I don’t want all fiscal powers to be delegated to the European Commission, much as I don’t think that centralised fiscal systems (France) are more efficient than decentralised ones (Germany). I do however believe that subsidiarity provides a generally good framework for governance and vertical distribution of tasks. This clearly begs the question: “What fiscal responsibilities should be given to the European Commission?”
I’ll leave that for later but for now I will say that whatever those responsibilities are, they should be sizeable enough that it can become the main debt issuer in the Eurozone in order to stand up to the ECB and get it to lean against the wind faster. Who knows, may be we are closer than I think…