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A good while ago, in the late 1970s and early 1980s, I wrote my doctoral thesis at Stanford about the possible design of a more integrated European monetary system. It was then still a somewhat nebulous prospect amidst experiments with semi-fixed exchange rate arrangements between participating European currencies (the “snake-in-the-dollar-tunnel”, then “le serpent dans l’espace” and, eventually, ERM I) following the unravelling of the Bretton Woods gold-dollar standard. Fast forward to the present: a genuine European central bank has been standing guard over a genuine European currency union for 25 years, steering it through a succession of turbulences. It has been and continues to be a fascinating story, with several plot twists and an abundance of intriguing questions. I could not resist the temptation of writing another book about it. It has actually been a joy writing it.
The book revisits the architecture of the European currency union as it continues to evolve in Europe’s incomplete EMU and now faces today’s concurrent challenges posed by government debt sustainability concerns and the considerable public expenditures, investments and reforms needed in particular to address climate change and the green transition, population ageing, the changing landscape of global trade and the rebuilding of credible defense capability.
Key components reviewed include (i) the single monetary policy for the euro area; (ii) the common rules and processes for keeping a measure of discipline and orderliness in the economic and budgetary policies of euro area Member States; (iii) the containment of financial fragmentation within the euro area; and (iv) stability support for euro area Member States under financial stress.
The book focuses on the central role of the European Central Bank (the “ECB”)[2] and considers such questions as:
(i) How has the ECB understood its monetary policy mandate within the matrix of broadly-worded objectives and constraints set by the EU Treaties? How has the Court of Justice of the European Union (the “Court”) defined the boundaries between the respective spheres of (centralized) monetary policy and (mostly national) economic and fiscal policies, given inevitable cross-over effects and gray areas?
(ii) How has the ECB navigated the possible tensions and trade-offs between its primary mission of inflation control (“to maintain price stability”) and the episodic need to avert risks to financial stability, contain financial fragmentation and preserve the cohesion of the currency union? What elbow room is or should be allowed to the ECB to deviate from the optimal path for inflation control in order to accommodate other policy concerns? When below-target inflation calls for monetary easing, what is the ECB’s margin for “leaning against the wind” by increasing policy rates to counter the build-up of asset bubbles that present risks to financial stability? When some more than passing supply-side shock (e.g., a steep rise in energy prices) increases inflation but decreases output and employment, to what extent could the ECB then go easier on inflation control to avoid further depressing economic activity and counteracting fiscal stimulus by euro area Member States?
(iii) More broadly, what if realpolitik and currency union cohesion make it desirable for the ECB to be a notch or two more lenient on inflation control so as to accommodate greater fiscal spending to address the challenges referred to above? Given already stretched national budgets and relatively high government debt ratios, could the magnitude of those challenges require a shift to a certain measure of “fiscal dominance”?
(iv) How can a single (“one-size-fits-all”) monetary policy effectively deal with the relative economic heterogeneity of the euro area Member States (in terms of structural and cyclical dispersion of inflation, growth, output gap and government deficit and debt)? Will one size not inevitably fit some Member States better than others at any given time? How is this factored in in the determination of the single monetary policy stance?
(v) Following Mario Draghi’s epic “whatever it takes” message of July 26, 2012, could or should the ECB (Eurosystem) engage in geographically selective asset purchases (as contemplated by the ECB’s OMT and TPI programs) to contain excessive widening of sovereign bond spreads and the attendant risk of destabilizing market dynamics? Does this clearly fall within the realm of monetary policy or is it something else? Do such purchases raise issues under the treaty prohibition of monetary financing (Article 123 TFEU)? Would they stand on firmer legal ground if carried out by a euro area intergovernmental organization like the European Stability Mechanism?
(vi) What is the ECB’s proper role in supporting the transition to a lower-carbon economy? Under the Treaties, environmental protection requirements must be “integrated” into the definition and implementation of EU policies and activities generally (Article 11 TFEU), and, without prejudice to its inflation control mission, the ECB must “support” general economic policies aimed inter alia at achieving “a high level of protection and improvement of the quality of the environment” (Articles 119(2), 127(1) and 282(2) TFEU jo. Article 3(3) TEU). Yet, the ECB must also act in accordance with “the principle of an open market economy with free competition, favouring an efficient allocation of resources” (Articles 119(2) and 127(1) TFEU). Must this be read to impose a requirement of allocative neutrality on monetary policy actions that would stand in the way of, or otherwise limit, differential treatment of “green” and “brown” assets? This may not be viewed as a particularly welcome question now that more and more voices call for a “greening” of monetary policy, but it is a question that must be considered.
(vii) Last summer in Jackson Hole, the elevated degree of economic uncertainty prompted Federal Reserve Chair Jerome Powell to observe, in an unusual instant of poetic inspiration, that “we [central banks] are navigating by the stars under cloudy skies”.[3] And since the spring of 2022, the ECB has repeatedly stated (with occasional variations in wording) that it will maintain “optionality”, “data dependence”, “gradualism” and “flexibility” in charting monetary policy, follow a “meeting-by-meeting approach” and mute forward rate guidance. It is likely to have contributed to greater volatility of market expectations as to the future policy rate path. But does higher uncertainty in linear fashion require greater policy discretion? Wouldn’t good stabilization performance be served by a more articulate statement of the ECB’s baseline monetary policy course for the near term and its key underlying assumptions – especially in times of significant economic fluidity?
(viii) The Treaty has entrusted euro area monetary policy, a critical part of macroeconomic policy, to an unelected body, the ECB, under a broadly-worded mandate, and at the same time conferred a high degree of independence on it, shielding it from political direction and control. Shouldn’t this place greater weight on effective judicial control? Yet, judicial review has to contend with the complexities and inherent uncertainties of monetary analysis and the ECB’s need of a broad margin of policy judgment. But would this necessarily limit the Court to a standard of marginal review – or, in starker terms, to censuring only the kind of more egregious (“manifest”) errors or transgressions that the ECB is unlikely to make in the first place?
These and other questions are explored in the book. The subject deserves our critical thinking but there are no easy answers. Given the sequence of disruptive events of our times (9/11, the 2007-2009 banking crisis, the 2010-2012 sovereign debt crisis, Greece’s near exit from the euro, Brexit, CoViD-19, Ukraine …), the currency union’s first 25 years didn’t in the end turn out too badly. At critical moments, imperfect actions proved to be better than inaction. One need only imagine the counterfactual of having had to weather all those turbulences with a snake-type semi-fixed exchange rate system and a set of distinct national monetary policies. But the past has little predictive value for the future. It would seem that supposedly slow-moving economic variables are beginning to shift and to interact in unexpected ways.
Jan Meyers
Advocaat, Brussel
Senior Counsel at Cleary Gottlieb Steen & Hamilton LLP
The views expressed in this post are strictly my own and do not reflect those of my firm or indeed of anyone else.
[2] The sole reference to the ECB is a bit of a shortcut. Formally, monetary policy is conducted by the ECB together with the national central banks of the euro area Member States, which jointly constitute the Eurosystem, as a reduced format of the European System of Central Banks. But monetary policy is effectively formulated and directed by the ECB, acting through its Governing Council (which includes the members of its Executive Board and the governors of the euro area central banks).
[3] Jerome H. Powell, “Inflation: Progress and the Path Ahead”, remarks at the economic policy symposium Structural Shifts in the Global Economy, Jackson Hole, Wyoming, August 25, 2023, https://www.federalreserve.gov/newsevents/speech/powell20230825a.htm.
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