The European Commission’s proposal for a ‘next generation’ recovery fund is an important step in forging a common response to the economic challenges that will follow in the wake of the COVID-19 crisis. Together with fiscal efforts at the national level, this fund should add useful stimulus to European economic performance. What remains to be seen is how the negotiations will play out within the European Council. There is reason for optimism but also reason for caution in that respect.

Meanwhile, the European Central Bank remains the primary source of macroeconomic stabilization. When the ECB’s Governing Council meets on 4 June, we should expect to see them add more stimulus of their own into the mix. The pandemic emergency purchase program will need to be larger. The Governing Council may need to adjust some of its other instruments as well. But Europe’s heads of state and government should be under no illusion that such actions will solve Europe’s macroeconomic problems or that they take any pressure off the European Council in agreeing on an ambitious recovery fund. The ECB can buy more time, but it cannot be the only game in town. And, as we have seen, even buying time is getting expensive. Increasingly, the Governing Council finds itself in situations where it is damned if it does and damned if it doesn’t: The ECB is a hostage to the effects of this crisis, to the actions of the European Council, and to the economic and political consequences of its own policy response – both real and imagined.

The European Central Bank drew considerable fire for its early response to the economic crisis that erupted alongside the novel coronavirus pandemic. In that sense, ECB President Christine Lagarde and her colleagues on the ECB’s Governing Council were all hostages to fortune. No one had ever experienced the economic consequences of a global pandemic first-hand and so few had any real idea what to expect. Between 12 March and 18 March, the scale of the crisis became apparent and both Lagarde and the Governing Council quickly changed tack to introduce an ever-widening array of unprecedented policy responses in order to blunt an economic shockwave that the economic staff at the ECB still relies on rough approximations to estimate. By 30 April, it was already obvious that the Governing Council would need to do more, even if how much remains uncertain.

As the crisis drags on, however, it becomes ever clearer that Lagarde and her team are also hostages of a different sort. They are bound to achieve a policy aim without being given all the instruments they need to accomplish that objective. They are left without any promise of adequate support from other European institutions or member state governments. And they are prevented either from admitting defeat or from sharing political responsibility for any failure. As a result, the Governing Council has no choice but to improvise with the policy instruments at its disposal, even those such improvisations threaten to go beyond the ECB’s legal authority while at the same time attracting political attention that the institution was never designed to manage.

 

Privilege as Constraint

The ECB is unique among central banks because it was created by international treaty with no clear, overarching political authority to which the Governing Council must answer. The European Council endowed the ECB with the task of ensuring price stability through the Treaty on European Union and an accompanying ‘statute’. Europe’s heads of state or government also established clear principles that the ECB is not to violate in the pursuit of its mandate. The most important of these are a prohibition against financing governments directly and an injunction neither to seek nor to accept political guidance from other European institutions or from the Member States.

Of course, the ECB still trades in government debt – it would be impossible to conduct monetary policy without managing an asset portfolio and dealing with collateral. Government-issued securities are the best assets for the ECB to use when trying to influence the markets. The ECB also communicates frequently both with other European institutions and with national governments. Monetary policy is only one part of the wider toolkit for stabilizing macroeconomic performance and the European Council made it clear in the Treaty and in the Statute that the ECB should play a role in supporting the wider economic objectives of the European Union. Communication is essential for coordination; communicating in order to coordinate policies is not the same as accepting political guidance.

Initially, the European Council framed these principles as ‘privileges’ or sources of empowerment because they released the ECB from having to underwrite fiscal policy as well as from any other form of political interference. During the last economic and financial crisis, however, these ‘privileges’ of the ECB – its ability to focus narrowly on monetary policymaking and its political independence – turned out to be constraints. The Governing Council could not achieve its policy mandate without engaging in activity that looked a lot like the direct financing of government and it also could not seek authorization from any higher political authority, including the European Council, for either bending or ignoring the constraints on its purchase of government debt.

Each time during the last crisis that the ECB found itself facing a contradiction between the pursuit of its policy mandate and the principles that surround government finances, the Governing Council split between those who did not want the ECB to sacrifice its principles and those who did not want the ECB to fail in its mandate. When then ECB President Mario Draghi promised to do ‘whatever it takes’, he necessarily conceded that such action would stay within the principles that frame the ECB’s mandate. Draghi’s ECB not only drew political fire as a result of this delicate balancing act, but it also found itself repeatedly confronting legal complaints for unlawful behaviour before the German Constitutional Court.

 

No Good Deed Goes Unpunished

The material success of Draghi’s ‘whatever it takes’ commitment did nothing to resolve the contradiction within the Governing Council or for the ECB as a whole. On the contrary, the more the ECB succeeded in stabilizing European economic performance, the less the other European institutions or member state governments committed to undertake unpopular reforms or to build more appropriate structures for managing a major economic crisis. These other policy actors were not complacent. By any historical comparison, they made dramatic improvements both in the regulation of European financial markets and in the coordination of national economic policies. They also made considerable progress – uneven across countries – in consolidating their government finances and in strengthening financial institutions.

Nevertheless, the tension built into the role of the ECB remains and the onset of the novel coronavirus-related economic crisis brought that tension quickly to the surface. When Lagarde gave her monetary policy press conference on 12 March, near the start of the crisis, she tried to strike the right balance between the achievement of the ECB’s mandate and the principles that constrain the Governing Council. She made it clear that the ECB was prepared to use every instrument at its disposal and yet also suggested that ‘other actors’ are responsible for stabilizing government debt markets. She went on to insist that the member state governments and other European institutions need to ‘rally around’ a ‘collective effort’.

The position Lagarde sketched in that press conference was not wrong in theory. On the contrary, it was an accurate representation of the ECB’s predicament. What Lagarde perhaps failed to factor into her analysis was the speed with which market participants would anticipate that those ‘other actors’ would shirk their responsibility and leave the ECB to take up the slack. Given that markets move much quicker than politics, it did not matter whether the other institutions or member state government intended to abandon the ECB. No sooner had Lagarde spoken, then the markets began to repond.

What mattered is that the ECB Governing Council moves more quickly and more decisively than any other part of the European Union’s macroeconomic policy machinery. Hence as soon as Lagarde and her team saw turmoil brewing in the markets, they decided to move much more aggressively. In doing so, the ECB finds itself even more exposed to accusations that it is straying beyond the principles that are meant to frame European monetary policymaking and to the very real prospect that it will fail to achieve its price stability mandate.

 

No Rest for the Weary

Unfortunately, the apparent success of the ECB’s intervention after 18 March means that other actors are less likely to step in to fill the breach – even though the ECB’s success is only partial and despite the fact that the breach between what the ECB can accomplish and the requirements to stabilize Europe’s economy may be widening. Everyone recognizes that the economic consequences of the novel coronavirus are unlike any shock Europe has experienced. Moreover, those members of the policy community working in other institutions or across the member states are responding both more quickly and more decisively during this crisis than they ever did in the past – aided, no doubt, by the institutions for financial market regulation and macroeconomic policy coordination that had been created in the interim.

These other European policymakers are not being complacent. But they are not going to push back against powerful domestic interest groups or pick what they regard as unwinnable political fights in order to forge a common response large enough to take pressure off the ECB. Indeed, many of them are committed to strong principles – like the preservation of national sovereignty or the avoidance of moral hazard – that they would not willingly violate in the interest of more ‘effective’ policy action.

In choosing that rationale, however, these other European policymakers leave the ECB in an increasingly difficult situation where it can only achieve its mandate by bending or ignoring the principles related to monetary financing. This makes the ECB a hostage. The Governing Council of the ECB is not a political actor in its own right. It is an agent with a specific mandate working on behalf of the European Council and those member states that have adopted the euro as a common currency. But it is a curious agent that is not allowed to seek special authorization for its actions.

The special constraints on the ECB emerged sharply when the German Constitutional Court rendered its decision on the public sector purchase program through which the ECB buys government assets. The German court argued that the ECB may have exceeded its mandate in 2015 and subsequently by taking monetary policy actions with disproportionate implications for government balances and economic policy more generally. In turn, the German court ruled that the ECB should demonstrate that its actions are ‘proportionate’ and do not inadvertently result in the monetary financing of government budgets in one or more countries that participate in the single currency. This ruling placed the Governing Council of the ECB in the awkward position of choosing between complying with the German court’s request and potentially violated its own independence or refusing to comply and provoking a fight with the German federal government.

The dual constraint that emerges from the prohibition of monetary financing and the political independence of the ECB means that the Governing Council has to find its own balance, both economically and politically. Moreover, it has to do so while responding to an unprecedented economic crisis. The ECB’s status as hostage to fortune is also important. The concern is that the institution will break under the weight of its internal contradictions. If the Governing Council fails, all of Europe will be hostage to what follows.

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This piece was originally published in Italian as ‘La BCE ci salverà dal virus’ in the June/July 2020 issue of Eastwest. The manuscript went into production on 7 May 2020. I added the first two paragraphs to bring the text more up to date.