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Dudley’s Vision of a Political Central Bank Is Alive. In Europe.

Dudley’s Vision of a Political Central Bank Is Alive. In Europe.

(Bloomberg Opinion) -- In the U.S., suggesting that central bankers need to be political is controversial; in Europe, it’s almost axiomatic. European Central Bank President Mario Draghi has shown that central bankers can be political and still be independent. While far from ideal, it is necessary for a still incomplete monetary union.

Bill Dudley, a former president of the New York Federal Reserve, sparked intense debate among Fed watchers this week when he argued in a column for Bloomberg Opinion that the Fed should resist cutting interest rates to dissuade President Donald Trump from prolonging his trade war with China. “If the goal of monetary policy is to achieve the best long-term economic outcome, then Fed officials should consider how their decisions will affect the political outcome in 2020,” he added.    

In Europe, his vision of a political central bank is alive and well. The single currency has one of the most independent central banks in the world, in the spirit of Germany’s Bundesbank, even setting its own target for monetary policy. It also has a weak political counterweight: ECB technocrats are accountable to the European Parliament, but there is no euro zone government — and certainly no president — to speak of. This puts the ECB president and the governing council more generally in a uniquely powerful position.

ECB policy makers have a mixed record when it comes to ensure they do not overreach. Jean-Claude Trichet wrote controversial letters to the Irish and Italian governments (the latter together with Draghi, his future successor), to prescribe what they should do to continue to obtain assistance from the central bank. In 2015, the ECB drip-fed emergency liquidity to Greece’s banks as the government led by Alexis Tsipras dragged its feet over signing a new rescue program with international investors. The central bank believes these actions were necessary to avoid the risk of “moral hazard” from politicians and to ensure its liquidity did not go to waste. Yet they were also criticized by many ECB watchers — most notably the think tank Transparency International EU —  for reasons which are similar to the criticisms of Dudley.

The paradox is that in an incomplete structure such as the euro zone, it is perhaps inevitable that an effective central bank president should be political. The ECB must navigate among different political and national sensitivities, which threaten to undermine not just the central bank’s legitimacy but also the single currency’s very existence. The ECB president is also a powerful voice in fostering the completion of the monetary union, which is the only way to ensure its survival. It is impossible to do it in purely technocratic fashion.

It is no coincidence that Draghi, the departing ECB president, has been hailed for his extraordinary political skills, which is a strange compliment to make to a central banker. Make no mistake: Draghi tried hard to ensure that the ECB had adequate political cover to carry out its policies. For example, when it introduced its “Outright Monetary Transactions” tool — which transformed the central bank into a lender of last resort to governments — Draghi insisted that the recipient country should first enter a rescue program with the rest of the euro zone through the European Stability Mechanism. This ensures that it is not only the central bank negotiating conditions with the recipient country but other democratically elected governments, too. But, ultimately, it was Draghi who won the trust of Germany’s political class — and above all Chancellor Angela Merkel — ensuring the ECB could do whatever it takes to save the euro.

The choice of Christine Lagarde as a successor to Draghi proves that the paradox of a political ECB is alive and kicking. But politicians must ensure the central bank does not go too far in abandoning its technocratic nature. Too many politicians are joining the ECB’s governing council, which is limiting its intellectual firepower. Meanwhile, the ECB is entering ever more policy areas — from monetary policy to banking supervision. This is bound to create conflict over its democratic legitimacy.

Of course, the best way to resolve this innate tension at the heart of the ECB would be to strengthen the other democratic and economic institutions governing the euro zone so that the central bank could take a more limited role. Unfortunately, that’s not going to happen soon. Dudley’s vision of a political central bank will live on — but in Europe.

To contact the editor responsible for this story: Daniel Niemi at dniemi1@bloomberg.net

This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.

Ferdinando Giugliano writes columns on European economics for Bloomberg Opinion. He is also an economics columnist for La Repubblica and was a member of the editorial board of the Financial Times.

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