Where Does the ECB Go From Here?
(Bloomberg View) -- I once congratulated Mario Draghi on his performance as president of the European Central Bank, telling him he had made only one mistake. “What’s that?” came the instant question. “Taking the job,” I replied.
My point was that by the time Draghi was appointed, the ECB could no longer hope to be a conventional central bank, if indeed it ever had been. Instead it had to serve as a highly political organization, compelled to stand in for the absent finance ministry of an incomplete political union. That’s an assignment no unelected central banker should relish.
Markets believed Draghi’s vow made in 2012 (ironically, at a conference to promote investment in Britain) that “the ECB is ready to do whatever it takes to preserve the euro.” Investors’ confidence in that commitment, bolstered by the statements of the German chancellor and French president the following day, was partly self-fulfilling: Because they believed Draghi’s promise, it was never actually tested. Such confidence is always more fragile than it looks.
The ECB and other European leaders understand this and have tried from time to time to promote more deep-seated reforms to the operation of monetary union. But they also understand there’s no democratic support for further moves toward a political union, so they have to adapt the existing institutions by stealth. This process has made the ECB the linchpin of the emerging European order -- a state in the making, run by administrators, not politicians. As the core institution of this new administrative state, the ECB can’t be led by an ordinary central banker.
Many observers have drawn comfort from the likelihood that Germany’s new “grand coalition” and French President Emmanuel Macron will indeed reform the basic architecture of monetary union. The language will be warm and encouraging, but the substance less so. In recent months I’ve been struck by the dissonance between, on the one hand, a common French and German determination to move ahead on the principle of reform to the monetary union, and, on the other, their governments’ clashing ideas about how to do it. Macron wants a fiscal union and a finance minister for the euro area. Germany doesn’t: It insists that countries must be responsible for their own fiscal position.
The likely compromise is that any fiscal transfers will be kept as small as possible -- no larger than needed to get past the immediate problem. That might suffice in reasonably normal times, but not if market confidence disappears as it did in 2010-12. At that point, the issue can no longer be fudged.
As these events unfold, Draghi and his successor, due to take over in October 2019, can expect to face many tests. The rise of populist parties in southern Europe is one -- but the greatest challenge is likely to come from opinion in Germany. So far, the monetary union has been good for German exporters and politicians but less so for German consumers, who’ve been denied the higher standard of living that an appreciating currency would have delivered. Many commentators, including the International Monetary Fund, have told Germany to use its budget surplus to increase public spending, but what Germany really needs is a higher real exchange rate. As things stand, that will have to come about through a rise in inflation.
For now, the ECB and Germany may continue to impose austerity on the rest of the monetary union to prevent external deficits from posing the financing challenge seen in 2010 and 2012. But in the end there’ll be some combination of higher inflation and surreptitious fiscal transfers from Germany and the Netherlands to southern members -- orchestrated by the administrative state of the EU, with the ECB at its heart. This will lead to rising opposition in Germany.
With the politics getting more difficult, Draghi may get out just in time -- but who should succeed him? Several candidates might serve the ECB with distinction. Erkki Liikanen, governor of the Bank of Finland and former EU commissioner, has the experience and political skills to be a worthy successor to Draghi. François Villeroy de Galhau, governor of the Bank of France, is sophisticated and equally politically adroit. Klaas Knot from the Dutch central bank is another strong candidate. But the ECB’s main purpose will be to hold the euro system together, and that may have little to do with talents of the usual kind.
The crucial thing will be to overcome resistance in Germany to higher inflation and fiscal transfers. Up to now, this resistance has been led by the Bundesbank and its allies in the German community of monetary scholars. What better way to stifle this opposition than to have as the ECB’s president a highly respected German central banker -- one who would in the end be compelled to do “whatever it takes” to save the euro system, but who could never be suspected of willingly accepting higher inflation and bigger fiscal transfers?
U.S. President Lyndon B. Johnson famously remarked about his FBI Director J. Edgar Hoover: “It’s probably better to have him inside the tent pissing out, than outside the tent pissing in.” I’ve no doubt Johnson would be strongly recommending the appointment of Jens Weidmann, the current president of the Bundesbank, and I wouldn’t be surprised if Europe’s governments see it the same way.
My advice to Jens? Think twice before accepting.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Mervyn King is a Bloomberg View columnist. He is a member of the U.K. House of Lords, and a professor of economics and law at New York University. He was governor of the Bank of England from 2003 to 2013.
For more columns from Bloomberg View, visit http://www.bloomberg.com/view.
©2018 Bloomberg L.P.