Some of the world’s largest central banks have been experiencing a difficult time of late. It is bad enough when markets and politicians gang up on the central bankers to do "more" when the world economy shows no signs of a full recovery. Indeed, the news appears to be getting worse as Asian economies — which until now have remained largely aloof to the slow growth that is gripping much of the advanced industrial world — are also potentially facing a slowdown of their own.
In the past few days, markets appear disappointed that the U.S. Federal Reserve (Fed) and the European Central Bank (ECB) have not been willing to announce a change in the stance of monetary policy. Both appear to be standing pat with promises to act decisively if, and when, it is necessary and appropriate. Words may suffice for a time but action will be needed if these two central banks are to maintain any semblance of credibility. What central bankers are doing, of course, is pushing back against some politicians’ views that the central bank is either too soft; wildly printing money with future inflation and all of its terrible consequences as the inevitable outcome; or too harsh, because, if only there was more easing, then confidence would be restored and economies would recover more quickly.
What we are seeing then is the age old tension between fiscal policy, operated by politicians, and monetary policy, independently managed by the central banks. Central banks are justified in saying that they have done their part in creating conditions conducive to a sustained and healthy economic recovery. A simple look at the balance sheets of the Fed and the ECB should make this clear. Not only have these expanded greatly but, in some cases, they have taken on assets that, in normal times, would be considered highly inappropriate to have on a monetary authorities’ balance sheet.
However, in the case of the ECB, we actually see a battle on two fronts. The euro zone’s central bank is now caught between politicians who ask for more, or less, depending on their ideology, and the euro system’s central banks, most notably the German Bundesbank, which has raised the alarm about the ECB’s plans to hold even more of the sovereign debt of some of the periphery countries teetering on the brink of default.
In the past, central banks have often lost the battle against the politicians who are more fixated on the short-term than the stability and long-term minded thinking of the central banker. But what if the "war" the ECB is now waging to save the euro is one that must be fought on two fronts? We are then in new territory and it is conceivable that central banks will lose on both fronts. Not only will they lose the battle to retain their independence but, if the euro zone survives, the voting members of the ECB may well be marginalized. Just as Fed decision-making was centralized in Washington following the Great Depression, and the Länder central banks in Germany ceased to hold as much sway in Bundesbank decision-making as they did when they were first created in the 1950s, so will national central banks in the euro zone cease to have as much influence as they currently have.
A few days ago in a speech in London, Mario Draghi, the ECB’s President, commented, “…we think the euro is irreversible” followed by the remark, “…the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” These extaordinary remarks put the institution clearly at odds with the stated opinions of the German Bundesbank.
It is worthwhile, therefore, to consider the recent discussion between the current President of the Bundesbank, Jens Weidmann, and a former President of the Bundesbank, Helmut Schlesinger, because it reveals the serious conflict that is beginning to emerge more openly than before, between the ECB and the Bundesbank. Schlesinger was Bundesbank President in the early 1990s when the combination of German reunification and weakness elsewhere in the EU, combined to produce the European Monetary System (EMS) crisis of 1992. The interview relives the extraordinary pressure Schlesinger came under from politicians in his own country and elsewhere in Europe. Clearly, one of the intentions of the interview was to remind the public that battle lines between politicians and central bankers have been drawn before.
The exchange between the two central bankers sheds light not only on the past but also hints at the line in the sand the German central bank is now marking as the ECB shows signs of, once again, thinking of coming to the rescue of the euro zone’s periphery. In particular, Schlesinger remarks that the decision to adopt monetary union (EMU) was a “…clear defeat for us” and that it “…is hard to envision how a loss of monetary sovereignty could be achieved in the absence of a unified state.” He then adds fuel to the fire by stating that, other than Germany, other euro zone members for the most part do not share Germany’s “culture of stability.” He effectively concludes, noting that “…it is even harder for the Bundesbank to assert its influence as it is just one of 17 central banks in the Eurosystem,” by asking the current President of the Bundesbank: “What impact does this have on your work?”
Weidmann’s reply is equally telling when he states: “We are the largest and most important central bank in the Eurosystem and we have greater say than many other central banks in the Eurosystem. This means we have a different role.” Quite the statement given that the Bundesbank’s voting share is exactly one vote out of 17. It would be interesting, for example, to ask what the Austrian central bank’s President thinks about German monetary orthodoxy. Ewald Nowotny, also a voting member of the ECB’s Council, has indicated that the European Stability Mechanism ought to obtain a banking license thereby granting it access to the ECB’s liquidity operations,
The stakes in this battle on two fronts is not only the survival of the euro. It also has implications for the survival of the EU in its current state and for the state of the global economy. Stay tuned!