The ECB’s Illusory Independence

A commitment to the independence of central banks is a vital part of the creed that “serious” policymakers are expected to uphold (privatization, labor-market “flexibility,” and so on). But what are central banks meant to be independent of? The answer seems obvious: governments.

In this sense, the European Central Bank is the quintessentially independent central bank: No single government stands behind it, and it is expressly prohibited from standing behind any of the national governments whose central bank it is. And yet the ECB is the least independent central bank in the developed world.

The key difficulty is the ECB’s “no bailout” clause – the ban on aiding an insolvent member-state government. Because commercial banks are an essential source of funding for member governments, the ECB is forced to refuse liquidity to banks domiciled in insolvent members. Thus, the ECB is founded on rules that prevent it from serving as lender of last resort.

The Achilles heel of this arrangement is the lack of insolvency procedures for euro members. When, for example, Greece became insolvent in 2010, the German and French governments denied its government the right to default on debt held by German and French banks. Greece’s first “bailout” was used to make French and German banks whole. But doing so deepened Greece’s insolvency.

It was at this point that the ECB’s lack of independence was fully exposed. Since 2010, the Greek government has been relying on a sequence of loans that it can never repay to maintain a façade of solvency. A truly independent ECB, adhering to its own rules, should have refused to accept as collateral all debt liabilities guaranteed by the Greek state – government bonds, treasury bills, and the more than €50 billion ($56 billion) of IOUs that Greece’s banks have issued to remain afloat.

Of course, such a refusal would close down Greek banks and lead immediately to Greece’s exit from the eurozone, because the government would be forced to issue its own liquidity. The only alternative would be a meaningful debt restructuring to end Greece’s insolvency. Alas, Europe’s political establishment, unwilling to adopt either option, has chosen to extend Greece’s insolvency – which it pretends has been resolved through new loan tranches.

The ECB’s ongoing acquiescence in the extend-and-pretend charade demanded by Greece’s creditors has demolished its claim to be independent. To keep Greece’s banks open, and accept their government-guaranteed collateral, the ECB is obliged to grant Greek debt an exemption from its no-insolvency rule. And, to keep the noose firmly around Greece’s neck, Germany insists that this exemption is conditional on its approval – or, in euro-speak, that the Eurogroup of eurozone finance ministers confirms that “Greece’s fiscal consolidation and reform program are on track.”

So, in effect, it is politicians that tell the ECB when to cut off liquidity to an entire banking system. While the ECB can claim independence vis-à-vis insolvent, peripheral governments, it is entirely at the mercy of the governments of Europe’s creditor countries.

To illustrate the ECB’s conundrum, it is worthwhile revisiting the creditors’ treatment of the Greek government elected in January 2015. By December 2014, it had become clear that the previous government was on its last legs and that the leftist Syriza party was on its way to power. The governor of Greece’s central bank, an arm of the ECB, “predicted” that markets were facing a liquidity squeeze, implying that a Syriza victory would render the banking system unsafe – a statement that would be inane were it not calculated to start a bank run.

By the time I became Finance Minister that February, after Syriza’s electoral victory, the bank run was in full swing and stocks were in free fall. The reason, of course, was the common knowledge that Germany, vehemently opposed to our government, was about to switch off the green light required by the ECB to maintain the exemptions allowing it to accept Greek collateral.

To stabilize the situation, I flew to London to address financiers with a message of moderation and sensible policies regarding both reforms and debt restructuring. The following morning, the stock exchange rebounded 13%, bank shares rose by more than 20%, and the bank run ceased.

On that day, the ECB, pressured by Germany, rescinded an important part of its exemption, thereby cutting off Greek banks’ direct access to the ECB and diverting them to pricier financing from Greece’s central bank (so-called emergency liquidity assistance). Unsurprisingly, stock prices plummeted and the bank run returned with a vengeance, bleeding €45 billion of deposits out of the system over the next few months. Meanwhile, Germany and other creditors began to push Greece to accept new austerity measures as the price of reversing the “ECB’s” decision.

This was not the ECB’s only politically driven intervention. Equally aggressive was its decision to curtail Greek banks’ spending on government treasuries, by instructing them to refuse debt rollovers. This diminished my ministry’s capacity to repay the International Monetary Fund, which was insisting on drastic pension cuts and on the removal of the last protections for Greek workers.

For five months, as the ECB’s noose tightened, we resisted German and IMF demands for further austerity. Finally, the complete cessation of all liquidity to Greece’s banks in June 2015 forced their closure. This was followed by the final push to divide our government and force the prime minister to capitulate – as he did, accepting the latest extend-and-pretend loan of €85 billion.

Almost a year later, Greece’s creditors were pushing for even greater austerity in exchange for more loan tranches. At this point, Greece’s central-bank governor (who had triggered the original bank run in December 2014) publicly alleged that our government’s stance until June 2015 caused the loss of €45 billion worth of deposits, the ensuing bank closures, and the new extend-and-pretend loans. The bully was blaming the victim, and the ECB was openly embracing its role as enforcer for its political masters: the creditors.

The eurozone’s current design makes ECB independence impossible. Worse, the pretense of independence serves as a fig leaf for interventions that are not only politically driven, but that are also utterly inconsistent with the principles of liberal democracy.

© Project Syndicate