It’s a fiction that monetary and fiscal policy are separate. The European Central Bank’s mandate should be enlarged to co-ordinate them in a new way.
Today, the European Parliament’s Committee on Economic and Monetary Affairs debates the mandate of the European Central Bank. Prioritising price stability above all else, the ECB’s mandate has, correctly, been regarded as exceptionally narrow. Advocates of progressive macroeconomic policies for employment and environmental sustainability in particular have long been discontented with its deference to inflation hawks and financial-market actors.
The German Constitutional Court has become the latest German actor to try to fortify the price-stability-only approach to monetary policy. In its instantly-infamous ruling, Karlsruhe demanded that the ECB adopt ‘a new decision that demonstrates in a comprehensible and substantiated manner that the monetary policy objectives pursued by the [Public Sector Purchase Programme] are not disproportionate to the economic and fiscal policy effects resulting from the programme’. If ‘proportionality’ were not documented within three months, the Bundesbank would stop its participation in the quantitative-easing programme and reinvestments.
The ruling met outrage among the monetary intelligentsia. It is absurd, they argued, to separate monetary from overall economic policy, when the ECB had made clear, over and over, that the transmission mechanism of monetary policy worked through the ‘real’ economy. Arrogant German judges could not be bothered to read the hundreds of ECB publications connecting the two.
Off the hook
While correct as economic analysis, this chorus let the ECB off the hook. The bank is guilty of not dismantling the ideological and institutional construct the German court has instrumentalised for its own legal battle with the Court of Justice of the European Union.
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The very notion of a clear-cut macroeconomic distinction between monetary and fiscal policy stems from the idea that money is merely a veil, popularised by Milton Friedman and his followers. According to this ‘vulgar monetarism’, monetary policy cannot really increase output or employment, and in trying to do so by printing money (to finance expansionary fiscal policies) it ends up generating inflation.
In fact, evolutionary changes in finance join monetary and fiscal policies at the hip. Consider the largest money market for European banks and institutional investors, the €8 trillion repo market. Two out of three euro borrowed through it have as collateral sovereign bonds issued by euro-area members (Germany and Italy being the largest). The repo market creates, and can easily destroy, liquidity for eurozone states, influencing their borrowing conditions and, ultimately, their fiscal-policy decisions. In Europe, it also creates an exorbitant privilege for Germany: in a crisis, banks run to German bunds because they preserve access to collateralised funding. This is why leaders of the ‘periphery’ euro countries watch the spread to German bunds so nervously.
Thus, private credit creation in the eurozone—the bread and butter of the ECB’s operations —fundamentally relies on sovereign bonds, and so on fiscal policy. The ECB’s actions are clear and consistent. ‘Whatever it takes’ outright monetary transactions, a ‘maybe not proportional’ PSPP and an ‘it is our job to close the spread’ Pandemic Emergency Purchase Programme are all variants of the same intervention, to prevent the explosion of the European financial system.
The ECB’s rationalisations for such interventions, by contrast, have changed over time. Initially, the narrative stressed ‘market failure’: in times of crisis, markets panic and seek safety in German bunds; hence the need to intervene to prevent a blow-up in other sovereign-bond markets. The subsequent, more sophisticated, rationalisation pointed to the integrity of the monetary transmission mechanism: interest rates on sovereign bonds influence the cost of private borrowing, so the ECB cannot let them explode.
But the ECB has been reluctant to spell out the implications: should it be targeting spreads between eurozone sovereigns, and if so at what level? What role does its own policy rate play? Should it abandon its signalling approach if it cannot encompass the fiscal-policy stance across eurozone member states? By ducking these questions, the bank has perpetuated the fiction of a neat separation between monetary and fiscal policy, thus making it possible for the German Constitutional Court to build its legal argument.
There has, however, been a third rationalisation. In a 2016 speech, Benoit Cœuré, then head of ECB market operations, argued that ‘market-based finance’ was now ‘organised around collateralised lending, which creates high demand for safe, and therefore low-price-volatility collateral’, such as sovereign bonds. Sovereign bonds thus have money-ness and eurozone finance ministries are increasingly moonlighting as central banks, providing the financial system with an asset similar to the high-powered money the latter create. They do so in a macro-financial architecture in which they must compete for liquidity in sovereign-bond markets—a contest Germany always wins in bad times, unless the ECB intervenes.
While that speech recognised that de facto the ECB co-ordinates monetary and fiscal policies, it reaffirmed the primacy of the ECB in controlling the terms. Fiscal authorities had to be subject to ‘market discipline’ (a misnomer unless markets are perfect) and to post-Maastricht rules expressly presuming that monetary and fiscal policies can and should be conducted separately. Such conflicting messages from the ECB on sovereign debt—essentially protecting its technocratic power—still leave it vulnerable to accusations of disproportionality.
A truly progressive macro-financial eurozone architecture must reverse the power hierarchy instituted by the Maastricht treaty. It would subjugate private financial actors to public, democratically-legitimised fiscal and monetary authorities.
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The ECB’s official line has long been that it must adhere to the fiction of ‘market neutrality’, when its operations validate the preferences and actions of the private financial system. Banks and asset managers decide which firms and sectors have access to credit, what is considered productive and useful, what may prosper and what must fail.
Unlike European Stability Mechanism support to governments, that from the ECB to market actors comes without environmental, tax- or payout-related conditionality. Its interventions in sovereign-bond markets are not to address sovereign-debt sustainability but to backstop the balance sheets of private financial actors. Improvement in financing conditions for governments, much decried in German circles, is not a policy target but a side-effect. In protecting the financial system, the ECB shores up its economic and political resilience, and thus effectively works against political projects aimed at building a progressive and sustainable macro-financial order.
The ECB should recognise this de facto co-ordination of monetary and fiscal policy—and that its logic needs to change. A better co-ordinated system of credit allocation and treasury financing allowed reconstruction in many post-war advanced economies. Public authorities identified priority investments, their rate of return and strategic sectors, enshrining the supremacy of public power over private money. Re-embedding money and credit in the pursuit of the common good has never been more imperative, and should be tailored to green and health-friendly objectives.
The ECB’s statute, which has the status of a European treaty, has ‘maintain price stability’ as the bank’s primary objective. In addition, and as long as price stability is secured, the ECB is mandated to ‘support the general economic policies in the [European] Union’. While a change of its statutory mandate would require a treaty change, the objectives of the ECB can be recalibrated within the existing treaty framework.
The ECB should change the quantitative and qualitative definitions of ‘price stability’. Moderately higher inflation is one of only three available options to reduce post-pandemic debt burdens, besides higher growth and taxation. While we welcome wealth taxes and measures against evasion, it would be naïve to assume such policies will be enacted and implemented on a sufficient scale and at sufficient speed. What is needed, therefore, is a form of fiscal-monetary co-ordination in which the central bank will not, at the slightest sign of inflation, tighten its monetary-policy stance and snuff out recovery.
In qualitative terms, the ECB should start to love ‘brown inflation’. In its current version, the Harmonised Index of Consumer Prices ignores the carbon footprint of goods and services. In light of the desirability of higher prices for brown consumer goods and services (such as petrol and air travel), greening the HICP would take the bite out of the price-stability mandate, while rendering it more consistent with the ECB’s secondary objective.
The euro area should meanwhile institute an open and recurrent process at the highest political level to specify which ‘general economic policies in the Union’ the ECB is required to support. Article 11 of the Treaty on the Functioning of the European Union already mandates ‘environmental protection’. Specifying such protection in relation to the full portfolio of central-bank activities—considerably broader than monetary policy proper—would provide political legitimacy for an unconditional ECB backstop of green public investment. This circular arrangement would amount to a substantial gain in fiscal sovereignty in the euro area.
These steps would not do away with central-bank independence, enshrined in treaty law. They would, however, do away with the ideology that states must be subjected to the discipline of the market. The gains for the planet, as well as for the 99 per cent, would certainly be disproportionate.
Benjamin Braun is a senior researcher at the Max Planck Institute for the Study of Societies and currently a member of the Institute for Advanced Study in Princeton. Daniela Gabor is professor of economics and macro-finance at University of the West of England, Bristol. She works on central banking in crisis, on (shadow) banking reform and critical macro-finance. Benjamin Lemoine is a Centre National de la recherche scientifique researcher at the Institut de recherche interdisciplinaire en sciences sociales, Université Paris Dauphine. He is also a member of the Institute for Advanced Study in Princeton.