The role of the ECB in supporting growth

by Véronique Queffélec on avril 30, 2012


April 26, 2012

In November 2011, Nicolas Sarkozy and Angela Merkel agreed to not publicly discuss the role of the ECB in order to preserve its independence in managing the crisis, which is concerned exclusively with the fight against inflation. The Maastricht Treaty indeed determines its main mission as controlling inflation, and sets the goal to prevent prices from rising more than 2% per annum in the eurozone.

Last week, a polemic started when Nicolas Sarkozy, declared during a campaign meeting on April the 15th, that if he was re-elected, he will “open a debate” on the role of the ECB to support growth in the euro zone. The same desire was also expressed by Francois Hollande in a speech on March The 17th. However, the Socialist leader made clear that he wanted to “renegociate” the EU treaty. With those declarations, France breached the November agreement and raised nervousness in Berlin, which has always been convinced that ECB must fulfill its mandate independently.

Nicolas Sarkozy and Francois Hollande argued that the priority given to inflation prevents the ECB from using a wider range of tools that could be useful in a period of crisis. They want a central bank which would be more like the U.S. Federal Reserve, ie. they want the ECB to play a more active role in buying more Eurozone countries’ debt in order to lower interest rates.

The consequences for Germany

German Chancellor Angela Merkel has reminded numerous times that the role of the ECB was solely to avoid excessive inflation by adjusting interest rates.

However, Germany accepted to be pragmatic at times. In December 2011 and March 2012, Angela Merkel closed her eyes when the ECB heavily injected money (nearly 730 billion euros in total) to over 800 European banks who could not raise funds on financial markets. This intervention was, however, contrary to the EU Treaty. This Germanic “laissez-faire” resulted form the November agreement with France.

Angela Merkel has been trying to preserve the independence of the ECB, because Germany contributes 20 % of the budget of the ECB. And if the ECB is to buy back countries debt indefinitely, it would play an active role in setting tax policy in the euro area. As a consequence, this would jeopardize the institution’s budget, and therefore by extension, that of countries that participate in its funding.

The reversal of the situation

On April the 25, the president of the European Central Bank Mario Draghi urged the Eurozone to adopt a “growth compact” to boost economic prospects, as an economic rebound in the Eurozone is unlikely to be expected this year anymore: The bloc was “probably in the most difficult phases” of a process in which fiscal austerity was “starting to reverberate its contractionary effects”, Mr Draghi told the European parliament. Austerity has taken a larger than expected toll and demand is tumbling for loans to business and consumers despite ECB action to help the banks.

François Hollande, the frontrunner in France’s presidential election, who strongly attacked austerity policies led by Berlin, probably did not expected the ECB to respond in a favorable manner to his request, even if significant differences remain in their theses.

Although Mr Draghi appeared to respond to demands from France’s presidential candidates for action to support economic growth, the ECB president said he saw any such plans as focused on growth-enhancing structural reforms and boosting competitiveness.

To him, a new pact on growth does not imply the renegociation of the European Treaty on fiscal discipline, signed in March by 25 of the 27 countries of the European Union, to force member states to reduce their deficits, but rather to take a separate initiative on growth.

Mr Draghi did not signal that further ECB action was imminent, but he was careful not to rule out fresh monetary policy steps if needed.

A french-German alliance saved

François Hollande, called for a “new Europe” which stressed “solidarity, progress and protection” and warned against a split between northern and southern countries in the EU, at a press conference on Wednesday : “If we say Germany will pay to cover the debts and deficits [of southern countries], I understand their reticence. Everybody must make their efforts [on public finances],” he said. “But Germany must realize that it is growth that will allow us to solve a big part of our problems.”

Angela Merkel, German chancellor, gave her blessing to Mr Draghi’s call for growth, agreeing that budget austerity alone was not the whole answer to the European economic crisis. But she insisted that Europe needed growth in the form of « sustainable initiatives, not simply economic stimulus programs that just increase government debt”. Ms Merkel has always maintained that growth measures must not be financed by increased borrowing by the Eurozone governments.

Moreover, although the Socialist candidate’s approach implies spending measures financed by taxation on financial transactions, the German Chancellor is also in favor of some form of financial transaction tax.

There might be room for compromise between Ms Merkel and Mr Sarkozy if he is reelected or Mr Hollande, if he is elected. The initiatives taken by the ECB, and its future role, are both a crucial aspect of the debate around the debt crisis in the Eurozone, and a new opportunity to maintain the alliance between the two largest economies of the area.