>> GROUP: Shadow ECB Council / EZB-Schattenrat  Andrew Bosomworth

Andrew Bosomworth: In an ideal world the Eurosystem of central banks would change its primary mandate, structure and decision-making process. Its primary mandate should be changed to assign more weight to financial stability, it’s structure to centralise more functions at the ECB, and it’s decision-making process to reduce the number of voters on monetary policy decisions.

The primary objective of the ECB and national central banks (NCBs)that together constitute the Eurosystem is to maintain price stability. The ECB originally defined price stability as consumer price inflation “below 2%” and subsequently revised to “below, but close to, 2% over the medium term” in 2003. There are two problems with a mandate narrowly focused on consumer price inflation. First, inflation increasingly does not respond to changes in unemployment, owing to supply-side factors outside the control of monetary policy. These factors include globalization of supply chains, technology, aging demographics and higher labour force participation rates. The traditional Phillips curve relationship between unemployment and wages and unemployment inflation has thus weakened over time to the point that the coefficients on the inflation curve is statistically indifferent to zero. Second, monetary policy affects real interest rates and through them asset prices and credit. Since 2008, central banks actively engaging in asset purchases and currency pegs have injected about $12 trillion worth of liquidity into global financial markets. While this liquidity averted a depression, it has since contributed to pushing financial and real estate asset prices to extreme levels and augmented what arguably is the formation of some bubbles, e.g. crypto-currency valuations. Low interest rates also contributed to a rise of indebtedness globally. Since 2008, debt owed by the global non-financial sector rose by almost 25 percentage points to 225% of GDP. Faced with flatter Phillips curves, rising asset prices and rising debt levels, the ECB and other inflation-targeting central banks should assign more weight to financial stability and tolerate longer periods of low inflation. The ECB is de facto already doing this by tapering its asset purchases while it’s inflation projections remain under 2%, however, this is driven by self-imposed technical limits on the quantity of government bonds it can hold rather than concerns about asset price bubbles.

The Eurosystem’s structure should be changed to centralise more functions at the ECB. NCB’s currently assist with the implementation of monetary policy, bank supervision, research and reserves management. The current structure reflects the historical passage of time, cultural and language differences, however, it is inefficient and I agree with Willem Buiter that a currency union of 19 countries does not require 19 regional banks to conduct monetary policy. Many functions can be consolidated at the ECB level. If the Eurosystem really believes in the federal structure of the eurozone advocated in the Five President’s report, it should set an example by creating a more centralized, efficient structure.

Related to its structure, the ECB’s voting system should also be reformed. Currently, 21 of the 25 Governing Council members vote on a rotating basis on monetary policy decisions. Literature suggests optimal decision-making committees consist of smaller sizes, between five to ten members, for example. For comparison, the FOMC consists of 12 members (of which 10 vote) while the BOE’s and BOJ’s monetary policy committees each consist of nine members. Ideally, the composition of the Governing Council’s voting members would more closely reflect the members states’ GDP and populations. The current distribution of votes results in a high inequality of voting power. Governors from smaller member states have a disproportional impact on outcomes relative to governors from large member states. The claim that NCB governors’ voting intentions are unbiased by their national circumstances is not credible.
>> Kontakt