European Central Bank: Its Changing Role, and Some Implications

Jean-Claude Trichet

Image by Ralph Orlowski/Reuters

(International Herald Tibune)

A few days back, I reported on the changing role of the European Central Bank in supporting the euro's stability, so I thought that I ought to follow that up with another report, this one borrowed from an article in the International Herald Tribune, "Trichet Faces Growing Criticism in Europe Crisis" (May 20, 2010), by Jack Ewing and Steven Erlanger.

According to Ewing and Erlanger, the president of the European Central Bank, Jean-Claude Trichet, came under heavy political pressure to act against his previously stated position:

In the early hours of May 10, European leaders cobbled together a nearly $1 trillion deal meant to stun bond investors who, after Greece was driven to the brink of default, were hungrily eyeing attacks on Portugal and even Spain.

A few days before, on May 6, Mr. Trichet had told reporters that the bank was not even considering buying bonds from the weakest governments of the shaken euro zone. On May 7, markets tumbled.

But a few hours after the leaders adjourned -- at 3:15 a.m. on May 10, and by all accounts under severe pressure from President Nicolas Sarkozy of France and other European leaders -- Mr. Trichet and the bank board members reversed themselves.

As Ewing and Erlanger explain:

Mr. Trichet has reversed himself on buying sovereign bonds from weak euro zone countries . . . [and also] agreed to keep accepting Greek bonds, however downgraded, as loan collateral.

The implications are striking:

Mr. Trichet's willingness to bend or break the rules and buy government bonds -- aimed at halting a potentially catastrophic sell-off -- served as final confirmation that the central bank had stepped once and for all beyond its narrow founding mission solely as a bulwark against inflation.

The European Central Bank now seems to have been pushed into the much larger role of guardian of financial stability in the 16 countries that belong to the euro area, with implications for all the 27 nations of the European Union.

Ewing and Erlanger do not spell out all these implications, but they seem to mean that the ECB is gaining a greater degree of power over the economies and finances of the EU at the same time that the ECB itself is coming under greater control by the heads of state in the EU. This is a potentially chaotic development unless some political structure is established to set the new rules, but such would require greater political centralization for the EU, a point that I raised in my earlier post, potentially enlarging the so-called 'democratic deficit'.

Why do I say that without greater political centralization, Europe faces a chaotic situation? Imagine a United States of America in which the Fed could be pressured to alter its policies by the more powerful states, say California, Texas, or New York. The risk would be that differing economic interests of two such states would throw the entire system into disarray as the two press for their divergent policies. That's a bit like the danger that we see in Europe currently if, for example, France and Germany should each attempt to gain control over the ECB.

But one 'solution' to this problem, further centralizing and empowering the EU's political system by giving more power to the President of the European Council, would increase the democratic deficit mentioned above because this President is appointed by the heads of state to the European Council rather than elected by the European population. Reducing this democratic deficit -- for instance, by expanding the role of the European Parliament and granting greater political power to its own President of the European Parliament in directing the EU's central political and economic policies -- would require a rather large transformation in which the heads of state would have to relinquish power, and that would necessitate a messy, and perhaps nasty, political fight.

We live in interesting times . . .