Shadow ECB Council worries about strong euro

At the regular meeting of the ECB Shadow Council on 29 October 2009 there was unanimity that the ECB should not change its key interest rate at the next meeting. Many members are worried about a rising euro threatening the fledgling recovery. They urge the ECB to be more open in its analysis of the consequences of exchange rate appreciation for growth and inflation. They expect this to contribute to dampening exchange rate gyration. All members endorse plans to give the European System of Central Banks a larger role in banking and financial supervision.

Forecasts made by Shadow Council members did not change significantly on average compared to a month ago. The prevailing expectation is for a return to moderate growth in 2010 and 2011 and slightly higher but still low inflation into 2011.

20090.3 (0.4)-3.9 (-3.9)
20101.1 (1.1)1.0 (1.0)

Contributors:. M. Annunziata; E. Bartsch; J. Cailloux; J. Callow; M. Diron, G. Horn, S. King; .J. Krämer; T. Mayer; E. Nielsen; J.-M. Six
Assumptions: All but one forecasters assumed that the ECB would leave its key rate at 1% for the next six months, one assumed a rate cut to 0.75%.

Rate Recommendation

While there was unanimity that the ECB should not change interest rates at the next policy meeting on 5 November, one member expects a rate hike to become appropriate within the next three month. In contrast, one other member expects that an expected further strengthening of the euro will make a rate cut necessary within the same time frame.

The Euro

According to the trade weighted index calculated by the ECB, the external value of the euro was about 1.5 percent below its historical peak from December 2008 on the day of the Shadow Council meeting. About half the members of the group share the concern that a further rise in the external value of the euro could threaten the fledgling recovery. They urge the ECB to explicitly include the exchange rate in the discussion of the prospects for growth and inflation and the risks for this outlook. They argued that such an explicit analysis would serve to link rate expectations to exchange rate gyrations in a way that would dampen the latter. If the exchange rate would go up, rate expectations would tend to go down. Recent statements by the Bank of Canada were cited as a successful example of such a communication strategy. However, many other members insisted that it was not a good idea for a central bank to talk about the exchange rate.

Liquidity Provision to Banks

Some members insisted that it was time for the ECB to communicate a plan for ending the unlimited provision of liquidity to banks. It was argued that by now markets were functioning reasonably well and that banks which still needed such extraordinary support should be considered insolvent, not illiquid. Phasing out this support would force governments to find lasting solutions for troubled banks it was argued. Most members agreed to the basic idea but many cautioned that restricting liquidity supply or just talking about it would result in a tightening of monetary conditions which by itself and through a strengthening euro might threaten the recovery. A majority position was that the ECB should make a conditional plan on how to proceed once the recovery was firmly established and monetary policy could be made less expansionary. This plan should entail, according to the majority view, an announcement that the first step would be to limit the excess liquidity supply before raising the main policy rate of one percent. Draining excess liquidity would, over time, bring the overnight interest rate (EONIA) back up to the main policy rate of one percent, which would improve the clarity of the ECB?s monetary stance.

Role of ESCB in Banking Supervision

The Shadow Council unanimously endorsed plans to give the European System of Central Banks (ESCB) a stronger role in macro prudential oversight and in bank oversight. These plans include the establishment of a Systemic Risk Board under the auspices of the ECB and the intention of the German government to make the Deutsche Bundesbank the sole supervisor of banks. One argument in favour was that the current crisis had made amply clear the need for better macro-prudential supervision and that central banks were best placed to provide this. To make sure that they could act on findings of vulnerabilities they needed some power to tell banks to reduce their risks. Furthermore, it was argued that ultimately central banks would need to bail out systemically relevant banks, which meant that they had a strong interest in making sure the need would not arise. The counter argument that an institution which could make complex decisions with potentially large fiscal consequences should be politically accountable was recognized but considered of lesser importance in light of recent experience.

Individual Votes

Members' individual votes for 3 September:
Jose AlzolaThe Observatory Groupno change
Marco Annunziata


no change
Elga Bartsch

Morgan Stanley

no change
Agnes Benassy-QuereCEPIIno change
Jacques Cailloux


no change
Julian CallowBarclays Capitalno change
Marie DironOxford Economicsno change
Gustav HornIMK Macroeconomic Policy Instituteno change (bias down)
Stephen King


no change
Jörg Krämer


no change (bias up)
Thomas Mayer

Deutsche Bank

no change
Erik NielsenGoldman Sachsno change
Jean-Michel SixStandard & Poor'sno change
Angel UbideTudorno change
Charles WyploszGrad. Institute. Genevano change

Frankfurt, 30. October 2009
Norbert Häring
Non-voting Chairman

Background information

The ECB Shadow Council was founded in 2002 upon an initiative of Handelsblatt, the German business and financial daily. It is an unofficial panel, independent of the ECB/Eurosystem, and comprising fifteen prominent European economist?s drawn from academia, financial institutions, consultancies and research institutes. The Shadow Council usually convenes by telephone conference on a monthly basis (though in November it holds a physical meeting). Its discussions take place a week before the monthly official ECB Governing Council "policy" meetings, and are intended to formulate an opinion as to what monetary policy decision its members believe that the ECB's Governing Council ought to undertake, both at its forthcoming meeting and also on a three month horizon.

Shadow Council members are encouraged to submit their own economic projections for euro area activity and inflation on a monthly basis, which constitutes the panel's forecast consensus as published each month. The Shadow Council's discussions and recommendations differ from surveys of economists concerning the outlook for ECB interest rates because the Shadow Council recommendation expresses the majority view of its' members opinion about what the ECB should do, rather than what they forecast it to do (and hence the "normative" views as expressed by Shadow Council members on what they consider the ECB ought to do can and often do differ from what they might say they expect the ECB to do). This "normative perspective can, however, give an early indication of shifts in the balance of opinion in the expert community, as can be seen by comparing the historic recommendations of the Shadow Council against subsequent decisions undertaken by the ECB Governing Council.

Members of the Shadow Council base their recommendations on the ECB's objectives as defined under the EU Treaty, though Shadow Council members do not necessarily adopt exactly the ECB's specific interpretation of its mandate: most Shadow Council members consider that a medium term inflation objective of two percent with a symmetric tolerance band around it would be clearer, more realistic and more appropriate than the definition adopted by the Governing Council, which defines price stability as an inflation rate of "below, but close to, two percent", in the medium term.

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