Bank rebalance Time for change at the ECB

As the race to replace Mario Draghi as head of the European Central Bank hots up, experts are beginning to ask an even more important question: How exactly should the ECB do its job?
Janet Yellen is already out the door at the Fed. Mario Draghi will soon follow.

Jens Weidmann cuts a rather unassuming figure when you listen to him speak, but that doesn’t make his words any less divisive. The president of the Bundesbank, Germany’s central bank, has opposed most of the European Central Bank’s crisis-fighting tools and been a thorn in the side of Mario Draghi, the Italian ECB head, for most of his nearly eight-year term in office.

With Mr. Draghi stepping down in October 2019, the race is already on to find a replacement. The idea of Mr. Weidmann taking his place probably strikes fear into the hearts of some southern Europeans, yet that’s exactly what many Germans are demanding (despite the outsized influence Germany might have in Europe, it’s never held the position of ECB president).

But there’s a more important question behind the nationalities and personalities: How should the European Central Bank best serve the euro-zone’s economy? “Nearly 20 years since the founding of the ECB, it’s time to take stock of what went well and what didn’t,” Burkhard Balz, a parliamentarian from German Chancellor Angela Merkel’s Christian Democrats, told Handelsblatt.

In that vein, some economists are starting to call for a complete overhaul of how the Frankfurt-based central bank does business. Maintaining financial stability, they argue, should be a greater priority than controlling inflation – the holy grail of central bankers for decades. And unlike the question of who should lead the central bank, there’s actually a fair amount of agreement on this across the bloc.

Price stability does not necessarily mean financial stability. Jörg Krämer, Commerzbank

Willem Buiter, chief economist of US bank Citigroup, is among those demanding a wholesale change to the ECB’s approach. “The ECB should have financial stability as its overriding target,” he said. “Subject to that, it should target price stability and full employment.”

It’s a view shared by most members of the ECB Shadow Council, a panel of top economists from across Europe (including Mr. Buiter) that is convened quarterly by Handelsblatt. The idea has been gathering steam ever since the 2008 financial crisis, which some critics blame on central banks for holding interest rates too low in the early 2000s.

“Price stability does not necessarily mean financial stability,” said Jörg Krämer, chief economist of Germany’s Commerzbank. “It is very important, also for our democracy, to avoid a new bubble or the burst of a bubble.”

That would mark a massive shift in policy. Central banks across the world largely set interest rates for their economies based on one goal: Keeping consumer prices from rising too quickly or too slowly. In most cases, this translates to a target of keeping annual inflation at around 2 percent.

Sure, financial stability comes into it, too, but the general idea is that, if a central bank can get price levels right, everything else should fall into place. Making sure banks aren’t going to upend the economy is typically seen as the job of other government regulators.

Even the Federal Reserve in the United States, which has a so-called “dual mandate,” is expected to look at unemployment and inflation, rather than financial stability, before setting interest rates. In Europe, however, a majority of those calling for a dual mandate for the ECB favor it taking a closer look at financial stability rather than employment levels like the Fed.

Consumer prices are increasingly outside the control of monetary policy. Andrew Bosomworth, PIMCO

Such a change would answer a beef that German economists have long had with the European Central Bank. The flood of cash into the euro zone’s economy since the financial crisis, so their argument goes, has given investors, companies and governments little incentive to be frugal – much like in the United States in the run-up to that very same crisis.

This may sound like scare-mongering for some economists elsewhere in southern Europe and in the United States, who have credited the ECB’s aggressive steps since that 2008 crisis with shoring up the euro-zone’s faltering economy and saving the currency zone. But Germany does have allies. Mario Draghi was famously handed a tulip when he visited the Dutch parliament – a reminder of the famous Dutch tulip bubble of the 1600s. The mood has shifted further, the longer that the ECB has been buying bonds.

Another reason for the shift is growing doubts about whether central banks can really control inflation anymore. The ECB hasn’t hit its goal of 2 percent inflation, at least on the less volatile core rate, since 2008. Andrew Bosomworth of bond manager PIMCO suggests consumer prices are increasingly “outside the control of monetary policy.” That would explain why prices haven’t risen significantly despite all the cash injected into the economy over the last decade. Meanwhile, stock and real-estate prices have once again been surging ahead.

“I’m quite concerned that the response of central banks who have been actively engaging in asset purchases over the last decade are the cause of the very high and somewhat precarious asset prices and real estate prices we see around the world,” Mr. Bosomworth, another member of the Shadow Council, said. “In an ideal world the [ECB] would change its primary mandate… to assign more weight to financial stability.”

Not that everyone agrees anything so drastic is needed. Julian Callow of Element Capital says that while inflation has been “stubbornly weak” over the last decade, it would be better to launch an in-depth investigation into why that’s been the case rather than give up on the idea of controlling inflation altogether. If the ECB gets things right then the financial system will be stable, too. “It goes without saying that financial stability is a prerequisite for price stability,” he said.

Jan Mallien and Frank Wiebe cover monetary policy for Handelsblatt and are based in Frankfurt. Christopher Cermak is an editor for Handelsblatt Global based in Berlin. To contact the authors: [email protected], [email protected] and [email protected]