Time for Change at 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?

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 has been a thorn in the side of Mario Draghi, the Italian ECB head, for most of his nearly eight-year term in office, Handelsblatt Global reported.

With Draghi stepping down in October 2019, the race is already on to find a replacement. The idea of 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 ECB best serve the eurozone’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.

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.”

Massive Shift in Policy

It’s a view shared by most members of the ECB Shadow Council, a panel of top economists from across Europe (including 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 Jorg Kramer, 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%.

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.

Little Incentive

Such a change would answer a beef that German economists have long had with the European Central Bank. The flood of cash into the eurozone’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 eurozone’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% 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.