The ECB has attempted to compensate for the political inertia with the adoption of a range of new unconventional monetary policies. This approach has, however, generated problems of its own
Since 2010, the EU’s political institutions have often been slow to respond to the challenges of the sovereign debt crisis, banking crisis and economic recession in much of the EU. In this context, the European Central Bank (ECB) has attempted to compensate for the political inertia with the adoption of a range of new unconventional monetary policies. This approach has, however, generated problems of its own, notably by undermining the ECB’s legitimacy: it has resulted in the ECB stretching its mandate, has led to an increasing politicization of the ECB’s decisions, and has undermined the transparency of both the ECB’s monetary policy and national macroeconomic policies.
Elections are not the only source of legitimacy
In democratic systems, legitimacy can stem from (at least) three different sources: First, it can stem from the participation of citizens in the election of political elites or the formulation of policies (input democracy). Second, it can be derived from policies that serve the general good (output legitimacy). And third, throughput legitimacy can come from the ‘quality of EU policymaking processes, judged by their efficacy, accountability, transparency, and inclusiveness’. This third concept is particularly relevant for non-majoritarian technocratic institutions (like central banks), that by nature perform poorly in terms of input legitimacy.
But what are the conditions of legitimacy in the case of an institution like the ECB? In the case of delegation to non-majoritarian institutions like the ECB, the mandate and powers of the institution should be clearly and narrowly defined and its policy-making should be characterized by a high level of ‘expertise, procedural rationality, transparency and accountability by results’. Similarly, Moravcsik finds a high level of ‘insulation’ of EU policy-making acceptable provided that the policies are regulatory, economic and fairly depoliticized. Before the sovereign debt crisis, academics often felt that the ECB’s precise mandate and policy output generated sufficient legitimacy (Majone, Moravcsik, Tallberg). The ECB could be criticized for lacking operational transparency, as its accountability to European institutions and national governments had been limited to ensure its independence. However, it could compensate for this by creating more transparency in national macroeconomic policy-making through its low-inflation policy, which prevented governments from using inflation as a tool to hide economic problems.
In the course of the sovereign debt crisis, many of these conditions for legitimacy were eroded. Specifically, the unconventional monetary policies of the ECB led to three problems.
The ECB’s policies stretched its original mandate in two respects. First, the mandate of the ECB as set out in the Maastricht Treaty defines the pursuit of low inflation (price stability) as the bank’s primary goal. Second, the Maastricht Treaty prohibits the monetization of member state debt and the ‘bail-out’ of one member state through another member state.
The inflationary effects of the ECB’s unconventional monetary policies became the subject of intense disagreement. This concerned especially the impact of the ECB’s liquidity boosting measures (notably, the purchase of covered bank bonds) and the ECB’s Securities Markets Programme (SMP) — specifically the purchase of sovereign debt on secondary markets of those euro area member states most at risk of default and facing high bond yields. Prior to mid-2012 euro area inflation remained well above the 2 per cent target and the ECB was frequently unable to neutralize the inflationary impact of its sovereign debt purchases. In Germany, in particular, the perceived departure from the ‘low inflation’ focus exposed the ECB to widespread criticism.
Second, the ECB pursued a course that arguably contradicted the treaty prohibitions on the monetization of sovereign debt and government bailout. Four nonconventional policies have had significant fiscal implications: the SMP, the Long Term Repurchase Operations (LTRO), the announced but yet to be activated Outright Monetary Transactions (OMT) Programme and, most recently, Quantitative Easing (QE). With the exception of the OMT Programme, these policies undermine both the transparency of national fiscal and macroeconomic policy and the strength of national structural reform efforts.
Under the SMP (2010-2012), the ECB bought sovereign bonds in an effort to bring down debt yields, thus enabling governments to fund themselves at lower rates. The SMP was widely criticized for breaking the ban on the monetary financing of debt and transforming the ECB into, de facto, a ‘lender of last resort’.
In early August 2011, the ECB extended bond purchases beyond the three ‘Programme countries’ — that is the euro area member states that were subject to macro-economic policy programmes monitored by the ‘troika’ of the European Commission, the ECB and the International Monetary Fund — to two countries (Spain and Italy) that were not subject to ‘troika’ monitoring. Thus, the ECB acted as de facto ‘lender of last resort’ without the quid pro quo of fiscal / macroeconomic policy constraint, despite ECB’s claims that the SMP was adopted to restore the effective transmission of its monetary policy throughout the euro area.
LTRO involved lending to commercial banks at a very attractive 1 per cent fixed rate with unlimited access to central bank liquidity subject to the provision of adequate collateral. Collateral requirements were in turn eased a number of times and the maturity of LTROs was lengthened. The principal impact of LTRO was that euro area banks — especially those in the periphery — borrowed funds to purchase sovereign debt with higher yields — notably that on the periphery. In addition to contributing very directly to the dangerous sovereign debt-bank doom loop, the ECB’s LTRO operations effectively helped to lower sovereign debt yields by increasing demand, thus allowing the cheaper financing of governments.
Third, the OMT Programme consists principally in a promise to conduct unlimited interventions in secondary sovereign debt markets to purchase the debt of a country on the condition that the member state government concerned accepts the conditions of a European Stability Mechanism (ESM) programme. In effect, OMT allowed the ECB to act potentially as a ‘lender of last resort’ in government bond markets. It also amounted to a significant form of ‘slippage’ in terms of the potential fiscal policy powers that the ECB assigned itself — albeit via the ESM.
Finally, on 22 January 2015, the ECB launched its QE programme with the purchase of up to €1.1 trillion in mostly government bonds. Officially, the ECB sought to diminish the risk of euro area deflation and bring the inflation rate up closer to target (ECB 2015). In practice, the desired and real effect of ECB policy was to lower government bond yields — albeit this time throughout the euro area — although the impact on different government debt varied, with yields on bonds already at historic lows.
The politicization of ECB policy-making
With the stretching of the ECB’s mandate, its decisions became increasingly politicized, in the sense that they attracted vocal internal and external criticism. Politicization took three main forms. First, dissent within the Governing Council and the opposition of the German Bundesbank and other Northern European Governing Council members to the ECB’s decision to engage in emergency bond buying exposed deep divisions over policy approaches. Northern European members argued that nonconventional monetary policy reduced the pressure on euro periphery governments to introduce much needed reforms.
Second, the tendency of governments to question ECB policy intensified. Government criticism focused on the ECB’s role in the Troika, but its unconventional monetary policies also attracted vocal criticism from the German government and especially Finance Minister Wolfgang Schäuble.
Third, the public took a greater critical interest in ECB policy-making and national political debate intensified. Public awareness of the ECB rose from 71 per cent in the autumn of 2007 to 85 per cent in the spring of 2015. In the meantime, public trust in the ECB declined from a high of 53 per cent in the Spring of 2007 to a low of 31 per cent in the Spring of 2014. The European Parliament also expressed concerns (ECB Annual Reports 2011 and 2012) over the ability of the ECB’s unconventional monetary policies to achieve their goals as well as over the risk of unintended consequences.
Non transparent monetary policy
In the course of the crisis, the ECB undertook a number of measures to improve its process legitimacy as it realized the increasing salience of its policies. For example, it moved to improve transparency through the publication of summaries of its meetings from 2015 onwards. However, at the same time, unconventional monetary policy arguably had the effect of creating less transparency on the ground. ECB unconventional monetary policy — by lowering bond yields — has undermined structural reform efforts in member states, thus directly contradicting stated ECB preferences on structural reform and the explicit objective of the Maastricht Treaty of avoiding the possibility of ‘fiscal dominance’. Furthermore, ECB monetary policy has undermined the transparency-inducing effects of EMU at the national level that Erik Jones vaunted.
Over the course of the sovereign debt crisis, both the ECB’s policies and the public perception of these policies changed. As a result, many arguments that had been used to support the democratic legitimacy of the ECB’s policies became less obviously valid. For a start, EU monetary policy is no longer regarded as a purely technocratic matter with limited (re)distributive effects. The ECB’s unconventional monetary policies supported certain member states while creating difficulties for other member states — notably Germany, given the impact of low and then negative real interest rates upon the country’s savers, pensions and banking sector.
The European Central Bank is at a crossroads. Its original mandate was to be an independent technocratic institution, the legitimacy and credibility of which was set in terms of meeting its price stability mandate — output legitimacy. However, from the outbreak of the sovereign debt crisis, ECB unconventional monetary policies had a significant impact upon the direction of euro area member state macro-economic policies — and in a manner that contradicted the ECB’s terms of delegation as outlined in the Maastricht Treaty, thus also undermining its input legitimacy. In light of the political salience of these policies and their impact, it is questionable whether the independence of the ECB remains democratically viable. ECB policy-making has become problematically controversial and politicized. At the very least, the reinforcement of European parliamentary scrutiny over ECB policy making is more urgent than ever.
Based on A.L. Högenauer and D. Howarth. 2016. “Unconventional Monetary Policies and the European Central Bank’s Problematic Democratic Legitimacy,” Journal of Public Law/Zeitschrift für öffentliches Recht 71(2): 425–448.