The independence of the European Central Bank (ECB) has become a very topical issue in recent times. In the face of a prospective slowdown in the European economy and a consequent risk that the mild improvement that has been seen in European unemployment over the past year could now be reversed, a number of politicians have jumped on the populist bandwagon and have sought interest rate cuts from national central banks.
Not surprisingly, the central banks involved have failed to respond. Indeed, the ECB president Mr Wim Duisenberg has made it very clear that he will not be influenced by the rantings of populist politicians. He has correctly pointed out that Europe's unemployment has much more to do with structural problems than interest rates.
The separation of powers between national governments and the European System of Central Banks (ESCB), which encompasses the ECB and the national central banks, is a very interesting topic of debate. Under the terms of the Maastricht Treaty, the ECB has a primary goal of price stability and is given explicit independence to pursue this objective without being forced to take instructions from any other body.
This is the sort of model upon which the Bundesbank has been based and which has proven to be a success for Germany, if indeed success is to be measured in terms of price stability and currency credibility. Some would argue that the Bundesbank has achieved these objectives at the price of jobs. The German central bank has, on occasions, been accused of carrying on a battle that has been long finished. Such sentiments are likely to be heard more frequently over the coming months and years as the ECB seeks to establish its own credibility against a background of persistently high European unemployment.
At one level, citizens of Europe could question why non-elected central bankers should be given such free reign. After all, politicians are elected democratically to look after our interests and as a result should be in a position to exert whatever influence is necessary on our central bankers.
This would logically mean that in the event of a trade off between inflation and employment, the latter would always win hands down. Such thinking would clearly be way too short-term because at the end of the day, rampant inflation will always and everywhere damage competitiveness and cost jobs ultimately.
A quick perusal of history will show that in general where central banks are heavily subjected to political influence, the results are not always desirable. However, there are also examples of happy balance.
It is against this background that the Maastricht Treaty gave such strong powers to the ECB and effectively removed it from the political sphere of influence. It is a bit rich that some European politicians are now trying to change the rules and remove some of the powers that have been vested in the new monetary institution. The Maastricht Treaty was ratified by all Euroland countries, either by parliament or by referendum, and as such has democratic legitimacy. Some of the newly elected politicians that are seeking to exert influence on the ECB were in opposition when the treaty was negotiated and ratified and so can seek to claim some immunity.
However, in opposition they supported the whole process and should now adhere to the old adage that if you enlist you must soldier.
This is not to suggest that it is right to devolve so much power in one institution, but the reality is that we have. Those who drafted the rules for the ECB might have been better advised to look more closely at the model in the US. The Federal Reserve has a high degree of political accountability.
The Humphrey Hawkins Act obliges the Fed chairman to testify before Congress a couple of times per year, and in reality he appears whenever he is asked. The Fed is also obliged to publish the minutes of its meetings within a specified time period and prepare regular state of the economy updates.
Furthermore, the Federal Reserve has twin goals of price stability and growth. Economists would argue that it makes little sense to tackle two objectives with one policy instrument, but the reality is that it works well in the United States, as illustrated by an unemployment rate of 4.6 per cent and an inflation rate of 1.5 per cent.
In order to change the rules governing the ECB, the Maastricht Treaty would have to be amended and re-ratified. This would not be a pleasing prospect for European politicians but, nevertheless, they will continue to pressurise the ECB to become more transparent and accountable.
If this is not forthcoming, the whole construct of the ECB could come under serious strain and at the end of the day it is probable that a couple of years down the road the ECB will be behaving in a manner slightly different than that outlined by Mr Duisenberg in recent weeks.
Jim Power is chief economist at Bank of Ireland Group Treasury. The views expressed here are personal.
