The new European Central Bank has been officially launched, helped by Riverdance, one of Ireland's latest export successes. All the right noises were made at the function in Frankfurt. The new boss, Wim Duisenberg, promised to win the confidence of the public by holding down inflation, while other luminaries spoke of bright new beginnings and European integration. Even Tony Blair didn't spoil the party, saying that Britain's attitude to Europe was becoming more positive.
Amidst all the hoopla, it would be easy to forget that the new central bank faces a momentous and difficult task. It is potentially Europe's most important institution, having real clout directly to affect people's lives through the decisions it takes. The EU Commission acts mainly through its influence on member-state governments. But the ECB will have the power to set interest rates across the euro zone and to manage the currency which will be used by more than 291 million people. The broad parameters within which it will operate will be set by politically elected EU leaders, but the ECB will have full flight clearance to implement policy and to set policy in many areas.
It faces two distinct challenges. One is to establish the confidence of the financial markets and of the European public. The other, related job is to design a monetary policy suitable for the entire euro zone.
Mr Duisenberg heads an institution which is potentially more powerful and more independent than the German Bundesbank. But the European public may not be as supportive as are the Germans of a policy of monetary rectitude. The Bundesbank had strong public support largely because of German history and memories of the two bouts of hyper-inflation this century. The rest of the euro zone, however, may take a different view. And the very independence which Germany insisted should be part of the ECB's operations is also a potential weakness. If things do go wrong, people will look to see to whom the ECB will be accountable. And the answer is far from clear.
True, the ECB will have to report to the European Parliament and be open to questions on its operation. The Council of Ministers remains the ultimate policy-setting forum. But the rules under which the ECB were set up clearly give it the right to control monetary policy across Europe as it sees fit. So it will be up to the bank itself to sell its message that it is doing its job properly. From time to time some governments will be happy with policy, while others will object to the direction being taken. The background tensions this creates will make it more difficult for the bank to sell itself as an institution for all the member-states.
Establishing its legitimacy will not be easy. The ECB will have to use the media to gets its message directly across to the citizens of 11 different states, many of whom will have only a vague idea of what it does. At the same time, the financial markets will be monitoring its every move and Wim Duisenberg's words will be every bit as important as those of Alan Greenspan, the head of the US Federal Reserve Board.
Before it gets its message across, of course, the ECB will have to decide what it wants the message to be. And one of its key difficulties will be shaping a monetary policy suitable for all the members of the euro zone. As outlined in these pages before, most of the peripheral economies are growing strongly and many face inflationary dangers. The core economies of France and Germany, however, are growing much more slowly albeit with some signs of a pick-up and thus do not face the same inflationary threat. The danger is that as interest rates in peripheral states such as Ireland fall towards core Europe's levels in the months ahead, the inflationary fires will be stoked and there will be very little that anyone can do to dampen them down.
This week Mr Duisenberg gave the first indication of how he saw this conundrum being solved. Interest rates across the euro zone were likely to fall to the levels now prevalent in France and Germany, he suggested, and this would be appropriate as the size of these economies means their interests must take priority in setting interest rate levels. The smaller economies would then have to rely on other measures to keep a lid on inflation and, he suggested, they should run a tight budget policy to compensate for loser interest rate policy.
This may be all very well in the economic text books. But even Mr Duisenberg will realise that monetary policy exchange rate and interest rates is a much more powerful tool in controlling inflation than budgetary policy ever can be. In Ireland, for example, a sharp increase in interest rates would have a powerful impact on cooling the housing market and slowing consumer spending. But the extent of spending cuts and tax increases needed to have the same impact through budgetary policy are simply inconceivable.
So in trying to control inflation across the entire euro zone the ECB appears to be facing a "Mission Impossible". And as it tries to impose a one-size-fits-all policy lecturing governments about their budgets along the way it may struggle to win public confidence, whatever about the backing of the financial markets.
To be fair to the ECB, these problems are not of its own making. They reflect the decision to introduce the single currency ahead of deeper political union which would have provided political counterweights to the ECB and in advance of genuine convergence of real economic performance. The advantages of the single currency may come to outweigh these factors. But the ECB is charged with managing the jump into the unknown and no one should underestimate the risks.
