ECB risks destroying the euro

Has the European Central Bank gone feral? If it has, this is an appalling vista which must be dealt with. But it’s not clear how, writes Brian Lucey.

ECB risks destroying the euro

It’s easy to criticise the ECB for its actions, inactions, and general antics during the European debt crisis.

It’s little unfair too, as it has tried to do something, if usually too little and too late. But at least it has tried. But sometimes the wrong thing is the wrong thing and the ECB has been doing the wrong thing.

However, it is clear to me now that the ECB is no longer a technocratic institution but has rather become deeply politicised if not ideological. Central bankers are among the most powerful people in the world, and when they go rogue they threaten everyone. Let’s look at what the ECB is supposed to do.

Its overriding mandate, as laid down in article 127 of the treaty establishing it, is to maintain price stability. Price stability here has been defined as inflation being at or around 2%. It is important to note the ECB council defines price stability. It is its own master. It could decide price stability is inflation at 4% or 9% or any level. It has chosen 2% and is nowhere close to that — even choosing its own benchmarks it is failing to do its job.

However, while that is what we always think of the ECB as being, a beefed-up version of the Bundesbank designed to fight inflation at a European level, it does actually have legally binding mandates to allow it to do other things.

The ECB has a mandate which is arguably at least as wide as that of the Federal Reserve. So long as it does not compromise price stability, it can do most anything and should act to further the aims of the union of which it is a pillar.

That it chooses not to operate so means that it is making a deliberate choice. It is choosing to operate in a deliberately political and aetiological manner. It has aligned itself with one bloc of nations to the detriment of others and is now acting in a manner that makes me wonder if and how it can be made right.

In Ireland, then in Cyprus, now most clearly in Greece the ECB has chosen to act not just to not pursue these aims but to act in a manner certain to result in their not being met. First, how exactly will the cutting off of liquidity to Greek banks help anything? It is a naked political play to ratchet up pressure on a sovereign engaged in political dialogue towards a political end.

These banks were stated, by the ECB itself, to be solvent. Therefore, if it was following its own ‘rules’ it should be quite happy to extend liquidity to Greece. That it is not doing so is because it fears, and it is a reasonable fear, that a disorderly withdrawal of Greece from the various bailout mechanisms will result in Greek government debt being marked down, and therefore the ECB losing money on this liquidity provision.

Secondly, it becomes clear from the above that there is in fact no breakage between the bank-sovereign death loop. Seven years into this crisis and we still have not solved the problem of the bank dragging down the state.

If the ECB is concerned with the solvency of Greece it should ensure that rendering illiquid solvent banks is very low on its agenda. Instead it is doing the exact opposite.

Third, leaving aside the ongoing inappropriateness, of timing and magnitude, of the monetary policy response in terms of the overall wellbeing of the union, the ECB is clearly not acting to its mandate on provision of balanced growth, nor can the threat levelled at Greece in any way square with the mandates for social protection and the rights of children.

Finally, the above has resulted in the Bank of Greece being the lender of last resort, much as the Central Bank of Ireland was to Anglo. Again, and in line with the byzantine approach to quantitative easing, which leaves the risk with national banks, it shows some erosion in faith in the ability of the system to survive as a system.

Perhaps after all, the ECB is composed of General Westmoreland acolytes. He famously stated in the Vietnam war that “to save the village it was necessary to destroy it”.

Acting to save the euro (seeing it as merely a neudeutschmark) the ECB risks destroying it.

Brian Lucey

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