CANDIDATE NAME: Stefano Locatelli

STUDENT NUMBER: c1262442

MODULE CODE: EUT115

MODULE TITLE: European Economic Governance and Policies

SEMINAR TUTOR: Kenneth Dyson

ESSAY TITLE: ‘Has the European Central Bank been the principal winner from the post-2007

crisis in the Euro area? If so, why?’

WORD COUNT: 2530

“Has the European Central Bank been the principal winner from the post-2007

crisis in the Euro area? If so, why?”

Since the beginning of the international financial crisis in 2007 the European Central Bank (ECB)

has been one of the most important actors. When the crisis was still financial, related more to a

lack of liquidity and to instability in the banking sector, the ECB has been acting mostly through

its standard instruments, bound by its mandate of inflation control (Jabko, 2010). But since the

European economy and the Eurozone in particular have showed to be almost in a stagnation

phase due to more profound and structural problems, the Central Bank had to resort to a series

of emergency measures. Some of these, as the issuance of very low-cost credit and the

purchase of governments bonds on the secondary market have raised many critiques and

accuses of the ECB acting beyond its authority.

Finally, the involvement as member of the Troika in the rescue plans and the upcoming role of

Eurozone Banking Supervisor have given space to the fear of a too powerful and politicized

Central Bank. The ECB has argued repeatedly of being operating within the boundaries of the

Treaties and of being pursuing its main objective of monetary policy. This essay does not aim to

evaluate the economic results of the Bank’s policies, but to overlook the development of its

powers into the EU framework and the main criticisms surrounding it. It will first analyse some

of the ‘non-standard’ monetary measures employed by the Bank, with particular attention to

the discussed bonds purchase program. It will then look to the involvement in the Troika and

finally to the new steps made toward a banking union and to the future ECB’s role into it.

‘Non-standard’ monetary measures are not a substitute of standard interest rated decisions,

but complementary. These measures do not aim at providing additional direct monetary

stimulus to the economy but at making more effective the standard policies, especially in times

of financial market tensions (Cour-Thimann&Winkler, 2012). They are defined by the ECB as

‘unconventional’ and as ‘exceptional and temporary in nature’1. Between 2007 and 2011 the

ECB has applied a series of measures as the fixed-rate full allotment2, six and nine months

longer-term refinancing operations (LTROs), a dollar swap line3 and two covered bond

purchases programmes4, to favourite the circulation of liquidity in the market and restore

investors’ confidence. But the turning point probably arrived in 2010, with the explosion of

sovereign debt crisis.

In May 2010 it was announced the most discussed measure, the Security Market Programme

(SMP), which will be analysed ahead. December 2011 was then a remarkable month in the

ECB’s policies timeline, with the introduction of three important measures. The first one was

the reduction of the reserve ratio from 2% to 1%, aiming to free up collateral and encourage

liquidity transmissions (Barber&Atkins, 2011). Secondly, it broadened the collateral eligibility

rules by lowering the standards for certain asset-backed securities, but keeping the collateral’s

value marked to market. This measure has been a controversial element of the ECB’s policies,

particularly in Germany where the head of the Bundesbank Jens Weidmann officially wrote to

Mario Draghi to complain about the lowering of collateral standards (Thompson, 2012). The

complaint was related also to the third and most important measure announced by the ECB in

the same month, the new tranche of LTROs.

These had a similar scheme to those launched by Trichet, but with an unprecedented maturity

of 36 months – i.e. 3 years, and an interest rate tied to the main refinancing rate5. The official

objective was to ‘ease the funding pressures that banks are experiencing’ (Barber&Atkins,

2011), thus to give easy credit to banks in a moment where they are having difficulties to raise

funds. Many observers have pointed these measures as the European equivalent of

quantitative easing as done by the Fed and the Bank of England, but Draghi has replied defining

them as ‘non-standard measures’ and as ‘unprecedented’, thus still falling into ECB’s mandate

(Barber&Atkins, 2011). Critiques have been advanced for the massive expansion of ECB’s

balance sheet consequently to the LTROs; however, large part of this liquidity is kept in the

overnight deposits at the ECB, thus reducing its effects on the general monetary policy situation

(Pisani-Ferry&Wolff, 2012).

The importance of the LTROs relied as well in the underlying objective of stimulating through

the supply of cheap credit the demand for peripheral sovereign bonds, which were under great

1 ECB (31/1/13) ‘Monetary policy instruments’, available online at

http://www.ecb.int/ecb/educational/facts/monpol/html/mp_010.en.html 2 With an interest rate which has been lowered to the record of 1% in October 2008, and has been subsequently

reduced firstly to 0.75% in July 2012 and then to 0.5% last week (Steen, 2013). 3 Agreement with the US Federal Reserve which committed to lend unlimited amounts of dollars.

4 CBPP and CBPP2.

5 1% at the moment of the launch.

stress at the end of 2011. The ECB is forbidden by the Article 123 of the TFUE (EU, 2010) from

financing directly Member States6, thus to act as lender-of-last-resort (LOLR) as other central

banks like Fed or BoE. Nevertheless, Frankfurt has been pursuing a series of policies which

aimed not only to give some “breath” to the credit sector, but as well to restore confidence in

the market and encourage the purchase of sovereign bonds so to avoid the spread of the

contagion and avoid Countries’ bankruptcies.

On 9 May 2010, the ECB’s Governing Council agreed on the so-called Securities Markets

Programme (SMP), a first time operation in ECB history. The initiative allowed the ECB and the

NCBs of the euro-area to ‘conduct outright interventions in the euro area public and private

debt securities markets’. Practically, the SMP enabled the ECB to intervene on the secondary

market to purchase governments’ bonds. The official objective was ‘to address the

malfunctioning of securities markets and restore an appropriate monetary policy transmission

mechanism’, thus in line with the ECB mandate of price stability (ECB, 2010). But it seems

evident that the underlying scope of the operation was to relax the tensions of the market over

the sovereign debts of countries under pressure, thus operating de facto as LOLR. Purchasing

“difficult” bonds, the ECB could generate demand and ensure their market yields, lowering the

borrowing costs for the Euro countries (Thompson, 2012).

The SMP has probably been the most discussed policy implemented by the ECB, seen by many

as beyond the original Bank’s mandate (Lupo Pasini, 2013). It created tensions even within the

ECB’s Governing Council, which took the decision with an “overwhelming majority” as opposed

to the usual “unanimous decision”, as announced by Trichet (Eichler&Hielscher, 2012:564).

The main opponents of the bond-buying policy have been the Germans, who did not like the

idea of an ECB taking the burden of sovereign debts (Vogel, 2013b). The main worries were

related to the risks losses on the ECB’s balance sheet, to the possibility of moral hazard by the

Governments and moreover to the possibility of inflation, due to the increase of the money

base7 (Kaiser, 2011). Almost one year later, on 11 February 2011, the President of Deutsche

Bundesbank Alex Weber resigned, stating that he did not want to support anymore the anti-

crisis policies of the ECB. Following him, in September 2011, it was the turn of Jürgen Stark,

German appointee to the Governing Council and Executive board. In the ECB press release the

resignation is presented as due to ‘personal reasons’ (ECB, 2011) but there are reasons to

believe that was again motivated by his divergent opinion on the bond-buying policy (Atkins,

2011; The Telegraph, 2011). The SMP ended on 6 September 2012, when President of the ECB

6 The Article is also recalled by the Article 21 of the ESBC/ECB Statute (ECB, 2008). The ECB cannot purchase

sovereign debt on the primary market through money creation – process known as “monetisation” – or other mechanisms, but it can operates on the secondary market where the issuers are private investors. 7 Actually the ECB has committed to conduct market operations of “sterylisation”, directed to reabsorb part of this

liquidity through the sell of other assets. In this way it increases the money base but not the money stock.

Mario Draghi officially presented the Outright Monetary Transactions (OMT) programme,

already announced on 2 August 2012.

The OMT is similar in nature and purpose to the SMP. The programme will practically enable

the ECB to buy sovereign debt in the secondary market. The official objective is again that one

of ‘safeguarding an appropriate monetary policy transmission and the singleness of the

monetary policy’ (ECB, 2012b). The Bank will purchase just bonds with less than three years’

maturity; this will help the institution to maintain that the measure falls within its monetary

policy mandate rather than engaging in ‘quasi-fiscal operations’ (Thompson, 2012). But the

major innovative element is the conditionality attached to the programme. The OMTs will take

place only where the beneficiary – the country issuing the purchased bonds – will accept a

broader agreement with the rescues funds, the EFSF/ESM. Therefore, countries asking for an

intervention by the ECB through the OMT will have to accept strict economic policy conditions

and monitoring by the European Commission8 (Thompson, 2012). The conditionality issue

seems to be a wink by Draghi to Germany, who has been so critic about the SMP and has

openly opposed over the years any kind of “granted” help, with no reforms implemented by the

beneficiaries (Gordon Smith, 2012).

Despite this clause, the German critiques have not missed. Bundesbank’s representative Jens

Weidmann was the only one to vote against OMTs in the Governing Council and stated that it

was too close to ‘state financing via the money presses’ (Gordon Smith, 2012). The argument

has been brought in front of Germany's Constitutional Court, which will hold a public hearing

on 11-12 June 2013 on complaints against the ECB’s bond-buying policy and the ESM (Reuters,

2013).

A further signal of ECB’s increased role and powers comes from its participation to the so-called

Troika. The reason about its involvement was never spelled out explicitly, but it can be traced to

European Council’s fear of possible recommendations from the IMF that would have challenged

ECB policies (Pisani-Ferry et al., 2012). In this way, it ensures the compatibility of the suggested

economic policies with the Eurozone monetary policy. Nevertheless, its participation to

negotiations raises doubts about possible conflicts of interest between its role of “trusted

adviser” and its general mandate of prices stability and liquidity control. Furthermore, through

the SMP the ECB has become direct creditor of the countries receiving assistance and this could

influence its position in negotiations about debt restructuring and fiscal consolidation (Pisani-

Ferry et al., 2012).

8 Draghi espressed as well an encouragement for a possible involvement of the IMF (ECB, 2012a).

But the main step through a real empowerment of the ECB has come in the last months, with

the decision to create a Single Supervisory System (SSM). The proposal, made in the EU Summit

in June 2012, became more concrete after the deal on 19 March 2013 between the MEPs, the

European Commission and the Council of Ministers (Vogel, 2013a). It is now waiting for the EP’s

vote scheduled on the 21st of this month. With this mechanism the ECB will become the main

supervisor of the Eurozone banking system as a whole, but actually directly supervising only of

a limited number of large banks – i.e. with assets of more than €30 billion. Smaller banks will be

still supervised by National Banks, but with the ECB exercising a ‘droit de regard’ over them

(Gross, 2013). The aim of the Mechanism is to improve the integration of the banking system

and overall to ‘help breaking the negative feedback loops between sovereigns and banks’, so

influential in the actual crisis (ECB, 2013). The European Commission as defined the SSM as ‘an

important step towards a real banking union in Europe’ (EC, 2013), which by the way still seems

far from full implementation. The first consecutive step will be the creation of a Single

Resolution Mechanism, the details of which are still under discussion.

Here again the criticisms do not lack. The main one is related to the overlapping of

responsibilities of the ECB, which besides the normal functions will be also managing a new

bank resolution fund, will create a unified deposit guarantee scheme and will cover several

supervision roles (Verhelst, 2013), resulting in an increased power to influence national fiscal

policies. Some States, firstly Germany again, are concerned that these new roles could have a

negative influence on ECB’s main function that is monetary policy. This concern derives from

two arguments. The first one is that one of a conflict between supervisory and monetary

responsibilities, with a detriment of the latter. The second one is about a possible negative

reputational impact on the ECB in general, deriving from eventual mistakes in supervision

(Verhelst, 2013). While the ECB has admitted the latter as a possible risk, it as definitively stated

as “false” the risk of possible conflicts of interests, arguing to have ‘clear separate and

hierarchical mandates’ where the goal of price stability remains on top (ECB, 2013).

These recurring complaints of possible conflicts of interests, neglecting monetary policy and

loss of independence are the clear symptoms of a gradual transformation of the ECB over the

past few years. The shift of new functions such as central supervisor and the involvement in the

Troika show how the EU sees the ECB as the most effective executive power at the moment.

Taking advantage of its independence, it has been able to pursue its decision-lines without

remaining entangled into Member States bargaining. In the moment of difficulty it was the only

institution able to provide direct and immediate answers, assuming so a decisive weight not

only in influencing the markets, but national policies too.

The programme of bonds purchase represents even better this blurring between the original

monetary mandate and its new involvement into fiscal policies. Despite the official “mask” of

improving monetary transmissions, the ECB has affectively acted as LOLR, thus determining

whether save a State or not. Working within the boundaries the of the Treaties it has eluded

Germany’s resistances and has become highly involved in fiscal policies, distancing itself from

the German model of independent bank on which it was created.

More doubts emerge about the democratic aspect. Since the ECB is not an elected institution,

many denounce how its involvement in political decisions represents a weakening of the

democratic set of the European Union (Rachman, 2012; Mahler, 2012). During a debate on the

ECB's annual report on 16 April 2013 the Members of the European Parliament called for the

need of more transparency and accountability by the bank, since its political involvement and

increased powers following the Eurozone crisis (BBC, 2013).

In this sense, the ECB can be considered the real winner of the crisis, since it has acted

resolutely and has gained new powers. It has had a central role in saving the Countries in

difficulty and in orientating the fiscal policies of the Eurozone members, becoming a more

political actor. Whether it will continue on this way or it will have to step back to its original

mandate, it will probably be the German Court’s decision in June to tell us.

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