Nationalism makes for bad economics, ECB edition

November 13, 2013

The Eurotower is home of the ECB in Frankfurt. (Hannelore Foerster/Bloomberg )

Last week, the European Central Bank decided to cut interest rates. To most of the American and British commentariat, it seemed like the imminently sensible thing to do. Inflation is running well below the ECB's 2 percent target. The continent has been in a recession for the last couple of years, with only a tentative perk-up into positive growth over the summer. Given the hordes of unemployed in some southern European countries, the risk of tipping into a Japanese-style generation of deflation seems quite real. All that made it seem like a no-brainer of a decision.

If anything, the ECB needs to do more to prevent expectations of falling prices from setting in. Peter Praet, a member of the executive board, said in a new interview published Wednesday that the bank could do exactly that. He told the Wall Street Journal that negative interest rates on bank deposits or direct intervention in markets to buy assets could be possibilities if further action is needed.

Inside the ECB, however, the idea of intervening to keep inflation from falling too low is quite a bit more controversial.

News in the last few days from well-sourced ECB reporters has pointed to deep fissures within the central bank over the rate cuts. The Financial Times reported that there were at least four dissents, from the two Germans on the ECB's governing council (Jens Weidmann, the president of the Bundesbank, and Jorg Asmussen, a member of the bank's executive board) along with central bankers from Austria and the Netherlands.

"People involved in the policy debates said divisions between northern and southern representatives on the ECB board have been mounting since market pressures on the euro zone relaxed," the FT reported, "with council members freed up to revert to national interests."

This is worrisome even apart from the merits of the interest rate decision. One of the great challenges for the ECB through its 15-year history has been to act as a single, unified whole, despite serving 17 nations. Yes, when euro zone political leaders gather in Brussels, they may be representing France or Italy or Germany. But when the continent's central bankers gather in Frankfurt to set monetary policy, they are supposed to check their national identity at the door, each official representing not his or her own nation but the interests of the entire currency bloc.

The organization's rules for operating are designed to make that easy. Unlike the U.S. Federal Reserve or the Bank of England, the outcomes of ECB votes are not released. Whereas we know that Esther George, the president of the Kansas City Fed, dissented at the last Fed policy meeting the instant the announcement was made, we only know of the dissents to the ECB decision because of deep background leaks to the press. Minutes of Fed meetings are released publicly after three weeks; the ECB takes 30 years to release that information.

The idea is that keeping voting information secret will reduce domestic political pressure on the central bankers to act only in their own nation's interest. A Spanish or Greek central banker, for example, could enter the circular board room on the 36th floor of the Eurotower and comfortably vote for higher interest rates that might be right for Europe but bad for Spaniards or Greeks, confident their countrymen would never know it.

In the last few years, though, it has become more and more routine for the details of who voted how to leak to the financial media, often within days. During his news conferences, ECB President Mario Draghi generally answers honestly when asked whether a given decision was unanimous, though he won't mention the names of the dissenters. These are steps toward greater transparency, which in concept are good. But the practical outcome appears to be a heightening of nationalistic tensions within an institution that is supposed to be free of them.

The whole episode is a reminder of another important fact: Central bank independence cuts both ways. The ECB was modeled after the German Bundesbank, with the concept of independence built into its bones -- the idea that a central bank must never allow inflation to take root.

But allowing excessive inflation isn't the only way a central bank can fail. To allow deflation to take root, as the Bank of Japan did in the late 1990s, is a failure that can have equally dire consequences. And just as there can be political pressure to run excessively easy monetary policy, there can be political pressure to run excessively tight monetary policy.

That's what Federal Reserve Chairman Ben Bernanke has experienced in the last few years as Republicans have pilloried the institution for its low interest rates and quantitative easing policies (Janet Yellen will receive an earful of the same at her confirmation hearing as Fed chief on Thursday). And that's what Weidmann, the Bundesbank president, is hearing now from his fellow German citizens, who are furious that savers are being "punished," in their view, by too-low euro zone interest rates.

To his credit, Weidmann pushed back on that notion in a speech on Wednesday. "There is no specific discrimination of German savers," he reportedly said, adding that savers across Europe have to live "with a low or even negative real interest rate, for example, also in Italy or Spain."

But if the experiment of a united Europe is to succeed, the central bankers will have to act with the unity that they have pledged. These divisions, if they persist and widen, could come at a cost of dysfunction in the one European institution that has stood tall against the challenge of holding a disparate continent together.

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Sarah Kliff · November 13, 2013