Select Committee on European Union Forty-Second Report


240. Our overall assessment of the ECB's monetary policy since its started operating on 1 January 1999 is positive. We commend the ECB for the fact that its monetary policy is achieving the desired objective of price stability. The consensus in the evidence we received was that the ECB had performed well so far given its mandate, and this is a view that we share. The ECB is still a young institution, but it has rapidly built up a high level of credibility. It is in the context of this positive assessment that our criticisms and recommendations that follow are to be understood. (paragraph 25)

241. In this inquiry, we did not examine the EU's institutional arrangements for prudential supervision, but we are aware of the debate on the adequacy of the current institutions arrangements for financial stability in the EU. We recognise that the Government considers that "official support operations remain a national responsibility for euro area members", yet the Financial Secretary also called for "more clarity in the arrangements" as to who the lender of last resort should be in the euro area. We would like the Government to explain how it would like the system of prudential supervision in the EU to develop over time, whether it considers that the ECB should be given any powers in the area of financial supervision, and what it considers to be the ideal institutional set up for prudential supervision in the EU. (paragraph 30)

242. As part of its contribution to the smooth conduct of supervisory policies in the EU, we would encourage the ECB to publish regular broad reports on financial stability in the EU. (paragraph 31)

243. We regard the strength of the ECB's mandate to be its unambiguous nature. The EC Treaty makes it clear that the primary objective of the bank is to achieve price stability. Price stability is desirable because it is conducive to, and a pre-requisite for, long-term stable growth and employment. It is right therefore that price stability is the primary objective of the ECB; we would not seek to change that. (paragraph 45)

244. Without prejudice to that objective, the ECB must also support growth and employment. For citizens of the EU, economic success must go beyond a narrow definition of price stability; EMU will be judged by its ability to deliver what the EC Treaty terms sustainable and non-inflationary growth and a high level of employment. As the EU's most visible financial institution, how people judge the ECB will inevitably be influenced by the level of growth and employment in the euro area; it is right therefore that the Treaty places these as key but subsidiary elements of the bank's mandate. It should be recognised, however, that there are limits as to what monetary policy alone can achieve. (paragraph 46)

245. The ECB enjoys a high degree of independence. The question arises whether greater political involvement could and should be introduced to the process by which price stability is defined for the euro area without seriously prejudicing that independence. Giving the right to define price stability for the euro area to a political body could arguably help to address perceptions that the process currently lacks sufficient political accountability. We believe, however, that for the time being the ECB should continue to define price stability for the euro area. If at some later date a political body outside the ECB were to define price stability for the euro area, that body could perhaps best be the Heads of State or Government of those Member States that have adopted the euro, acting on a recommendation from the Eurogroup. (paragraph 56)

246. We welcome the fact that at the start of its operations the ECB announced a quantitative numerical value for its objective of price stability. Such a decision was essential for transparency and accountability. The ECB's initial definition of price stability as being a "year-on-year increase in the Harmonised Index of Consumer Prices (HICP) for the euro area of below 2%" did not make it clear that there was a lower limit. This led to some confusion and left the ECB open to criticisms that it was not sufficiently vigilant about the risks of deflation. (paragraph 79)

247. In the light of the ECB's announcement on 8 May 2003 of the results of the Governing Council's review of its monetary policy, the bank's definition of price stability is clearer than it was before and not so open to criticisms of asymmetry. Nonetheless, comparisons with the symmetrical inflation targets of some other central banks remain unfavourable, and the ECB's definition of price stability could still be clearer. (paragraph 80)

248. The ultimate test for the success of a central bank's monetary policy strategy is its record of actual policy decisions. As we say above, this has generally been good so far. Where the strategy has not performed so well is in communicating the bank's decisions. (paragraph 81)

249. The ECB's definition of price stability has recently been reaffirmed and clarified. We hope that Mr Trichet, the bank's incoming president, will sustain this process of clarification of the current definition in order to safeguard the bank's credibility and that of its monetary policy strategy. (paragraph 82)

250. The task remains of communicating the ECB's new strategy effectively. It is with a view to improving this external communication that we recommend that the ECB should in due course adopt an inflation target, expressed as a symmetric range around a central figure. Such a target would constitute a natural focal point that could be observed and understood by the public; it would provide observers with a more precise focus for forming inflation expectations and taking forward-looking decisions. An explicit target for inflation would be entirely transparent and so would reduce the uncertainties for other economic agents, by giving clearer guidance for their inflation expectations, which should in turn help to stabilise the economy. A symmetrical inflation target would also provide a clearer benchmark against which the bank could be held to account. (paragraph 83)

251. The two main criticisms of the ECB that concern its definition of price stability are the related claims that the ECB has not focused enough on growth and employment and that the ECB is not sufficiently vigilant in fighting deflation. We think that these claims are unfounded. A symmetrical inflation target would, however, address these two fears directly. The lack of symmetry to the ECB's definition of price stability has contributed to the perception that the bank does not take sufficient account of deflationary risks, pays inadequate attention to growth and is only concerned with achieving a low rate of inflation; a symmetrical inflation target would reduce these uncertainties over the ECB's aims. (paragraph 84)

252. We agree that the medium term is the right period of time for the ECB to be aiming to achieve price stability. Monetary policy should dampen or smooth fluctuation in both output and inflation without causing undesirable volatility in interest rates, employment or GDP. The medium-term orientation of the ECB's strategy allows such a flexible response to temporary shocks. (paragraph 88)

253. The monetary pillar does not appear to have significantly affected the ECB's interest rate decisions. The prominent position of this monetary analysis in the ECB's presentation of these decisions did, however, cause problems and hindered the bank's communication of its monetary policy. We therefore welcome the changes in the President's press statement and the editorial in the bank's monthly bulletin, in which the monetary growth pillar plays a less prominent role, which helps the bank's communication strategy. (paragraph 109)

254. We believe that it is sensible that the Governing Council continue to monitor monetary developments in order to inform its decisions on interest rates. We accept that the two pillars of the ECB's monetary policy strategy provide a useful framework for the internal analysis of information that facilitates the debate within the Governing Council. We respect the ECB's view that it does not want to create the wrong impression that controlling inflation is an exact science. However, the ECB's decision to reject inflation targeting and maintain its two-pillar framework does not imply that the bank is prevented from adopting an inflation target. The ECB could announce an explicitly symmetrical inflation target and state that that its actions in trying to achieve this target will be based upon its two-pillar framework rather than be guided solely by the relationship between forecasted and target inflation. (paragraph 110)

255. The ECB has said that its "two-pillar framework has over time become the hallmark of the strategy in conjunction with the medium-term orientation of the ECB's policy framework." Our proposals do not necessarily call for either of these aspects of ECB's monetary policy strategy to be changed. We believe that our recommendations represent a sensible compromise between the ECB's determined attachment to its two pillars and calls for the bank to change to an inflation-targeting regime. The ECB could combine what it considers to be the organisational advantages of its two-pillar framework with the important communication benefits associated with the anchoring role of an inflation target. Were the ECB to adopt a symmetrical inflation target, however, it might reconsider the role and necessity of its monetary analysis. (paragraph 111)

256. We are encouraged that the ECB has said that the process of review is ongoing. We hope that the bank will adopt the practice of conducting regular reviews of its monetary policy strategy. By the time such a review next takes place, the perceived dangers to the bank's credibility of changing its definition of price stability should have receded and the bank might at that point find it made sense to adopt a symmetrical inflation target. (paragraph 114)

257. It would be a mistake for the euro area to adopt an exchange-rate target. We are satisfied that the ECB has paid attention to the exchange rate when making its interest rate decisions, but it is clear that affecting the exchange rate has not been the primary aim of the bank's monetary policy. This has not, and should not, preclude occasional interventions by the ECB in the markets to dampen excessively rapid swings. We are convinced that this is the correct policy for the ECB to pursue. (paragraph 123)

258. The Governing Council is the highest decision-making body of the ECB; it sets interest rates for the euro area. The question of reform of the Governing Council of the ECB is therefore an issue of major importance. It is regrettable that the enabling clause provided by the Treaty of Nice was drawn so tightly as to prevent the Commission and the ECB from considering more radical proposals for reform of the Governing Council but instead limited them to considerations of its voting procedures. (paragraph 155)

259. The agreed reform, based on an overly complex rotation model, is not a sensible way to deal with the fundamental problems posed to the workings of the Governing Council by enlargement of the euro area. It fails to achieve what it was meant to do because it does not satisfy the principles on which it was supposed to be based. It is not an efficient mechanism for setting interest rates in the euro area; it caps the number of voting and non-voting members of the Governing Council at a level which is far too high; it is not transparent; it is overly complicated and difficult to communicate, so it will be extremely difficult for it to gain the trust of the public. Furthermore, it violates the principle of the ECB statutes, which prescribe that the NCB Governors sit on the Governing Council as individual experts, not as representatives of their own countries. All in all, we do not consider that the agreed reform will work satisfactorily. It is extremely disappointing that such an important decision on reform was taken so quickly and with limited opportunity for consultation, debate or parliamentary scrutiny. (paragraph 156)

260. There is a functional need for the ECB to have the best possible design for its interest-rate setting body. The reason that we have independent central banks is to ensure that monetary policy is not compromised by political considerations. For this reason we recommend that the ECB should eventually have a small Monetary Policy Council composed of the six members of the ECB Executive Board and up to six independent external experts. These part-time, non-executive members of the Monetary Policy Council would be appointed for their individual expertise, without regard to their nationality, by an open and transparent process; like the Members of the Executive Board, they would be mandated to consider exclusively the interests of the euro area. We believe that such a model is the most sensible consequence of the decision to operate a single monetary policy. We recognise and appreciate the political impetus for there to be some national input into the running of the ECB. That is why we recommend that the Monetary Policy Council should operate under the oversight of the current Governing Council, where the central banks of all of the Member States of the euro area are represented. The Monetary Policy Council would meet monthly and take decisions on interest rates; the Governing Council would retain all the other responsibilities that it currently holds. The Governing Council would continue to formulate the monetary policy strategy for the ECB, which the Monetary Policy Council would follow and implement. The Governing Council would set general guidelines for monetary policy in, say, quarterly meetings and monitor the policy execution by the Monetary Policy Council. Such meetings would allow the national central bank governors to continue to contribute their indispensable knowledge of economic developments and sensitivities in their own countries to the working of the ECB. If independent experts were appointed to the Monetary Policy Council, it would mean that all the members of the rate-setting board would become directly accountable to the European Parliament, which is not currently the case, as it cannot call the national central bank governors to appear before it. (paragraph 157)

261. The Member States should, as a matter of urgency, reconsider reform of the Governing Council at the present Inter-Governmental Conference. A new enabling clause should be provided allowing fundamental reforms to the structure of the ECB to be agreed by the European Council, acting unanimously. There should be a new provision in the Protocol on the Statute of the European System of Central Banks and of the European Central Bank that would facilitate reforms that go beyond amending Article 10.2 of Protocol. Proposals for reform under a broader remit are necessary to allow changes to the functions of the Governing Council and the establishment of a Monetary Policy Council as a decision-making body of the ECB. Without such a provision, it would be extremely difficult to amend the structure of the ECB any further, making reform of the Governing Council unlikely in the foreseeable future. (paragraph 158)

262. Central banks should be subject to the scrutiny of a democratically elected body. For the ECB, this accountability needs to be in a form which does not put its independence at risk. It is a popular misconception that, unlike the Bank of England, the ECB is not accountable to parliament. The ECB is accountable to the European Parliament, and we remain of the view that it would not be practicable, or even desirable, to make the ECB also directly accountable to national parliaments. (paragraph 165)

263. The President of the ECB and other members of the Executive Board regularly appear before the Committee on Economic and Monetary Affairs of the European Parliament. Ever since the establishment of the ECB, we have said that we would expect these hearings "to be televised and to become a prime means of [the ECB] communicating with the people of the euro zone countries." We are disappointed that this is still not the case. (paragraph 166)

264. We welcome the publication of economic projections by the ECB, but the bank should increase the frequency of their publication to four times per year, as there can be significant change in the economic outlook over six months. More frequent publication would help the Bank to provide clearer and more transparent explanations for their monetary policy decisions. (paragraph 171)

265. The President's press conferences after meetings of the Governing Council provide a most timely opportunity for the ECB to present and explain its monetary policy decisions. We would welcome it if the incoming President, Mr Trichet, continued this practice. (paragraph 174)

266. On the basis of the evidence received, we accept that it would not be appropriate for the ECB to publish minutes of the meetings of the Governing Council which are attributed and contain full voting records: to do so would run the risk of exposing individual members of the Governing Council to criticisms or pressures from their own countries, and thus of impairing, or at least appearing to impair, the independence of the ECB itself. (paragraph 195)

267. However, the ECB's communication strategy will need to develop and evolve over time. The bank should, by a series of incremental steps, gradually move towards greater transparency of the Governing Council. The first step could be taken without further delay by announcing that the central bank is to publish records of the meetings of the Governing Council in which the various arguments and reasoning would be spelled out clearly but not attributed. Such a move would enhance transparency and understanding of the ECB's decision-making processes and win wide public support, both in the press and with commentators and the markets. We see no reason for the bank to delay in providing more detailed information about the arguments used in the meetings of the Governing Council, whilst protecting the identity of those participating. (paragraph 196)

268. If it were to be decided that the ECB's interest-rate decisions should be taken by a Monetary Policy Council where the non-executive members were appointed as individual experts, the publication of attributed minutes and the balance of votes within the Monetary Policy Council could be given further consideration. (paragraph 197)

269. The manner by which the first President of the ECB was appointed was regrettable and did not conform to the spirit of the Treaty. A situation of split mandates should not be allowed to happen again. (paragraph 204)

270. We see the hearings that the European Parliament holds with candidates for the Executive Board as an extremely valuable part of the appointment procedure. The hearings bring some openness and democratic legitimacy to the process. Over time the nature of these hearings may evolve and their significance will probably increase. At some later date consideration could be given to granting the European Parliament the power to confirm the Council's nomination for the Executive Board; but it is essential to prevent the process from becoming unduly politicised. We are strongly of the opinion that the time is not yet right to take the final decision on appointments to the Executive Board away from the Member States. (paragraph 213)

271. The Stability and Growth Pact can help Member States to control their debt and deficits, which should provide stability for the ECB. (paragraph 218)

272. EMU has led to the unprecedented combination of a single monetary policy co-existing with separate national fiscal policies. There are those who suggest that some other body is needed as a partner for the ECB. Whether this unique, historical asymmetry can succeed in the long term without further steps towards economic union remains an unanswered question. It is generally accepted that the economic fortune of a nation depends on the monetary, fiscal and structural policies that it pursues. Co-ordination between these three policy elements in the euro area, while theoretically desirable, is difficult to achieve fully in practice, especially between countries in different economic conditions. We have seen no evidence, however, to suggest that a lack of such co-ordination has had any major adverse effects on economic performance in the euro area so far. Evidence provided suggested that other factors, including the unwillingness and dilatoriness of Member States to face up to the need for structural reforms in capital, labour and product markets in their own economies, have been more important in this regard. (paragraph 237)

273. As of yet, there has not been a great need for co-ordination of monetary and fiscal policies in the EU to go beyond the exchange of information. We note that there is some concern that economic circumstances might change to the extent that more active and explicit co-ordination of particular policies could become necessary at some point in the future. In such circumstances, it is hard to know at present how the EU would respond. (paragraph 238)

274. There is a case for strengthening the arrangements for communication between the ECB and the Eurogroup. We do not think that this would jeopardise the ECB's independence, which should be rigorously observed and maintained. If the Treaty formalised the Eurogroup and enabled it to operate under a more permanent leadership than presently allowed under the six-monthly rotation of the presidency, it would provide the ECB with a more stable and coherent interlocutor, which could facilitate their dialogue and the exchange of information between them. It could thus strengthen the capacity of the ECB to perform its own functions effectively. Such a change would not alter the powers of the Eurogroup, which would remain a body that could not take any formal decisions on policy. (paragraph 239)


275. The Committee considers that the subject of the European Central Bank raises important questions to which the attention of the House should be drawn, and we make this Report to the House for debate.

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