Select Committee on European Union Written Evidence

Memorandum by Mr Klaus Regling, Director General of the Directorate-General for Economic and Financial Affairs, European Commission

  1.   It has been suggested to us that if the ECB adopted a symmetrical inflation target this would help its communication strategy, as it would serve to align the ECB rhetoric with the policy that it pursues. Would the Commission welcome such a move?

  The Eurosystem had to design its monetary policy under very difficult circumstances with only a small amount of euro area data available and with a lot of uncertainty about how the introduction of the single currency would affect the behaviour of euro area citizens. In this set-up the Eurosystem has defined price stability as "HICP inflation rates of less than 2 per cent over the medium term". This definition explicitly takes on board a lower bound as declines are not covered and an upper bound as rates of 2 per cent and above are not covered either. As I said before the Treasury Committee on 6 February 2003, this does not constitute a symmetric inflation target, but it provides the public with clear indications about the bounds of the definition of price stability.

  The review of the strategy in the first half of 2003, which included an in-depth analysis of the definition of price stability, has not provided evidence that there is a need to change the definition as such. However, the ECB has clarified the Eurosystem's definition by saying that it aims at HICP inflation rates of "close to 2 per cent from below" over the medium term. This can be seen as a narrowing of the range of inflation rates the ECB is aiming at. Therefore the guidance the ECB provides to the public has been improved and the narrow range of HICP inflation rates below 2 per cent can serve as a focal area for the formation of inflation expectations, which have been around 1Ø per cent for quite some time.

  All in all, the Eurosystem's monetary policy has been successful in the past and it is therefore reasonable that the serious assessment and evaluation of the strategy has not resulted in changes of the definition of price stability. In particular, the ECB has succeeded in guiding inflation expectations and the clarification of 8 May 2003 should reinforce those expectations. The Commission has welcomed the review and its results as a valuable contribution to the ongoing process of improving the macroeconomic policy framework of the euro area.

  2.   Should the period over which the ECB is committed to meeting its inflation target be made more explicit?

  The Eurosystem's monetary policy strategy is fairly clear about the time horizon by comprising a definition of price stability that refers to developments in the HICP "over the medium term".

  Some factors affect the HICP inflation rate in the short run without necessarily providing reasons for responses by monetary authorities; examples include adverse weather conditions, changes in administered prices, oil price hikes or animal diseases. These are the cases which I already described before the Committee on 6 February 2003, where inflation exceeded the upper bound of the definition of price stability in the short run. As regards these short-term outliers of the HICP inflation rate, ie what I called "temporary overshooting", it would not make sense to have a very precise short-term horizon over which a central bank should be committed to achieve its primary objective. As a long-run horizon would also not be acceptable for various reasons, it is the medium term that should matter for achieving price stability.

  The fact that the concept of the medium term does not come along with a specific number of months or years should not be seen as a disadvantage. I share the view of the new Governor of the Bank of England, Mervyn King, who once argued that `central banks with inflation targets—and in that respect a central bank with a price stability mandate can be regarded as similar—in the end will be held accountable in such a way as to make the time horizon irrelevant.[5] If this is true for inflation targeting central banks, it seems to be the right approach for the ECB as well.

  3.   What would be the effect of the recent decision of the European Council to amend the voting modalities of the Governing Council?

  The Governing Council is composed of the governors of the national central banks of the Member States having adopted the euro, as well as the 6 members of the Executive Board. Each member of the Governing Council has a single voting right (18 voting members in total at the present moment). Under unchanged rules, each enlargement of the euro area would give rise to an increase in the total number of voting rights in the Governing Council.

  With regard to the voting modalities of the Governing Council, the 3-group rotation model introduces a ceiling on the total number of voting rights. This ceiling corresponds to a total of 21 votes (6 + 15), possibly increasing to 24 votes (6 + 18) during a transitional period. The adoption of such a ceiling effectively reduces the total number of voting rights, compared to the status quo, which will be exercised within the Governing Council in a future enlarged Union. The reformed voting modalities help to ensure that the Governing Council will continue to take decisions in an efficient manner and it therefore constitutes an important step in the adjustment of ECB decision making in the context of enlargement. The allocation of governors to three groups will be based on a specific indicator based on two components: the share of the aggregate gross domestic product at market prices of the Member States without a derogation and the share in the total aggregated balance sheet of the monetary financial institutions of the Member States without a derogation.

  The rotation model will not lead to any immediate change. Its full and entire effects will only be felt as from the date on which the number of members of the Governing Council exceeds 21, ie not before 2007 at the earliest. Moreover, if the Governing Council decides so, the effective start of the rotation model could be further deferred until the number of governors exceeds 18.

  4.   Looking beyond the mandate given to the ECB to amend Article 10.2 of the ESCB Protocol, what in the Commission's opinion would be the optimal solution to the problems posed to the workings of the Governing Council by enlargement?

  As foreseen in the relevant legal basis (Art. 10.6 ECB), the Commission was invited to issue an opinion on the ECB's Recommendation. Proposing an "optimal" solution as regards the workings of the Governing Council evidently requires a prior comprehensive review and assessment of the ECB's governance. This did not form part of the Commission's role and assignment in the context of the reform of the voting modalities of the Governing Council and was moreover excluded by timing constraints.

  However, the Commission felt that it was appropriate to draw attention to the fact that the content and limitations of the "enabling clause" (Article 10.6 of the ESCB/ECB Statute) prevented the consideration of more comprehensive changes to the ECB's decision-making in the area of monetary policy, and/or on the role of the Executive Board.

  The Commission's Opinion moreover sets out the different conditions which should be fulfilled in order to implement a successful and effective governance model. These conditions are fourfold and relate to the efficiency of decision-making, the fact that the interest of the whole euro area need to be kept in mind by the decision-makers, the neutrality of the system vis-a"-vis existing and future Member States and the need for the voting and decision-making system to be comprehensible to markets and media.

  5.   Is there a conflict between national interests and European interests? If so, how might these be reduced? Article 108 of the EC Treaty is supposed to guarantee the independence of the ECB and protect the members of the Executive Board and the Governing Council from such pressures. Does the Commission consider that this Article needs redrafting; and if so, how?

  As far as the ECB's Governing Council is concerned, its members should make decisions with the interests of the entire euro area in mind. The modification of the voting modalities as described in Article 10.2 of the Statute of the ESCB/ECB does not affect this essential principle.

  Article 108 EC aims at preserving the independence of the ECB, the national central banks and the members of the decision-making bodies of these institutions. The Commission is not aware of any particular difficulties in this respect which would justify or require an amendment to Article 108 EC, and therefore has no amendments to propose.

  6.   Should there be an independent "monetary policy board"? How should such a board operate? Who would take the final decision on the level of interest rates?

  An answer to this question presupposes that the Commission would have carried out a full and comprehensive assessment on ECB governance, and notably on the working of the ECB's Governing Council and the Executive Board in particular. For the reasons explained above (see reply to question nr 4) this was not the case. The Commission is therefore not in a position to propose a final answer to the different questions put forward. As already pointed out, the legal framework for the revision of the ECB's governance, as established by the enabling clause forming part of the Nice Treaty, moreover did not allow more comprehensive changes to be envisaged.

  In the framework of a wider mandate, going beyond amending Art. 10.2 ESCB/ECB, it would certainly be appropriate to examine in greater detail the relative merits of other central bank governance models, such as those based on a monetary policy board, notably because this approach has been successfully operated by many central banks, including some EU central banks, and therefore deserves to be closely examined in the context of a possible future reform of the ECB's governance.

  7.   The Opinion suggests that the Executive Board be "possibly enlarged". What should be the relative size of the Executive Board in relation to the Governing Council?

  In the Commission's opinion, a possible enlargement of the Executive Board is only relevant in case this body would be transformed into a monetary policy board. The extension of the responsibilities of the Executive Board, together with the wider geographical scope of the euro area in the medium term, could justify the enlargement of the membership of the Executive Board.

  8.   The Opinion says that it would be "appropriate to modify the current rules for appointment of the Executive Board". What should be the roles of the Commission, the European Council, the European Parliament and national parliaments in appointing the President and the other Members of the Executive Board?

  The Commission believes that it would be appropriate to appoint the different members of the Executive Board by qualified majority rather than by common accord (ie unanimity) as is currently the case. This proposition is particularly relevant in the context of an enlarged Union composed of 25 Member States and eventually even more. This view has received support from many Member States and the Commission therefore hopes that this change could be agreed in the forthcoming IGC.

  Apart from this change to the voting rules, the Commission does not consider that the role of the different institutions involved in the appointment process of the members of the Executive Board should be modified.

  9.   Does the Commission have any other proposals for changing the structure and governance of the ECB?

  In the framework of the activities of the Convention on the future of Europe, the Commission has submitted several contributions, in particular COM(2002)247 final and COM(2002)728 final. In both cases, the Commission did not consider that any other elements, apart from those already raised in its Opinion of 19 February 2003 (COM(2003)81 final), relating to the ECB, were in need of reform.

  10.   Should the ECB continue to set its own inflation target? Is there an alternative that the Commission would prefer?

  The inflation record of the EU Member States varied a lot in the 1970s and early 1980s. While some Member States performed rather poorly, displaying not only double digit rates but rates of more than 20 per cent, others performed relatively well. But even later in the 1980s and 1990s the performance of central banks differed a lot. As price stability had been decided to be the primary goal of the Economic and Monetary Union, it was reasonable to look closely to those central banks that had performed well. These central banks had never worked with a specific inflation target imposed on them from the outside world (the same can be said about the Fed in the U.S. though it does not have a primary goal).

  In order to make use of the better parts of the European monetary heritage it was decided to keep the tradition of letting the central bank determine its operational value. The experience of the euro area in the first years confirms the advantages of such a set-up.

  The Commission is aware of an ongoing debate about the way in which targets are set. Some, including the Economic and Monetary Affairs Committee of the European Parliament and several academics have argued that more control is needed and that democracy would imply that the Parliament gets some influence. In the UK, on the other hand, the government has responsibility for the operational value, while in Sweden the Riksbank sets the value on its own. Another issue would be the frequency of decisions and the risk to move to a more discretionary monetary policy, which would be exactly the opposite of what has been targeted by provisions making the ECB an independent central bank. Even without repeating the discussion of rules versus discretion, it should be obvious that each proposal for a modification has some disadvantages.

  All in all, I think that the system of checks and balances between the ECB and other European institutions has worked effectively. From that point of view I do not regard changes as desirable.

6 June 2003

5   See Mervyn King, Challenges for monetary policy: new and old, in: New challenges for monetary policy, Federal Reserve Bank of Kansas City, 1999, pp 11-57. Back

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