Select Committee on European Union Minutes of Evidence

Examination of Witnesses (Questions 85-99)




  85. Welcome. As you know, we are conducting an inquiry into the ECB's monetary strategy and organisation. It would be useful if I could ask you how you think, on monetary policy, so far, the ECB has worked out? How successful has it been?

  (Professor Giavazzi) There is an issue of substance and one of form. As far as substance goes, the Bank, taking into account it is a relatively young institution with no history behind it, has been pragmatic and has behaved overall as I would expect a central bank to behave. Where the Bank has been lacking is in the ability to communicate clearly to the outside world what they were doing, how they were making decisions. The outcome of this inability to communicate makes it very difficult to hold them accountable, to understand whether they have been behaving or not. As far as substance, I think they have behaved well. As far as form, it is very difficult to hold them accountable.
  (Mr Bootle) I largely agree with that verdict. The ECB has come in for a lot of criticism in this country for all sorts of things. A lot of it has been ill judged. In particular, the ECB has managed to avoid making any gross policy mistakes. I cannot think of it having made a major policy mistake. It has avoided being completely misled by aspects of its remit and the way it has officially interpreted it, such as the monetary pillar. It has avoided being misled into gross errors. It has been much more flexible than the rhetoric would have you believe. However, I think there are a number of aspects of the set-up which are deeply worrying for the future and in particular, although it has not had an easy ride, it has not yet had the degree of serious challenge that I think it is now facing with regard to deflation. In those circumstances, these minor quibbles one might have about communication and how the target is framed and interpreted could prove to be of the utmost importance.

  86. Can you say a little more about that? You are basically saying we are in a new world. Is the implication of what you are saying that the ECB's remit is not the right one?
  (Mr Bootle) There are several aspects that are worrying. It strikes me as being deeply disturbing that, from the papers I was sent, one of the questions before us is what is the ECB's inflation target. I find it very odd that we should be having a debate about what the ECB's inflation target is. There is an awful lot of confusion, following the revision. Some people think there was a change; others think there was not. Professor Issing has said that nothing is different and below two per cent is just a clarification of what we have been doing so far. That strikes me as being an extremely odd and potentially dangerous position when we are entering a situation where deflationary forces could become very strong. Similarly, there is a lack of clarity about why we are using the expression "price stability". Historically, one knows why this is. It is because of the inheritance from the Bundesbank and the obsession with fighting inflation but when the prime danger is deflation and when there are structural reasons within the expanded eurozone in particular—one assumes in due course the accession countries will join the euro—while some countries should have inflation somewhat higher than has been aimed for already, just parroting these words over and over again about price stability without clarity is extremely damaging. In particular, it reminds me of the position of the Bank of Japan. If the Bank of Japan had had clarity and other people had been clear about what its responsibilities were and there had been an open, full discussion of the problems, the possibilities, the tools, instruments and the dangers, I suspect Japan would not be in the position it is in today.

  87. Do you want to add to your opening remarks?
  (Professor Giavazzi) To put this in perspective, there are two successful central banks in the world. One is the Bank of England and the other is the US Federal Reserve. It is surprising how different they are. The Bank of England has a clear remit. It is accountable. It publishes an inflation report. The monetary policy decision making is very open with individual votes published. The Fed on the contrary, first of all, is not even independent. Congress could fire Mr Greenspan overnight. It is also a very discretionary institution whose success largely depends on the personality of the chairman. They are both successful so I do not think we have a single model of what a successful central bank is. I think we both share the view that we would prefer the Bank of England model because it relies less on personalities. If the next chairman of the Fed were less successful than Volcker or Greenspan, there might be trouble, but they are very different models.

Lord Sheldon

  88. We have a different target from the European Central Bank. How would you compare our kind of targeting with that of the European Central Bank? Should they not move closer to the sort of situation we have with the Bank of England? Should there not be some outside input into all of this? In Britain we have the government and the Bank of England. In the European Central bank they do not have anything like the kind of outside input which may be regarded as a deficiency. Do you regard it as a deficiency? If so, how should it be remedied?

  (Professor Giavazzi) I think it is very difficult to find an economist who does not think that targeting a specific inflation rate is the proper way to go for a central bank which does not keep an exchange rate target. The ECB has practically an inflation target although formally it is hard to follow what they do. First, they do not have a clear, symmetrical range. The up to two per cent rule is not clear. Professor Issing does not interpret the up to two per cent as symmetrical. Secondly, they have never been very clear about what the horizon is. We know that monetary policy works with lags of a year or a year and a half. They should be clear whether they are targeting inflation a year or two years down the road and they have never been. This may put them in a difficult position. Assume that inflation jumps up three months from now. They could be held responsible for this even if they do not have an influence on the situation. On whether the target should be given to them by the government or left to the Central Bank to decide, I would be concerned to let ECOFIN with 15 or possibly 25 finance ministers agree on the target. I would prefer simply price stability as the objective.

Lord Taverne

  89. I can see why Roger Bootle is worried about the deflation threat, but is not the record so far quite encouraging, suggesting that they may not make the mistakes of the Bank of Japan? Considering the fact that they rather disregarded this apparent indication of how they should go from the monetary figures and have sometimes acted to lower interest rates when the official signs appear to be that they should be acting against inflation, does this not suggest that they are aware of the inflationary dangers and one should be cautious and worried but not necessarily feel that a cataclysm is round the corner?

  (Mr Bootle) I think that is partly right. I mentioned in my opening statement that I think the facts belie the rhetoric and they do not warrant the criticism that has been made of them. They have been much more flexible in practice than you would think from the rhetoric. Nevertheless, they have displayed quite a lot of slowness in adapting to changing situations. We have already remarked on the poor communication skills and the confusion that has existed after interest rate decisions. Indeed, the confusions exist now even with regard to what the target is and how to interpret it. One thing one knows about countering deflation is that this is an intensely psychological phenomenon. The Bank of Japan is in a battle for people's minds. The way that there is so much confusion in the ECB and about the ECB does not lead one to be confident that in those circumstances it would act either well in advance or clearly enough to carry the system with it.

Lord Lea of Crondall

  90. We Have had several conversations, as you know, about this already. One of the recurrent themes is, to use the expression used by Roger Bootle, this theme of poor communication skills but I think the jury is still out on it. There are vested interests in what you might call the markets in journalism for wanting to say that there has been some ambiguity but even in America there is ambiguity. Somebody quoted—I do not know whether it was Volcker or Greenspan—at a press conference, saying, "If you have understood what I have just been saying I did not make myself clear." That is different from the Bank of England situation but we cannot have the Bank of England situation in the ECB, am I not right, for all the reasons about the politics of a large number of countries and in particular not everyone speaks English with the same nuance as we do. You simply cannot have "unelected bankers" and the democratic deficit problem made worse by doing it like the Bank of England do it. The same people who often criticise unelected bankers running Europe are very happy with the Bank of England so there is that difference as well, is there not, in not being able to do it like the Bank of England so we are left with this problem of what we call poor communication skills. Apart from nailing it down and saying symmetrical around two per cent, what is the substantive question behind these so-called poor communication skills?

  (Mr Bootle) There certainly are problems created by the multinational nature of the institution. It would not be easy to do things the way the Bank of England does them. I do not want to sound as though everything that the Bank of England does is wonderful and should be copied everywhere but quite a lot of features of the Bank of England system are pretty good. It is not just a communications problem. It is also now the proposals for the restructured voting which stem from the same source, namely the constant need to account for the different nationalities in the makeup of the ECB. There was a question earlier on from Lord Sheldon about outside input. It seems to me that, difficult though it is, there will be a lot to be said for the ECB tackling this issue by moving towards something more like the Bank of England position having independent experts on the committee and breaking away from the notion of national representation; and then some other form of institutional oversight, either at a different level or through the European Parliament has to cater to the question of national interests and accountability. Otherwise, I suspect whatever is done, whether in terms of the way the decisions are made in meetings, how they are presented in press conferences, what the voting structure is, all these things are going to be from a technical point of view distinctly sub-optimal.

  91. To gloss your response to Lord Sheldon, you would have a sort of two-tier system—these are my words, not yours—in the sense that you would treat the supervisory board as not having executive authority which would be for this other agency, which would be responsible?
  (Mr Bootle) That is probably what I would do.

Lord Marlesford

  92. I would like to go back to Mr Bootle's point on the Bank of Japan. Surely the essence of what has been happening there is that ten years ago Japan had a downward budget and it now has a deficit of about seven per cent. What has been happening there is that the Japanese government has been managing a slow deterioration of the economy by making the Bank of Japan buy up almost all the debt it has issued at very low rates of interest so in effect it has saved the Japanese people from depression. There is gloom in the boardrooms but there is not rioting in the streets. Investors have seen their paper fortunes decline very rapidly so it has been a very crucial operation which is quite impossible to have in the European set-up of the power of the government of Japan, which the government in Europe does not have, to require the static to finance effectively mega-Keynesian policies. Do you think that is right?

  (Mr Bootle) The Japanese situation is complicated. We do not want to get drawn very far down that particular byway but most people who have thought about this issue would argue that the failure to tackle deflation in Japan is essentially a political failure. It is a failure of institutions. There is not a technical problem about ending deflation. You ask yourself why the Japanese have been poor at doing it. I think a substantial part of the reason lies with the behaviour of the Central Bank. Its decisions have been poor. It has been extremely slow. It has been very confused, divided and just opaque about what it believes it is up to. It has not been a contributor to the successful fighting of deflation. You have in Japan a chronic problem which the text books will all tell you is a non-problem and is solvable at the drop of a hat. Why do they have this problem? The answer is institutional failure. That is the sense in which I was saying that I thought all these issues of what the target is, how things are voted on, how they are communicated could come to be critical.

  93. You mentioned the Bank of Japan but it is really the remit that central banks have. The crucial difference between the Fed and the ECB is the remit of the Fed is pretty simple. It is basically maximum growth consistent with stable prices. That is a remit which is certainly much more relevant to the present situation than the remit based entirely on inflation. In the case of the Bank of England it is a different one because it is the government which sees the growth part and it can change the targets at any moment on inflation.
  (Professor Giavazzi) The statutes of the ECB state that, consistent with having achieved price stability, the bank should support the general economic policies of the EU. As in the Fed and as in the Bank of England, price stability is at a higher pillar compared to growth, but they are both there and I think the wording is very similar. The interpretation can be different from one bank to another but the statutes are very similar.

  94. The Fed has no inflation target and that is very important. Once you give a central bank a public inflation target, that is what everybody looks at and that is what it judges its performance most on.
  (Professor Giavazzi) If you want to go by the books, even the ECB does not have an inflation target. ECOFIN does not give it an inflation target. The bank could tomorrow change the two per cent into three per cent. It is more flexible than the Bank of England in that sense and more similar to the Fed. They may not do it but formally they could, say, because of the entry into the euro of the countries of central and eastern Europe, which have higher structural inflation.


  95. Mr Bootle, would you give your views on the remit issue? Do you think the remit of the ECB ought to be changed to be more in line with the Fed?

  (Mr Bootle) I agree with what the Professor has just said. If you look at the articles, the wording is very similar to what is said for the Bank of England: without prejudice to the objective of price stability, to give support to the other policies which include growth, full employment and so forth. The problem is that there is very little agreement as to exactly what all this means. In one appearance before the European Parliament Duisenberg listed these other responsibilities which include the distribution of income and said, "Heaven knows what on earth people think the ECB can do about all this." There is an acknowledgement that there is this other set of objectives and yet there is a confusion about quite how in practical terms it should affect the ECB policy. That also exists in the UK. What precise status should there be given to that second set of objectives? In the UK's case, the way I interpret what has happened with the MPC is that as time has gone on that second, supposedly subsidiary, objective has taken on increased importance. No one has actually said it quite but the way that the MPC has acted has been to give that other objective more importance. According to the ECB statutes, the same thing could happen. The thing could be interpreted in such a way as to give growth more importance without necessarily having to change the wording. The problem is more the inheritance of the ECB. It had the Bundesbank inheritance round its neck from the beginning and the obsession of large parts of the European establishment with fighting inflation. Therefore, any hint of trying to give recognition to the growth objective was potentially dangerous. That is why one suspects it has not received due weight as an objective, but it seems to me that it could do, even under the present set-up.
  (Professor Giavazzi) The central banks all over the world which follow an inflation target regime produce inflation reports, and there is now an independent ranking done by academics of who does the best one. The Bank of England has come out number one. Surprisingly, the Central Bank of Brazil is number two. The Swedes did not come out very well; they are number seven or eight. These Reports are very helpful in forcing the bank to explain where they think inflation is going, where output and employment are going and therefore explaining what decisions they make. The ECB is getting there. Their projections are moving slowly in that direction. In my view, the bank should be pushed in the direction of developing these instruments that are very useful, the tools like inflation reports, and to compare the projections in the reports with those produced by other central banks and maybe put them in the ranking.

Lord Armstrong of Ilminster

  96. Do both our witnesses think that the ECB should give itself or be given a symmetric inflation target, a range around its central point?

  (Professor Giavazzi) Yes.
  (Mr Bootle) I certainly do.

  Lord Sheldon: Professor Giavazzi did answer my question but Roger Bootle did not come in about the question should there not be some outside input into the European Central Bank on inflation targets and how they should operate? There was mention about the finance ministries coming in.


  97. I think he did say there should be outside experts.

  (Mr Bootle) Yes, along the MPC lines. It is rather embarrassing to be banging on about how wonderful the MPC is but it would be better also if the inflation objective were not decided by the ECB but were decided from the outside and given to the ECB.

Lord Sheldon

  98. It is that "outside" that I was wondering about.

  (Mr Bootle) Who should it be?

  Lord Sheldon: Yes.


  99. That is the problem.

  (Mr Bootle) That is a serious problem to which I do not think I have a particularly striking or compelling answer. Bearing in mind the deficiencies of the ECB and the awkwardnesses of the way policy is framed and presented, for the ECB to be deciding on this itself is potentially very dangerous, particularly with regard to not just the form of the target but the target level. I do not think there has been enough debate about what the number should be at the centre of the symmetrical range. This goes to the point I made earlier about the deflation danger and why precisely they are aiming for the inflation number that they are. To aim for a number below two per cent for the eurozone as a whole is already imposing a substantial deflationary threat on Germany and, as and when the eurozone is extended to the east, that threat will be even greater. I would argue that not only should the target be symmetrical but it should probably be at a number a fair bit higher than two per cent in order to allow for that very factor. It goes again to what I said earlier about price stability. Why should the ECB be able to price stability accurately? It seems to me that there will be strong arguments as to why it should be aiming for something which involves a higher, positive rate of inflation. If it does not do that, it endangers a substantial part of the eurozone with regard to deflation.

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