Select Committee on European Union Minutes of Evidence

Examination of Witness (Questions 191-199)




  191. Welcome. Thank you very much for coming. As you know, we are doing this inquiry on the European Central Bank (ECB). What are your general views about how the ECB has done? Perhaps you would like to kick off with a short general statement.

  (Professor Draghi) First of all, thank you very much for inviting me here; I am honoured to be here. To answer this general question broadly, ECB has done fairly well overall. In a sense it has improved very much over time, partly because of its novelty. At the beginning, in the first six to nine months of the new currency, it was very bumpy. The new financial product had been oversold, it was not widely understood, and it was certainly not very easy to run a monetary policy in a much more complex setup. More complex in having a multi-country framework than one-country framework for most of the national governors. So the first nine months were particularly trying. Over time the monetary framework has been constantly reviewed, more in practice and in substance than in its formal wording, and in its capacity to look after its own actions I feel that overall the experience of these first few years has been positive. There are many things which can be and certainly will be improved. To give you an example, the most recent monetary policy strategy review has shown a certain pragmatic approach by the Bank, especially by the Bank's executive board, in revising those aspects of the monetary policy framework which have not worked very well. That is what makes me confident that the future is certainly going to be better than the last few years. Let me add one set of marginal considerations. There is also a psychological aspect. With any brand new institution, there is obviously an initial period where people learn by doing, but the more they learn and the more they become self-confident, the more pragmatic they also become and ready to fix what is wrong. Rather than taking the stance many of my colleagues have taken of being over critical of everything the ECB has done over the last few years, I would judge it dynamically. My sense is that things can only improve.

  192. Things can only get better.

  A. I think so. All in all, even if they can improve, if you judge the monetary policy on average over the last three years, it is not that far off the mark.

Lord Sheldon

  193. Have they not been fortunate in their timing? If they had been set up ten years ago, they might have found it much more difficult to deal with the world economic situation through banking procedures than they have done more recently. The timing seems to have been very fortunate, has it not?

  A. I would say that it has been a fortunate time for all policy makers, not just for the ECB. They are now starting to discover how lucky they have been. This is absolutely true. They, like others, have been fortunate. Even so, let us ask ourselves whether they could have done better during this fortunate time, between, say, 1999 to 2001. Let us assume that the first six or seven months were important for learning and let us ask whether they could have done better during the last fortunate 24 months at the end of the 1990s. You will remember that the ECB was widely criticised, especially in the United States by our American colleagues, for being too cautious and for reacting to events much more slowly than the US Fed had done and actually are still doing. The monetary style of the ECB is radically different from the monetary style of the Fed. Have they been too cautious? With the benefit of hindsight now, we would not say so. We would say they were just on the mark. Could they have lowered interest rates more when the Fed was much more aggressive? They refused to do so, because they were afraid of inflation. Inflation did not materialise, but at the same time the case for lower interest rates in the year 2000 and beginning of 2001 is, with the benefit of hindsight, now much less strong than it looked at that time. I would say they have been fortunate, but they have also done fairly well during that period.

  194. Given that they were fortunate in the past, one cannot assume that good fortune is going to continue. What we need to see is how they are equipped to deal with the problems of the future. Should there not be some sort of oversight as to how they are doing things? Should they not have some accountability to some other body?

  A. In a sense they have improved their way of making monetary policy. The fact that during their last monetary policy strategy review they seemed to have—I would not say abandoned—de-emphasised the first pillar, the growth in M3 pillar is a sign that they are improving their monetary policy framework. The other thing to consider to a lesser degree is that their capacity to analyse the euroland economy in aggregate has improved substantially. One of the things which came out quite clearly during the first six or seven months of experience was that the euroland economy was not simply the aggregate of different national economies, but it was a much more complex and dynamic reality. The whole of euroland was changing, trade patterns were changing, labour flows were changing, the behaviour of prices was changing once it opened, once it had adopted the single currency. So what used to be a very useful knowledge of the single nation states' economies turned out to be insufficient to analyse the newly financially and monetarily integrated area. From this viewpoint, the European Central Bank has adapted its capacity to analyse. My sense is that they are well equipped to deal with future challenges. Your second point: should they not be more accountable? I know this is a point which is very frequently made. When people make this point, they may mean several things. They may mean, for instance why should they be the ones who set up their inflation target? In many other contexts it is not the central bank which sets the target. Ideally I would agree with this criticism. The problem with this is that the Treaty is quite specific in designing the ECB's remit. If we wanted to change that, we would have to change the Treaty. Is there a good case for changing it? Again, ideally yes, but practically let us consider what the alternative could be. Let us imagine for instance that the new euroland inflation rate were to be fixed by the eurogroup. There you have 12 finance ministers, each one strongly convinced that their own country's interests are to become the European interests; each one, because of his national interest, is less keen to give in to other countries' views. A European inflation rate set by a body made up of 12 finance ministers seems to be, to me at least, a fairly complex, possibly cumbersome process. If the inflation rate were to be set by other bodies like the Commission, it would be even less accountable than the ECB, because the Commission is made up of non-elected officials. Even though I share this criticism, especially when we compare this framework with other countries' monetary policy frameworks, both the objective difficulties of amending the Treaty and the practical difficulties of having a process working to produce a reasonable outcome make me think that it is kind of hard to change the present framework into something which is more accountable.

Lord Hannay of Chiswick

  195. Basing myself a little bit on your original analysis, which was that the ECB had been in practical pragmatic terms rather successful in moving its monetary policies a little bit and the way it applied them, but not affecting the form and so on, do you think that there is any risk that what one would be tempted to call a very Anglo-Saxon practical approach is lacking in transparency and therefore lacking in public acceptance and understanding? Indeed it is not so much accountability only that we need to think about, but it is also transparency and understanding by the markets of what they are really doing. It does seem to me that they have made some shift in their position, or something pretty close to a symmetrical inflation target, but they have not said so. Do you think there is any risk in going on in that way, that there ought not to be a greater effort by the bank to explain its thinking a bit more clearly? The second question, which is not to do with that at all, is that I would be very interested to hear your views on whether you think that the bank should, either itself or more likely on the mandate of the eurogroup ministers, be doing anything at all to try to influence the exchange rate of the euro against the dollar, or should it simply recognise that it is neither part of its own remit, nor in the interests of the eurozone to get into that business?

  A. On your first point, we should distinguish from the start two different issues. The first one is communication and the second one is transparency. In terms of communicating its own views and intentions to the market, the ECB has learned a lot. One could safely say that in the first six to nine months communication was certainly not an art in Frankfurt. In fact many of the criticisms levelled against the ECB at that time were really comparing how good a communicator Chairman Greenspan was with how poor a communicator ECB was. Later on, things improved markedly. For instance, consider now the change in the monetary policy framework which has evolved from the last monetary policy strategy review. There is an emphasis on the M3 growth pillar, but there is also a more symmetric approach to the inflation rate targeting. They have not said that, but they have said that they would consider any inflation rate below one per cent to be undesirable. Having combined the two statements of aiming at the two per cent inflation rate over the medium term with a one per cent floor, markets have now considered and are viewing a 3.5 per cent inflation over the medium term as the range within which the price changes would be tolerable. Of course the price changes, which would be viewed as exclusively temporary, would also be considered, even though outside that range. In terms of the changes in price, which would be viewed as permanent, market expectations have adjusted around this value of two per cent. At least that is what we see in the market practices. So from a communication standpoint, in a somewhat rather indirect fashion, the ECB has now succeeded in being understood by the markets. The transparency issue, however, goes beyond communication and, for instance, deals with the fact that not only markets, but also other participants in the political process in Europe, would like to know how a certain decision is reached. So transparency would have to take issue with aspects such as whether the ECB should publish their minutes and whether the names of the individual participants behind the decisions which are being taken should be visible in the minutes. In other words, should the voting members be named publicly? Ideally, again I think the answer is yes. Certainly the minutes should be published. Whether the names should be made public: here the arguments for or against go both ways. Some people argue that if the names are to become public, people would become even keener to represent their national interest. They would not want to be viewed by their fellow countrymen as going against the national interests. Others would argue that the people who sit on the governing council have usually led lives with high ethical standards. Thus they would understand that once they sit on that council, they really represent the interests of Europe and would in a sense be more reluctant to see their names associated with a petty narrow defence of their national interests, rather than being viewed as champions of Europe. So I could argue the other way round and say that publishing names could help the case for transparency and could make these people glad to be viewed as champions of Europe. All in all, I should be in favour of publishing the minutes of the meetings. Is this an insurmountable obstacle? No. It can be overcome easily. It does not have anything to do with the Treaty, it has to do wholly with the ECB's practices. Do I believe it will be overcome? Yes, I do. This goes back to the case I made for greater self-confidence. I am absolutely sure that as the institution becomes more and more self-confident, issues like publishing the minutes and being more transparent and abandoning certain defensive behaviours which we have seen in the past will be resolved. On the second question about the exchange rate, what I believe is that the ECB should not have an exchange rate target. All our previous experience shows that it is pointless, and it is very often a source of serious policy mistakes, because the target is wrong. It is often, almost always, an unenforceable target. So I do not think there should be a target. Should the ECB be indifferent to what happens to the exchange rate? The answer there is no, it cannot be indifferent. The reason is that the most relevant aggregate in judging whether a certain policy, is friendly to business or is restrictive, should look at several variables, not only interest rates but at the short and long-term interest rates, should look at stock markets and how they behave and should look at exchange rates. In our company we have elaborated what we call an index of financial conditions and a good example of why we should look at all these variables, a good example of the usefulness of this index, is given by recent events. In euroland interest rates went down a little, but the exchange rates appreciated. The overall result on financial conditions, even though the stock market went up, was that they certainly were not more expansionary than they were six months ago. In a sense the very same thing could be said in the United States, or could have been said until a month and a half ago, before the stock market went up. The Fed lowered short-term interest rates dramatically. At the same time long-term interest rates went up, so the financial conditions index, especially combined with the ever strong dollar, has not become significantly more expensive. What changed that, was that the stock market then rallied and financial conditions are now slightly better, more expansive than they were six months ago. The ECB cannot be indifferent to the exchange rate. In other words: should the ECB or any other central bank try systematically to affect the level of the exchange rate towards some ideal level? No, I do not think so. Let me add something. It has always been very difficult to steer exchange rates towards ideal targets or ranges, but nowadays it is practically impossible, unless there is a multilateral concerted effort by all central banks, primarily the Fed towards this target. That simply is not there. Even in a multilateral framework, we have seen cases of failure. If we consider the multilateral intervention carried out in autumn 1999, when both the Fed and US Treasury and the ECB and the Central Bank of Japan all intervened to prop up the rapidly fading euro, it did not produce any outcome, because capital markets are simply too big now.

Lord Geddes

  196. The highly commendable clarity of your answers so far may have overtaken my first question. In your opening statement you said that the ECB could only get better, which immediately triggered in my mind: so what is wrong? You have to be better than something. To a large extent I think you have answered that already to Lord Sheldon and others. If there is anything else in that very general context, what is it that you think could be better? May I then quickly get in a second specific question. What do you consider to be the role of the European Parliament in the appointment of governor and members of the board? At the moment, they are consulted. Should they have the right of veto?

  A. As far as I am concerned the ideal answer is yes. You want to increase democratic accountability.

  197. You are saying yes, to my second question are you on the European Parliament?

  A. Yes, the European Parliament. Sorry, what was your first question?

  198. You said that things can only get better. My question is: better than what? But you may well have already answered that.

  A. I think I probably have, but I will start with the second question. Yes, ideally. As far as I am concerned at least, I am still in favour of increasing democratic accountability of any institution of such importance which is run by non-elected officials. Should the European Parliament be in a position to reject a candidate to the board for instance? I do not recall exactly what the specific words of the Treaty are, but my sense is that there are certain limitations that the Treaty would place on this process. The Treaty is quite specific on how the board members should be appointed, whose prerogative it is to appoint the board members. It cannot easily be adjusted to encompass a more active presence of the European Parliament. Suppose now that we move from the present state and we give the European Parliament the right to confirm or reject appointments. Then we would face a legal vacuum, because the European Council, the council of European prime ministers and heads of state, would say this was their own prerogative. The European Parliament presently has no right to reject or confirm. My sense is that we would have to change the Treaty to give the European Parliament this right. Should we do this ideally? Again, probably the same considerations I made about the eurogroup would apply here. Ideally yes, I think we should, but if we consider what euroland is nowadays, it is still an ensemble of different nation states. Are we sure it would work towards a common goal as spontaneously, effectively and speedily as we would certainly want a process for confirmations or rejections of such important appointments as the ECB appointments to do? Are we sure? I am not sure it would do so in any time frame. Should I resist any request for greater democratic accountability just for the sake of expediency? No, I would not consider this a good answer.

Lord Lea of Crondall

  199. As the Professor is undoubtedly aware, the debate in Britain about these matters is still stuck in the Stone Age as compared with the sort of discussion we are having at the moment. The big question in popular discussion is that one-size-fits-all is nonsense and it cannot work and what about Germany? Everything is thrown into that pot. When you said that you thought it was doing okay, pretty well, not too bad, did you mean to exclude the a priori question that you have to take as a given that one-size-fits-all? Were you just talking about the technical competence of the ECB, given all the givens that lay behind that? That is my first question. My second question may follow your answer to that, if you would perhaps comment on that first. Which was it you were commenting on? Was it the a priori points or the technical points?

  A. I think the two points go together hand in hand. The reason I say that is that if we are to have a one-size-fits-all, just one central bank, for probably what is to be the largest financial area in the world, one central bank works and one currency works only to the extent that the various parts of this very large area trade a lot together, that labour and capital flow freely and to a much bigger, much greater intensity than they do today. The one currency bet relies on our capacity to improve our labour mobility; that is also a partial answer to the last question. It is a gamble on our capacity to increase our labour mobility, to increase and expand dramatically our internal trade volumes and our financial flows. But this does not occur naturally simply because we have one currency. Certainly one currency helps. It has removed the foreign exchange uncertainty, but it is not enough. If we want to be the one capital market, we need to proceed with one financial legislation in all capital markets. When I say one, I am perhaps making too dramatic a case, but basically in all financial legislation there is a set of principles and rules which to a great extent cover financial legislation. You can have different countries, with different specifics in each country. That would not change the essence which is that one should have the same takeover rules in all the areas of the Community. We should not have a union with different takeover rules, where countries can defend themselves or their national champions from other companies from other countries or things of this nature. For instance, when we go to financial markets and capital markets, you need the same standards of transparency. When companies list themselves on the stock markets, they should be asked the same kind of questions all over Europe. The issue then is why we cannot find an agreement on something which is so simple. It is conceptually simple, because everybody in the Union should be able, if he or she speaks in good faith, to say which country has the best financial legislation and which one has the worst. So conceptually it should be simple to adopt the best financial legislation for all. And so on, even though the issues would become more complex in the labour market; politically complex, not conceptually complex. The goal of all this effort should be the adoption of the best financial or labour market or best legislation for each section. Instead of looking for national champions, let us look for what is best practice and adopt it. If we lose that gamble, the concept of one currency becomes fragile.

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