Currently the ECB is taking strong criticism from bankers and economists on one side, and from citizens and politicians on the other. That is a new experience for the ECB, which has been more accustomed in the recent past to having its actions hailed with cheers.
Investors have responded to the meltdown in the return on fixed income investments by moving to equity investments, which are more expensive and more risky than they were, thanks to increased uncertainty about financial and economic stability. Extremely low interest rates prevent desperately needed structural reforms in euro countries with high deficits and debt.
In short, the ECB is undermining financial stability and inhibiting structural reforms.
Is this high price for the side effects of the ECB's policies nevertheless an acceptable price? Does the monetary policy of the EU have a visible positive effect on the economies of its member countries?
The official aim of ECB policy is not to stimulate the economy, but to raise inflation to 2%, and it is not working, despite massive and recently increased liquidity injections. Inflation is the result of excess demand in the real economy, but demand is currently stagnating because many companies first have to reduce debts before they can proceed with investments (Baldwin and Giavazzi 2016).
Euro countries are also facing decreased Chinese growth, and the dramatic drop of the oil price. The central bank’s low interest rates hardly affect these processes. Liquidity can facilitate the demand for goods and services with liquidity, but it cannot force it.
When inflation is too high, central banks increase interest rates and create a liquidity squeeze to bring it down. Very low ECB interest rates, on the other hand, are clearly not pushing up inflation, which remains subject to supply and demand conditions in the real economy. In motoring terms the ECB is giving the economy more gas, but the clutch doesn't work, and the car does not move. A slipping clutch like this creates a lot of smoke (Eijffinger 2016a).
We can conclude that national governments should take more responsibility for Europe's economic recovery. So far the ECB has been doing the dirty work, but ECB president Mario Draghi is now feeling the disapproval.
So leadership has to be taken over by the strong euro countries — Germany, Finland, and the Netherlands — while the ECB supports their actions with monetary policy. The agenda of the Eurogroup, headed by Minister Jeroen Dijsselbloem, should dominate, with the help of the European Commission and its 'Six Pack' powers. This goes beyond monitoring the Stability and Growth Pact. Those strong countries can establish sound stimulus packages and tax measures. So far the existing Juncker plan has not taken off, and so Europe is in stalemate, though with pressure on countries like France and Italy to reform their domestic economies. This plan should now involve a trade-off between France (€50 billion of reforms) and Germany (€50 billion of stimulus), with supplementary investments by the European Investment Bank.
Also, let's establish a presidium within the Eurogroup, with the French and German ministers providing a leading role for the Franco-German axis, permanently complemented by Draghi, his vice president Vitor Constancio and the president and one vice-president of the European Commission. This should increase the weight of the Eurogroup, and allow it to work more closely with the ECB and the European Commission to implement coordinated stimulus and structural reform measures. Germany has also to give priority to a modest budget deficit, and to invest more in infrastructure and research and development investments. The Netherlands should do this as well, with a provisional exemption from the pursuit of a structural deficit of 0.5%. But these investments depend on France, Italy, and other countries to implement the necessary structural reforms. The ECB could increase interest rates later, in coordination with the Eurogroup. A small forum like this presidium (Eijffinger 2016b) is the best way to plan this.
This informal presidium will lead to a European finance minister, provided Europe's citizens and politicians are ready. Former ECB president Jean-Claude Trichet has pointed out many times that the Eurozone cannot function without a fiscal union, and that means a European finance minister as the logical consequence (Financial Times 2011).
Europe, then, will need its own Alexander Hamilton (the first US Treasury Secretary, who was in office from 1789 to 1795). A union of this type isn't just about existing and new debt, but it will also impose strict balanced budget rules for national governments. This will require a transfer of national sovereignty to the European level. Currently, this is unrealistic.
It may be politically impossible now, but a European fiscal union is the only structural solution in the long run (James and Sinn 2013). The Stability and Growth Pact that we have at the moment, supplemented by the 'Six Pack' powers, is only a 'second best' solution. Under it, the Eurogroup goes from crisis to crisis. Brexit, and the recent Italian banking crisis, mean that there is little appetite for tension within the Eurogroup.
Therefore, why not establish an informal presidium right now, in which the Eurogroup, the ECB and the European Commission cooperate closely to implement coordinated stimulus and structural reform measures? The European Monetary System (EMS) has been a necessary stage leading up to Economic Monetary Union because within the EMS policymakers can learn how to coordinate incentives and structural reforms.
The history of European integration has always shown that we need a 'goldilocks' crisis – not too big, not too small – to make the next leap forward. This is particularly true for a European fiscal union. So when will we finally get a European Alexander Hamilton?
Baldwin, R and F. Giavazzi (2016), How to fix Europe's monetary union: Views of leading economists, VoxEU eBook, 12 February 2016, CEPR, London.
Eijffinger, S (2016a), “The ECB Goes Rogue”, Project Syndicate, 18 March 2016.
Eijffinger, S (2016b), “Perspectives of Risk and Liquidity for the New Global Economy Scenario”, Keynote Lecture, 51st Colombian Banking Summit, 2 June 2016, Cartagena (video: https://vimeo.com/174214834/67e3e80808 and slides: www.sylvestereijffinger.com)
James, H and H-W Sinn (2013), “Mutualisation and constitutalisation”, VoxEU column, 26 February 2013, CEPR, London.
Financial Times (2011), “Trichet seeks single EU finance ministry”, 2 June.