The ESCB: independent, transparent and communicative
Speech delivered by Dr. Willem F. Duisenberg, President of the European Monetary Institute, at the Bankers’ Club Annual Banquet in London, 16 February 1998
Undoubtedly, the establishment of European Economic and Monetary Union is one of the most significant developments in the international monetary system in the last fifty years. Although the United Kingdom has decided to make use of its opt-out negotiated at Maastricht, whether "in" or "out", the introduction of the euro will have a significant impact on the UK economy. I should like, therefore, to devote the first few minutes of my speech to the question of the United Kingdom’s position on EMU. However, I have chosen as my main theme this evening to talk about a number of key features of the ESCB. The ESCB will be independent, and I shall try to explain the background to this and what it means. I shall also discuss the issue of how central bank independence can be combined with accountability, with transparency in decision-making, and the way in which the ESCB may conduct a fruitful dialogue - an exchange of views and information - with government ministers, European institutions (such as the European Parliament), social partners and the general public. These are, of course, issues with which you will be familiar in the United Kingdom, not least because they have recently been discussed in this country in the context of the establishment of new arrangements for the conduct of monetary policy by the Bank of England.
The UK decision to opt out
Let me say, first of all, that of course I respect the decision as regards the opt-out made at the end of last year by the UK Chancellor of the Exchequer. On the one hand, I think it is unfortunate that such an important country as the United Kingdom will not participate from the outset. However, it was useful to end the speculation and uncertainty that surrounded the UK’s position and I was pleased to hear that the government not only is in favour of joining EMU in principle, but also plans to assess this in terms of the economic benefits to the United Kingdom. The debate in the United Kingdom very often focuses on the political aspects or, if you want, the more psychological aspects of the matter. The Chancellor in my view rightly made it clear that EMU also needs to be assessed on the economic merits of the case.
As to the possible entry of the UK to the euro-area, I only want to mention very briefly one particular issue. That is the issue of exchange rate stability of the pound sterling. Even allowing for the fact that the United Kingdom is not a member of the ERM, which according to the Treaty is a criterion for entry to EMU, there has not been a high degree of stability of the exchange rate. Achieving lasting exchange rate stability will be necessary for the UK to be eligible to join the euro-area. In the future, this will require an increased emphasis on the exchange rate vis-à-vis the euro in the framework of the UK’s monetary policy.
I make this point not just for the sake of formality, because it is required in the Treaty. Above all, I say this for economic reasons: to strengthen credibility and inspire confidence in the irrevocable fixing of an exchange rate at a certain point in time, it is necessary that for a considerable period prior to that moment that exchange rate is perceived by the markets as stable, or "quasi-fixed", already. After all, this is the fundamental reason why the so-called exchange rate criterion was included in the Treaty in the first place. But let me now turn to the main subject of my talk.
Independence of the ESCB: the historical background
Before considering the independence of the ESCB as set out in the Maastricht Treaty, it is worth looking briefly at the historical background. Significant changes have taken place in the thinking with regard to the role of monetary policy in the last two decades. There has been a growing recognition, perhaps stemming from the turbulent experience of the 1970s, that in the long term monetary policy can only systematically control the price level and not real economic variables such as output growth or unemployment. Over a shorter horizon, monetary policy does indeed affect both real and nominal variables. However, it is by now widely accepted among policy-makers and in the academic literature that any deliberate attempt to exploit the short-run trade-off between prices and output is ultimately going to result in a permanently higher and more variable rate of inflation, with significant adverse consequences for resource allocation, long-run output and employment, productivity growth, as well as the income distribution.
Against this background, the primary goal of monetary policy has increasingly become the achievement and maintenance of price stability, with any other economic objectives receiving emphasis only to the extent that price stability is not endangered. This is a recognition of the adverse consequences of inflation and of the efficacy of monetary policy in this field, while at the same time being an acknowledgement that there are limits to what monetary policy can achieve. Primarily, the monetary authorities can support job creation and the attainment of higher living standards by fostering a stable macroeconomic environment in which business decisions can be made.
Partly as a consequence of this widespread consensus regarding the limits of monetary policy, there has been a tendency to delegate responsibility for conducting monetary policy to independent central banks, as the most appropriate way of ensuring price stability oriented policies. Modern economic theory emphasises the inflationary bias in economic policy, which relates in particular to the so-called time-inconsistency issue, i.e. the problem of convincing financial markets and the general public that the monetary authorities will resist the temptation to stimulate output growth in the short run by creating "inflationary surprises". The public may lack faith in the authorities’ promises to maintain low inflation if the authorities have succumbed to the temptation in the past. Unless these promises are underpinned by a credible form of pre-commitment, the equilibrium inflation rate will be higher than is needed, with no better performance in terms of output - and possibly even a deterioration.
As a solution to this problem, it has been suggested that responsibility for monetary policy be separated from political control and that this should also be enshrined in legislation. According to this view, central banks should be given the freedom to formulate and execute monetary policy in line with their primary objective as determined by the legislator. This allows central banks to take a medium-term orientation and not to be distracted by short-term political motives, an approach which benefits the credibility, transparency, predictability and efficiency of monetary policy.
In line with the foregoing analysis, more and more EU central banks - but also an increasing number of central banks outside Europe as well have over time been assigned the task of guaranteeing price stability, either explicitly by national law, or more informally as a reflection of an underlying culture of stability. In many cases, these reforms went hand-in-hand with the move towards a greater degree of central bank independence.
This rather broad consensus - both with regard to the role of monetary policy and the appropriate institutional arrangements for its conduct - had been broadly reached prior to the initiation of deliberations on the design of the future ESCB. In this respect, we have been in the rather fortunate position of being able to utilise and implement this consensus in the design of the future ESCB; the fruits of this quite long monetary policy "soul searching", so to speak, are evident in the design of the ESCB. Thus, in the institutional arrangements for Stage Three of Monetary Union, as set out in the Maastricht Treaty and the ESCB Statute, the primary objective - the maintenance of price stability - is stated explicitly. The Treaty also states that, without prejudice to this objective, the ESCB shall support the general economic policies in the Community.
Both the Treaty (in Article 107) and the Statute of the ESCB (in Article 7) contain very clear provisions regarding the independence of the ESCB. To quote a key sentence: "neither the ECB, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body". Moreover, the aforementioned authorities shall also - and I quote again - "undertake to respect this principle and not seek to influence the members of the decision-making bodies of the ECB or of the national central banks in the performance of their tasks".
For national central banks to become an integral part of the ESCB, Member States have to ensure that national legislation is compatible with the Treaty (Article 108) and the Statute of the ESCB (Article 14). This obligation of legal convergence does not require the full harmonisation of central bank statutes, but does insist that inconsistencies with the Treaty be eliminated in respect of features such as institutional, personal, functional and financial independence. With the exceptions of Denmark and the United Kingdom, this requirement applies to all Member States, including those which may initially be unable to adopt the single currency owing to insufficient economic convergence. Member States have made significant progress in recent years in amending their central bank statutes where needed in order to fulfil their Treaty obligations. For those interested in further details, I would refer you to the EMI’s report on legal convergence published last October, which contained a detailed account for each country of the provisions which would still need to be adapted. An update of this will be included in the EMI’s convergence report which is currently being prepared.
The importance of these institutional arrangements for creating an appropriate monetary policy setting in Stage Three of EMU cannot be underestimated. The essence of good monetary policy is a sound institutional design and I would like to illustrate this by reference to the following two arguments. First, these arrangements underline the continuity with the experience of those EU central banks with the most successful track record in terms of price stability over the past decades. In fact, in legal terms the ESCB will enjoy an even higher degree of independence than the most independent national central bank at present. Moreover, these legal arrangements are firmly anchored in the Maastricht Treaty and could thus only be changed by a Treaty revision. As you know, this is a very difficult and time-consuming procedure, involving both the European Parliament and all the national parliaments, which thus ensures that such a step is not taken lightly. This brings me to a second point, namely that initially the ECB will have no track record of its own, although it may inherit some of the credibility of the national central banks that are part of it. This implies that financial markets and the general public will assess the performance of the ESCB to a great extent on the basis of the effectiveness of the monetary policy framework adopted and the ability to act in accordance with its primary objective.
Taken together, these two arguments make it clear that the independence of the ESCB underpins the credibility and effectiveness of the single monetary policy and is thus a key condition for the maintenance of price stability in the euro area. Given this legal framework, the Governing Council of the ECB will be able to decide on the basis of its own judgement on the scope and timing of monetary policy actions and how they should be executed. Naturally, in its assessment the Governing Council will take account of a wide range of relevant factors - including the state of the economy in the Monetary Union - but always with the focus on price stability. This does not imply, as is sometimes suggested, that the secondary objective of providing support to the general economic policies in the Community has no real meaning. Nevertheless, under its mandate the ESCB can only pursue this additional goal provided it does not prejudice the primary objective of price stability. Moreover, as said, the best contribution monetary policy can make to a sustainable growth of income and employment is to pursue price stability. Price stability is not inconsistent with these ultimate goals of economic policy, but rather a pre-condition for their achievement on a durable basis.
The benefits of central bank independence have also been appreciated in the United Kingdom, with the recent granting of operational independence to the Bank of England. Nonetheless, there is an important difference between the "operational" independence of the Bank of England and the type of independence which the ECB will enjoy. The ECB will be free to choose the timing and the extent of adjustment of the relevant instruments, as the Bank of England is now, in order to pursue its objectives. However, the ECB will also be responsible for setting its monetary policy target; while in the United Kingdom the government formulates the objective, which the Bank of England has to pursue.
The ESCB: transparent and communicative
Central bank independence has already proved to be a key institutional ingredient for achieving and maintaining price stability. However, I think that we would all agree that independence needs to be complemented by accountability. As a matter of principle, in a democratic society there is clearly no room for a lack of accountability in public institutions, and the ESCB, being an important public institution, must be accountable. In turn, accountability requires effective communication, since otherwise it would seem difficult, if not impossible, for any central bank to be held properly accountable. I am aware that it has sometimes been argued that there is a so-called "democratic deficit" in the current arrangements at an EU level ; that the ESCB will be a powerful, but "unaccountable", institution. I disagree with this view. The ESCB cannot afford, any more than existing European central banks, to contemplate the conduct of monetary policy "in a vacuum". The ESCB has to be accountable, and this has to be underpinned by a high degree of transparency and an active communications policy.
But apart from the democratic duty of the ESCB to be accountable, coherence and being communicative also serve other practical purposes. For instance, well constructed and well explained monetary policies can influence the expectations of private agents, such as trade unions and employers. Market expectations are of importance for the effectiveness of monetary policy measures and clear as well as transparent and predictable policies may enhance and facilitate the conduct of monetary policy. Let me give you an example. If the central bank is known to react to excessive wage demands by raising interest rates, thereby stabilising prices at the cost of a temporary reduction in output and employment, the excessive wage demands may not occur in the first place. Thus, if economic agents understand how the central bank will react, the need for monetary policy measures - and the consequences in terms of foregone output and employment - may be substantially reduced.
In addition, coherent and well-explained monetary policies are also needed in order to enable the national authorities to conduct compatible policies. This applies, in particular, to the overall fiscal policy stance in the Monetary Union. Monetary and fiscal co-ordination may be difficult in an environment of unpredictable and poorly understood monetary policies.
Although the benefits of transparency and of being communicative are indisputable, the question is how best to organise such a process - and particularly a constructive dialogue with other policy-makers - as well as establish communication links with markets and the general public.
The current situation in Member States is that the governor of the national central bank finds a natural sparring-partner in the minister of finance, with whom frequent contacts exist, often on a weekly basis. Sometimes the question is asked, "who will the governor of the ECB have breakfast or lunch with?" (referring to the arrangements in the United States and the Netherlands). In the environment of Stage Three, the situation is more complicated, but the Treaty does contain some provisions in this regard. The President of the ECOFIN Council (and also a member of the Commission) may participate in the meetings of the Governing Council of the ECB, without the right to vote (Article 109b.1). The President of the ECB will be invited to take part in meetings of the ECOFIN Council when matters relating to the objectives and tasks of the ESCB are on the agenda (Article 109b.2). Furthermore, in addition to the national central banks, the ECB will participate with two members in the meetings of the Economic and Financial Council, the successor to the current Monetary Committee.
Since the ECOFIN Council also includes delegates of EU countries that do not participate in the single currency, the decision has been taken to establish a forum made up of representatives of participating countries. It is currently called euro-x, until the number of euro countries is known. In view of the fact that the institutional provisions of the Treaty do not mention the creation of a new Community body with restricted membership, such a forum can only exist in an informal capacity. It goes without saying that the statutory independence of the ESCB is not in any way affected by its deliberations. Such a forum may play a role in organising an efficient dialogue between the ECB and national governments of the euro area countries.
With regard to the currently envisaged arrangements, the President and the other members of the Executive Board of the ECB, at their own initiative or on request, may also be heard by the competent committees of the European Parliament (Article 109b (3)). In October of last year, for instance, I had the pleasure of addressing the members of the Monetary Sub-Committee of the European Parliament on the progress of the move to Stage Three of EMU and the main challenges facing the EMI in the near future. I have already been invited and accepted the invitation, to present the EMI’s convergence report, which will be released on 25 March 1998.
In order to facilitate the exchange of views, and to achieve its statutory objectives, it will be necessary for the ESCB to be as transparent as possible in its conduct of monetary policy. In addition to the means already described, the Treaty requires the ECB to publish an annual report covering the single monetary policy and other activities of the ESCB. The President of the ECB presents this annual report to the Council and the European Parliament, which on that basis could subsequently hold a general debate. For a fruitful dialogue with the ESCB it is crucial that its mandate of achieving price stability is respected and that it is acknowledged that it cannot be made responsible for short term employment objectives.
Reports on the activities of the ESCB will also be published during the year, at least quarterly, in addition to weekly financial statements. The ESCB will announce a quantified definition of what it understands "price stability" to mean in terms of its Treaty obligations. The publication of specific targets for monetary policy, and an explanation for any deviations from the target together with an explanation of the policy response, will facilitate an assessment of its policy performance. This will further add to the transparency of the ESCB and thereby enhance its accountability.
All these provisions - to which I may add the expectation that in the future there will also be many speeches to the public and statements to the press - will clearly promote the understanding of monetary policy objectives, intentions and actions. They thereby support the effectiveness of monetary policy. At the same time, the Treaty recognises that the ECB cannot be made responsible for outcomes in terms of inflation month-by-month, since there are lags between a change in the course of monetary policy and its effect on prices. Moreover, in the short term, the inflation outcome may reflect the incidence of certain temporary factors over which the ECB has no control.
To conclude, I have set out this evening to provide you with a description of some of the key features of the ESCB, which will be founded three months from now. The ESCB will be a powerful institution. Of that there is no doubt. It will be independent of political influence in pursuing the goal of achieving and maintaining price stability, as delegated to it under the Maastricht Treaty. The preparations and institutional arrangements are in place to enable the ESCB to fulfil its obligation to maintain price stability within the euro area. Monetary policy has, therefore, to be conducted and also be assessed in a medium term framework.
In the pursuit of its statutory objectives, it has to be an open organisation, so that the policies of the ESCB are clearly understood by national and European political bodies, financial markets and by the general public. The ESCB has to engage in an exchange of views and information with these parties. Ultimately, of course, the ESCB will be held accountable to the general public through its record of achieving price stability. And this accountability has to be underpinned by both the transparency of its monetary policy actions and an effective communications policy.