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The governance of the euro area (eight years on)

Speech by Lorenzo Bini Smaghi, Member of the Executive Board of the ECBat the round table organised byHEC School of ManagementBrussels, 27 February 2007


The fact that the governance of the euro area is frequently discussed in academic and policy fora could suggest that the issue has not yet been settled, i.e. that there is not yet a clear governance framework for the euro area.

This impression is wrong. The Treaty provides a clear governance structure for the euro area. The real question that one should address is whether the existing governance functions adequately and, if not, whether it should be changed or better implemented.

The existing economic governance of the euro area can be analysed from three main viewpoints: the policies, the goals and the institutions:


  • monetary policy

  • fiscal policies

  • structural policies


  • price stability

  • income stabilisation

  • sustainable long-term growth


  • European Central Bank (and Eurosystem)

  • Eurogroup

  • national governments

The governance of the euro area can be assessed on the basis of several criteria. I will concentrate on the criteria of effectiveness, accountability and efficiency. The following guiding principles can be adopted:

  • effectiveness is pursued by assigning each policy instrument primarily to one objective;

  • accountability is pursued by making each institution responsible primarily for one policy instrument;

  • efficiency is pursued by designing institutional cooperation arrangements that allow each institution to take spillover effects into account.

These principles are incorporated in the Treaty. As far as effectiveness is concerned, price stability is the main priority for monetary policy, cyclical stabilisation for budgetary policy and sustainable long-term growth for structural policies. Accountability is ensured in particular by the fact that monetary policy is the responsibility of a separate institution, the European Central Bank, which has to give a regular account of its actions. Cyclical stabilisation is assigned to national budgetary authorities and sustainable long-term growth to national governments. Finally, efficiency is ensured by a series of interinstitutional arrangements (in particular the Stability and Growth Pact) ensuring dialogue and cooperation between the various policy decision-makers.

I will limit my analysis of the efficiency of the current governance of the euro area to three issues: monetary policy, the interaction between monetary policy and budgetary policies and the exchange rate policy of the euro.

Monetary policy and price stability

The first eight years of EMU confirm that the choice to assign monetary policy one primary objective – price stability – has been correct. In fact, since the Treaty was signed and ratified many other industrial and developing countries have modified the statutes of their central banks to make them independent and to assign them a clear objective, i.e. price stability. Notable examples are Canada, the United Kingdom, Australia, New Zealand, Sweden, Norway and Israel. [1]

In none of these countries is there any more discussion on the issue of central bank independence and on the responsibility for price stability, whether in the academic or political sphere. Yet now in the euro area the issue of changing again the Treaty to give the ECB a direct responsibility for growth as well as price stability is occasionally raised, often just before elections.

It should be clarified from the outset that these proposals have very little chance, if any, of succeeding. The Statute of the ESCB, which establishes independence and the primary objective of monetary policy, is enshrined in the Treaty. The Treaty cannot be changed, except with the unanimous support of 27 countries. The recent debate surrounding the French election campaign seems to suggest that no other country has any desire to change the Treaty in this respect.

The discussion on changing the Statute of the ESCB might therefore seem fairly theoretical. In fact one could think that the issue has been raised precisely because it is theoretical and has no chance of actually being implemented.

What is then the reason behind this debate? One hypothesis is that by focusing the discussion on the ECB, the latter becomes the scapegoat for domestic policy shortcomings.

The main excuse that is given by those who ask for a change in the Statute of the ESCB is that the Federal Reserve System has a dual mandate, i.e. not only price stability but both price stability and growth. [2] If the ECB had a dual mandate – so goes the argument – it could implement a policy more favourable to growth, while at the same time preserving price stability. If the ECB had a dual mandate, it could – as the Federal Reserve System did between 2003 and 2004 – have pushed interest rates as low as 1%, thus giving a much greater stimulus to growth.

Let me briefly explain why it would be inefficient in the current context to change the statute of an independent central bank so as to give it a dual objective of price stability and economic growth. I will make four points.

First, neither the economic literature nor the empirical evidence provides support to the hypothesis according to which, ceteris paribus, a central bank can systematically implement an expansionary monetary policy that would stimulate economic activity without producing more inflation over time. Thus if the call for giving a dual mandate to the central bank is aimed at achieving systematically more growth, it is also implicitly an invitation to create more inflation. In fact, those that advocate a dual mandate implicitly suggest that inflation should be higher than the level targeted by the ECB (lower than but close to 2%). Indeed, some of these advocates even go to the point of suggesting that the ECB is “obsessed” by inflation.

But is it really?

European-wide opinion surveys seem to suggest the opposite. In the euro area, only a small minority of people consider that price stability is very well or fairly well ensured, while more than two-thirds think that it is not very well or not at all ensured. Furthermore, an overwhelming majority believes that it is important that the ECB preserves price stability and that the ECB should be independent in order to achieve this objective.

Second, it is now widely recognised that in modern economies with developed and efficient financial markets, the best way for monetary policy to support economic growth, in particular through low ex ante real interest rates, is for the central bank to be perceived to be credible in its anti-inflationary stance. The traditional analytical framework based on the Phillips curve shows that growth can be enhanced not by increasing inflation but by shifting the whole trade-off to more favourable terms by lowering inflation expectations. How can inflation expectations be lowered? By giving the central bank a clear objective of price stability.

Recent experience shows that interest rates can be at low levels in the euro area only because the ECB is perceived by the markets to be fully committed to price stability.

The third point is that the existence of a dual mandate is likely to reduce the transparency of monetary policy. In particular, any central bank with a dual mandate would have difficulties in clearly specifying the objective for price stability, in quantitative terms, without also having to specify an objective for employment or growth. However, defining ex ante a plausible combination of quantified objectives represents an impossible task, given that so many factors other than monetary policy can affect inflation and growth. If the central bank achieved one goal, but not the other, it would easily be subject ex post to criticism for having favoured one objective at the expense of the other. This is the reason why central banks with dual mandates tend not to specify, in a clear and understandable manner for the public at large, the quantitative definition of price stability for which it is accountable.

The fourth, and related point, is that a dual mandate cannot be easily reconcilable with the independence of the central bank. A central bank with a dual mandate would have to constantly choose ex ante between growth and price stability, assuming – again – that there was such a choice. If the central bank was indeed led to make such a choice, it would immediately be subject to the criticism that in modern democracies only elected representatives are allowed to choose between alternative objectives that affect the well-being of citizens. Specific policies can be delegated to independent non-elected institutions only to the extent that the latter have a very precise mandate. If the ECB did not have a very precise mandate, and was able to choose between two different and contrasting objectives, some would claim that it should be subjected to political guidance.

In fact, one could suspect that the request to provide the ECB with a dual mandate is ultimately motivated by the wish to reduce the independence of the ECB.

The analogy with the Federal Reserve System, which is often mentioned by the proponents of the dual mandate, is not relevant and is misleading for a number of reasons.

First, the statutes of the Federal Reserve System date back to the end of the 1970s and have not been modified since to take into account developments in the literature on rational expectations and the time inconsistency of optimal monetary policy, which are at the basis of modern central banking. On the other hand, even with a dual mandate, the Federal Reserve System constantly reminds market participants, the public at large and the political authorities that its objectives are price stability and growth and employment, “in that order”. [3] In all their speeches, Federal Reserve System Chairmen, lately Alan Greenspan and Ben S. Bernanke, have reiterated that the best contribution that monetary policy can make to sustainable growth is to ensure price stability in a credible manner. The latest discussions in the US Congress seem to confirm that the dual mandate might indeed be an obstacle for making the definition of the objective of price stability more explicit, as would be desirable from the point of view of the central bank’s accountability. Finally, there is now research that shows that in the recent cycle, controlling for the differences in economic structures and the nature of macroeconomic shocks between the United States and the euro area, the policy enacted by the Federal Reserve System has not been more supportive of economic activity than that of the ECB. [4]

To sum up, the governance of the euro area with respect to the ECB, its monetary policy and its objective of price stability have been clearly agreed in 1992 and ratified by all countries. It has become state of the art in industrial countries and is fully consistent with mainstream economic literature.

The bottom line is that there is no need to change.

Interactions between macroeconomic policies

I will not comment extensively on the two other policies, i.e. budgetary and structural policies. According to the Treaty, these are the competence of national authorities. There is nevertheless an issue of interaction among the various policies and policy actors, given that these policies might affect not only the objective that they target primarily but also the other objectives. The interaction takes place at two levels: i) at the European level, among the various European institutions; and ii) between the European and the national levels, for a given policy.

At the European level, the interaction between the authorities in charge of monetary, budgetary and structural policies is well codified in the Treaty. This is also consistent with the mainstream literature and with the experience in most industrial countries.

The main goal of the interaction is neither to blur responsibilities nor to make pre-commitments between independent institutions but to ensure an appropriate exchange of information so that each policy can be conducted on the basis of the best possible knowledge of the economic environment. The exchange of information between the ECB and the finance ministries takes place in various fora. Every month the ECB President attends the Eurogroup meetings. These meetings are prepared by the Euro Working Group, which comprises the deputies of the euro area finance ministers and ECB representatives. Furthermore, the President of the Eurogroup and the Commissioner for Economic and Monetary Affairs are invited to attend each meeting of the ECB Governing Council, which takes place every fortnight. This allows both of them to be at the core of monetary policy-making, obviously without the right to vote, and to benefit from all the discussions leading to the final decision. This arrangement is without analogy in other industrial countries.

Any meeting between the ECB and the Eurogroup can be held at any time, if needed, to discuss issues of relevance.

The dialogue between the various European institutions takes place with due regard to the independence of each and works appropriately. There appears to be no need to formalise in any bureaucratic way the format of the dialogue beyond what is already provided for.

The second type of policy interaction is between the European and national levels, in particular in the Eurogroup. Budgetary policies are conducted at the national level, in the context of the coordination process provided by the Stability and Growth Pact and the Broad Economic Policy Guidelines. One question to be asked is whether such policy cooperation is effective and efficient in achieving the desired objectives, such as income stabilisation and sustainable long-term growth.

I will not address this issue today. I would just note that some people have expressed disappointment at the way in which the Eurogroup has been able to exercise its prerogatives in the budgetary field. Some progress has been achieved over the years in terms of improving the functioning of the Eurogroup, for instance by lengthening the term of its presidency from six months to two years.

The call for creating some sort of European economic government is frequently proposed. However, these calls have never really been substantiated with concrete proposals, aimed at effectively improving the conduct of national budgetary policies and at implementing a coordinated policy action at the euro area level. I recently made some proposals, related in particular to the way in which budgetary policies are prepared in the Member States, with a view to taking better into account the European dimension and the interaction with budgetary policies conducted in other countries. [5] The problem is that the Member States, including those that have been calling for a strengthening of the Eurogroup, have resisted adapting even their national budgetary procedures to the European context.

Overall, there does not seem to be any desire within national or European policy circles to shift decision-making powers from the former to the latter. Incidentally, the prevailing economic literature does not support such a move. [6]

In this context, the suspicion may arise that the call for such a government is motivated mainly by the attempt to exert influence on the ECB’s monetary policy.

A final word on international economic policies and cooperation. In this field the euro area member countries continue to exercise their national sovereignty separately, in the IMF, the G7 and other fora. Some coordination takes place to try to achieve common positions, but the degree of success is unequal. Although the current situation is quite inefficient and does not allow for synergies to be maximised, there is still strong resistance within some policy circles to a more unified and consistent approach.

This is why, in my personal view, the euro area has a political role that does not match its potential, in light of its population of over 310 million and a GDP comparable with that of the United States. [7]

Exchange rate policy

The governance of the euro area on exchange rate policy is specified in the Treaty. The choice of exchange rate regime is made by the EU Council of Ministers, after consulting the ECB in an endeavour to reach a consensus consistent with the objective of price stability. It was decided at the start of EMU that the exchange rate regime of the euro would be a purely floating regime, similar to that in other major industrial countries.

In the current regime, the responsibility for conducting foreign exchange interventions is exclusively the competence of the ECB. The EU Council, acting by qualified majority, can formulate general orientations for exchange rate policies. It can only do this on a recommendation by the European Commission or the ECB. These orientations cannot be in contradiction with the ECB’s primary objective of promoting price stability. No general orientation has been given thus far.

Arrangements in the euro area differ somewhat from those in other major countries, such as the United States and Japan, where the responsibility for foreign exchange policy, including interventions, is within the competence of finance ministries. However, experience has shown that the euro area arrangements are fairly balanced and are consistent with the way in which financial markets work in advanced economies. Indeed, the involvement of the central bank, and consistency with monetary policy, is essential for the effective implementation of any foreign exchange policy. In addition, any foreign exchange policy, including intervention in the foreign exchange markets, is likely to be ineffective unless it is agreed with the other major partners, in particular the G7.

In the euro area, the decision concerning foreign exchange interventions remains exclusively with the ECB. There is a strong interaction with the Eurogroup, with a view to achieve a common position with the other main partners, in particular the United States and Japan. The euro area has always acted united in the relevant fora, such as the G7, where common positions on exchange rate issues are achieved and expressed in public, in particular through the G7 communiqués. From this point of view, the present arrangements are working properly, and even better than in some other countries.

To be effective, policy messages on exchange rates have to be consistent, within institutions, between institutions and across countries. This is the main reason for having G7 communiqués, so that they can be used consistently by all G7 members for consistent public communication. For the euro area this would imply that public communication on exchange rate issues should be conducted mainly by the President of the ECB and the President of the Eurogroup, consistent with the practice of the other main partners. The members of the Eurogroup should thus align their communication to the message agreed between the ECB and the Eurogroup Presidency.

When euro area finance ministers express themselves on exchange rate issues in terms that differ from each other and from the agreed euro area and G7 positions, the most likely outcome on financial markets is the opposite of that intended. Indeed, market participants interpret differences in words as potential disagreements between policy-makers and tend to push rates in the opposite direction to that desired by the authority making the statement. This confusion also undermines the authority of the President of the Eurogroup to speak on behalf of the euro area finance ministers.

Overall, although the current arrangements on the exchange rate policy of the euro area are well designed, they probably need to be better implemented, in particular to achieve more stringent verbal discipline.


To conclude, there is a clear framework for the economic governance of EMU. It is fully implemented as far as monetary policy and the coordination between the ECB and the Eurogroup is concerned, in particular with respect to exchange rate policy.

There is certainly room for improvement in several areas. The first is the coordination, within the Eurogroup, of budgetary policy, to improve the conduct of national policies. The second is the external representation of the euro area, in particular in international financial institutions.

  1. [1] In the case of Canada, Israel and New Zealand, the adoption of an inflation targeting scheme was agreed on slightly earlier than the signing of the Treaty.

  2. [2] In fact the Federal Reserve System has a triple mandate, as it has to ensure low long-term interest rates.

  3. [3] As FOMC member Anthony M. Santomero was quoted as saying in the Financial Times of 30 September 2005.

  4. [4] See the article entitled “Monetary policy “activism”” in the November 2006 issue of the Monthly Bulletin.

  5. [5] See “Decision-making in the euro area lacks synchronisation”, Financial Times, 8 September 2005.

  6. [6] See, for instance, Bini Smaghi and Tabellini (2003), “How to Improve Economic Governance. The Coordination of Macroeconomic Policies in Europe”, Aspen European Dialogue, February.

  7. [7] See “Powerless Europe: Why is the Euro Area Still a Political Dwarf?” International Finance, 9:2, 2006.


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