Select Committee on European Union Eighteenth Report



108. The ECB has set short-term interest rates on the basis of an inflation target of 0-2 per cent annual growth of the harmonised index of consumer prices (HICP) for the euro-zone. The interest rate[93] was initially set at 3 per cent in December 1998. It was cut to 2.5 per cent in April 1999, raised to 3 per cent in November 1999, then successively raised to:

  • per cent in February 2000;

  • per cent in March 2000;

  • per cent in April 2000;

  • per cent in June 2000;

  • per cent in August 2000;

  • per cent in October 2000 (the rate in force when this Report was drafted).

109. As Figure 1 shows, short-term interest rates in the euro-zone have consistently been lower over this period than those in the United States or in the United Kingdom.

110. Dr Duisenberg, the President of the ECB, has explained[94] that its decisions were taken "to counteract the emergence of risks to price stability in the euro-zone" which had been shown both by monetary analysis (showing of "very generous liquidity conditions in the euro area") and by the analysis of other indicators (showing that the strong increase in oil prices and the depreciation of the euro were putting pressure on prices). For the Deutsche Bank Group, Dr Walter rather surprisingly described the seven consecutive increases in interest rates after November 1999 as "courageous", adding:

    "The analysis and reasoning that led to these decisions were well considered. On top of this, the ECB deserves credit for excellent timing" (p 122).

The German Ambassador considered that the ECB had reacted correctly by tightening monetary policy when upward price pressures appeared: equally, it had not over-reacted (Q 300).

111. In reaching its decisions, the ECB uses a two pillar approach, the first pillar being monetary growth (with a 4½ per cent reference value—not a target—for the annual growth rate of the broad monetary aggregate M3), and the second being a broadly based assessment of non-monetary indicators[95]. Dr Walter pointed out that the ECB's money supply reference value was less stringent than those which the Bundesbank used to apply, allowing more flexibility. He also suggested that the markets found difficulty in predicting the ECB's decisions because it did not reveal which of these two pillars had more weight in the decision-making process (p 123). But the Governor of the Bank of England did not think that the twin pillar approach of the ECB affected market confidence; it was inherited from the Bundesbank, and the practical difference from the Bank of England's apparently single pillar approach was very small, since in practice the Bank of England did "pay very great attention to monetary developments" (Q 284).

112. There had been recent suggestions that the ECB should take asset prices into account in deciding on the rate of interest[96]. Professor Minford considered that when central banks had taken asset prices as a guide, monetary policy had gone "incredibly badly wrong". He instanced the behaviour of the Federal Reserve Board in 1928-29, and that of the Japanese Central Bank in 1989: in both cases the policy had had the effect desired by the central bankers, but with disastrous effects on the economy, producing undesirable structural reforms. In his view:

    "What monetary policy ought to do is look strictly at the economy. Asset prices, after all, reflect the market's valuation of future profits. If future profits are thought by the markets to be high and asset prices consequently higher, I see no reason at all why monetary policy should worry about it" (Q 219).


113. Article 105 of the EC Treaty reads as follows:

    "The primary objective of the ESCB[97] shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2[98]".

But the concept of price stability is not defined in the Treaty. And there is no doctrine on how the other specified objectives should be taken into account.

114. Dr Duisenberg has said[99] that the Treaty laid "a very solid" foundation for the successful conduct of monetary policy in the euro area, because it established a clear hierarchy of objectives, whereas "in the past, central banks were often set several, in many cases conflicting, objectives that could not possibly be met by using monetary policy alone". For HM Treasury, Mr Ramsden told us that the Government "would certainly agree that it is right that the primary objective of the ECB should be price stability. That seems to us to be a key platform for the potential success over time of the euro area" (Q 4). But Mr Taylor emphasised also the secondary objective of supporting the overall economic policy of the EU, and argued that Dr Duisenberg's comments on the one occasion when the ECB had reduced interest rates "did seem to imply that the Bank was looking at things through a wider perspective than simply the single objective of price stability" (Q 24).

115. As to the definition chosen for "price stability", Mr Ramsden saw "a lot of similarities" between the ECB's target that price increases should not exceed 2 per cent and the United Kingdom's symmetric inflation target around a single point estimate of 2.5 per cent (Q 6). Professor Minford queried the way in which the ECB had formulated its target: it was not clear whether the aim was an average of 1 per cent, nor whether an increase in inflation in one year should be clawed back in following years, to avoid "base drift" (Q 215). Mr Power considered the target to be too rigid, arguing that the market perceived the ECB as having a distinctly anti-growth bias and that a wider target range for inflation would increase the credibility of monetary policy (QQ 181-182). The Governor of the Bank of England did not agree that the ECB target was too rigid. If he had a concern, it related to the potential asymmetry of using a range rather than a given target, which during the Asian crisis had resulted in a decline towards the bottom end of the range (whereas the Bank of England's target had allowed it to respond more readily to stimulate the economy) (Q 267). Professor Minford argued that the defined target was not in fact very important, because central banks tended to behave rather similarly whatever targets they were given, and even with a sole target of price stability the ECB would need to consider the effects of the interest rate on the state of the economy, because that would have implications for future inflation (Q 218).


116. In her written evidence to us on behalf of the Committee on Economic and Monetary Affairs of the European Parliament, Mrs Christa Randzio-Plath (its Chair) said:

This is not, however, a truth universally acknowledged. Some have argued that decisions on the target level of inflation, and on the balance to be struck between price stability and other objectives, should be made by Ministers rather than the ECB[100]. Mr Power favoured having a greater political counterweight to the ECB (Q 181). The Governor of the Bank of England pointed out that there was already political influence in the sense that it was open to the euro-group[101] to ask the ECB to pay more attention to the exchange rate[102] (Q 283), and Ms Schulz (of the Frankfurter Allgemeine Zeitung) believed that it was unavoidable that in the end targets would be set by that group (Q 69). On the other hand, Mr Peet (of the Economist) was suspicious of the motives of those who wished to see a stronger political influence, reminding us that "during the long discussions leading up to the Maastricht Treaty the French were habitually seeking for ways of trying to make sure that the European Central Bank was not, in practice, as independent as the Bundesbank has been, and they always had an agenda to try to erect … some kind of political counterweight to the Central Bank"[103] (Q 70).

117. The view of Mr Trichet (Governor of the Banque de France and a member of the Governing Council of the ECB) was that it would be inappropriate for governments to set the ECB's inflation target (Q 113). The Finnish and Irish governments agreed (QQ 141 and 251). So did Professor Minford: "The more you get politics into the process the more difficult it becomes for the ECB" (Q 216).

118. Greater political influence might increase the danger that the ECB would be unduly swayed by the situation in one Member State—a danger which some see even in the present arrangements. Professor Minford said that it had been suggested that the ECB was bound to pay attention to the problems of any one participating Member State "that could threaten to derail it"; it might "flex" in order to accommodate the problems of an important member, for example by giving disproportionate weight to German problems, since "obviously the ECB would be distraught if Germany started to show a lack of enthusiasm about the euro at a political and popular level" (Q 210). Small participating Member States, on the other hand, realised that their problems would inevitably carry less weight in the decision-making process than those of the major economies, even if they had more influence than they had previously enjoyed. In this connection it is interesting to note the composition of the Council. Of its 16 members, 11 are the governors of the central banks of the participating Member States[104]. The other five are the remaining members of the Executive Board, who originate from the Netherlands (the President of the ECB), France, Germany, Italy and Spain. The result is that the "core" members of the euro-zone (Austria, Belgium, France, Germany, Luxembourg and the Netherlands) between them have nine of the 16 votes.

119. This year's BEPGs say:

    "participation in the euro area implies the need for enhanced policy co-ordination. To this end, the Ministers of the euro-area Member States will continue to meet informally in the [euro-group], without prejudice to the role of the ECOFIN Council at the centre of the economic policy co-ordination and decision-making process. The [euro-group] is deepening its discussion of issues of common concern, in line with the conclusions of the Luxembourg European Council. In doing so, they pay attention inter alia to issues such as euro exchange rate developments, current account positions, capital market developments, and cyclical positions and budgetary stances of participating Member States. The [euro-group] will continue, and where appropriate strengthen, the continuous surveillance of budgetary developments and policies of the Member States participating in the euro area … On external issues relevant to its competence, the [euro-group] will continue to formulate common euro-area positions in international fora … Building on the experience gained over the past two years, the group continues to develop and strengthen a common language, where appropriate, prepared by the Economic and Financial Committee, and agreed positions among themselves, so as to ensure coherent expressions of views on subjects of common concern" [105].

120. While the United Kingdom remains outside the euro-zone, the Government must have a particular concern that the euro-group does not usurp the role of ECOFIN. For HM Treasury, Mr Taylor and Mr Ramsden were clear that the main thrust of economic policy still remained the responsibility of ECOFIN as a whole, although it was a legitimate part of the role of the euro-group to make statements on the level of the euro (QQ 35-40). The Austrian government assured us that binding decisions were taken by ECOFIN not the euro-group, thus ensuring "that the spirit of co-operation was extended even to those not directly involved" in the euro-zone (p 112). The Dutch government saw the role of the euro-group as increasing: "Recently the euro-group also started discussing budgetary developments in Member States. In the future more attention will be devoted to structural issues" (p 106). But the German Ambassador pointed out that it was important to maintain the overall role of ECOFIN in anticipation of enlargement: the new Member States would not immediately join the single currency, and would therefore not initially be members of the euro-group (Q 316). It was suggested that at the meeting of ECOFIN on 17 July the French Finance Minister might make a proposal to strengthen the role of the euro-group relative to that of ECOFIN[106], but the Presidency statement following the meeting did not touch on this point.

121. In our previous Report, we welcomed the fact that HM Treasury saw the Economic and Financial Committee "as fulfilling at least some part of the vital function of pulling together the different strands which together determine economic policy in the euro-zone"[107]. We asked our Treasury witnesses whether this expectation had been fulfilled. Mr Taylor explained that the Committee consisted of senior finance ministry officials from all EU Member States (not just participating Member States), together with representatives of the ECB, of the Commission, and of national central banks, meeting monthly. Its functions were defined in the Treaty[108], and included in particular preparation for ECOFIN meetings (QQ 31-33). In addition, the Governor of the Bank of England said that he sat on the General Council of the ECB which had certain responsibilities under the Statutes[109], but which also held general discussions about progress within the euro-zone, and the Bank of England was also represented on a number of technical working groups (Q 280).


122. In our previous Report, as well as emphasising the need for the ECB to be independent, we considered the concepts of transparency and accountability. We argued that ultimately the ECB would earn credibility by its results, but that "in the unavoidable interim period the ECB should foster its political acceptability and its eventual credibility by whole-hearted commitment to listening and explaining—in a word, to transparency"[110]. As for accountability, we laid emphasis on the role of the European Parliament, saying that we would expect the hearings of the President of the ECB and members of the Executive Board "to be televised and to become a prime means of communicating with the people of the euro-zone countries"[111]. For HM Treasury, Mr Taylor cited the information provided by the ECB[112] as evidence of its accountability. However, he conceded that the provision of information did not in itself constitute being called to account—rather, it was a necessary precursor of being called to account (as the ECB was by the European Parliament) (QQ 25-26). We were anxious to distinguish the two concepts.

123. The German Ambassador described the ECB as "one of the most transparent central banks in the world" (Q 311). Dr Walter agreed:

    "Although the ECB has done a good job it has nevertheless been heavily criticised—by academics, analysts and market participants—for not being transparent and for pursuing an unclear strategy. To a large extent, the criticism with regard to transparency seems exaggerated as the ECB communicates actively with the general public and the markets".

He pointed out that the United States Federal Reserve Board was far from being transparent, but he did think that the ECB should increase its transparency even further by revealing not only the arguments in favour of a key interest rate decision but also the arguments against (p 123).

124. Mr Trichet said that the ECB had always been "very, very keen on having as complete transparency as possible vis-à-vis public opinion and the markets". Its policy was to produce the evidence on which each decision on interest rates was based, and to hold a press conference to explain it "in real time", rather than several weeks later (Q 117). The ECB recognised that there had to be permanent communication, responding to "this unique challenge to explain the monetary policy in nine different languages to eleven different cultures" (Q 112). The Governor of the Bank of England agreed that the ECB did "try extremely hard" to explain itself:

    "I think if you compare it with the Bundesbank, its ancestor, as it were, it is just chalk and cheese … indeed all our media are absolutely full of the President of the ECB being too transparent and being too ready to speak".

He would look to see a continuing evolution in the ECB's processes, but he did not agree with the European Parliament (p 126) that the ECB had to increase transparency in order to increase credibility (Q 275).

125. There is a particular question as to whether minutes, including voting records, should be published. During our previous inquiry, we were persuaded[113] that although the decisions of the ECB and the reasons for them should be published promptly

    "publication should not go so far as to disclose the course of the argument, with its ebb and flow as minds are made up and changed … Disclosure to this extent would lead to the identification of individuals and countries with particular policy positions. This would, we believe, diminish the collective or collegiate nature of the Governing Council's decision-making process. It would also risk turning what should be decisions taken with the whole euro-zone in mind into contests between national points of view with all the emotion, publicity and posturing that this would attract"[114].

126. Although it was recognised that failing to publish minutes and voting records might be arousing suspicions in the market about what was being concealed, the general view of witnesses to this inquiry remained that they should not be published. As HM Treasury put it[115], "the members of the Governing Council do not act as national representatives, but in a fully independent personal capacity. This is reflected in the principle of 'one person, one vote'" (p 2). The Governor of the Bank of England opposed publication on the grounds that it would be an invitation for nationalist pressure on individual governors of national central banks—which would be perceived to happen even if it actually did not (Q 275), and Mr Trichet said that this was the consensus among governors of euro-zone central banks (Q 117).

127. Only the European Parliament seemed to be in any doubt. Mrs Randzio-Plath said that the Parliament would be in favour of a summary of minutes being published, and that it was still considering whether to press for the publication of voting records. It had been argued that publication would lead Board members to "become particularly attentive to the need to justify [their] own positions in terms of their mandate to scrutinise developments in the euro area as a whole rather than developments in their own Member State"[116]. Nevertheless, the European Parliament had so far taken the view that at this early stage in the life of the single currency "the Europeanisation process should not be disturbed by speculation about voting" (p 126).

128. As for accountability, the European Parliament was in no doubt that under the Treaty[117] the ECB was fully accountable to it, "as the sole democratically-legitimised institution" (p 125). Initially, the Parliament was consulted on the appointment by Member States of the six members of the Executive Board. Now that the ECB was in operation, its President was required to present an Annual Report to the Parliament on the activities of the ESCB, and on monetary policy. And he, and other members of the Executive Board, could be asked to give evidence to the Committee on Economic and Monetary Affairs. Mrs Randzio-Plath explained that the Parliament was especially concerned with the appropriateness of the quantitative definition of price stability and with the two pillars[118] on which decisions about interest rates were based. She considered that the Parliament was improving its methods of holding the ECB to account. At their meetings, "increasingly well-prepared Members of the European Parliament question the President on the monetary decisions of the ECB and his views on the economic situation, thereby holding him to account"; minutes and a verbatim account of the meetings were to be found on the European Parliament website (p 126).

129. Just as we were completing this Report, the ECB announced that it would in future publish its internal economic forecasts, "to improve the market's understanding of its monetary policy and dispel criticism of excessive secrecy"[119]. The European Parliament had been calling for this to be done (despite fears that forecasting inflation rates might turn out to be a self-fulfilling prophecy[120]), regarding the publication of forecasts as part of implementing real accountability:

    "Simply providing the European Parliament with information is not sufficient … The ESCB has to make it clear how monetary policy is intended to contribute to a balanced and appropriate policy mix in order to promote sustainable growth and employment, without prejudice to the objective of price stability"

What was needed was a "regular monetary dialogue where the representatives of the European citizens debate with the President of the ECB", not merely explanations after the event (pp 126-127).

130. Mr Power was much more critical of the present situation, apparently considering that the ECB should be accountable to individual participating Member States. In his view:

    "There is no accountability that we can be aware of. [The ECB] is a very independent policy-making body. It is quite clear that most members of the European Central Bank are not influenced by domestic policy considerations. If that were not the case, interest rates would not have increased by as much as they have increased over the last 12 months" (Q 184).

He said that he "would certainly agree" with the suggestion that the European Parliament was not doing its job in holding the European Central Bank to account (Q 185). Mr Peet shared the view that accountability was "not yet adequate"; he thought that more formal arrangements were necessary with the European Parliament, "and perhaps, sometimes the national parliaments as well" (Q 79). In our previous Report, we had envisaged that the President of the ECB or other members of the Executive Board "might find it helpful to appear before national parliamentary committees from time to time"[121]. It appears that the ECB would not agree with the latter suggestion: in response to an invitation to give evidence to this inquiry, Dr Issing (the ECB's Chief Economist, and a member of its Executive Board) told us that "as a matter of principle we do not appear before national parliaments", though he did offer an informal exchange of views[122].

93   That is, the "repo" rate, the main rate used in the ECB's interventions in financial markets. Back

94   Lecture at European Business School, op citBack

95   Dr Duisenberg suggested that the "potential tensions" between the results of the two indicators constituted "the essence of a robust approach to monetary policy making" (ibid).  Back

96   Cecchetti, Stephen G, Hans Gensberg, John Lipsky and Sushil Wadhwani, Asset prices and central bank policy, Geneva Reports on the World Economy, no 2, ICMB, Geneva and CEPR, London, 2000. Summarising the conclusions of their widely discussed study, the authors argue that "a central bank concerned with stabilising inflation about a specific target level is likely to achieve a superior performance by adjusting its policy instruments not only in response to its forecasts of future inflation and the output gap, but also to asset prices". They argue that responding to asset prices may prevent asset price misalignments (such as stock market bubbles or exchange rate misalignments) coming about in the first place, and that taking account of asset prices can improve the quality of forecasts of inflation. Back

97   The provision now applies to the ECB. Back

98   Which include promoting economic and social progress and a high level of employment and to achieve balanced and sustainable development.  Back

99   Lecture at European Business School, op citBack

100   Which would parallel the relationship between the United Kingdom Government and the Bank of England. Back

101   The group of finance ministers of participating Member States: also known previously as euro-x, then as euro-11, and now as euro-12. Back

102   Though he thought such a request would elicit the response that the ECB's prescribed primary objective was price stability. Back

103   In July, there were press reports that Mr Fabius, the French Finance Minister and current Chairman of ECOFIN, had told the European Parliament that it "was reasonable to ask" whether the inflation target should be set by euro-zone governments rather than by the ECB (Financial Times, 18 July 2000).. Mr Trichet told us that Mr Fabius had been misreported (Q 114). The press statement issued by the European Parliament after Mr Fabius' appearance before the Economic and Monetary Affairs Committee on 11 July ( reports him as having said that although monetary policy came within the exclusive competence of the ECB, the exchange rate was a shared responsibility between the ECB and euro-zone ministers-a somewhat different proposition. Back

104   A central bank governor from one of the smaller countries sits on the Executive Board; membership rotates between them, the present member being the Governor of the Central Bank of Finland. Back

105   9223/00, p 4. Back

106   Hence our request to Treasury witnesses at Q 38. Back

107   Op cit, paragraph 106. Back

108   Article 114(2) EC. Back

109   Protocol (No 18) on the Statute of the European System of Central Banks and of the European Central Bank (1992) defines these in Article 47; they are basically advisory. Back

110   Op cit, paragraph 108. There is not however universal agreement that, however desirable transparency may be politically, it is necessarily optimum from an economic point of view (see Henrik Jensen, "Optimal degrees of transparency in monetary policy-making", draft of September 2000). Back

111   Op cit, paragraph 110. Back

112   In its evidence to us, HM Treasury gave a full account of the ECB's efforts to publicise both its decisions and the reasons for them (p 3). Back

113   Largely by the arguments of Dr Tietmeyer, then President of the Bundesbank.  Back

114   Op cit, paragraph 109. Back

115   Quoting from the 1999 Annual Report of the ECB. Back

116   The reverse of the argument put forward by most witnesses. Back

117   Article 113(3) EC and Articles 15.1 and 15.3 of the ESCB Statute. Back

118   See paragraph 111. Back

119   Financial Times, 17 November 2000. Back

120   See Dr Duisenberg's lecture at European Business School, op cit. Dr Walter opposed this proposal: "the willingness to publish an inflation forecast will not result in the ECB's attaining godlike status, but will lead instead to myriad misinterpretations by underemployed analysts and academics. Every inflation forecast above the average will be understood as an announcement of a tightening bias and, conversely, every forecast of inflation being below the target will be interpreted as an announcement of an expansionary policy" (p 123). Back

121   Op cit, paragraph 111. Back

122   Letter of 6 July 2000. Back

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