Select Committee on European Union Written Evidence


Memorandum by Mr Lorenzo Codogno[1], Managing Director, Co-Head of European Economics, Bank of America

1.  THE STRUCTURE OF THE ECB

What would be the effect of the recent decision of the European Council to amend the voting modalities of the Governing Council?

What would be the optimal solution to the problems posed to the workings of the Governing Council by enlargement? Is there a conflict between national interests and European interests? If so, how might these be reduced? What should be the relative size of the Executive Board in relation to the Governing Council? Should there be an independent monetary policy committee, along the lines of the MPC of the Bank of England?

What should be the roles of the European Council, the European Parliament and national parliaments in appointing the President and the other Members of the Executive Board?

  1.1  The EU Council of Heads of State or Government recently decided to modify the voting modalities in the Governing Council of the ECB on the basis of a recommendation from the ECB. The reform was aimed at ensuring that the Governing Council will be able to take decisions in a timely and efficient manner in an enlarged euro area.

  1.2  The new voting modalities are likely to accommodate the impact of EMU enlargement on the ECB decision-making body, but it will not solve the fundamental problems of the current setting. Indeed, it is likely to increase the complexities of the decision-making process. The only benefit of the new arrangement is to provide a politically acceptable way to accommodate EMU enlargement.

  1.3  The ECB cannot be blamed for the poor proposal as it acted within the limits imposed by the "enabling clause" as amended by the Treaty of Nice. The "enabling clause" in Art 10.6 of the ECB Statute introduced by the Treaty of Nice restricted the options of the ECB in proposing changes to just changes in voting modalities as laid down in Art. 10.2. More fundamental changes, such as the changes in the composition of the Governing Council or a different distribution of tasks between the Executive Board and the Governing Council, are not covered by this clause. Moreover, the ECB added self-imposed fundamental criteria: "one member, one vote", "ad personam participation", "representativeness", "automaticity", and "transparency". The reform of the voting system responds to the same logic that informed the original setting of the ECB, that is adequate representation of euro area countries, and the principle of `representativeness' can be justified more by political than economic considerations. As a result, the new arrangement increases the number of Governing Council members: a larger number of voting members, and an even larger number of governors participating to Governing Council meetings.

  1.4  Voting members will become 21 on a rotating basis with enlargement from the current 18. In addition to 6 Executive Board members, voting rights will eventually be allocated among three groups of national governors that will be formed by using a composite ranking indicator based on the relative size of the economy and the financial sector of the Member State. A rotation system would represent an "equitable, efficient and acceptable way in which to allocate voting rights among governors within the Governing Council" (ECB Monthly Bulletin, May 2003). A large number of voting members and a mushrooming number of non-voting members, who will have no voting rights but will participate fully in the discussion, is likely to reduce the "intimacy" of the decision-making process and may lead to an inability to react promptly to changes in the economic environment. Moreover, reaching consensus in a large decision-making body may become difficult, and this could also reduce the ability to react promptly to economic developments. Although the ECB cannot be blamed for having made major policy mistakes since its inception, it has been argued-probably with some reason—that the ECB has been slow to react to changes in the economic outlook. The new voting provisions are likely to make the risk of a slow reaction even higher.

  1.5  As a possible enhancement, the EU Commission has already suggested lowering the number of governors with voting rights. The EU Parliament flatly rejected the ECB proposal observing that the rotation model has been widely criticised for being excessively complex. The European Parliament called for the adoption of a solution "which would distinguish between operational decisions, to be taken by an enlarged Executive Board of nine Members, adequately representing the euro area economy, and strategic and general monetary policy decisions to be taken by the Governing Council acting on a double majority, based on the population of the Member States, the total size of the economy and the relative size within it of the financial service sector". The EU Parliament proposal introduces an awkward double-key majority for the Governing Council. Still, this proposal appears more sensible than that of the ECB, as it would allow efficient policy decision making for the Executive Board. However, the EU Parliament thinks that only "once we have gained sufficient experience with the enlarged Euro area and achieved progress in the real convergence of its economy, we should aim for a durable solution with a genuinely European approach". Over the "short and even medium term" the EU Parliament would leave operational monetary policy decisions to the Governing Council, with a voting mechanism that is as awkward as the one proposed by the ECB.

  1.6  There is clearly a trade-off between the political need to maintain country representation and the even more understandable and justified economic need to have the best designed decision-making body. Even in the US, the Federal Open Market Committee uses a similar rotating voting system, although it consists of only 12 voting members versus 21 at the ECB post enlargement. The seven members of the Federal Reserve Board always vote on the Committee, together with five of the 12 Federal Reserve Bank presidents on rotating one year terms. All members participate to the meetings and in the discussions, and contribute to the overall assessment of the economy and policy option, but the total number is only 19. At the Bank of England, there are only nine Monetary Policy Committee members. At the ECB the participation of all governors at the meetings could potentially make for a very large number of participants as new countries join the EMU. Enlargement of EMU by 15 new countries would result in 33 central bankers sitting at Governing Council meetings.

  1.7  What is the rationale for country representation? The US example may be inspiring. In making appointments, the President is directed by law to select a "fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country." These aspects of selection are intended to ensure representation of regional interests and the interests of various sectors of the public. The ruling of the EU Council and the carefully balanced representation among Member States would imply that there may indeed be a conflict between national interests and European interests to the point of justifying such a bickering for the voting system. If Governing Council members take or are influenced by national views on policy matters, there may be a conflict of interests, and therefore it would be justified to introduce a careful balance in order to properly represent regional interests. However, Governing Council Members are supposed to have a euro area perspective in their deliberations. The principle of so-called "ad personam participation" should be there to guarantee that members participate in a personal and independent capacity and make their own personal judgement without being influenced by national interests. The principle of "one member, one vote" and that of "ad personam participation" should guarantee that the "force of arguments count and not the country of origin, or whether that country is large or small" (ECB Bulletin, May 2003). However, there are clearly risks, also in light of some aberrations that still exist in the mandate to national governors. In practice, country governors are elected as representatives of each national central bank, and most of the times they are politically elected and sometimes not fully independent. Although the Maastricht Treaty severed incestuous links between central banks and governments, de-facto some of these links still exist. As an example, the Governor of the Bank of Italy has a life appointment, but the government retains the right to withdraw its mandate. This leaves the central bank governor potentially subject to political pressures, which may then easily echo within the ECB Governing Council. Finally, a "Council of European Central Bank Governors" could be set up with an advisory role to exchange views and to monitor developments at regional level. This arrangement would probably close the perceived democracy-gap of not having a representative from each country presenting regional issues to the decision-making body of the ECB. Moreover, it would enable central bank governors of this enlarged Council to communicate ECB policy in a credible way to market participants and to the wider public.

  1.8  Governing Council members should be protected from any kind of indirect political interference and sit on the board exclusively as professional economists to whom a clear mandate to maintain price stability has been given. This would probably still imply a political appointment, but then any link should be cut and the mandate should be longer than the usual political term. It must be recognised that as an institution the ECB reflects the tensions and the political difficulties of European integration. In fact, while it would be desirable to immediately shift to a new system, political consideration may suggest a smooth and gradual process. There are a number of possible intermediate solutions that can be chosen, ranging from a small, fully independent Governing Council to the current patchy arrangement.

  1.9  Governing Council members should not be appointed by national parliaments or governments in order to avoid appointments becoming part of the usual political wrangling. To maintain the technical nature of the appointment, it would probably be better if a special commission of the European Parliament or the EU Commission proposes candidates, with the selection made purely on technical grounds. Candidates should be selected among central bankers, "outsiders", and even among non-EMU citizens in line with what the Bank of England is already doing. Then, candidates should have the blessing of the European Parliament and the European Council.

  1.10  The work of central bankers is mainly a technical job, which should aim at achieving price stability. Other issues may easily interfere with this primary objective and result in a sub-optimal policy. It is hoped that within the framework of the Convention on the future of Europe and the forthcoming Intergovernmental Conference (IGC), more comprehensive changes will be adopted to streamline the decision-making process. The IGC could design a "road map" to move gradually away from the current country-based representation in favour of appointments based exclusively on professional grounds. One way to incrementally move in this direction would be to decrease the number of national governors with voting rights, thereby reducing the weight of non-executive members in the decision making-process. In addition, the appointment of Executive Board members from outside of the "central banks" club' should be encouraged. The setting of the Bank of England's Monetary Policy Committee should be taken as an example. It maintains a majority of votes for "insiders" and at the same time opens the Monetary Policy Committee to "outsiders" who add different perspectives to the policy debate.

2.  TRANSPARENCY OF THE DECISION-MAKING SYSTEM

Should the bank's communication strategy and its implementation be changed?

What has been the effect of the press conferences held immediately after the meetings of the Governing council?

Should the ECB publish unattributed minutes of meetings of the Governing Council? Should the ECB publish the results of votes of the Governing Council? Would identifying individual positions cause problems in a multi-national organisation? How might any such problem be overcome?

What is the experience of interactions between the ECB and the NCB's? Other than the Council meetings, what structures are in place to facilitate communication between the staff of the ECB and the NCBs?

  2.1  In May, the ECB concluded the review of its monetary policy strategy and introduced some changes in its communication strategy. These changes, although not comprehensive and far-reaching, addressed some of the issues that were perceived as problematic in the past.

  2.2  The monetary policy strategy of the ECB used to give a prominent role to money in the assessment of risks to price stability. More than four years of implementation have shown that it is very difficult to clearly and transparently refer to money supply growth in communicating policy to the general public. Money supply growth has suffered from a number of distortions in the past and data needs to be adjusted to provide a meaningful indication for monetary policy. While money supply growth certainly maintains an important and crucial role in the ECB strategy and will probably correctly continue to do so in the future, before the strategy review it had become an extremely tricky element in the ECB communication policy. This is why the ECB decided to downplay its role. Monetary policy decisions continue to be based on a comprehensive analysis of the risks to price stability, but in its new structure of the introductory statement the monetary analysis no longer has a prominent role. It now "mainly serves as a means of cross-checking, from a medium to long-term perspective, the short to medium-term indications coming from economic analysis" (ECB press release, 8 May, 2003). This makes much easier and more effective the ECB communication process.

  2.3  There are, however, other important communication and transparency issues that need to be addressed and these are closely linked to the previous point, ie the composition of the Governing Council and the voting system. The ECB has designed its communication strategy within the current institutional framework. An independent Governing Council, not formed on the basis of country representation but exclusively on professional grounds, would change the current debate on communication and transparency. The issues related to the press conference immediately after the ECB Governing Council decision, the publication of minutes and votes, and the identification of individual positions would have a different flavour.

  2.4  With the current and prospective composition of the Council based oil national representation, it would be embarrassing and not advisable to publish minutes that could identify individual positions, let alone voting behaviour. In a multi-national organisation in which Council members participate exclusively in a personal and independent capacity and make their own personal judgement without being influenced by national interests, it would instead be feasible to do so. The bare fact that the Governing Council members are the governors of the national central banks is constraining the ability of the ECB to achieve the maximum desirable level of transparency and the best communication strategy.

  2.5  The press conference immediately after the decision can be considered the maximum level of transparency a central bank can provide, while protecting the anonymity of member positions and voting behaviour. Although the ability of ECB President Duisenberg to perform this extremely difficult task has been better than his critics appear to suggest, there is no doubt that sometimes the press conference adds confusion and does not deliver clear messages. And, in turn, this may cause undesirable volatility in financial markets. Moreover, it unduly exposes the credibility of the central bank to the ability of its President to clearly spell out Governing Council conclusions and the different aspects of the debate within the Council. However, given the current and prospective bias to national representation within the Council, it would be desirable to maintain this risky, but at the same time important, exercise in transparency, and not publish minutes. According to the ECB, "the Governing Council acts as a collegiate body and is collectively responsible for its decisions" and given the current setting this seems to be the most desirable arrangement.

  2.6  Should the appointment to the Council and voting modalities change in the future to the point that individual positions are fully de-linked from perceived national interests, the communication policy could change. The abolishment of the press conference and the introductory statement in favour of a short communiqué followed by detailed minutes with a short delay (one-two weeks) would then be a desirable change. This would add transparency, in a sense that positions and reasoning would be spelled out clearly while reducing the risks of misinterpretation.

  2.7  The interaction between the ECB and the European System of Central Banks has developed in a way one would have expected given that the boundaries of responsibilities are sometimes not clearly defined or agreed. The latter problem does not appear to have substantially interfered with the conduct of monetary policy. The preparation of Governing Council meetings relies on preparatory meetings and close consultation with national banks, the details of which are not publicly available. There seems to be no anecdotal evidence that this process has not performed properly. One way to improve this relationship, would be to re-direct economic analysis at national level to make it more co-ordinated and relevant on a pan-European scale, possibly by publishing regular updates on regional developments (a report similar to the "Beige Book" in the United States).

  2.8  Finally, one important issue is whether the ECB communication strategy has constrained its action, and especially its ability to react promptly to economic developments. The publication of minutes and individual views may have the effect of binding individual Council members to previously expressed positions, or even "lead to undue pressure to deviate from a euro area perspective" (ECB), and this is a risk the ECB is not running. However, the fact that individual members of the ECB Council have not substantially deviated in their public appearances from the line defined in official ECB meetings may have reduced the possibility to "prepare" financial markets for policy shifts. This "lack of preparation" may have postponed monetary decision that would have otherwise been taken earlier. In the question and answer session of the 5 June press conference, Mr Duisenberg was asked why the ECB had not cut rates before and he replied: "the markets have—to a large extent—already discounted the move we made today, whereas they would have been very surprised if it had been done last time". Allowing individual members to express themselves not as representatives of the Council but as individual members expressing their own views would allow financial markets to be alerted by shifts in Council members' views, and therefore project possible changes in Council monetary stance. In the past, individual positions have emerged anyway, as it is almost impossible to prevent individual members from adding their personal flavour to a commonly decided line. Still, this would happen more openly with a different Council arrangement. There are also some drawbacks to openness. Allowing Council members to publicly express themselves in advance of the next policy meeting would risk increasing volatility in financial markets and sending contrasting messages. But these drawbacks are acceptable. All in all, it looks like the constraints of the ECB communication strategy have produced a modest, although probably non-negligible, delay in monetary policy decisions.

3.  ACCOUNTABILITY

Should the ECB continue to set its own inflation target? What alternatives are there?

What is the experience of the testimonies of ECB before the European Parliament? Does the European Parliament sufficiently call the ECB publicly to account? To what extent has the ECB been steady to listen, to explain and, if necessary, to learn?

How regularly have members of staff of the ECB appeared before national parliaments?

  3.1  Some pundits have argued that it is rather unusual to give a mandate to an institution and, at the same time, allow this institution to set its own targets against which it is measured. This is currently the case for the ECB, while in the United Kingdom, for instance, the government sets the inflation target for the Bank of England. In the United States, the Federal Reserve has not set an explicit, numerical objective for inflation. Federal Reserve Chairman Paul Volcker offered the following definition of price stability in 1983:

  "A workable definition of reasonable `price stability' would seem to me to be a situation in which expectations of generally rising (or falling) prices over a considerable period are not a pervasive influence on economic and financial behavior. Stated more positively, `stability' would imply that decision making should be able to proceed on the basis that `real' and `nominal' values are substantially the same over the planning horizon—and that planning horizons should be suitably long."

  3.2  In 1994, Federal Reserve Chairman Alan Greenspan described the price stability objective in a similar way:

  "We will be at price stability when households and businesses need not factor expectations of changes in the average level of prices into their decisions."

  3.3  Translating this broad objective into a specific numerical target is a rather technical exercise and the answer may change over time. The ECB is best equipped to answer this question in the most qualified manner, especially if we compare its ability to European governments, the EU Parliament, the EU Commission or the EU Council. The fact that the ECB sets its inflation objective to be "below 2 per cent" with the aim to maintain it "close to 2 per cent" over the medium term, and at the same time is judged against this benchmark is not an aberration, provided the target is spelled out clearly. The issue as to whether this target is spelled out clearly would open up a long discussion, but there is no doubt that the ECB can be held accountable for this self-imposed target.

  3.4  Considering the public documents available, the experience of testimonies of the ECB before the European Parliament, as well as ECB staff before national parliaments, has been acceptable from the point of view of accountability and transparency.

9 June 2003


1   The opinions expressed herein are those of the author and not necessarily those of his employer. Back


 
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