Approaches

Ⓑ The European Central Bank has gone too far and should go back to its original mandate

Reader's digest

• When it was designed in the 90s, the ECB was supposed to focus on one narrow objective of assuring price stability, using interest rates as its primary tool.
• Since the 2008 financial crisis and the Covid-19 crisis, the ECB has found itself in a difficult situation. Its usual tools were no longer effective, and so they had to develop new instruments (such as quantitative easing) to meet the new challenges.
• These new instruments, quantitative easing in particular, have been blamed for their undesired side-effects that are intruding on other policy areas such as the financing of governments, known as fiscal policy. It also contradicts the principle of central bank independence, and has left the ECB vulnerable to legal challenges.
• Furthermore, the recent discussion on whether the ECB should also support the fight against climate change creates a fear that the ECB is going beyond its mandate without the political backing for it.

Full explanation

When it was created in 1998, the European Central Bank (ECB) was intended to focus on one narrow objective: price stability, by using one simple tool: adjusting the level of interest rates in the economy.

Today, the ECB has developed new so-called unconventional instruments (such as quantitative easing (QE) and negative interest rates) that have side-effects on the distribution of income and fiscal policy. 

For example, many blame the ECB for “punishing” savers, by pushing down yields of private pension funds, insurance companies and other savings products. This is a mechanical consequence of the ECB’s asset purchase programme (QE): as the ECB creates more money to buy financial assets, this results in creating more demand for a limited supply of assets, which logically results in raising asset prices and to reduce the interest rate on them.

The ECB is doing all of this in order to push inflation up to 2%. But is inflation well measured? 

Inflation is measured by monitoring the evolution of thousands of prices of goods and services. Using this data, the Harmonised Index of Consumer Prices (HICP) is then calculated based on an average basket of products and services that most people need such as food and haircuts. However, the price of things like financial assets or real estate are not incorporated in the inflation index. This could mean that the real inflation level today is closer to the 2% target than what the official figures show. 

Hence, some people are suspicious that the ECB’s policies seem to be motivated by objectives other than the mere pursuit of price stability. For example, the ECB’s QE programmes make borrowing notably cheaper for governments (because it pushes down interest rates on government bonds), which is seemingly contrary to the principle that the ECB must not directly finance governments.

This begs the question of whether, by adopting these unconventional measures, the ECB has gone beyond its mandate as originally set out in the European Treaties?

Over the years, the criticism against the ECB has been repeatedly addressed in the European Court of Justice, the highest court of the European Union. The court has previously ruled in favour of the ECB while imposing certain limitations that the bank must respect. For example, by telling the ECB that it must not purchase more than 33% of public debt from one country. More recently, the German Constitutional Court has criticised the ECB for not adequately taking into account the side-effects of its policies, or, at least, for not being transparent about it.

However, with the current health crisis and the adoption of new QE programmes, such as the Pandemic Emergency Purchasing Programme (PEPP), the ECB is on course to exceed those limits. Up until now, the ECB has justified such measures as being necessary to address crises. This would imply that they are temporary and exceptional in nature, and that the bank would phase them out once the crisis has passed. Nevertheless, some people fear that this will never happen and that these new, unconventional measures will become the new normal. If that proves to be the case, it will arguably aggravate the concerns about the ECB going beyond its mandate, and make it vulnerable to future legal challenges.

Today, there is even a debate on whether the ECB should support the fight against climate change. If the ECB were to tackle climate change, should it then arguably also intervene in other industrial policy? What about supporting digital innovation? And the wishlist would go on. Those debates are reinforcing the fear and risk that the ECB is drifting away from its original mission.

So what should the ECB do? Should it simply get rid of the unconventional measures that it has adopted since the financial crisis of 2008 and go back to its original mandate and toolkit? Or should it permanently adopt its new normal? Or should it go in another direction completely?

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Start the debate

From crisis to crisis, the ECB has overstepped the boundaries of the original mandate that was given to it in 1998. The ECB has deployed massive money creation programmes, known as QE, which are increasingly hard to justify given that inflation today is only slightly below the 2% target, and given the impact that negative rates have on people’s savings and pensions. The ECB should therefore stop using unconventional measures and return to solely focusing on maintaining price stability by adjusting interest rates.

Want to dig even deeper in this debate? Click on any of the links to discover concrete ideas for the future of the ECB, or join the debate and contribute your own ideas.

→ #1 Include housing prices in the inflation index

→ #2 Decrease or stop quantitative easing

→ #15 Periodic democratic review of the ECB mandate