Fratzscher, Marcel
Article — Accepted Manuscript (Postprint)
Rules versus Human Beings, and the Mandate of the
ECB
CESifo Economic Studies
Provided in Cooperation with:
German Institute for Economic Research (DIW Berlin)
Suggested Citation: Fratzscher, Marcel (2016) : Rules versus Human Beings, and the Mandate
of the ECB, CESifo Economic Studies, ISSN 1610-241x, Oxford University Press, Oxford, Vol.
62, Iss. 1, pp. 68-87,
https://doi.org/10.1093/cesifo/ifv018 ,
https://academic.oup.com/cesifo/article-lookup/doi/10.1093/cesifo/ifv018
This Version is available at:
http://hdl.handle.net/10419/157540
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This is a pre-copyedited, author-produced PDF of an article accepted for publication in CESifo Economic Studies
following peer review. The version of record
Rules versus Human Beings, and the Mandate of the ECB / Marcel Fratzscher. In: CESifo Economic Studies 62
(2016), 1, p. 68-87
is available online at: http://dx.doi.org/10.1093/cesifo/ifv018
Rules versus human beings, and the mandate of the ECB
Marcel Fratzscher
1
4 September 2015
Abstract
The actions by the European Central Bank (ECB) during the global and European crises have triggered a highly
controversial debate, in particular in Germany, about the costs and benefits of the chosen policy path. The paper
reviews, compares and evaluates the different arguments made in favour and against ECB policies around three key
dimensions – the link of the policy path to price stability, financial stability and economic policy. It argues that this
debate is not only about the weighing of the benefits against the costs of monetary policy, but it is primarily about
the question which mandate the ECB should pursue. This question remains unanswered.
JEL No.: E50; E60; E58.
Keywords: mandate, price stability, financial stability, European Central Bank, Germany, unconventional policies.
1
DIW Berlin, Humboldt-University Berlin and CEPR. mfratzscher@diw.de, Mohrenstrasse 58, 10117 Berlin,
Germany. This paper is based on my keynote lecture at the CESifo Area Conference on Macro, Money &
International Finance, and has been prepared for CESifo Studies.
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“… Men can be trusted in crisis to perform better than rules.”
Charles Kindleberger (1984, in “Rules versus men: lessons from a century of monetary policy”)
I. Introduction
Why do economists sometimes differ so fundamentally in their views on economic policy? Sometimes
the answer lies in their nationality or geography. A good example is the discussion on the monetary
policy of the ECB, an issue which divides economists by geography. How is it possible that in this age, in
which information is so abundantly available and shared globally, nationality or the environment in
which people operate play such a big role?
A large literature in fields such as finance shows that information at the micro level and behavioral
differences are important for understanding differences in views and decisions by economic agents. But
it is more puzzling when it comes to macroeconomic issues, such as monetary policy, for which relevant
information is widely shared. Globally there is a strong consensus among academic economists that the
policy of the European Central Bank (ECB) has been very successful, and in fact could even have been
more expansionary sooner. By contrast, there is a significant majority of academic economists in
Germany, who have been arguing fiercely for years that ECB policy has been wrong - too expansionary,
ineffective or even with adverse effects, using inappropriate instruments, or pursuing the wrong
objectives.
In no country in the world is there such an opposition to the ECB. Why do well-trained scientists in one
country come to such different conclusions on ECB monetary policy? Clearly, national or personal
interests may influence the way information is perceived and processed. Or economists may weigh
various arguments in a fundamentally different way.
The objective of this policy paper is not to speculate on these different views. The aim is rather to inform
the debate and contribute to a more rational, informed discussion on ECB monetary policy. This is not a
mere academic exercise. For better or worse, economists are exerting a significant impact on public
opinion. This holds true also and possibly in particular in Germany. Scientists and in particular
economists are often used as expert witnesses by the media, which are inclined to try and
instrumentalise economists in support of their own views and agenda.
This poses a huge challenge for the ECB. Monetary policy never functions in isolation of what other
policymakers do and of what the media communicates, and thus what companies and private
households perceive and believe. There has been a media storm in Germany criticizing the ECB, its
policies and even its policymakers. It has gone so far that influential German media outlets have
criticized the personal integrity and nationality of the ECB President. In short, the media has an
important impact on the standing and hence the credibility of institutions, including the ECB.
Eurobarometer surveys, for instance, show that the reputation of the ECB in Germany has been declining
sharply in recent years.
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Without a high degree of credibility it becomes ever more difficult for a central bank to be effective and
successful. The best example is the announcement of the OMT purchase program by ECB President
Draghi in late July 2012. There is a broad global consensus that this announcement was hugely successful
in calming financial markets and avoiding a much deeper crisis. The ECB managed to do so with a mere
announcement, without having to spend a single euro on purchasing sovereign debt through this
program. This illustrates the enormous importance of credibility. A high degree of credibility is essential
for monetary policy to function and to be effective. Central bank communication is sometimes, as in the
case of the OMT program, even able to substitute for policy action.
The paper intends to systematically list and discuss the arguments that have been put forward in
Germany in favor as well as against the ECB’s expansionary policy stance, and in particular its
announcement on 22 January 2015 to start a new program of quantitative easing (QE). The paper
intentionally focuses on this German debate and perspective. Under the QE program, the ECB will
purchase EUR 60 bn. of mostly sovereign debt of the individual euro area countries, at each country’s
capital key, from March 2015 till September 2016, and till the inflation path is consistent with the ECB’s
price stability mandate. While the purchases include also debt of European institutions, such as the ESM
and EIB, most of the purchases of national debt will remain on the balance sheets of the respective
national central banks (NCBs).
The paper organizes these arguments along three lines – what ECB policy means for its mandate of price
stability, its impact on financial stability and the question of effectiveness, and its relation to economic
policymaking in the euro area. The paper is intended to organise thoughts and give a hopefully fairly
comprehensive overview of the different arguments put forward in the public discussion in Germany.
The focus is primarily on this public discussion, rather than on the academic literature. We economists
are too often too closely attached to our theoretical and conceptual priors in order to be sufficiently
open-minded about reality.
I will argue that the risks and costs of ECB monetary policy, and in particular the QE program, are
substantial. The main conclusion of this discussion is, however, that much of the criticism against the QE
program is really about the question what the ECB mandate should be, and thus what the ECB should be
doing, rather than how it is acting to achieve its preferred objective. In other words: many German
economists opposing the ECB’s expansionary policy stance essentially one of the ECB to follow a
different mandate.
Many German economists hide behind legal reasoning, arguing the ECB’s actions are not covered by EU
Treaty. That is a very poor strategy in a discussion among economists. As much as lawyers should be
careful in interpreting and defining monetary policy, economists should refrain from interpreting the
law. The paper argues that the same economists who claim the ECB is breaking European law, i.e.
engaging in monetary financing, are those who argue the ECB should break the law by ignoring its
mandate of price stability.
The paper concludes by asking what this discussion implies about the mandate of the ECB. It is perfectly
legitimate to take issue with the mandate of a central bank. The primary focus on price stability has
become a panacea among central bankers over the last 25 years. Yet there is no compelling empirical
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evidence that inflation targeting is always and everywhere the superior monetary policy strategy. In fact,
during the global financial crisis and its aftermath, many central banks have de facto deviated strongly
from or even given up their price stability mandate.
The paper is linked to a broad literature on the conduct, communication and mandate of central bank
policy. Before the crisis there was a broad consensus that price stability should be the main, if not the
sole, objective of monetary policy. Nowadays many central banks also give considerations to financial
stability, often because they have been given responsibility for macro-prudential supervision. Some
central banks have also been given a larger role in micro-prudential supervision of banks or have become
responsible for this, such as in the case of the ECB.
Central banks in several industrialised countries have introduced forward guidance and unconventional
monetary policies. Borio and Disyatat (2010) show that before the financial crisis monetary policy in
most countries was defined exclusively in terms of a short-term interest rate and was primarily aimed at
maintaining (a quantified) price stability (objective).
Nowadays, many central banks in advanced economies communicate about their future policy rates
(Blinder et al. 2008). Whereas some central banks already before the financial crisis started publishing
their expected path of future policy rates as part of an inflation targeting (IT) strategy, others introduced
communication about future policy rates as a way to enhance the effectiveness of monetary policy by
influencing expectations when policy rates are at or close to the effective lower bound, such as by
promising monetary accommodation in the future once the ELB ceases to bind (Eggertsson and
Woodford 2003, Filardo and Hoffman 2014).
Moreover, many central banks, have purchased assets in an effort to drive down private (long-term)
borrowing rates (Gagnon et al. 2011, Fratzscher et al. 2014, Eser and Schwaab 2013). Many have also
engaged in qualitative easing (Lenza et al. 2010) with the aim to change the composition of asset
holdings is changed. For instance, the Bank of England’s QE policy had elements of both quantitative and
qualitative easing (Joyce et al. 2011).
In particular the changing mandates of central banks have profound implications for central banks. The
experience with monetary policy at the zero-lower bound and the risk of deflation have rekindled the
debate on the proper level of inflation to target. It has been argued that the risk of hitting the ELB is less
for a higher inflation target (Blanchard et al. 2010, Buiter 2014, Walsh 2015). The mandate of many
central banks now includes also maintaining financial stability (Born et al. 2012).
The paper is organized as follows. The next three sections each deal with one of the three elements of
the public discussion in Germany on the ECB’S policy stance - the mandate of price stability, the impact
on financial stability and effectiveness, and the link to economic policy. Section 5 then discusses the
implications for the mandate of the ECB. Section 6 concludes.
II. The ECB’s mandate of price stability