THE EUROPEAN CENTRAL BANK: RECENT REFORMS AND FUTURE PROSPECTS Álvaro Anchuelo Crego Research Group in International Economics Real Colegio Complutense, Harvard Summer 2005
PARTS • I: EMU’s Eastern Enlargement. When? • II: reform of the ECB’s Council of Government. International comparisons. • III: the MP Target • IV: the MP Strategy • V: Transparency • VI: other future challenges
Some of the changes related to EMU’s Eastern Enlargement. When will it happen?
PART I: OUR OWN UP TO DATE CONVERGENCE REPORT
OUR OWN UP TO DATE CONVERGENCE REPORT • Prepared by the ECB and the European Commission • At least once every two years (or at the request of the Member State with a derogation, 10+Sweden) • UK and Denmark: opt-out arrangements. Only examined at their own request • Last in 2004, data until August. Now (May 2005)?
CRITERION ON INFLATION • an average rate of inflation, observed over a period of one year (12-month average) • measured by means of the consumer price index on a comparable basis (HICP) • that does not exceed by more than 1½ percentage points that of the three best performing Member States in terms of price stability (deflationary not best performing DEGREE OF ARBITRARITY IN INTERPRETATION).
DEGREE OF ARBITRARITY ININTERPRETATION • 3 best performing Members of the EU? 2 NOT IN EMU Finland (0.33) + Sweden (0.92) + Denmark (1.13) Average = 0.8 + 1.5 = 2.3% • 3 best performing Members of the EMU? Finland (0.33) + Netherlands (1.32) + Germany (1.87) Average = 1.2 + 1.5 = 2.7% • Why not to take the EMU’s inflation as the reference? 2.2 + 1.5 = 3.7% • Or the target? 2 + 1.5 = 3.5%
LONG-TERM INTEREST RATE • To assess durability of convergence achieved • of long_term government bonds (10 years) • average over the latest 12 months • not exceed by more than 2 points the average of the 3 best performing Member States in terms of inflation
AGAIN, DEGREE OF ARBITRARITY ININTERPRETATION • 3 best performing Members of the EU? 2 NOT IN EMU Finland (3.95) + Sweden (4.17) + Denmark (4.12) Average = 4 + 2 = 6% • 3 best performing Members of the EMU? Finland (3.95) + Netherlands (3.92) + Germany (3.87) Average = 3.9 + 2 = 5.9% • EMU as the reference? Not data.
FISCAL DEVELOPMENTS • sustainability of the government financial position • without a deficit that is excessive (the ratio to GDP exceeds a reference value of 3%) • the ratio of government debt to GDP exceeds a reference value of 60% (unless it is sufficiently diminishing)
EXCHANGE RATE DEVELOPMENTS • Participating in the ERM II (since January1999, width of the fluctuation ±15% ) • observance of the normal fluctuation band for a period of at least two years without devaluing (changing its central rate) against the euro * No opting-out for new members, but date of entry into ERM II not specified (eg. Sweden)
If not now, then when (I)? • 27-6-2004: Estonia, Lithuania and Slovenia entered the ERM II + 2 years = 27-6-2006. • Next Convergence Report due around October 2006. Council of Ministers decides and fixes the date of entry. • Criteria on i, d, b already fulfilled today. • Inflation: not far away • COULD ENTER EMU (the soonest) 1-1-2007. They want to introduce € cash since the beginning
If not now, then when (II)? • 2-5-2005: Cyprus, Latvia and Malta entered the ERM II + 2 years = 2-5-2007. • Next Convergence Report due around October 2008, but can request one. • Further away from fulfilling all the criteria. • COULD ENTER EMU (the soonest) 1-1-2008.
If not now, then when (III)? • Czech R., Slovakia, Hungary and Poland: yet to enter the ERM II + 2 years • Further away from fulfilling all the criteria (except Czech R., fulfills all). • COULD ENTER EMU later than 1-1-2008. More likely in 2009 or 2010. THEY ARE THE LARGE ECONOMIES.
PART II: REFORMS IN THE DECISION MAKING COUNCIL OF THE ECB AND INTERNATIONAL COMPARISONS
PROCEDURE THAT LED TO THE ADOPTION OF THE NEW VOTING SYSTEM: • Treaty of Nice contains an ECB “enabling clause”. • Recommendation from the ECBadopted unanimously by the Governing Council (3 February 2003). • European Commission presented its opinion (19 February 2003). “Important step…”. • Plenary session of the European Parliament adopted a resolution(13 March 2003), rejected, complex. • EU Council adopted unanimously the decision on this amendment to the Statute (21 March 2003). • To be ratified by the Member States in accordance with their respective constitutional requirements.
HOW THE NEW SYSTEM WORKS (I)? • 6 permanent voting rights for Executive Board members. • 15 (rotating) voting rights for national Governors. • Rotation system based on groups that hold the voting right with different frequencies. • Ranking based on an indicator of the relative size of the economy (GDPmp)and financial sector (total aggregated balance sheet of the monetary financial institutionsTABS-MFI → LUXEMBOURG). • Relative weights of the two components: 5/6 for GDP and 1/6 weight for TABS-MFI.
HOW THE NEW SYSTEM WORKS (II)? As soon as the 22nd Member State enters, 3 groups: • 5 governors from the countries which occupy the highest positions in the ranking. Share 4 voting rights. • Half of all governors, rounded up to the nearest full number, selected from the subsequent positions of the ranking. Share 8 voting rights. 3) The remaining governors, who share 3 voting rights.
TRANSITORY FIRST STAGE Voting rights will start operating as the 16th Member State enters first on the basis of two groups: • The 5 governors from the countries with the highest ranking. Share 4 voting rights. • All other governors. Share 11 voting rights. • If there are 16, 17 or 18 governors the first group would – temporarily – have a voting frequency of 100% (to ensure that his voting is not lower than in the second group). • Depends on the sequencing of enlargement. • Governing Council can (by a 2/3 majority of all its members) postpone the start of the rotation until governors exceed 18.
PROCEDURE FOR DECISION –MAKING NOW • Starts (2 meetings per month, in the first i setting) with global review of the economic situation of the euro area by the Executive Board, through one of its members. • Then all NCB Governors express their views, centered in their own countries. • Executive Board has agreed previously common position. • Only 3 Governors needed. Large economies (higher weight in inflation index, more synchronized) natural allies. • “Shadow voting”, minutes not published, incentives for collegiality and consensus.
PROBLEMS • Complex. Number still too large (21 voting, all taking part in the discussions). • Stresses national character of Governors, treating them differently. • Executive Board too small proportionally (now 6 previously agreed +3 = majority, President has casting vote if there is a tie; then 6+5. Only excludes majority of small ). • Secret voting: shielding from national pressure or from international supervision? Even the Executive Board. • Usually consensus (vote if requested by any, secret if requested by 3), but “shadow voting”? More difficult to reach consensus. • “Enabling clause”. But chaging the Treaties more fundamentally as difficult as the process followed.
ALTERNATIVE PROPOSAL (EUROPEAN PARLIAMENT AND EXPERTS): • Delegate decision-making to (an enlarged?) Executive Board. • Governing Council: general strategic guidelines. Exchange of views on state of the economy. Incorporate country-knowledge of Governors. HOW DOES THE ECB COMPARE TO OTHER CENTRAL BANKS?
THREE DIFFERENTE MODELS • Delegation to small committee of experts (or with experts). Inflation targeting countries (UK, Sweden, Norway, Australia, Canada). New Zealand started: only Governor, appointment reviewed. 2) Groups within which voting rotates. US Fed, ECB. • Groups with one representative each. IMF, World Bank, Bundesbank after reunification. LET’S SEE MAINLY UK (MODEL OF GOOD PRACTICE) AND US (MODEL FOR ECB?)
UK: MONETARY POLICY COMMITTEE • 5 internal members (Governor, 2 Deputy Governors, Chief Economist, Executive Director for Markets) • 4 external experts appointed by Chancellor • One person = one vote • Representative from the Treasury (without vote) • Meets monthly for a 2 day meeting. • Individualistic discussion and voting
PROCEDURE • Deputy Governor responsible for MP speaks first. • Other MPC members follow, giving indication of policy preferences • Governor concludes and puts a motion that he expects will command a majority. • Vote. Dispersion: out of 85 meetings, 46 (54%) at least one dissenter, average=2. In 6 meetings, 5-4 vote.
US: FEDERAL OPEN MARKET COMMITTEE • 7 Governors make up the Board of Governors of the FRS. Nominated by President of the US, elected by Senate. 14 year terms (specifying Chairman and Vice Chairman for 4 years). • 12 Regional (of Districts) Federal Reserve Banks, with their Presidents. NY Fed permanent member of FOMC, performs MP operations. 4 others with a rotating voting right within groups. • Meets 8 times a year, (or when needed).
4 Groups (similar GDP initially) • Boston, Philadelphia, Richmond • Cleveland, Chicago • Atlanta, St. Louis, Dallas • Minneapolis, Kansas City, St, Francisco One vote each group. Rotating annually (1st January) Non-voting Presidents attend the meeting and participate in discussions
PROCEDURE • Governors always can outvote the Presidents. Previous talks. • Staff of the Board of Governors provides all background information. Attends meetings. • Strong leadership of Chairman: speaks first, presents his policy proposals, asks for votes (usually agree). Eg. Out of 44 meetings only in 7 (16%) not unanimity, in 6 only 1 dissenting vote. NOT TRUE THAT ECB MODEL
MAIN CONCLUSIONS • Smaller decision making bodies • Larger role to permanent members with global outlook over regional ones
THE ECB’s TARGET • Treaty: primary objective of price stability Governing Council announced its quantitative definition (1998) • Increase in the HICP. Easily understood by the general public. Purchasing power of money. • Below 2% (clarification 8 May 2003 “close to 2%” ). To guide inflation expectations. Not deflation in some countries. Potential bias in HICP. Downward nominal rigidities. TOO LOW? ENLARGEMENT, BUT SMALL WEIGHTS. • Over the medium term. Concerns about output fluctuations. Supply shocks, gradual response. DUAL, BUT HIERARCHICAL TARGET. Transmission mechanism variable, uncertain. BUT UNDERMINES CREDIBILITY OF NUMERICAL TARGET.
THE FED’s TARGET • Dual mandate, inflation and growth on equal footing (since 1978) • Not explicit definitions (no numbers, which index?). Inflation around 3% nowadays.
UK’s TARGET • 1997-2003: 2.5% for RPIX. • Since 2004: 2% for CPI. • Decided by Chancellor annually. IMPORTANT. • Symmetrical (sort of band) if more than ±1%, Governor required to send a letter to the Chancellor detailing reasons and responses.