Radu Vranceanu, Professor of Economics at ESSEC Business School, looks at the track record of the euro and the European Central Bank as a counterweight to the rise in European populism.
The rise of the miracle-makers
The Euro Area economies were deeply affected by the Global Financial crisis of 2007-2009, which further acted as a catalyst for the euro-sovereign bond crisis of 2010-2012. The other member countries of the European Union (EU) also had to cope with difficulties, as the EU economy is deeply integrated, in terms of exchanges of goods and services, supply chains and capital markets.
The weak economic performance of the region mainly in terms of high unemployment and sluggish growth, combined with fears of uncontrolled immigration from the Middle East and Africa – as was the case in 2015 – were at the origin of a rise in populist political parties that surfed on these worries. These parties exploit the fears of the citizens and will offer solutions that have little economic feasibility. Most of them involve huge public spending initiatives, absurd regulations, miracle solutions (“that no one has imagined before”), which they package and deliver in a nationalistic rhetoric. Moreover, traditional parties have their populists too – if by populists we understand all those who claim they can manage the economy while paying lip service to the principles of economics.
From the Lega (former Lega Nord) (Italy), to Rassemblement National (France), and Alternativ fur Deutchland (AfD), FPÖ (Austria), including Vox in Spain, and others, all these parties have now a non-negligible electoral base, are represented in governing bodies, and even participate in ruling the country. If immigrants are identified by the populists as the fundamental threat to the EU citizens’ well-being and identity, immediately next to it the other major risks for national well-being would be trade liberalization and the single currency.
The Euro: Track record
The euro was created in 1999 by eleven countries; since then, eight other EU countries joined the European Monetary Union. A new central bank, the European Central Bank (ECB) took in charge the monetary policy of the euro block. Since its creation, the ECB has delivered on its main mission to maintain price stability in the euro area, and, by so doing, to create an economic environment supportive to growth. There is nothing more harmful to sustainable development than fluctuating and uncertain inflation. The main goal of the ECB is to maintain the inflation rate below, but close to 2%, in the medium run. In the last 20 years, the inflation rate has been close to the target, at a lowly 1.8%.
All in all, the ECB has coped in a successful way with the large macroeconomic and financial shocks that hit the euro area after 2007. It provided liquidity to banks in a period of high uncertainty, and helped them overcome temporarily difficulties, brought down to zero the main (short-term) interest rate to stimulate loans and investment, undertook an efficiency quantitative easing campaign that helped reducing long term interest rate, and provided liquidity to banks under long term refinancing operations. The euro itself has supported the economic integration of the area and growth, a main desideratum of European peoples, as required by the Treaty on the European Union.
While some populist parties might have a pro-business and pro-market attitude (Austria, Spain) many populists are very critical of the ECB. Outside of Germany, they often present the ECB as a German domination device through which Germany imposes its austerity on all countries. At the same time, the AfD in Germany would rather present the ECB as soft lender to weak foreign banks, that expropriates German savers and exposes them to excessive financial and inflation risks. These allegations are obviously false, yet one can understand how they can flourish given the complexity of the task of the ECB to manage monetary policy for 19 countries with a very different economic structure, labour market and macroeconomic policies. Populists need archetypal enemies, on which to focus their criticism, and make the more naïve electors believe that by following the recommend course of action, all their problems will vanish. As a wealthy, efficient, competent and independent institution, the ECB is a perfect target for populists.
Sometimes tough – but necessary
Like other important central banks, the ECB benefits from substantial autonomy and independence that it has used efficiently in steering short-term interest rates, without responding to populist calls, and fulfilled without a glitch is mission to maintain price stability. Furthermore, the implementation of non-standard measures after 2007 (quantitative easing, forward guidance, long term refinancing operations, the tax on reserves) proved the ability of the ECB to implement atypical measures when the pursuit of the price and financial stability goals required it.
For instance, it is legitimate to believe that Mario Draghi, the President of the ECB between 2011 and 2019, ended the sovereign debt crisis when it approved the Outright Monetary Transaction mechanism in 2012. At that time, his commitment “to do whatever it takes to rescue the euro, within the mandate of the ECB” was trusted by investors, and financially distressed governments found a way out of what seemed to be a path to sovereign default. On the other hand, the programme extended the scope of action of the ECB beyond what observers would have considered as normal in 1999, since the ECB can now, under very strict conditions, buy bonds from financially distressed governments. It is true that, before agreeing with Mario Draghi’s move, the German government required that all euro member countries set their house in good order by committing to avoid aberrant deficits in good times, and to reduce the level of public debt to sustainable levels. This put an end to the unsustainable spending policies launched in 2008, and a tightening of the fiscal stance, that populists on all boards commented on as an attack to the “sovereignty” of their countries. In Germany, populists argued rather that the ECB was guaranteeing the debts of bankrupt governments and exposing German savers to unbearable risks. In fact, the simple existence of this policy brought interest rates on treasury bonds down to normal levels (for instance in Spain and Italy), and calmed down investors’ fears and restored stability: the policy never had to be implemented.
To carry out any extravagant spending plans, populists need money. In the past, they could just borrow. Alas, after the global financial crisis, any country running an absurd fiscal trajectory risks to see interest rates exploding. Thus, the only nice source of funds would be to have them printed by the central bank, which is clearly not an option today. Without surprise, many populists have the hidden or declared dream of pulling their country out of the euro, and taking control over monetary policy, most probably to print domestic currency, in a Venezuela-style macro-stability. Unfortunately, the rising power of populism in Europe might make investors doubt the credibility of the ECB and an additional risk premium might appear. In turn, this would be another cost for the whole euro area, possibly reinforcing populists, in a vicious circle.
Competition is strength – not liked by all
Despite the pro-European rhetoric of many “traditional” governments, before the euro crisis the project of a European banking union never could be implemented. National banking sectors were organized as relatively tight oligopolies, as attested by their frequent abuses of market power. Governments blocked any attempt of cross-border merger and protected their “national banking champions”. The crisis revealed that these national oligopolies were extremely fragile, as living in their comfort zone prevented innovation and made them take excessive risks by investing in assets that proved to worth little – such as Greek bonds or US mortgage-based complex structured products.
After the crisis, the idea according to which banking competition at the EU level would increase the resilience of the sector slowly made its way out. Thus, after many hesitations, the European banking union was created in 2014, and all large European banks were placed under the supervision of the ECB. This move infuriated the populists who saw another source of influence and indirect control on the economy vanishing. Now, because banks have nothing to expect back from the government, they will be more reluctant to buy the government’s paper should the latter begin to derail. When in January 2019 the ECB in its regulator role asked Italian banks to take more efficient measures to clean up their bad loans, a prominent government member commented that the ECB was “attacking” the banking sector, causing “instability” and “hitting savings”.
All EU member countries (except for the UK and Denmark) have committed to join the euro, and all the “rich” EU members (but Sweden) did so. Contrary to the Baltic states who all have adopted the euro, many Eastern European countries are now attempting to postpone the official adoption of it (Poland, Hungary, etc.). Populist demagogy sometimes fuels this delaying tactic. It is claimed that by joining the euro, these weaker countries will lose a useful adjustment mechanism: devaluation would support growth in crisis times.
This argument neglects the fact that the euro already circulates as money in these economies, and most prices, loans or wages are indexed to the euro. In this case, currency depreciation only destroys balance sheets and further strengthen the crisis. A more plausible motive for postponing the decision to join the euro, moreover, is related to governments in these countries playing the political cycle and impose loose monetary policies when elections come close.
Facing the populists’ demagogical criticism, Mario Draghi, the President of the ECB, recalled in October 2018 that the most important asset of a central bank, and the best guarantee for price and financial stability, is its credibility. He urged legislators to further protect the independence of the bank: the latter should be insulated from fiscal or political influences and should be free to choose the most appropriate instruments to deliver on its mandate. On the other hand, the ECB has improved its accountability after 2007, but there is room for progress. In the US, the Fed is accountable to Congress. On the other hand, the ECB is accountable to the European Parliament, an institution that is much weaker, both in terms of political weight and expert skills. However, it is true that the ECB’s direct communication toward the public is of an excellent quality.
In the future the ECB will hopefully move toward the “normalization” of monetary policy. It will have to unwind non-conventional measures mainly by reducing its balance sheet, and probably carry out a gradual increase in interest rates. Populists will no doubt have a new reason to shout. Reasonable people must support our central bank. If we take seriously the challenge of fostering growth and firms’ competitiveness, it is not the strength of the euro that should be criticized, but the lack of progress in labour market reform and the lack of competition in many markets.
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