Global: The Case Against the ECB ---Stephen Roach (from Antibes, France)
As the world’s newest central bank, the ECB has had its hands full from the start. The verdict nearly 2 1/2 years later has not exactly been kind. Europe’s new currency has fallen by more than 25% against the dollar since the beginning of 1999. The central bank has failed to deliver on its price-stability mandate, with inflation now breaching the ceiling of its zero to 2% target zone. And the Euroland economy is quickly moving into the recession danger zone. "Bring back the Bundesbank" is the whisper that I am hearing these days in my travels through Europe.
Hindsight, alas, is a great luxury. Like any policy authority, the ECB undoubtedly wishes it knew then what its knows now. The Teflon-like resilience of the US dollar has surprised many, myself included. The allure of dollar-denominated assets in the face of America’s record current-account deficit is not something traditional macro would easily predict. Food and energy shocks were just that -- shocks that few saw coming ahead of time. The debate is open as to whether these shocks will spill over into core inflation. We think not, but it’s understandable that a new central bank might want to err on the side of caution before turning its cheek away from a headline inflation alert.
The sudden deterioration of the Euroland economy is, however, a different matter. The operative view in Europe -- and one we shared initially -- was that the Euroland economy would remain a relative oasis in the midst of a US-led global slowdown. After all, Euroland’s exports to the US accounted for just 2% of the region’s GDP. What the ECB and most everyone else missed is that Euroland is highly sensitive to the ups and downs of global trade. Fully 15% of the region’s GDP goes to exports -- far in excess of the external exposure of the rest of the industrial world. With global trade now in the midst of its sharpest year-to-year slowdown on record -- going from roughly a 13% increase in 2000 to 5.5%, or lower, in 2001 -- the Euroland economy is now on the ropes. The ECB could have seen that one coming.
But "should haves" and "could haves" are cheap shots. All of us would like to be able to fast-forward the tape and peer into a murky future with greater clarity. That’s not really the issue here. Of far greater concern, in my view, is the one trait that lies at the heart of any central bank’s persona -- its credibility. In my private conversations with ECB board members, the first word that invariably rolls off their tongues is "credibility." The Bundesbank spent decades earning its credibility as an inflation fighter in world financial markets. While the Federal Reserve ended up in the same place, it took fully 15 years before investors truly "forgot" about the US central bank’s inflationary miscues of the 1970s and early 1980s. The ECB started at "ground zero" on the credibility front in early 1999. It fully conceded, both publicly and in private, that it would have to do a lot of heavy lifting before it was held in the same regard as the Fed or its predecessor, the once mighty Bundesbank. But the ECB desperately wanted just that.
Credibility, however, is in the eyes of the beholder. In central banking circles, the credibility factor is set by the ability of the monetary authority to hit its target -- whatever that target may be. Ironically, the Fed has a tougher task on that score than the ECB does. Fed Governor Larry Meyer put it best in a recent speech in Scotland ("The Global Outlook and Challenges Facing Central Banks around the World," May 24, 2001). Meyer contrasted the ECB’s "hierarchical mandate" with the Fed’s "dual mandate." In the former instance, price stability must be attained before the ECB can get on with tackling other problems of the Euro-zone, such as sluggish growth or high unemployment. In the latter case, the Fed is charged with the seemingly impossible balancing act of hitting both full employment and price stability.
In many respects, the Fed faces a far more daunting challenge than the ECB, giving the ECB a natural edge in the credibility battle. For one thing, the ECB has an explicitly defined mandate -- the operative definition of price stability is set in the 0-2% range. By contrast, the Fed’s targets are set implicitly, leaving the numerical details of full employment and price stability open to considerable, and often intense, debate. Moreover, the ECB has mathematics on its side -- it is attempting to hit one target with one instrument -- the overnight refi rate. The Fed, by contrast, is faced with the conundrum of attempting to hit two targets with one instrument, the federal funds rate. Add in an implicit stock-market target for an increasingly wealth-dependent US economy, and the Fed is facing a problem that would be tough for anyone to solve.
I’m not exactly a big fan of the Fed’s record in managing the US economy during and after the great equity bubble. But I am obviously in a distinct minority. Bubble or not, in the eyes of world financial markets, the Fed’s performance over the past two and a half years has been vastly superior to that of the ECB. That’s the unmistakable verdict of foreign change markets, the ultimate arbiter of relative performance. Not only has the euro plunged against the dollar since the ECB’s inception, but the new currency has also weakened further against the yen in recent months. It’s one thing to lose the credibility battle against the strongest economy in the world. It’s another thing altogether to fall behind on the credibility front against the sickest economy in the industrial world, Japan.
The hows and whys of the ECB’s ignominious launch will long be debated. But it’s time for the new central bank to wake up and smell the coffee. It has lost big on the very front that it aspired to win on -- the credibility battle. Its communications with the marketplace have been confusing at best and bumbling at worst. All too often it speaks with multiple voices and has taken multiple positions on tactics (currency intervention) and targets (money supply growth) -- to say nothing of confusing the financial markets over policy intent. Policy credibility is as much an art as it is a science. The ECB has stressed the latter but has failed at the former. Recently, it hired a leading ad agency, Publicis SA, to set the story right. That presumes that the story is, indeed, right. The ECB need to take a long and hard look at the verdict in the marketplace. In my opinion, it does not have a public relations issue that a slick ad campaign can fix. It has a serious credibility problem that only it can address. |
