Rocky road ahead for euro central bank

Rocky road ahead for ECB

Bank may have too much power for politicians, not enough for its own liking

December 8, 1998: 11:50 a.m. ET

Fed chief sees euro success - Nov. 20, 1998

Hands off, says ECB - Nov. 06, 1998

European Central Bank

Federal Reserve Board

NEW YORK (Reuters) - U.S. experts see potential political pressures as the main challenge facing the European Central Bank when it sets a single monetary policy for the 11 European nations launching the euro in January.

Richmond Fed Director of Research Marvin Goodfriend sees an obvious parallel to the fledgling European System of Central Banks (ESCB). "There is no question the Federal Reserve provides a model of sorts for the ECB," he says.

Both include an Executive Board while the ECB has 11 national central banks compared to the 12 Fed district banks.

But there are important differences between the two. When it comes to voting on monetary policy, the ESCB and the Fed differ markedly, says Goodfriend.

The seven Fed governors always vote while the 12 Fed bank presidents, except for New York, vote on a rotating basis. This means the governors will always have a greater say than the presidents.

But in the ESCB, the six members of the Executive Board -- the equivalent of the Fed governors -- vote, as do the 11 national central bank governors. Their views, therefore, could outnumber that of the Board's by almost 2-to-1.

"Federal Reserve history teaches that a decentralized system needs a strong center," says Goodfriend, who wrote a paper on federal central banking systems. "The Board of Governors exercises a lot more power in the Federal Reserve System than does the ECB in the ESCB."

The ECB's mandate is solely geared at fighting inflation, unlike the broader Fed goals that call for both price stability and maximum sustainable growth.

But the need to generate more economic growth may lead some European nations to lean on the central bank governors to seek a more stimulative monetary policy.

"We have before us a new enemy, which is not only the increase in unemployment but also the contraction of employment," Bank of Italy Governor Antonio Fazio said last month. It was the latest sign that economic growth rather than the fight against inflation will be European politicians' key priority in 1999.

Fiscal and Monetary Policy

"Monetary union implies some sort of political bargaining over monetary policy that eventually will need to be resolved through some sort of European political process," says Stanford University professor of economics Romain Wacziarg.
He points out that Europe lacks a unified political structure which will make it difficult to conduct a monetary policy that would represent the different interests of 11 sovereign nations.
"The lack of a true federal fiscal structure will increase the likelihood of conflict over monetary policy," he said.
Wacziarg co-authored with Harvard University professor of economics Alberto Alesina a paper entitled "Is Europe going too far?". It details the uncertainty about conducting monetary policy in an environment of multiple political powers.
In it Wacziarg cautioned that fiscal restraint under the stability pact may lead a cash-strapped country to try to influence ESCB policy, "expanding the area of disagreement from the fiscal to the monetary arena."
"Europe stands at a crossroads in terms of institutional design," Wacziarg also said.

A Central Bank Without Banking Regulatory Power

Another important function of central banking is the banking supervisory and regulatory role. Unlike the Fed, because it is not the central bank of any country, the ECB will not have any of these responsibilities at first.
Former Federal Reserve Vice Chairman Alan Blinder says central banks often need more power in times of banking or financial crisis. "There is some virtue in having some of the banks' supervisory and regulatory functions with central banks," says Blinder, who also heads an international think-tank, The Group of Seven.
"At the very least, the central bank should have very good information about what is going on with bank supervision. That's a minimum requirement and the ECB would want that. But it's one of the unresolved issues in the Maastricht Treaty."
There may be an easy resolution, says Blinder. "I would not be surprised if some years from now, there is one single European bank supervisory body."