29 April 2012

FT: A job description for Frankfurt

In the run-up to the French presidential election, the two front runners have debated whether the European Central Bank's mandate needed to be changed. It is a question that should be taken seriously throughout the eurozone.

There are three things the euro’s elected leaders can do to have Frankfurt pursue price stability in a more growth-friendly way.

First, they should tell the ECB to focus on domestically generated inflation. The current broad measure includes price changes that really reflect terms of trade shifts. A better measure would remove a perverse incentive for the ECB to rein in an already-depressed economy in an attempt to undo spikes in global commodity prices. This has encouraged the governing council to stay its hand.

Second, they should make absolutely clear that undershooting the target is as bad as overshooting it. At a time when deflation is a real threat to the eurozone’s economic wellbeing, it is a scandal that the ECB should be more comfortable below the target than above it.

Third, they should stress that the ECB may use any monetary instrument it sees fit. By rights this is already so, but political pressure has shrunk Frankfurt’s freedom of action with respect to buying government bonds. Direct monetary financing must remain prohibited, but Frankfurt should be allowed any financial intervention needed to keep its control over the price level. The ECB has no business, however, to oppose turning the eurozone’s rescue fund into a bank – a good idea supported by both contenders in the French presidential elections... [and] revived by François Hollande, the French presidential contender.

The value of independence is that an autonomous central bank is better able to achieve goals set by elected leaders than those leaders themselves. In a democratic society, this ability cannot be sustained if the population feels that the central bank’s goal is at odds with their economic wellbeing.

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