|
|
Monetary policy and the art of separation
By tearing down the walls between monetary, fiscal and financial policy, the freedom of central banks to achieve different ends will diminish rather than flourish. Put in economic terms: Monetary policy runs the risk of becoming subject to financial and fiscal dominance.
To avoid any misunderstanding: This does not mean that central banks have no role to play in financial stability. The necessary separation pertains to the policies, not to the institution. But it does mean, for example, that the decision-making body responsible for monetary policy should not be in charge of supervising banks as well. In Europe, under current plans ultimate responsibility for the new European banking supervision mechanism will rest with the ECB Governing Council. To avoid possible conflicts of interest, this should not become a permanent solution. A change of the European treaties is required to allow for a body within the ECB other than the Governing Council to have the final say in supervisory matters. If this avenue is not taken, an independent supervisory institution will become necessary, in my view.
(...)
For monetary policy to deliver price stability, it is ultimately dependent on sustainable fiscal policy. This is why acting as a lender of last resort for governments can prove a slippery slope. If governments can expect to be bailed out by central banks, chances are that they will adjust their behaviour accordingly. And in the euro area, a lender-of-last-resort role for the Eurosystem does not square with the institutional architecture. The monetary union differs from other currency areas in one crucial aspect: While monetary policy is a common undertaking, fiscal policy remains a national prerogative.
Evidently, the unsound fiscal policies of one Member State can have repercussions on the union as a whole. Conversely, the negative consequences of bad policies can be better externalised to the rest of the currency area, thereby undermining incentives for sustainable policies. To mitigate this risk, precautions were taken in the form of fiscal rules, the no-bail-out clause and the prohibition of monetary financing. The guiding principle was self-responsibility: Member states are free to pursue their own fiscal policies. But they are subject to common rules and market discipline - and they are liable for their decisions.
A lender-of-last-resort role would violate this principle of self-responsibility - in that same way as eurobonds in this setting are at odds with it. Therefore, it would aggravate, rather than alleviate, the problems besetting the euro area.
Separating banks and sovereigns
If monetary policy cannot disentangle the euro area's fiscal and financial conundrums, what can? Central to any stable framework is a balance between liability and control: Those who act must also be liable for their actions. And substantial measures were taken to contain the sovereign debt crisis. These measures - notably the two European stability mechanisms, the EFSF and the ESM - stabilised the euro area in the short term by offering financial assistance in exchange for structural reforms. In the process, the balance between liability and control has been thrown out of kilter. While fiscal policy remains essentially a national domain, liability has been increasingly transferred to the European level.
To strengthen the framework laid down in the European Treaties implies stiffening the fiscal rules, which were bent and ignored too often in the past, with Germany being one of the culprits. The new Stability and Growth Pact is a step in the right direction. But the mere existence of these rules will not suffice. We need to apply them. And the European Commission is responsible for enforcing them. However, up to now the Commission has adopted a rather lenient interpretation. In addition to stronger rules, we need to make sure that, in a system of national control and national responsibility, banks and sovereigns can default without bringing down the financial system. Hence, breaking the "sovereign-bank doom loop" will be central to solving the euro-area crisis.
How can we break this "doom loop"? With regard to spillovers from banks to sovereigns, we need to make sure that taxpayers do not foot the bill when banks run into problems. The strengthened Basel III capital rules are a first step in that direction, the Banking Union, with its Single Supervisory Mechanism, is another one. Strict and stringent supervision ensures that tough rules are equally applied to all. The Single Restructuring Mechanism currently under discussion is necessary in order to establish a bail-in regime that assigns a clear hierarchy of creditors. But the sovereign-bank nexus goes both ways. We also have to address spillovers from sovereigns to banks. We therefore need to end the preferential treatment for sovereign debt.
The idea of monetary policy safeguarding stability on multiple fronts is alluring. But by giving in to that allure, we would likely end up in a world even less stable than before. This holds true especially for the euro area, where a Eurosystem acting as a lender-of-last-resort role for governments would upend the delicate institutional balance.