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On 1 November 2003, Jean-Claude Trichet took over as President of the European Central Bank (ECB) from Wim Duisenberg. Eight years later, on 1 November 2011, he will now hand over to Mario Draghi. This is a good moment to take stock and review the performance of the ECB, since it started operating on 1 January 1999, and to assess the perspectives for the future. After a short overview of the monetary policy environment, Collignon evaluates the Bank's achievements with respect to inflation, growth and employment. He then shows how monetary policy under Trichet was different from the Duisenberg era, and discusses the ECB's role in the crisis after 2008. He concludes on some future perspectives.
Since January 1999, the ECB has gone through three major phases: foundation, consolidation and financial crisis. Through all this period it has achieved its primary and secondary objectives with remarkable precision. Collignon estimates a reaction function and finds that under Trichet, increased credibility and a more stable macro-economic environment allowed monetary policy to shift focus in favour of employment and financial stability. Handling the financial crisis was Trichet’s masterpiece, although Member States have not made it easier for the bank.
The tasks ahead for Mario Draghi
Forecasting what Mario Draghi will or should do over the next eight years is of course impossible. If the ECB loses its power struggle with Member State governments over the provision of liquidity to distressed debtors, it is possible that the euro will not survive and Mario Draghi would simply be the last administrator of a failed enterprise. However, we must assume that common sense will prevail. We can then see the major challenges for ECB President Draghi.
The first is solving the debt crisis. This is without any doubt the most delicate task. The ECB must continue to steer a path between austerity policies that kill growth and debt bailouts that invite moral hazard. This is essentially a political task to which Mario Draghi with his personal background of experiences in the private sector, the Italian Treasury, central banking and international Institutions, including as Chairman of the Financial Stability Board is uniquely well qualified.
The second is terminating non-standard monetary policy operations as the situation in European financial markets normalises. An important distinction may have to be made between the liquidity situation in money market and in bond markets, which will remain distorted by sovereign debt for a considerable period of time.
The third is the speed of raising interest rates back to levels above 2 per cent, i.e. to levels where expected interest rates are positive in real terms. The present level of 1.5 per cent is not sustainable over the medium run, and probably not even compatible with the present level of core inflation. If one can learn one thing from the Greenspan experience in the mid 2000s, it is that negative real policy rates fuel financial bubbles. It is, however, possible to combine rising interest rates with non-standard monetary policy operations at least for some time.
The fourth challenge is the evolution of the global economy. The risks of a global recession are increasing, as the United States struggles with a fractioned political system and structural weaknesses. Japan still has to overcome the Tsunami shock. China is emerging as the new global economic player, but it is handicapped by rising domestic inflation which bears serious risks for political stability at home.
Finally, the global economy will profoundly change over the next eight years. Aging populations will require new social and fiscal policies. The growth centres in the world will shift to Asia and later to Africa. During its first decade, European Monetary Union has benefited from the Great Moderation, which made achieving the ECB's primary objective relatively easy. The integration of China into the global economy added a quarter of the world's labour force and therefore kept a lid on wage pressures worldwide. However, there are signs that China's unlimited supply of labour is coming to an end. This will transform the conditions for maintaining price stability and conducting monetary policy over the next decade.
Study results
In this context, a refusal to vote for the extension of the European Financial Stability Facility is the summum of hypocrisy and irresponsibility.