Gunfight at the ECB Corral: The Question of Who Succeeds Jean-Claude Trichet

By Engelen, Klaus C. | The International Economy, Fall 2010 | Go to article overview

Gunfight at the ECB Corral: The Question of Who Succeeds Jean-Claude Trichet


Engelen, Klaus C., The International Economy


Europe's eleven-year-old monetary union is still being tested by skeptical investors and markets. It was barely saved by a 750 [euro] ($955) billion rescue plan that European Union leaders put together in May of this year.

Although the immediate danger of Greece---or other eurozone member countries like Portugal or Spain--defaulting seems to have been averted, the pressure from markets to cut public deficits, stabilize banks, and reform economies remains. A look at the interest rates and insurance premia that financially weak eurozone countries have to pay on their new sovereign debt issues makes it clear that the crisis is not over. A year of major challenges for the sixteen- member eurozone is in store, with an uncertain outcome.

For Europe's central bankers and policymakers, one of those challenges is to rebuild confidence in the euro and its guardian, the European Central Bank.

Since the ECB joined the international rescue of Greece and other financially weak nations on Europe's southern periphery and announced that it would indefinitely accept those countries' debt as collateral regardless of credit rating, the ECB, its President Jean-Claude Trichet, and its governing council have been confronted with a credibility crisis.

"Trust in the ECB, as measured by the standard Eurobarometer (and other) surveys, has fallen to an unprecedented low--especially in the larger euro area countries," concludes a major empirical study by Daniel Gros and Felix Roth of the Centre for European Policy Studies. They found that up until the start of the recession in 2008, trust in the ECB was little affected by business cycle variables such as growth and inflation. This changed radically with the recession, with trust in the ECB becoming correlated quite closely with growth. For the first time, more euro area citizens tended to mistrust the ECB than trust it. Their findings imply that "European citizens appear to hold the ECB responsible not only for price stability in the narrow sense in which the ECB has interpreted its mandate, but also for financial stability in a wider sense. In this latter respect the ECB did not succeed."

For the German public, increasing pressure from European politicians--in particular French President Nicolas Sarkozy--on the ECB to expand its crisis financing role for the financially weak southern eurozone periphery is raising the haunting specter of scrapping the "no bailout" clause of the Maastricht Treaties. This would change the European monetary union into a European transfer union, under which German taxpayers--in the form of a common liability union--would have to foot the bill if countries such as Greece go bankrupt through a combination of poor public finances, an overburdened state sector, and uncompetitive industries.

But look at the complete the picture. The fact that some capital market experts see the rescue of Greece and other southern eurozone countries essentially as a bailout operation for highly exposed French, German, and other eurozone banks and bond investors is largely ignored. In these creditor countries, banks and governments have a common interest in avoiding a debt rescheduling with sizable discounts on nonperforming government bonds.

In the previous issue of TIE, Howard Davies, former Chairman of Britain's Financial Services Authority and a former Deputy Governor of the Bank of England, drew attention to another disturbing development, the "unresolved questions about the structure of the [ECB] and how it makes its decision to buy Greek bonds directly." He warns that "some issues that Europe's decision makers have wanted to keep under the carpet have now been rudely exposed. The decision to buy Greek bonds directly was not unanimous. The world now knows that Axel Weber, the president of the Bundesbank, voted against it. His was one vote out of twenty-two, but he represents 27 percent of eurozone GDP, so he cannot be dismissed as an insignificant outlier. …

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