Independence and democracy of the European Central Bank

The European Central bank is an interesting institution, because it only exists in plans and is not altogether sure if it will exist at all. Some might argue that it will possess formalist bias in the analyses. However, if one assumes legal status of the bank as a proxy for its politics in reality, it is justifiable to analyse the independence and democracy of the European Central Bank.

At this point of time it seems most likely that the Institution will take its place as planned. Combining a relatively strict form of independence from the political authorities with a clearly expressed priority given to the price stability objective. Many countries have already changed their legislation, in a way which is in line with the Maastricht Treaty.

Most recently the European Commission published its forecasts about the European economic perspectives. According to these forecasts the economy is growing strongly and it seems likely that even 11 countries will be eligible to join the second stage of the Monetary Union on time( Raivio, Helsingin Sanomat 15.10.95). Also according to the latest pieces of news the tensions between French and German officials about the government of the ECB has been settled and it seems likely that the institution will be able to implement its policies in line with former plans (Paljakka, Helsingin Sanomat 15.10.95). For the credibility aspect of the Central Bank it is important that the convergence criteria will be judged in a strict manner. This signals to outsiders that the rules cannot be bought and that there is a seriousness about the project. (Pikkarainen,luentomuistiinpanot, 1997)

Katja Heinonen: I suppose you mean that '11 countries will be eligible to join' the THIRD stage of the EMU and not the second.

Institutions and structures of the European Central Bank

The System of European Central Banks (ESCB) consists of the European Central Bank (ECB) and the Central Banks of the member countries of the European Union. The system is hierarchally organized in a two tier model, where national central banks will act in accordance with the guidelines and instructions of the ECB. The ESCB will be ruled by central decision making bodies of the ECB and when national central banks will perform autonomous tasks they are not considered as a part of ESCB.

The central decision-making organ in the system is the Governing Council. It consists of national central bank governors and of the executive board members. The governing Council will confirm the plans, ESCB should undertake to meet the required objectives. It will outline the common monetary policy and interest rates. The council will meet at least ten times per year. Decicisions concerning the monetary policy will be taken by simple majority votes.

The Executive Board will realise the monetary policy objectives set by the Governing Council. In this respect it will advise the national central banks. The Governing Council will consist of the President, vice President and two to four other members. These will be appointed from amongst persons of recognised standing and professional experience by common accord of the member states. In the Executive Board every member will have one vote.

During the transition period the System of European Central Banks will also have a General Council as in its decision making body. This body will consist of the President and the vice-president of the Executive Board and the governors of the central banks of all member states. The General Council finishes the will finsh the duties appointed to the European monetary institution and prepare the way for the countries that weren€t included at the beginning of the Monetary Union.

Independence of the European Central Bank

The European Central Bank will manifest its goal and instrument independence in many ways. Many specialists argue that its independence is even more obvious and strict than that of its model, the German Bundesbank.

In terms of goal independence the European Central Bank€s will apply lexicographic ordering of preferences by having as an ultimate goal price stability as stated in the Maastricht treaty (Maasricht treaty, Protocol on the Statute of the Article 2). What the target will explicitly be depends on the bank and its Governing Council. It should also support the general economic policy, but without any prejudice to the objective of price stability (Maasricht treaty, Protocol on the Statute of the€Article 2). In addition the bank will have other duties such as holding and managing the official foreign reserves of the member states and promoting the smooth operation of payment systems. It is probable that the Euro currency will float against other major currencies. The fact that European Council is responsible for ruling over exchange rate relationship towards other currencies could limit the Central Bank€s ability to commit itself to low inflation but also the Council should take into account Bank€s precommitment to price stability. (Maastrich treaty, Article 109)

It is worth notions that the usual central bank function as €the lender of the last resort€ is not explicitly included in its agenda. However, maintaining the smooth operation of the payment system would in financial crisis most likely require some kind of adjustment measures.

As far as instrument independence is concerned, the ECB will have possibilities to plan and choose how it will best achieve and maintain low inflation. The preparatory work will be made by European Monetary Institution that is trying to plan the basic instruments and strategies for the framework of monetary policy.

The Central Bank€s formal insulation from the decision making mechanisms and procedures of the European union is also obvious. Article 7 in the statute of the European System of Central Banks and of the European Central Bank guarantees a complete independence for the European central bank. Community institutions and national governments may not try to influence decision making of the Central Bank and nor may the officials of the Central Bank seek or take instructions from the Community institutions.

Appointment and dismissal practises of the ECB also reflect the search for independence. Members of the board will be appointed by the common accord of the Member States on a recommendation from the European Council after it has consulted both the European Parliament and the Governing Council.( Maastricht treaty, Protocol on the Statute of the Article 11.2). The terms of the office are eight years and are not renewable. If a member of the board no longer fulfils the conditions required for the performance of his (her) duties or if he (she) has been guilty of serious misconduct, the Court of Justice or the Executive board may compulsorily retire him. (Maastricht treaty, Protocol on the Statute of the Article 11.4)

These procedures of appointment and removal are to guarantee that the members of board are shielded from the shorter-run orientations of elected politicians. Further, the executive officers don€t have to consider reappointment because it is not possible so they don€t have to take into account any other opinions in their decision making. As in any human interaction by appointment procedures one cannot rule out the possibility of some kind of corruption. In this case one could for e.g. reward the officers with some other nominations if they behave in certain ways. It should be observed that the independence can never be absolute, although one can improve it by certain procedures.

In reality it is likely that the formal independence of the bank will come under great pressure by the governments of the member countries. It has been emphasised in many studies that the countries that will make up the monetary union are very different from each other.( esim. Valtioneuvoston selonteko, Rahapolitiikka rahaliitossa ja sen ulkopuolella, 1997) Therefore when an exogenous chock affects the Union, countries should adjust in different ways, because the influences of the chock and the adjustment measures will transition in different ways in the different economies. On the other hand, the price stability process will also be different in different parts of the union. Therefore, the Governing Council must decide according to what inflation situation it will take the adjustment measures. In the practise it is especially interesting to see if larger countries€ opinions will be emphasised in decision making.

In practice the Governing Council, which should set the principal guidelines for monetary policy could assign certain decision making power to the executive board. Cucierman argues that this would increase the credibility of the bank; that is its commitment to the price stability objective.( Cukierman 1992, 114)

Democracy of the European Central Bank

Accountability towards the member states and Union institutions can be found in the operation of the ECB€s reporting procedures. There will be quarterly reports on the operation of ESCB and a consolidated financial statement will be published each week. It shall address an annual report to the European Parliament , the Council and the Commission and the European Council. These could be considered essential basic instruments for reporting from the operation of the bank but they still owe much to democracy, because they are by no means a way to actually influence the decision making procedures.

Another monitoring mechanism is the possibility that the President of the Council and a member of the Commission may participate in the meetings of the Governing Council and the General Council of the ECB. Teivainen considers this not to be insignificant, because it establishes a formal channel of consultation between the Bank and the institutions of the Community, even though the Bank taking instructions from the politicians has been ruled out.

The democracy of the European Central Bank has also been questioned by politicians of the European Union. In the Helsingin Sanomat (Paljakka, Helsingin Sanomat 26.9.97) a German member of the Euro-Parliament Christa Randzio-Plath argues that one cannot improve the democracy without violating the principle of independence of the Central Bank. She introduces a five point plan that includes the appointment power of the excecutive board members to be divided between the parliament and the member countries. Now all the power is held by member countries. She especially argues that the President of the Executive Board should be approved by both the Parliament and the Council.

She also argues that despite the crucial role of independence in assuring moderate level of inflation the central bank should be operated transparently. In her opinion the chief executive officer and other board members should visit parliament to clarify several issues and answer written questions. In addition the Governing Council should publish its meeting€s results as early as the following day after a meeting. Voting behaviour and the budget should also be made open to the public.

The idea that a central bank should be reach one explicitly stated goal leads different views as to how this would affect the institution€s democratic accountability. Goodhart argues that greater independence is more likely when a bank is designed to reach a single outcome. If a bank aims at several objectives simultaneously, with the need to balance between them, it tends to be under greater oversight by the political authorities ( Goodhart, s. 1427). Further, if it is designated for a single outcome, a bank is more democratically accountable because its success in achieving the outcome is made transparent. Teivainen sees this as being valid in a country where the political authorities maintain credible legal mechanisms for enforcing their authority in serious conflicts with the central bank, but in case of the ECB it is very hard to sustain.

Katja Heinonen: What are the credible legal mechanisms?

Locking oneself tightly into achieving one certain outcome could certainly be the right decision if there were no trade-off between the inflation goal and other economic variables. If there exists doubts about this relationship it is hard to justify locking in a community which is based on western democratic ideals. Through the delegation the political authorities accept restrictions to their future freedom of action. With ECB-type of central banking one cannot be sure that there are no long-term aberrations between society€s preferences and those of the central bank. According to democratic theory any institution executing functions of governance is only acceptable if it is subordinated to a politically legitimised body.( Busch 1994, s.64)

Speciality in comparison to other central banking institutions is that the ECB€s insulation from politicians is guaranteed by an international treaty. While e.g. in the German Bundesbank, which is considered as one of the worlds most independent central banks, legislation can be changed with a simple majority vote, the ECB legislation is based on an international treaty, which is considerably more difficult to change. This in turn creates a problem in relation to the democratic principles of the Community. On the one hand in terms of future flexibility and on the other hand for the legitimacy of this institution.

Teivainen asks in his article that what if the chances for modifying the existing practise of central bank legislation have become too narrow. At a time when there exits a world wide trend towards liberalisation and democratisation one simultaneously is insulating meaningful institutions from the hands of the decision makers. With this development will Europe become more rule governed. This could be needed for building a community based on the rule of law. Having relatively binding policy rules at the EU level could be considered necessary. It might be, however, that in case of the ECB these rules have become too binding, especially in case of precommitment to price stability. For this reason an analyses has been made of different perspectives for agreements on monetary policy. One is commonly known as the New Zealand -model of central banking. This will be briefly evaluated in the last section of this paper.