Tuesday, September 25, 2007

Trichet v. Sarkozy: a senseless and costly argument

Central bankers should not engage in a public war of words with heads of state, heads of government and ministers of finance or the economy. It is a conflict that has no winners, only losers. And the main loser is the ability of the central bank to pursue a policy of flexibility with commitment and credibility. It is especially important that operationally independent central banks not be drawn into a public political slanging match.

Jean-Claude Trichet has failed this test. In an hour-long interview on TV5-Europe1, he laid into the policies of the French government, specifically the high levels of public spending and France’s inability to contain production costs. Such topics are indeed fair game for domestic or foreign political opponents of Nicolas Sarkozy and his government. Mr. Trichet was no doubt provoked by Sarkozy’s incessant banging on about the failure of the ECB to take steps to engineer a weaker external value of the euro, preferably by taking a leaf from Ben Bernanke’s book and cutting interest rates by at least 50 basis points. But the fact that Mr. Sarkozy (not for the first time) ran roughshod over Article 107 of the Maastricht Treaty and Article 7 of the ESCB Statute, does not mean that Mr. Trichet has the right to shout the moral equivalent of “and so’s your sister” at the French head of state. These Articles guarantee the independence of the ECB, the national central banks, and the members of their decision-making bodies in exercising their powers and carrying out their duties. They are not allowed to seek or take instructions from the government of any member state, any organization of the European Community, or any other body. These governments, institutions, and bodies are indeed obliged to refrain from trying to influence the ECB or the national central banks in the performance of their tasks.

It is a mistake for central bankers to express, in their official capacities, views on what they consider to be necessary or desirable fiscal and structural reforms. Examples are social security reform and the minimum wage, subjects on which Alan Greenspan liked to pontificate when he was Chairman of the Board of Governors of the Federal Reserve System. Ben Bernanke has spoken out on free trade, globalisation and inequality and teenage pregnancy. Even when I agree with him, I wish he would stick to his monetary policy brief and his banking supervision and regulation brief, rather than becoming a participant in partisan political debates that have nothing to do with the central bank’s mandate.

It is not the job of any central banker to lecture, in an official capacity, the president, the prime minister of the minister of finance on fiscal sustainability and budgetary restraint, or to hector the minister of the economy on the need for structural reform of factor markets, product markets and financial markets. This is not part of the mandate of central banks and it is not part of their areas of professional competence. The regrettable fact that the Treasury and the Ministry of the Economy tend to make the symmetric mistake of lecturing the operationally independent central bank on what they perceive to be its duties (which generally amounts to a plea for lower interest rates) does not justify the central bank’s persistent transgressions.

There are but a few examples of central banks that do not engage in public advocacy on fiscal policy and structural reform matters. The only examples I am aware of are the Bank of England and the Reserve Bank of New Zealand.

Central bankers indeed have a duty to explain how their current and future interest rate decisions are contingent on economic developments that may include or may be influenced by, the actions of the fiscal authorities and the success or failure of structural reforms. The central bank should clarify what its reaction function is, given the economic environment in which they operate, which includes the fiscal authorities and the government and ‘social partners’ engaged in structural reforms.

Independent central bankers can, and where possible should, cooperate with and coordinate their actions with those of the fiscal authorities and with those charged with structural reform. If central banks, Treasury ministers and ministers of the Economy were to act cooperatively toward each other, and with credible commitment towards the private sector, good things may well happen. The reason this does not happen in the EU, or even in the Eurozone, is not a question of principle, but of logistics. There is no coordinated fiscal policy in the EU or in the Eurozone, so the pursuit of coordination between fiscal and monetary policy in the EU or in the Eurozone is simply not possible. Mr. Jean-Claude Juncker could have private breakfasts and/or public lunches with Mr Jean-Claude Trichet every day of the week, every week of the year, it would not bring monetary and fiscal policy coordination in the Eurozone an inch closer to realisation.

The only time central banks have the right and duty to speak out on issues beyond monetary policy narrowly defined, is when the independence of the central bank is threatened. So Mr Trichet certainly is within his rights to publicly sort our Mr. Sarkozy on Article 107 and Article 7.

Unsustainable public finances are not a matter on which the central bank should speak out, even if they threaten to confront the central bank with the dilemma: live with a sovereign debt default or bail out the improvident government through monetisation that threatens the central bank’s price stability mandate. The central bank’s mandated course of action is clear: they should let the government default on its debt rather than monetise that debt in a way that undermines price stability.

Even when the central bank also has a financial stability mandate, the right policy when faced with and unsustainable fiscal-financial policy programme is no different: it is to let the government default rather than to bail them out with monetary issuance that threatens price stability. After all, default is a re-assignment of property rights, and a recognised contingency for any debt instrument. Fundamentally, it is a redistribution of wealth from the owners of the debt to current and/or future tax payers and current and/or future beneficiaries of public spending. There are political mechanisms for sorting out such deeply political distributional issues. They are not the business of the central bank. Financial regulation should ensure that no systemically important financial institution is so exposed to the debt of any sovereign, that the financial viability of the institution would be threatened by the default of the sovereign.

By publicly attacking the economic policies of the French government, Mr. Trichet politicises the ECB. This threatens its independence. When enough political anger and hostility is generated towards the central bank, neither Article 107 nor Article 7 will save it. Ultimately, the Treaty, like any Constitution, is a piece of paper. It is not the Treaty or the Constitution that is sovereign, but the people. Not even the most independent central bank in the world should forget that.

No comments: