Wednesday 26 June 2019

Colm McCarthy: 'We'll all pay the price if the ECB's leader isn't picked for professional competence'

The role of European Central Bank president is too important to be decided simply by politics and nationality, writes Colm McCarthy

Mario Draghi's time as president of the European Central Bank is coming to an end. Photo: REUTERS/Ints Kalnins
Mario Draghi's time as president of the European Central Bank is coming to an end. Photo: REUTERS/Ints Kalnins

On Thursday, June 20, the European Council convenes in Brussels for its quarterly two-day meeting, the first since the European Parliament elections. The main business will be the choice of new presidents for the European Council itself, to replace Donald Tusk, for the European Commission to replace Jean-Claude Juncker and for the European Central Bank, where Mario Draghi's term of office is also ending.

The succession to Draghi is important for the 19 countries in the eurozone, especially for those likely to be most exposed to ECB policies. This category includes Ireland, given the high debt level and the unfortunate experience in 2010 and 2011 at the hands of Draghi's predecessor Jean-Claude Trichet. In the chaotic conditions of the financial crisis, the ECB filled a policy vacuum in securing the survival of the common currency area and particularly in the oversight of rescue programmes in Greece, Ireland, Portugal and Cyprus. The eurozone had not been designed as a full monetary union and the crisis exposed design flaws, including a policy role in programme countries for the new central bank which had not been foreseen.

Partial remedies have since been implemented but the process is incomplete. The essence of the design weakness in Europe's self-described ''monetary union'' is that it was no more than a common currency area and is not yet a full monetary union. The centralisation of supervision for the larger banks has been accomplished but the system lacks a clear mechanism for dealing with failing banks or sovereigns, does not have a proper capital markets union and the only ''safe'' financial assets at the core of the system are the heterogeneous bonds issued by the member states. The result has been continued financial fragmentation and unequal retail credit costs and conditions, not what was advertised when the system was established 20 years ago. A costly flaw in Ireland's case was the pronounced exposure of individual member states to failures in local banking systems. In full monetary unions, such as the United States, the system design is more robust.

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There could be another eurozone crisis during the seven-year term of the next ECB president, and it could come soon given the recent pressure on the Italian bond market. Countries with high debt burdens could be re-classified as ''peripheral'' and yield spreads could get big enough to disrupt financial markets. The competence of the ECB in the next crisis will matter greatly to those member states likely to be in the firing line and the improvements seen under Draghi may not be maintained should a less capable successor be chosen.

The failures under Trichet should be etched in the memory of Leo Varadkar and the other attendees at the meeting next Thursday week in Brussels. The initial crisis response included an increase in system-wide interest rates, the reverse of what was needed, and foot-dragging about measures to relieve pressure in the markets through direct intervention. It was only when Trichet was replaced by Mario Draghi, a professional economist and an expert in macroeconomics and monetary policy, that the ECB caught up with other central banks in dealing with the crisis.

In the summer of 2010, when the late Brian Lenihan was finance minister, and again in March 2011 when Michael Noonan had replaced him in a new government, Trichet's ECB threatened the Irish authorities with arbitrary sanctions unless holders of unsecured and unguaranteed bonds issued by banks already bankrupt and closing down, were repaid in full with borrowed Exchequer funds. On the second occasion Ireland was already in a financial rescue programme organised by European institutions and the International Monetary Fund. Officials from the IMF opposed Trichet's exactions on their indebted client, for which there was no precedent and not even a secure legal basis in the ECB's statutes. The financial damage wrought by Trichet was partly undone when the ECB, under his more competent successor Mario Draghi, facilitated the unwinding on favourable terms of the extra government debt issued to bail out creditors in the bust banks.

Trichet's motive in forcing a member government, already in an IMF programme, to incur extra debt to finance billions in payments to private bondholders to whom it owed nothing, was to reassure lenders to French, German and other eurozone banks. These banks were still able to sell bonds at the time but were quickly unable to do so, and his actions were futile on their own terms. There were political consequences too. Hostile interventions aimed specifically at an individual member state raised troubling questions about the accountability of the European Central Bank, exacerbated when Trichet refused to attend at the Oireachtas banking inquiry, to which IMF officials were happy to report. Instead Trichet appeared at a contrived event in April 2015 at the Royal Hospital in Kilmainham, declined to testify under oath and contradicted Michael Noonan's entirely credible version of events. Fianna Fail's Marc McSharry described the event as ''demeaning'' and it was.

The Trichet affair is relevant to the appointment of the next ECB president because several of the candidates could fall short of the improved standard Draghi has set. The appointment of the ECB's council is haphazard, by statute. Each of the 19 member states appoints a governor of its national central bank and that person automatically joins the 25-member council, the supreme policymaking body. The last two Irish appointees, Patrick Honohan and Philip Lane, were chosen for technical qualifications and experience in macroeconomics and monetary economics. But many countries select senior public officials or retired politicians. The six full-time members are the president and five ECB staffers. Philip Lane has recently joined this group and will, according to the Financial Times, strengthen its technical capacity.

The appointment of people with the right analytic background is no guarantee that central banks will make the best decisions: managing interest rates and setting monetary conditions is not an exact science and there are uncorrected design flaws in the eurozone which make things harder. The current favourites to succeed Draghi include the Bundesbank chief Jens Weidmann who opposed (at times in public) several of the key measures introduced by Draghi, and the Banque de France president and former senior official Francois Villeroy de Galhau. There are two Finnish candidates and a Dutch central banker in the field, but the economists' favourite is another Frenchman, Benoit Coure, currently a highly regarded member of the ECB's executive board. Coure was an unsuccessful candidate for the presidency of the Banque de France in 2015 when Villeroy de Galhau was preferred by the government of Francois Hollande.

Top European jobs are dished out on a political basis and the European Council may opt for a German to succeed Juncker at the Commission. If so, the ECB presidency could go to France and Emanuel Macron reportedly favours Villeroy de Galhau. There is however a choice of French candidates.

Leo Varadkar will be the only politician present, when Draghi's successor is selected, with personal experience of poor performance in the leadership of the ECB. He was a member of the Irish government undermined in its first weeks by Jean-Claude Trichet. He should insist that the next ECB president, of whatever nationality, is chosen for professional competence.

Sunday Independent

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