Sunday 8 December 2019

Dan O'Brien: 'Ex-lawyer Lagarde looks to be on the money - but faces a tough job dealing with financial maelstrom'

Your mortgage repayments won't go up any time soon. For many readers, that is by far the most important thing to know about today's change of leadership at the European Central Bank. (stock photo)
Your mortgage repayments won't go up any time soon. For many readers, that is by far the most important thing to know about today's change of leadership at the European Central Bank. (stock photo)
Dan O'Brien

Dan O'Brien

Your mortgage repayments won't go up any time soon. For many readers, that is by far the most important thing to know about today's change of leadership at the European Central Bank.

The Frankfurt-based institution, which has been setting interest rates for Ireland for two decades, is getting a new boss tomorrow. Departing is Mario Draghi, the Italian who has led the ECB since 2011 and who never once raised interest rates during his time in office. Taking over is Frenchwoman Christine Lagarde. She is very unlikely to increase rates, at least in the first years of her eight-year term.

Why interest rates will remain at rock bottom for some time yet is in part related to the personalities and orientations of the outgoing and incoming ECB presidents.

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Draghi has earned a reputation as a hard-headed pragmatist who saved the euro. There is good reason for that. Over a 30-month period at the beginning of the decade, starting with the government debt crisis in Greece, the single currency was strained to breaking point as the crisis spread from one country to the next, weakening the entire system.

After his appointment as ECB president in late 2011, Draghi played a central role in convincing other decision-makers to roll out the sort of unconventional measures that central banks around the world were deploying. In essence, and somewhat over-simplistically, that meant printing money, or being prepared to do so.

Few argue that the money-printing undertaken by central banks over the past decade is a good thing. The strongest argument in its favour is that not doing it could have led to the break-up of the euro in 2012 and, more recently, much weaker economic growth, a spiral of falling prices and more joblessness. Draghi needed strong powers of persuasion to convince others that the bad choice of money printing was better than letting events take their own course.

Six people, including the president, form the core leadership team of the ECB in Frankfurt. That 'executive council' joins with the 19 heads of the national central banks (which are members of the euro) to form the 25-person 'governing council'.

They collectively make decisions on interest rates, money printing and keeping the entire euro area financial system on the rails.

The ECB's decision-making council is much larger than those of other central banks. As anyone who has ever sat on any kind of committee knows, the more people there are on a committee, the longer it takes to reach agreement, and the greater the chance of spats. In recent months, one of the most serious spats ever has been raging among the central bankers of the euro area.

Because interest rates are already as low as they can go, the ECB can't cut them further to stimulate the economy. Instead, Draghi recently pushed through more money-printing measures. He argued that the euro-wide economy had weakened enough to warrant them and, more specifically, that the ECB has not brought consumer price inflation up to its target rate of just below 2pc (prices are currently rising by less than 1pc annually across the bloc).

The decision to fire up Frankfurt's printing presses again has caused some consternation. One member of Draghi's executive board resigned in protest. A significant minority of the 19 national central bank governors have let it be known that they opposed the measures. A slew of retired central banking grandees have also publicly come out against the measures.

Into this maelstrom comes Christine Lagarde.

She has long had a profile in Ireland. She was French finance minister in 2010 when Ireland was bailed out - by the troika of the ECB, the European Commission and the International Monetary Fund. Her boss at the time - French president Nicolas Sarkozy - tried to make the bailout conditional on Ireland jacking up its corporation tax rate.

Sarkozy successfully put Lagarde forward to lead the IMF in 2011. She has just stepped down from that role to move to Frankfurt where she will take the helm at the ECB tomorrow. On the ongoing disagreement on policy matters, Lagarde has been clear that she is on the side of Draghi and those who favour more action.

That has made her appointment somewhat controversial in the countries which oppose the measures. Her appointment has not been uncontroversial in other regards, too.

Lagarde is a lawyer by profession, not an economist, as is the norm for central bank bosses. That is no trifling matter. Setting interest rates in normal times is a tricky, technical business. Setting monetary policy when rates are already at zero and central bankers are engaged in giant money-printing experiments has been challenging even for those with the most expertise in the field.

Nearly all of those on the 25-person governing council have more direct experience than Lagarde. That may prove to be a weakness if arguments break out among members of the council.

Owing to the divisions discussed above, recent meetings of this group have been tense, according to well-informed media reports. Lagarde will have her work cut out merely to stop the existing divisions deepening. Here, her proven political nous and pragmatism should stand her in good stead.

At the centre of these debates has been whether printing more money is proportionate to the scale of the challenge of below-target inflation and the risk that low inflation could turn into a deflationary spiral. Advocates have argued that the unconventional measures taken to date have worked and should be continued. Opponents say that too-low interest rates penalise savers and risk inflating financial bubbles.

Who is right? The jury is still out. Economists are not too confident that there won't be ill-effects from money printing in the longer term. Nor is there anything approaching consensus on why inflation has been so persistently low in so many countries.

If the causes of very low inflation are not well understood, there are no hard indicators that the phenomenon will end any time soon. As long as inflation is low, interests rates, including on mortgages, will not go up.

That may not sit well with savers, but for those paying off home loans it offers more years of respite from higher housing costs.

Irish Independent

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