For years, the ECB has egregiously violated its own statutes. Today’s high inflation is the predictable result.
For the first time in more than 10 years, the European Central Bank has increased its key interest rate, raising it by 0.5 percent. The move follows a long period of decreasing interest rates and pumping money into the economy via so-called quantitative easing. Europe, like the United States, was flooded with liquidity.
Some in the media even called the 0.5 percent rate rise a “courageous” step, because it was more than the expected 0.25 percent. The increase is ostensibly meant to help slow inflation, which the ECB leadership first denied and then ignored for months after it first appeared. Yet even as she announced the rises, ECB President Christine Lagarde made veiled promises to continue her institution’s irresponsible financing of some member states.
She revealed that the ECB’s governing council had approved the creation of a new policy tool, called the Transmission Protection Instrument. The TPI will enable the ECB to buy government bonds from certain member countries if the “risk premium” (the rate of return above that which is guaranteed) rises too much. Its purpose is to counteract what the ECB calls “unwarranted, disorderly market dynamics which pose a serious threat to the effectiveness of monetary policy in the euro area.” This statement is outrageous. The market dynamics that increase the risk premium are entirely justified, as the risk is naturally higher in fiscally mismanaged countries. In fact, any so-called “market disorder” would be the consequence of fiscal irresponsibility among member states, which the ECB among others, had encouraged with its policies over the years.
Breaking the rules
Do these explanations expose incompetence? Or is the easy-money policy a centralist agenda at the ECB, which clearly counteracts the bank’s role, function and statutes? If a company’s management team were to break the firm’s rules so egregiously, it would be considered a criminal act.
The ECB’s primary objective is to maintain price stability. It is clearly forbidden from financing public debt or setting fiscal policy. This is the cornerstone of the euro area’s monetary system. Guaranteeing the ECB’s political independence was crucial to ensure that it would not meddle in such matters. This meant safeguarding its institutional independence: the ECB must not seek or take instruction from any institution, government, or other body. It also meant assuring the bank’s functional and operational independence, financial and organizational independence, legal independence and the personal independence of its executive board members.
Unfortunately, most eurozone member countries began violating the rules of the Maastricht Treaty, which set limits on government deficit and total debt, shortly after it was signed. France and Germany were the first to do so. Yet these criteria formed a key pillar of the monetary union. Breaching them put stress on the system and led directly to the financial crisis of 2012.
Inflation does not come upon us as a curse or a tragic fate; it is always brought about by a frivolous or even criminal policy.
That crisis was certainly not a market failure. Instead, it was a failure of states, due to excessive debt, caused by oversized public sectors. Governments refused to tackle the problem at the root by reducing the size and role of state institutions. On the contrary, the ECB president at the time, Mario Draghi, famously said on July 26, 2012, that the bank was “ready to do whatever it takes to preserve the euro.”
With that statement alone Mr. Draghi had already broken the ECB’s fundamental rule that its primary goal was to protect the value of the euro, not finance fiscal deficits. At that point, member governments had, de facto, received carte blanche to spend. Any problems that arose were “solved” by dousing them with money. To be fair, it is worth noting that such bad practices were not limited to the euro area.
The amount spent on financing eurozone members’ deficits increased more and more. After Ms. Lagarde, a professional politician, was appointed ECB president in an agreement between German Chancellor Angela Merkel and French President Emmanuel Macron, money printing rose to staggering levels.
If Mr. Draghi’s statement had not made it clear, then in the following years it became obvious that the ECB’s main purpose was no longer protecting the purchasing power, savings and income of those in the eurozone. Instead, the goal had become the defense of the euro itself as an institution.
This mentality was rife among Europe’s leaders. Chancellor Merkel, for example, made the outrageous statement in 2011 that “if the euro fails, Europe fails.” In doing so, she essentially admitted that she believed Europe’s very existence depended on a currency that governments could use to spend away their problems. What a cynical dismissal of the continent’s strengths, rules and people!
Centralization not the answer
Indeed, the ECB has not been carrying out its centralization scheme alone, but in collusion with EU governments, the European Commission and the European Parliament. The ECB’s executive body is appointed by the European Council. When Ms. Lagarde was nominated, it was clear that she would continue and probably increase the bank’s purchases of government debt. As the European Council includes all member states’ heads of government, they at least agreed to breach the rules. Once a year, the European Parliament officially receives the ECB’s annual report. Yet it has never passed a resolution to stop the rules from being broken.
Cheap money and technocratic centralization will not protect European integration. Harmonization must only occur where necessary – all other problems should be addressed by local solutions. What could bring out Europe’s real strength is less state and union intervention.
That inflation would hit was easily foreseeable, though even a year ago President Lagarde denied that it had appeared. As it bites down further, the damage done will become obvious. Those responsible for the devastation are now blaming factors out of their control: Covid-19 or the war in Ukraine. While these phenomena certainly did not help, they are also not the root of the disaster.
Ludwig Erhard, the great German cabinet minister who put in place the framework for Germany’s postwar Wirtschaftswunder once said: “Inflation does not come upon us as a curse or a tragic fate; it is always brought about by a frivolous or even criminal policy.”