Roundtable: Monetary Policy in the EU
The Hegemony of Central Bankism and Authoritarian Neoliberalism as Obstacles to Human Progress and Survival

February 26, 2021

Jeremy Leaman, Emeritus Research Fellow in Political Economy, Loughborough University

Central Bankism: Fashionable but Destructive

Macroeconomic policy within the so-called advanced economies has, for more than four decades, been dominated by “central bankism” and its ideological cousins, monetarism, ordo-liberalism and supply-sidism. These strands of economic thinking became popular under the umbrella of neo-liberalism in the late 1970s. While they differ in both epistemological terms and in practical policy-making, these strands share a common hostility to Keynesian and other statist theories of political economy, along with a common belief in the greater efficiency of private markets for the allocation of resources within society and economy.  Policy-makers within OECD-states have, in varying degrees, remained in thrall to the prejudices of neoliberal thinking, most notably to central bankism. This thraldom is characterised by the primacy of monetary policy-making as the core function of a supposedly slimmed-down state, and the corresponding subordination of fiscal policy to the disciplinary controls placed on public sector borrowing and overall state debt. This subordination has been increasingly codified in legal statutes and, in the current century, in constitutional limitations on the fiscal latitude available to states. Fiscal “consolidation”, fiscal “austerity” are the watchwords of this incoherent and destructive fashion in political economy.

The Embeddedness of Failed Ideas

Heterodox political economists have long been united in their rejection of this “doctrine” of “failed ideas”[1] , but its codification in statutes, and its embeddedness in institutions and in political and cultural discourse bear witness to its extraordinary tenacity, to its “strange non-death”[2]. Despite its profound contradictions and flaws, central bankism is hegemonic in Gramscian terms; it is a key element of a neoliberal historical bloc[3]which has decisively determined key policy preferences in the era of transnational, financialised capitalism. This bloc is maintained politically by the major autonomous central banks within the OECD – the Federal Reserve, the Bundesbank and, since 1999, the European Central Bank. At the beginning of the 1970s, the Fed, the Bundesbank and the Swiss Central Bank were the sole institutions that enjoyed a high degree of independence within their respective states. However, the main political vehicle for the popularisation of independent central banking within the OECD and beyond was the German Bundesbank. That said, the process which drove the rapid march towards autonomisation of monetary authorities, particularly in Europe, cannot be described in terms of a hegemonic strategy on the part of either the Federal Republic or its central bank, but rather of the very particular circumstances that emerged as a result of the collapse of the system of fixed exchange rates after 1971, the associated weakening of the United States’ hegemonic role within advanced capitalist states and the OPEC revolt of 1973.

Towards Bundesbank Hegemony

In the context of stagflation in the second half of the 1970s, the floating of exchange rates generated high levels of volatility in currency markets and, in consequence, in sovereign bond markets, as states were forced to raise interest rates to attract the growing volumes of vagabond capital, including petro-dollars, or to maintain the loyalty of domestic capital. The combination of market volatility and asymmetrical balances of trade and payments exposed the weaknesses of several European currencies and reinforced the leverage of the stronger Deutschmark, cushioned – as it was – by (West) Germany’s powerful trading position in

high-grade goods with their lower price-elasticity. The performance of the Bundesbank in the alien environment of stagflation[4], with its single mandate of price-stabilisation, was ostensibly far superior to that of macroeconomic authorities in other EEC-states, both in terms of comparatively low rates of inflation and low central bank interest rates. Moreover, it deployed its main policy instruments – discount rates, Lombard rates and open market operations – in a manner which seemed to serve German interests and was celebrated in domestic political debates; its autonomous policy choices were made in part at the expense of Community partners. The subsequent initiatives to stabilise market conditions within Europe (the currency Snake, Snake-in-the-Tunnel, European Monetary System (EMS)) were thus informed to a large degree by fears of unilateral political action on the part of the (independent) Bundesbank. The manoeuvrings within the EEC in the late 70’s and 1980’s are well-documented.[5] For the purposes of this brief analysis, it is sufficient to assert that, whether by design or by default, Europe’s major states were persuaded to adopt the institutional model of independent central banking.  The primary reason for this momentous trend were simply the politico-economic realities of Bundesbank hegemony over monetary policy. It was a very messy compromise: to exchange the damaging asymmetries of national central bankism for the hope of better balanced shared institutions of European central bankism, rooted in the separation of monetary authority from parliamentary control.

The Bundesbank in fact resisted the political initiative of Giscard d’Estaing and Helmut Schmidt to establish shared commitments by national central banks to intervene to defend agreed exchange rate margins, within the EMS. In the wake of Germany’s contentious currency union process, the Bank also did its best to obstruct the negotiations surrounding European Monetary Union (EMU), succeeding at least in insisting on very strict conditionalities for membership.  Subsequently, ECB and ECOFIN policy has been conducted in the tacit acknowledgment of the need for Bundesbank approval. This has arguably slowed the progress towards EU reforms in fiscal and monetary policy within the Eurozone. The significant doubts, raised in other states in the run-up to EMU, about the merits of separating monetary policy and fiscal policy, of establishing a less answerable, less accountable technocratic agency for the conduct of monetary policy, of increasing rather than reducing Europe’s democratic deficits, were thus set aside in the name of pragmatic expediency. Europe could not hope to “deepen” and “widen” its political potential without the Bundesbank or Germany’s ordo-liberal preferences, so they chose to make those preferences their own.

The Challenge of Abandoning a Bad Orthodoxy

This brings us back to the fundamental contradiction highlighted in the opening paragraph above, namely that the policy preferences that have become baked into institutions, the statutes, the political behaviour and the intellectual mindset of the European Union are bad preferences. Together with the institutions of financialised capitalism, they have contributed to an increase in the disparities of income and wealth within the Union, to a declining trend in productive investment in its core states, including the now-united Germany, to weak recoveries from cyclical and structural economic crises and, most critically, they have side-lined heterodox, critical voices within both the research and policy communities of Europe concerning the actual merits of central bankism. Debates on these issues since the Great Financial Crash of 2008 and, more recently, in the wake of failed austerity programmes and the Covid-19 pandemic, have not changed the fundamental parameters governing the legitimacy of central bank autonomy. These remain largely unchallenged. What policy communities have been focussing on – adding a fiscal dimension to Eurozone macroeconomic management, allowing the partial mutualisation of state debt, adding a green dimension to the ECB’s mandate, analysing the relevance of (Germany’s) legal rulings on Eurozone reforms – is arguably mere displacement activity, akin to re-arranging the deck chairs on the Titanic.[6] It is, in contrast, the very case for central bank independence that requires radical re-examination. The precipitate capitulation of European political elites to the “Bundesbank myth”[7] demands the close scrutiny of contemporary and future analysts, as does the parallel capitulation of those same elites to the delusions of “neoliberalism”. Firstly, that capitulation took place at a time when the scholarly credentials of monetarism and (German) central bank practice were being arguably undermined by the realities of global, financialised capitalism in the eyes of heterodox critics of central bankism. Secondly, the theoretically dubious case for the autonomisation of European and other central banks as a means to combat inflation, was based on an empirical sample of one, namely the Bundesbank; little more than a crude syllogism. Bibow notes the eccentricity of the political choice of a model based, as it was, on “peculiar German traditions”[8] , governed by “very peculiar historical circumstances”.[9]Indeed, the seminal legal acts, establishing the autonomy of the Reichsbank (1922, 1924) or the Bank deutscher Länder (1948) were implemented as a result of the diktat of the victors of the First and Second World Wars respectively[10]; the political and parliamentary circumstances before the passage of the Bundesbank Law (1958) were also informed by both the preferences of the western Allies, dominated by the US, prioritising the weakening of the powers of Federal parliament and government, and by the electoral opportunism of the Social Democrats[11] who came out strongly in favour of central bank independence!

Changing the Narrative away from Central Bankism

Since 1958 there has been very little serious debate about central bank autonomy. Rather, more intellectual effort has been invested in crafting and polishing a mythology of the Bundesbank and its supposedly key role in the success of the “social market economy”. This has significant consequences for the popular reception of comparative institutional achievements. What the economic history of the Federal Republic demonstrates above all, is that the lionising of the Bundesbank as the primary architect of Germany’s macroeconomic success exaggerates the central bank’s role to a grotesque degree and correspondingly trivialises the greater importance of many other determinants – domestic and international – which underpinned the nation’s passage to industrial and exporting dominance.[12] One particularly egregious example of this fatal deification of the Bundesbank is the hagiography by Dieter Balkhausen, published under the title of Good Money, Bad Politics (Gutes Geld und schlechte Politik)[13]; above all it reflects and seeks to reinforce the authoritarian scepticism towards democratic politics in Germany that survived two wars, and was increasingly reflected in opinion surveys of popular trust in institutions: the Bundesbank consistently outscored elected assemblies at central, regional and local level, to such an extent that Jacques Delors famously pronounced that “not all Germans believe in God, but they all believe in the Bundesbank”.

Distrust in democratic institutions is ubiquitous, notably in times of social crisis, but the historical sanctification of the Bundesbank in Germany has had deep and lasting consequences beyond the country’s borders, and it runs parallel to the structural neutralisation of Keynesianism within German institutions and, in consequence, among the country’s political and academic elites.[14] Jörg Bibow’s conclusion that “Germany’s Anti-Keynesianism has brought Europe to its knees”[15] is certainly persuasive, and equally applicable to the theocratic adulation of the Bundesbank. This is particularly relevant when one observes the extreme difficulties facing European policymakers in the wake of the Great Financial Crash, and now in the context of both climate crisis and pandemic which derive to a significant degree from the statutory obstacles which central bankism has baked into the legal and institutional structures of the European Union.

The relevance of the active, strategically agile and well-resourced state in the triple global crises of financialised capitalism, environmental collapse and a devastating pandemic is irrefutable. Likewise, the case for integrated cross-border macroeconomic coordination of monetary and fiscal policies, underpinned by well-informed electorates and civil society actors, is unanswerable. The mobilisation of resources to ensure the physical survival of the planet and its occupants is urgently critical and the global community of states cannot afford to be disrupted by the fundamentalist delusions of monetarism, neoliberalism and central bankism. Equally, the scope of that resource-mobilisation has to include not just uniquely high levels of state-borrowing and regionally mutualised debt but also the rigorous national and international eradication of tax-avoidance, tax-evasion and money-laundering, too long tolerated by permissive neoliberal policy-elites, alongside more equitable, more progressive rates of income and wealth taxation. The triple global crises constitute a unique challenge, far beyond even the exigencies of war. COVID-19 has delivered a volcanic shock to the foundations of the neoliberal “leaner, fitter, state” and the nonsense of “crowding out”; it has also provided a glimpse of the real value of those areas of human endeavour that ensure the health, welfare and social well-being of societies (nursing, doctoring, essential services, food-production and -distribution, schools, university research departments) and, in turn, has raised questions about occupations that focus on value-extraction. Above all, the emergence of a younger generation of enquiring, politically aware activists, gives us some reason to hope that transformative change is a realistic ambition.

Additional References

Behringer, Jan, Jan Sebastian Gechert, Jan Priewe, Torsten Niechoj, and Andrew Watt. “The Euro at 20.” Special Issue of Journal of Economics and Economic Policies: Intervention 17, no. 2 (2020): 127-128. https://www.elgaronline.com/view/journals/ejeep/17-2/ejeep.2020.02.02.xml

Kramer, Alan. West German Economy 1945-1955. Oxford: Berg, 1991.

Leaman, Jeremy (2012) ‘The Size that Fits No-One. European Monetarism Reconsidered’, In: Chiti, Edoardo, Augustin José Menéndez, Pedro Gustavo Teixiera (eds) The European Rescue of the European Union. The Existential Crisis of the European Political Project, Oslo (Arena) Report No.3/2012 https://pure.au.dk/ws/files/69770796/RECONreport1912.pdf

Mee, Simon. “Monetary Mythology: the West German Central Bank and Historical Narratives, 1948-78.” PhD thesis, University of Oxford, 2016.


[1]Lehndorff, Steffen. The Triumph of Failed Ideas. European models of capitalism in the crisis. Brussels: ETUI, 2012.

[2]Crouch, Colin. The Strange Non-Death of Neo-Liberalism. London: Polity, 2011.

[3]Bohle, Dorothea. “Neoliberal hegemony, transnational capital and the terms of the EU’s eastward expansion.” Capital and Class 30, 1 (March 2006): 57-86, http://dx.doi.org/10.1177/030981680608800104..

[4]Market theories (qua Phillips Curve) had historically assumed a trade-off between inflation and unemployment.

[5]Marsh, David. The Bundesbank – The Bank that Rules Europe. London: Mandaring, 1992; Kennedy, Ellen. The Bundesbank: Germany’s Central Bank in the International Monetary System. London: Pinter, 1991.; Leaman, Jeremy. The Bundesbank Myth. Towards a Critique of Central Bank Independence. London: Palgrave, 2001; Schulmeister, Stefan. “EURO-Projekt – Selbsterhaltungsdrang der Bundesbank und das Finalen Deutschland gegen Italien.“ WSI-Mitteilungen, 5/1997; Mee, Simon. Central Bank Independence and the Legacy of the German Past. Cambridge: CUP, 2019.

[6] See other contributions to Just Money on this subject: https://justmoney.org/monetary-policy-in-the-european-economic-and-monetary-union/.

[7]Leaman, The Bundesbank Myth. Towards a Critique of Central Bank Independence; Mee, Central Bank Independence and the Legacy of the German Past; Bibow, Jörg. “A Post-Keynesian Perspective on the Rise of Central Bank Independence: A Dubious Success Story in Monetary Economics.” Levy Economics Institute of Bard College, Working Paper no. 625 (October 2010), http://dx.doi.org/10.2139/ssrn.1691706..

[8]Bibow, A Post-Keynesian perspective on the rise of Central Bank Independence: A Dubious Success Story in Monetary Economics, 5f.

[9]Bibow, A Post-Keynesian perspective on the rise of Central Bank Independence: A Dubious Success Story in Monetary Economics, 9.

[10]Leaman, The Bundesbank Myth. Towards a Critique of Central Bank Independence, 73, 91ff.

[11]Leaman, The Bundesbank Myth. Towards a Critique of Central Bank Independence, 103ff.

[12]Abelshauser, Werner. Wirtschaftsgeschichte der Bundesrepublik Deutschland 1945 bis 1980. Frankfurt am Main: Suhrkamp, 1983; Leaman, Jeremy. The Political Economy of West Germany 1945-1985, London: MacMillan, 1998.

[13]Balkhausen, Dieter. Gutes Geld und schlechte Politik. Düsseldorf: Econ-Verlag, 1992.

[14]Abelshauser, Wirtschaftsgeschichte der Bundesrepublik Deutschland 1945 bis 1980, 106ff.

[15] Bibow, Jörg ‘How Germany’s Anti-Keynesianism has brought Europe to its Knees’, International Review of Applied Economics 32, no. 5 (2018): 569-588, https://doi.org/10.1080/02692171.2017.1369938.

Opening up ECB’s Black Box and Painting it Green – the Monetary Policy Mandate in the Age of New Challenges and Uncertainty

February 18, 2021

dr Agnieszka Smoleńska, European Banking Institute

How to assure sufficient democratic control of central banks, in particular those in advanced economies? This question is becoming ever more pertinent as institutions such as the European Central Bank (ECB) seem to veer ever further off the orthodox monetarist path and become increasingly concerned – and rightly so – with the great challenges we face as societies, be it climate change or inequality. Amid calls for greater politicisation of central banks in response, particularly in the context of the ECB, this post draws on the jurisprudence of the Court of Justice of the EU (CJEU) to draw attention to the limitations of existing mechanisms of judicial control of the central bank’s mandate perimeter. Such limitations, however, become opportunities where they shed light on the types of choices which the central banks are likely to make as they become increasingly active in combating climate change.


Keeping track of the ECB’s expanding mandate

Changes in the theory and practice of monetary policy over the last decade have challenged how we think about the accountability and legitimacy of central banks. The new objectives and tools wielded by these institutions in an increasingly uncertain world – one where the assumptions of many economic models are being called into question – undermine the idea that monetary policy is a technocratic and mechanical instrument, one which must be insulated from politics and political processes. Though the process of transformation has affected central banking globally, it has rattled especially our thinking about the ECB due to its tenuous democratic anchoring and the ambiguous role it played in the last economic crisis. The first step in thinking about adjusting mechanisms of control must begin with acknowledging how the mandate evolved.

The ECB, established at the time when the monetarist approach appears to have been at its peak, was held up as a paragon of independent narrow central banking.[i] Its primary mandate is price stability (Art. 127(1) TFEU), defined by the Governing Council in 1998 to be in the range of close to 2 % inflation. Since the Great Financial Crisis of 2008, however, the ECB has broken new ground with regard to its role in the financial sector with the stabilising effects of Mario Draghi’s “whatever it takes”, followed by the establishment of a centralised system of euro area bank supervision under the ECB (Banking Union). Further, the ECB acquired new responsibilities vis-à-vis the Member States through an array of rescue programs implemented both as part of monetary policy, and also through its role in the euro area’s sovereign debt stabilisation programmes in the context of the highly controversial “troika.”

At the same time, the ECB’s internal perception of its role in the economy changed. First, concerns about “protecting” and “enhancing” the transmission of monetary policy in the context of market turbulence became omnipresent in the speeches of central bankers and in decisions on individual asset purchase programmes as the key to explaining why the ECB was determined to act. Second, financial stability, once a contested objective of central banking (or at least one that is substantially shared with other – national – institutions), now is omnipresent in the language of the ECB. Third, and in tandem with the evolution of the markets more broadly, the ECB reached increasingly for oversight over those financial institutions which were proving to be of critical importance in how (and where) the market operated (e.g. Central Clearing Parties (CCPs)).[ii]


Reigning in the ECB

As the ECB ventured further afield from the narrow mandate of monetary stability, the debate about its democratic anchoring erupted. Calls for increased transparency and accountability are ever louder, in particular those from the European Parliament.[iii] It was judicial accountability, however, which became the control mechanism of choice, and called upon by many interested parties – states, citizens and corporations – to question the legality of the decisions taken by the ECB.

The CJEU in a series of high-profile cases (e.g. examining the legality of the sovereign bond purchase programmes OMT and PSPP) applied a two-step test to determine, first, whether the ECB had competence in a particular area, and second whether the instrument chosen was implemented in a proportionate manner. Yet even with the test being applied, so far deference to the technical knowledge ensconced in Frankfurt has been the hallmark of the jurisprudence of the CJEU in this area. This has provoked a rich debate, not only among EU scholars, but also national courts, ranging from ardent defence of the CJEU’s cautious approach, to outright criticism, most notably from the German Federal Constitutional Court in Karlsruhe. [iv]  

Given this controversial nature of the court’s test, what could it ever tell us about the ECB’s power to green its monetary policy? So far, the CJEU’s approach has been only applied to matters of economic nature – monetary and fiscal policies, financial stability, financial infrastructures. Given the controversies, could we ever expect the test do any better in the context of climate change action? Such a question appears pertinent as the ECB is clearly preparing itself to take the plunge and take monetary policy action explicitly in light of climate change considerations.[v] Below I sketch the questions that would arise in the context of an instrument of ECB’s monetary policy and which have to be answered to meet the criteria of legality laid down by the CJEU.


Testing the ECB’s mandate

The first part of the CJEU’s test asks whether the ECB’s mandate includes climate change at all. The emerging scholarship in the field of sustainable central banking, drawing on CJEU jurisprudence as well as teleological interpretations of the Treaty, suggests that a route to reading climate change mitigation into the ECB’s mandate can be found.[vi] In fact, such a path leads not only – as would perhaps be most obvious – through the auxiliary, secondary mandate of the ECB (i.e. its general obligation to contribute to the economic policies of the Union), but as also through the ECB’s primary mandate, namely that to ensure price stability in the euro area. After all, climate change may cause supply shocks and destabilise financial markets, while the way in which governments’ policies seek to mitigate it create further risks for the bank’s balance sheets (so-called transition risks). Climate change considerations must become part of the scenario within which the ECB conducts its monetary policy. The fact that not only climate activists, but increasingly central bankers themselves, argue that the ECB’s mandate must include the power to design asset purchase programs in a manner so as to exclude significant CO2 emitters, suggests that this view is steadily entering mainstream.[vii]If asked, the Court may well confirm such a mandate, given the route which climate considerations have taken into the central banks areas of interest, namely methods of scenario building and extending the time horizon for considering factors relevant to monetary policy formulation. This is likely all the more so, given the general effort of EU institutions in mitigating climate change (Green Deal).

Once the existence of a mandate is confirmed, there are a variety of tools which the ECB may use to pursue it. These range from how the ECB manages its own funds (where greening would pose little controversy) to unconventional measures such as asset purchases (where greening would raise eyebrows due to market impact and how far apart it appears from traditional monetary policy). For any instruments to be deemed in line with the EU Treaties following the CJEU’s approach, they need to be appropriate, necessary and proportionate to the aim.  


Questioning the ECB instruments’ design

In reviewing the instrument chosen by the ECB the CJEU asks specifically about its appropriateness (is it the right tool?), necessity (is the intervention kept to a minimum?) and proportionality (has it been balanced against other objectives/goals?).

The answer to the first question allows us – external observers of ECB action – a glimpse into the types of proof that the ECB uses to make its decisions and the logic it employs in determining the link between the instrument chosen and the expected results. But what results could be expected in the context of a climate action objective? Could the ECB ever measure its results by how they contribute to keeping the Earth’s temperature steady, or to reducing emissions? The appropriateness question drives home the importance of translating climate change concerns into the financial language of risks, but as well that of the type of expertise required to identify such aims, namely climate expertise. This in turn raises the question of whether the manner in which monetary policy draws on such areas of science warrant specific scrutiny. Or do we trust that economists know better, and at least if they do not know themselves, that they know who to ask?

The second question of the CJEU verifies the self-restraint of the ECB by testing whether the intervention in the market was kept to minimum and whether market incentives were kept in place. In other words, this step is oriented at ensuring that the actions taken by the ECB do not go beyond what is necessary to achieve the stated aim, whilst limiting the interference ECB in the market processes. In the past, at this stage, the CJEU assessed the conditions attached to the policy instrument, e.g. those which imposed quantitative or time limitations. Yet in the context of climate change action, how could the ECB simultaneously remain “neutral” yet help steer the market in such a way that it delivers greener outcomes? The necessity test, if it is applied treating the ECB as an intervenor but non-participant in the market, reinforces the principle of “market neutrality” which acts as a significant constraint on ECB action. Arguably, necessity test could only be met in the case of climate change action on the part of the ECB, if a recalibration of the EU’s “open market economy” model with regard to objectives such as climate change action is acknowledged.  

The third question of the CJEU in turn strives to ensure that there is a balancing of interests affected by the instrument chosen by the ECB. So far, the CJEU has limited itself to confirming that the ECB has performed such an exercise and has done so only in the context of fiscal and monetary policies. Introducing the climate change dimension, which has a significant bearing on economic policies at EU and Member State levels, energy policies as well as social (cohesion) ones, will necessarily alter the nature of the task. Therefore, it appears warranted that the balancing the ECB conducts include consideration of the impact of its actions in other areas of EU competence, for example for the internal market as a whole. The process of balancing and the sources of knowledge for the ECB in acting become paramount here. However, if such a balancing exercise can be done in a transparent manner, it provides an enormous opportunity for a greater understanding of the distributive effects of choices ECB makes.  


Opening up the ECB’s black box

As this post has argued, in the light of the ongoing discussion about democratic control of ECB’s action it is useful to think about the prospects of greening of ECB’s monetary policy (as the most recent expansionary trend) through the lens of the CJEU’s proportionality test.  This constraint on how the ECB exercises its mandate allows us to formulate specific questions about how the ECB makes its decisions, what type of information it draws on, what issues it considers relevant and how it understands (or projects) its role in the market. Crucially, in the context of greening of monetary policy, these questions allow us to think about the evolution of the ECB not in isolation, but as an element of a general transformation of the EU’s economic constitution.  In an increasingly complex and uncertain world this is no small thing.

Such an approach does not solve the question of whether outright politicisation, such as subjecting central banking to electoral processes, is needed. However, it helps understand that the problems that lie at the heart of many criticisms of ECB arise from how today’s capitalist economies operate, in particular with the advancing financialisation of all aspects of our lives, from climate to societal well-being.

When we return to the question of exercising democratic control over the ECB, it is clear that an adaptation of the tools used to monitor the perimeter of its mandate is needed especially with regard to the interdisciplinary questions. Nonetheless, the Court’s test can – by requiring transparency which the ECB may well offer even before it is even challenged before the courts – help us citizens better understand the choices being made, and therefore also weigh in.

Based on a working paper presented with Paweł Tokarski “The Greening of the ECB- a legal-economic analysis” prepared for the “Shining a Light on Energy: 10 Years of the Lisbon Treaty” College of Europe (Natolin) conference, 17-18 June 2020.

[i] Johnson, J. (2016). Priests of prosperity: How central bankers transformed the postcommunist world. Priests of Prosperity: How Central Bankers Transformed the Postcommunist World, Cornell University Press. doi:10.1080/13876988.2020.1804299

[ii] Smoleńska, A. and Héritier, A. (2021). Political Accountability and effects: Capital Markets Union’ in Regulating finance in Europe: Policy effects and political accountability, A.  Héritier and J. Karremans (eds.), Edward Elgar Publishing.

[iii] Curtin, D. (2017). ‘Accountable independence’ of the European central bank: Seeing the logics of transparency. European Law Journal, 23(1–2), 28–44.

[iv] Feichtner, I. (2020). The German constitutional court’s PSPP judgment: Impediment and impetus for the democratization of Europe. German Law Journal, 21(5), 1090–1103, Sarmiento, Daniel; Weiler, Joseph H.H.: The EU Judiciary After Weiss: Proposing A New Mixed Chamber of the Court of Justice, VerfBlog, 2020/6/02, https://verfassungsblog.de/the-eu-judiciary-after-weiss/, Van Der Sluis, M. (2019). Similar, therefore different: Judicial review of another unconventional monetary policy in Weiss (C-493/17). Legal Issues of Economic Integration, 46(3), 263–284., De Boer, N., & Van’t Klooster, J. (2020). The ECB , the courts and the issue of democratic legitimacy after Weiss. Common Market Law Review, 57(6), 1689–1724.

[v] Lagarde, C. (2020). Climate change and the financial sector, Speech at the launch of the COP 26 Private Finance Agenda, London, 27 February 2020.

[vi] Solana, J. (2020), A reminder from the courts for the European Central Bank to take climate change seriously Commentary on 20 May, 2020 https://www.lse.ac.uk/granthaminstitute/news/a-reminder-from-the-courts-for-the-european-central-bank-to-take-climate-change-seriously/, De Serière, V. (2020). Idealism or realistic approaches? Regulatory possibilities to require financial institutions to more substantially contribute to achieving climate goals? An overview. Journal of International Banking Law and Regulation, 35(3), 94–106.

[vii] Financial Times, Christine Lagarde expected to make ECB a climate change pioneer, 2 January 2021, https://www.ft.com/content/00d5dc18-b95d-4a15-b936-e87c98fb17fc; Schabel, I. (2020). Never waste a crisis: COVID-19, climate change and monetary policy

Speech by Isabel Schnabel, Member of the Executive Board of the ECB, at a virtual roundtable on “Sustainable Crisis Responses in Europe” organised by the INSPIRE research network, 17 July 2020. https://www.ecb.europa.eu/press/key/date/2020/html/ecb.sp200717~1556b0f988.en.html

The Distributive Impact of Central Banks’ Quantitative Easing Program

February 10, 2021

Brigitte Young, University of Münster, Germany

An important and still contested issue is the introduction of unconventional monetary policies of central banks in high-income countries. Quantitative Easing (QE) was first introduced in Japan in the 1980s to stimulate the economy. In response to the financial crisis of 2007, the US Federal Reserve (FED) purchased longer-term securities (government bonds as well as mortgage-backed securities) from the open market to increase the money supply and expand economic growth. These purchases have the effect of expanding the quantity of assets in the balance sheets of central banks. QE is used when the interest rate is close to zero, and when the normal tools of monetary policy are no longer effective. Buying financial assets in large quantities adds new money to the economy in order to provide banks with more liquidity. When central banks purchase securities, it increases the demand for these assets, which in turn raises their price. Since bond prices and bond yields (interest rates) are inversely related, the interest rates fall as the bond price increases. As interest rates fall, banks are able to lend at easier terms to stimulate the economy by keeping credit markets functioning and interest rates low.[i]

Between 2008 and 2014, the FED enacted three QE programs. The Bank of England followed with QE between 2009 and 2014 and introduced it once again after the Brexit vote in July 2016. In contrast to these early introductions of QE, the European Central Bank (ECB) started the policy only in 2015. Recently, an extraordinary QE program, the Pandemic Emergency Purchase Program (PEPP) was implemented during 2020 to address the Covid-19 pandemic’s depressing effects on both the supply and demand side.[ii] The ECB recently signaled that it would expand its €1.35tn emergency bond-buying program for the next year to stem the ‘worrying’ fallout from the pandemic.[iii]  

The distributional impact of central bank policy in advanced countries has received little attention until recently. Only with the persistence of central banks interest rates at the zero lower bound and the consecutive switch of major central banks to unconventional monetary policy did distributional impacts of QE increasingly enter the policy and economic agenda. This is reflected in a rise of speeches and papers by central bank governors, central bank board members and affiliated researchers focusing specifically on the distributional impact of QE.[iv] Yet, there is considerable disagreement among experts in assessing the effectiveness of the QE programs.

Quantitative Easing of the ECB seems to have had a strong effect on the exchange rate, having weakened the euro-dollar exchange rate. It lowered the long-term interest rates and thus improved investment conditions for businesses, discouraged savings and lowered the yields on sovereign bonds. Yet, QE failed as a tool to increase inflation to the stated target of 2%. In addition, the fall in interest rates has reduced banks’ profitability, since their business model consists of turning short-term savings into long-terms loans. If long-term interest rates are low, banks make less money. Low interest rates have also led to virtually zero interest rate returns for deposit owners.[v]

Of particular concern is the role of QE in increasing inequality, although the impact of QE on wealth inequality is difficult to quantify. In response to the Fed’s announcement of QE, steep stock market rallies in equities occurred. This was the case in 2014, when the US stock market rose almost 20 percent since mid-October, twice as much as the US S&P 500.[vi]The same increase in equity prices happened after the ECB’s extension of QE in March 2016 when the ECB raised the amount of bond purchases from €60bn to €80bn, including also high-quality corporate bonds.[vii]

Equity prices were almost 90 percent higher in 2014 than in 2009 when QE commenced in the UK. Corporate bond prices are over 40% higher and government bond prices 15% higher. In the US, the numbers are 120%, 30% and 12% respectively. In other words, the wealth, as well as the income, would most probably have been materially smaller absent extra-ordinary monetary stimulus.[viii] After three rounds of QE, where the Fed purchased billions of bonds, the Fed’s balance sheet rose from $2.1 trillion to $4.5 trillion.[ix] 

While the increase in asset prices is not exclusively triggered by unconventional policy, nevertheless studies show that QE may have contributed to higher wealth inequality.[x] Central banks’ increased asset purchases have boosted asset prices. Given the uneven distribution of assets across private households and with higher-income households accumulating a disproportionate share of total assets, QE increases wealth inequality.[xi] However, as a caveat, there is much uncertainty linking QE to wealth inequality, since there are indirect effects such as a reduction of the unemployment rate and the increase in the labor income of the poorer segment of society.

Nevertheless, Ben Bernanke, the former Chair of the Federal Reserve, explicates a possible link between the increase of asset prices and inequality in a Brookings blog:   

The claim that Fed policy has worsened inequality usually begins with the (correct) observation that monetary easing works in part by raising asset prices, like stock prices. As the rich own more assets than the poor and the middle class, the reasoning goes, the Fed’s policies are increasing the already large disparities in wealth in the United States.[xii]

Bernanke refers to the asset price channel of QE which impacts asset prices. Bond purchases by the central bank increase the demand for and the prices of those assets. In addition, financial market actors might use the liquidity which the central banks provide to the market via its QE operations, to purchase other assets, e.g., equity or real estate.[xiii] Restored and increased asset prices improve the balance sheet of asset holders which are financial intermediaries, including banks, but also companies and private households. Stronger balance sheets of market actors in turn could encourage stronger credit supply by financial intermediaries and stronger credit demand by companies and private households.

Yves Mersch, a former member of the ECB‘s Executive Board, acknowledges that in times of exceptionally low interest rates and non-standard monetary policy measures there may be distributional effects, some resulting ‘in potential economic damage to some parts of society; and the potential for others’.[xiv] However, Mersch qualifies this intervention and notes that central banks are not charged with the task of addressing inequalities and are not responsible for economic justice for society as a whole. The clear mandate of the ECB is to maintain price stability over the medium term. The possible distributional side-effects are, according to Mersch, to be tolerated as collateral effects, and these non-standard measures should be temporary.[xv]

The asymmetric power of central banks might also partially account for the long-term trend in inequality. The most vulnerable groups of society are foremost squeezed during economic down-turns or periods with restrictive policy, but these groups are not lifted back up to their pre-crisis social and economic status during expansionary phases. The negative impact of the down-turn is not necessarily reversed. Janet Yellen, former Federal Reserve Chair, acknowledged the widening inequality and suggested that while the stock market rebounded, wage growth and improvements in the labor market have been slow, and the increase in the home prices has not fully restored the housing wealth lost by a large majority of households for which the home is their primary asset. Yellen invoked the ‘Great Gatsby Curve’ suggesting that greater income inequality is associated with diminished intergenerational mobility.[xvi]

As pointed out above, QE is not neutral in terms of distributional effects, neither in the short-term nor in the long-term. Accordingly, distributional impacts of QE should be of concern to central banks and be included in future academic research. Not least because inequality might reduce the operation of the monetary transmission channel, limit the multiplier effect of aggregate demand and hence dampen the expansionary effects of QE on growth.

One area which has received little attention in the literature is the different impact QE has on income and wealth inequality for women and men, and minority groups. Discovering an asset bias, a phenomenon which would show whether (white) men, the better educated, those with higher incomes, or those that own inheritance are more likely to benefit from an increase in the value of shares, bonds and mutual funds is a much-needed research topic. Such an analysis may demonstrate that wealth and income distribution are both correlated with the central banks’ QE programs in that unconventional monetary policy increases wealth inequality particularly in the higher income quintiles. For example, the top 10% of Americans own 84% of the country’s shares. The top 1% own about half. The bottom half of Americas own almost no stocks at all.[xvii]  In my present quantitative research relying on the results of the Household Finance and Consumption Survey (HFCS) of the ECB, I hypothesize that since the rich own more assets than the poor, unconventional monetary policy benefits the wealthier quintile in the eurozone countries (on average, comprised of more men) at the expense of the poorer strata of society (on average, comprised of more women).[xviii]   

While the role of money is that it is one of the most important channels in the transmission between monetary policy and household wealth, none of the central banks, affiliated researchers, or even economic gender experts have included the topic of gender and racial impacts in empirical studies, nor is the topic accounted for in monetary policy formulation or policy design. This theoretical and structural neglect of gender and racial impact in the design of monetary policy needs to be explored further in order to deepen our understanding of the operation of monetary policy, and in particular quantitative easing, to identify the different impacts on income and wealth inequality among different gender and minority groups, different countries and regions, and different economic structures.

[i] Liber8, Economic Information Newsletter, Quantitative Easing Explained. Research Library of the Federal Reserve Bank of St. Louis (April 2011).   

[ii]  Luigi Bonatti, Andrea Fracasso, Roberto Tamborini, Covid-19 and the Future of Quantitative Easing in the Euro Area: Three Scenarios with a Trilemma, European Parliament (September 2020) https://www.europarl.europa.eu/RegData/etudes/IDAN/2020/652740/IPOL_IDA(2020)652740_EN.pdf

[iii] Financial Times, ECB signals additional eurozone stimulus (November 27, 2020), p. 2

[iv] Yves Mersch, Monetary Policy and Economic Inequality, Keynote speech at the Corporate Credit Conference, Zurich (October 17, 2014). https://www.ecb.europa.eu/press/key/date/2014/html/sp141017_1.en.html  

[v] Maria Demertzis and Guntram B. Wolff, The Effectiveness of the European Central Banks’ Asset Purchase Programme, Bruegel Policy Contribution, Issue 2016/10.  https://www.bruegel.org/2016/06/the-effectiveness-of-the-european-central-banks-asset-purchase-programme/

[vi] Atkins, Ralph and Michael Mackenzie, Bonds: Caught in a debt trap. Financial Times, (28. January 2015).  p. 7. 

[vii] Financial Times, ECB cuts rates and boosts QE to ratchet up eurozone stimulus. (11 March 2016). pp. 1-2)

[viii] Haldane, Andrew G. Unfair Shares, Remarks at the Bristol Festival of Ideas Event. Bristol (21st May, 2014).

[ix] Yahoo!finance. The Fed caused 93 % of the entire stock market’s move since 2008: Analysis. https://finance.yahoo.com/news/the-fed-caused-93–of-the-entire-stock-market-s-move-since-2008–analysis-194426366.html

[x] Claes, Gregory, Zsolt Darvas, Alvaro Leandro and Thomas Walsh. The effects of ultra-loose monetary policies on inequality, Bruegel Policy Contribution, Issue 2015/09:1-23.

[xi]  Martina Metzger, Brigitte Young, No Gender Please, We’re Central Bankers: Distributional Impacts of Quantitative Easing, Berlin School of Economics and Law, Berlin, Working Paper No.136/2020. https://www.econstor.eu/bitstream/10419/214915/1/1692376071.pdf  

[xii] Ben Bernanke, Monetary policy and inequality (2015). https://brookings.edu/blogs/ben-bernanke/posts/2015/06/01-monetary-policy-and-inequality

[xiii] Epstein, Gerald, Montecino, Juan Antonio. Did Quantitative Easing Increase Income Inequality?  INET Working Paper No. 28 (October 2015).

[xiv] Mersch op., cit. 2014. 

[xv] Mersch ibid., p. 1

[xvi] Janet Yellen, Perspectives on Inequality and Opportunity from the Survey of Consumer Finances. Speech delivered at the Conference on Economic Opportunity and Inequality, Federal Reserve Bank of Boston, Mass. (October 17, 2014). https://www.federalreserve.gov/newsevents/speech/yellen20141017a.htm

[xvii] Edward Luce, A dangerous reliance on the Fed. Financial Times. (4. January 2021).

[xviii] Brigitte Young, The impact of unconventional monetary policy on gendered wealth inequality. Papeles de Europa. 31(2) 2018: 175-185.


Money and the Debunking of Myths

February 3, 2021

Jamee K. Moudud, Professor of Economics, Sarah Lawrence College

In recent years a number of authors have argued that in order to achieve vital social and environmental goals such as the Green New Deal, legislatures must democratize the banking system including the central bank which is at the heart of the financial system.  An important aspect of the democratization of the central bank is to recognize that its operations cannot and should not be delegated to “experts” at its helm, quite simply because it is socially-embedded and monetary policies have real social consequences. As the ultimate source of high-powered money, in a democratized system the central bank has to play an accommodating role vis-à-vis the banking sector, beyond its generally accepted lender of last resort function.  However, this requires us to call into question the notion of central bank independence, the attainment of which, has become the gold standard of economic policy over the past three decades. This article argues that the rationale for central bank independence rests on a mythology and that an institutionally-grounded theory of state–central bank relations can provide a new way to mobilize credit while blunting criticisms by proponents of central bank independence.  This in turn requires an understanding of the exogenous versus endogenous theories of money, Keynes’ insights on central banks, and the histories of European central banks.

In neoclassical economics the purported ability of apolitical technocrats to control both the money supply and inflation is seen as the key to promote economic growth.  “Independence” entails legal restraints on the legislature and executive branches from influencing the supply of money.  In general equilibrium theory it is assumed that money is neutral and subject to exogenous control with no effects on the real economy which is assumed to be barter-based.  The New Classical Macroeconomics (NCM) approach argues that in controlling the money supply central bankers face a time-inconsistency problem.  This problem arises when, despite their commitment to a price anchor, they become tempted to follow discretionary short-term monetary policies.  On the basis of the NAIRU (non-accelerating inflation rate of unemployment) framework, an unexpected increase in the money supply by the central bank will only temporarily lower the unemployment rate below the NAIRU level thereby raising the actual rate of inflation. With the implicit assumption that workers believe in the NCM model and have rational expectations, they will expect future inflation to increase.   They will therefore successfully push for higher money wage growth so that, at the end of the day, output will return to the NAIRU level. Persistent such “surprises” by central bankers will only generate higher rates of inflation with no effect on long-run output and employment.  Thus, the optimal solution to this time-inconsistency temptation is for central bankers to commit themselves to a rule-based policy in which money supply growth should be rigidly tied to maintaining price stability.  Monetary policies to promote employment or industrial transformation (say a Green New Deal or equivalent policies) should be abandoned since public policies of such types will always be short-circuited by wily, far-seeing market actors who, by believing in the NCM framework, will correctly predict future inflation. This is the policy ineffectiveness criterion with “market forces” automatically short-circuiting progressive public policies.

The policy ineffectiveness criterion is consistent with zero involuntary unemployment (i.e. full employment) giving workers the bargaining power to raise their money wages.  The further assumption is that firms will not face a profit-squeeze with the higher money wages, leading to layoffs (including outsourcing or investments in labor-saving technological change) and thus unstable labor markets, i.e. the increased precarization of work which would lower workers’ bargaining power. This point is all the more significant when one considers that even during the boom of the 1990s labor market insecurity actually increased as Alan Greenspan observed in a testimony to Congress in 1997.  Finally, it should be noted that the inflation – unemployment tradeoff at the heart of the NAIRU model is a relationship that has been violated in several periods – for example in the stagflation of the 1970s or the falling unemployment and stable inflation rates in the 1990s. Further the NAIRU has been periodically redefined, including in an upward direction in the deepening crisis of the 1970s and 1980s.  This recasting of structural involuntary unemployment as “full employment” is mythology masquerading as science, suggesting the incapacity of the framework to deal with growing labor market distress.  

  Equally problematic is the broad neoclassical tradition’s ignoring of not only the intellectual history of money and creditbut its incapacity to acknowledge how actual central bankers understand the money creation process.  As McLeay et al of the Bank of England’s Monetary Analysis Directorate discuss, textbooks misrepresent the money creation process.  According to the neoclassical money multiplier model, taught in all standard money and banking classes, banks first passively accept reserves and then create the loans and thus deposits.  According to this model, the central bank, by controlling the supply of high powered money, controls the money supply. McLeay et al observe that money creation is exactly the opposite of this model.  The banking sector makes loans by creating deposits, increasing the money supply automatically, and generally obtains reserves on demand from the central bank.  Individual banks also obtain reserves by borrowing from other banks with excess reserves (Fed funds market) and via asset and liability management.  And of course, as Post Keynesian economists have long argued, loan supply is demand-driven subject to banks’ profitability and solvency goals.

In short, banks are not passive intermediaries of household savings as in the neoclassical loanable funds model.  As Keynes argued savings are not synonymous with bank finance and whether households consume more or less of their income does not change aggregate bank reserves by an iota.   The supply-side vision of money creation, controlled exogenously by the central bank, was the basis of an important critique by Banking School theorists like Thomas Tooke in the nineteenth century. These authors argued that the supply of credit is demand-driven and thus cannot be controlled by the Bank of England as the Currency School argued. As Marx and Keynes and later authors in heterodox economics discussed, the capitalist economy is fundamentally a monetary system, beginning with monetary outlays by firms that need to be recouped as monetary profits. This is what enables firms to be what John R. Commons called going concerns.  In short once one recognizes that actual business investment is driven by the expectation of profits, as Marx, Veblen, Keynes, and business management textbooks discuss, the economy cannot possibly be anything but a monetary system. Money has real consequences and is not a veil.

Given the demand-driven nature of money it is not surprising that industrialization has entailed the need for a relatively elastic supply of credit as economic historians have argued. Central banks have historically been at the core of the mobilization of credit. For example, despite being a private institution, the Bank of France (BoF) played a key role in fostering industrialization in effect acting as the Treasury’s banker.   Despite this close relationship inflation was negligible throughout the nineteenth century until the First World War. And the Bank of England also played an important role in the development of English public financethereby enabling the state to act in a developmental capacity  while maintaining an Empire that benefited British economic development.

What is one to make of these examples where major central banks were clearly not “independent” in the modern sense but were not “piggy banks” either of the government? As Bertrand Blancheton discusses, the BoF maintained an autonomous role vis-à-vis the French state throughout the time period leading up to the Second World War.  There was a clear asymmetry of power between the two institutions (in no small measure generating conflict at times) and yet the central bank maintained a certain level of freedom to pursue its aims.  As Eric Monnet discusses, despite being a nationalized institution in the postwar period the BoF continued to play a key role in facilitating domestic re-industrialization a consequence of which were the so-called trentes glorieuses.  

In line with Jörg Bibow ’s discussion, the above examples suggest a type of relationship between the government and the central bank that Keynes proposed. Keynes suggested that the relationship between the two institutions should be such that while the government, acting under the control of parliament, would make the key decisions on national economic policy it would not provide diktats to the central bank management.  Rather policy coordination with the latter would have to be done cooperatively. How can such an institutional framework exist where one institution is clearly subordinate to the other and yet maintains a high degree of autonomy? One can clearly see such a relationship in regards franchises which operate quasi-autonomously while observing the rules created by the parent corporation.  In fact Robert Hockett and Saule Omarova treat private commercial banks as public franchises of the government.  This franchise framework suggests the need for a particular legal-institutional framework or bundle of rights undergirding central banks granting them the privilege to operate autonomously within the context of the state’s governance goals.

Debunking neoclassical myth-making about money and central banking requires a deeper understanding of institutions and the ways in which politics and the law provide varying foundational frameworks to the economy. This insight, at the heart of the approaches of institutional economists such as John R. Commons and American Legal Realists Robert Hale and Wesley Hohfeld, is vital to understand how bargaining power is determined in all markets (including that of labor) and between institutions (say central banks and parliaments).  And of course, we cannot understand the nature of money without recognizing its legal foundations. The neoclassical failure of the imagination to recognize alternatives to the independent central bank model with the concomitant aim of democratizing credit reflects an analytical weakness in regards the understanding of institutions and how they construct the economy.

Post-Crisis Central Banking and the Struggle for Democratic Oversight in Europe – a Trilemma and a Paradox

January 25, 2021

Sebastian Diessner, European University Institute and London School of Economics

The European Central Bank is in the process of reviewing its strategy, having vowed to ‘leave no stone unturned’ in a quest to render its monetary policy framework ‘fit for years to come’. The central bank is certainly right in doing so: as has become clear for all to see, the ECB’s strategy is reaching its limits in terms of both effectiveness and legitimacy. This roundtable contribution seeks to address both of these limitations in turn, thereby revealing a trilemma and a paradox.

After a deceptively calm first decade of EMU, the successive crises of the second decade and the ECB’s unconventional monetary policy response have resulted in a conundrum for the independent central bank – one which is thrown into sharp relief by the ongoing pandemic-induced recession: how can the ECB manage to achieve price stability (to fulfil its de jure primary mandate), maintain financial stability (to fulfil its de factopost-crisis mandate) and minimize risks on its balance sheet (to avoid threats to its de facto independence stemming from fiscal and/or financial dominance) all at the same time? While the ECB’s post-crisis conundrum is not dissimilar to the situation of other major central banks – all of which are stuck at the zero lower bound in a quest to revive inflation through quantitative easing ad infinitum –, it displays a couple of uniquely European features. The conundrum is probably best understood as a trilemma: the ECB can only comply with two of the three imperatives listed above.


(Source: Diessner 2020)

The rationale behind this is as follows. European monetary policy-makers can have either:

  • Price stability and financial stability. To achieve both of these, the ECB would need to continue net asset purchases and provide cheap credit to the financial sector. Its balance sheet would be bound to remain large and subject to a variety of risks (including interest rate and default risk). A persistently large balance sheet raises the spectre of fiscal and/or financial dominance: that is, the central bank’s hand constantly being forced by market panic and/or the needs of government debt management, calling the ECB’s de facto independence into question. This scenario may be referred to as ‘QE infinity’.


  • Price stability and minimal (risks on) balance sheet. To achieve both of these, the ECB would need to end net asset purchases and unwind its balance sheet, and resort to interest rate-setting as the main monetary policy tool (including deeply negative interest rates where necessary). This would likely increase risks of instability in government bond markets and raise the spectre of fragmentation. This scenario may be referred to as ‘narrow central banking’.


  • Financial stability and minimal (risks on) balance sheet. To achieve both of these, the ECB would need to provide direct support to member state governments, households or firms, without pursuing net asset purchases. Whether this would risk an overshoot in the ECB’s inflation target depends on whether we are in an inflationary or a deflationary regime to begin with. This scenario may be referred to as ‘monetary finance’ or ‘helicopter money’.


This stylized trilemma entails two important qualifications. First, it should matter greatly whether the euro area finds itself in an inflationary or a deflationary regime. In the case of a deflationary spiral – which appears likely in light of the COVID-19 crisis – monetary finance of government deficits arguably provides a way to resolve the trilemma: a limited programme of monetization would help eliminate doubts about the sustainability of public debt (thus contributing to stability in bond markets) and provide an extraordinary boost to persistently sluggish inflation. Given that the effect of monetary finance would be permanent and amount to the respective government debt essentially being forgiven, interest and default risk on the ECB’s balance sheet would be minimized as well. Second, only the pursuit of price stability and financial stability should matter economically to the ECB, while the requirement to minimize (risks on) its balance sheet is of a more legalistic and Eurozone-specific nature.

The paradox of legitimacy-as-accountability post-crisis

While the ECB’s strategy review is predominantly concerned with the conduct of monetary policy, a thorough review of the central bank’s democratic oversight is equally urgent and pertinent, given that its powers and responsibilities have a tendency to expand from one crisis to the next. Despite these expansions, the independent central bank’s democratic legitimation remains decidedly ‘thin’. Its ‘input legitimacy’—that is, input participation by the people—is reduced to a narrow but ultimately vague mandate specified in the EU Treaties, and is crucially limited by the central bank’s far-reaching independence, which rules out to ‘seek or take instructions’ of any sort (Art. 130 TFEU). In turn, ‘output legitimacy’—that is, the effectiveness in achieving mandated policy outcomes—is diminishing fast, given the central bank’s mounting difficulties with achieving its inflation target over the years.

This essentially leaves the ECB with what Vivien Schmidt has termed ‘throughput legitimacy’, a procedural form of democratic legitimation that is mostly concerned with the quality of governance processes and revolves around efficacy, transparency, openness/inclusiveness of interest representation and, most importantly in the EMU context, accountability. Among the different channels of the ECB’s democratic accountability, its quarterly ‘Monetary Dialogue’ with the European Parliament’s Committee on Economic and Monetary Affairs (ECON) undoubtedly stands out as the most important. The Monetary Dialogue exemplifies how throughput legitimacy differs from input legitimacy in EMU: in effect, the ECB’s accountability amounts to answerability to the questions of Members of the European Parliament (MEPs) who do not, however, have substantive means to reward or sanction the central bank. This non-substantive form of democratic oversight renders the ECB’s legitimacy contingent on perceptions of accountability among MEPs – that is, whether MEPs deem their (written and oral) questions to have been answered adequately by the ECB or not.

This thin and contingent form of democratic legitimation gives rise to a paradox post-crisis: on the one hand, the central bank’s enlarged crisis-fighting roles require ever-broader scrutiny and parliamentary debate; on the other hand, the quality of accountability arguably hinges on the specialization and focus of those involved. One way to address the seemingly contradictory challenge of both wider and more specialized central bank oversight would lie in reshaping and formalizing the procedures of the Monetary Dialogue and in the creation of a parliamentary sub-committee of ECON dedicated to overseeing the ECB in particular.

Viewed in this light, the strategy review and the accompanying ‘ECB Listens’ events can be read as attempts to remedy some of the ECB’s missing input legitimacy and to recalibrate its monetary policy framework towards achieving mandated policy outputs. Both should be complemented by a serious attempt to enhance its throughput legitimacy as well, by means of strengthening democratic oversight.

Yet, whether the strategy review will provide a genuine opening to change the central bank’s modus operandiultimately remains to be seen. To be sure, a growing coalition of actors from diverse backgrounds appears poised to challenge the current path towards ‘QE infinity’ and demand more radically innovative instruments, including direct cash transfers. As so often, however, the ECB might well find itself caught in the middle between those who want it to do (even) more and those who want it to do (even) less, thereby allowing it to settle for the status quo with only a few minor tweaks. But the very recognition of the need for a strategy review implies that the status quo should not be an option this time.

The ECB, the climate and the interpretation of “price stability”

January 18, 2021

Jens van’t Klooster, KU Leuven

The European Central Bank is not in an easy spot. It is expected to do much more than before 2008, but also stay within a mandate conceived in the 1980s. This has led the ECB to increasingly broaden its understanding of the price stability objective – recently also analysing climate change as a potential threat. It is a strategy that undermines its legitimacy and hinders its effectiveness.

In a recent article, Nik de Boer and I analysed the ECB’s conundrum in terms of authorization gaps: the ECB makes choices with far-reaching consequences for which there is no clear basis in its mandate. As a consequence of such gaps, the ECB’s actions lack clear democratic authorization. I will build on that article for my contribution to this roundtable but focus on recent efforts to define climate change as a threat to price stability. As I argue, to help avert 21st century environmental catastrophe the central bank needs better democratic authorization.

When the European community initiated the process of monetary unification, the task of the central bank was meant to be simple. At the time, sometimes referred to as “Eurofed”, it was meant to pursue price stability by setting short term interest rates. The economic effects of monetary policy were widely deemed benign – price stability, in the words of the ECB’s first chief economist Otmar Issing, was not merely “one of a long list of political and economic objectives”, but rather “a pre-condition for the successful pursuit of other objectives”. Importantly, what counts as “price stability” is not explained in the treaty. Instead, it explicitly states that the task of the ECB is not just to “implement”, but also “define” its monetary policy. In the 1990s and early 2000s, the ECB set out a simple and quantitative definition: consumer price inflation of below, but close to, 2% over a two to five-year horizon.

That simple definition of price stability came from a world where financial markets were deemed efficient and high wages a threat to economic stability. A lot has changed since then. After a decade of crises, few still believe that financial markets can be left to their own devices. Hence, central banks receive much closer scrutiny.

Since monetary policy is the most important economic competence entirely delegated to the EU-level, it is not surprising that the ECB is time and again expected to act. In response to new challenges, the ECB has sought to broaden its objectives in part by redefining its understanding of price stability. The interpretation of the term “price stability” is now the prism through which its Governing Council members decide, and outsiders are expected to debate, monetary policy.

In the 2010-12 Eurozone crisis, the price stability objective became the rationale for buying sovereign bonds of individual member states – most notoriously in the ECB’s Outright Monetary Transactions (OMT) Programme. At the time, buying sovereign bonds was widely deemed to go beyond the ECB mandate, which explicitly prohibits lending directly to governments.  The mandate, however, does not rule out buying them indirectly – from primary dealers, sometimes just days after issuance. To justify its 2012 OMT-programme, the ECB conceptualized the sovereign debt crisis as a threat to price stability. It argued that large divergences between bond markets for individual member states undermined its ability to set financial market conditions across the euro area. Buying bonds was part of its efforts to maintain price stability.

The legal basis for the OMT programme is an example of what we in our article describe as an authorization gap, because the ECB could equally well have argued that it should not implement the programme. The German lawyers who sued the ECB in the 2015 Gauweiler case argued that OMT constitutes a “suspension of the market mechanisms which violates the Treaties”; a view also supported by Bundesbankpresident Jens Weidmann. However, neither the ECB nor the German litigants have a clear-cut case. The ECB mandate simply does not contain provisions for whether, and if so how, the ECB should deal with sovereign bond yields.

Since the OMT programme, authorization gaps have popped up left and right, leading the ECB to ever broaden its account of price stability. After the Eurozone crisis ended, European economies remained in a deep recession. Youth unemployment topped 40% in Greece and Spain. Absent a coordinated fiscal expansion, the ECB decided to embark on a quantitative easing (QE) bond buying programme. By far the largest programme, the multi-trillion euro Public Sector Purchase Programme (PSPP) again targetedsovereign bonds. The side-effects of low interest rates have become pervasive, raising the question at the heart of the May 2020 Bundesverfassunsgericht ruling: is the pursuit of the self-imposed 2% target still proportionate? Can the ECB simply continue to pursue it even if that has massive repercussions for the general trajectory of European capitalism? Again, there is a clear gap in the PSPP’s democratic authorization.With the 2020 Pandemic Emergency Purchase Programme (PEPP), the ECB has moved even further into uncharted constitutional territory – as earlier contributions to this Roundtable have already shown.

 The ECB has acted forcefully in providing massive fiscal support to the Member States to fight the Pandemic, but remains more timid in its efforts to green the EU’s financial system. The central bank has tentatively started to consider whether climate change may be a threat to price stability. This connection is not as far-fetched as it may initially sound. Investors currently fail to adequately price financial risk that result from climate change. Decarbonizing the economy will require ditching carbon intensive infrastructure, productive capacity and even whole sectors of the economy. Extreme weather events threaten coastal real estate and can damage the economy’s productive capacity. Droughts and biodiversity loss threaten agriculture. Economically, the effects of climate change could be both deflationary and inflationary.

Climate change, accordingly, will have consequences for the central bank’s ability to achieve its medium-term inflation target. Moreover, climate change fits the general rationale for the price stability objective; to make sure nominal price developments track real economy growth. Since Mark Carney’s 2015 ‘tragedy of the horizon’ speech, central bankers have published volumes on environmental threats to monetary stability. At the ECB, Isabel Schnabel and Christine Lagarde have both linked climate change to the ECB’s primary mandate (here and here).

Central banks are sure to take some actions to manage the climate transition. The political questions today concern what they do, how much is left to financial markets and where the public gets a say over the actions of central banks.

Against that background, there are major concerns with the ECB’s recent efforts to conceptualize climate change as a threat to price stability. Although an activist trajectory can be justified in terms of the legal mandate, the past decades have made clear that almost anything can be. This is the real problem with the ECB’s authorization gaps; law has lost much of its role in constraining monetary policy. Authorization gaps make the democratic basis of any actions – activist or not – thin. Acting to green the financial system would arguably be less political than doing nothing, but that itself does not legitimize any particular ECB policy. The Karlsruhe judges have already signalled their willingness to weigh in on green bond purchase programmes.

Treating climate change as a threat to price stability makes democratic debate on the proper ECB response all but impossible. The considerations at stake in defining price stability are too technical for inclusive deliberation. What good is a multi-lingual ‘ECB listens’ campaign when you need an Economics PhD to formulate your opinion in the right vocabulary?

The imperative to subsume ECB action under the price stability mandate will also undermine its effectiveness. What should ultimately matter is that the global climate does not enter a trajectory where catastrophic outcomes can no longer be averted. Policies that target consumer prices in 2035 are unlikely to be the best way to achieve that.

If tweaking the price stability objective is not the right way to fight climate change, what is? In our article, we outline a range of democratic tools that could be used to give new ECB policies adequate democratic authorization. Many of these do not require ratification of a new treaty – a process involving an intergovernmental conference, queens, dukes and dozens of other political bodies. Rather, these proposals can rely on tools available within the existing constitutional framework.

For one, the ECB is already subject to a secondary mandate for supporting the EU’s broader economic policy objectives (where this does not hinder its pursuit of price stability), which are spelled out in Article 3 TEU. The objectives include “the sustainable development of the Earth”. Article 121 (2) TFEU allows the Council to articulate how it sees the role of environmental and climate-related objectives in that secondary mandate. Moreover, Article 129 (3) TFEU allows the Council and European Parliament to amend the instruments assigned to the ECB in its statutes.

The ECB could itself also do more to incorporate existing EU positions on the contours of its mitigation trajectory into the design of operations. For example, the ECB can draw on the so-called Green Taxonomy for economic activities that contribute to the EU’s environmental objectives. One way to do that is a proposal I made for Green TLTROs, which would make ECB open market lending rates conditional on lending in accordance with the Green Taxonomy (as far as I know, a similar proposal has not yet been written for the Federal Reserve – hint hint!).

For now, treating climate change as a threat to price stability may be the best way to navigate the ECB’s new challenges. Over time, however, Europe’s central bank needs better constitutional arrangements. The interpretation of decades old treaty provisions is not a good basis for running the world’s largest economy.

Beneath the Spurious Legality of the ECB’s Monetary Policy

January 12, 2021

Marco Dani, University of Trento, Edoardo Chiti, Sant’Anna Scuola Universitaria Superiore Pisa, Joana Mendes, University du Luxembourg, Agustín José Menéndez, Universidad Complutense de Madrid, Harm Schepel, University of Kent, Michael A. Wilkinson, London School of Economics

Asked recently whether the European Central Back (ECB) would provide debt relief to Eurozone Member States by cancelling their bonds that it holds, President of the ECB Christine Lagarde replied categorically that it would not, because the Treaty forbids it. She was referring to Article 123 TFEU, which prohibits the monetisation of public debt by the ECB. By doing so, Lagarde was merely echoing the prevailing view that this provision, along with Article 125, which prohibits the assumption by the Union of Member State debt, is a core part of the European monetary constitution. Or, what is the same, that it is a “constitutional red line” which the ECB must respect, and which is subject to the control of the Court of Justice (“Court”). Articles 123 and 125 TFEU are fundamental pillars, supporting not only ‘price stability’ (the core mandate of the ECB according to Article 127 TFEU) but also ‘sound public finances’ (Article 119(3) TFEU). There is, therefore, no doubt about the correctness of Lagarde’s stern assertion. Or is there? Are European Treaty provisions real constitutional norms or are they honoured primarily in the breach, perhaps because they are impossible to comply with? The last decade has shown that constitutional curbs and boundaries are, at the very least, surmountable.

The track record of the ECB is mixed, at best. Over the last decade, the ECB has departed from a strict mandate of price stability to provide stimulus and support to the Eurozone economy. In so doing it has elided the artificial Treaty distinction between monetary and economic policy which anchors the institutional structure of Economic and Monetary Union (EMU), as well as its democratic legitimacy. In key moments, and with the support of the European Council, the ECB established programmes that stretched the boundaries of price stability and the prohibition of monetary financing. Its Outright Monetary Transactions (OMT) Programme (announced in 2012), designed for an exceptional economic context, signaled the mutation of the ECB into a conditional buyer of government debt (the 2010 Securities Markets programme was a timid, albeit relevant, precedent). The quantitative easing programmes pursued by the ECB since 2015 have seen it acquiring both corporate and sovereign bonds outside of any explicit crisis situation. In response to persistently low inflation and the need to inject liquidity and stimulate economic growth, the ECB has turned squarely into a ‘market maker’.

The justification for these interventions, however, continues to be price stability and the preservation of the mechanisms of transmission of monetary stimuli into the “real” economy. Such was the argument that the legal service of the ECB defended before the Court in both the Gauweiler and the Weiss proceedings and such was the verdict of the Court. Faced with the need to determine how far ECB monetary policy programmes may encroach into economic policy, the Court chose to defer to the ECB, from whom “nothing more can be required” than a careful and accurate deployment of its “economic expertise and the necessary technical means at its disposal” (Gauweiler, para 74; Weiss, para 91). The way the Court delimited the boundaries of monetary policy (by reference to its objectives and instruments) and adopted an innocuous interpretation of the proportionality principle – strongly contested by the German Constitutional Court (GCC) – was key in this regard. Importantly, however, both courts held that the ECB programmes satisfied the Treaty’s prohibition of monetary financing. The programmes’ conditions upheld the incentives for Member States to maintain sound budgetary policy, as the Treaty requires, and preserved uncertainty for market operators and Member States, which is key to maintaining market discipline, both in exceptional (Gauweiler rulings) and in normal (Weiss rulings) circumstances.   

Despite the political implications of the ECB’s inflated balance sheet, the ECB’s status of independence from political interference and its technical expertise in stabilising prices continue to coat the legitimacy of its actions. But the veneer can hardly hide the cracks. Under the pandemic programme (PEPP), the ECB is purchasing unprecedented amounts of sovereign bonds (since March an estimated 71% of the total debt issued by Eurozone states), and while it is clearly breaching the limits set by the Weiss rulings to avoid monetary financing, the members of its executive board cannot but insist that the ECB is acting well within the limits of the Treaty’s strictures. “Forceful action” is needed to maintain “the singleness of our monetary policy and the effectiveness of the transmission mechanism”. The ECB’s actions remain, purportedly, “temporary, targeted and proportionate”. The preservation of “market functioning and price formation mechanisms” continues to justify the PEPP, even though the ECB is going much further than before and occupying terrain that would have been politically unimaginable and legally unfeasible before 2010. There are plenty of reasons to doubt that the ‘money’ the ECB is guarding remains the same as it was ten years ago.

What has clearly changed is the ECB itself. How far can the Frankfurt-based institution go in re-shaping its mandate while continuing to resort to the justification of ensuring the singleness of the EU’s monetary policy and the effectiveness of monetary transmission mechanisms? The Weiss saga made clear that judicial review cannot safeguard Treaty boundaries, at least as long as the Court maintains a view of monetary policy that leaves the ECB the power to determine its own mandate, and as long as proportionality is something that the ECB can demonstrate by simply showing that it has weighed the economic effects of its monetary policy instruments. The conundrum now, as before, is clear: while legality may be difficult to maintain, a conclusion of illegality would curtail action, which —at least in the short term— has been as functionally necessary as it has been politically disputed, as well as having quite problematic distributive implications. Should the Court ever be required to review PEPP, it would again become the arbiter of contending political views on the legitimate reach of the ECB’s action (the identity of the plaintiffs in the cases that have hitherto reached the Court  via preliminary references confirms as much).

Irrespective of the Court’s assessment of the legality of the programme, such an assessment would not be sufficient to compensate the weak legitimacy of an interventionist ECB. It would not be sufficient to justify an unprecedented degree of central bank discretion. No judicial verdict can resolve the fundamental political and economic problem that the ECB faces. The ECB was meant to operate in an institutional framework which separated monetary and economic policy. It has now become a massive holder of government debt, acquired “in a flexible manner allowing for fluctuations in the distribution of purchase flows over time, across asset classes and among jurisdictions” (Article 5(2) PEPP Decision) in order to support the Member States’ economies. The imbrication of monetary and fiscal policies has ultimately led the ECB to face the political ‘red line’, the “forbidden” act of debt monetisation, and thus, debt cancellation.

With the de facto enlargement of the ECB’s mandate, EMU is profoundly transformed. The current line between EU monetary competences and national-subject-to-EU-surveillance fiscal policies, if formally upheld, has already shifted. This raises issues far deeper than the question of legality. Unsurprisingly, the transformation is occuring through the same executive logic that has guided the birth and evolution of the EMU over the past decade. The agents and proponents of this transformation – lawyers, economists, academics, and officials – are of course aware of its radical character. They rely on the existing EU institutions and procedures to sustain its legitimacy and legality due to the sheer difficulty of formal treaty amendment,. Although aspects of this transformation can be legally contested, judicial channels often give the green light. They thereby strengthen the position of the ECB and of its preferred solutions to problems which the legal framework not only cannot resolve but also was not designed to address.

With German and European Courts holding that the ECB’s buying of sovereign bonds under the PSPP did not cross the ‘red line’ of monetary financing, only to see a new programme doing just that in a context of the pandemic crisis, political leaders shy away from proposing radical solutions such as sovereign debt cancellation. The course set appears to depend more on the discretion of the ECB, in turn dependent on the political struggles within its Governing Council and on their perceived leeway of action, than it does on the rules of the Treaty or the possibilities of political action.

No matter what the future holds, political battles about how the economy should function ought to be fought through democratic channels, not in court, nor in the backrooms of central bank governors through processes that are fully in their hands (such as the on-going ECB strategy review). Maybe law, by a stretch of its techniques of interpretation can accommodate such processes, but it is in danger of losing any trace of the political and social legitimacy that grounds its constitutive function. It might still be law, but certainly not democratic law, and thus lacking the integrative properties of the latter. By the same token, the transformation of the ECB is the result of EMU’s institutional flaws and the inadequacy of its political economic paradigm. As long as these remain, and the official and legal justification for the ECB’s decisions continues to invoke existing Treaty provisions subject to judicial control, the EU’s biggest challenge – how to generate social and political legitimacy – lingers on, unaddressed

Rekindling Public Trust in Central Bankers in an Era of Populism

January 4, 2021

Annelise Riles, Northwestern University

In a recent interview with the Financial Times, Vladimir Putin declared “liberalism has become obsolete.”  By liberalism, Putin seemed to mean representative democracy, in which, authority is delegated by the public to representative officials, who in turn delegate authority to the experts—from immigration authorities, to the military, to the central bank.

Liberalism, Putin asserted, has given way to nationalist populism. Raising the specter of multiculturalism in particular, he implied that the experts don’t share ordinary people’s values and can’t be trusted to do what ordinary people want. The legitimacy of delegated authority, mediated by expertise, no longer holds, Putin seemed to suggest. 

The European Monetary Union is certainly one site where the legitimacy narrative of delegated authority mediated by expertise seems to be in crisis.  In many corners of Europe—as in Japan, the U.S., Turkey and elsewhere—central bankers and central bank independence have emerged as targets for populist politicians.

Why is this the case? In the old legitimacy narrative, the zone of politics and the zone of expertise were clearly different things. Take for example, the building of a bridge. Where the bridge should go, or if there should be a bridge at all, was a matter of politics, to be decided by elected representatives who were accountable to the voters. But what kind of concrete or steel reinforcements should be used was a matter for the engineers. You wouldn’t want the politicians meddling in that. The literature on central banks from the 1990s was all about making this point: eminent economists like Lawrence Summers wrote papers purporting to show that countries with more central bank independence had lower rates of inflation (back then, a good thing!) because the politicians stayed in their lane and let the experts do the job.

But since the financial crisis, the public has become wary of the idea that the zones of politics and expertise can be easily delineated. How wide the bridge should be, for example, might be seen as an engineering question, but it turns out to have implications for how many people can cross the bridge at rush hour, and how high the tolls or taxes to fund it will be.

Similarly, a new generation of citizen groups is raising concerns about the actions of central bankers. From Occupy Wall Street on the left to End the Fed on the right to powerful new NGOs like Positive Money, whose principal target is the European Central Bank (ECB), citizen movements are demanding that, if central banking is political, citizens should have a direct voice in its operation. And citizen groups are not the only threat to the experts at the ECB: large banks like UBS and JP Morgan and newer Fintech companies like Circle and Flywire are luring retail customers to forms of digital payment that circumvent the central bank altogether. The rise of digital currencies is, at its core, a challenge to the authority of the state and its expertise over the market. Although the rise of popular movements is exciting, let’s remember that this populism is not always something to cheer for.  The critiques of central bankers on Internet sites like Breitbart trade in familiar anti-Semitic conspiracy tropes and spin militarist fantasies, as well as just plain misunderstanding about such things as the possibility of returning to the gold standard.

Why does all this matter? It matters because the livelihoods of so many people will turn on the ability of central banks to manage the next great financial crisis, and managing the next great financial crisis will in turn depend on one critical element: public trust in the experts inside the central bank, which is in jeopardy.

Populist critiques of central banks exploit a contradiction: In neoliberalism, states should stay out of markets. But in the work of central bankers, markets and states are always mixed together.

Central banks are, at their core, tools of state intervention in the sustenance and governance of markets. In Japan, where I did my first fieldwork on central banks, market participants were so clear on this point that they had an adage: The Central Bank is our mother.  And if you know anything about Japanese mothers and sons, you know where the power lies in that relationship.

As experts, central bankers have always had two constituencies—the market and the public. What is interesting about this moment, however, is that the two are increasingly fused into one.  The push from social movements for a “Green QE” for example is a call for central bankers to pursue goals that are at once economic and social. A new kind of social actor is emerging—the “Financial Citizen” who participates in the spheres of the state and the market at once.  The Financial Citizen is a consumer of retail goods and services, but also a political activist who participates in social movements online and in person; an investor in financial products but also a voter who follows financial issues and a direct commentator on the actions of central banks and financial regulators.

This participation is enabled and fueled by new digital technologies. Consider for example, the twitter reaction to Bank of England Deputy Governor Bed Broadbent’s poorly chosen words about the economy “entering a menopausal phase”:  the comment unleashed a fury from commentators around the world far beyond the usual circle of central bank watchers who decried the words as “offensive,” an example of “ignorant prejudice,” and “pejorative tosh.”

In one sense, therefore, Putin is right: representative democracy doesn’t account for the relationship between central bankers and today’s financial citizens. The old delegation of power from citizens to elected officials and, in turn, to experts, is increasingly supplanted by technologies that do the mediating instead.  These technologies increasingly cut out the elected representatives, putting citizens in direct conversation with the experts.

Central bankers in general, and ECB central bankers in particular, have largely had their head in the sand about these changes. When they consider questions of legitimacy, the debate is mainly about whether or how to tweak the number of reports they give to political branches or whether there should be term limits for central bankers. Most think that engaging the public directly is dangerous at best and politically illegitimate at worst.  To her credit, ECB President Christine Lagarde has met with NGO representatives and done more to maintain a public facing presence than her predecessors by far.

But we need something much more revolutionary to reinstate public faith in representative democracy and the legitimacy of delegated authority to central banks.

We need an institutional configuration for public engagement and a legitimacy narrative that is widely shared. We need a story that matches the realities of our current world, and motivates experts and citizens to work together. It must be a story that enables us to make coherent distinctions between legitimate and illegitimate arguments, between better and worse options. The key element of this new narrative is not central bank independence but central bank interdependence.  Central banks do not do their magic alone. They never have. Their work depends on market participants and yes, on the political branches of government–and that interdependence does not stop at national boundaries. It requires trust, and new forms of mediation between conflicting constituencies and interests. This means that the skill of the expert includes an ability to listen and to collaborate, and that citizens have responsibilities to do their share in the collaboration.

Will Bateman, Quantitative Easing, Quasi-Fiscal Power and Constitutionalism

December 28, 2020

Dr Will Bateman, Associate Professor, Law School, Australian National University [PhD, LLM (University of Cambridge), LLB, BA, (Australian National University)]

Unconventional monetary policies, particularly quantitative easing (QE), have pushed central banks into unchartered territories, triggering anxieties about (hyper-)inflation, asset bubbles and central bank credibility. As QE has expanded in response to the COVID-19 pandemic, new anxieties have arisen, notably central banks’ potential role in distorting price discovery in capital markets, as debt capital is directly monetised via central bank corporate bond purchases and equity capital is inflated via the portfolio re-allocative effects of QE.

Deep constitutional issues lurk behind those high-profile economic topics.

Liberal constitutional systems assume a hard boundary between fiscal and monetary authority. Special rules are imposed on fiscal authorities, requiring parliamentary voting for taxation and public expenditure. Those rules recognise the potency of governments’ economic powers and bless the largest economic actor in advanced mixed-economies, the state, with a measure of democratic legitimacy.

All central banks in the OECD fall outside those rules, implicitly or explicitly. Older constitutional systems (like the US and UK) developed their rules for governing fiscal authority before the growth of modern central banks.[1] Newer constitutional systems (like the EU) explicitly remove central banks from the set of fiscal institutions by banning them from directly funding treasuries via so-called, “monetary finance” rules.[2] In both cases, central banks occupy a sui generis constitutional position: they clearly exercise the state’s economic power and their actions impact on fiscal policy, but their market operations are unburdened by parliamentary voting requirements and judicial review.[3]

This essay argues that QE fundamentally challenges the constitutional status quo for central banks.[4]

First, it explains how monetary (central banks) and fiscal (treasuries) institutions interact legally and financially under QE, focusing on the direct and indirect monetary finance provided by central banks in the US, EU and UK. Secondly, it addresses the consequences of blurring the fiscal/monetary divide, commenting on the relevance of “central bank independence” and the shift from conventional to unconventional monetary policy on the sui generis constitutional position of central banks. Thirdly, the essay concludes by mooting various constitutional futures facing central banks.

QE’s Fiscal and Monetary Dimensions

The highly technical debates about QE can obscure some basic facts, common to the US, EU and UK, about the financial relationship between central banks and treasuries.

  1. QE involves central banks buying large volumes of sovereign debt.
  2. QE coincides with unusually-large issues of sovereign debt.
  3. QE results in the consolidated public sector buying-back its own debt.
  4. Legal rules require profits earned on sovereign bonds in QE portfolios to flow back to national governments and reinvestment of QE portfolios reduces financing costs for treasuries


1.  QE and sovereign debt: while all QE programs include a mixture of debt instruments, in the US, EU and UK non-sovereign debt purchases are relatively insignificant.[5] This is a point of political sensitivity, which can lead to awkward and misleading public relations campaigns. The ECB insists on presenting its “Public Sector Purchase Programme” (PSPP, in which sovereign debt is purchased) as only 1 of 4 “Asset Purchase Programmes” (APP), and the PSPP is always listed below the “Corporate Sector Purchase Programme”. The optics distort the reality that Eurozone QE, like US and UK programs, is primarily concerned with purchasing central government debt.[6]

2.  QE coincides with historic government debt issues: QE began in the Western Hemisphere with government-guaranteed residential-mortgage backed security purchases by the Federal Reserve Bank of New York (FRBNY) in 2008, but then promptly switched focus to government debt in 2009-2010 just as the US Treasury started to scale bond issues to fill fiscal deficits created by economic stabilisation measures. QE continued to increase in lock-step with widening fiscal shortfalls and concomitantly large debt issues in the US and UK between 2010 and2015. In the Eurozone, the commencement of QE also tracked increased government debt issues, as was starkly illustrated by the “Securities Markets Programme” (SMP) in 2010, which authorised the “National Central Banks” (NCBs) (largely the Bundesbank, Banque de France and Banca d’Italia) to purchase sovereign bonds issued by distressed treasuries in Greece, Ireland, Italy, Portugal and Spain. The aborted 2012 “Outright Monetary Transactions” program reinforced the connection between Eurozone QE and sovereign indebtedness. The headline Eurozone QE programs, the PSPP (2015->) and the “Pandemic Emergency Purchase Programme” (2020->) confirmed the connection.

3.  Consolidated public sector buying-back its own debt via QE: Under financial reporting rules promulgated by the IMF and OECD, and adopted in the US, EU and UK, central banks and national treasuries exist within the “consolidated public sector”.[7] Thus, at the level of economic reality, QE involves the public sector buying-back its own financial liabilities. While sovereign bonds remain in QE portfolios, those liabilities are effectively cancelled, because national treasuries’ formal debt servicing liabilities are discharged by making payments to monetary authorities (central banks) within the same accounting entity, which are under legal obligations to remit profits from interest earning back to the treasury and have signalled a policy position to re-invest principal payments in the same treasury’s debt securities and have reliably followed-through on that policy.[8].

4.  Remittances and reinvestment: in the US, EU and UK central banks are under legal obligations to transfer (to “remit”) most of their annual profits to their national treasuries.[9] Prior to QE, those remittances were economically and financially insignificant. Post-QE, they are vastly more important.[10] As treasuries pay interest on the bulk of sovereign bonds held in QE portfolios, central bank profits increase substantially. By complying with the legal frameworks governing remittances, central banks act as conduits for a “round robin” of public debt costs: treasury -> central bank -> treasury.

Even in the Eurozone, with its fixation on “monetary finance”, NCBs remit sovereign bond earnings to their treasuries in compliance with member-state law and the size of the remittances can be enormous.[11] A stunning example is the Bundesbank, which remitted a bumper profit of +€4billion to the German state in 2013,[12] accounting for all of Germany’s budget surplus in that fiscal year. Much of that profit stemmed from earnings on distressed Greek, Italian, Irish, Spanish and Portuguese bonds purchased through the SMP.

When sovereign bonds in QE portfolios mature, central banks “reinvest” the capital. In the US, that is done directly at US Treasury auctions: ie, the FRBNY directly purchases US sovereign debt in Treasury refinancing operations.[13] In the EU and UK, reinvestment purchases occur on the secondary market. In both cases, the effect is to provide guaranteed demand in sovereign debt markets by a purchaser (the central bank) that is unmotivated to squeeze every basis-point of interest out of the treasury. The (roughly) 30 American, British, French, German and Japanese banks and securities dealers that are the principal (if not exclusive) bidders at treasury auctions price their bids to maximise profit.[14] Central banks, contrastingly, price their market operations to deliver a diverse set of public goods, including:[15] the familiar (pre-Crisis) triad of “price stability, employment and growth”; the nebulous set of objectives (assumed post-Crisis) such as supporting large and small enterprises, maintaining credit offerings to the real economy and saving the payments system from collapse; and (in the future) the progressive de-carbonisation of the financial industry.[16]

Financial reality vs intentions

Some readers may dismiss those 4 basic facts about QE and public debt as a repetition of the, so-called, “Modern Monetary Theory”.[17]

That would be a mistake.

None of the 4 basic facts is “theoretical”. Each simply presents the legal and financial reality of central bank and treasury relations under QE.

Together, they meet standard definitions (used by the IMF and the OECD) of “monetary finance”:[18]illustrating how central banks use their money issuing authority to support public expenditure by reducing the public debt burden. Coupon payments flow from treasury to central bank and back to treasury, cancelling out much of the interest liability on the proportion of sovereign debt purchased via QE. Central bank reinvestment of maturing QE assets and an expansions of QE programs provides enormous primary and secondary market support for treasuries, especially where fiscal fundamentals are lacking, as they were for most of the last 10 years, and will be again for the foreseeable future.

A different view is taken by some central bankers, who define monetary finance very narrowly. So it goes, monetary finance only occurs when central banks “intend” to issue money for treasuries to spend.[19] On that view, a definitive answer to the question “is QE monetary finance” can be deferred until the successful cross-examination of a central bank governor: i.e., indefinitely.

Ultimately, any conflict between those who argue QE is/is not “monetary finance” is rhetorical. One can readily concede that public debt purchases through QE are motivated by attempts to provide monetary stimulus to “the economy” rather than “the treasury” while recognising the reality that QE provides very direct, and desperately needed, financial accommodation to national governments. It is also relatively clear that the financial press, financial markets and prominent central bankers accept the reality that QE boosts sovereign coffers.[20]

Constitutional predicates of legitimate fiscal power

Rather than hand-wringing about “monetary finance”, the more interesting topic is whether the intimate connection of central banks and treasuries via QE call into question the sui generis constitutional position of central banks. If central banks are providing the raw material for public expenditure, then what justifies their distance from the constitutionally-enshrined principles governing fiscal institutions?

One answer to that question focuses on the reasons for “independence”: the risks of inflation and economic mismanagement requires that central banks be separated from the cut and thrust of political and parliamentary life, particularly where national budgets are concerned.[21] While interesting, that answer overlooks the fact that central banks were constitutionally sui generis (being formally and functionally immune from judicial review and parliamentary oversight)[22] well before “independence” became voguish and the principal villain of the pre-independence era, inflation, has not arisen since QE began and central banks started subsidising treasuries: at least not the “CPI” version of inflation.[23]

A more satisfying answer could focus on the nexus between “conventional” monetary policies and fiscal power: central banks’ exclusion from constitutional accountability mechanisms was justified when their core function was lending to (rather than buying from)[24] the commercial banking sector.[25] When monetary policy focused on setting interest rates, central banks were less directly embroiled in fiscal policy.[26] Theoretically, higher/lower rates meant lower/higher lending, lower/higher employment and, therefore, lower/higher tax revenues; but that final fiscal impact depended on the behaviour of several million market actors, each acting at arm’s length from treasury officials. In that way, “conventional” monetary policy was comparatively remote to treasury decisions about funding, say, the construction of a new hospital or the rate of an old-age pension.

Under QE, central bank operations directly impact on those substantive policy choices. Decisions of monetary policy committees and central bank markets-teams about which sovereign bond to buy (interest rate, duration, commercial structure) potently affect the resources available to treasuries to, say, provide pay-check insurance programs or free childcare programs, both high-profile measures in a post-COVID-19 recovery. Reliable public delivery of social services under persistent fiscal deficits depends on guaranteed access to cheap sovereign credit, as tax revenues falter and demand-driven expenditure surges, and QE pays a number of concrete dividends to government debt managers. It reduces financing costs in primary markets by creating favourable market conditions at bond auctions. It reduces debt-servicing costs by remitting interest payment on public debt held in QE portfolios. It guarantees favourable re-financing via reinvestment programs.

Viewed in that way, QE breaks new constitutional ground for central banks, moving them outside the exclusive category of “monetary institutions” and into a “quasi-fiscal/quasi-monetary” category.

Pathways forward

If the brute facts of QE justify labelling central banks as quasi-fiscal institutions, what next for their sui generisconstitutional position?

In a world of frictionless policy choices, there are three main options.

Option 1: stop and unwind QE: flooding the market with sovereign bonds, absorbing excess reserves, returning to interest-rate setting and erasing the quasi-fiscal complexion of modern central banks. While that would cure the constitutional dilemma, it is a longshot option. Despite the sunk reputational costs in describing QE as “unconventional”, no financial cognoscenti serious contemplates its reversal over the medium term.

Option 2: continue QE and leave the institutional status quo un-touched. Although it appears to be the preference of many policy makers, that option carries significant risks to the legitimacy of central banks, treasuries and governments, given the widespread acceptance of the quasi-fiscal behaviour of central banks running QE programs. Many legitimacy problems can be ignored if underlying institutional conditions remain outside the public domain. Concealment is a non-viable option for the legitimacy problems stemming from unconventional monetary policy, which is a topic of vibrant public debate in major financial and non-financial newspapers.

Option 3: continue QE and amend institutional frameworks to ensure a measure of constitutional accountability of central banks in recognition of their quasi-fiscal role. This appears to be the preferred option of some major monetary systems: notably, the European Parliament is moving to re-think the balance of constitutional authority of monetary policy.[27] Elsewhere,[28] the reality of monetary finance under QE is forthrightly denied with the hope that constitutional confrontations can be avoided. Practical solutions to those confrontations could include institutional reforms inside central bank governance structures, perhaps the creation of ‘fiscal policy committees’ which could release summaries of their deliberations to parliaments and the public. Deeper interventions could include legislative reforms which make parliamentary voting a condition precedent to the exercise of central bank powers which directly implicate fiscal authority. Article 34 of the Bank of Japan Act would be an exemplar.[29]

Whatever solutions are settled on, it is clear that QE has upended central banks’ sui generis constitutional position and exposed the reality that central banks are both “bankers’ banks” and “governments’ banks”.[30]The revelation of that dual identity clashes with conventional wisdom in mainstream policy circles, financial markets and economics faculties: so it goes, monetary authority is exercised via financial markets, not via government spending. That thinking, although never entirely true, stems from the “mystique” which was once understood as the vital precondition to effective central banking.[31] If the enemy of conventional wisdom is “not ideas but the march of events”,[32] no gentle restoration of a hard boundary between monetary and fiscal authority should be expected. Under those conditions, central banks face a legitimacy crisis which can only credibly be overcome by embracing the end of “conventional” monetary policy, and their greater integration into the architecture of liberal democratic government. The end point of that process should not be the radical politicisation of central banks, but the fusion of economic and technical expertise with the deliberative processes under which self-governing societies choose their futures.

[1] This glosses a complex of issues covered, variously, in Will Bateman, Public Finance and Parliamentary Constitutionalism (2020, Cambridge University Press); Peter Conti-Brown, The Power and Independence of the Federal Reserve (Princeton University Press, 2017), Rosa M Lastra, International Financial and Monetary Law (Oxford University Press, 2015); Forrest Capie, Charles Goodhart and Norbert Schnadt ‘The Development of Central Banking’ in Stanley Fischer, Charles Goodhart and Norbert Schnadt (eds), The Future of Central Banking: The Tercentenary Symposium of the Bank of England (Cambridge University Press, 1994).

[2] Prominently Art 123 of the Treaty on the Functioning of the European Union. This is a uniquely European legal position, as the US Federal Reserve Banks are legally authorised (and do) purchase debt securities directly from the US Treasury, and the Bank of England is legally authorised to (and does) provide unsecured lines of credit to the UK treasury. For the interpretation of s 14(b) of the Federal Reserve Act that permits the FRBNY to participate directly in US Treasury auctions, see Kenneth Gardabe, ‘Federal Reserve Participation in Public Treasury Offerings’ (Federal Reserve Bank of New York Staff Report No. 906, December 2019); for the legal authority of the Bank of England to provide vanilla credit to the UK Treasury, see s 12(7) of the National Loans Act 1968 (UK); and for the full legal analysis in both jurisdictions, see Will Bateman, ‘The Law of Monetary Finance under Unconventional Monetary Policy’, Oxford Journal of Legal Studies (forthcoming), Part 2.

[3] The Bundesbank being the exception that proves the rule: see, Weiss v Bundesbank, BVerfG, 2 BvR 859/15 (5 May 2020); Charles Goodhart and Rosa Lastra, ‘Populism and Central Bank Independence’ (2018) 29(1) Open Economics Review 49; Chiara Zilioli, ‘Justiciability of Central Banks’ Decisions and the Imperative to Respect Fundamental Rights’ paper presented to ‘ECB Legal Conference 2017: Shaping a New Legal Order for Europe: a Tale of Crises and Opportunities’ (December 2017); Bateman (n1), chs 3 and 8; Bateman (n 2), Part 4.

[4] The extended arguments and empirical evidence for this proposition are contained in Bateman (n 2).

[5] Before 2020, non-sovereign debt assets never exceeded 40% (or $1.5tr) of the QE purchases in the US (but virtually all securities purchased were, directly or indirectly, guaranteed by the US government), 10% (or €600b) in the Eurosystem and 25% (or £126b) in the UK: Federal Reserve Bank of New York, SOMA Holdings: https://www.newyorkfed.org/markets/soma/sysopen_accholdings#export-builder; European Central Bank, Asset Purchase Program: https://www.ecb.europa.eu/mopo/implement/omt/html/index.en.html; Office of National Statistics, Public Sector Finances – PSA9. All those percentages have dropped precipitously since March 2020.

[6] Public sector purchases amount to +83% of the total asset purchased under Eurozone QE (APP+PEPP): data available at https://www.ecb.europa.eu/mopo/implement/app/html/index.en.html#cbpp3; https://www.ecb.europa.eu/mopo/implement/pepp/html/index.en.html(accessed 13/11/20).

[7] The foundational documents are the IMF Government Finance Statistic Manual and the OECD System of National Accounts 2008 which entrench the accounting treatment of central banks within the public sector in the US, EU and UK.

[8] A further curiosity is the treatments of the ‘central bank reserves’ issued through QE as ‘liabilities’ of the central bank despite the fact that a central bank is under no legal obligation to do anything in respect of a credit balance in a reserve account. For legal and economic arguments against that accounting treatment, see Michel Kumhoff, Jason Allen, Will Bateman, Rosa Lastra, Simon Gleeson and Saule Omarova, ‘Central Bank Money: Liability, Asset or Equity of the Nation’ (Cornell Legal Research Paper 20-46, 17 November 2020). For legal treatments of central banks reserves, see Simon Gleeson, The Legal Concept of Money (Oxford University Press, 2018), 4.41, 6,10-6,12, 6.58; Charles Proctor, Mann on the Legal Aspect of Money (Oxford University Press, 2012, 7th ed), 2.75-2.76, 33.57.

[9] For the US, see, the Federal Reserve Act, s 7; for the complicated legal structure governing QE remittance in the UK, see Bateman (n 1), ch 7.

[10] For the UK experience, see Bateman (n 1), ch 7.

[11] Eg, ECB Statute, Arts 29-33 and Decision (EU) 2016/2248 of the European Central Bank of 3 November 2016 on the allocation of monetary income of the national central banks of Member States whose currency is the euro (ECB/2016/36) [2016] OJ L 347; Bundesbank Act, Art 27; Statute of the Bank of Italy, Art 38; Monetary and Financial Code Art L 142-2.

[12] Deutsche Bundesbank, Annual Report 2013, page 74.

[13] Since the 1930s, s 14(b) of the Federal Reserve Act has been interpreted as permitting direct transactions between the FRBNY and the US Treasury at auctions ‘if they were undertaken on terms specified in Treasury circulars, i.e., on terms available to the general public’: Gardabe, (n 2), page 7. Data on direct US sovereign bond purchases by the FRBNY from: US Treasury, ‘Auction Allotments By Investor Class For Marketable Treasury Coupon Securities’ <https://home.treasury.gov/data/investor-class-auction-allotments>.

[14] ‘Primary Dealers’ in France, Italy, Japan, Spain and the US; members of the ‘Bund Issues Auction Group’ in Germany; ‘Gilt-Edged-Market-Makers’ in the UK: see further Will Bateman and Steffen Murau, ‘Intermediating Central Bank and Treasury Balance Sheets: Primary Dealers in Sovereign Bonds’ (forthcoming).

[15] Much relevant literature on the impact of QE on the borrowing costs of sovereigns is collected in Loriana Pelizzon et al, ‘Scarcity and Spotlight Effects on Liquidity and Yield: Quantitative Easing in Japan’ (IMES Discussion Paper Series No 18-E-14, Bank of Japan, 22 February 2019).

[16] See the comments of President Lagarde of the ECB on the likely prospects of adopting targeted “green” monetary policy operations in the Eurosystem (Committee on Economic and Monetary Affairs, Monetary Dialogue with Christine Lagard, President of the European Central Bank, Brussels, 28 September 2020), page 13) in response to Jens van t’ Klooster and Rens van Tilburg, ‘Targeting a Sustainable Recovery with Green TLTROs’ (Working Paper: Positive Money Europe and the Sustainable Finance Lab, September 2020): <https://www.positivemoney.eu/2020/09/green-tltros/>.

[17] “MMT” is quite a broad church, stretching from academia to deep in the Twitter-sphere: canonical texts include L Randall Wray, ‘Modern Money’ (Levy Economics Institute Working Paper No. 252, November 1998); L Randall Wray, ‘The Origins of Money and the Development of the Modern Financial System’ (Levy Economics Institute Working Paper No. 86, May 1999); Bill Mitchell, L Randall Wray and Martin Watts, Macroeconomics (Red Globe Press, 1999).

[18] Richard Hemming, ‘The Macroeconomic Framework for Managing Public Finances’ in Richard Allen, Richard Hemming and Barry Potter (eds), The International Handbook of Public Financial Management (Palgrave Macmillan, 2013) 17, 21.

[19] David Andolfatto and Li Li, ‘Is the Fed Monetising Government Debt?’ [2013] (5) Federal Reserve Bank of St Louis: Economic Synopses 1; Andrew Bailey (Governor of the Bank of England), ‘Bank of England is not doing ‘monetary financing’’, Financial Times (5 April 2020).

[20] Gertjan Vlieghe, ‘Monetary policy and the Bank of England’s balance sheet’ (Speech, Bank of England, 23 April 2020).

[21] Jens Weidmann (President of the Bundesbank), ‘Money Creation and Responsibility’ (Speech, 18th colloquium of the Institute for Bank-Historical Research, 18 September 2012).

[22] See, eg, Raichle v Federal Reserve Bank of New York, 34 F.2d 910 (2d Cir. 1929); The King v The Governor and Company of the Bank of England (1819) 2 Barnewall and Alderson 620 [106 ER 492]; The King v The Governor and Company of the Bank of England (1780) 2 Douglas 524 [99 ER 334].

[23] For some squabbles about the impact of QE on “asset prices” see Ben Broadbent, ‘The History and Future of QE’ (Bank of England, 23 July 2018); Thomas Hale, ‘The Bank of England has a strange idea of what QE has achieved’ (Financial Times, 3 August 2013), Rob Macquarie, ‘The History and Future of QE: 3 Ways the Bank of England’s Analysis Falls Short’ < https://positivemoney.org/2018/07/the-history-and-future-of-qe/>.

[24] Of course, most interest rate setting operations occurred through sale and repurchase operations rather than vanilla “loans”: the defining feature of QE’s outright purchases is the omission of the “repurchase” arm of the operation.

[25] The institutional and constitutional impacts of the shift from “conventional” to “unconventional” monetary policy are elegantly explained by Christine Desan and Nadav Orian Peer, ‘The Constitution and the Fed after the COVID-19 Crisis’ (Just Money, Policy Spotlight): https://justmoney.org/the-constitution-and-the-fed-after-the-covid-19-crisis-2/.

[26] As Gardabe and Lastra explain, interest rate setting did have meaningful impacts on fiscal policy and government finance: Kenneth Garbade, ‘Direct Purchases of U.S. Treasury Securities by Federal Reserve Banks’ (Staff Report No 684, Federal Reserve Bank of New York, August 2014); Rosa Lastra (n 1) ch 2.

[27] See, Rosa Lastra, ‘Accountability Mechanisms of the Bank of England and the European Central Bank’ (Report to the European Parliament, September 2020); Rosa Lastra and Alexander Kern, ‘The ECB Mandate: Perspectives on Sustainability and Solidarity’ (Report to the European Parliament, June 2020).

[28] Eg, Andolfatto and Li (n 14); Bailey (n 14).

[29] See, Bateman (n 2).

[30] A point emphasised by Perry Mehrling, ‘Essential Hybridity: A Money View of FX’ 41, Journal of Comparative Economics No. 2 (May 2013): 355-363; and ‘Monetary Policy Implementation: A Microstructure Approach’ in Robert Leeson (ed), David Laidler’s Contributions to Economics (Palgrave Macmillan, 2013), 212.

[31] As the former Governor of the Bank of England, Mervyn King, wrote “When I joined the Bank of England in 1991, I asked the legendary American central banker Paul Volcker for one word of advice. He looked down at me from his great height (a foot taller than I) and said, ‘Mystique.’”: The End of Alchemy (WW Norton & Company, 2017),

[32] According to Kenneth Galbraith, ‘The Affluent Society’ easily found in The Essential Galbraith (Houghton Mifflin Company, 2001), page 24.