“In accordance with Article 105(1) of the Treaty, the primary objective of the ESCB shall be to maintain price stability.”
“Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community with a view to contributing to the achievement of the objectives of the Community as laid down in Article 2 of this Treaty. The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 4 of this Treaty.”
The above piece of text is the text of Article 2 of the Statute of the European Central Bank, which is the ECB’s manual, not to say constitution. Article 2 is about the bank’s objective. The statute of the ECB is the document that is quoted several times in almost every speech by and almost every interview with members of the bank’s Executive Board.
They use phrases such as “within our mandate” or “in accordance with our mandate”. Everything the bank does, they say, is not in conflict with the objective the ECB has been given by society.
Let us take a closer look.
The main objective of the ECB is to maintain price stability. The bank defined that in 1999 as “inflation below 2%”, which was changed in 2003 to “below, but close to 2%” and last year to “2%”.
When I look at the actual annual inflation in the euro area since 1999 with those definitions in mind, the only conclusion that can be drawn is that the ECB has only managed to deliver price stability for one year. Well, one year… actually no year because the only year when inflation in the euro area met the definition of price stability was 1999.
ECB failed in its primary task
Inflation in that year had nothing to do with ECB policy because the bank started its work in that year. In short, for more than 20 years the ECB has failed in its primary task. In my view, there is a good chance that this will not change in the coming years.
This is important because we read in Article 2 that the bank also has to support the general economic policies in the EU but “without prejudice to the objective of price stability”. I read that as “first make sure you fulfil your primary task and then you can try to do other things”. However, the ECB does all sorts of other things, often very controversial, and so far the bank has not fulfilled its primary objective for a single year.
“The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources.”
I already had great difficulty seeing how quantitative easing, the large-scale buying up of government and corporate bonds, can be reconciled with “free competition” and “efficient allocation of resources”, and this is certainly true of the TPI programme that the bank recently announced. TPI, which stands for Transmission Protection Instrument, aims to curb increasing interest rate differences between euro countries.
The new instrument will be used in the event of “unwarranted disorderly market developments that pose a serious threat to the transmission of monetary policy throughout the euro area”. No one knows or can know what is “unwarranted” or when market developments are “disorderly”. If Italian interest rates rise relative to German rates because the government falls or an incumbent government refuses to reform the economy, that seems to me to be anything but unjust. But the ECB will probably intervene.
So the next time you hear an ECB official say that the bank is acting “in accordance with its mandate”, remember the provisions of Article 2 of the bank’s constitution.
Forward guidance: impossible
Finally, something the bank has done away with is the verbal tool of forward guidance, policies where central banks tell people in advance what they intend to do. The ECB said that future possible interest rate increases will depend on developments in the economy. Logical, but it does mean that forward guidance is no longer possible. That is quite important for investors. You could say that forward guidance provided some certainty about future policy. Without forward guidance, it seems to me that the uncertainty and unpredictability of that policy will be greater. Especially since the Fed has also taken forward guidance off the table.
Edin Mujagić is the chief economist of OHV Asset Management and author of the book ‘Keerpunt 1971’. At the end of the month, he writes an ECB Watch on the European Central Bank’s monetary policy for Investment Officer. This article originally appeared in Dutch on InvestmentOfficer.nl.