With euro area inflation rising, ECB credibility drifting down, the euro area economy slowing down and global financial markets unable to sort themselves out from the current turmoil, there is great uncertainty about the ECB’s next policy move. Now more than ever, it is important for the markets – and the public – to understand the reasoning behind the ECB’s policy decisions. But this remains an impossible exercise, because the way the Governing Council interprets the data and makes its interest rate decisions remain clouded.
A recent example suggests how large the benefits of greater transparency might be. In late 2005, when the ECB started raising rates, markets were left in the fog as to the rate the Governing Council was aiming for and the speed with which it was planning to get there. If markets had correctly anticipated that the Governing Council was aiming at a policy tightening of 200 basis points within two years, such expectations would themselves have made monetary conditions less expansionary, and the same path of interest rates would have resulted in a lower euro area inflation.
Maybe the Governing Council was divided on both counts, the amount of the overall tightening and its speed. This is normal when decisions are made by a committee—and is also a sign of good health, of an institution that is open to different views rather than being dangerously driven by a single way of thinking. If this was the case it would have helped markets – and the public – enormously to understand the reasoning behind the various positions. But this is impossible because the deliberations of the Governing Council remain secret.
The bottom line is that the ECB would find it easier to control inflation by doing more to shape market expectations.1 Helping markets to anticipate next month’s decision is not enough, because markets care much more about the entire future course of action. The simplest and best way to shape expectations would be for the ECB to publish its anticipated interest rate path.2 This would be much more effective than the current approach involving the use of code words. Code words may be misinterpreted and their very imprecision reduces the effectiveness of monetary policy.
The ECB needs to become more transparent, and the simplest way to achieve this is to publish the voting records of the Governing Council. Analyzing the voting patterns in other central banks one learns that decisions are rarely unanimous, so voting records are generally informative. Publishing the balance of votes would lead to a better understanding of how the Governing Council responds to economic information. Publishing votes does not mean that the votes of individual members should be revealed: this could be dangerous, since monetary policy votes could subject central bank governors to national political pressures.
Greater transparency would have another important benefit for the ECB. The only defence for central bank independence in a democracy is popular support. This can be eroded by determined politicians, as evidenced by the declining trust in the ECB among French citizens. Such a development may tempt more politicians to earn popular support by criticizing the ECB, and the repetition of largely misguided attacks may succeed in denting the reputation of the central bank. It should not be so. The solution is better communication, and not just toward financial markets. Better communication, in turn, must rest on a clear strategy and a higher degree of transparency.
Ten years down the road, the time has also come to reconsider whether the way the Executive Board and the Governing Council work could be improved.
The internal organization of the bank should be reconsidered, separating the role of Executive Board members from the responsibilities of running the bank. One never exaggerates emphasizing that setting monetary policy and explaining it to the public are difficult tasks and constitute a full-time job. Managerial responsibilities are distractions that reduce the effectiveness of board members in carrying out the task for which they have been selected.
Board members—with the possible exception of the president and vice-president-- should have a single responsibility: formulating and communicating monetary policy. This would also make it harder for politicians not to appoint the best monetary experts—an objective which does not appear to be their top priority at the time of appointments.
The way the Governing Council works could also be improved. Meetings should be less frequent. Moving to the FOMC six-week frequency could help extend the time the Council dedicates to monetary policy decisions. Participation in the meetings dedicated to technical issues could be delegated to NCB deputies, or organized with a conference call. The ECB not only abstains from publishing minutes of the meeting: it also does not tell which Council members attended the meeting and who was instead represented by an alternate. We find the possibility of delegating the vote to an alternate troublesome.
The way the ECB has responded to the liquidity crisis has earned high marks from financial markets. Now is the time to build on this success by improving the bank’s communication, its transparency and its governance. Sooner or later these issues will have to be addressed, but the ECB would benefit from doing so now at this time of heightened uncertainty.