The first of November will be a remarkable day for the European Monetary Union (EMU). The current president of the European Central Bank (ECB) Mario Draghi will be succeeded after a term of 8 years by Christine Lagarde. Such succession would only be the third one in the 21-years existence of the Euro, and a new president will undoubtedly impact the European economy.
Lagarde, the former chairman of the International monetary Fund (IMF) and French minister of Finance during the last great recession, seems the ideal candidate for Europe to succeed Draghi. The ECB is a prestigious institute, it conducts monetary policy over and directly interferes in the third largest economy of the world (GDP corrected for PPP) (ECB, 2019). The move from the IMF to the ECB therefor seems a beautiful step in Lagarde’s career.
But this once so unassailable institute wavers on its fundaments. Although Draghi’s ‘aggressive’ interventions in the financial markets always have been a contested topic, the governing council always made the impression to unanimously support these policy instruments. How different is this regarding the latest stimulus package announced at 12 September. The deposit rate will be lowered further to -0.5%, and the ECB will restart net accumulating 20 billion of government bonds per month. Draghi expects that these measures will invoke the low inflation in the Euro-area (0.8%), especially in South Europe where the inflation rate is close to zero. Higher inflation will probably again stimulate the ever-welcome economic growth.
However, this package faced unprecedented resistance within the ECB, as one-third of the governing council voted against the proposal. The unanimous appearance of the governing council towards the public, seemed to shatter as multiple governors of national banks openly criticized the decision. Also, our president of the Dutch central bank (DNB) Klaas Knot called the measures ‘disproportional towards the current situation of the European economy’. Former chief economists within the ECB, Otmar Issing and Juergen Stark published an open letter in which they stated the ECB has crossed its mandate (inflation-targeting), subsidizing governments as these measures will push yields on government bonds further in the negative. The policy would besides have a lot of negative side effects, as disturbing the proper function of financial markets, with a large risk of bubble-forming. Even Draghi’s closest allies openly question his latest move. Governor Ignazio Visco (Italy) is very critical at the risk/reward rate of this package (Wall Street Journal).
The ECB currently possesses a balance sheet which is 40% in size of the Eurozone’s GDP. To put this in perspective, this is double the amount as the Fed owns in terms of the US GDP! The policy package implemented under Draghi will only increase this balance sheet, clearly not to the delight of everyone within the ECB. Lagarde will enter a very difficult position, where she must make up her mind about the policies of her processor without invoking a rebellion among the governors. To her the task to rebuild the ruin to the state of prestige it once held.
By: Joris Hoefnagel