When Christine Lagarde became president of the European Central Bank in November, she inherited a challenging legacy from her predecessor Mario Draghi. The ECB’s key people are openly divided on the future direction of monetary policy. Markets are expecting interest rates to stay ultra-low for decades, and parts of the continent’s banking system remain fragile.
There was no shortage of issues for Lagarde to tackle. The new ECB president had her work cut out for her.
Yet Lagarde has added another issue to this list that has the potential to change the nature of Europe’s central bank. By focusing on climate change and green bonds, she is about to turn her institution into an industrial policy agency, a European super-ministry.
In theory, the responsibility of the ECB is clear. Its sole mandate under European treaty law is to maintain price stability, which is defined by a 2 percent inflation target.
However, Article 127 of the Treaty on the Functioning of the European Union also states: “Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union.”
In plain English, as long as the ECB seeks to maintain price stability, it can engage in other areas. The list of policy goals in Article 3 of the Treaty is long. It encompasses everything the European Union does. The EU’s goals include sustainable development, full employment, social progress, protection and improvement of the quality of the environment, scientific and technological advance, social exclusion and discrimination, social justice and protection, equality between women and men, solidarity between generations, protection of the rights of the child, economic, social and territorial cohesion, and cultural and linguistic diversity.
Under normal circumstances, the ECB would not have much to do with these goals. Its usual policy levers are interest rates, which only indirectly affect non-monetary policy goals.
However, there is nothing normal about European monetary circumstances, since the ECB has long been practising unusual monetary policy. For many years now, the ECB has been buying both government and corporate bonds to stimulate the economy and push up the inflation rate.
In doing so, the ECB has successfully depressed yields on government bonds, reduced the financing costs for European companies and pushed up asset prices, not least in property. The one thing it has not achieved is 2 percent consumer price inflation. By the ECB’s standards, inflation is still too low.
In the ECB’s logic, that means the bank has not done enough monetary easing and should thus continue to flood the market with even more newly created central bank cash. And this is where articles 127 and 3 of the respective European treaties come into play.
At her hearing in the European Parliament’s Committee on Economic and Monetary Affairs in September, Lagarde was at pains to underline that whatever she would do as President of the ECB would be within the ECB’s mandate.
At the same time, she left no doubt she would see it as the ECB’s role to play an active role in climate change policy. In her short opening statement to the Committee, she already mentioned climate change three times. She explained that public institutions like the IMF, where she was before, and the ECB had to address the “fundamental issues of our time” and called for a “monetary policy [that] is forward-looking and considers the broader context in which price stability is achieved.”
In discussion with the EU Parliamentarians, Lagarde then explained that the ECB had so far not been able to prefer certain assets in its quantitative easing policies under the principle of market neutrality. That was about to change though as the EU was about to introduce a harmonised definition of green assets, a so-called taxonomy. And once that was done, so Lagarde, the ECB would see how it could become more active in this space.
Not surprisingly, Lagarde is personally interested in being a participant in climate change policy. Back in 2017, when she was still at the IMF, she told a conference in Saudi Arabia “if we don’t do anything about climate change now, in 50 years’ time we will be toasted, roasted and grilled.”
But for the ECB, the move to leave market neutrality behind and engage in fiscal policy is leading the Bank into uncharted territory.
The most critical voices on the ECB’s move into fiscal policy are coming from Germany – a country that had bad historical experiences with politically motivated central banks (and two resulting hyperinflations in the first half of the 20th century). The Bundesbank’s President Jens Weidmann thus warned to leave the market neutrality principle behind and interfere in areas for which the ECB has no democratic mandate.
Hans-Werner Sinn, one of Germany’s leading economists, did not mince his words, either. “Ultimately, this is the financing of politically desired private economic activities with money from the printing press,” the former long-serving President of the IFO research institute said. And he warned that the “ECB must not define its mandate itself, but the limits of the mandate must be set by others, by the parliaments.”
For Sinn, the ECB’s activism is a slippery slope. “Just because the ECB sits at the printing press and owns the money is no reason to undermine the established political structures and decision-making bodies. This leads to a centrally planned market economy."
There is a danger that the greening of the ECB’s asset purchase programme sets a precedent. The list of EU policy goals is long, so what would stop the ECB from selecting assets that create jobs, reduce inequality or promote certain technologies?
In a democracy, there are institutions in charge of such issues. These are parliaments and governments – and they are both subject to regular elections. The ECB, meanwhile, is not subject to democratic control, nor can it claim democratic legitimacy.
In fact, parliaments and government are also better placed to deal with climate change than the ECB. The Bank can only support climate change policies while it engages in quantitative easing. Conversely, it means it would have to end its policies should monetary policy return to more normal conditions. Therefore, one cannot bank on central banks to deliver climate change policy forever – it is none of their core business.
Lagarde is about to set a dangerous example for an activist, winner-picking central bank. It is a precedent for the ECB itself – and for other central banks wishing to follow the ECB’s transformation.