June 1st marked 20 years since of the founding of the European Central Bank (ECB). The bank is one of seven main EU institutions and acts as the bulwark of the Eurozone. Over the past two decades, it has overseen the Eurozone economy, whose 340 citizens have experienced a 50% rise in GDP per capita. On this anniversary, it is worth considering how the ECB has contributed to the stability of the Eurozone in general, and Southern Europe in particular.
The Origin Story
The ECB grew out of several decades of progressive economic integration dating back to the European Coal and Steel Community in 1951. Following the publication of the 1988 “Delors Report”, members of the European Community committed themselves to the creation of a European Economic and Monetary Union, which included a common currency. The goal was to provide the foundation for the easier movement of goods, services, and people across borders. However, a common currency couldn’t operate if there were multiple central banks. As a result, the European Central Bank was created in order to set monetary policy for those member states that chose to adopt the euro as their currency.
The ABCs of the ECB
The overarching goal of the ECB is the maintenance of price stability. To this end, the ECB’s Governing Council has defined its inflation target at 2%. Since the creation of the euro, inflation across the eurozone has averaged 1.7%. This is a significant achievement and has helped stabilize the economies of Southern Europe. For instance, during the 1980s, Italy’s inflation rate swung between a high a of 21% and a low of nearly 5%. Similarly, Spain experienced inflation rates ranging between more than 15% and just under 5% during the same period.
Why is a stable inflation rate important? While economists want prices to rise at a steady rate, a precipitous increase constrains the purchasing power of consumers. A dramatic rise in prices means that the same amount of money will cover the cost of fewer goods or services, thereby reducing an individual’s welfare. Conversely, a decreasing inflation rate means that consumers may put off purchases with the expectation that prices will continue to fall. This has a particularly negative effect on businesses. Consequently, the ECB’s ability to provide stable, predictable inflation rates has made consumers in Southern Europe better off and businesses more prosperous.
Doing Whatever it Takes
Without the deliberate intervention of the ECB, it is possible that the financial crisis could have forced some Southern European member states to leave the eurozone. While the ECB’s role in the crisis has garnered some controversy, it cannot be denied that it provided much needed support to the region’s vulnerable member states.
Most remarkable of all is the now famous statement made by Mario Draghi, president of the ECB, during a speech at the Global Investment Conference in 2012. Specifically, Draghi stated, “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough.” The phrase “whatever it takes” helped restore confidence in the markets and reduced the financial pressure on Southern European economies.
This was followed by a broad asset-backed securities purchase program often referred to as quantitative easing. Initially, it involved the purchase of 60 billion euro worth of government bonds, securities issued by European supranational institutions, corporate bonds, asset backed securities, and covered bonds. The programme’s success subsequently enabled the ECB to claw back its purchases to 30 billion euro per month. This action helped provide credit in markets where banks were unable to lend, stabilize inflation, and reduce borrowing costs for countries such as Spain, Italy, Portugal and France.
Forward Guidance
So how will the ECB’s role continue to evolve? Looking forward, the ECB is expected to play an increasingly important role in overseeing not only price stability, but the health of financial markets. More than 100 banks across the Eurozone are now supervised by the ECB. The ECB also participates in the Single Supervisory Mechanism and the Single Resolution Mechanism, two parts of the yet-to-be completed banking union.
With digital currencies all the rage, there is the possibility that the ECB could delve into new regulatory territory. While Mario Draghi has said that regulating cryptocurrencies isn’t very high on the bank’s to-do list, ECB board member Yves Mersch has spoken out in favour of greater oversight. He has specifically warned of the need for banks to separate their traditional assets from their digital currency dealings. If the size of the cryptocurrency market continues to increase, the next ECB president may decide to take a more active role in regulating this nascent financial asset. Such a move would have a notable effect on countries like Malta that are aiming to become global cryptocurrency centre.
Despite the controversy surrounding its unconventional intervention, Southern Europe is on stronger footing today because of the ECB’s actions. The creation of the ECB ushered in an unprecedented period of price stability for the region, and in so doing, provided the necessary foundation for economic growth. Imperfect it may be, but expendable it is not.
