Synopsis: The President of the European Central Bank (ECB), Mario Draghi is set to step down later this year and the race to replace him is not short of Qualified candidates. Whilst his replacement is important, their ability to support economic activity and ensure low and stable inflation around the 2.0% target amidst an uncertain economic backdrop is essential. Furthermore, any president must think carefully about creating policy space to respond to the next crisis such as moving interest rates from negative territory towards zero lower bound. Furthermore, a creative macroprudential policy framework must be envisaged to balance bank profits against financial stability risk.
The president of the ECB, Mario Draghi is set to retire in October. The race to find a replacement has seen a slew of qualified candidates emerge even if qualified women are continuously left out. The next ECB president will need to have four qualities to ensure the monetary policy is delivered in a crisis-proof manner.
1). Consensus Builder: The next ECB president will need a strong understanding of the EU’s political realities whilst forging consensus with Central Bankers across the continent. Whilst disagreements regarding the type of monetary policy which the ECB should employ will be evident in, sometimes, divergent speeches, the incoming president should advocate policies that reflect the current economic realities, without compromising the legitimacy of the euro as the Eurozone’s anchor. Erkki Liikanen, the Governor of the Central Bank of Finland has earned a reputation as a consensus builder and appears to be the favorite in that regard.
2) Sound Economic Knowledge: The incoming ECB president should have a sound understanding of the economic theory underpinning ECB monetary policy. Nevertheless, as the intensity transmission mechanisms – such as the pass-through between, quantitative easing, financial markets, and the real economy as well as unemployment and wages – become increasingly important, the next president must have a sound understanding of the heterogeneous impact of resulting monetary policy or credit easing mechanisms. This will provide legitimacy to any new policies that may emerge. Nevertheless, the economic thinking behind ECB policy needs little legitimacy added with Philip Lane as its Chief Economist.
3) Uncertainty is the new normal: Central Bankers are famed for consistently reiterating risk to financial system and economy. While this is likely to underpin the incoming president’s communications, they must finely balance economic risks without exacerbating already jittery markets. As such, risks to the global economy – trade uncertainty and geopolitical uncertainty – must be outlined in a measured manner to improve the signals from monetary policy. In this regard, Jens Weidmann, President of the Bundesbank and Chairman of the Board of Directors of the Bank for International Settlements, Claudia Buch, Vice president of the Bundes Bank and Christine Lagarde are best placed to guide monetary policy during abnormal times. This is especially salient as inflation is increasingly contingent on oil prices, which are driven by geopolitical uncertainty. The case for policy mistakes cannot be understated. This is compounded by the unique situation of the EZ economy, which has seen unit labor cost rise with no resounding increase in underlying inflation.
4) Unconventional monetary policy is here to stay: The EU economy will never be the same following the 2008 financial crisis and sovereign debt crisis. While economic theory advocates continued monetary accommodation, the competitiveness of EU banks and economic convergence are unlikely to trail very far behind. My rationale for the above rests on the need for a concerted and equally effective response to an oncoming crisis. I have argued in previous articles that raising interest rates from negative territory to the zero lower bound isn’t unwelcome by market participants. Not only will this improve the effectiveness of the monetary policy, but it’ll also prevent the negating effects of negative interest on the real economy from stymieing economic growth. On this basis, Christine Lagarde and her reformist and innovative background can support a more targeted QE during a crisis and
5) The Banks role in shoring confidence in the euro: There’s been no shortage of articles decrying the absence of tools to weather the next crisis. This is not Europe-specific but marks a challenge for the incoming President. The next ECB president will have to communicate their readiness to ensure inflation at the 2.0% whilst ensuring the economic legitimacy that underpins ECB decisions are not eroded. This will be particularly problematic with erratic oil prices and uncertain economic conditions.
Dove Vs. hawks?
Admittedly, recent discourse regarding the ECB has focused on credentials and the eventual nominee’s dovishness. The proxy for this has been whether or not they objected to ECB asset purchase. Nevertheless, appointing a dove or hawk is beside the point as neither will be able to escape the economic realities of the EU, plagued by an aging population and lower potential growth.
Policy space via macroprudential policy
With monetary policy tools scant and fiscal balances unlikely to suffice in the event of a financial crisis, monetary policy must complement its fiscal counterpart. As such, even as the ECB’s mandate is constrained to economic activity and inflation at the 2.0% target. The next president of the ECB is just as relevant as their ability to forge consensus. Even as economic activity and inflation around the 2.0% target remains the overriding objective of monetary policy, continued accommodative monetary policy. Instead of doing whatever it takes during a downturn, the nominee and its deputy must do “whatever it takes” now to achieve the mandate and ensure sustained economic growth.
Central Bank policy in the 21st Century
It is misplaced and short-sighted to argue for female nominees just for the sake of it. Nevertheless, the ECB president and deputy should comprise a man and woman. The EU is not short of female and male central Bankers to choose from. As Central Bankers grapple with improving communication and regaining public confidence, they must ensure that nominations to the council are representative of the Eurozone. Maintaining the status quo via male-only nominations will suggest continued divergence between Central Banks and the public. Regardless of the outcome, the “who” is less relevant than would otherwise be the case as the “how” for monetary policy has never been more relevant. As such, the process, rather than the nominee will ultimately determine the success of ECB.