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THE EUROPEAN CENTRAL BANK: RECENT REFORMS AND FUTURE PROSPECTS. Álvaro Anchuelo Crego Research Group in International Economics Real Colegio Complutense, Harvard Summer 2005. PARTS. I: EMU’s Eastern Enlargement. When?

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The european central bank recent reforms and future prospects l.jpg

THE EUROPEAN CENTRAL BANK: RECENT REFORMS AND FUTURE PROSPECTS

Álvaro Anchuelo Crego

Research Group in International Economics

Real Colegio Complutense, Harvard

Summer 2005


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PARTS

  • I: EMU’s Eastern Enlargement. When?

  • II: reform of the ECB’s Council of Government. International comparisons.

  • III: the MP Target

  • IV: the MP Strategy

  • V: Transparency

  • VI: other future challenges



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PART I: When will it happen?

OUR OWN

UP TO DATE

CONVERGENCE REPORT


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OUR OWN UP TO DATE CONVERGENCE REPORT When will it happen?

  • Prepared by the ECB and the European Commission

  • At least once every two years (or at the request of the Member State with a derogation, 10+Sweden)

  • UK and Denmark: opt-out arrangements. Only examined at their own request

  • Last in 2004, data until August. Now (May 2005)?


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CRITERION ON INFLATION When will it happen?

  • an average rate of inflation, observed over a period of one year (12-month average)

  • measured by means of the consumer price index on a comparable basis (HICP)

  • that does not exceed by more than 1½ percentage points that of the three best performing Member States in terms of price stability (deflationary not best performing DEGREE OF ARBITRARITY IN INTERPRETATION).


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DEGREE OF ARBITRARITY IN When will it happen?INTERPRETATION

  • 3 best performing Members of the EU? 2 NOT IN EMU

    Finland (0.33) + Sweden (0.92) + Denmark (1.13)

    Average = 0.8 + 1.5 = 2.3%

  • 3 best performing Members of the EMU?

    Finland (0.33) + Netherlands (1.32) + Germany (1.87)

    Average = 1.2 + 1.5 = 2.7%

  • Why not to take the EMU’s inflation as the reference?

    2.2 + 1.5 = 3.7%

  • Or the target?

    2 + 1.5 = 3.5%


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LONG-TERM INTEREST RATE When will it happen?

  • To assess durability of convergence achieved

  • of long_term government bonds (10 years)

  • average over the latest 12 months

  • not exceed by more than 2 points the average of the 3 best performing Member States in terms of inflation


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AGAIN, DEGREE OF ARBITRARITY IN When will it happen?INTERPRETATION

  • 3 best performing Members of the EU? 2 NOT IN EMU

    Finland (3.95) + Sweden (4.17) + Denmark (4.12)

    Average = 4 + 2 = 6%

  • 3 best performing Members of the EMU?

    Finland (3.95) + Netherlands (3.92) + Germany (3.87)

    Average = 3.9 + 2 = 5.9%

  • EMU as the reference? Not data.


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FISCAL DEVELOPMENTS When will it happen?

  • sustainability of the government financial position

  • without a deficit that is excessive (the ratio to GDP exceeds a reference value of 3%)

  • the ratio of government debt to GDP exceeds a reference value of 60% (unless it is sufficiently diminishing)


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EXCHANGE RATE DEVELOPMENTS When will it happen?

  • Participating in the ERM II (since January1999, width of the fluctuation ±15% )

  • observance of the normal fluctuation band

    for a period of at least two years without devaluing (changing its central rate) against the euro

    * No opting-out for new members, but date of entry into ERM II not specified (eg. Sweden)


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If not now, then when (I)? When will it happen?

  • 27-6-2004: Estonia, Lithuania and Slovenia entered the ERM II + 2 years = 27-6-2006.

  • Next Convergence Report due around October 2006. Council of Ministers decides and fixes the date of entry.

  • Criteria on i, d, b already fulfilled today.

  • Inflation: not far away

  • COULD ENTER EMU (the soonest)

    1-1-2007.

    They want to introduce € cash since the beginning


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If not now, then when (II)? When will it happen?

  • 2-5-2005: Cyprus, Latvia and Malta entered the ERM II + 2 years = 2-5-2007.

  • Next Convergence Report due around October 2008, but can request one.

  • Further away from fulfilling all the criteria.

  • COULD ENTER EMU (the soonest)

    1-1-2008.


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If not now, then when (III)? When will it happen?

  • Czech R., Slovakia, Hungary and Poland: yet to enter the ERM II + 2 years

  • Further away from fulfilling all the criteria (except Czech R., fulfills all).

  • COULD ENTER EMU later than 1-1-2008. More likely in 2009 or 2010.

    THEY ARE THE LARGE ECONOMIES.


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PART II: When will it happen?

REFORMS IN THE DECISION MAKING

COUNCIL OF THE ECB

AND

INTERNATIONAL COMPARISONS


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PROCEDURE THAT LED TO THE ADOPTION OF THE NEW VOTING SYSTEM: When will it happen?

  • Treaty of Nice contains an ECB “enabling clause”.

  • Recommendation from the ECBadopted unanimously by the Governing Council (3 February 2003).

  • European Commission presented its opinion (19 February 2003). “Important step…”.

  • Plenary session of the European Parliament adopted a resolution(13 March 2003), rejected, complex.

  • EU Council adopted unanimously the decision on this amendment to the Statute (21 March 2003).

  • To be ratified by the Member States in accordance with their respective constitutional requirements.


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HOW THE NEW SYSTEM WORKS (I)? When will it happen?

  • 6 permanent voting rights for Executive Board members.

  • 15 (rotating) voting rights for national Governors.

  • Rotation system based on groups that hold the voting right with different frequencies.

  • Ranking based on an indicator of the relative size of the economy (GDPmp)and financial sector (total aggregated balance sheet of the monetary financial institutionsTABS-MFI → LUXEMBOURG).

  • Relative weights of the two components: 5/6 for GDP and 1/6 weight for TABS-MFI.


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HOW THE NEW SYSTEM WORKS (II)? When will it happen?

As soon as the 22nd Member State enters, 3 groups:

  • 5 governors from the countries which occupy the highest positions in the ranking. Share 4 voting rights.

  • Half of all governors, rounded up to the nearest full number, selected from the subsequent positions of the ranking. Share 8 voting rights.

    3) The remaining governors, who share 3 voting rights.


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TRANSITORY FIRST STAGE When will it happen?

Voting rights will start operating as the 16th Member State enters first on the basis of two groups:

  • The 5 governors from the countries with the highest ranking. Share 4 voting rights.

  • All other governors. Share 11 voting rights.

  • If there are 16, 17 or 18 governors the first group would – temporarily – have a voting frequency of 100% (to ensure that his voting is not lower than in the second group).

  • Depends on the sequencing of enlargement.

  • Governing Council can (by a 2/3 majority of all its members) postpone the start of the rotation until governors exceed 18.


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PROCEDURE FOR DECISION –MAKING NOW When will it happen?

  • Starts (2 meetings per month, in the first i setting) with global review of the economic situation of the euro area by the Executive Board, through one of its members.

  • Then all NCB Governors express their views, centered in their own countries.

  • Executive Board has agreed previously common position.

  • Only 3 Governors needed. Large economies (higher weight in inflation index, more synchronized) natural allies.

  • “Shadow voting”, minutes not published, incentives for collegiality and consensus.


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PROBLEMS When will it happen?

  • Complex. Number still too large (21 voting, all taking part in the discussions).

  • Stresses national character of Governors, treating them differently.

  • Executive Board too small proportionally (now 6 previously agreed +3 = majority, President has casting vote if there is a tie; then 6+5. Only excludes majority of small ).

  • Secret voting: shielding from national pressure or from international supervision? Even the Executive Board.

  • Usually consensus (vote if requested by any, secret if requested by 3), but “shadow voting”? More difficult to reach consensus.

  • “Enabling clause”. But chaging the Treaties more fundamentally as difficult as the process followed.


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ALTERNATIVE PROPOSAL (EUROPEAN PARLIAMENT AND EXPERTS): When will it happen?

  • Delegate decision-making to (an enlarged?) Executive Board.

  • Governing Council: general strategic guidelines. Exchange of views on state of the economy. Incorporate country-knowledge of Governors.

    HOW DOES THE ECB COMPARE TO OTHER CENTRAL BANKS?


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THREE DIFFERENTE MODELS When will it happen?

  • Delegation to small committee of experts (or with experts). Inflation targeting countries (UK, Sweden, Norway, Australia, Canada). New Zealand started: only Governor, appointment reviewed.

    2) Groups within which voting rotates. US Fed, ECB.

  • Groups with one representative each. IMF, World Bank, Bundesbank after reunification.

    LET’S SEE MAINLY UK (MODEL OF GOOD PRACTICE) AND US (MODEL FOR ECB?)


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UK has good reputation When will it happen?


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UK: MONETARY POLICY COMMITTEE When will it happen?

  • 5 internal members (Governor, 2 Deputy Governors, Chief Economist, Executive Director for Markets)

  • 4 external experts appointed by Chancellor

  • One person = one vote

  • Representative from the Treasury (without vote)

  • Meets monthly for a 2 day meeting.

  • Individualistic discussion and voting


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PROCEDURE When will it happen?

  • Deputy Governor responsible for MP speaks first.

  • Other MPC members follow, giving indication of policy preferences

  • Governor concludes and puts a motion that he expects will command a majority.

  • Vote. Dispersion: out of 85 meetings, 46 (54%) at least one dissenter, average=2. In 6 meetings, 5-4 vote.


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US: FEDERAL OPEN MARKET COMMITTEE When will it happen?

  • 7 Governors make up the Board of Governors of the FRS. Nominated by President of the US, elected by Senate. 14 year terms (specifying Chairman and Vice Chairman for 4 years).

  • 12 Regional (of Districts) Federal Reserve Banks, with their Presidents. NY Fed permanent member of FOMC, performs MP operations. 4 others with a rotating voting right within groups.

  • Meets 8 times a year, (or when needed).


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Addresses and When will it happen?phone numbersBanksBranches


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4 Groups (similar GDP initially) When will it happen?

  • Boston, Philadelphia, Richmond

  • Cleveland, Chicago

  • Atlanta, St. Louis, Dallas

  • Minneapolis, Kansas City, St, Francisco

    One vote each group. Rotating annually (1st January)

    Non-voting Presidents attend the meeting and participate in discussions


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PROCEDURE When will it happen?

  • Governors always can outvote the Presidents. Previous talks.

  • Staff of the Board of Governors provides all background information. Attends meetings.

  • Strong leadership of Chairman: speaks first, presents his policy proposals, asks for votes (usually agree). Eg. Out of 44 meetings only in 7 (16%) not unanimity, in 6 only 1 dissenting vote.

    NOT TRUE THAT ECB MODEL


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MAIN CONCLUSIONS When will it happen?

  • Smaller decision making bodies

  • Larger role to permanent members with global outlook over regional ones


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PART III: When will it happen?TARGET


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THE ECB’s TARGET When will it happen?

  • Treaty: primary objective of price stability Governing Council announced its quantitative definition (1998)

  • Increase in the HICP. Easily understood by the general public. Purchasing power of money.

  • Below 2% (clarification 8 May 2003 “close to 2%” ). To guide inflation expectations. Not deflation in some countries. Potential bias in HICP. Downward nominal rigidities. TOO LOW? ENLARGEMENT, BUT SMALL WEIGHTS.

  • Over the medium term. Concerns about output fluctuations. Supply shocks, gradual response. DUAL, BUT HIERARCHICAL TARGET. Transmission mechanism variable, uncertain. BUT UNDERMINES CREDIBILITY OF NUMERICAL TARGET.


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THE FED’s TARGET When will it happen?

  • Dual mandate, inflation and growth on equal footing (since 1978)

  • Not explicit definitions (no numbers, which index?). Inflation around 3% nowadays.


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UK’s TARGET When will it happen?

  • 1997-2003: 2.5% for RPIX.

  • Since 2004: 2% for CPI.

  • Decided by Chancellor annually. IMPORTANT.

  • Symmetrical (sort of band) if more than ±1%, Governor required to send a letter to the Chancellor detailing reasons and responses.


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OTHER TARGETS When will it happen?

  • New Zealand: 1-3% for CPI since 2002

  • Sweden: 2 and ±1% band, CPI.

  • Japan: not numerical target.


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Not big differences in practice: Taylor rule with endogenous weighting, higher weight for output gap in U.S.


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Not big differences in practice: Taylor rule with endogenous weighting, higher weight for deviations of inflation in EMU.


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PROPOSALS FOR ECB weighting, higher weight for deviations of inflation in EMU.

  • Larger value, band.

  • More involvement of democratic institutions in determining it.

  • Clearer policy horizon, flexible.

  • Faster responses.

  • More weight to output.


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PART IV: weighting, higher weight for deviations of inflation in EMU.THE MONETARY POLICY STRATEGY


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THE INICIAL STRATEGY weighting, higher weight for deviations of inflation in EMU.

Two pillars:

  • Prominent role to money. A reference value (revised annually) for the growth of M3 was announced. Close relationship over extended horizons. BUNDESBANK.

    2) Broadly based economic analysis to identify short to medium-term risks. Identify the nature of shocks. SORT OF INTERNAL INFLATION TARGETING. THE IMPORTANT ONE.


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THE REFORM OF 8-5-2003 weighting, higher weight for deviations of inflation in EMU.

  • Former 2nd pillar becomes the 1st (Economic Analysis).

    2) Former 1st pillar becomes the 2nd (Monetary Analysis). No longer review the reference value for M3 on an annual basis.


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US weighting, higher weight for deviations of inflation in EMU.

  • Eclectic approach

  • Use a broad range of indicators, “all available information”…

  • Lack of explicit strategy


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UK weighting, higher weight for deviations of inflation in EMU.

Main tool: check if the inflation forecast (model based + judgment) is hitting the target at the 2 year horizon under current interest rates.

Although not mechanical reaction.

Fan charts to indicate probabilities.


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PROPOSALS FOR THE ECB weighting, higher weight for deviations of inflation in EMU.

  • Get rid of second pillar

  • Specify flexible policy horizon

  • Publish Governing Council’s conditional inflation forecast at 2 years


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PART V: weighting, higher weight for deviations of inflation in EMU.COMMUNICATIONS AND TRANSPARENCY


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ECB weighting, higher weight for deviations of inflation in EMU.

  • Press release, same day, announcing policy changes. Without explanations or votes.

  • Same day, too: press conference by President, with Introductory Statement and questions.

  • Minutes after 20 years.

  • Transcripts: never.

  • Monthly Bulletin and Annual Report. Staff projections, not very important.


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US weighting, higher weight for deviations of inflation in EMU.

  • Press release of Statement following decision. Includes brief explanation. No press conference. Details votes.

  • Minutes 3 weeks later.

  • Full transcripts 5 year later.

  • Semiannual Report to Congress with several staff’s inflation forecasts.


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UK weighting, higher weight for deviations of inflation in EMU.

  • Press Statement after decision. Usually without explanations. No press conference.

  • Minutes published after 2 weeks, specifying individual votes

  • MPC (not staff) 2 year forecast with fan chart published quarterly (Inflation Report). Press Conference with questions.


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PRESS RELEASE weighting, higher weight for deviations of inflation in EMU.

7 July 2005 - Monetary policy decisions

At today’s meeting the Governing Council of the ECB

decided that the minimum bid rate on the main refinancing

operations and the interest rates on the marginal lending

facility and the deposit facility will remain unchanged

at 2.00%, 3.00% and 1.00% respectively.

The President of the ECB will comment on the considerations

underlying these decisions at a press conference starting

at 2.30 p.m. today.


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MINUTES (MPC, Bank of England) weighting, higher weight for deviations of inflation in EMU.

The Governor invited the Committee to vote

on the proposition that the repo rate should be

maintained at 4.75%. Five members of the

Committee (the Governor, Rachel Lomax,

Andrew Large, Richard Lambert and Paul Tucker)

voted in favour. Four members (Kate Barker,

Charles Bean, Stephen Nickell and David Walton)

voted against, preferring a reduction in the repo rate of 25 basis points.


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HINTS PREPARING THE MARKETS IN ADVANCE weighting, higher weight for deviations of inflation in EMU.

  • ECB: markets respond to any member of the Governing Council. Collegial speeches and voting.

  • Fed: Chairman. Individualistic speeches, but collegial voting directed by Chairman.

  • Bank of England: confusion. Collegial speeches, but individualistic voting. Surprises.


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PROPOSALS FOR THE ECB weighting, higher weight for deviations of inflation in EMU.

  • Publish minutes of meetings

  • Publish voting records

  • Publish transcripts with a reasonable time-lag


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SEVERAL APPROACHES CAN OBTAIN GOOD RESULTS weighting, higher weight for deviations of inflation in EMU.


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Inflation (euro area, U.S. and Japan) weighting, higher weight for deviations of inflation in EMU.


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Long-run interest rates weighting, higher weight for deviations of inflation in EMU.


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GROWTH weighting, higher weight for deviations of inflation in EMU.


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FUTURE CHALLENGES weighting, higher weight for deviations of inflation in EMU.

  • Asset prices (housing, shares). Bubbles?

  • Coordination with Fiscal Policy. Worse after Reform of the Stability Pact.


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Household´s debt and house prices weighting, higher weight for deviations of inflation in EMU.



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