The European central bank is no U.S. federal reserve or people’s bank of china or Bank of england… Recent matters in Greece have highlighted some of the problems with the European Union. One of the most important is the EU does not have a single government pursuing a coherent fiscal policy. Nope. As The Economist suggests, it’s a conglomeration of countries with disparate economic goals and circumstances.
A writer at Forbes captured the essence of the problem in a Tweet: “No currency-issuing national central bank would freeze the money supply in a depression. But that’s what the [European Central Bank] ECB has done to Greece.”
The lesson about money supply was learned during the Great Depression. The Federal Reserve began tightening monetary policy in 1928. It allowed money supply in the United States to shrink by about one-third from 1929 to 1933, and that had a disastrous effect on the American economy. It’s hard to grow when you have less and less money. In 2002, then-Fed Chairman Ben Bernanke fessed up, “…the Great Depression can reasonably be described as having been caused by monetary forces.”
But the heart of the Forbes Tweet is the observation that no national central bank would freeze money supply. The Economist pointed out that the ECB is not a national central bank. It is an international central bank, and that is problematic.
“The ECB, of course, doesn’t derive its mandate from the Greek government, but from all euro zone member governments. And here there is a clear conflict of interest; Greece owes money, not just to the rest of the EU, but to the ECB itself. When the ECB provides liquidity to Greek banks, it increases the bank’s exposure to a government that may not repay it. This works both ways; neither the British nor the American government would want the credibility of their central banks to be undermined. But the Greeks don’t have any interest in maintaining the reputation of the ECB.”
If the interests of the various countries in the EU don’t align, how does the region pursue a coherent fiscal policy? How does the ECB implement effective monetary policy? Should one country’s pension or healthcare system be more generous than another’s? How does the United States do it?
Eurozone countries have a complex relationship. We’re likely to learn a lot about its long-term sustainability in coming weeks.