Nearly 30 years ago, the satirical Spy magazine began posing the now-familiar question – “separated at birth?” – above lookalike images of two unconnected public figures. Donald Trump was paired with Elvis Presley, Marie Osmond with Monica Lewinsky, and the list goes on (and on). Had Spy found humor in juxtaposing institutions rather than personalities, it still wouldn’t have landed on the Fed and the ECB (which didn’t yet exist): their buildings look nothing alike.
Yet, in terms of governance and communications, the Fed and the ECB have evolved over the past 15 years into virtual doppelgängers. The remaining differences in their decision-making and communications frameworks are secondary. Even the widely-touted differences in their mandates – with the ECB focusing first on price stability and the Fed placing equal emphasis on employment and prices – have limited practical significance in differentiating their behavior.
In our view, the key behavioral disparity between the two central banks in recent years – with the Fed more willing to expand its balance sheet aggressively – arises primarily from the differences in their financial systems that make it more challenging for the ECB to implement quantitative easing (and some other types of unconventional policy). Put differently, if we were to replace the ECB’s mandate, governance apparatus, and communications practices with the Fed’s, we doubt that euro-area monetary policy would change much.
Let’s start with the stunning convergence of governance and communications between the two central banks. This re-alignment reflects changes on both sides, as practical experience (nurture) trumped nature.
When the ECB began operation in July 1998, observers focused on a wide range of differences with the Fed that have disappeared or will soon do so. For example, to limit national influences, the ECB Governing Council made decisions primarily by consensus. On the infrequent occasions when contentious issues required a show of hands, every Council member voted. The Council reviewed monetary policy on a monthly basis. To highlight its focus on price stability, the Council gave top billing to the growth of the M3 monetary aggregate in its policy framework. To communicate ECB policies, the President made public statements and led press conferences after every meeting. However, citing Treaty protocols regarding confidentiality of its proceedings (see page 59 of the ECB’s semi-official history), the Governing Council did not publish minutes. Even vague documents regarding meetings of the European central bankers prior to monetary union are posted on the ECB’s website only with a 30-year lag!
Some of these practices changed years ago. Already in 2004, the Governing Council downgraded the role of money growth to the status of a “cross-check” for its broad policy assessment. As far as we know, no monetary policy decision of the Governing Council was ever determined by M3 growth, although it has frequently been outside the projected range. (We wrote about the Eurosystem on the occasion of its 10th anniversary.)
As of January 2015, convergence goes three steps further. First, with the accession of Lithuania, membership on the Governing Council will rise to 25 persons and trigger a voting rotation that mirrors the longstanding practice of the FOMC. Like Federal Reserve Board Governors, ECB Executive Board members will always vote, but national central bank (NCB) presidents (like the presidents of the regional Federal Reserve Banks) will rotate. The purpose is to make decision-making efficient as new countries enter monetary union, expanding the Council. Second, like the FOMC, the Council will discuss monetary policy only every six weeks. Finally, and most importantly, the Council will begin publishing minutes of its meetings (probably a few weeks following the meeting).
On the other side of the Atlantic, the Fed has adopted the ECB’s clarity about policy objectives, along with some of its key approaches to communication. In 2012, the FOMC settled on a statement of long-run principles that makes clear its 2% inflation objective, much like the ECB’s objective of “close to, but less than 2%.” Following each FOMC meeting, the official policy statements have been getting longer and more detailed – including the record-long statement this month – converging toward the longer written analysis that the ECB President provides after every Governing Council meeting. And the Fed Chair now conducts a press conference following the FOMC meeting that discusses members’ quarterly inflation and growth projections, which the FOMC also publishes. (Recent papers – here and here – have documented the steady increase in central bank transparency over the past three decades.)
Of course, there remain differences of both governance and communications. The ECB’s budget comes from the NCBs, while the Federal Reserve System’s Board of Governors sets the budgets for the Federal Reserve Banks. The Governors constitute a voting majority on the FOMC, while the ECB’s Executive Board remains a minority of the Governing Council. Furthermore, the ECB doesn’t plan to identify in the minutes how each Council member votes – presumably to limit national pressures. And, it has published neither interest rate projections of the Council members nor transcripts of Council meetings. The Fed, for its part, doesn’t release in a timely way the staff’s economic and inflation forecasts and proposed policy options that inform decisions at each FOMC meeting.
Unsurprisingly, we expect practical experience to promote further convergence of policy communications on both sides. Yet, we doubt that the lingering disparities between communications practices, policy objectives or governance rules account for the most prominent difference of behavior between the ECB and the Fed in recent years. While inflation has fallen further below the ECB’s target than the FOMC’s, the latter has acted aggressively and consistently in providing monetary stimulus through an expansion of its balance sheet. Compared to August 2008, the month before Lehman failed, Fed assets have increased by a multiple of nearly five to $4.5 trillion (rising from 6% to 26% of U.S. GDP), while the ECB’s assets have risen by 1.4 times to €2 trillion (climbing from 16% to 21% of euro-area GDP). (See the chart below.)
Sources: ECB, FRB, and FRED.
Differences in the financial systems probably are the principal drivers of this divergence, just as they have accounted for the differences in the two central banks’ liquidity-provision operations. Unlike the Fed, which can buy Treasuries and federally guaranteed bonds, the ECB has no euro-denominated risk-free instruments that it can purchase to expand its balance sheet. It has provided liquidity primarily by lending to banks (as we described in an earlier post). As its new plans to acquire asset-backed securities and covered bonds highlight, the ECB must widen its securities portfolio – and accept worsening credit and liquidity risks – in order to expand it. Over the years, the ECB already has been compelled to accept a widening range of illiquid and risky securities as collateral for its main refinancing operations (the list of eligible securities – published here daily – currently exceeds 36,000 instruments!).
Imagine that, instead of buying Treasuries and federally guaranteed securities, the Fed would have been forced to purchase trillions of dollars of U.S. state and municipal debts to expand its balance sheet in recent years. Under the Federal Reserve Act, which authorizes Fed purchases of municipal debt only for issues with a specific revenue source (things like turnpike authority bonds) and with up to six months of maturity, there would not have been sufficient eligible debt for the Fed to get the job done. Even if Congress were to broaden this authority, and states increased issuance, FOMC members would still have to worry about the lack of liquidity and the potential for insolvency among state and municipal bond issuers. (We noted the illiquidity of these issues in an earlier post.) And the Fed would be very unhappy about the bad incentives provided to profligate states (think of those with large unfunded pension programs for public employees) if it were to become a big forced buyer.
In the end, if euro area inflation continues to fall, we expect the ECB to do “whatever it takes” to secure long-run price stability, including purchasing large quantities of low-quality, illiquid sovereign debt. But, we shouldn’t be surprised that the Governing Council would hold its nose when doing so. The FOMC would, too.