The European Central Bank Performance - Essay Example

The European Central Bank The European Central Bank (ECB) is one of the banks under the European System of Central Banks (ESCB), along with the national central banks of the European Union (EU) member states which have not yet adopted the euro. It was established in 1998 replacing the European Monetary Institute. It has its headquarters in Frankfurt, Germany. (ECB, n.d.) ECB's main objective is to maintain euro's price stability to keep inflation rate below 2% per year. According to the ECB website, its tasks include: defining and maintaining monetary policy of the euro area; ensuring that the foreign exchange operations remain consistent with the aims of the central bank's monetary policy; promoting smooth operation of payment systems; and holding and managing foreign reserves. (ECB, n.d.) From the moment of its inception, the European Central Bank has been a favorite target of criticisms from economists and political leaders alike. Surprisingly, among its staunch critics are European countries themselves which suffer economically because of the oftentimes rigid and unreasonable policies ECB follows. Many say that the objectives set by the EU for the ECB are so narrow that they fail to address other pressing economic issues within the EU member states. The question now is how successful is the ECB in helping improve economic growth within the European area This paper will thus examine how the political and economic world perceives the performance of the central bank in this regard. Commentaries from analysts, studies done by independent economic research bodies, and the media will be the three main sources for this research. Challenges facing the European Central Bank "The list of challenges is long and a lot of work lies in front of us." This was the concluding statement of Gertrude Tumpel-Gugerell, member of the ECB Executive Board during a speech on a conference in Vienna, Austria in 2004. However, she was optimistic that the system would be able to handle challenges that would be present along the way. (ECB, 2004) What are these challenges And how does the ECB handle those challenges Among the many challenges present is how to balance decision-making with regards to rate increase to benefit all the economies of the EU member states. Because the ECB does not only cater to a single economy, it has this inherent challenge. An increase in rate would mean a negative effect on a country with a growing economy while it is a positive move for a country with a high inflation rate. The GoCurrency website cited that "several larger economies in the euro area (Germany, for example) that were recently coming out of an economic slump were unhappy as the higher rates would stunt their growth."(GoCurrency, 2006) One classic example often mentioned by analysts is the effect of low interest rates in countries with property bubbles such as Ireland. Because "the ECB was keeping rates low to help the stodgy economies of France and Germany, where growth was weak and needed nurturing, the need of the Irish to raise rates to help their already ailing economy is not addressed". (Louth, 2007) With the recent slump in mortgages in the American market, ECB is once more in the dilemma of raising rates in September or not. It should be noted that this is the first time since September 2001 that there is a proposed increase in rates. (MECB Update, 2002, p 3) Jean-Claude Trichet, President of ECB, indicated in August that the ECB "will raise its key refinancing rate to 4.25 from 4.0." (TodayOnline, 2007) However, there has been pressure from the world community to halt this intended rate increase. The article that appeared on the Business World website entitled "NCB: Another ECB hike could be risky", quoted NCB analyst Dermot O'Brien as saying that the credibility of the ECB may be in question if it does not proceed with the intended rise in rates and sticking to its original plan would be seen as immature stubbornness. This is the current dilemma. (Business World, 2007) With the "surprisingly weak growth figures for the 13-nation eurozone", ECB may be inclined not to push through with the increase, according to Honor Mahony in his article "Trichet says markets returning to normal" posted on August 24. Mahony further stated that Germany, Italy and France reported poor growth. This prompted France's President Nicolas Sarkozy to say that ECB has not been doing enough for growth. (Business Week, 2007) What analysts have to say An article written by International Herald Tribune reporter Eric Pfanner entitled "Europe's central bank gets rare pat on the back" outlined findings from a study conducted by the Center for Economic Policy Research on the performance of ECB. It described the bank as "too fixated on stamping out inflation at the expense of economic growth and justifies its monetary policy using irrelevant economic data." The article further stated that many analysts say that the bank's policy of keeping price increase below 2% does not help much in achieving economic growth. (International Herald Tribune, 2002) John Grahl described ECB as the "inflexible bank" which is undemocratic and unreasonable. Grahl also mentioned that the ECB has not helped in the annual growth rate of the region which resulted to only 1.5% on the average for the past four years. There is increase in unemployment, financial problems, and disorganisation. (Grahl, 2005) According to analysts, ECB should adopt a symmetrical inflation target just like the Bank of England. This would mean that the bank has to give equal attention to a situation when the inflation is too high and when it is too low. The present ECB strategy is to take action only when it is too high. Aside from its monetary policy, the ECB has also been criticized for being secretive or lack transparency. Adam S. Posen, in his paper "Six Practical Views of Central Bank Transparency" said that greater disclosure will allow the (bond) markets to see (or enforce) greater predictability in central bank actions. This goes to the general idea that communication removes noise from financial markets." (Posen, 2002) Conclusions The establishment of the European Central Bank was an optimistic action of the European Union to overcome economic and political hurdles in exchanging goods and services among the European countries. Having a single currency across the region is seen as something that would contribute to the growth of the EU member states. However, there are complex issues that the ECB has to address. As analysts see a problem in its system and policies, it is but worthwhile for the bank to consider different strategies suggested by economists. One of recommended strategies is to adopt the symmetrical inflation target which is being used by the Bank of England. At present, the ECB is seen by many analysts, political leaders, and the media as not successful enough in strengthening the economy of the European region as a whole. Flexibility and transparency are two of the key factors that would make the bank meet the world's expectations. Works Cited: Associated Press. (2007, August 21). European Central Bank may recant rate increase. El Paso Times. Retrieved August 27, 2007 from http://www.elpasotimes.com/business/ci_6674652. European Central Bank. (www.ecb.int). German economists warn ECB against rate rise. (2007, August 24) Today Online. Retrieved August 27, 2007 from http://www.todayonline.com/articles/207322.asp. Grahl, John. (2005, July). Europe's inflexible bank. Le Monde Diplomatique (English edition). Retrieved August 27, 2007 from http://mondediplo.com/2005/07/05bank. Keegan, William. (2000). The ECB: Too Much Focus on Prices, Not Enough on Growth. European Affairs. Retrieved August 27, 2007 from http://www.europeanaffairs.org/archive/2000_spring/2000_spring_43.php4. Kennedy, Simon. (2007, August 26). Trichet may keep options open as investors look for rate signal. Bloomberg. Retrieved August 27, 2007 from http://www.bloomberg.com/apps/newspid=20601085&sid=a7tnzH1ZOJS8. Louth, Nick. (2007, August 22). Why the Irish economy is paying for its property dependency. The Daily Reckoning. Retrieved August 27, 2007 from the Money Week website: http://www.moneyweek.com/file/33841/why-the-irish-economy-is-paying-for-its-property-dependency.html Mahony, Honor. (2007, August 15). Trichet says markets returning to normal. EU Observer. Retrieved August 27, 2007 from the Business Week website:. http://www.businessweek.com/globalbiz/content/aug2007/gb20070815_693359.htmchan=search NCB: Another ECB hike could be risky. (2007, August 24). Business World. Retrieved August 27, 2007 from http://www.businessworld.ie/livenews.htma=1816744;s=rollingnews.htm. Pfanner, Eric. (2002). Europe's Central Bank gets rare pat on the back. [Electronic version]. International Herald Tribune. Retrieved August 27, 2007 from http://www.iht.com/articles/2002/04/27/t1_112.phppage=1 Posen, Adam S. (2002, May). Six practical views of central bank's transparency. Peterson Institute for International Economics; CESifo (Center for Economic Studies and Institute for Economic Research). Retrieved August 27, 2007 from the Social Science Research Network website: http://papers.ssrn.com/sol3/papers.cfmabstract_id=312667. The European Central Bank. (2006). Go Currency. Retrieved August 27, 2007 from http://www.gocurrency.com/articles/european-central-bank.htm Read More