Trichet needs help to deliver the bad news

By David Marsh - published on 22/05/09 in Financial Times

The omnipresent Jean-Claude Trichet brings apparent simplicity to the European Central Bank, where he has been president since 2003, by dominating its external policy representation. In reality, though, the ECB’s constitutional life is Byzantine in its complexity: the 22 central bankers on its decision-making council oversee a unified currency and interest rate policy for 16 countries, each with its own government, parliament and finance ministry.

It is time for the ECB to put its governance and public image on to a broader footing. The bank should form a muscular six-person “committee for euro stability” to carry its policy messages to a wider public inside and outside economic and monetary union. Over the next two years, Europe’s multi-speed recovery from financial crisis will bring exceptional pressures. Europe is suffering from a lack of political clout, nationally and at the European Commission. The ECB should make an effort to fill the leadership vacuum.

The central bank’s handling of the financial and economic crisis has been reasonably deft so far. Although it erred in raising interest rates by ¼ percentage point when Europe was entering recession in July last year, the ECB has won general praise for handing out plentiful liquidity to European banks, including when the subprime mortgage crisis first broke in August 2007. It has cut interest rates seven times in eight months.

However, tough times lie ahead. Europe’s recovery will be patchy. It is likely to be led by Germany and other export-oriented northern countries. Debt-burdened southern and western nations – Greece, Italy, Ireland, Portugal and Spain, suffering from low competitiveness, large current account deficits and financial imbalances – will lag behind. Probable ECB interest rate increases later this year will see it accused of stifling an upturn in the euro area’s troubled periphery.

Reflecting the political fragmentation that remains the euro’s main weakness, the ECB is reluctant to shed light on its decision-making processes. The ECB council fears unfavourable publicity from contradictions between the positions of its national representatives – who are supposed to consider overall euro area requirements – and the disparate needs of individual member states.

For these reasons, the ECB’s decision-making processes are more opaque than those of the Federal Reserve or the Bank of England. But these factors also put Mr Trichet in pole position. A man who combines charm and steel in equal measure, Mr Trichet is by far the most experienced member of the ECB board. He plays a commanding role in internal deliberations and in external policy utterances.

The strains on the euro are now sufficiently grave that the ECB needs to move away from undue reliance on its president. Five council members should join Mr Trichet in an active policy unit arguing on a variety of platforms – including before national parliaments – for policies to secure the euro’s longer-term solidity. This euro stability committee could comprise some of the most articulate of the 22-member council, including Mario Draghi, governor of the Bank of Italy, Axel Weber, the Bundesbank president, and Athanasios Orphanides, governor of the Central Bank of Cyprus.

Mr Draghi is tipped to take over from Mr Trichet when the latter’s eight-year term ends in 2011, and could use a spell in the European limelight as a dress rehearsal. Mr Weber, who consistently pleads for firmness in Germany, needs to test his hawkishness across the euro area. Mr Orphanides, who served for 17 years at the Federal Reserve, can launch his skills on a wider plane.

The committee needs to argue for public spending and debt cuts as soon as the first signs of recovery appear. It should admit that, by opting for a single currency among countries with varying inflation, Europe’s governments have inevitably caused dramatic distortions in eurozone competitiveness, which it will be arduous to reverse. And it should explain that “one size fits all” interest rates bring initial benefits, by spurring growth of higher-inflation members, but cause pain later.

For the euro to prosper, this pain has to be spread. Sometimes central bankers should ration communications with the outside world. This is not one of those times. The ECB should embrace collective leadership and tell the euro area’s people some sobering truths about the challenges they face – before it is too late.

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