25 years of the ECB: turbulent times full of ups and downs


analysis

Status: 05/24/2023 4:11 p.m

The European Central Bank saved the euro and kept prices stable for years. But recently inflation got out of hand. How does the ECB stand a quarter of a century after it was founded?

“Here comes the euro”: With these simple words, Wim Duisenberg, then President of the European Central Bank (ECB), welcomed the new European common currency around 25 years ago. The Dutchman appeared unconventional and relaxed. In doing so, he quickly made the new money popular, even if he had to admit that the euro was already expensive at the time.

Overall, however, the economic and financial world was still in order. This allowed the ECB to concentrate on its core task of keeping prices in check and calmly seek its place in the international world of central banks.

One crisis follows the other

Today, a quarter of a century later, the world looks completely different: The current president, Christine Lagarde, would probably be happy if she still had an environment like in Duisenberg’s time. Instead, the Frenchwoman has been chasing from one crisis to the next since taking office in autumn 2019: corona pandemic, supply chain collapse, Russia’s war against Ukraine, energy debacle, tensions with China.

Everything, directly or indirectly, fueled inflation, which at times reached record highs and remains at the highest levels in decades. So far, Lagarde has not been spared anything.

Central bank chief Christine Lagarde comments in the tagesschau.de interview on the 25th anniversary of the ECB.
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Meticulous preparation for the start

In these confused and turbulent times, the European Central Bank is celebrating its 25th birthday this week with a lot of pomp and prominent guests – a few days before June 1st, the official date on which the currency watchdogs started their work in Frankfurt am Main. Not off the cuff, but very well prepared.

The European Monetary Institute (EMI) had previously spent three and a half years meticulously designing the structure, organization and working methods of the new central bank, down to the last detail, and thus provided the blueprint for the ECB. This was based on the Maastricht Treaty of 1992, in which the European Economic and Monetary Union (EMU) was decided.

This gave the euro an institution that is spectacular and unique in its form, but at the same time controversial and contradictory. Nowhere in the world was and is there a central bank that then comprised eleven and now 20 member countries – all with different economic power, sometimes divergent monetary policy traditions and different views on how the common currency should work.

ECB President Lagarde has announced a further tightening of monetary policy.
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Critics were initially skeptical

Critics did not give the project too much chance and did not believe in the idea that the common currency would even out differences in the member states and thus lead to the desired harmonization of the economy and level of prosperity. It actually didn’t succeed, but the ECB withstood all the storms and thunderstorms and quickly became the second most important central bank in the world.

Volker Wieland from the House of Finance at Frankfurt’s Goethe University, former chairman of the Economic Wise Men and well-known “ECB Watcher”, puts it in a nutshell: The ECB is responsible for “a very unique constellation, namely the monetary policy for an association of states that has not been seen before has given”. So far, the institution has “managed it much better than many skeptics and critics expected”.

The record inflation in the euro area puts the monetary authorities under pressure to act.
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From 2007 it will be more complicated

Arguably the ECB’s happiest times were the tenures of Duisenberg and his successor, Jean-Claude Trichet, who succeeded him in 2003. Duisenberg occasionally made a mistake and unsettled the financial markets with his statements. But overall, like the French Trichet, the Dutchman managed to establish a robust, stable currency whose inflation rates were not only enviably low, but many times below the levels achieved when countries had their own currencies.

Dutchman Wim Duisenberg was the first President of the European Central Bank from 1998 to 2003.

In the last third of Trichet’s term of office, from 2007 onwards, however, dark clouds were brewing: First came the so-called subprime crisis, i.e. the collapse of the US real estate market due to speculative business by the banks. It led to the first massive interventions in the financial markets by the ECB. When the resulting financial crisis broke out, fueled by the collapse of the US bank Lehman Brothers in September 2008, the ECB also had to support the European banking sector with numerous cash injections.

The ECB will raise interest rates today for the first time in around eleven years – albeit only moderately.
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“Whatever it takes”

It got really turbulent, but also dangerous, after Trichet’s successor, Mario Draghi from Italy, took over the office in the Eurotower in autumn 2011. The financial and debt crisis weakened the European economy. Speculators massively attacked the euro, trying to destroy the common currency. With a clever move in July 2012, Draghi saved the euro with his famous “Whatever it takes” speech in London: “Within our mandate, the ECB is ready to do anything to preserve the euro. And believe me : It will be enough.”

It was enough: Billions upon billions went into buying bonds. This should stimulate the economy and later the specter of deflation – ie constantly falling prices – be driven away. At the same time, interest rates continued to be lowered until they finally ended up in negative territory. Economically an absurdity. But Draghi simply pulled out all the stops.

Much more powerful than originally planned

In this way, it was possible to preserve the euro and support the common currency. However, this was not free of charge for the citizens of the euro zone: the result was a zero interest rate policy for years. It led to bubbles in stock and real estate markets. Because politicians were unwilling or unable to reform the monetary union, the ECB increasingly became a fire brigade; it had to step in where political responsibility failed.

As a result, the powers of the ECB have been expanded. In 2014, she was also given the banking supervision for the largest financial institutions in the monetary union. Critics complained that different and conflicting interests between monetary policy and financial supervision should not be under one roof. The ECB introduced a “Chinese Wall” between the two sectors, arguing that one doesn’t work without the other.

Overall, the ECB became much more powerful than its founding fathers envisioned. Suddenly, it was no longer just about following the actual mandate, i.e. ensuring price stability: it was about securing the entire monetary union, ensuring stability in the financial sector and achieving favorable financing conditions for member states that are heavily indebted.

The ECB has bought bonds from governments and corporations for trillions of euros.
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Criticism from the German side

The members of the Governing Council were not always happy about Draghi’s actions, who also liked to go it alone. There was much controversy between the so-called “hawks” and “doves”, ie representatives of a tight monetary policy on the one hand and loose handling on the other. Some threw in the towel, especially on the German side: ECB Chief Economist Jürgen Stark, Governing Board member Sabine Lautenschläger and Bundesbank President Axel Weber left the Governing Council because they could no longer support the ECB’s monetary policy and did not want to. Some disputes in this context even ended up before the highest European court, but could not harm the ECB.

Instead, the institution grew larger, more stable, and more influential. Their new home – the Eurotower, inaugurated in 2015, one of the most spectacular buildings in the Main metropolis – became a symbol of this new status of power and of the new wind that was now blowing in the ECB. Draghi – much criticized, but also successful – left the Eurotower in November 2019 with the aura of the Eurosavior and left behind an institution that had outgrown its infancy at great speed.

Demands on the ECB to decide on an interest rate hike very soon are getting louder.
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Inflation assessed as a “temporary phenomenon”.

At the time, everyone actually thought it would be less turbulent now. Already in the last few months of Draghi’s term of office, the massive bond-buying program was scaled back, and a normalization of monetary policy was on the horizon. France’s Christine Lagarde has now taken over the helm: an imposing personality and long-time head of the International Monetary Fund (IMF), but without a stable odor from the world of central banks.

Corona and war with all the economic turbulence quickly brought the ECB back on the scene. The loose monetary policy was continued. Despite all the warnings that the virus had also changed economic structures and was thus promoting inflation, the ECB ignored them. It was recognized much too late that the price explosion was not just a “temporary phenomenon”, as the currency watchdogs repeatedly claimed.

With inflation rates well over 20 percent in the Baltic states, 10.6 percent in the euro zone and 8.8 percent in Germany, record values ​​were reached last year. While the Anglo-Saxon central banks in particular reacted quickly and massively to inflation by raising interest rates, the ECB hesitated. As a result, inflation in Euroland was able to take hold in many areas. But at least Lagarde initiated the turnaround in interest rates, abolished negative interest rates and pushed ahead with the normalization of monetary policy.

“No, I’m not satisfied”

“If you ask me if I’m satisfied with where we are now,” says the President exclusively ARDInterview and immediately replies: “No, I’m not satisfied,” says Lagarde. “I will only be satisfied when we reach our goal, that is, have inflation of two percent in the medium term.” Until then, a lot of water should still flow along the Main.

Despite all the turbulence and criticism, the roughly 340 million people in the euro zone still have faith in the common currency and the ECB. In a survey, almost 80 percent of respondents said they trusted the euro. There can hardly be a nicer gift for the currency guardians.

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