Last week’s press conference was the second time less than 12 months that the European Central Bank’s (ECB’s) communication of a key policy initiative fell short. The first occasion, of course, was on 12 March last year, during the announcement of the EUR120 billion asset purchase program (APP) expansion, when President Lagarde insisted “we are not here to close spreads”—a comment that has the rare distinction of being footnoted and clarified in the transcript. Just 6 days later the Pandemic Emergency Purchase Program (PEPP) was rushed through, a program certainly designed to closed spreads.
The latest communication muddle again relates to ECB asset purchases, this time in the execution of expanded PEPP purchases. It arguably originates with the fact that the Governing Council is split on the need to fully use the EUR1,850 billion envelope. At the December announcement of the PEPP extension and expansion, it was clarified in the introductory statement that “if favourable financing conditions can be maintained with asset purchase flows that do not exhaust the envelope … [it] need not be used in full. Equally, the envelope can be recalibrated if required…”
This discussion was further illuminated in the account of the December meeting, published last week, where the PEPP is described as “the cornerstone of the Governing Council’s monetary policy package.” Still, the Governing Council was a split on its size. The discussion went on, with emphasis added, “preserving favourable financing conditions implied a move away from a constant monthly pace of purchases towards adjusting the pace according to market conditions… This approach, combined with forceful communication, could allow the Governing Council to reduce the pace of purchases while having an equivalent effect on financing conditions. This could result in greater efficiency and in using less than the entire envelope over the duration of the programme.”
Notwithstanding the acknowledged need for “forceful communication,” this policy was undermined unnecessarily last week in two ways. First, the caveat on the envelope not being used in full was added to the press release—hinting that this was a subject of continued emphasis at the Governing Council. Second, clarification during the press conference of what favourable financing conditions (FFC) means, to which PEPP is now explicitly linked, was confused to say the least. Consider Lagarde’s description:
“So how do we identify whether or not we are in the presence of favourable financing conditions? Well, I would say first of all that it is based on a holistic and multifaceted approach, our assessment, and it is intended for all sectors. So, all sectors means households, SMEs, corporates, sovereigns. And we look at the financing conditions and as a result of that we look at the bank lending rates. We look at the credit conditions, we look at the yields of corporates, yields of sovereigns, and it’s this composite approach and this multiple-indicators approach that we take into account to determine whether the financing conditions are favourable or not. But don’t forget that favourability is always assessed relative to inflation dynamics. So, we have to decide whether the financing conditions are appropriate to return inflation to its pre-pandemic path. So, those are really, I’d like to think in terms of this, the compass and the anchor and the two of them interact in order to assess whether or not we need to adjust and calibrate our purchases of any period. Because don’t forget that PEPP is intended to preserve the financing conditions, is earmarked by flexibility, and that flexibility, you’ve heard me say before, is flexibility along time sequences, flexibility in asset classes, flexibility in countries. And it has this dual function of stance and transmission as well. So, all that remains unchanged and the flexibility is still, you know, one of the key attributes of our PEPP.”
All the media and markets need are three reassuring words like “whatever it takes.” Instead, we’ve got “the compass and the anchor” and images of a quayside pub full of drunk sailors.
How has the ECB got itself into such a muddle? The simple answer is that the removal of automaticity of PEPP flows and explicit link to FFC has added a new concept in the conduct of policy—not a target that is easily defined let alone communicated.
But the deeper answer probably lies in Lagarde’s own description her job as ECB President during her first press conference in December 2019. At that time Lagarde took a moment to reflect on her more inclusive style of governing and willingness to reach over the heads of the press in communicating. Speaking directly to the gathered media, Lagarde noted how:
“…each and every President has his or her own style of communicating. I know some of you are keen to compare and rate or rank. I will have my own style. As I’ve said before, don’t over-interpret, don’t second-guess, don’t cross-reference. I’m going to be myself and therefore probably different… I have certainly made a point of my tenure to include members of the Governing Council and to seek their views and their consideration before any decision is made. I have huge respect for the work that you do. You are a main audience for the central bank. But you are not the only audience, and I would also encourage you not to try to draw too many conclusions or decisive findings from communication that I would address to a different audience with a slightly different language in order to be maybe better understood by those who do not have your level of skills and in-depth knowledge of the matters that we deal with.”
While useful in a skilled politician, embracing a diversity of views alongside communication to non-specialists is a toxic combination when managing monetary policy. It can only sow confusion. Arguably, attempts to shoehorn the diverse views of the Governing Council into a coherent single message has created both these blunders over the past year.
And these communication slips have brought additional governance concerns.
It was in light of the “close the spreads” remark in March that Chief Economist and Board member Philip Lane began holding post-meeting private conference calls with market participants. His diary for March, released only in June, reveals teleconference calls with 11 investment banks and large asset managers on the day these remarks were made. Considering that the PEPP program was agreed by the Governing Council less than one week later, making these conversations inside what would normally be the quiet period for communication ahead of regular meetings, the danger that market sensitive information about Lane’s intentions might inadvertently slip into select private market participant’s hands was and remains very real. And while these meetings were eventually publicly disclosed, for those of us not privy to such conversations, even disclosure that they were happening at the time would have been useful. Better still, the meetings should be open to general participation and be recorded for posterity. It would also be useful, as an additional safeguard, if Lane were asked to guarantee that he won’t seek remuneration in any form from any of those privileged institutions once his tenure at the ECB ends.
It is these private communications that were made the subject of a recent question by a Dutch MEP, Derk Jan Eppink, to the European Parliament’s Committee on Economic and Monetary Affairs and to which the ECB responded last week. Lagarde’s response notes that “The ECB is continuously learning and reviewing its policies and practices with a view to making them as effective as possible – this is also true for the field of communication. To this end, the format of the calls [to market participants in private] you referred to is also being reconsidered.”
In her response, Lagarde also referenced the Code of Conduct for senior officials at the ECB in guiding these external communications. Yet when at the IMF it is well known, to those who witnessed such behaviour up close, that on Lagarde’s watch senior Fund officials regularly flouted staff rules. These rules are only “aspirational” if you dare to raise it with the Fund’s Ethics Office. And since Lagarde turned a blind eye at the Fund, will she be equally willing to accept breaches at the ECB?
In any case, while these private calls should indeed be discontinued and replaced by something more inclusive, doing so will not address the origins of the ECB’s communication challenge.
For the fundamental problem facing the ECB today is that governing by committee also requires determined and strong leadership, especially when communicating with markets. This was addressed explicitly by Alan Blinder in his Lionel Robbins Lectures at the LSE, Central Banking in Theory and Practice, when reflecting on his time on the FOMC. Consider the following passage from his first lecture:
“While serving on the FOMC, I was vividly reminded of a few things probably all of us know about committees: that they laboriously aggregate individual preferences; that they need to be led; that they tend to adopt compromise positions on difficult questions; and—perhaps because of all of the above—that the tend to be inertial… Inertial behaviour has its virtues, as I will explain shortly. But it also has some vices. In particular, decisionmaking by committee may contribute to the systematic policy errors I have mentioned already…
While the Federal Open Market Committee has not been immune to this ailment over the years, there is at least one tradition at the Federal Reserve that tends to minimize it: that of the powerful chairman… no one has ever doubted that Alan Greenspan, or Paul Volcker, or Arthur Burns were ‘more equal’ than others… So, to a significant extent, FOMC decisions are his decisions, as tempered by the opinions of the other members. Nonetheless, a chairman who needs to build consensus may have to move more slowly than if he were acting alone.”
Contrast this with Lagarde’s own description of her style of policymaking quoted above, of seeking the views of Governing Council members for consideration before any decision is made. For Blinder, such consensus building in monetary policy decisionmaking is prone to errors. Can anybody doubt that Draghi was leading the Governing Council when making policy decisions between 2011 and 2019? Recall the backlash following his penultimate policy meeting in September 2019. Such is the price to pay for good policy.
What needs to be done now? The pressing problem is to clarify the size of the PEPP and the ECB’s willingness to use it. The FFC concept is too complicated to define and communicate. Drop it. Such a policy approach should be considered during the Strategy Review, of course. But for now, admit that the Executive Board was trying to be too cute and has in the process created confusion and uncertainty. Better to clarify that, although there is a diverse range of views on the Governing Council, based on the baseline judgement of the Executive Board, a PEPP envelope of EUR1,850 billion is necessary through March 2022. Of course, this can be recalibrated through the year as new information comes available. But on current plans it will be used in full. It is little commented that the Asset Purchase Program (APP) in 2020 fell short of its intended net purchases by about EUR30 billion (8 percent of target). As long as circumstances allow, PEPP could likewise fall short and it wouldn’t garner much attention. What matters is the determination to execute on policy and make sure markets are aware of it.
The more fundamental challenge is to wrest back control over policy from the consensus building approach. In its place the Executive Board needs to be more assertive over policy direction and to stop communicating with markets through side-channels. What the Governing Council should come to realise, if they haven’t already, is that it will be better for them in the long run to be overruled instead of pandered to. Indeed, the size of the PEPP program is probably larger than it otherwise needs to be just because of the “close the spreads” comment. In placing too much emphasis on the German Constitutional Court’s concerns, policy was badly impaired in March. Likewise, by excessively weighing the views of those for and against larger PEPP, we are left with confusion about the current policy stance. This has a fiscal cost, of course, and for the ECB a loss of credibility that can only be countered by a larger bazooka. In the end, everyone loses.
There are numerous opportunities to get communication back on track through scheduled speeches by Board members over the coming week. Let’s stop with policy experimentation, drop the compass and the anchor, and get back to the decisive policy needed to get through a global pandemic. The Strategy Review is the right place for thinking through new approaches. For now, stay focussed on PEPP and don’t be distracted by nonsense notions of financing conditions.
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The General Theorist 