What the ECB must do now

During a closed-door meeting last week, the Governing Council of the European Central Bank reviewed and discussed the ongoing strategy of the ECB. In an opinion piece for the Frankfurter Allgemeine am Sonntag, Professor Lars Feld, a long-serving member of the German Council of Economic Experts, and I outlined what we believe are the current and future key issues the ECB should be tackling. I would like to share a summary of our article and viewpoints below.

The question that is certainly on everyone’s mind is: what will come out this review of the ECB’s strategy? A symmetrical inflation target à la Fed and green monetary policy. The crucial challenge here is a different one: After a decade of unconventional monetary policy, we need to bring this huge experiment to a good end without sliding into a new crisis of gigantic proportions, i.e. putting financial market stability at risk.

How can this be accomplished? 

1. We must stop the current debt explosion caused by negative interest rates and bond purchases. 

2. Banks must not lose their role as financial intermediaries. If we can ensure that this is the case, we can guarantee that risk discipline on the financing side will once again take place in earnest. 

3. We must once again balance out the redistributive effects of monetary policy. Our policies cannot come at the expense of savers. This point, in particular, can only be achieved if the ECB returns to the interest rate cycle. In the USA, interest rates at the long end of the market have already risen. In the case of highly indebted member states in the Euro area, the ECB should not attempt to counter any resulting market signals. Instead, they should welcome them as an indication of a resurgence of the market mechanism in the capital markets. 

4. We must restore confidence in capital markets, which has been badly shaken by a casino and self-service mentality. Moreover, citizens must once again view capital markets as the central authority for the most productive use of funds to generate prosperity in the long term.

In our view, a strong commitment to fostering market stability would be a much more important and valuable outcome for the ECB than “merely” fine-tuning the inflation target. Financial market stability in the broader sense of a functioning financial market can and should once again be a lever for prosperity in Europe in which all participants can fulfill their roles appropriately. It is a mistake to believe that the state alone will be able to save the future.

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