Sunday, 30 October 2011

European Central Bank - Modelling its Behaviour (wonkish)

As Shakespeare anticipated, sorrows have struck Europe not as single spies but in battalions. Fiscal and Financial woes abound, not to mention the political (not much sign of leadership from Brussels as Sarkozy tells Cameron to "shut up" and that he is "sick of" him whilst Berlusconi, Europe's most famous comedian, denounced Angela Merkel as an "unfuckable lard arse").

I want to interpret the events in Europe through the lens of two different models, to see what each might say the future holds for Europe.

Specifically, I want to look at the issue of the European Central Bank. A new ECB President is imminent, and many in the press are saying that only if the ECB agrees to provide full backing to governments with high yield sovereign debt (essentially via offering to buy their debt by 'printing'* money) can the crisis be averted. Under the previous ECB President, Jean Claude Trichet, such a move was ruled out (JCT is said to be heavily influenced by the German experience of hyperinflation and therefore anything remotely similar to monetizing the debt is a big no-no).

Realist models, like those of Geoffrey Garrett, tend to hold that the institutions of the EU are held on a tight Principal-Agent rope, and so their choices simply reflect the interests of the member states as a unanimous body. Policy change from the ECB, therefore has to be unanimously agreed and Draghi will probably just hold the line his predecessor did - no bailouts for 'bad behaving' governments. Neofunctionalists on the other hand hold that individuals can 'go native'. Mario Draghi, as the President of the ECB, would oversee an enormous expansion of his own power if the Central Bank were to gain the ability to act as a Lender of Last Resort, which is effectively what we are talking about here. So, the Neofunctionalists would tend to see the crisis as being solved by Mario Draghi pushing his own agenda. Of course, in order for that to go from being Draghi's preferred solution to policy, I believe in this case the Germans would in fact have to sign off. That in turn would require approval from the Bundestag/Bundesrat, which is, to understate, a challenging prospect.

Realists like Sebastian Rosato are publishing in recent editions of International Security saying the EU will stagnate or collapse. Of course, realists have always been saying this. Many neofunctionalists on the other hand see this crisis as an opportunity for policy entrepreneurs to push through an expansion of European Institutions' power, including the ECB's power to act as a Lender of Last Resort and also for the EU to jointly offer Eurobonds. The next few months and years will not be a clean cut empirical test of these theories, but it will come close. Whilst I think the case on how the ECJ functions is more or less closed now, what happens over the next few months will give us an important way of thinking about how the ECB functions, and the ability of Europe to handle a crisis that the ECJ cannot solve, with force majeure. If this crisis leads to increased integration in the Euro-zone, Realist models will be discredited and realist theorists of the EU will have to head home, not in single spies, but in battalions.

(Apologies for the likely shortfalls in spelling and grammatical accuracy in the above).
*Obviously no printing is actually done when a central bank engages in 'printing' money.

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