7 April 2025
Quantitative Easing and the importance of the administrative independence of the ECB
The independence of central banks is one of the pillars of economic and financial stability in any country.
The independence of central banks is a widely discussed topic in economic science and consists of the autonomy of the currency-issuing institution to make decisions and fulfill its mandate without government interference. In other words, an independent central bank is one that makes strategic decisions focusing on topics such as economic growth or price stability, considering the economic situation of the country or region and not the political aspirations of government leaders.
Thus, it is very important that there are institutional factors that protect central banks, such as: long and non-renewable mandates, their own budget, and the appointment of the central bank president not coinciding with that of government heads. This sum of institutional factors that promote the autonomy of monetary policy decision-makers is essential, given that there is an empirically negative correlation (tested by academics and organizations such as the International Monetary Fund) between central bank independence and inflation.
Therefore, more autonomous central banks are more successful in combating inflation and yield less to political pressures for increased output. In economic terms, less independent central banks usually have a greater weight on the output growth component in the Taylor Rule, while others (e.g., ECB) prioritize almost exclusively inflation.
In the case of Europe, the economic crisis stemming from the sovereign debt crisis led the European Central Bank to adopt a very expansive monetary policy to combat near-zero inflation and almost negative interest rates, i.e., a liquidity trap situation where conventional monetary policies lose strength.
(…) more autonomous central banks are more successful in combating inflation”
Thus, the then President of the ECB, Mario Draghi, implemented the heterodox policy of Quantitative Easing in 2015 (in addition to qualitative easing, forward guidance, and reduction of the minimum reserve ratio) similar to the US post-2008 crisis. Draghi argued that inflation expectations were anchored at 1% and that it was necessary to stimulate the economy to bring inflation to the 2% target. Therefore, the adopted strategy (Quantitative Easing) consisted of buying bonds (mostly) from states in the secondary market to inject liquidity into the economy, which generated an artificial inflation of financial assets, which could lead to massive financial bubbles, in addition to other problems, such as the Cantillon Effect and distortion in the price system.
Thus, the asset purchase program (APP) totaled more than 3 trillion euros and lasted more than 5 years, gaining strength again during the pandemic, through the Pandemic Emergency Purchase Program (PEPP) between 2020 and 2022. This time, inflation and the key interest rate in the Eurozone began to rise again in 2022 with the start of the war in Ukraine and cost-push inflation and supply crisis.
In terms of the ECB's independence, the Quantitative Easing policy generated much skepticism and was criticized especially by Germany, to the extent that it was alleged that the policy violated Article 130 of the Treaty on the Functioning of the European Union (TFEU), responsible for typifying the principle of the ECB's decision-making autonomy. In this context, the German Constitutional Court alleged, in 2015, that Quantitative Easing violated Article 130 of the TFEU because it financed governments through the massive purchase of bonds, which would directly violate Article 123 of the TFEU, which prohibits direct financing of governments by the ECB, which is considered a clear transgression of the principle of autonomy. However, the Court of Justice of the European Union stated that there was no illegality and that the purchases were made in the secondary market, not the primary.
(…) the Quantitative Easing policy generated much skepticism and was criticized especially by Germany”
Therefore, the remaining reflection is: although the Quantitative Easing policy was carried out within the bounds of legality, it is imperative that the autonomy of central banks (including the most solid ones) is always guaranteed and safeguarded, in order to protect price stability and the financial quality of life of European citizens. Furthermore, the development of heterodox mechanisms for times of financial and monetary crises such as those of 2008 and 2011 is important, as well as for times of threats to the independence of monetary authorities, such as the case of Donald Trump and his influence on the Federal Reserve.
Author: Eduardo Beltrão - Business Developer nBanks
Image credit: Unsplash