The three mandates of the European Central Bank: the price level, employment and stability

Summary. According to the European treaties the ECB does have an employment mandate next to its inflation mandate. Looking at more prices than just consumer prices as well as at a historical output gap shows that there is ample scope and necessity for more aggressive monetary policies by the ECB.

I received some comments on my post about Jeroen Dijsselbloem, also by email, to which I will answer in a couple of blogposts. The first of these will be about the mandates (plural) of the European Central Bank, the other(s) will be about recent developments.

The ‘single’ price stability mandate is, at the moment, invoked again and again as an excuse for bad monetary policies. This is remarkable, as according to the treaties the ECB does not have a single mandate at all. It has, de jure, a clear double mandate. De facto it even has a triple mandate. Let’s first look at what ‘The consolidated version of the Treaty on the functioning of the European Union‘  has to say (article 127, part 1 and 2, emphasis added)): 

1. The primary objective of the European System of Central Banks (hereinafter referred to as ‘the ESCB’) shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union. The ESCB shall act in accordance with the principle of an open market economy with free competition, favouring an efficient allocation of resources, and in compliance with the principles set out in Article 119.
2. The basic tasks to be carried out through the ESCB shall be:
— to define and implement the monetary policy of the Union,
— to conduct foreign-exchange operations consistent with the provisions of Article 219,
— to hold and manage the official foreign reserves of the Member States,
— to promote the smooth operation of payment systems.

This leads us to Article 3, note that the Treaty on European Union is not the same as the Treaty on the functioning of the European Union: (emphasis added, part 1-3):

The Union shall establish an internal market. It shall work for the sustainable development of Europe based on balanced economic growth and price stability, a highly competitive social market economy, aiming at full employment and social progress, and a high level of protection and improvement of the quality of the environment. It shall promote scientific and technological advance.

It shall combat social exclusion and discrimination, and shall promote social justice and protection, equality between women and men, solidarity between generations and protection of the rights of the child.

It shall promote economic, social and territorial cohesion, and solidarity among Member States. It shall respect its rich cultural and linguistic diversity, and shall ensure that Europe’s cultural heritage is safeguarded and enhanced.

The least you can say is that as long as it does not compromise price stability the ECB is bound to support ‘stable economic growth’ and ‘aim at full employment’. Remember: unemployment is at historical heights and the 20% decline of GDP does not fit any definition of balanced economic growth I’m aware of. But how does the ECB define ‘price stability’? As is well-known it defines this as an about 1,8% increase in the Eurozone wide consumer price, de facto including VAT and other taxes, in the medium run (about 8 years). This is not stipulated by the treaties but has been a deliberate choice by the ECB, inspired by rational expectation economists who stated that (a) it in fact doesn’t matter which target is chosen, as long as a target is chosen which binds the central bank (wrong) while (b) financial stability is by definition the same thing as low and stable inflation (wrong again). Look here for an interesting recent article about this. Taking house prices as well as national differences into consideration would have shown that there was much less price stability between 2000 and 2012 than indicated by the consumer price level.

Also, the ECB itself has recently published an interesting volume on statistics and financial fragility, with the title (notice the word: ‘separate’): “Central bank statistics as a servant of two separate mandates – price stability and mitigation of systemic risk”, which shows that at least some people at the ECB have, belatedly, ditched rational expectation economics. A very interesting finding in this study from Muhammad bin Ibrahim (p. 44): the only agent (companies, the government, households, banks, the central bank) which never has a balance problem central bank during financial crisis is the central bank. Nowhere. Never.

Which means that there are, within the boundaries set by the treaties,ample  possibilities for the ECB to intervene more aggressively and to enhance employment and social progress which, at this moment, will also lead to more financial stability. And about Cyprus: not really an example of the smooth functioning of payment systems.