The European Central Bank (ECB) is the central bank for the nineteen-nation eurozone, with a mandate to maintain price stability by setting key interest rates and controlling the union’s money supply. After the emergence of the eurozone’s sovereign debt crises between 2009 and 2011, the ECB sparked controversy by undertaking a range of unorthodox monetary policies—including a program of unlimited bond-buying, the use of negative interest rates, and a $1.2 trillion quantitative easing plan—that divided policymakers and economists between those who thought it overstepped its authority and those who argued for it to take more aggressive action. Meanwhile, the ECB has been placed at the center of the initiative to create a eurozone-wide banking union, granting the bank new powers of supervision over Europe’s largest financial institutions, even as the 2015 resurgence of Greece’s debt crisis has renewed questions over the future of the common euro currency.
History and Mandate of the ECB
The 1992 Maastricht Treaty mandated the creation of the European System of Central Banks (ESCB), which comprises the ECB and the EU’s twenty-eight national central banks. Under the ESCB sits the Eurosystem, composed of the ECB and the national central banks of eurozone countries. The ECB took over responsibility for monetary policy in the euro area in January 1999, two years before the euro was introduced into circulation.
The ECB is made up of three decision-making bodies: the General Council, the Executive Board, and the Governing Council. The General Council, which operates largely as an advisory body for the ECB, includes all of the EU’s national central bank governors, as well as the president and vice president of the ECB. The Executive Board of the ECB, the hub of day-to-day operations and decision-making, consists of the ECB president, vice president, and four other members, all of which are appointed by the European Council. The Governing Council comprises the entire Executive Board and all of the national central bank governors of countries that use the euro, and meets bimonthly to adopt decisions on monetary policy for the euro area.
The Statute of the ESCB and the ECB tasks the ECB with achieving price stability, mainly by setting key interest rates by which it seeks to keep inflation rates below, but close to, 2 percent. In addition, the ECB is the sole issuer of euro bank notes and it manages the eurozone’s foreign currency reserves. The ECB’s responsibility to supervise financial markets and institutions has also been augmented by the eurozone’s moves toward greater banking union.
The Bank’s Response to the Debt Crisis
The ECB’s response to the eurozone sovereign debt crisis, in which it stepped outside of its traditional role by repeatedly purchasing government bonds, has generated an intense debate over the bank’s mandate. Unlike the U.S. Federal Reserve, the ECB does not have a mandate to pursue full employment, and the Maastricht Treaty prohibits it from directly financing national governments. At the same time, the absence of a fiscal union, including a eurozone-wide treasury to pool debt, has made the ECB’s potential role as lender of last resort more complicated.
Throughout 2011 and 2012, as the eurozone struggled through the global financial crisis, European leaders debated the ECB’s ability to support ailing economies. Divisions arose particularly between France’s Socialist President François Hollande and monetary conservatives in Germany. German Finance Minister Wolfgang Schaeuble has articulated the objections to a more activist ECB: "If the central bank finances government debt, it’s a modern form of the old bad habit" of printing money, he said in 2012. For Schaeuble, ECB intervention in bond markets would reduce the incentives for eurozone government to undertake difficult budget reforms.
Nonetheless, as Greece’s sovereign debt crisis intensified in the spring of 2010, the ECB, under former President Jean-Claude Trichet, initiated its Securities Market Program (SMP), through which it purchased Greek government bonds on the secondary market. As the debt crisis spread, the ECB extended the SMP to Ireland, Italy, Portugal, and Spain, which succeeded in temporarily bringing down rising borrowing costs.
When Italian central banker Mario Draghi took over the ECB in November 2011, some feared he would not be as vigilant in maintaining sound monetary policy as the well-known inflation hawk Trichet. Draghi won the support of German Chancellor Angela Merkel, but ultimately reversed Trichet’s controversial interest rate hike. Just days after taking office, Draghi promptly lowered the ECB benchmark rate from 1.5 percent to 1.25 and then 1 percent, beginning a slide toward 0 percent interest rates that would continue through 2015.
The Introduction of Open-Ended Bond Buying
During the summer of 2012, fear over the potential breakup of the eurozone peaked as bond yields in Italy and Spain reached unsustainable levels. As markets panicked, Draghi made forceful public comments on July 26, 2012. "The ECB is ready to do whatever it takes to preserve the euro," Draghi said. "And believe me, it will be enough."
Draghi’s comments were soon backed up by policy action. On September 6, Draghi announced a new program of eurozone-wide bond-buying, known as Outright Monetary Transactions (OMT). Under OMT, in contrast with the previous Securities Market Program, the ECB could buy the bonds of struggling eurozone economies on the secondary market in potentially unlimited amounts. Applicant countries would be held to stringent conditions, first having to accept economic and budgetary reforms. OMT bond-buying would also be fully "sterilized," meaning that the ECB would remove an equal amount of money from elsewhere in the system to keep the total money supply constant.
The sterilization rule was meant in part to soften opposition to the program among German policymakers. According to Guntram Wolff, director of the Brussels-based think tank Bruegel, German conservatives, including Bundesbank chief Jens Weidmann, argued that OMT amounted to "essentially monetary financing" of governments, which is proscribed by EU treaty. Weidmann was the only member of the ECB Governing Council to vote against OMT.
As of 2015, OMT had not yet been used. Many argue that the very fact that the ECB was willing to wield this "big bazooka" calmed investors and meant that it never had to be "fired." But challenges to this new ECB authority have persisted. In February 2014, Germany’s constitutional court found the OMT program to be illegal, sending the case to Europe’s top court, the European Court of Justice (ECJ) to decide the issue. On June 16, 2015, the ECJ upheld OMT, concluding that "the purchase of bonds on secondary markets does not exceed the powers of the ECB."
The Push for Banking Union
Meanwhile, in 2012 EU officials began work on plans for a eurozone banking union. The economic crisis had led to a cascade of unpopular bank bailouts, totalling over 590 billion euros ($653 billion) in overall European taxpayer assistance by 2012. A banking union would seek to both make banks less likely to fail, as well as provide a more orderly process for dealing with their failures when necessary. To provide better oversight, the Single Supervisory Mechanism (SSM) was created, while the Single Resolution Mechanism (SRM) would be set up to manage failing banks.
The ECB took over primary responsibility of the Single Supervisory Mechanism in 2014, further enlarging its authority over Europe’s economy. Under the SSM, the ECB is charged with monitoring the financial stability of all euro currency members. This means directly supervising all "significant" banks, defined by those with a particularly large share of a country’s economic activity. Smaller banks remain supervised by national-level regulators.
The ECB’s first major effort as the new supervisor was its handling of region-wide "stress tests" designed to determine the health of Europe’s banks. Completed in October 2014, the yearlong assessment investigated the solvency of 130 different financial institutions, which together accounted for over 80 percent of eurozone banking assets. The ECB’s tests found that banks faced a cumulative $30 billion capital shortfall—less than estimated by private analysts. Still, a number of critics argued that the tests were overly optimistic. Economist Philippe Legrain called the results a "whitewash." NYU economist Viral Acharya found that the major banks, especially in France and Germany, were much weaker than the ECB indicated, while CFR’s Benn Steil and Dinah Walker also argued that the tests were deeply flawed.
Steil and Walker also point to the precarious nature of the new Single Resolution Mechanism, which they argue wasn’t yet prepared to properly recapitalize the region’s weak banks. The SRM, through the Single Resolution Board and its Single Resolution Fund, is meant to administer the process through which failing banks can either be recapitalized or shut down. But the Board won’t be fully operational until 2016, and its funds will take up to ten years to accumulate. The EU’s permanent emergency lending institution, the European Stability Mechanism (ESM), is barred from directly supporting banks.
Quantitative Easing and the Return of the Greek Crisis
By the start of 2015, the ECB’s efforts had calmed the immediate eurozone debt crisis, but Europe still faced major economic headwinds. Growth was low and eurozone unemployment remained above 11 percent, with youth unemployment above 20 percent. Perhaps most distressingly, inflation was falling fast: in December 2014, consumer prices in the eurozone fell for the first time in more than five years.
To fight deflation—which makes debt harder to service and further dampens consumer spending—the ECB announced its most unorthodox monetary policy yet on January 22, with the launch of quantitative easing, or QE. QE, already pursued by the Bank of Japan and the U.S. Federal Reserve, involves large-scale asset purchases to inject liquidity into the economy in the hopes of sparking inflation and growth. The ECB plan called for 60 billion euros ($66 billion) of public debt purchases each month until September 2016, for a total expenditure of some 1.1 trillion euros ($1.2 trillion). This move followed the bank’s highly unusual June 2014 decision to introduce negative interest rates, but for many supporters it did not come soon enough. George Mason University economist Scott Sumner argued that the ECB was not moving aggressively enough, while Pimco founder Bill Gross called the QE program "too little, too late."
As with the previous debate over OMT, German policymakers, including the Bundesbank’s Weidmann, strongly opposed QE. As part of a compromise with its German critics, the ECB agreed to the condition that risk would not be shared equally across the eurozone, but rather that each national bank would buy the bonds—and bear the risk on any losses—on their own. In addition, Greek bonds were excluded from the plan while negotiations for a new bailout proceeded.
After the January 25, 2015, election of the anti-austerity Syriza government in Greece, the ECB was once again thrust into the center of Europe’s debt drama. Despite Greece’s troubled financial sector, its banks had received liquidity from the ECB at the same rate as all other eurozone countries since 2010, as long as Greece complied with its bailout requirements. After newly elected Prime Minister Alexis Tsipras put Greece’s cooperation in doubt, however, the ECB limited this cheap access to capital. Beginning on February 4, Greece’s banks could only receive ECB funds through Emergency Liquidity Assistance (ELA) at the ECB’s discretion and at higher interest rates.
Though the ECB is an avowedly nonpolitical institution, Greece’s reliance on ELA gave the bank an unavoidable role in the fraught negotiations over a new Greek bailout. As the crisis intensified, more people withdrew their money from Greece’s banks, making them increasingly reliant on the ECB, whose emergency liquidity support surpassed 88 billion euros ($97 billion) by June 2015. In the 2010 Ireland and 2013 Cyprus bank crises, the ECB effectively forced compromises by threatening to cut off ELA altogether. But as Greece has come to the brink of exiting the eurozone, the ECB has so far sought a balance. It capped ELA, forcing Greece to impose capital controls, but it has not halted its support—leaving its role in resolving the continent’s persistent debt crises both larger and more uncertain than ever.