One Bank To Rule Them All

The ECB has released this letter from its former President, Jean-Claude Trichet, to the Spanish Prime Minister in August 2011. It is excruciating reading.

The letter starts with a reminder about the Spanish government's responsibilities:
We recall that the Euro area Heads of State or Government summit of 21 July 2011 concluded that "all Euro countries solemnly affirm their inflexible commitment to honour fully their own individual sovereign signature....."
Well, ok, this letter is about the threat to the Euro caused by spiking Spanish bond yields and the fear of default and redenomination at that time, so it is probably reasonable of the ECB to ask for assurance that the Spanish government intends to honour its debt obligations. But that's not all:
"...and all their commitments to sustainable fiscal conditions and structural reforms."
And the letter then goes on to explain in some detail exactly what "structural reforms" the ECB expects Spain to undertake. There are three groups of changes:
  • changes to the labour market, including decentralising wage bargaining, ending indexation of wages and "reviewing other regulations" in order to make it easier for the unemployed to find jobs. Apparently making it cheaper for firms to sack people and eliminating restrictions on the rollover of temporary contracts makes it easier for the unemployed to find jobs. I am not quite sure how this logic works. 
  • additional "structural fiscal consolidation" (i.e. permanent spending cuts and/or tax rises) of 0.5% of GDP, apparently to "convince markets" that the 6% deficit target could be met. This was to be coupled with strict control of sub-sovereign budgets, new rules enforcing transparency in sub-sovereign accounts and a "spending rule" restricting spending increases to the trend growth of GDP.
  • product market reforms, mainly to improve competition in key sectors and promote housing rentals.
I am not in this post going to discuss the wisdom or otherwise of these proposals. I am interested in the fact that it was the ECB that made them. In what insane world is fiscal policy the responsibility of a central bank? Which EU treaty gives the ECB the right to dictate policy to a sovereign government, even one subject to the "excessive deficit procedure"? It is very hard not to conclude that the ECB strayed far beyond its mandate. But why did it do this?

The final paragraph gives the game away:
"Overall, we trust that the Spanish government is aware of its very high responsibility for the smooth functioning of the Euro area at the current juncture and will decisively undertake all necessary measures to regain market confidence in the sustainability of its policies again."
The impression that this gives is that restoring market confidence in the Euro was the responsibility of the Spanish government, not the ECB. An emasculated ECB was desperately trying to persuade the Spanish government to do whatever was necessary to prevent disorderly breakup of the Euro. Poor thing.

We now know that this is total nonsense. What markets really needed to restore confidence was not Spanish structural reforms or fiscal consolidation. It was a guarantee from the ECB that it would stand as "buyer of last resort" for Eurozone sovereign debt. And when the ECB finally gave that guarantee - though admittedly hedged around with conditions - calm was restored to the markets and bond yields fell to normal levels.

So it was not the Spanish government that needed to act. It was the ECB.

In this letter, the ECB attempted to evade its own responsibility for ensuring the stability of the Euro. Nor was this the first time it had tried this trick. The Irish letters also include instructions to the Irish government about "fiscal reforms", though not in such detail. But in the Irish case, the ECB threatened to withdraw liquidity from the Irish banking system if the Irish government did not comply. It is a total mystery to me why the Irish government did not call the ECB's bluff. There was no way the ECB could possibly have done any such thing. It would have brought down the European banking system and caused a disorderly breakup of the Euro.

The Spanish letter does not include overt threats. But the message is clear. The ECB believed it had the right to dictate fiscal policy to a sovereign government. Had the Spanish government resisted, no doubt threats would have followed. And once again, they would not have been credible - any more than the ECB's conditions for sovereign bond purchases are credible. The fact is that the ECB must do "whatever it takes" to prevent Euro breakup, even if that means buying every sovereign bond and bailing out every bank. Its threats are empty.
This must be the last time the ECB is allowed to usurp fiscal sovereignty from a member state government. By design, the Eurozone does not have a single fiscal authority. It may be that at some time in the future, member states will agree to create a supranational fiscal authority. But until then, the governments of member states remain sovereign. The ECB needs to be firmly put in its place. One Bank it may be, but it should never rule them all.

UPDATE: It seems Spain was not the only sovereign subjected to ECB fiscal diktat in 2011. Via Filippo da Fiume comes this letter sent by Trichet and Draghi to Berlusconi, which - as with Spain - details three groups of fiscal policy recommendations:
  • measures to improve growth
  • fiscal consolidation 
  • streamlining of public administration.


  1. Hi Frances,

    I'm going to take the complete opposite view on this controversy (while still admitting there is a controversy here)

    In his reply to Trichet's Letter, (link here: ) then Spanish PM Zapatero said " The
    Spanish government is of the opinion that the European Central Bank could play a
    pivotal role in easing tensions by means of the purchase of Spanish public debt on
    a sufficient scale to stabilise the markets and to ensure the proper functioning of
    the transmission mechanism of monetary policy."

    That letter was dated August 6 2011.

    The next week, the ECB resumed purchases under the Securities Markets Programme (see illustration here )

    So, it seems to me that the ECB may have been telling governments what they should do, but the governments have been telling the ECB what it should do, and the ECB has been doing it.

    So much for independent monetary policy..

    1. Lorcan,

      Actually, on consideration, this isn't really the opposite view. Rather, you've shown that the sovereigns still have teeth, and the ECB is far more bark than bite. In the end, the ECB could not force Spain to do what it wanted, and it still had to defend the Euro. It had no choice but to do what Spain suggested. So Spain called its bluff. The mystery is why Ireland didn't.

    2. "The mystery is why Ireland didn't."

      Maybe size matters?

  2. Apparently making it cheaper for firms to sack people and eliminating restrictions on the rollover of temporary contracts makes it easier for the unemployed to find jobs.

    I show students pictures of a "Right To Work" march and then tell them about "Right-to-work" laws. The Orwellian effect would work better if the march didn't require so much explaining - the idea of demanding jobs from the government is fairly foreign to the current generation of young people. Still, another few years of austerity may change that.

  3. “In what insane world is fiscal policy the responsibility of a central bank?” Answer: in a common currency area where part of the area has had a lax fiscal policy which has led to it becoming uncompetitive relative to the average for the area.

    Yorkshire is part of a common currency area. Suppose Yorkshire borrowed and spent excessively with the result that it became uncompetitive relative to the rest of the UK, then the UK government / central bank would have a right to tell Yorkshire to get its act together. And in practice, the UK government adopts the “insane” policy of keeping a sufficiently tight rein on Yorkshire’s fiscal freedom of movement, that the latter “competitive” problem scarcely arises.

    And before some bleeding heart accuses me of being indifferent to unemployment and related social problems in Spain, I’m simply making the point that if a country joins an EZ style common currency area, it loses sovereignty, plus it’s letting itself in for a system where lack of competitiveness is deal with via several years of excess deflation and excess unemployment. If you don’t like that system, and I wouldn’t blame you, then don’t join an EZ style common currency area.

    To complain about the lack of sovereignty and excess unemployment that can occur in common currency area is a bit like complaining about the dangers involved in paragliding: if you want minimum exposure to danger, don’t go paragliding, horse riding, skiing, etc.

    1. Ralph,

      As usual you have completely missed the point.

      The UK is nothing like the Eurozone. In fact it is not even like other currency unions such as Germany or the United States, since it is not a federation. Yorkshire does not have fiscal independence - it is not in any sense "sovereign". Most of the changes suggested by the ECB concerned employment regulations and taxes, benefits (including pensions) and competition law, none of which Yorkshire has because in the UK these are at national level.

      In contrast, Italy, Spain and Ireland are sovereign states that have chosen to join a monetary union. They did so on the understanding that they retained fiscal sovereignty. As I said in the post, the absence of a single fiscal authority is a design feature - but it is also a dangerous flaw. Because there is no supranational fiscal authority, the ECB sees itself as fiscal enforcer for states that in its view do not "toe the line". Unelected technocrats can dictate policy to elected governments. That is FAR beyond the remit of a central bank. It is the end of democracy.

    2. Frances,

      I’ll take your points in turn. If English counties are “not in any sense sovereign”, how come Lancashire issues bonds? See:

      Re employment law, taxes etc, it is not true to say that this is all decided at “national level” in the UK. Employment law is decided at national level, but counties / cities have a say in LOCAL taxes: the so called “Council Tax”. That’s sovereignty of a sort.

      Re your objections to a central bank having a say in EZ countries’ fiscal policies, a weakness in that claim is that it is quite normal for “undemocratic” central banks to have a big say on stimulus in general (e.g. the “undemocratic” Bank of England and the Fed determine interest rates). However, “stimulus” can be split into monetary stimulus and fiscal stimulus, and as you rightly say, the ECB’s monetary powers have been neutered in that the Euro elite is determined to preserve the Euro, so the ECB buys up periphery debt almost willy nilly.

      Now if the ECB’s powers to impose deflation on the periphery via monetary means is neutered, there’s only one alternative: fiscal. Granted it’s normally “democratically elected” politicians who implement matters fiscal, but if they WERE GIVEN those powers in the EZ, would they actually impose fiscal constraints on the periphery or would they give into populist pressure and in effect print money willy nilly? Hard to say. I know exactly what Greek politicians would do or vote for.

      Alternatively, if Euro politicians in Brussels DID BEHAVE responsibly and impose fiscal deflation on the periphery, then they’d be acting pretty much as the ECB is currently acting: i.e. ordering Spain etc to deflate. You could argue that it’s Spanish politicians who should determine the EXACT FORM of that deflation, rather than the ECB. But I’d guess the ECB already gives Spanish etc politicians some room for manoeuvre in how deflation is imposed.

      In short, your claim that present arrangements are “the end of democracy” is going too far. On the other hand there might well be scope for a bit more democracy in the sense of individual countries having more say on exactly how they impose deflation on their populations once they’ve been told to either by the ECB or EU politicians.

    3. Ralph.

      Lancashire may be able to issue bonds on the basis of its power to enforce property taxes, but Westminster has the power to override Lancashire's tax-raising decisions (and does so). There is no equivalent to Westminster in the Eurozone set-up. I'm disappointed that you can't tell the difference.

      Unelected Eurocrats have no power to tell elected sovereigns what to do. They may advise. That is all.

      The ECB does indeed have to do whatever it takes to preserve the Euro. That is its primary mandate - and its principal weakness.

    4. @ Ralph.
      The super drive toward competiveness is the problem.
      It really means you cannot afford to consume what you produce.
      We can see therefore the political ambition of the ecb was to destroy the post 1648 nation state or capitalistic monopoly.
      We can see this same objective in Richard Werner's look at the masters of the yen.
      We can therefore deduce that the guys behind the curtain of the ecb are anti capitalist but not in a good way.
      As they want to both destroy capitalism and yet maintain concentration.
      Their objective is famine on a mass scale.

  4. I agree, indeed. My opinion:

  5. See Art 127(4). ECB is entitled to advise govts. Govts not entitled to tell the ECB what to do.

    1. To advise, but not to dictate or to threaten. And it may not use a government's refusal or failure to do its budding as an excuse not to fulfil its primary mandate, which is to ensure the survival of the Euro. Its threats to put the stability of the Euro at risk if governments don't do what it wants are not only beyond its mandate but, more importantly, unenforecable.

    2. Playing with words here. Don't forget that govts made commitments and ECB merely reminding them of those they failed to honor. That's legit. Spain telling the ECB what to do is not legit.

    3. Reminding governments about commitments is one thing. Dictating government policy is quite another, and way beyond the ECB's mandate. As is making hollow threats. This post is about the behaviour of the ECB, not Spain.

    'If not for window guidance we would compete until hari-kiri""
    11m to 16 m............
    Japan externalised its capitalistic costs via mercantilism but internally it was very different from the Irish model where local capitalists lost everything - including now it seems sir antoney......

  7. I clearly remember Turkish wage slaves shipped in to work exclusively on the road to macroom......just before the end.
    No Derry power like characters need apply which meant a implosion of domestic exchange..........Irish alcohol consumption went south in 2001 and not 2007

  8. We now know the Ecb was engaged in a concentration experiment which seems unfamiliar as it operates outside the national capitalistic monopoly system
    Local fly boys will always be burnt if they decide to play the central bankers at their own game.


  9. Post 1975 we can clearly see the objective - to create new facts on the ground and thus destroy the ghost of Christmas present using pointless competition and attacks on the commons as the primary tools.
    This subsequently leaves little to be consumed other then the enormous amount of capital goods ( see cars and the roads to carry them) required to chase scarce money.

    If we chart the history of a typical populist politician we can observe this.
    In 1969

    Charlie haughey announced the widows pension was to be backdated no less to the consternation of the Dublin 4 set and by the 1980s was engaged in the new reality on the ground that is liberal economics.
    Central bankers objectives has been to detach the balls from populist politicians....
    Leaving only wage slave politicians with no political base or power foundation outside the now closed monetary loop.

  10. At the ECB one wonders if that famous bank manager, Captain Mainwaring, is now a member of the key strategy team.

  11. It does look bad, but it may be a case of shooting the messenger.

    Trichet is on record as saying nobody listened to him at EU summits when he wanted, if I recall, a more or less unconditional bailout of Greece during the earlier stages of the crisis. And he became suddenly all powerful? Maybe it's more like a tantrum.

    Besides, the letter could have been signed, indeed probably should have been signed, by the chair of the Eurogroup (the eurozone finance ministers thing) and/or whoever had the rotating presidency of the European Council (the prime ministers thing) for it was very much their policy that is expressed here. Actually for accuracy, it should have been co-signed by Merkel but one can imagine that would have broken etiquette a bit. So in that sense he was just passing on his employers decision (as seen in the reference to summit decisions in the letter). If you see it at that level the threat is perhaps not the ECB pouting on its own, but really northern members threatening to dump the union, and that is a credible threat, if a possibly perilous and highly charged one politically.

    Back to now, I'd like to know if it's a systematic release (e.g. documents get public after N years automatically) or if the ECB has purposefully chosen to publish it now, perhaps to tell the member states, via the controversy caused, "get your act together and put up the right institutions in place so that we don't have to do your job next time". It's a fairly good time to do this as markets are not bothered, and they need prodding otherwise they'll procrastinate til the next crisis.

    1. I think this letter - including Spain's response - actually exposes how weak the ECB is. As do the Irish letters. Now I've read Geithner, I can well believe no-one listened to Trichet's argument for gentler treatment of Greece. The fiscals were out for blood.

      The point of this post is that the ECB really has very little power, but is forced to behave as if it is omnipotent because to do otherwise would undermine confidence in its ability to defend the Euro. The real power still rests with the fiscal authorities. Really, the only person who can discipline the periphery is Merkel. So yes, I do see this as northern members threatening to dump the union, using the ECB as their messenger. But actually their threat is not credible either. Northern members have an AWFUL lot to lose from disorderly breakup of the Euro. They couldn't pull the plug on it purely because one southern state won't do what they want. As it stands, northern members can use the threat of breakup to discipline southern members only because southern members are as scared of it as they are. If that changes, that threat will be exposed as the hollow sham it really is.

      This is supposedly a systematic release, but it seems an awfully timely one.


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