The ECB’s Illusory Independence

ATHENS – A commitment to the independence of central banks is a vital part of the creed that “serious” policymakers are expected to uphold (privatization, labor-market “flexibility,” and so on). But what are central banks meant to be independent of? The answer seems obvious: governments.

In this sense, the European Central Bank is the quintessentially independent central bank: No single government stands behind it, and it is expressly prohibited from standing behind any of the national governments whose central bank it is. And yet the ECB is the least independent central bank in the developed world.

The key difficulty is the ECB’s “no bailout” clause – the ban on aiding an insolvent member-state government. Because commercial banks are an essential source of funding for member governments, the ECB is forced to refuse liquidity to banks domiciled in insolvent members. Thus, the ECB is founded on rules that prevent it from serving as lender of last resort.

The Achilles heel of this arrangement is the lack of insolvency procedures for euro members. When, for example, Greece became insolvent in 2010, the German and French governments denied its government the right to default on debt held by German and French banks. Greece’s first “bailout” was used to make French and German banks whole. But doing so deepened Greece’s insolvency.