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What will Christine Lagarde’s ECB look like?

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Via Financial Times

When Mario Draghi was asked last week whether his successor as European Central Bank president, Christine Lagarde, would have as dramatic an eight-year term as he had, he replied that he “would not wish that on anyone”. Yet when Ms Lagarde takes over as the head of Europe’s most powerful financial institution on Friday, she will know that while Mr Draghi is credited with rescuing the euro, the ECB still faces some daunting challenges.

The job brings with it responsibility for setting eurozone interest rates, controlling the supply of euros and overseeing the biggest banks in the 19-country group. Ms Lagarde’s every word will be closely scrutinised by investors for clues on the direction of financial markets.

But she is also walking into one of the most vicious, internecine feuds in the bank’s two-decade history, something that overshadowed Mr Draghi’s final days in office.

Mr Draghi has spent the past eight years stretching the limits of his powers as he has defended Europe’s single currency against the worst financial crisis since its creation two decades ago. The 72-year-old leaves knowing that the job is only partially complete.

Global growth is slowing at a time when economists believe central banks are running out of firepower to stimulate their economies and criticism of their actions is becoming louder.

“Monetary policy is almost out of ammunition, but if the central banks say this too explicitly, the markets may freak out,” says Olivier Blanchard, who was chief economist at the IMF for four of Ms Lagarde’s eight years as managing director. “So, Christine Lagarde has to do this delicate balancing act of saying there is more she can do, while insistently asking others, including fiscal policymakers, to help.”

The IMF warned this month that the world economy was in a “precarious” situation and cut its growth forecast to the lowest level since the 2008 crisis, blaming the US-China trade war and uncertainty over Brexit. Germany’s export-dependent economy has been hit particularly hard, with the eurozone’s engine room now on the cusp of recession.

Mario Draghi, President of the European Central Bank (ECB), arrives for the press conference following the meeting of the Governing Council in Frankfurt am Main, western Germany, on October 24, 2019. - The European Central Bank held key interest rates and other monetary tools unchanged at its meeting, leaving departing European president Mario Draghi to defuse differences among policymakers over continued stimulus as best he can in a final press conference. (Photo by Daniel ROLAND / AFP) (Photo by DANIEL ROLAND/AFP via Getty Images)
Mario Draghi on October 24. The departing ECB boss has been criticised for his decision to cut interest rates and print €20bn a month to buy more bonds

Under Mr Draghi the ECB moved into the topsy-turvy world of negative interest rates, which forces many large depositors to pay for putting money in banks, while massively expanding the ECB’s balance sheet through the purchase of €2.6tn of bonds issued by governments and companies.

Mr Draghi often cites the 11m European jobs created in the past decade as proof that these policies are working, while the ECB estimates that without its actions the eurozone economy would today be almost 1 per cent smaller.

Yet banks and insurers complain bitterly about the corrosive impact of negative interest rates on their business models. Others worry that the ECB’s flow of cheap money is creating bubbles in property markets and supporting zombie companies that would otherwise collapse.

The ECB’s deposit rate is at a record low of minus 0.5 per cent and its bond-buying programme is close to self-imposed limits on how much of each country’s debt it can own. Economists believe its toolkit is almost empty. The US Federal Reserve and the Bank of England avoided negative rates, so have more capacity to respond to any crisis.

“There is a limit to how far and how deep you go into negative territory,” Ms Lagarde said in a recent interview with CBS. “There is a bottom to everything, but we are not at that bottom at this point in time.”

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Further complicating Ms Lagarde’s task is the fact that the central bank’s decision last month to cut interest rates and to print €20bn a month to buy more bonds has opened divisions within the top echelons of the central bank itself.

Philip Lane, chief economist of the European Central Bank (ECB), speaks at a discussion during the annual meetings of the International Monetary Fund (IMF) and World Bank Group in Washington, D.C., U.S., on Wednesday, Oct. 16, 2019. The IMF made a fifth-straight cut to its 2019 global growth forecast, citing a broad deceleration across the world's largest economies as trade tensions undermine the expansion. Photographer: Andrew Harrer/Bloomberg
Philip Lane, chief economist of the ECB. Ms Lagarde is likely to rely on the former Irish central bank boss for monetary policy

The heads of the German, French, Dutch and Austrian central banks — representing over half of the eurozone by population and economic output — criticised parts of the package. The ECB’s decisions went against the advice of its own staff and were even attacked by a group of retired ECB grandees.

“I would expect the level of disagreement to increase, not because people are becoming more extreme, but because the benefits and costs of additional policies are much less obvious,” says Mr Blanchard, now a senior fellOw at the Peterson Institute for International Economics in Washington.

The unusually intense debate within the ECB governing council, its main decision-making body that includes the eurozone’s 19 national central bank heads, is likely to make it harder for Ms Lagarde to loosen monetary policy further. This could frustrate investors, as markets are pricing in another rate cut by next spring.

“There is no doubt that improving team spirit on the governing council is an important challenge for Christine Lagarde and for all of us,” says Olli Rehn, head of Finland’s central bank. “One of her outstanding qualities is team building and she is excellent at communications, so I very much look forward to her putting these to good use.”

Ms Lagarde is, in many ways, an unconventional choice to lead the ECB. Unlike most central banking heads, the 63-year-old is not an economist and she has never devised monetary policy. To make up for her lack of technical expertise, she is likely to rely on Philip Lane, the bookish former Irish central bank boss who this summer became the ECB’s chief economist.

“She is the anti-Draghi to some extent,” says Frederik Ducrozet, senior economist at Pictet Wealth Management. “She is not an economics expert and is not as much into central bank plumbing as Draghi. She represents a shift to a more political ECB.”

After studying law at University Paris X Ms Lagarde did a masters in political science in Aix-en-Provence. Twice rejected by the École Nationale d’Administration — the Parisian training ground for the French political elite — she joined US law firm Baker McKenzie in 1981. Ms Lagarde rose to chair its executive committee before leaving in 2005 to become a minister in the French government, under President Jacques Chirac. His successor, Nicolas Sarkozy, named Ms Lagarde as France’s first female finance minister.

Jens Weidmann, Bundesbank head
Jens Weidmann © Reuters

She won plaudits among western leaders for the calm, competent way she navigated the financial crisis. This made her an obvious choice to replace Dominique Strauss-Kahn when he was forced out as head of the IMF over a sex scandal in 2011. There she won admiration for her diplomatic skills and ability to find a consensus, such as during talks over the 2012 Greek bailout that helped avoid a break-up of the eurozone.

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Investors believe Ms Lagarde represents continuity with Mr Draghi on the key areas of monetary policy, as shown by the bounce in stock markets when her appointment was announced. But in other areas she is expected to be very different. The incoming ECB president is a warmer, more outgoing personality than Mr Draghi. She has been known to lock the doors of a meeting room until those inside — often mostly men — reach a decision. When appearing on a US television chat show in 2009 she proceeded to whip out a French beret and started cracking jokes.

After Berlin last week nominated economics professor Isabel Schnabel to join the ECB executive board, Ms Lagarde will be one of only two women out of 25 people around its top table. She once quipped that the financial crisis may have been avoided if Lehman Brothers had instead been Lehman Sisters, and is likely to use her position to address gender imbalances in central banking, finance and the economy in general.

Appearing before the European Parliament in a confirmation hearing in September, Ms Lagarde also promised to make tackling climate change a “mission critical” priority at the ECB. She told MEPs it could “direct” its asset purchases towards green bonds once regulators agree a common framework for sustainable finance.

“Where she is likely to push and perhaps have some space for action is in directing asset purchases to address climate change,” says Lucrezia Reichlin, an economics professor at the London Business School and the ECB’s former head of research. “A lot of central banks are thinking about this.”

Olivier Blanchard, former chief economist of the International Monetary Fund (IMF), speaks during a Hutchins Center on Fiscal and Monetary Policy event at the Brookings Institution in Washington, D.C., U.S., on Monday, Jan. 8, 2018. The event was entitled Should the Fed Stick with the 2 Percent Inflation Target or Rethink It. Photographer: Andrew Harrer/Bloomberg
Olivier Blanchard, former chief economist of the IMF. He says Ms Lagarde will have a delicate balancing act in her new post 

Such a move could encourage governments to invest more to meet their Paris climate accord targets for reducing carbon dioxide emissions, which would boost economic activity. However, if the ECB started buying green bonds from governments it could be accused of blurring the lines between monetary and fiscal policy, particularly by the Bundesbank, Germany’s central bank.

Criticism of the ECB has been fiercest in Germany, where it is regularly accused of penalising the country’s prudent savers while rewarding profligate southern European countries. Jens Weidmann, head of the Bundesbank, even gave evidence against the ECB in a constitutional court case on its bond-buying programme.

Attempts to explain monetary policy in Germany often generate a backlash from politicians and the media, says Marcel Fratzscher, the ECB’s former head of international policy analysis who now runs the German Institute for Economic Research (DIW) in Berlin.

“My big hope for Lagarde is that she will be more successful at communicating to the average man in the street what the benefits of ECB policy are for them, even if they earn nothing on their bank deposits,” says Mr Fratzscher. “This is really hard, especially in Germany.”

The ECB: Draghi and beyond

ECB - Governing Council meeting 07.12. 2017
The central chamber of the ECB, where the executive board plus heads of the 19 euro area countries’ central banks meet

$2.6tn

Of bonds issued by governments and companies bought by the ECB

11m

Jobs created in the eurozone over the past decade, cited as proof of Draghi’s policy success

2

Women on the 25-member ECB executive board — including Ms Lagarde

A potential solution to some of the problems confronting the new ECB boss would be for northern European governments with strong budgetary positions — particularly Germany — to break with years of fiscal prudence and use fiscal policy to stimulate the economy, something Ms Lagarde has repeatedly advocated.

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Mr Draghi has said US president Donald Trump’s tax cuts are the main reason that growth and inflation are higher in America than in the eurozone, while calling for European leaders to do more. But his pleas have fallen on deaf ears and economists expect Ms Lagarde to use her political experience and contacts to try to break the deadlock.

“The biggest challenge facing Christine Lagarde will be to get Berlin to do a major fiscal stimulus,” says Melvyn Krauss, a senior fellow at Stanford University’s Hoover Institution. “Germany’s continued refusal was the main reason Draghi couldn’t solve Europe’s too low inflation problem and why Ms Lagarde could face a similar fate.”

Ms Lagarde is also expected to embark on the ECB’s first strategic review of its main monetary policy objectives and tools for 16 years. This looks set to be the next battleground between the “doves” and the “hawks” — those in favour of more monetary easing and those against it.

A particularly contentious question is whether to take some pressure off the central bank by changing its core aim to achieve inflation of below but close to 2 per cent — something it has failed to do for years as consumer prices have stagnated across the world.

“The ECB faces the risk of monetary policy becoming overburdened while it experiences challenges in delivering on its inflation aim and the risks of pushing harder are mounting,” says Klaas Knot, the hawkish head of the Dutch central bank. He wants the ECB to target a range of inflation instead, so it can tolerate periods of lower price growth.

Some economists such as Mr Krauss says such a move would condemn Europe’s ageing population to a future of low growth, low inflation and low rates — similar to Japan’s sleepy economy.

When it was created in 1998, the ECB was modelled on the Bundesbank, with a narrow focus on keeping a lid on inflation and maintaining its independence from governments. This included a strict ban on any type of “monetary financing”, which means a central bank printing money to finance government spending.

Since he took over in 2011, Mr Draghi has reshaped the ECB more in the mould of the US Fed by increasing the tools at its disposal and bringing more flexibility to its mandate of “price stability”. When southern European countries were faced with ballooning borrowing costs and collapsing banking systems in 2012, Mr Draghi promised to do “whatever it takes”, a move widely credited with preserving the euro.

Ms Lagarde was in the room that day. When MEPs asked recently if she shared Mr Draghi’s determination to do whatever it takes to protect the eurozone, she responded that she aimed to avoid ever finding herself in such a situation.

“I hope I never have to say something like that because if I do it will mean that other economic policymakers have not done what they have to,” she said. As if to emphasise that the ECB cannot wave a magic wand and keep coming to the rescue, she added: “I am not a fairy.”

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