A central bank steers the economy not only with interest and money, but also with credibility. The markets must believe that the ECB will do what it takes. That is why one sentence from an ECB president can have enormous influence and that is why the choice of Christine Lagarde's successor is more important than the technocratic nature of the institution suggests. That is the message of Thijs Knaap (Chief Economist at APG Asset Management) during a broadcast of the program Vroeg! on NPO Radio 1.
In the broadcast, Thijs Knaap calls the ECB one of the most important and best functioning European institutions. He compares her to the fire department: you need her badly when it matters, but she shouldn't be too prominently visible. Knaap: "You'd rather not have her come by. When we talk a lot about the ECB, there is usually something wrong in the economy."
Knaap explains that the ECB's main task is price stability, but it also implicitly has a second crucial task: ensuring that the monetary union stays together. In a financial crisis, the ECB can intervene quickly and directly where political European institutions need much more time.
Interest rate is a powerful but crude instrument
The ECB can fight inflation by raising interest rates. This slows down demand almost everywhere: mortgages, business investment, consumption and other forms of financing become more expensive. The problem, according to Knaap, however, is that the ECB has to steer on incomplete and delayed economic information, while it is also not known exactly how strongly an interest rate change will have an effect.
That makes the current problem extra difficult. Higher energy prices are the result of a supply shock. The ECB cannot produce oil or gas. It is raising interest rates mainly to prevent the initial price increase from spreading through the economy. At the same time, there is a risk that it will slow down the economy too much and even cause contraction. "Interest rates are a coarse and heavy instrument. There is a good chance that you will do too much and slow down the economy too hard."
Person of ECB president matters
The ECB is formally a technocratic, independent institution. You might therefore think that it makes little difference who is president. According to Knaap, the opposite is true, because financial markets are constantly trying to estimate what the ECB will do in the future. For this, the president's words are interpreted very carefully. "We weigh the words of the ECB president on a gold scale. We try to deduce from this what the ECB will do next."
Lagarde leaves behind credible ECB
According to Knaap, Christine Lagarde was initially a remarkable choice, partly because she is not an economist. In the end, it was her way of working that worked out well. She took a lot of time to bring people together within the ECB and, according to him, restored some of the harmony that had been lost under her predecessor Mario Draghi.
Despite the high current inflation, people still expect it to return to 2 percent in the longer term. According to Knaap, this shows how strong the credibility of the ECB is. "Lagarde leaves behind an institution with great credibility. Perhaps that is the most important thing in her legacy."
Klaas Knot
The broadcast covers other interesting topics, such as the challenge for the ECB of high European sovereign debt and in particular that of France. Knaap also gives his opinion on a possible succession of Lagarde by Klaas Knot, former president of the Dutch Central Bank.