Central Banks in The Age of Euro

Central Banks in the Age of the Euro
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Central Banks
in the Age of the Euro
Europeanization, Convergence,
and Power
Edited by
Kenneth Dyson and Martin Marcussen
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Acknowledgements and Preface
By general consent European monetary union represents an historic event for

European unification and for European Union (EU) member states. Manifestly,
it is also historic in central banking: A new ‘stateless’ central bank managing a
single currency, the euro, for (by 2009) sixteen EU member states, which
voluntarily delegated their sovereignty over monetary policy.
This book examines the effects of this new ‘age of the euro’ on European
central banks: Euro Area ‘insiders’, temporary ‘outsiders’, and semi-permanent
‘outsiders’. These effects are matters of great topical and academic interest. They
provide insights into the complex relations between Europeanization, power,
and convergence in European central banking and into how international,
European, and domestic factors shape these relations into different configur-
ations.
The book is a companion to The Euro At 10 (OUP) in addressing the same
questions but with a narrower focus. Central banking provides an opportunity
to explore a paradox. On the one hand, it has been subjected to major Euro-
pean-level institution building with the creation of the ‘Eurosystem’, which
brings together the European Central Bank (ECB) and its national central banks
(NCBs). Europeanization processes have in consequence, been unusually
powerful. On the other hand, central banking is deeply and exceptionally
embedded in an internationalized professional community, in globalized finan-
cial markets, and in academic macroeconomic debates. These three character-
istics shape its contemporary professional character: cosmopolitan, market-
oriented, and technocratic. Consequently, the independent impact of Euro-
pean monetary union (EMU) on central banking is limited. Europeanization
reinforces central banking policy beliefs and practices that have their roots in
wider processes of international diffusion. As will also become clear, the limi-
tations of Europeanization also stem from the significance of domestic political
contexts and historical legacies, most evidently in ‘semi-permanent’ outsiders
like Britain and Sweden. Nevertheless, Europeanization has never before been
so potent a force in European central banking; this process has accompanied
the empowerment of central banks in macroeconomic discourse and manage-
ment; whilst convergence pressures in central banking have strengthened. This
book maps these three interconnected phenomena.
v
The book’s distinctive character derives from the focus, questions, and ap-
proaches typical of political science in addressing comparative political econ-
omy. It deals with Europeanization, power, and convergence in institutions and
policy processes. It focuses on ideas, institutions, discourse, and strategies in
central banking; asks questions about how they mediate the effects of the euro
on states (Europeanization) and about what they tell us about power and
convergence. At the same time a key theme is the limits of Europeanization as
a concept for capturing processes of change in central banking and differences
in reform trajectories.
The book benefited from two major opportunities to bring together contri-
butors in research workshops. The EU-CONSENT Network of Excellence sup-
ported a first workshop in Cardiff University in May 2007. Special thanks are
due to the British Academy for co-funding a second research workshop in
November 2007 with the EU-CONSENT Network. These workshops provided
invaluable opportunities for authors to present drafts of their chapters for
discussion. In particular, Angela Pusey at the British Academy displayed great
courtesy, patience, and efficiency in ensuring the smooth running of the British
Academy workshop.
In addition, the final revision of chapters benefited greatly from the com-
ments of all contributors, who served as discussants on each other’s papers at
the two workshops. Particular debts of gratitude are owed to Professor Charles
Goodhart (LSE) and to Professor Ivo Maes (Catholic University of Louvain) for
their trenchant advice.
Dominic Byatt and his team at Oxford University Press have offered unfailing
encouragement and support at every stage. Through their commitment, will-
ingness to work as a team, and patience with our efforts at guidance, the
contributors have made our task pleasant and rewarding in personal as well as
in academic terms. The combination of OUP’s professionalism with the dedi-
cation of contributors lightened the editorial load. Nevertheless, as ever, any
shortcomings in the final product remain the responsibility of the editors.
Finally, a few words are needed about the immediate context of the book. It
was written as the dramatic events associated with the financial crisis of 2007–8
began to unfold. The US sub-prime mortgage crisis and the crisis in the inter-
bank money markets had occurred. However, the US rescues of the mortgage
financing giants Fannie Mae and Freddie Mac and the insurance giant AIG, the
bankruptcy of Lehman Brothers, and the spread of bank solvency crises to the
EU and Euro Area lay ahead. By September 2008, the three Benelux govern-
ments were rescuing Fortis bank; the German government and Bundesbank
were bailing out Hypo Real Estate; a number of German states were rescuing
their state banks; whilst EU governments were offering guarantees for bank
deposits in an ad hoc, initially uncoordinated manner. Central banks were
drawn into liquidity support operations and into bank rescue operations on a
massive scale, rediscovering their role as banker to the banks; huge public stakes
vi
were taken in banking systems, not least in the United States and Britain, the
homes of archetypal ‘Anglo-American free market capitalism’; the regulation
and supervision of financial markets became a high-profile political issue;
whilst monetary policy stood uneasily poised between the challenge of infla-
tion and threats from the financial crisis to the real economy of output and
jobs. The economic and political world of central banking was in transform-
ation: A favourable tailwind for monetary policy had been replaced by strong,
volatile headwinds. Clearly, this book does not have the benefits of being able
to look back on this crisis and assess its historical scale and long-term effects on
central banking, an exercise that will be possible in a few years time, though
some points are fairly safe to establish even at this early stage. We can only take
note of events up to spring 2008. This problem is not, however, central to the
book. The first chapter recognizes that since 1999 the age of the euro has been
embedded in a political economy of (in historical terms) good times. This era is
closing. Central banks, financial markets, politicians, and officials will be mak-
ing history in a very different context of hard times. Just how different that
context will be, and what effects their actions will have, we do not yet fully
know.
Kenneth Dyson
Cardiff University, Wales
Martin Marcussen
Copenhagen University, Denmark
June 2008
vii
Contents
List of Figures xi
List of Tables xiii
Abbreviations xv
Notes on Contributors xix
1. The Age of the Euro: A Structural Break? Europeanization,

Convergence, and Power in Central Banking 1
Kenneth Dyson
Part I The Changing Context of Central Banking

2. Differentiation in the European System of Central Banks:
Circles, Core, and Directoire 53
Gaby Umbach and Wolfgang Wessels
3. The European Central Bank: The Bank That Rules Europe? 73
David Howarth
Part II Eurosystem ‘Insider’ Central Banks

4. National Banks of Belgium and the Netherlands:
Happy with the Euro 91
Ivo Maes and Amy Verdun
5. Bank of France: The Challenge of Escaping Politicization 111
David Howarth
6. German Bundesbank: Europeanization
and the Paradoxes of Power 131
Kenneth Dyson
7. Bank of Greece: Latecomer, Uphill Adjustment 161
George Pagoulatos
ix
Contents
8. The Banca d’Italia: Between Europeanization and Globalization 183

Lucia Quaglia
Part III ‘Temporary’ Outsiders: Pace Setters and Laggards

9. Estonia, Hungary, and Slovenia: Banking on Identity 203
Béla Greskovits
10. Czech Republic and Poland: The Limits of Europeanization 221
Rachel Epstein and Juliet Johnson
Part IV ‘Semi-Permanent’ Outsiders

11. Bank of England: Learning to Live with the Euro 241
Charles Goodhart
12. Denmark and Sweden: Networking by Euro-Outsiders 263
Martin Marcussen
Part V Lessons from Non-European Central Banks

13. The Political Economy of Central Banking in Australia
and New Zealand 287
Chris Eichbaum
14. The US Federal Reserve and the Politics of Monetary
and Financial Regulatory Policies 307
John T. Woolley
Part VI Convergence and Divergence

15. Financial Supervision: Internationalization,
Europeanization, and Power 337
Michael Moran and Huw Macartney
16. Monetary Policy Strategies 355
Iain Begg
17. Scientization of Central Banking: The Politics of A-Politicization 373
Martin Marcussen
18. Transparency and Accountability 391
Nicolas Jabko
References 407
Index 435
x
List of Figures
2.1: Groups of ESCB membership 55

2.2: The ESCB—‘Europe of concentric circles’ led by a ‘core Europe of the
able’
with traces of a ‘directoire of the powerful’ 59
7.1: The Greek electoral cycle: fiscal and monetary expansion, 1975–99 164
7.2: Greek inflation, interest rates, and short-term bank-lending deposit rate
spread, 1950–2000 164
7.3: Real short-term interest rates: Greece and EU, 1980–2000 168
7.4: Bank of Greece organization chart, 2007 178
10.1: Central bank participants in CCBS, JVI, and IMF institute courses,
1991–2000 225
11.1: Bank of England: numbers of staff by area, 2000 and 2001 255
12.1: Public support for the euro in Sweden and Denmark 264
12.2: The Danish central bank’s participation in ESCB committee work,
2004 and 2008 270
12.3: Central bank transparency, 1998–2005 272
12.4: Busy Danish and Swedish euro-outsiders 276
12.5: Development in staff numbers (FTEs) of the Danish
and Swedish central banks 278
14.1: US real GDP growth over quater year prior, 1964–2007 310
14.2: US headline and core inflation; Euroland inflation 1964–2007 310
14.3: US unemployment rate, 1964–2006 311
14.4: Nominal and real rederal funds rate January 1964–February 2008 311
14.5: References to inflation, FOMC meetings 323
14.6: References to output and [un]employment, FOMC meetings 326
14.7: ‘Euro’ references (EMS, EMU, ECB, Euro) as share of FOMC references to
European countries and institutions (e.g. Bundersbank, Bank of France,
Germany, France) 327
14.8: All references to European currencies, central banks, or countries, FOMC
meetings 1978–2001 328
xi
List of Tables
5.1: Appointments to the Bank of France’s Conseil de la politique monétaire

(1994–2007) and Comité Monétaire (2007–present) 116
7.1: Bank of Greece governors, 1946–2008 167
9.1: Non-performing loans, and domestic credit to private sector and
households in Estonia, Hungary, and Slovenia, 1993–2006 206
9.2: Employer organization, union density, and pattern of wage bargaining in
Estonia, Hungary, and Slovenia, 2002–3 207
9.3: Transnationalization of commercial banking in Estonia, Hungary, and
Slovenia, 1988–2006 207
9.4: Economic performance of Estonia, Hungary, and Slovenia, 2004–6 208
9.5: Hopes and fears about the euro in Estonia, Hungary, and Slovenia
(% of answers) 219
11.1: Bank of England expenditure budget 254
12.1: Referenda in Denmark and Sweden on EMU 264
12.2: The Danish and Swedish central banks in successive cooperative currency
arrangements 266
12.3: Staff costs in the Danish and Swedish central banks 273
12.4: Danish and Swedish central bank governors’ salaries, 2003 (US$) 273
12.5: Average tenure in the Danish and Swedish central banks 273
12.6: Two worlds apart: institutional reforms in the Swedish and the Danish
central banks 277
12.7: Danish and Swedish strategies of coping with being euro-outsiders 280
14.1: Greater US economic stability after 1983 312
17.1: Central banking throughout the ages 376
17.2: The impact of scientization on governance, knowledge,
and accountability 384
xiii
Abbreviations
AMLF Asset Backed Commercial Paper Money Market Mutual

Fund Liquidity Facility
APRA Australian Prudential Regulation Authority
ASIC Australian Securities and Investments Commission
BCBS Basel Committee on Banking Supervision
BEPG Broad Economic Policy Guidelines
BFIC Banking, Finance and Insurance Commission
BIS Bank for International Settlements
BoG Bank of Greece
BSC Banking Supervision Committee
CBI Central Bank Independence
CCBM Correspondent Central Banking Model
CEBS Committee of European Banking Supervisors
CECEI Comité des établissements de crédit et des entreprises d’investissement
CEE Central and Eastern Europe
CEG City Euro Group
CFR Code of Federal Regulations
CNB Czech National Bank
CP Core Purposes
CPFF Commercial Paper Funding Facility
CSSB Czechoslovak State Bank
DNB De Nederlandsche Bank
EBRD European Bank for Reconstruction and Development
ECB European Central Bank
ECMS Euro Collateral Management System
EFSAL Enterprise and Financial Sector Adjustment Loan
ERM Exchange-Rate Mechanism
EMI European Monetary Institute
CPM Conseil de la Politique Monétaire
xv
Abbreviations
EMS European Monetary System

EMU Economic and Monetary Union
EP European Parliament
ESCB European System of Central Banks
FFIEC Federal Financial Institutions Examination Council
FFR Federal Funds Rate
FIDL Financial Institutions Development Loan
FOMC Federal Open Market Committee
FRB Federal Reserve Board
FSA Financial Services Authority
FTE Full-Time Equivalent
GDP Gross Domestic Product
HFC Holland Financial Centre
IGC Intergovernmental Conference
IMF International Monetary Fund
IT Inflation Target
JVI Joint Vienna Institute
MMIFF Money Market Investor Funding Facility
NBB National Bank of Belgium
NBP National Bank of Poland
NCB National Central Banks
NCP National Convergence Program
NSP National Stability Program
OCR Official Cash Rate
OECD Organization for Economic Cooperation and Development
OEEC Organization for European Economic Cooperation
OFS Overview of Financial Stability
PDCF Primary Dealer Credit Facility
QMA Quarterly Monetary Assessment
ROW Rest of the World
SDP Social Democratic Party
SEPA Single Euro Payment Area
SGP Stability and Growth Pact
SNB Swiss National Bank
TAF Term Auction Facility
TARGET Trans-European Automated Real-time Gross Settlement Express Transfer
xvi
Abbreviations
TEU Treaty on European Union

TSLF Term Securities Lending Facility
USAID US Agency for International Development
WP Working Party
xvii
Notes on Contributors
Iain Begg is a Professorial Fellow in the European Institute at the London

School of Economics and Political Science. His research focuses on the political
economy of European integration and on EU economic policy, on which he
has published numerous co-authored, edited, and co-edited books. He was a
co-editor of the Journal of Common Market Studies from 1998 to 2003.
Kenneth Dyson is a Research Professor in European Politics at Cardiff
University, Wales. He is a Fellow of the British Academy and an Academician
of the Learned Society of the Social Sciences. His books on EMU include Elusive
Union: The Process of Economic and Monetary Union (Longman 1994); The Road to
Maastricht: Negotiating Economic and Monetary Union (with Kevin Featherstone,
Oxford University Press 1999); The Politics of the Euro-Zone: Stability or Break-
down? (Oxford University Press 2000); European States and the Euro (Oxford
University Press 2002); Enlarging the Euro Area: External Empowerment and
Domestic Transformation in East Central Europe (Oxford University Press 2006);
and The Euro At 10: Europeanization, Convergence and Power (Oxford University
Press 2008). He was an adviser to the BBC2 series ‘The Money Changers’ on the
making of EMU. His main research interests are in German policy and politics,
European economic policies and politics, and the EU. He is the co-editor of the
journal German Politics.
Chris Eichbaum is a Senior Lecturer in Public Policy in the School of Govern-
ment at Victoria University of Wellington New Zealand. His doctoral research
entailed a comparative study of the shaping of the institutions of central
banking in Australia and New Zealand. His current research interests are in
the institutions of central banking, governance and public administration,
and political and bureaucratic actors in executive government.
Rachel Epstein is an Assistant Professor at the Graduate School of Inter-

national Studies at the University of Denver. She is the author of In Pursuit of
Liberalism: International Institutions in Postcommunist Europe (Johns Hopkins
University Press 2008) and has written widely on NATO and EU enlargement
as well as on the effects of the International Monetary Fund and World Bank in
the post-communist transition. She was a Jean Monnet postdoctoral fellow at
the European University Institute in 2001 and 2002 and returned to EUI in
xix
2004 to serve as the Robert Schuman Centre’s Transatlantic Research Fellow.

She received her PhD in the Department of Government at Cornell University
in 2001.
Charles Goodhart, CBE, FBA is a member of the Financial Markets Group at
the London School of Economics (LSE), having previously, 1987–2005, been its
Deputy Director. Until his retirement in 2002, he had been the Norman Sosnow
Professor of Banking and Finance at LSE since 1985. Before then, he had worked
at the Bank of England for seventeen years as a monetary adviser, becoming a
Chief Adviser in 1980. In 1997, he was appointed one of the outside independ-
ent members of the Bank of England’s new Monetary Policy Committee until
May 2000. Besides numerous articles, he has written a couple of books on
monetary history; a graduate monetary textbook, Money, Information and Uncer-
tainty (2nd edn, 1989); two collections of papers on monetary policy, Monetary
Theory and Practice (1984) and The Central Bank and The Financial System (1995);
and a number of books and articles on financial stability, on which subject he
was Adviser to the Governor of the Bank of England, 2002–4, and numerous
other studies relating to financial markets and to monetary policy and history.
Béla Greskovits is a Professor of International Relations and European Studies

at the Central European University, Budapest. He is the author of The Political
Economy of Protest and Patience. East European and Latin American Transformations
Compared (Central European University Press 1998). His most recent articles on
the political economy of policy reform and the diversity of post-socialist capit-
alism have appeared in Studies in Comparative and International Development;
Labor History; Orbis; West European Politics; Competition and Change; and Journal
of Democracy.
David Howarth is a Senior Lecturer in Politics at the University of Edinburgh.
He is the author of the French Road to European Monetary Union (Palgrave 2001);
(with Peter Loedel) The European Central Bank (Palgrave 2003 and 2005); and
(with Georgios Varouxakis) Contemporary France (London: Edward Arnold
2003). He has written several articles and book chapters on French economic
policy and policy-making and Economic and Monetary Union.
Nicolas Jabko is a research director at the Centre d’Etudes et de Recherches

Internationales (CERI) of SciencesPo in Paris. He is the author of Playing the
Market: A Political Strategy for Uniting Europe, 1985–2005 (Cornell University
Press 2006) and the co-editor of the eighth volume of the State of the European
Union (Oxford University Press 2005).
Juliet Johnson is an Associate Professor of Political Science at McGill Univer-
sity. She is the author of A Fistful of Rubles: The Rise and Fall of the Russian
Banking System (Cornell 2000) and the co-editor of Religion and Identity in
Modern Russia: The Revival of Orthodoxy and Islam (Ashgate 2005). She is also
xx
the co-editor of the Review of International Political Economy and has published
numerous articles and book chapters on post-communist political economy
and identity politics. She has served as both a Research Fellow in Foreign Policy
Studies at the Brookings Institution (1995–6) and the A. John Bittson National
Fellow at the Hoover Institution (2001–2). She is currently finishing a book
entitled Priests of Prosperity: The Transnational Central Banking Community and
Post-Communist Transformation. She received her PhD in Politics from Princeton
University in 1997.
Huw Macartney is an ESRC Postdoctoral Fellow at Nottingham University.
He has recently completed his PhD, Transnational Social Forces, Variegated
Neo-liberalism and Financial Market Integration in the EU, at the University of
Manchester and has a forthcoming article in the British Journal of Politics and
International Relations.
Ivo Maes is a Deputy Head of the Research Department of the National Bank of
Belgium and holds the Robert Triffin Chair at the Institut d’études Européennes
of the Université Catholique de Louvain. His current research focuses on the
history of central banking and European monetary and financial integration.
His recent publications comprise Economic Thought and the Making of European
Monetary Union (Edward Elgar 2002); The Bank, the Franc and the Euro, A History
of the National Bank of Belgium (Lannoo 2005, co-author); and Half a Century of
European Financial Integration. From the Rome Treaty to the 21st Century (Merca-
torfonds 2007). He has been a visiting professor at Duke University (USA) and at
the Université de Paris-Sorbonne.
Martin Marcussen is an Associate Professor of Politics at the University of
Copenhagen. He specializes in global governance, European integration, and
the role of ideas in public policy. He is the author of Ideas and Elites: The Social
Construction of Economic and Monetary Union (Aalborg University Press 2000).
Michael Moran is WJM Mackenzie Professor of Government at Manchester
University and a Fellow of the British Academy. His most recent book is The
British Regulatory State: High Modernism and Hyper-Innovation (Oxford University
Press, 2nd edn, 2007).
George Pagoulatos is an Associate Professor of Politics at the Department of
International and European Economic Studies, Athens University of Economics
and Business, and Visiting Professor at the College of Europe in Bruges. He was a
member of the Greek government’s Council of Economic Advisors (2002–4). He
has published extensively in journals such as West European Politics; Journal of
Common Market Studies; Journal of Public Policy; Public Administration; and European
Journal of Political Research. His book Greece’s New Political Economy: State, Finance
and Growth from Post-war to EMU (Oxford St. Antony’s Series, Palgrave Macmillan
2003) received the Academy of Athens award for best book in economics.
xxi
Lucia Quaglia is a Senior Lecturer in Politics and Contemporary European

Studies at Sussex University. In addition to numerous articles in journals and
chapters in edited volumes, she has published Central Bank Governance in the EU:
A Comparative Analysis (Routledge 2008).
Gaby Umbach is a research associate at the Jean-Monnet Chair for Political

Science, University of Cologne. Her main field of research and expertise in-
cludes European integration and governance and Europeanization studies. Her
doctoral thesis is on the Europeanization of British and German employment
policies and policy-making structures.
Amy Verdun is a Professor of Political Science, Jean Monnet Chair and Director
of the Jean Monnet Centre of Excellence at the University of Victoria, Canada.
She is the author or editor of nine books and has served as guest editor of five
special issues of peer-reviewed journals. She has published in peer-reviewed
journals such as British Journal of Politics and International Relations; Journal of
Common Market Studies; Journal of European Public Policy; Journal of Public Policy;
and Review of International Political Economy.
Wolfgang Wessels holds the Jean Monnet Chair for Political Science at the
University of Cologne. In 2007, he received the European Award ‘Jean Monnet’
in Gold. He is chair of the Executive Board of the Institut für Europäische Politik
(Berlin) and of the Trans European Policy Studies Association (Brussels), as well
as coordinator of the EU-CONSENT Network of Excellence. Recent publications
include Economic Government of the EU. A Balance Sheet of New Modes of Policy
Coordination (ed. Ingo Linsenmann and Christoph O. Meyer, 2007).
John T. Woolley is a Professor of Political Science and Chair of the Political

Science Department at the University of California, Santa Barbara. Starting with
Monetary Politics (Cambridge 1984), he has published extensively on the politics
of monetary policy and European monetary integration. He has studied the
politics of environmental politics and is co-founder of a well-known web site,
The American Presidency Project www.americanpresidency.org
xxii
1
The Age of the Euro: A Structural Break?
Europeanization, Convergence, and
Power in Central Banking
Kenneth Dyson
The coming of the age of the euro, signalled by the establishment of the
European Central Bank (ECB) in 1998, represented a bold novelty in the history
of central banking. It involved the birth of a small, untested, supra-national
central bank, which was cast directly into the role of the second most powerful
in the world, only half a decade after the European Exchange-Rate Mechanism
(ERM) had been convulsed by crises in 1992–3 (on which Dyson 1994). The
unprepossessing context was an institutionally weak European polity, without
independent fiscal competence, not least to bail out cross-nationally active
banks, and without a centralized European banking supervisory structure
(Dyson 2008b). A lonely ‘institution-in-the-making’, the ECB was responsible
for managing a new single currency, the euro, for over 300 million Europeans
in, initially, 11 of 15 European Union (EU) member states. As one of its first
Executive Board members noted, its youth, its distinctive institutional loneli-
ness, and its lack of the attributes of a fully integrated central bank—notably in
banking supervision—left it exposed (Padoa-Schioppa 2000, 2005). Second, the
age of the euro involved a core grouping of European states, which incorporated
a mosaic of historically formed identities, voluntarily merging their currencies
in a time of peace. In consequence, the ECB was formed in elite consensus but
had weak resources of European identity and solidarity on which to draw.
Unsurprisingly, given these two aspects of its context, its first Chief Econo-
mist, Otmar Issing (2008) stresses the scepticism that prevailed initially, not
just amongst characteristically cautious central bankers but also in the financial
markets and amongst financial journalists (cf. Woolley’s chapter on the US Fed
in this volume). Structural rigidities, not least in financial, services, and labour
markets, suggested the danger of persisting and economically and politically
1
problematic differentials in output growth; there was high uncertainty about

whether monetary union would disrupt economic relationships and regu-
larities; institutional arrangements for cross-national banking supervision
were weakly developed; procedures for cross-national bank bail outs remained
uncertain; whilst member-state governments were often reluctant to ‘own’ the
importance of compliance with stability-oriented fiscal policy rules and struc-
tural reforms (Weber 2008a).
Finally, in a post-war European integration process that had had containment
of German power as one of its central motifs, the age of the euro represented the
most explicit example of Europeanization on the basis of a German central
banking template (Dyson and Featherstone 1999). It embodied German ‘soft’
power in the most vivid structural terms. This power was evident in the ECB’s
institutional modelling on the Bundesbank; in the role accorded to monetary and
credit analysis and long-term time horizons in monetary policy; and in historical
lesson drawing from the Bundesbank’s relative success in the 1970s–80s in for-
ging a powerful reputation for fighting inflation by pre-emptive action to shape
expectations and by its belief that ‘stability begins at home’.
The Birth of the Euro
The idea of the age of the euro as a structural break was blunted by the reality of
its smooth birth. The ECB’s early success owed much to its careful, meticulous
technical preparation by EU central bankers in the decade before its launch.
More specifically, it derived from ‘borrowing credibility’ by its institutional
modelling on the foremost and most-admired EU central bank, the German
Bundesbank. In particular, from 1 January 1994 the new European Monetary
Institute (EMI), composed of EU central bankers, prepared this final stage
three of Economic and Monetary Union (EMU) (on which Dyson 2000;
Dyson and Featherstone 1999). This period offered an opportunity to build a
team approach to monetary policy and for many national central banks to
begin upgrading their analytical capacity to contribute to this process. In fact,
the post-1979 ERM had served as an even longer training ground in monetary
policy coordination and in learning through crisis management, on which
many of the founding central banks could draw (Dyson 2000).
The EMI period also clarified the centrality of the principle of decentraliza-
tion in the design of the Eurosystem. Its justification depended on the role of
the national central banks in cultivating public confidence by maintaining the
quality of banknotes in circulation. It also recognized the historically different
functions of national central banks in their own societies (on which see pp. 19–28
below). Finally, given the association of national central banks with a state-
based EU, they were essential for communicating monetary policy to different
domestic audiences. At the same time, the EMI period manifested a concern of
2
national central banks—cloaked behind the principle of decentralization in

designing the new central banking system—to find a new mission for them-
selves, protect their activities, and thereby secure jobs. This concern focused on
ensuring their role in monetary policy implementation and on designing
an appropriate formula-based approach to the allocation of monetary income
in the Eurosystem. Against this background EMI ‘staffers’ sought successfully to
ensure that adequate resources were made available for the new ECB to discharge
its functions effectively. The results of the ERM experience and of the EMI period
supported a seamless transition, first to monetary union in 1999 and then to
currency union. It was the culmination of the technically demanding transition
to euro notes and coins in January 2002 that intensified domestic questioning of
national central banks’ inherited structures and staffing levels, even rhetorical
questions about their very rationale to exist.
The euro evoked expectations of a structural break that went beyond just
locking in a cross-national ‘stability culture’ across its member states by means
of a radically independent ECB. It represented the promise of a new symbol of
European identity and unity, of a political catalyst for closer European integra-
tion, of an economic stimulant to increased trade and financial integration, and
of a new rival international currency to the US dollar (on its performance in
these respects, see Dyson 2008b). At the same time, however, echoing the EU
into which it was born, the Euro Area remained a political pygmy on the
international stage, unable to speak with a single authoritative voice in inter-
national economic diplomacy (cf. European Commission 2008). It also failed,
at least in its first decade, to become ‘loved’ by the citizens of the Euro Area
(on which in detail Dyson 2008b). Not least, three Euro Area states rejected
further EU treaty-making exercises in deepening political union: France and the
Netherlands in 2005, and Ireland in 2001 and 2008. Paradoxically, Irish rejec-
tion took place in the context of Eurobarometer data suggesting that the euro
had led to a greater increase in European identity than in any other Euro Area
state (ibid.).
The distinctiveness of the age of the euro lies in a paradox. On the one hand,
the ECB is a supra-national central bank, which by 2009 covered 16 out of 27
EU member states. It possesses a radical form of Treaty-based independence,
including the capacity to define what its strictly limited Treaty mandate of
securing price stability means: the so-called ‘goal’ independence. In addition,
the ECB, and the wider Eurosystem of central banks of which it is part, consti-
tutes a ‘missionary’ institution. It is unified around a coherent, intellectually
robust body of macro-economic knowledge about the normative basis of, and
causal mechanisms at work in, monetary policy. In addition, the ECB is held
together by a sense of ‘making history’. This combination of radical supra-
national independence with epistemic consensus and missionary character
makes it more akin to the European Court of Justice than to the European
Commission in its unity, self-confidence, and didacticism.
3
On the other hand, the ECB lacks the traditional central banking advantage
of being able to take shelter, as a technocratic entity, beneath the protective
umbrella of a unified political authority that supports its mandate. It lacks
the supportive political context of a federal European fiscal stabilizing mech-
anism to cushion and smooth adjustment to asymmetric economic shocks.
Perhaps more ominously, in light of the traditional function of central banking
in safeguarding financial stability, the ECB cannot confidently rely on a federal
‘bail-out’ mechanism in case of contagious, systemic cross-national banking
and financial crisis. The EU-level Memorandum of Understanding in April 2008
represented progress in organizing cross-national ‘stability groups’ of super-
visors for some 20 to 30 cross-border banks. Nevertheless, the Euro Area had a
weakly developed and, up to the 2008 financial crisis, untested institutional
capacity for cross-national crisis management and is deficient in traditional
symbols of collective solidarity in dealing with future configurations of the
political economy of ‘hard times’ (Dyson 2008a). The ECB is a ‘stateless’,
isolated central bank in an ‘institutionally fuzzy’ polity (on which Dyson
2008b).
The age of the euro combines sharply defined central bank independence in
monetary policy with institutional ‘fuzziness’ in the key functions of financial
stability and fiscal compensation. It represents a form of hybrid central bank-
ing. The Euro Area is both located ‘beyond the state’ in monetary policy and yet
constrained by member states’ willingness to ‘own’ the euro in their domestic
fiscal, economic reform, and banking and financial market supervisory policies
and in coordinating nationally organized bank bail outs. At the same time, in
involving the most radical Europeanization of its member states through dele-
gation of sovereignty in monetary policy, the age of the euro highlights even
further the domestic distinctiveness of the constituent national central banks
of the Eurosystem. These national central banks are the most ‘Europeanized’ of
domestic institutions. In consequence, they are particularly interesting cases for
Europeanization research.
This institutionally lonely and exposed position of the ECB and of the
national central banks of the Eurosystem induces tension. In this context the
striking, even radical accentuation of the principle of central bank independ-
ence is functional. It acts as collective insurance for a new untried currency
against the heightened risks to credibility from its political dependence on
problematic domestic ‘ownership’ and loyalty by member-state political and
economic elites. It relies on them to expedite reforms to make adjustment
processes more speedy and efficient and to lower the costs of disinflation. In
this paradox, we encounter the elusiveness of Eurosystem central bank power in
the age of the euro: the combination of strong institutional profiling and
discursive confidence in monetary policy with problematic domestic political
ownership in fiscal and economic reform policies and weak institutional cap-
acity in cross-national financial market crisis management and bank bail outs.
4
Institutional and policy privileging of the ECB in an ‘ECB-centric’ Euro Area

(Dyson 2000) and its bias to anti-inflation ‘vigilance’ in monetary policy are the
counterweight to the distinctive set of political and economic uncertainties
that it faces in attempting to deliver its Treaty mandates of price stability and
promoting financial stability. The euro was born against the historic back-
ground of deep scepticism in international banking and monetary policy cir-
cles, notably in the United States, that European monetary union would go
ahead and, if so, could prove feasible. The scepticism was in part technical,
notably related to the gigantic scale of the problems in conversion to the new
currency across 11 member states, to the paucity of relevant, reliable economic
and monetary statistics for the Euro Area, and to incomplete institution build-
ing notably in macro-economic coordination of domestic fiscal policies and
economic reforms and in banking supervision and crisis management. Above
all, there were the political as well as economic uncertainties associated with a
‘one-size-fits-all’ monetary policy for an economically heterogeneous group of
states, lacking the attributes of an ‘Optimum Currency Area’. There was also
uncertain knowledge about how monetary policy transmission mechanisms
would work. In confronting these, and other more widely shared, sources of
uncertainty in central banking, the ECB had to rely on ‘borrowing’ credibility
from the German Bundesbank. Above all, the ECB faced uncertainties about the
collective action capacity of the Euro Area and the wider EU and about domestic
ownership by political elites. Domestic political elites faced temptations to play
a ‘blame-shifting’ populist politics, in which the ECB would emerge as a scape-
goat for domestic failures to tackle problems of economic growth, employment,
and unsustainable public finances.
Populist incentives to shift blame to the ECB materialized in the French
Presidential elections of 2002 and 2007 and the Italian elections of 2006 and
2008. National central banks, for instance in Greece, were drawn into domestic
political controversy as they argued for more comprehensive and faster domes-
tic economic reforms. Central banking in the age of the euro was a story of
stronger independence and a more central role in domestic macro-economic
policy coexisting in tension, and potentially in conflict, with politicization.
Europeanization of central banking involved simultaneous de-politicization
and politicization as the domestic reform implications of the age of the euro,
above all market liberalization, made institutional veto points and partisan veto
players more transparent, mobilized losers, and raised politically difficult prob-
lems of their compensation in exchange for reforms, especially when public
finances were already ‘unsound’.
In another sense, however, the combination of Treaty-based independence,
creating a very high legal hurdle for collective political action to curb the ECB,
with the sheer number of veto points and partisan veto players increased
the credibility of central bank independence (cf. Keefer and Stasavage 2003).
The decentralized structure of the Euro Area helps insulate the ECB from
5
political interference, in a way that further mimics earlier German experience

(cf. Hallerberg 2002; Lohmann 1998). As French President Nicolas Sarkozy and
Italian Prime Minister Silvio Berlusconi discovered, organizing an EU-wide
unity of purpose to curb the ECB is highly problematic, not least faced with
resolute German attachment to the principle of its independence. In the con-
text of partisan veto players and high Treaty-based hurdles, the ECB could take a
fairly relaxed view of its independence.
Key Questions
As an exercise in comparative political economy this volume seeks to avoid

idiosyncratic, detailed accounts of changes in European central banks and
central banking (and in their non-European equivalents). It seeks to address a
set of common questions within a shared framework of concepts—‘European-
ization’, ‘power’, and ‘convergence’. These three questions focus on the issue of
what, if anything, is distinctive about European central banks and banking.
To what extent, in what ways, how, and with what effects, have European central
banks changed within the framework of European monetary integration, pre- and post-
euro, and whether as euro-insiders or euro-outsiders?
The volume examines different dimensions of change in European central
banking—in scope, content, process, and outcomes. What changes can we
identify in the functions, structures, instruments, styles, and cultures of central
banking? Can they be attributed to European integration? In answering these
Europeanization questions, we need to be sensitive to the domestic and the
international embeddedness of central banking and banks. The danger is attri-
bution bias: presuming the significance of European integration. It can be
reduced by contextualizing and problematizing Europeanization. Changes in
European central banking reflect different domestic historical legacies from
individually distinctive ‘defining moments’, different domestic political oppor-
tunity structures, and varying attitudes to monetary ‘sovereignty’ and how it
relates to national identity. These changes also respond to international devel-
opments in financial markets and asymmetries in exposure to financial crises,
to pressures from international institutions (and how they relate to the timing
of development of national central banking), to new ideas about monetary
policy and about public management that are trans-national, and to new
information and communication technologies.
There is, in addition, the dimension of time. The longue durée invites us to
reflect on different ‘ages’ of central banking: how, over time, the characteristic
functions, styles, and cultures of central banking have evolved. These ‘ages’
have in turn a quality of myth in that they are idealized representations of a
much more complex reality. They include the ‘classic’ pre-1914 Gold Standard
6
era and the post-1945 ‘US-dollar-backed’ Bretton Woods era till 1973. They
provided a set of international rules in which central banks were embedded.
Correspondingly, the contexts and experiences of globalization differed across
these ages of central banking, in ways that profoundly affected their functions
and organizational cultures.
What do these changes consequent on European monetary integration reveal about
the power of central banks?
There are two senses of power: ‘power over’ and ‘power to’ (cf. Morriss 2002).
In its first, most frequently used sense, the power of central banks rests in their
power over other actors, in its being asymmetric. This power describes their
capacity to make others comply with their distinctive preferences: for instance,
to gain or retain functions and legal competences; to align market and political
expectations with their mandate for price stability; to increase their monetary
income in the Eurosystem; or to gain longer periods of exercising voting rights
in reform of the ECB Governing Council. Perhaps most strikingly in this
respect, the age of the euro disempowered the Bundesbank and empowered
other central banks in monetary policy.
Conventionally, this perspective sees power in ‘relational’ terms. It imputes to
central banks self-interested motives of ‘bureau’ expansion of functions, career
opportunities, and budgets: for instance, in developing and managing euro
payment and settlement systems, in centralizing banking supervision, or in
maximizing their monetary income. The question is whether in practice they
make effective use of the various resources of power on which they can draw to
enhance their relative power at domestic, European, and international levels.
These resources include their legal authority to act; professional expertise and
ideas; experience and reputation; information about markets and probable effects
of policy actions; the scale of the economy (defined by GDP size and financial
assets); and the weight of the currency in international markets and in central
bank reserves. Because of varying resources, some central banks are relatively
more powerful (at least potentially) than others, the US Fed internationally and
traditionally the Bundesbank in Europe. In reallocating these resources of power
EMU has transformed relative power in European central banking.
‘Power over’ also has a structural element, which expresses itself in the two
less visible dimensions of central bank power: the power to frame and shape
how other actors define their economic interests (what is seen as appropriate
behaviour), and the power of agenda setting in economic policy (including
keeping certain issues off the agenda) (cf. Lukes 2005). Seen in these terms,
EMU ‘uploaded’ to the Euro Area the structural power of the Bundesbank and its
distinctive Ordo-liberal ideas as well as ratified a more general international
structural shift to ‘stability-oriented’ policies (see Dyson’s chapter). By this
mechanism of ‘Europeanization as Germanization’ it reframed domestic
debates about macro-economic policy interests across the Euro Area towards
7
‘stability’ and shifted agenda setting to issues of ‘competitiveness’ and ‘fiscal

discipline’. Central bank power is at work even when there is no overt conflict.
In its second sense, the power of central banks refers to their capacity to
shape outcomes in areas where they have a function, notably to safeguard price
stability and to promote financial stability. This power rests on their functions
being widely socially valued and supported by a public ‘permissive’ consensus
(a long-term ‘stability culture’ of the kind enjoyed by the Bundesbank); on their
professional capacity and reputation especially with markets, at a time when
the shift to financial intermediation and ‘shadow’ banking, new complex
and opaque forms of structured finance, and internationalization meant that
they had lost power to markets; and, not least, on them having policy instru-
ments fit for purpose. ‘Fitness for purpose’ is clearer in the case of interest-rate
policy and fighting inflation than of banking supervisory policy and financial
stability (cf. Tinbergen 1952). The power ‘to’ pursue their price stability
mandate has been enhanced by an emerging consensus around an ascendant
‘stability-oriented’ economic paradigm that has empowered central banks. It
assigns special knowledge, purpose, and significance to their activities and
pronouncements. In monetary policy, central banking had renewed its intel-
lectual capital, from which it gained increased professional self-confidence and
credibility: namely, a set of theoretically validated beliefs in stability-oriented
policies. In the process an imbalance emerged between its two functions of
macro-economic stability and financial stability. This process was reflected in
internal central bank power, which shifted from the experiential realm of
financial stability, involving detailed, hands-on supervision, to the more intel-
lectual realm of macro-economic competence in inflation fighting.
A key dimension of the dramatic financial crisis of 2007–8 was the shock to
the money markets, where banks’ confidence in each other’s solvency evapor-
ated and liquidity tensions proved persisting. It exposed just how dependent
macro-economic stability was on financial stability and highlighted the signifi-
cance of the traditional, and more recently, neglected role of central banks
as banker to the banks. It showed how weakly positioned central banks were
vis-à-vis the financial markets, whose convulsive transformations in the wake
of the pace of innovation, the amount of embedded leverage in the system, and
more interconnected markets had implications for monetary policy that had
not been fully appreciated. Central banks were vulnerable to claims that their
monetary policies had been too accommodative in the face of asset price
bubbles, in short been pro-cyclical and asymmetrical across the financial
cycle, and had encouraged excessive risk taking, laying the ground for crisis
(Draghi 2008). They had been too disposed to trust in the superior knowledge of
the private sector in asset pricing.
More generally, central banks are faced with the acute recurring fragility of a
market-based financial system whose lifeblood is trust. The events of 2007–8
were a lesson in how a confident discourse of stability, competitiveness, and
8
fiscal discipline, rooted in the less visible structural dimensions of central bank
power, can mask the highly contingent nature of this trust, the problematic
relationship of instruments to goals, and a vulnerability to market complexity,
opacity, and volatility. In addition, it highlighted the continuing openness of
structural power in banking and financial markets to political contest, espe-
cially once banking ‘originate-and-distribute’ business models proved reckless,
reward structures were vulnerable to charges of being iniquitous, and the state
was drawn into multiple bank rescues and sought to impose new regulatory
conditions. As we see below, persisting national variability in political constel-
lations of ideologies and interests, in ‘path dependence’ and in state traditions
of thought define the varying limits of central bank power to frame how
interests are conceived and to keep certain issues off the agenda.
In banking supervisory policies and financial stability the relationship of
instruments to goals is more problematic and vulnerability to markets most
acute. Analytical models are less robust in the face of the fast pace of financial
market innovation and multiple hidden potential sources of shocks, rules fail to
give strong backbone to supervisors, regulatory self-confidence is more brittle,
and central bank policy instruments are less clearly fit for purpose. Examples
were plentiful in 2007–8 with the manifest failures to regulate the ‘shadow’
banking system, the ongoing uncertainties about who owned securitized loans
and about what they were worth, the muddled rescues of Bear Stearns and of
Northern Rock, the systemic aftershocks of the collapse of Lehman, the massive
governmental interventions to recapitalize banks, buy up toxic assets and
guarantee credits, and central bank engagements in providing liquidity to
credit-starved banks. Policy was torn between the poles of avoidance of ‘moral
hazard’ associated with banking bail outs (thereby giving an incentive to reck-
less lending) and preventing systemic crisis, which feeds into the ‘real’ econ-
omy of output and jobs. The central, blunt central bank policy instrument of
interest-rate changes cannot alone deliver both price and financial stability
(Draghi 2008). The use of interest-rate hikes to prick specific asset price ‘bub-
bles’, say in housing, risks broad damage to macro-economic growth and
employment. Conversely, problems of locking in price stability have been
historically linked to asset ‘bubbles’: note the United States in 1929, Japan in
the 1990s, Asia in 1997–8, and sub-prime mortgages in 2007–8. By mid-2008
the international central bank community had yet to devise simple, transparent
supervisory rules that would enable supervisors to play a credible counter-
cyclical role in moderating excessive bank lending and accumulating bank
capital reserves during booms (cf. Goodhart and Persaud 2008). In their
absence, there was a plausible case for making greater use of monetary policy
for macro-prudential purposes (cf. Bank for International Settlements 2008).
A number of hypotheses about central bank power seem well supported
by the evidence in this volume. First, a complex combination of European
with domestic and international factors has strengthened central bank
9
power. In particular, their structural power has grown in the form of a cross-
national convergence in general political support for price stability, central
bank independence, tighter internal management efficiency, and strengthened
accountability and transparency.
Second, this strengthening of central bank power has been dwarfed by the
growth of the structural power of the global financial markets, in relation to
which central banks have been spectators rather than independently active
regulatory players. In consequence, central banks sought to play a difficult
balancing game. On the one hand, they attempted to work with the markets
to ensure their continuing efficiency, creativity, and dynamism in providing
liquidity. Central banks had also to recognize that financial and asset markets
were of increasing importance for monetary policy transmission, making finan-
cial stability of growing importance in monetary policy formation (Weber
2008). On the other hand, central banks have to ensure that they are not
captured by the markets, that they exercise independent professional judge-
ment, and take a system-wide independent perspective. Consistent with this
view, they distrust signals of readiness to bail out troubled banks as creating
potential moral hazard, providing incentives to reckless risk taking, and jeop-
ardizing financial stability and their own professional reputation. The acute
difficulties of this balancing game came to the fore in the credit crunch and
financial crisis of 2007–8.
Third, the growth of the power of the global financial markets simultaneously
empowers and threatens to disempower central banks. They are empowered as
political elites come to rely on central banks as professional ‘gate keepers’ to
complex, volatile, interconnected, and opaque markets. Central bank inde-
pendence and the appointment of ‘hawkish’ central bankers act as a form of
political insurance. Conversely, the sheer scale, creativity, and proneness of the
global markets to excess threaten to disempower central banks through new
sources of systemic risk and crisis. Once, as in 2008, financial crisis spills over
into acute threat to the ‘real’ economy, the issue of confidence shifts from
financial markets and central banks to governments, which became massively
active on a scale designed to ward off risks of any repeat of the Great Depression
of the 1930s. Keynesian ideas of counter-cyclical, government-led fiscal policies
enjoyed an intellectual renaissance that suggested a shift in structural power
away from central banks towards elected governments.
Fourth, at least in the period till the financial crisis of 2008, EMU had served
to shore up the structural power of European central banking via an ‘ECB-
centric’ Euro Area and by EU accession and Maastricht conditionality criteria
for Euro Area accession. At the same time EMU led to divergent changes in the
relative power of different European central banks. In the case of Euro-insiders,
the Bundesbank was the big net loser; others, especially the central banks of
smaller states, were net gainers. Diminished relative power in Europe for
the Bundesbank translates into new domestic weakness and vulnerability.
10
Conversely, increased relative power in Europe for many small state central
banks creates potentially enhanced domestic leverage over policy, a more
authoritative role in domestic policy debate, and—as in Greece—new exposure
as a focal point in domestic political opposition to a ‘neo-liberal’ agenda of
reform. Domestic leverage is increased when national central banks retain
a wide range of national functions that predate the Eurosystem (e.g. the
National Bank of Belgium). However, this outcome does not hold when these
functions—like protecting a weak domestic banking sector in the case of the
Bank of Italy—involve ‘misfit’ with EMU and EU templates.
Fifth, for euro-outsiders the international sources of a strengthening of
structural power of central banking remain similar, notably in the impacts of
global financial markets and of ascendant trans-national policy ideas that
privilege stability-oriented policies and a set of shared understandings about
their institutional, procedural, and policy preconditions. However, in these
cases domestic variegation in Europeanization is even more pronounced. This
variegation reflects contrasts in attitudes to monetary ‘sovereignty’ and how it
relates to national identity; the timing of central bank development in rela-
tion to international financial market liberalization; the character of the
economic and financial structures in which central banks are embedded;
how domestic political parties use the processes of granting central bank
independence and of appointments to top posts; and whether, in conse-
quence, central bank governors are seen to be personally politically independ-
ent and thus reliable authoritative professional figures. These factors are
explored in the volume.
To what extent, and in what ways, is EMU producing convergence across these
various dimensions and across functions?
‘Europeanization’ begs the question of whether it is associated with conver-
gence, with central banks coming to resemble each other. This resemblance can
take different forms: resemblance in agenda stemming from increasingly shared
pressures; in ideas and functions; in instruments and structures; in cultures; and
in outcomes. Hence convergence is a multi-dimensional concept. The question
produces, in consequence, differentiated answers depending on precisely what
we are talking about.
Convergence exhibits functional specificity. Patterns of convergence/
divergence vary across monetary policy, transparency and accountability,
financial market supervision, and research. In this volume, Marcussen outlines
a convergence around a new age of the ‘scientization’ of central banking,
exemplified in the new prestige to research and ‘knowledge-based’ policies in
legitimating their power. Macartney and Moran identify simultaneous epi-
stemic convergence and institutional divergence even within the same func-
tional area of financial market supervision: whilst Jabko points out that policies
on transparency are very different in financial market supervision from mone-
tary policy. Begg sees an international process of convergence in monetary
11
policy strategy towards inflation targeting, though one in which the ECB
remains an outsider.
However, convergence in central banking is often superficial. On closer
examination it turns out to be more variegated and to involve multiple
equilibria. The dynamic nature of convergence highlights, in part, the ‘path-
dependent’ specificities of historical and institutional contexts. These specifi-
cities shape the differential reception of ideas (Hay 2000). However, they also
illustrate the sheer randomness in market and political developments. The
incidence and particularities of crises in central banking vary and have the
potential to shift central banks off their trajectory of development. These crises
become in turn embedded in different institutional memories, for instance
about the dangers of exchange-rate fixing in the Bank of England and of
‘hyper-inflation’ in the Bundesbank.
In consequence, convergence displays not just functional specificity but also
temporality. It exhibits historical contingency. The preparatory phase of the age
of the euro was associated with convergence in inflation rates. Since European
monetary union, however, differences in inflation have proved persistent. This
persistence threatens longer-term strains through consequent loss of competi-
tiveness and serious protracted adjustment problems that could lead to diver-
gences in wider macro-economic performance, especially output growth and
employment. Outcomes can, in short, move in different directions over time,
again reflecting contingency. Similarly, the national banking systems in which
European central banks are embedded display strong historical path depend-
ence so that institutional arrangements for supervision are resistant to conver-
gence. As we see below, ‘New Public Management’ ideas have also been adopted
variably: amongst euro insiders more by the Bundesbank than the Banque de
France, and amongst outsiders more by the Swedish than the Danish central
bank.
In addressing these questions about Europeanization, power, and conver-
gence, the volume retains a strong sense of varying historical, international,
and domestic contexts. Weighing these contextual factors raises perennially
problematic issues of scholarly judgement about the appropriate ‘level of
analysis’. The editors have not sought to ‘resolve’ these issues. In fact, we have
encouraged pluralism by juxtaposing European country case studies with Euro
Area-level chapters, functionally specific chapters, and non-European ‘control’
cases.
In a comparative and international context, is what is happening in European

central banking distinctive?
The issue of distinctiveness is raised in asking the questions about European-
ization, power, and convergence. The specific EU context—its institutional
‘fuzziness’, its lack of unified political authority, and its historically varied states
with their varying identities voluntarily ceding monetary sovereignty but
12
retaining fiscal, economic policy, and banking supervision sovereignty—

imparts a specificity and originality to the Eurosystem. In addition, the distri-
bution of power in the negotiation of EMU meant that the German Bundesbank
‘uploaded’ many of its core Ordo-liberal ideas into the design of the ECB and the
Euro Area: the strictly defined Treaty mandate of price stability, a radical version
of central bank independence, a ‘principles-based’ approach to monetary policy,
the stress on long-term, multi-dimensional ‘monetary analysis’, and scepticism
about analytical modelling based on ‘real’ time economic data and forecasting in
monetary policy strategy (Weber 2006b). In these terms, Europeanization
served as ‘Germanization’ of European central banking (see Dyson’s chapter).
The Treaty entrenchment of central bank independence meant that the ECB
was in fact a more institutionalized form of the Ordo-liberal model than the
Bundesbank; whilst the principle of decentralization in the Eurosystem was
more akin to the earlier Bank deutscher Länder than to the Bundesbank.
Finally, though differentiated integration is not unusual in the EU, the Euro
Area represents its most distinctive institutional development both in supra-
national design and in the toughest and most wide-ranging entry criteria.
At the same time, the larger historical context of post-Bretton Woods, global,
volatile, and opaque financial markets, and US economic hegemony, however
variable and threatened its fortunes, means that European central banking—
whether for euro insiders or outsiders—cannot escape its historical and inter-
national embeddedness. In terms of financial markets the pacesetter has been
the United States, with the United Kingdom taking up this role in Europe in the
1980s. This UK role was further evident in the EU organization of a coordinated
set of principles for bank bail outs in October 2008. The British Prime Minister
was invited to the first meeting of Euro Area heads of government to present
British plans as a model for the wider EU.
In terms of power to effect international financial markets and monetary
policies the US Fed remained unrivalled in the first decade of the euro. If the
earlier collapse of the US-centred Bretton Woods system had provided the
catalyst for EMU, the continuing reputation of the US Fed (a reputation that
grew in the Volcker-Greenspan years) remained a constraint on the ECB’s
capacity to play an independent and distinctive international role. In its inev-
itably protracted birth—unlike the US Fed it must anticipate continuing Euro
Area enlargement and thus spatial incompleteness and it must build its own
identity—the ECB had less incentive to be forced prematurely into a role of
international leadership. European leadership is a sufficient challenge. Behind
the US Fed stood a formidable intellectual armoury both in monetary policy
and in financial market supervision (though even its weaknesses were manifest
in 2007–8), with the ECB playing ‘catch up’. However, the events of early 2008
suggested that divergence of interests and outlooks could lead the ECB to
attempt at least initially to decouple its monetary policy direction from the
US Fed in order to emphasize its strict price stability mandate and ‘hawkish’
13
attitudes. This decoupling became more problematic as the financial crisis

proved systemic and required cross-national coordination.
Meanwhile, in a world of two big central banks—asymmetric in their power—
small central banks have opportunities and incentives to carve out niches of
creativity in central banking. This process is apparent in monetary policy—New
Zealand, for instance, in inflation targeting; Sweden in the New Public
Management and in transparency; and, inside the Eurosystem, small central
banks in cash management and in exchange of credit information.
The Eurosystem creates an intense institutional context in which through
technical harmonization and benchmarking there is a high degree of self-
referential behaviour in European central banking. In contrast, European cen-
tral banks in states that have opted for ‘semi-permanent’ euro outsider status are
much more catholic in their pursuit of independent profiles. In compensation,
they focus more intensively on building their individual international net-
works and on extracting policy lessons from a wider international central bank-
ing milieu. As Umbach and Wessels show, differentiation in European central
banking has grown. However, this differentiation has not been just a formal
matter of membership. It reaches deep down into international policies and
what are judged to be the appropriate role models for lesson drawing. In
designing independence for the Bank of England, overhauling financial market
supervision, elaborating fiscal rules, even producing tests for euro entry, the
British Treasury studiously ignored European templates.
Europeanization, Power, and Convergence
The questions that animate this volume, and its core organizing concepts and
approaches, reflect its intellectual origins in comparative political economy,
notably the study of the institutional basis of macro-economic policies. ‘Euro-
peanization’, ‘power’, and ‘convergence’ offer a cluster of interrelated concepts
with which to examine change in central banking.
Europeanization
Europeanization refers to the domestic effects of European integration on
policies, polities, and politics and characteristically focuses on mechanisms
and the qualitative aspects of time (Dyson and Goetz 2003; Featherstone and
Radaelli 2003). This volume examines the effects of the creation of the Euro
Area on national central banks: their competences, their structures and func-
tioning, and how they relate to their political and policy contexts. We are
interested in how they respond to European-level requirements and in how
they make strategic use of the creation of the Euro Area. In the first sense,
Europeanization functions as a ‘top–down’ mechanism. It provides strongly
14
Germanic institutional templates that highlight ‘misfit’ and need to adapt at

the domestic level by ‘downloading’ EU requirements (cf. Green Cowles, Capor-
aso, and Risse 2001). For instance, EU accession requires the abolition of
monetary financing of government deficits and domestic central bank inde-
pendence. ‘Top–down’ Europeanization increases in potency once states enter
ERM II, thereby subordinating domestic policies to the stable exchange rate
with the euro, and directly target compliance with the Maastricht convergence
criteria for euro entry (covering inflation, long-term interest rates, fiscal deficit
and public debt, as well as the exchange rate).
In the second sense, Europeanization operates as a ‘bottom–up’ process (cf.
Dyson and Goetz 2003). Domestic central banks seek to seize the new oppor-
tunities offered by political commitment to EU accession and later euro entry
to augment their status and power. Central bankers in Greece, for instance,
defined euro entry as a ‘modernization’ process that involves a comprehensive
range of reforms and through which the central bank carves out a strong
leading domestic role. With more mixed success, the Bundesbank sought new
domestic roles to compensate for its lost monetary policy-making function,
invoking European models like the Dutch model of banking supervision. With
euro entry, NCBs play a new role in communicating ECB monetary policy to
domestic audiences and the ‘logic’ of monetary union for structural economic
reforms.
The effects of ‘Europeanization as Germanization’ on central banks are by no
means uniform. They range from ready accommodation, where there is sub-
stantial domestic ‘fit’ with the European template; through substantial trans-
formation where ‘misfit’ coincides with domestic political will and capability to
reform; to inertia and even resistance. Respective examples are the German
Bundesbank (in monetary policy accommodation), the Greek central bank
(in leading debate on domestic economic policy transformation), and the
Bank of France (in inertia on internal structural reforms) and the Bank of Italy
(in resistance to opening Italian financial markets to competition). European-
ization is a variegated experience. However, its result is to turn the NCBs of the
Eurosystem into the most Europeanized domestic institutions. The paradoxical
result is their empowerment and heightened vulnerability to domestic critique.
Power
Europeanization of central banks and banking is bound up with power. Power
remains a complex and elusive concept with many facets. It sources are varied:
moral authority, legal competence, position in domestic economic governance,
expertise, financial resources, performance, even personal attributes of central
bankers. Central bank power is relative to, and contingent on, possession of
these various resources, which are distributed unevenly across space and over
time. It is, in consequence, fragile and mutates.
15
Potential to exercise central bank power, above all to rely on suasion, is

related to several variables: the legacy of its role in state and nation building
and in historical memory, shaping whether its central purpose is endowed with
popular support; its historically acquired range of competences and degree of
independence; the range of domestic veto players that it faces and whether
there is a unity of purpose amongst them in support of its mandate; its capacity
to attract and retain highly rated expert staff; the role of its currency in inter-
national financial markets and in central bank reserves; whether it has been
effective in delivering price stability and handling banking and financial crises
(‘matching words to deeds’); and the status and respect in which its governor
and senior officials are held amongst peers and in the markets (including the
mythology of central bankers). On these indicators, the Bank of England had
relative power in the age of the classical Gold Standard; the Bundesbank in the
post-Bretton Woods age in Europe; and the US Fed in the post-Volcker period.
The differences within the Eurosystem are examined in this volume.
The power of central banks is an enduring and controversial theme in the
history of international political economy. Sometimes it is reduced to individ-
ual central bankers like Montague Norman, governor of the Bank of England or
Alan Greenspan at the US Fed. Conversely, their power is seen as an epiphe-
nomenon of structural changes: in ascendant notions of domestic governance,
in a wider shift to ‘scientization’ in contemporary society, or in the growing
power of the international financial markets (which they ‘ratify’). Underpin-
ning these debates are alternative understandings about power. For some,
central bank power is relational. It depends, for instance, on the persuasiveness
of individual central bankers or a favourable constellation of actors and circum-
stances, which help them to win arguments. For others, power is structural:
rooted, for instance, in whether central banks are central in dominant eco-
nomic policy beliefs, and in whether political elites are dependent on them to
‘control’ dominant market player. In short, power rests in intellectual ascend-
ancy in macro-economic policy through the prestige of monetary economics
and expertise in dealing with complex, opaque, and volatile markets. Structural
power helps them both to act as agenda-setters on behalf of price stability and
to shape how other actors—governments, financial institutions, firms, trade
unions—perceive and reframe their own interests (cf. Lukes 2005). In this
narrative, the age of the euro, at least up the financial crisis of 2008, has been
characterized by both the relational and the structural power of the ECB.
Europeanization provided central bankers with enhanced resources of legal
authority, especially in monetary policy independence, and thereby augmented
their structural and agenda-setting power. This increased potential to exercise
power had its roots, however, in global-level developments. The research and
‘knowledge base’ of central banking has been transformed by monetary eco-
nomics (see pp. XX). Following the ‘stagflation’ of the 1970s and the eclipse of
Keynesianism, central banking acquired a powerful intellectual armoury, which
16
in turn strengthened its agenda-setting role in macro-economic policy. Growth

and employment problems were ‘assigned’ to governments and to employers
and trade unions; their solution resided not in monetary policy or fiscal activ-
ism and ‘fine-tuning’ but in structural reforms to the supply side. In short,
central banks promoted an agenda of product, services, labour, and financial
market liberalization: in 2008, for example, the ECB Governing Council called
for the end of wage indexation policies in seven Euro Area states as inimical to
price stability. The age of the euro strengthened this agenda-setting role by
removing the alternative policy options of exchange-rate and interest-rate
adjustment. ‘Structural reform’ was the mantra of European central banking
and a matter of broad consensus in the economics profession; embodied in and
articulated by international institutions like the Organization for Economic
Cooperation and Development (OECD) and the International Monetary Fund
(IMF); and the benchmark for measuring the success of governments and states.
The potential of NCBs in the Eurosystem to exercise domestic power
increased in three ways. First, they have a new incentive to use their enhanced
reputation for objectivity by seeking a stronger shaping role in domestic eco-
nomic policy debate, for instance by publishing their economic forecasts.
Second, NCBs have an incentive to carve out a role as domestic pacesetters in
public-sector reforms by adopting the efficiency-oriented agenda of the New
Public Management with its target setting, performance indicators and mon-
itoring, and ‘outsourcing’. This agenda had an external function in protecting
NCBs against political charges of hypocrisy in calling for domestic structural
reforms and an internal function in strengthening centralized management.
Third, NCBs have a new incentive to seek out domestic political support for
enhancing their legal competences, for instance in banking and financial mar-
ket supervision, so that they can compete more effectively in the competition
of ideas in the Eurosystem.
However, there are also aspects of new vulnerability. In particular, ‘the bright-
est and the best’ tend to move ‘upwards’ in career terms to the ECB, which has
steadily strengthened its research and monetary policy armoury. The NCBs have
little leverage to halt this process. Second, NCBs face domestic challenge on
‘overstaffing’ and internal delays in their own structural reforms. At one level,
they face increasing domestic questioning about the efficiency of their oper-
ations; at another, the ECB has been increasingly active in setting performance
indicators for the Eurosystem and adding to internal pressures through system-
atic comparisons. Rationalization has proved internally contentious and typic-
ally protracted. In its absence, it has been difficult to release extra resources to
strengthen internal expert research to strengthen profile in the Eurosystem. The
French central bank exemplifies this difficulty. In general, the smaller NCBs
have had an easier time in sustaining domestic coalitions of support, notably for
their role in banking and financial market supervision (e.g. the Dutch and Irish
central banks). However, this role also highlighted their vulnerabilities as the
17
financial shock of 2008 gathered pace, especially as the scale of their national
commercial banks potentially eclipsed the domestic capacity to bail them out.
The varied sources, different manifestations, and discrepancies between
potential and actual power underline the continuing difficulty of pinning
down power, not just in the Eurosystem, but even in the financial markets.
At least up to the financial crisis of 2008, financial institutions seemed to exude
vast power. However, much of this power depended on their creativity in
inventing new complex products, like various forms of derivative, and more
problematically on their capacity to retain market confidence in these products.
Moreover, these ideas were hard to patent, could be easily copied, and soon
became low-margin widely available products. Hence they were in practice
vulnerable to rapid loss of competitive advantage. The result was an enormous
incentive to permanent creativity that briefly marked out certain key individ-
uals and companies as powerful. In short, creativity took its place, alongside
capital and financial leverage, as a key source of market power. Financial market
players, as well as central bankers, proved acutely vulnerable to the complexity
and opacity that followed from this creativity and the ‘herd’ instincts in search
of higher yield, as the crisis of 2008 revealed. The paradox of central bank power
was that, in successful delivering low real interest rates and in neglecting the
mundane world of financial stability for the intellectually exciting world of
monetary policy strategy, they increased incentives to the markets to be more
creative and take higher risks in search of yield.
The complexities and paradoxes of central bank power are highlighted in part
by the above focus on the political criterion of their capacity to make a difference
to outcomes. They also surface in the use of the moral criterion of praise or blame
in evaluating the responsibility of central bankers for outcomes. Here a tension
opens between ‘power to’ and ‘power over’. Providing central bankers with the
‘power to’ deliver outcomes, whether to entrench low inflation or promote
financial stability, is a matter of endowing them with appropriate instruments.
However, the possession and, above all, use of these instruments open central
bankers to the moral paradox of praise for delivering socially desired outcomes
like price stability and blame for exercising excessive power over others (dom-
ination) without sufficient democratic accountability and transparency. This
moral conundrum bedevils the debate about central bank power.
Convergence
The creation of the Euro Area was notable in both expressing and reinforcing a
broader international and historical trend to enhanced central bank power in
macro-economic policy. In other words, Europeanization is bound up with
international convergence, especially in common pressures. Central banks
look more alike—even if not exactly the same—on such dimensions as their
independence, collective internal decision-making structures, monetary policy
18
strategies that target inflation, stress on transparency, and ‘knowledge-based’

operation.
In empowering central banks and banking, Europeanization acts as a catalyst
for convergence around German templates in the organization and making of
macro-economic policies. However, as we shall see, its domestic effects—on
both the power of European central banks and their convergence—have been
more complex, variegated, and contingent. Continuing divergence reflects in
part their hybrid characters in combining European with varying national
competences, domestic path dependency in development, and economic
and political contingencies. National central banks have different institutional
relationships to social partnership (note Maes and Verdun’s chapter on the
Belgian and Dutch central banks). Moreover, both the EU and the Eurosystem
lack a single authoritative institutional model in banking supervision so that
the role of national central banks in this area varies widely. Central banks in
smaller states tend to be more involved not just in supporting domestic adjust-
ment through social partnership but also in operational banking supervision,
reflecting the less complex domestic banking structures. Finally, national cen-
tral banks demonstrate internal differences and differences in domestic
support for playing effective roles in the new dynamics of the competition of
ideas inside the Eurosystem. In particular, they exhibit different trajectories in
internal reforms.
Historic Commonalities and Variations Amongst Central Banks
On both the international and the European levels, central banks perform
broadly similar core functions in delivering price and financial stability. They
are embedded interdependently in international and interconnected financial
markets, characterized by complex opaque forms of intermediation, and hence
have a common vulnerability to contagious financial crises. In the face of a
market context driven by greed and fear, central bankers share common profes-
sional attributes, ranging from an ingrained caution and risk aversion, through a
‘stability-oriented’ conception of macro-economic policy, to a focus on capacity
to communicate in suitably coded terms with financial markets. Not least,
central banks interact cross-nationally to an unusual extent in a variety of
international forums. In consequence, they represent an ‘epistemic community’
with a high degree of readiness to engage in cross-national policy coordination
(cf. Haas 1992). Central bankers’ professional beliefs also dispose them to seek to
build effective cross-national policy coordination on the solid foundations of
credible domestic commitment and capability to build stability ‘at home’. In
short, their attitudes to international coordination tend to be similarly condi-
tional. These factors suggest a potentially relatively high level of convergence
amongst central banks in professional beliefs, in functions, and in pressures.
19
Historically speaking too, central banking is two shared stories of transition.

The first is from an early phase of central banks as primarily banks financing
wars, dispensing short-term commercial credits and emerging as banker to the
banks, ensuring efficient and secure payment systems, and lenders of last resort,
to a central macro-economic role for monetary policy. This story is one of the
displacement of an image of professionally ‘boring’ work, requiring tacit
knowledge and practical career experience, to an image of intellectual ‘fire-
power’. The second is the story of the ‘de-territorialization’ of certain national
currencies—notably the pound sterling, the US dollar, and the former D-Mark—
as they become dissociated from state boundaries, making more pivotal the role
of market forces (Cohen 1998). At the same time, this second story is more
Anglo-American. Most continental European central banks retained the his-
toric imprint of their origins in unifying banknote circulation in the context of
convertibility crises associated with several issuing banks. Maintaining public
confidence by guaranteeing the quality of banknotes in circulation was more
fundamental to their identity. Notwithstanding this variation, these two stories
are linked to internal changes in central bank career structures and socialization
processes that reflect wider structural changes. They opened up central banks to
academic economics and to international financial market experience, at a cost
to their traditional, more practical work as bankers to the bank that was high-
lighted with the financial crisis of 2007–8.
At the same time central banks remain context-specific, exhibiting a high
degree of historical path dependency and persisting national variation.
National variation is evident even within the Eurosystem and can be traced to
five main sources. The first is dealt with elsewhere in this chapter (pp. 20–23).
Their relationship to international financial markets and the strength/weakness
and organization of their domestic financial sectors help distinguish ‘core’ and
‘periphery’ central banks. Ceteris paribus ‘core’ central banks in the inter-
national financial system are more likely to be able to exert domestic as well
as international power. Outside the Eurosystem the Bank of England and the
Swiss central bank have benefited in this way. This section focuses on the other
four factors.
‘Path Dependence’ and State Traditions: Institutional Legitimacy

Central banks have different relationships to historical processes of European
state building and nation building and to the consequent character of the states
in which they are embedded. Generally, this association endows them with
dignity and status in embodying some conception of highly valued public
interest and with symbolism in representing shared identity. However, ‘path
dependence’, in the form of differences in starting points in state building,
shape and constrain the limits of change in central banks. It also affects notions
of institutional legitimacy.
20
In certain cases central banks acquire a heroic role, as with the Baltic
State central banks in the post-1991 process of independence from the Soviet
Union. Intimate association with independence means that they, and the
currencies that they manage, become bound up in images of national identity
and state sovereignty. This factor distinguishes the central banks in the Baltic
States—where there is substantial public (though not elite) reluctance to give up
national currencies—from that in Hungary (cf. Greskovits chapter). They are
key arbiters of national economic policy debate and enjoy high levels of trust.
In other cases, like France and the German Second Reich (1871–1918), central
banks had a more ‘humdrum’ role in national debates. Although part of state
building, they were not so intimately linked to national independence, com-
pared for instance to the government bureaucracy and the army.
An aspect of ‘path dependence’ is the timing of state and nation building—
and hence central bank formation—in relation to the development of the
international political economy. Notably, the east central European central
banks were reconstituted after the end of the Cold War in an international
context of consensus about freedom of capital movement, central bank inde-
pendence, and ‘stability-oriented’ policies (cf. Epstein and Johnson chapter).
This timing empowered them domestically as ‘liberalizers’ and ‘modernizers’
and powerfully shaped their identity.
In addition to ‘path dependence’, state traditions of thought about the role of
public authority in economic development matter (Armstrong 1973; Dyson
1980). Association with state building highlights the particularities of state
traditions in economic development, which in turn help forge role conceptions
of central banks and leave their own distinct genetic footprints. The French
central bank, for instance, retains an image and style of ‘interventionism’, of
embodying certain state purposes. This style was evident in a ‘developmental’
role in the early post-1945 period in implementing economic priorities in
national plans through its credit policies; in its role with government in seeking
consolidation of the French banking sector (e.g. the BNP, Paribas, and the
Societe Generale in 1999); or, since 2006, in assuming a ‘social’ role in personal
debt management (cf. Howarth’s chapter). The image of the Bank of England is
bound up in a very different relationship of state building to the economy. Its
traditional ‘hands-off’ approach centred on supporting the international role of
the City of London. The Bank was embedded in the ‘club-like’ social networks
of the City that were premised on a gentlemanly code of trust and informally
held together government, central banks, and finance, at least till the 1980s
(Kynaston 2002; Roberts and Kynaston 1995).
In Belgium, the Netherlands, and Sweden, by contrast, the imprints of social
partnership find their expression in a role in supporting ‘concertation’ amongst
employers and trade unions. In reaction to the cataclysm of the collapse of the
Weimar Republic and the Third Reich, the Bundesbank embodies the post-war
Ordo-liberal conception of a new German state bound by clear principles and
21
firm rules to safeguard long-term stability. Hence it espoused a ‘public trustee’ role
on behalf of price stability that made it more distant from the ‘short-termism’ of
financial markets (than the Bank of England), government (than the French
central bank), and the social partners (than the Belgian or Dutch central banks).
‘Path dependence’ in state building also deeply shaped notions of institu-
tional legitimacy in central banking, especially conceptions of accountability.
The chapter by Eichbaum on Australasian central bank illustrates the back-
ground role of the British Westminster political model in the development of
ideas on central bank independence and inflation targeting. This constitutional
model, which focuses on ministerial responsibility to Parliament, has a ‘misfit’
with ideas of ‘goal’ independence (as opposed to ‘instrument’ independence) in
central banking. Conversely, it fits with the idea of political determination of
the inflation target and central bank accountability for meeting this target.
However, as the chapters on the US Fed and the ECB and Jabko’s chapter
show, these ideas flow less easily into different constitutional frameworks. The
US separation of powers model involves more complex accountability relation-
ships to Congress and the federal executive. In the Euro Area context two
different constitutional models have competed, though very asymmetric in
terms of their power over central bank design. The French republican model
focuses on accountability to the nation, whose will is delegated to the sovereign
political institutions of the Republic. Hence it fits badly with ‘goal’ independ-
ence in central banking and advocates European-level ‘economic government’,
to which the ECB should be accountable and which should coordinate eco-
nomic and monetary policies (see Howarth’s chapters). Far more powerful in
shaping the institutional design of independence and accountability of the ECB
have been German Ordo-liberal ideas of trusteeship (see Dyson’s chapter on the
Bundesbank; also Dyson and Featherstone 1999 for the reasons). These ideas
focus on a strong institution with a narrowly defined mandate for price stabil-
ity, on behalf of which the central bank acts as public trustee.
Domestic Governance Patterns: ‘Strong’ and ‘Weak’ States

Central bank power also varies in relation to the institutional characteristics of
domestic economic governance and the wider politico-administrative systems in
which they are embedded. This factor highlights distinctive domestic political
constellations and interests, like intra-governmental pattern of power, party
ideologies and strength, party factionalism, and cohesion or fragmentation in
party systems. They affect the balance in the relationships to finance ministries
and more widely to governments. Although there are patterns, their precision
should not be exaggerated. In analysing ‘path dependence’, we have noted differ-
ent types of state tradition in terms of their distinctive preferences. Simplistically,
on the measure of their historical capacities to act on behalf of these preferences,
there are ‘strong’ and ‘weak’ states and ‘strong’ and ‘weak’ central banks.
22
‘Weak’ states lack the unity of purpose amongst domestic veto players to
pursue consistent economic policies and suffer from a plethora of veto points
on change. In short, they lack institutional capacity to deliver their preferences.
These veto points are to be found in party system fragmentation and party
factionalism, in ministerial ‘fiefdoms’ within coalition governments, in poten-
tially competing legislative majorities in lower and upper houses, in various
organized groups, and in structures of territorial interest. As the Italian case
demonstrates, they can be associated with (relatively) ‘strong’ central banks,
providing an opportunity to carve out a niche of power: a case of a ‘strong’
central bank in a ‘weak’ state. Conversely, ‘weak’ states do not guarantee central
bank power: the Greek central bank was a ‘weak’ central bank in a ‘weak’ state.
‘Weak’ states can erode the authority of central banks, whether by enmeshing
them in clientele relationships for rewarding supporters or by politically
motivated processes of partisan advantage through appointments to top
posts. In consequence, their authority is eroded (see Greskovits’ chapter on
east central Europe). If state capacity to act matters for central banks, so too does
whether state actors share or subvert their core purposes.
Conversely, ‘strong’ states embody a greater unity of purpose that enables
coordinated action amongst various veto players. Again, there is no single
pattern. Where state capacity to deliver is linked to a shared social purpose
with the central banks, a ‘strong’ state is consistent with a ‘strong’ central bank.
An example is Sweden, where the central bank has been supported by the
capacity of the state to deliver a context for neo-corporatist forms of respon-
sible, macro-economic–focused collective bargaining. The Bank of England has
similarly benefited from the capacity of the British state to deliver on fiscal
discipline and market liberalization (when governments are so inclined). In
contrast, the French central bank has been a ‘weak’ central bank in a ‘strong’
state. In this case, domestic political ideology has proved less supportive of fiscal
consolidation and structural reforms to liberalize markets.
In consequence, there are cross-national variations in the institutional capacity
of states to support central banks by delivering domestic stability-oriented fiscal
policies and wage bargaining. There are also variations in the vulnerability of
central banks to the political use of the appointments process to their top posts,
notably in undermining their reputation for objectivity (see Greskovits’s chapter).
‘Output’ Legitimacy; ‘Matching Words to Deeds’

Central banks vary in their image for professional competence and objectivity
according to their effectiveness in performing their functions. Some central
banks are more trusted than others to match ‘words to deeds’. Most notably,
the Bundesbank gained from its perceived, though hard-fought, success in
delivering price stability in Germany, in the context of growth and high
employment. Central banks are, in short, dependent on ‘output’ legitimacy.
23
The ‘output’ legitimacy of the Bundesbank made it the model for the design
of the ECB. In gaining ‘output’ legitimacy in its first decade the relative power of
the ECB within the Eurosystem was strengthened. However, this legitimacy is
contingent on performance.
The Eurosystem provided a new challenge of ‘output’ legitimacy for constituent
national central banks: their capacity to pursue internal efficiency-oriented
reforms, like tighter strategic control, ‘de-layering’ of structures, ‘outsourcing’,
and performance measurement. Here again contrasting trajectories of reform
were evident, with different emphases in individual cases (cf. Pollitt and
Bouckaert 2000). The French and the Greek central banks adapted to maintain
the status quo. Rationalizing measures were introduced without recourse to the
legitimating discourse of the New Public Management. ‘Outsourcing’ initiatives
were limited. Strong internal trade-union presence proved a key constraint. Thus
in 2008 the union’s forceful demonstration led to an exemption of Bank of Greece
staff from the pension system reform. In the Banque de France internal vested
interests blocked major strengthening of macro-economic research capacity.
A different emphasis was apparent in the Danish central bank, which also
eschewed a pace-setting role in public-sector reforms. A key reason was that
it experienced little external pressure for reform because of the continuity in
making monetary policy from the ‘old’ ERM to the ‘new’ ERM II.
More characteristic of Eurosystem central banks was modernization through
transformation of existing structures. These central banks sought to be paceset-
ters in domestic public-sector reform and included Germany and the Nether-
lands. The ‘outsider’ Swedish central bank became a key benchmark. In these
cases the New Public Management was a legitimating discourse. The third
reform trajectory—‘marketizing’ central banks by introducing private-sector
practices—was pursued much more cautiously and characteristically in the
function of cash management.
Central Banker Preferences

A final source of variation lies in the preferences of central bankers themselves
in a context of discretion, however constrained. At this more individual level,
factors of socialization and career ambitions and incentives play a role
(cf. Adolph 2003). Recruitment to top central bank posts from government
service or from the financial sector seems to have implications for whether
monetary policy preferences are ‘dovish’ or ‘hawkish’ (Adolph 2005 and p. 32
above). There are also different positions on the appropriate trade-off between
risks of damaging market efficiency and innovation through tight supervision
(stressed notably by Greenspan) and risks to systemic financial stability from
the misalignment of private incentives through lax supervision (highlighted by
the Bank for International Settlements). Here again socialization and career
incentives seem relevant.
24
In addition, though there may be broad general shifts in central banking and
evidence of epistemic convergence, there is room for differences of view on a
range of issues. For instance, views on how random and unpredictable are finan-
cial markets feed into different assessments of the value of formal macro-
economic modelling in monetary policy and of how much reliance to place in
an individual ‘anchor’ like money supply growth, exchange-rate targeting, or
inflation targeting. The view that markets are random and unpredictable trans-
lates into the belief in the primacy of expertise in the form of tacit knowledge,
grounded in the value of long experience of managing crises, in the cultivation of
a certain mystique in central banking, and in personal trust as vital to the transfer
of this tacit knowledge (cf. Collins 2007). There are also differences of view on
whether central banks should ignore asset prices and deal only with the eco-
nomic consequences of an asset price bust the ‘mop-up-after’ policy (cf. Green-
span 2007) or be more proactive and ‘lean against the wind’ (e.g. the Bank for
International Settlements 2008; Bordo 2007; Draghi 2008; Weber 2008). Simi-
larly, transparency can be regarded as potentially subversive, to be conceded in
response to demands from political institutions (see Woolley’s chapter on the US
Fed), or as an instrument for making monetary policy more effective and hence to
be embraced pro-actively (see Marcussen’s chapter on Sweden).
Central banker preferences are typically linked to domestic state traditions.
In accountability, for example, two positions can be identified. Central banks
can be seen as embedded in principal/agency relations, in which the governing
majority delegates and in turn demands accountability. This notion fits closely
with states that emphasize Parliamentary sovereignty (as in the ‘Westminster’
model) and with inflation targeting as a device for holding central banks to
account. Conversely, central banks can be seen as ‘disinterested’ trustees for a
specific public interest. This notion is very strong in the post-war German
tradition and has been uploaded into the ECB. The ECB is accountable to the
public of the Euro Area to deliver its Treaty mandate of price stability.
Within the shared context of the Eurosystem, these four factors—alongside
the international strength of the domestic financial sector—provide different
opportunity structures and constraints for central banks. They account for
persisting variations in their potential to project and exercise power. The pres-
ence and effect of these factors is even more evident outside the Eurosystem.
Persisting national preferences in key areas like accountability and transparency
keep the Bank of England and the Swedish Riksbank at an intellectual distance
from the Eurosystem.
History-Making: From State Building to Europe Building
The age of the euro suggests an inversion of the historic relationship bet-
ween central banks and the state. The mechanisms are twofold: a collective
25
empowerment of Eurosystem central banks vis-à-vis states through explicit and

clear Treaty mandate; and their focus, for monetary and closely associated
policies, on Euro Area identity and loyalty. In the process, the age of the euro
has made more transparent the weaknesses in institutional capacities of states
in fiscal and economic reform policies and in financial crisis management. This
new capacity of central banks to transform European states does not amount
to the end of the state nor of their distinctive, dissimilar characters. It means
that the Eurosystem has become an agency of Europe building and of state
transformation.
The novelty of the age of the euro stems from the breaking of this historical
association of the creation of European central banks with ‘state building’ and
‘nation building’—even if this association continued to be exemplified post-
1991 in the Baltic States and post-1993 in Slovakia. The previous section
showed how varying roles in state- and nation-building processes have given
central banks distinctive characters and shaped how their functions have
evolved. For instance, the Bundesbank’s role in stabilizing post-war German
democracy and differentiating it from the ‘failed’ Weimar Republic (and the
hyper-inflation of 1923) involved a one-dimensional focus on price stability.
It also highlighted the importance of the timing of their creation and entry into
the modern state system. The development of the British and Dutch central
banks in the seventeenth century had its rationale in providing a key driver of
state building, namely, financing expensive wars without recourse to punitive
and unpopular taxation (Roberts and Kynaston 1995; Tilly 1975). In conse-
quence, the early central banks acquired the privileged functions of banker and
advisor to governments. This war-fighting context of geo-military competition
in the European state system was the antithesis of the context of central bank
re-formation in the modern EU.
In later post–nineteenth-century stages of state and nation building, the
changed political economy backgrounds of more developed international
financial markets, combined with greater relative economic backwardness,
meant that central banks were designed with other functions in mind, not
least to provide monetary guarantees in order to safeguard the interests of
international creditors (Gerschenkron 1965). Their evolution reflected the
ambitions of states to strengthen their power through supporting the secure
long-term financing of increasingly costly—because technologically more
sophisticated—industrial development by mobilizing large sums of capital. In
this context, central banks assumed functions as credit providers, using direct
methods of intervention, and as ‘bankers of last resort’, offering safety nets to
private banks (Broz 1997; Epstein 2005). Central bankers became pre-eminently
‘banker to the banks’. Where liquidity was limited and the private sector
undeveloped, the state supported extensive financial intervention by the
central bank, which targeted credit to particular sectors and activities judged
conducive to economic development. Examples of this interventionist
26
role included the central banks of France, Italy, Prussia, and Spain. This
interventionist historical context of much continental European central bank-
ing contrasts with the market-based financial system into which the age of the
euro was born.
Despite these marked historical contrasts in the European state system and in
relations between states and markets, central banks bear the imprint of this
past. In their origins central banks served to augment the power of European
states. They attained, in consequence, as we saw above, a status of dignity and
high social prestige. This status expressed either the ethic of public service,
which was imputed to a social class that embodied the civic virtues (character-
istic of the Bank of England), or their embodiment of the authority of the state
and its purposes (as in the German Reichsbank). Equally, central banks reflected
the historical variability in state- and nation-building experiences and—in the
case of the Bundesbank—historical ruptures.
This historical context means that central banks articulated the financial and
monetary dimensions of sovereignty. Just as it had armed forces and police to
protect its subjects and its borders, so the state had its own money. The central
bank was there to safeguard the value of the national currency. It had, accord-
ingly, a symbolic power. It represented the nation. Central banks were bound
up with nation building as well as state building. In the process their individual
definitions of their common functions took on the attributes of distinct con-
ceptions of statehood and nationhood.
This role of central banks in state and in nation building was articulated in
their architecture, characteristically austere, classical, dignified, and imposing,
and in the formality of their rituals and traditions. The imposing edifices of the
Bank of England and the Bank of France convey powerful images of historic
grandeur and solemnity. In contrast, the German Bundesbank’s modernist
architecture symbolizes a ruptured tradition after 1933–45, a new central
bank for a new state, and a redefined nation. Even so, the traditional central
bank images remain: calm solemnity and the ‘private’ government of public
money.
The striking feature of the age of the euro is the historic attenuation of this
association of European central banking with state, sovereignty, and national
identity. Architecturally, it is the post-modern age of central banking, symbol-
izing a hybrid of European cross-national identity building with national par-
ticularities. The futuristic design of the ECB tower in Frankfurt expresses this
spirit. Socially and culturally, the ECB brings together seconded officials from
national central banks with permanent officials from a range of European
states. Their commonality resides in shared central banking professionalism,
in cultivating a Euro Area identity in policy formation that is non-national, and
in the exclusive use of the English language. In short, the ECB represents a
highly cosmopolitan expert elite, a trans-national ‘epistemic community’
united by shared beliefs and policy projects (on which Haas 1992).
27
The distinctiveness of the ECB resides in its ‘stateless’, ‘supra-national’ char-

acter, which is expressed in the non-national symbols on euro notes (the main
motifs being bridges and gateways). Simultaneously, it remains embedded in
enduring European states and in national identities. These identities are still
reflected in the motifs chosen for the euro coins. For instance, Slovakia adopted
three motifs: the first represented a national cultural monument (Bratislava
Castle), the second expressed the permanency and firmness of the state (the
double cross on three hills), and the third was a symbol of the protection of
Slovak independence and historical territory (Krivan peak).
The next two sections deal with the determinants of the substance and the
process of European monetary integration, highlighting, respectively, inter-
national dynamics of convergence and intra-European dynamics.
The International Context of the Age of the Euro
In contrast to the internal European processes leading to its birth and evolution,
the age of the euro is defined in substance by the larger spatial and historical
framework of the international political economy.
Historical Legacy: Core and Periphery Central Banks

Historically, power to shape monetary and financial stability policies migrates
to the central bank or banks in the major international financial centre or
centres, creating ‘core’ and ‘periphery’ central banks. These centres are defined
by the size, depth, and liquidity of their financial markets and by the signifi-
cance of their domestic currencies in financial market trading and in central
bank reserves. Central banks in these locations gain status and power over
international capital flows and over the politics of international coordination
denied to others. This advantage is enhanced when they are able to accumulate
their own large reserves and to avoid unsustainable external imbalances that
threaten to unwind. Even under a ‘managed’ system like the classical Gold
Standard (1880–1914), these ‘core’ central banks have greater discretion about
whether, when, and how to act and not least about whether to engage in central
bank cooperation (Eichengreen 1985). Whether with or without explicit rule-
based international coordination, ‘periphery’ central banks adjust to the actions
of ‘core’ central banks and the expectations that they generate. They fear capital
flight to the financial ‘core’ at times of strain. The result is an asymmetric central
bank experience of the realities of international coordination. Coordination
looks less smooth from the perspective of the periphery, where crises tend to
concentrate. Of course, financial crisis management takes on a different char-
acter when it originates in and strikes at the ‘centre’, as in 1929–31, 1987, and
2007–8, compared to its origination in the periphery, as in 1997–8.
28
The big international central banking story of the first part of the twentieth
century was the protracted power shift from the Bank of England, the putative
fulcrum of the classical Gold Standard, to the US Fed. The ‘gold-backed’ age of
globalization witnessed even higher levels of trade and financial integration
than in the ‘US-dollar-backed’ Bretton Woods age of globalization. It rested on
the credible commitment of the Bank of England to convertibility of the pound
sterling to gold. Given this external discipline and the associated notion of
‘automaticity’ in adjustment, there was little incentive to develop national
central banking. Its emergence in the period 1870s–1914 owed more to a new
and growing emphasis on ‘monetary sovereignty’ associated with newly emer-
gent ‘nation’ states, a process that gathered pace in the interwar period. The
shift to the post-1945 ‘US-dollar-backed’ age of globalization reflected a rebal-
ancing of financial and economic power within the North Atlantic–centred
world economy away from London to New York and a new willingness of the
United States, not apparent in the 1930s, to assume the leadership role in
international stabilization.
Central banking in the age of the euro reflected this legacy of international
economic history. Historical legacy, notably associated ‘agglomeration’ effects,
along with its favourable location between international time zones, meant
that London remained the core European financial centre. This comparative
advantage was reinforced by the pioneering role of the British government in
deregulating the financial sector in the 1980s and in benefiting from the
financial services revolution; it was seen again in October 2008 in the model
character of the British banking bail out for the EU. The City was the main
global centre for international business. Hence a further distinctive feature of the
age of the euro has been the separation of ‘financial’ Europe (centred on
London and firmly global and US-centric in outlook) and ‘monetary’ Europe
(focused on the ECB in Frankfurt). In consequence, the Euro Area lacks the core
European financial centre.
More fundamentally, however, the post-1945 period has been characterized
by the financial and monetary ascendancy of the United States, represented by
New York and Chicago, the US Fed, and the US dollar. Despite recurrent and
often sharp volatility, the US dollar remains the core international currency in
foreign-exchange trading, the main denominator in world trade, the main
‘anchor’ currency for states pursuing explicit exchange-rate policies (leading
to talk of an informal ‘Bretton Woods II’), and the dominant reserve currency
for other central banks. Financial and monetary crises transmit more forcefully
outwards from the United States than into the United States. Post-1973, the
leadership role of the US Fed survived the end of the Bretton Woods system,
which had been in effect a US dollar-based international exchange-rate system,
and the tribulations of the US dollar in the late 1970s and beyond. Drawing
on memories of the disruptive effects of US-based market excesses and
benign neglect of international responsibilities, the age of the euro was in
29
part designed to better insulate Europe in this new era of market-led globaliza-
tion. Although this aim could in part be realized in terms of the reduced
external trade dependence of a large currency union, global financial market
integration continued to provide powerful transmission mechanisms through
which US power was manifested.
In this context of a ‘financial’ Europe centred on London and of US-centred
global financial and monetary power, the ECB had limited scope to carve out an
international role. This constraint offered an extra incentive to focus on estab-
lishing credibility through fulfilling its Treaty mandate of price stability
and through encouragement of member-state governments to increase the
output growth potential of the Euro Area by domestic economic reforms.
Performance—‘output’ legitimacy—was the key to international credibility
but ran into the paradox and uncertainties outlined at the outset of this chapter.
Market-Driven Globalization Post-1973: Ideational and Socio-Cultural

Change in Central Banking
No less fundamentally, the context of the international political economy into
which the age of the euro was born was the newly established centrality of central
banks in domestic macro-economic policy. This centrality was established either
de facto, as with the US Fed under powerful chairs like Paul Volcker and Alan
Greenspan, or de jure, most notably in Germany. The substantive content of the
negotiations on EMU in 1988–91 reflected an underlying, pre-existing structural
shift in economic policy ideas, usually described simplistically as the shift from
Keynesianism to monetarism, from discretionary demand management based
on fiscal policy activism to rule-based stability-oriented policies (Dyson 2000;
cf. Kydland and Prescott 1977). Discretion favoured the role of political elites in
monetary policy and using central banks to complement fiscal policy. Rules
favoured policy commitment by delegation to expert central bankers.
This characterization of the ideational shift from fiscal discretion to monetary
rules, from Keynesianism to monetarism, can be overstated. It underestimates
the ongoing nature of contest within the new consensus about stability-
oriented policies, central bank independence, and rules, exemplified in the
‘uploading’ of German Ordo-liberal ideas into ECB monetary policy strategy.
It also fails to recognize the development of New Keynesian models and their
particular appeal to central bankers as arguably the most influential macro-
economic theory. The Bundesbank continued to offer a critique of New Keynes-
ian models of monetary policy for their excessive stress on short-term ‘real’
economic data, at the expense of nominal indicators, and for their reliance on
economic forecasts which were exposed to high uncertainty. Above all, it
advocated a ‘principles-based’ approach over reliance on the so-called dynamic
stochastic general equilibrium model and stressed the virtues of longer-term
‘monetary analysis’ and the high risks in ignoring asset price bubbles models.
30
New Keynesian models were seen as weak in spotting asset price developments,
notably ‘bubbles’, through longer-term analysis of money and credit and too
prone to ‘real-time’ data problems and estimation errors that could lead to
destabilizing effects from monetary policy (Weber 2006b). The Bundesbank
saw its views on the importance of money and credit analysis as confirmed
and strengthened by the 2007–8 financial crisis and as the indispensable sta-
bilizing element in a more symmetric long-term monetary policy across the
financial cycle that could dampen fluctuations (Weber 2008).
At the same time the Bundesbank accepted that New Keynesian models were
useful in highlighting the concept of ‘staggered’ prices and the role of ‘friction’
in the real, imperfect world of wage and price adjustment and in picking up
cost-push factors like productivity growth, regulatory and competition policies,
wage indexation formulas, labour-force developments, fiscal policy shifts, and
tax structure (classically Woodford 2003). The real-world problems of insuffi-
ciently rapid adjustment of wages and prices, compared to the United States
(notably in services), meant that New Keynesian models retained a strong
appeal to EU central bankers. In consequence, the ECB sought to reconcile
New Keynesianism and German ‘money growth’ models in its two-pillar mon-
etary policy strategy, though in the process retaining a critical distancing from
the US-centred, New Keynesian consensus.
In particular, within the consensus on stability-oriented monetary policies,
contest focused on asset price ‘bubbles’ like the bursting of the Internet bubble
in 2000 and of the credit and house price bubble that burst in 2007. Given two
key problems—that bubbles can be hard to identify until they burst and hard to
prick without collateral damage to other activities, there were differences of
view about whether monetary policy could, and should be used to counter
them or whether it was better to rely on regulation of capital requirements and
lending standards. Recurrent bubbles prevailed over regulatory quality and,
above all in 2008, exposed an Achilles heel of central banking. In the wake of
the credit crisis of 2007–8 the Bank for International Settlements (2008) stressed
the need for greater use of monetary policy for macro-prudential purposes. The
frequency and severity of crises could be reduced by a more symmetrical use of
monetary policy: by tightening it when credit growth soars and asset prices
explode, even if it temporarily reduces inflation below target levels. This assess-
ment rested on the attribution of a sizeable portion of blame for the 2007–8
crisis to the central banks, led by the US Fed, for tolerating a long period of easy
money and rapid asset price inflation.
Academic monetary economists were in general powerful advocates of rules,
though their advocacy varied from money supply growth, exchange-rate target-
ing, to direct inflation targeting. Central bankers were also attracted to rules as
insurance to protect against political incursions on their independence and,
not least, as an anchor to entrench market expectations of inflation consistent
with their objectives. However, they were most directly exposed to the volatility
31
and random character of increasingly large, fast-changing, interconnected,

and opaque financial markets. In consequence, they were both unsure what
constituted the appropriate rule and cautious about using simple rules. They
differed on how much insurance they were prepared to pay to protect them-
selves against failure to meet their target. Central bank career officials (‘lifers’),
as well as academic economists and government officials after appointment to
top central bank posts, were typically more disposed to the pragmatism of ‘rule-
bound’ discretion. This underlying professional pragmatism was apparent in
how the Bundesbank actually used its monetary targeting, 1974–98, and in the
ECB’s design of a ‘two-pillar’ monetary policy strategy. It was evident in its
decision in December 2003 to stop publishing a reference value for growth of
money supply in favour of more detailed, multi-dimensional ‘monetary analy-
sis’ to cross-check ‘economic analysis’.
The diffusion of this ideational shift to rules and institutional independence
was reinforced by a change in the career backgrounds and incentives of top
central bankers from the late 1970s and thus a strengthened disposition to
‘hawkish’ attitudes to inflation. This preference shift was independent of insti-
tutional independence and reflected the role of central banks as ‘revolving
doors’ in careers. Internationally, though the mixture of career types varied
between central banks, the trend was away from appointing those with non-
specialist bureaucratic experience in government to top central bank positions;
they were associated with a more ‘dovish’ attitude to inflation (Adolph 2003:
24). There was a stronger representation from the private banking and financial
sectors, which were more closely linked to ‘hawkish’ attitudes to inflation and
which acted as a ‘shadow principal’ of central banks and incentivized inflation-
aversion (Posen 1995). Similarly, the career inducements of the financial sector
to central bank ‘lifers’ and to those from finance ministry backgrounds offered
an incentive for them to be ‘hawkish’. The second shift was to a greater presence
of academic economists in top posts; they were often, if less frequently, ‘hawk-
ish’ in views (Adolph 2003, 2005). In short, career socialization and incentive
patterns changed, privileging ‘conservatism’ in monetary policy preferences.
However, these same career and socialization factors produced a disincentive to
pay attention to financial stability issues and to asset price bubbles from which
market participants made major financial gains. The effects of this disincentive
were demonstrated in 2007–8 and raised questions about the de facto relation-
ship of central bankers to financial markets.
Moreover, at least amongst ‘outsider’ EU central banks, there is some limited
evidence that the appointment process to top posts is used as a channel for
political influence by trying to entrench attitudes to monetary policy that
complement the stance of fiscal policies: respectively, favouring ‘dovish’ atti-
tudes in appointees when fiscal policy is tight and ‘hawkish’ when it is relaxed
(Hix, Hoyland, and Vivyan 2007). It is precisely the element of discretion in
monetary policy that makes the preferences of central bankers—and their
32
socialization and career inducements—important and that offers an incentive

to use this political channel of influence.
In acting as a catalyst for a new ‘market-driven’ age of globalization, the
post-1973 period represented a more definitive structural break with the legacy
of ‘gold-backed’ globalization. Against this international background, the new
centrality of central banks in macro-economic policy making evolved gradually
and at different speeds. It responded to the new post-Bretton Woods context
of floating exchange rates amongst the leading currencies, US-led (and in
Europe UK-led) capital liberalization, and increasingly powerful, internation-
ally integrated, and institutionally more complex and interconnected financial
markets.
Market-driven banking and financial crises increased substantially, alongside
the liberalization of capital flows, becoming as high since 1980 as in any period
since 1800 (Reinhart and Rogoff 2008; also Kindleberger and Aliber 2005). They
were the trigger for domestic political elites to absorb two painful lessons. First,
in the absence of a formal international ‘anchor’, backed by a leader willing and
capable of leading international stabilization, and given the sheer scale and
speed of capital movements, pegging the exchange rate was hazardous. In this
respect, the notion of a ‘Bretton Woods II’, in effect an informal ‘dollar zone’ as
states like China pegged to the US dollar and became ‘takers’ of US monetary
policy, lacked traction. It was a subtext in the international monetary history of
the period, though one that spoke to ongoing US monetary power. The most
credible choices were ‘floating’—with a credible domestic monetary policy, a
‘hard peg’ (like currency boards) or a monetary union (Fischer 2001). Floating
appealed particularly to believers in national monetary sovereignty and to those
who saw devaluation as a speedier means for regaining lost competitiveness.
Second, domestic political elites came to see that central bank empowerment
through independence offered valuable institutional insurance against the
heightened risks of exchange-rate volatility and ‘overshoots’ at costs to the
real economy, of inflation, and of banking and financial crises. These risks
increased once external constraints, like exchange controls, were relaxed and
once complex financial market intermediation made supervision of markets
more difficult. Governments recognized their increased vulnerability to domes-
tic pressures for politically motivated loose monetary (and fiscal) policies, to
consequent electoral ‘boom’ and ‘bust’ cycles, and to episodic exchange-rate
crisis. Empowerment of central bakers reflected a series of painful political
experiences: the Great Inflation of the 1970s, fuelled by trade-union power
over wage setting; exchange-rate crises that threatened to disrupt European
integration and reduce trade (like the ERM crises of 1983, 1987, and 1992–3);
and periodic contagious banking and financial crises, even if chiefly originated
outside Europe.
This changed international context led to major conceptual and theoretical
innovations in monetary economics, which in turn legitimated a stronger role
33
for central banks in macro-economic policy. Inflationary and financial crises

provided a receptive context for the international diffusion of new policy ideas.
Monetary economics constructed an impressive technical edifice of ideas that
buttressed the assignment of an explicit mandate of price stability to independ-
ent central banks. They centred on the restoration of the traditional belief in the
neutrality of money in the late 1960s to early 1970s (arguing that, in the long
term, monetary policy does not affect ‘real’ variables like growth and employ-
ment) and an emerging consensus that high and variable inflation has detri-
mental effects on macro-economic performance, job creation, and social
stability (on which the European Central Bank 2008). In short, inflation is a
monetary phenomenon; and effective monetary policy helps maximize the
long-term productive potential of the economy.
In further refinements inflation was recast as a phenomenon of private-sector
expectations, whose management required policy credibility; and macro-
economic policy was viewed as confronting a ‘time inconsistency’ problem.
This problem was created by political intervention to boost economies prior to
elections, destabilizing expectations, and undermining policy credibility. The
consequence was a new emphasis on the policy solutions of non-monetary
financing of fiscal deficits, central bank independence and transparency in
monetary policy, ‘rule-based’ fiscal and monetary policies as the embodiment
of commitment to deliver stability, and ‘supply-side’ reforms of market liberal-
ization to generate growth and employment.
Hence the birth of the age of the euro was encapsulated within, and substan-
tively defined by, the longer age of post-Bretton Woods. Central banks gained
new political power by offering improved insurance to states against volatile
international financial markets. In turn, by the 1980s market players were being
creative in offering investors new insurance against heightened risks from
currency and interest-rate movements through the new instrument of deriva-
tives and credit default swaps in particular. These instruments, in turn, could be
used to speculate. The result was a bitter irony: whilst central banks gained
political power, they were more vulnerable to market players’ self-interest in
generating complexity and opacity to create commercial advantage in offering
innovative forms of high-yield risk insurance. Indeed, as by the 1990s central
banks succeeded in bringing down interest rates, they encouraged financial
market players to be even more creative in helping investors achieve good
returns—for instance, credit default swaps and collateralized debt obligations.
Stability and Change in Domestic Political Incentives

Above all, the age of the euro helped not only to accelerate the timing and
tempo of central bank independence but also to shape its distinctive details on
German Ordo-liberal lines, most notably in a critical distancing from New
Keynesian models in monetary policy (Weber 2006b). Domestic political elites
34
learnt from painful experience that they were acutely vulnerable to the massive
size, global scale, speed, and random behaviour—in short, power—of highly
complex, interconnected and opaque financial markets. European monetary
union provided collective insurance, above all to small and medium-sized
states, by safeguarding the trade and investment gains of the post-war European
integration process, not least the single European market. In addition, it offered
higher trade and investment gains through the elimination of exchange-rate
risks and reduction of transaction costs.
The age of the euro helped to speed and consolidate the macro-economic
power of central banking in Europe by overcoming vestigial domestic resistance
to the idea and practices of central bank independence. This resistance reflected
an enduring political incentive to try to control the business cycle for political
reasons, not least by relaxing policies to gain electoral support. It was strength-
ened in 2008 as financial crisis in money and other markets and implosion of
leading banks threatened recession. Bank bail outs were associated with a new
loosening of fiscal rules in favour of counter-cyclical action. The political and
intellectual context of central banks changed.
Incentives to control the political business cycle were stronger under two
conditions. First, where domestic institutional rules established fixed electoral
terms, as in France and Germany, governments lacked the discretion to time
elections during a favourable period of economic expansion or in order to pre-
empt a pending economic downturn. Hence they had a stronger incentive to
manipulate the economy (Kayser 2005). Second, where governments were
locked into long cycles of economic stagnation and weak wage growth (as in
Germany in 1993–2005 and in Italy), they had an incentive to seek to manipu-
late economic conditions to favour re-election, irrespective of whether they
had fixed or discretionary electoral terms. Deprived of monetary policy, the
emphasis shifted to fiscal policies. In turn, politically opportunistic fiscal
policies—and the credibility of the Stability and Growth Pact—became a
major source of uncertainty and vulnerability to the ECB (Issing 2008).
In addition, many European states had an historic legacy of ideas favouring
political intervention in the economy. These ideas were variously rooted in
Catholic social teaching, social democratic ideas, ‘realist’ views of the state and
markets, and not least dominant domestic political memories where they
associated financial market power with unemployment. French dirigisme rests
on the idea that elected governments, not least the President under the Fifth
Republic, embody the superior republican legitimacy of the will of the nation.
In Hungary and Poland, strongly entrenched ideas of social solidarity underpin
a distrust of independent central bankers. In Italy, the state functions in a way
that offers political elites scope to reward and protect their clienteles, not least
subverting domestic structural reforms. Hence, central banking is exposed to
varying European attitudes to the legitimacy of technocratic power in eco-
nomic policy.
35
The paradox of the age of the euro was that, in a project constructed
around Franco-German political leadership in European integration, French
and German ideas about the relationship of central banks to the state were
least easy to reconcile. Although the Treaty was firm on central bank independ-
ence, the ECB remained politically exposed to this paradox. Its capacity to
endure this exposure reflected in part the tough Treaty provisions and high
hurdles to amendment (unanimity in domestic ratification) and in part firm
German support for central bank independence, grounded in bitter historical
memories of interwar and post-war hyperinflation. The motto that ‘the euro
must be at least as strong as the D-Mark’ overshadowed German policy towards
the ECB.
Other than Germany, European states had two main incentives to renounce
their residual sovereign powers over monetary policy, as well as the symbol-
ism of their national currencies for identity: removing the capacity of the
financial markets to directly punish and humiliate elected governments
through exchange-rate crisis; and neutralizing German power over European
monetary policies. A single currency and a single monetary policy eliminated
a key international vulnerability of post-war European states and were con-
sistent with an enduring post-war motive of power balancing, notably against
Germany, in the European integration process. These incentives were espe-
cially strong for the smaller European states. They stood to gain dispropor-
tionately from the end of exchange-rate risk and the reduction of transaction
costs in both trade and investment and from having formally equal ‘voice’ in
monetary policy.
Changing International Vulnerabilities: From Exchange

Rates to Financial Stability
In the process, however, the axis of vulnerability for European states in the age
of the euro shifted from the exchange-rate crisis to contagious cross-national
banking and financial crisis. Although this vulnerability was increased by
strengthened incentives to trans-national European banking with the euro, it
was more deeply rooted in the interconnectedness and opacity of global finan-
cial markets. Even if US-centred, the 2007–8 liquidity and solvency crisis high-
lighted the ongoing vulnerability of European states to excesses in financial
market risk taking and the deficiencies of fragmented European regulatory
systems in an age of interconnected financial markets. The age of the euro,
and the financial crisis of 2008, challenged European central banks to refocus
priorities around the financial stability function. The issues extended beyond
their involvement in macro-level financial market risk analysis and stress test-
ing; through the problem of their frequent exclusion from the micro-level,
operational aspects of banking and financial market supervision; to questions
36
about the adequacy of the rules underpinning banking supervision. In conse-

quence, they lacked early warning of threats to financial stability and of pres-
sures on their monetary policies from crisis in monetary market operations.
As the financial crisis of 2008 showed, the problems were exacerbated by
the breaking down of the distinction between ‘regulated’ commercial banks
and other lightly, even non-regulated financial actors—notably investment
banks, hedge funds, private equity companies. Crisis overwhelmed this latter
sector. Moreover, commercial banks were exposed to new ‘off-balance-sheet’
risks through creating new ‘structured investment vehicles’. Central banks
faced a new ‘shadow’ banking system, endogenously creating credit. As the
US-Fed orchestrated Bear Stearns rescue in 2008 and later systemic rescue
package revealed, other financial entities were becoming ‘too interconnected
to fail’ and drawing central banks into crisis management. In exchange,
central banks shifted their focus to designing more intelligent rules to
align private incentives to make markets efficient and innovatory with the
public good of financial stability: interesting themselves in counter-cyclical
capital requirements to offset asset bubbles and bursts and in increased
capitalization over the cycle. However, the initial focus of this shift was
primarily global, focused on the Financial Stability Forum, the IMF, the
G7/8, and the Bank for International Settlements, rather than on redesign
of the Euro Area.
This shift towards financial stability was made difficult by several factors. The
general central banking problem was ‘moral hazard’: their policies should not
encourage financial institutions to take reckless risks, secure in the knowledge
that they are too ‘systemically important’ to be allowed to fail. Policies that
offer inducements to reckless behaviour threaten to create future financial
crises. A further general factor was ‘turf wars’ within complex, multi-layered,
often segmented regulatory bodies: for instance, in the United States. The Euro
Area encountered its own problems in promoting financial stability. They
included varied, historically distinctive domestic banking and financial struc-
tures, for instance, the ‘three-pillar’ structure in Germany and a traditionally
highly protective, interconnected Italian banking structure; the incentive for
national central banks, once deprived of monetary policy, to seek to carve out a
niche in financial stability and in banking supervision and in the process to
delimit the role of the ECB; the failure of non-central bank national financial
market regulators to share information about bank exposures in a timely way
with the ECB; and, most fundamental of all, the problem that states were even
more hesitant to pool sovereignty in this area than monetary policy and that a
Treaty basis did not exist to establish a European banking supervisory authority.
Ultimately taxpayer money was required to act as lender of last resort to the
banking system in a trans-national solvency crisis. Governments were unwill-
ing to make their publics hostage to bailing out banking failures elsewhere in
the Euro Area. In this context, the technocratic rationale for central bank
37
independence in monetary policy was less credible in financial stability pol-

icies. Hence the age of the euro represented a shift in vulnerabilities for Euro-
pean states and central banks. The threat of a Euro Area power vacuum was
higher in financial stability than in monetary policies and was exhibited in the
uncoordinated nature of Irish and other interventions as the 2008 financial
crisis unfolded.
The Changing Global Context of Monetary Policy
Additionally, the ECB had to cope with new vulnerability in monetary policy
from two shocks: international energy and commodity price shocks and
imported inflation from emerging markets; and the deflationary effects
from the credit crunch and financial crisis of 2008. The ECB benefited in its
early years (1999–2005) from the historical accident of a relatively ‘good
birth’. The international political economy offered a context of ‘good times’
for monetary policy. The global economy grew at an unprecedented rate,
even if the Euro Area economy exhibited symptoms of anaemic overall GDP
growth, productivity growth and high structural unemployment, largely
consequent on the weak performance of its core former ‘D-Mark-Zone’ econ-
omies. Its locomotives lay outside Europe in US consumer-led growth and in
the powerful entry of China and India into the international economy as
exporters of cheap manufactures (with by 2007 China accounting for just
over 25% of world economic growth at purchasing power parity). Above all,
‘globalization’ became associated for a period with the magic reconciliation
of the so-called ‘Great Moderation’ in low inflation, low short-term real
interest rates, and high growth (christened by the governor of the Bank of
England the ‘NICE’ decade of ‘non-accelerating inflation and continuous
expansion’). In this benign context, like other central banks, the ECB was
able to pursue an ‘accommodative’ monetary policy without endangering its
strict price stability mandate, which it redefined in 2003 as ‘below but close
to’ 2 per cent. Above all, it succeeded in locking in long-term market expect-
ations of inflation broadly consistent with this definition at historically low
real interest rates. The age of the euro benefited from this historical accident
of a good birth.
In contrast to the greater complacency about inflationary pressures exhibited
by some other leading central banks, from 2005 this ‘accommodative’ ECB
monetary policy was gradually reduced. Its ‘monetary’ pillar identified mount-
ing inflationary risks in the context of continuing low output growth potential.
Even so, by late 2007, Euro Area inflation was accelerating well above target.
‘Globalization’ had ceased to function as a one-way inflation dampener. Food,
commodity, and energy prices rose sharply, reflecting partly supply problems
and partly new demand from rapidly growing economies like China and India;
38
subsequent falling real wages meant falling disposable income; whilst financial
crisis intensified as the effects of the US sub-prime debacle spread across markets
and, through tightening credit policies, into the real economy. Even if the
threat of ‘second-round’ effects in wage settlements on the 1970s pattern was
ameliorated by subsequent product, trade, and labour-market deregulations, as
well as higher immigration, a global inflationary process threatened.
Hence, the ECB faced new challenges in monetary policy. The accommoda-
tion of new threats to the real economy of growth and employment from
financial crisis proved more difficult to reconcile with the threats to the price
stability mandate from imported global inflation. These ‘globalization’ chal-
lenges opened up new political space for tensions and conflicts about ‘winners’
and ‘losers’ and between supra-national central bankers, loyal to the Treaty
mandate of price stability, and European governments, anxious about their
electorates’ tolerance for cuts in real incomes and determined to protect their
national banks and depositors from banking failures. This changing environ-
ment offered new incentives to form coalitions of ‘losers’, altering the axis of
political debate about globalization, financial markets, and central banks.
The potential for tension and conflict was already apparent in that the age of
the euro had provided stark domestic challenges of economic and institutional
reforms in Euro Area member states. In the process, it made more transparent
both the weaknesses and failures of domestic political leadership and the deeper
institutional, political, and cultural problems of managing economic change in
the political and the corporate spheres. Euro Area member states had lost two
traditional core mechanisms to speed adjustment to asymmetric shocks: the
exchange rate, notably devaluation to regain lost competitiveness (in short,
exporting adjustment problems to others); and the interest rate.
The age of the euro meant a ‘one-size-fits-all’ monetary policy that, in some
cases, fuelled credit booms notably in residential investment through low, even
negative real interest rates (as in Ireland and Spain up to 2007) and, in others,
acted as a constraint through higher real interest rates (as in Germany till 2005–
6). In consequence, there was a divergence in credit cycles between Germany
and these states. Moreover, persisting inflation differentials and differentials in
productivity growth led to changes in relative unit labour costs and ‘real’
exchange-rate changes inside the Euro Area. Firms in some states, notably
Ireland, Portugal, Greece, Spain, and Italy, became less competitive and their
current account deficits widened. In contrast, Germany, Austria, Finland, and
Belgium gained competitiveness. In order to deal with asymmetric shocks in
this altered policy framework, Euro Area states had to rely more on regaining
budgetary room for manoeuvre through sound sustainable fiscal policies, on
disciplined wage policies to enhance competitiveness, and on labour-market,
employment, and product and service market policies to encourage flexibility.
Domestic reform pressures mounted and were articulated not least by national
central banks. In the process they were drawn into domestic political contest.
39
The combination of this gradual build up of differentials in competitiveness

through contrasting unit labour cost development with political failures to
expedite domestic structural reforms threatened to lock Euro Area states
into long cycles of growth and stagnation. The German long cycle of painful
adjustment, first to German unification and then to over-valuation of the
D-Mark on conversion to the euro, is exemplary, above all for the timescale
and pain in ‘bottom–up’ corporate-led change in the context of a domestic
credit crunch. States that become locked into protracted periods of painful
structural adjustment are at greater risk from random political outcomes from
opportunist populist mobilization. For a variety of historical and institutional
reasons Germany was relatively resistant to these domestic risks. The German
pattern was unlikely to prove general.
The age of the euro is one in which the power of central bankers is vulnerable
to the lack of domestic ownership for the euro’s implications. This lack of
ownership derives not just from political elites in fiscal and structural reform
policies—witness the crisis of the Stability and Growth Pact in November 2003
and the failures of the Lisbon process of economic reforms. It depends also on
the dynamics of wage bargaining by employers and trade unions and on the
behaviour of corporate elites in restructuring their activities to capture the
potential gains of a single currency. Consequently, however, it may have
empowered central bankers, the age of the euro remains an uncertain venture
in central banking. Adjustments are likely to be long-term, painful, and con-
tested, testing domestic political will and the institutional capacity to reform
and potentially making monetary policy more difficult to conduct. Although
central banks are formally independent, they cannot be indifferent to the
distribution and intensity of domestic political preferences. The multiplicity
of domestic institutional and political veto points and of partisan veto players
implies adverse conditions for unity of purpose in European macro-economic
policies. This point applies not least to the independent central banks in east
central Europe in the context of euro entry strategies.
States, Central Banks, and the Internal Governance

of the Eurosystem
At the level of process the age of the euro was above all a European affair, bound
up in the economic and political dynamics of European integration. It was part
and parcel of various pro-integration arguments: about completing the ‘logic’ of
European customs union and the single market (‘one market, one money’);
about trade and investment gains from eliminating exchange-rate risk and
reducing transaction costs; and about making European integration, in German
Chancellor Helmut Kohl’s words, ‘irreversible’ and ensuring no future wars in
Europe. Historical memory of catastrophic twentieth-century European wars
40
and the failure of traditional faith in the ‘balance of power’ hung heavily over
the politics of the process (Dyson and Featherstone 1999).
Central Banks, State Power, and Differentiated Integration
The euro raised in a highly focused manner the question of the relationship of
European integration to state power. At its heart was a trade-off that invited
different political choices based on contrasting domestic structures of preference.
On the one hand, loss of state power was implicit in the formal renunciation of
‘monetary sovereignty’, both in its symbolic trappings especially of ‘identity’ and
in the nominal form of the interest rate and the exchange rate as domestic policy
instruments for cushioning asymmetric shocks. Domestic contests were shar-
pened: over implications for different national economic and social models, for
who wins and who loses, and for whether ‘real’ convergence in living standards
represented by GDP per capita was being sacrificed to ‘nominal’ convergence.
On the other hand, euro entry offered the gains of currency and monetary
union. These gains in state power included the elimination of increased vul-
nerability to domestic exchange-rate crises in the post-Bretton Woods age of
floating exchange rates and volatile global financial markets; sharing in Euro-
pean monetary policy rather than being a passive ‘policy taker’ from the
Bundesbank in the Exchange-Rate Mechanism (ERM); as well as increasing
growth and employment through trade effects from reduced transaction costs
and reducing risk through access to much larger, more liquid financial markets
The complex trade-offs were evaluated differently by domestic elites.
Amongst the ‘old’ 15 EU member states in 1998–9 Britain, Denmark, and
Sweden chose to remain ‘outsiders’; whilst newer EU member states divided
between ‘leaders’ and ‘laggards’ on euro entry and shifted their positions on this
spectrum (on which Dyson 2006, 2008).
Above all, the age of the euro represented the most advanced example of
differentiated European integration. In contrast to full integration of all EU
member states, it produced a radical restructuring of European central banking
into the ‘Eurosystem’ and ‘outsiders’. The Eurosystem comprised the ECB and
the national central banks of those EU member states whose currency was the
euro. In this new context, the formal conditionality attached to EU accession,
and later to entry into monetary union, acted as powerful, top–down, European-
level pressures for convergence around a clear, specific and detailed insti-
tutional template of central bank independence, prohibition of monetary
financing of deficits, and strengthened incentives to pursue disinflation and
fiscal discipline.
At the same time, as this volume shows, in the context of contrasting political
choices, and not least underlying economic structures, national central
banks behaved differently. The Bank of England, an ‘outsider’, focused very
41
successfully on preparing the City of London wholesale markets so that London

would become the major centre for euro-denominated financial business
(Goodhart’s chapter). Two Nordic ‘outsiders’, the central banks of Denmark
and Sweden, pursued contrasting strategies; Sweden led in the practices of the
New Public Management and transparency; whilst both compensated by more
active international networking (Marcussen’s chapter). The German Bundes-
bank, an ‘insider’, had to radically reconfigure strategy and structures to cope
with monetary policy ‘disempowerment’ (Dyson’s chapter). Another ‘insider’,
the Bank of Italy, suffered a profound crisis of its centralized corporate govern-
ance in 2005, consequent on the failed attempt to act as champion of a
protectionist approach to domestic banking consolidation (Quaglia’s chapter).
In east central Europe the domestic political complexities of euro entry, and
often of partisan appointments to senior posts, exposed central banks to fre-
quent challenges to their independence (Epstein and Johnson’s chapter; Gres-
kovits’s chapter). These and other experiences of central banks in the age of the
euro are examined in this volume.
Competing in Ideas; Seeking Niches: Developing Cooperation
More generally, the NCBs in the Eurosystem sought to occupy different special-
ized niches in the new more competitive environment of ideas. This pursuit of
specialization within the Eurosystem was visible in contributing ideas to mon-
etary policy, financial stability, new research networks, the euro payment and
settlement system, the agenda of the New Public Management, and EU/Euro
Area enlargement and transition economies. NCBs were forced to consider their
comparative advantage and build their own niches as the basis for leadership
roles in pooling services through specialized cooperation activities in the Euro-
system. How they developed specialization, and responded to wider Eurosystem
pressures, reflected the historical accidents of their competences and strengths;
the constraints of their size; and their geographical location. In competences,
for instance, the Belgian and French central banks had traditionally strong roles
in national accounting and in collecting data about firms, giving statistics a
strong profile in their work. The Belgian and Dutch central banks had particular
strengths in developing collateral central bank management systems that they
could transfer to the Eurosystem. In general, smaller NCBs had a greater incen-
tive to seek out cooperation. For instance, two systems of cooperative pooling of
the operational management of the ECB’s foreign reserve assets were established
in 2007: between the Luxembourg and Slovenian central banks; and between
the Cypriot, Greek, Irish, and Maltese central banks. Although small NCBs had a
new incentive to engage in monetary policy analysis, they could not hope to
match the ECB. In contrast, as a large central bank with an eminent reputation
in monetary policy performance, the Bundesbank had a strong incentive to
42
maintain both its traditional role in this policy area through its advocacy of a
principles-based approach and its high international profile in various Eurosys-
tem cooperative ventures to provide technical advice to states outside the EU,
including Russia, the Gulf Cooperation Council, and the western Balkans.
Geographic location led the Austrian and Finnish central banks to focus,
respectively, on the Balkans and the Baltic States.
Contest emerged about different forms of cooperation, part of a larger debate
about operating modalities in the Eurosystem, on which the Governing Council
set up a Task Force. Examples of ‘bottom–up’ cooperation included the leading
role of the Belgian National Bank in developing harmonized, efficient, and
secure IT-based management of cash flows with the cash single shared platform
(Cash SSP in 2006) as the model for a future Single Euro Cash Area; and, building
on their geographic locations, the Austrian and the Finnish national banks in
fostering privileged relations with post-communist transition economies in Euro
Area enlargement. A more ‘top–down’ cooperation, negotiated in the ECB Gen-
eral Council, was the German Bundesbank, the Banque de France, and the Banca
d’Italia leadership in the shared computer platform for the TARGET 2 electronic
euro payment and settlement system. This leadership group was extended to the
Spanish central bank in developing the proposal for TARGET2-Securities (T2S)
for settlement of securities transactions using this shared platform. On issues like
cross-border collateral management and statistics a tussle was apparent over the
form that cooperation was to take. The new Collateral Central Bank Manage-
ment (CCBM2)—endorsed by the ECB Governing Council in 2007—was mod-
elled on the Belgian and Dutch central banks, but participation remained
voluntary pending consultation on its further development.
The less central a function was to monetary policy, the greater was the scope
to develop flexible, ‘bottom–up’ cooperation. Alongside the Cash SSP in cash
management (by 2008 the Belgian, Dutch, Luxembourg, and Finnish central
banks), an example of ‘bottom–up’ cooperation in banking supervision was the
2003 Memorandum of Understanding on the exchange of data in national
central registers. This cooperation allowed better evaluation of credit risk in
cross-border lending and involved a consortium of the central banks in Austria,
Belgium, France, Germany, Italy, Portugal, and Spain. Membership was neces-
sarily limited to those states with national credit registers and—given the focus
of banking supervision on the EU level—not in principle limited to Eurosystem
central banks.
Agendas and Processes of Change: Benchmarking

and Binding Rules
‘Analysis/research’, ‘efficiency’, and ‘specialization’ gained a new status in the

internal vocabulary of NCBs. In particular, the Eurosystem stimulated two
43
agendas of change. First, NCBs were under increased pressure to stake out
leadership in promoting internal efficiency through the techniques of ‘New
Public Management’. This pressure derived from their vulnerability to two
arguments: that with centralized monetary policy making they were ‘over-
staffed’ in relation to functions, bloated self-serving bureaucracies; and that
they were hypocritical in calling for structural reforms when they were unwill-
ing to bear the pain of reform themselves in the face of major structural change.
Here the main model was a Eurosystem ‘outsider’, the Swedish central bank.
Under Axel Weber the Bundesbank sought to carve out a leadership role on New
Public Management; whereas the Banque de France, caught up in more difficult
public-sector trade union problems, proved a laggard. The New Public Manage-
ment was attractive to the new ECB because it combined an association with
‘modernization’ with centralizing implications and legitimated transformation
in central banking.
Second, NCBs were under pressure to upgrade their applied research, conse-
quent on the need to mount persuasive arguments in a new context in which
they were no longer ‘monopolists’. Quality of analysis was exposed when they
had to share in debates in a large number of Eurosystem committees and
working groups and, above all, to ensure that their governors were well-briefed
for Governing Council meetings on both monetary and non-monetary matters.
The Bundesbank’s focus on developing its niche in the ‘monetary analysis’
pillar of ECB monetary policy strategy represented an attempt to directly
shape centralized policy and to give more analytical clout to its traditional
‘principles-based’ approach. Similarly, building on its advantage in competence
in banking supervision, the Dutch National Bank sought out a niche in the
financial stability function. Overall, however, even for the top performers in
quality research performance like the Dutch and Finnish central banks, it
proved difficult to match the growing scale of research capacity in the ECB. In
the three Eurosystem research networks—on monetary transmission (1999–
2002), inflation persistence, and wage dynamics (2006–8)—ECB researchers
played key roles. In cooperation with NCB research directors, the ECB also
developed benchmarks for assessing research quality, ranking key policy-
oriented academic journals. This new, intensifying benchmarking process in
turn increased internal pressures to invest in research, as well as controversy
about the appropriateness of benchmarking English-language journals when
NCBs should be communicating more actively with domestic audiences.
Above all, the age of the euro witnessed the evolution of a body of principles,
rules, and practices of cooperation and teamwork within the Eurosystem. In
addition to the intense benchmarking described above, the Eurosystem
spawned a body of binding rules. At the heart of this evolution was the search
to marry common goals with the principle of decentralization that had been
established in the preparatory work of the EMI. Centralization was in principle
confined to monetary policy making; though its implementation was a matter
44
for the NCBs. Nevertheless, the monetary policy function spawned the need to
extend binding rules to ensure both consistent implementation and that
related functions, like payment and settlement systems, were supportive.
This body of binding rules can be accessed elsewhere (see Dyson and Quaglia
2009). They include the following:
. Treaty articles, notably 4, 105, and 106
. The Statute of the European System of Central Banks (ESCB), especially
articles 3, 12, 17–20
. The ECB regulation on the application of minimum reserves, December
1998 and subsequent amendments
. The ECB decision of 1998 (and subsequent amendments) on the key to
subscriptions of NCBs to the capital of the ECB
. The decision on the rules of procedure of the ECB, February 2004
. The ECB monetary policy rules as laid down in October 1998 and ‘clarified’
in May 2003
. The ECB guidelines on monetary policy instruments and procedures of the
Eurosystem, with various amendments
. The evolution from a two-tier to a single list in the collateral framework
. The correspondent central banking model
. The Council regulation of May 2000 on further calls of foreign reserve
assets by the ECB
. The ECB guidelines of October 2003 on the management of foreign
exchange reserves and operations
. The standards in the EU securities settlement systems
. The Council regulation of November 1998 on collection of statistical
information and the ECB guidelines of November 2000 on statistical report-
ing requirements by the NCBs
Binding rules went along with the evolution of a body of principles about the
organization of cooperation, which reflected the practices that had grown up in
the various committees and working groups of the Eurosystem. They were
articulated in the Eurosystem Mission Statement of 2005. The focus in the
Mission Statement was on ensuring the effectiveness of the Eurosystem as a
‘team of central banks’, able to ‘speak with one voice’ and ‘exploit synergies’.
Is the Age of the Euro a ‘Structural Break’?
Prima facie the age of the euro suggests a ‘structural break’ in European central
banking. The arrival of the euro as the second world currency after the US dollar
45
is clearly an important moment in international monetary history. It is syn-

onymous with a new, potentially powerful actor in international central bank-
ing: the ECB in Frankfurt. The possibility of the long-term displacement of the
dollar by the euro, and of a multiple currency world, suggests a new era in
central banking. However, one needs to be more precise in claiming that the age
of the euro is a ‘structural break’. To what extent is it a structural break in
European integration, to what extent in central banking?
The most obvious sense in which the age of the euro is a structural break is in
terms of the EU. The euro and the ECB have generated a set of institutional
innovations, for instance, in EU financial market integration, and—in insuring
Euro Area states against global financial market power—helped to rescue them.
At the same time, it has been of limited significance in accelerating political
union and shared identity (witness the Dutch and French ‘no’ votes on the
Constitutional Treaty in 2005 and the Irish ‘no’ to the Lisbon Treaty in 2008)
and has done nothing to reinforce the fiscal capacity of the EU (Dyson 2008b).
More pertinently, the euro and the ECB are less central to the development
of the political capacity of the EU than the EU’s ability to extract revenue,
acquire an independent fiscal competence, and engage in debt financing (cf.
McNamara 2002b). Faced with the de-territorialization of money, EU member
states have proved more jealous of their fiscal than their monetary sovereignty.
The result is an imbalanced development in European economic governance
and policies—between fiscal and monetary policies—and in the ECB—between
its monetary and its financial stability/banking supervisory functions (Dyson
2008b).
In terms of structural power, the age of the euro embodies a ‘Germanization’
of central banking in institutional design and monetary policy development.
Above all, it represents a structural break for the central banking system of the
Euro Area. The chapters by Dyson on the German Bundesbank and Pagoulatos
on the Bank of Greece suggest a real sense of structural break at the micro-level.
These cases of Europeanization of national central banks point in different
directions of ‘disempowerment’ and ‘empowerment’.
The age of the euro may also serve as a structural break in the sense of producing
more than ‘one Europe’ inside the EU. The Euro Area is the most potent expres-
sion of formally differentiated European integration: not all national central
banks share the same rights and obligations. Just as some are Euro Area ‘insiders’,
other national central banks are ‘outsiders’. ‘Insiders’ themselves exhibit differ-
entiation into ‘core’ and ‘non-core’ (see Umbach and Wessels’ chapter). Only two
EU states (Britain and Denmark) have an ‘opt out’ from the euro and thus are not
obliged by treaty to seek euro entry. Given that they also lack euro entry plans
with timetables they must be seen as ‘semi-permanent’ outsiders. In their cases,
we would expect very different central bank trajectories in the age of the euro,
plotted in the chapters by Goodhart on the Bank of England and Marcussen on
the central banks of Denmark and Sweden. Sweden highlights how even a state
46
with an obligation to seek entry can behave as a ‘semi-permanent’ outsider;

whilst Denmark shows that, even with a formal ‘opt out’, a central bank can
be bound by the constraints of linking its exchange rate to the euro through
membership of the ERM II.
In addition, there is a large group of EU states, notably in the Baltic, east
central Europe, and the east Balkans, which are formally ‘temporary’ outsiders.
This status of derogation involves having euro entry plans with dates. Here the
force of EU formal ‘conditionality’ operates on national central banks: in for-
malizing central bank independence and in meeting the so-called Maastricht
convergence criteria. The chapters by Epstein and Johnson and by Greskovits
explore Europeanization in relation to Baltic and east central European central
banks. Their effects appear as variegated. In this case, as well as the ‘semi-
permanent’ outsiders, the age of the euro does not suggest a structural break
in central banking, rather a point in a well-defined trend line. The structural
break is nationally diverse processes of post-communist transition that predate
EU, let alone Euro Area entry. Moreover, some of these states may repeatedly
defer euro entry to a degree that suggests ‘semi-permanent’ outsider status.
Hence, seen in terms of the European integration, the age of the euro is by no
means destined to shift from short-term differentiation in national central
banks and banking to longer-term integration of all in the Eurosystem. For
some, possibly a good number of, EU central banks the age of the euro will
not operate as a structural break.
To what extent is the age of the euro a structural break in central banking?
The euro is not a new ‘age’ in central banking. Ages of central banking have
typically been defined either in terms of central bank functions and styles of
operation (see Marcussen’s chapter on ‘scientization’) or in terms of changes in
the underlying balance of power (hegemony) in the international monetary
system (as in this chapter).
In functions and style, the age of the euro has not involved Europe-centred
innovation. It reflects a ‘global sea change’ (Epstein 2005: 3) or ‘quiet revolu-
tion’ (Blinder 2004) in central banking, whose origins lie in the power and
complexity of global financial markets, in monetary economics, and in chan-
ging ideas of democratic governance (Siklos 2002). Traditionally, central
bankers were conservative, cautious and remote, addicted to opaque, circum-
spect and coded Delphic utterance, the cultivation of monetary mystique and a
professional image of boredom, and the notion that central banking was pre-
eminently an art, whose practice depends on tacit knowledge and experience
(Hawtrey 1932). In turn, personal trust was vital to the transfer of this tacit
knowledge (cf. Collins 2007). They represented a relatively closed gentlemanly
world of expertise grounded in values of personal integrity and trust. This world
was symbolized in Montagu Norman at the Bank of England and in William
McChesney Martin at the US Fed, the latter famously describing the stern duty
of central banks as to ‘remove the punch bowl before the party gets going’.
47
Although it has by no means disappeared in central banking, the financial crisis

of 2007–8 suggested that it had become in short supply.
In the post-1973 world of market-led financial globalization, central bankers
are expected to engage in a subtler more Socratic—though still coded and
esoteric—dialogue with powerful financial market actors. Securing and retain-
ing credibility in this context meant possessing the authority of macro-
economic expertise, the capacity to communicate with markets that are
themselves driven by new complex products and processes, and the possession
of a feel for the markets (Bernanke 2004a; Blinder and Wyplocz 2004; Woodford
2005). In consequence, the career boundaries to academic economics and to
financial markets were significantly opened. The effects of this opening were felt
not just in socialization and in career incentives of central bankers (cf. Adolph
2003), underpinning a shift to more ‘hawkish’ attitudes to inflation. They also
highlighted a new tension between macro-economists, who took a more remote
view of markets, and those who had been closer to the minutiae of financial
markets, especially the sensitive interbank market. This tension fed in turn into
the politics around top central bank appointments, as in the case of the deputy
governorship of the Bank of England in 2008. More seriously, it raised the
question of whether central banks had too passive vis-à-vis the markets, in effect
‘moping up’ after bust and increasing moral hazard in the process.
In terms of balance of power in the international monetary system, the age of
the euro raises the question about whether the ECB can decouple monetary
policy from the US Fed and whether the euro could over the longer-term
displace the US dollar as the pivot of the international monetary system. Far
more powerful than the age of the euro has been the structural break in central
banking associated with the birth of the ‘post-Bretton Woods’ system, post-
1973. The collapse of the short-lived Bretton Woods system ushered in a new
age of floating exchange rates, capital liberalization, and the exponential
growth of a market-driven, Anglo-American, transaction-based global financial
system. The ‘post-Bretton Woods’ age of market-led globalization oversha-
dowed the birth of the age of the euro and more generally delimited the scope
and reach of central bank power. Its globalizing financial markets—their scale,
complexity, creativity, risk-taking, and opacity—defined the context in which
central banking redefined its functions, recruitment, and styles of operation.
This point comes out in both the non-European ‘control’ cases (the chapters by
Eichbaum and by Woolley) and the chapters dealing with central bank func-
tions. Where an element of central bank distinctiveness arises is in the stronger
influence of German Ordo-liberal thought on money growth models in ECB
monetary policy, its more critical distance from New Keynesian models, and in
the 2008 financial crisis the ECB’s stricter separation of its monetary policy
from its liquidity operations than the US Fed.
Seen in a macro-historical context, the age of the euro is more a point in a
well-defined ‘trend line’ that goes back to the ERM (1979–99) and the European
48
‘Snake’ (1973–9). Both these mechanisms—leading up to the euro—were part of

a long-term process of trying to protect the trade gains of European integration,
to reduce the vulnerability of European governments to the high randomness
of global financial markets, and to centre money and credit growth in monetary
policy. The unwinding of the Bretton Woods system in 1971–3 was the key
structural break; whilst the ‘trend line’ exhibited abiding German Bundesbank
influence.
Some Final Reflections: Central Banks and ‘Europe Building’
Despite the qualified conclusion that it is more of a structural break in European

integration than in central banking, the age of the euro involves an inversion of
the historic power relationship between central banks of the Eurosystem and
states. Principally in monetary policy (and related policies like financial market
infrastructure including TARGET 2 and SEPA), central banks have carved out a
historically new role and identity in ‘Europe building’. However, this new role
and identity of central banks as the most Europeanized domestic institutions
does not imply ‘Europeanization as homogenization’ of European central bank-
ing on German Ordo-liberal terms. It means even less ‘the end of the state’ or
that member states are becoming convergent. Europeanization of central banks
involves different trajectories of domestic reform. These trajectories range from
adapting to maintain the status quo, through modernizing by large-scale
internal transformation, to ‘marketizing’ functions through private-sector tech-
niques and involvement (cf. Pollitt and Bouckaert 2000). They represent
contrasting ways, often mixed together in individual central banks in different
forms, through which the age of the euro is rescuing European states. Central
banks that seek a reform strategy of modernization through transformation
carve out a role as pacesetters. In contrast, those adapting to maintain the status
quo tend to remain laggards. The choice of central bank reform strategies is
both structurally constrained and strategic, variable in nature, and designed
with reference to ‘path dependence’, state traditions, domestic governance
mechanisms, and domestic political constellations.
In this new age of the euro the most interesting aspects of central bank power
have been its least visible dimensions in reframing and shaping how macro-
economic policy interests are conceived and in agenda setting on behalf of
competitiveness, stability, and fiscal discipline (cf. Lukes 2005). Its mechanisms
are in part Europeanization, notably consequent on ‘uploading’ German Ordo-
liberal ideas into Eurosystem design, and in part wider international diffusion
of central bank best practices. However, this structural power is more evident in
monetary policies than in financial stability policies, highlighting the shift of
internal power within central banks and the problematic imbalance between
these two core functions. Even in monetary policy it is open to domestic and
49
European contest. Central bank power is vulnerable to the potential for political
mobilization of collective action on behalf of losers (putative or real) and to
the association of central bank power with ‘neo-liberal’ Europeanization and
globalization (and their conflation). Its Ordo-liberal variant is also subject to the
contesting legitimacies of the republican and (should the UK ever enter) the
Westminster models of institutional legitimacy and accountability.
Continuing broad political support for the high collective action capacity of
central banks in safeguarding price and financial stability depends on their
dissociation from the ‘excesses’ of financial market power and their avoidance
of ‘moral hazard’. The banking excesses revealed in the 2007–8 financial crisis
and the systemic bail outs of the banking sector brought home this point.
‘Working with the market’ could be reconstructed as ‘being captured by the
market’, as being over-accommodating to reckless risk taking and unjust private
gains at huge cost to the public interest. Broadly held social norms of what
constitutes appropriate behaviour in markets and in central banks are them-
selves a form of structural power that constrain central banks. Central banks
have to be seen to be ensuring compliance with these socially valued norms,
not just facilitating narrower standards of utility maximization by financial
market actors. In this respect, public opinion, as mediated by political elites
and given voice in the media, continues to matter in central banking. Central
banks cannot rely for power on their institutional independence, their close-
ness to and understanding of the markets, or their macro-economic expertise.
As the events of 2007–8 highlighted, they are caught up in larger political
processes of (re)definition of norms of acceptable behaviour, whose neglect—
benign or not—can only undermine popular support for central bank power.
50
Part I
The Changing Context of
Central Banking
2
Differentiation in the European System
of Central Banks: Circles, Core, and
Directoire
Gaby Umbach and Wolfgang Wessels
In officially launching the euro with only a limited number of EU Member

States partaking in the Eurosystem, the third stage of Economic and Monetary
Union (EMU) intensified trends to the differentiated integration of Member
States in tasks and competences within the EU system (Giering 2007; Janning
1997; Junge 2006; Tekin and Wessels 2008). The ex ante limitation of member-
ship, as defined by the Maastricht convergence criteria, consolidated differen-
tiated integration within monetary policy and the European System of Central
Banks (ESCB). So, viewed from a systemic perspective on European integration,
out of ‘all the current activities of the European Union in which flexible
integration plays or may play a role, the single European currency is undoubt-
edly the most important’ (Federal Trust 2005: 23).
Institutionally dominated by the European Central Bank (ECB) both the
ESCB and EMU show different patterns of differentiated integration. The
major argument of this chapter is that EMU, and also the ESCB, can be charac-
terized by the dynamic co-existence of a ‘directoire’ of ‘core insiders’, which
seeks to steer a ‘core Europe’ group of Eurosystem ‘insiders’, that is surrounded
by several ‘circles’ of Eurosystem ‘outsiders’. The logics and dynamics of the
co-existence of these three differentiation patterns are assessed to lead to their
co-evolution over time.
This differentiation is mirrored in different groups of ESCB membership. It is
not only relevant for the ESCB and its decision-making processes. It is also
politically relevant as it influences, and to a degree ‘pre-defines’, the future
development of the ESCB, of EMU, and, most probably, of the overall political
system of the EU. It does so by creating different starting conditions and
opportunity structures for EU Member States to influence and shape the system
from within.
53
Differentiation in the European System of Central Banks
As a starting point, it is necessary to examine the ESCB as an arena in which

functional and institutional treaty-based, as well as ‘real world’, differentiation
play a central role. This analytical focus provides the basis for more precise
conclusions on the ESCB as well as on implications for ‘insiders’ and ‘outsiders’.
The key questions are whether the ESCB is moving towards a ‘core of able and/
or willing’ or even a ‘directoire of the powerful’, that is, a de facto steering group,
with smaller and/or weaker members surrounding the core in concentric circles;
and whether the institutional set up of ESCB governing bodies supports or
suppresses such forces within the ‘living ESCB’.
The chapter starts with a tentative typology of different groups of ‘insiders’
and ‘outsiders’, which are defined by their (non-)membership in the Eurosystem
and form the building blocks of institutional EMU/ESCB differentiation charac-
terized by the distinct patterns identified above. Together with the most relevant
areas of functional differentiation presented below, this typology forms the
reference point for the analysis of ESCB differentiation. Throughout its analysis,
the chapter draws on the examination of the ESCB’s treaty-based foundations
(‘legal/formal ESCB’) and gives examples of its institutional and functional
elements in practice (‘living ESCB’). Finally, the chapter’s conclusions summar-
ize the results and elaborate further on differentiation within the ESCB.1
Differentiation within the ESCB: A Typology of Facets,

Groups, and Patterns
This section is based on the analysis of the two most relevant dimensions of
differentiation of the ESCB, institutional and functional. With reference to
institutional differentiation, the two groups of ‘insiders’ and ‘outsiders’ form
the main point of reference. The second section of this part of the chapter
analyses the functional dimension of ESCB differentiation.
Groups of ESCB Membership

The two formal groups of ‘insiders’ and ‘outsiders’ can be identified on the
structural basis of Eurosystem membership. These two groups can each be
further divided into informal (conceptual) sub-groups (Figure 2.1).
INSIDERS OF THE EUROSYSTEM (MATRIX: BOX 1)

The first formal group of the ‘willing and able’ forms the core of the ESCB as it
combines ESCB and Eurosystem membership, given that they comply with the
Maastricht criteria and chose to become members of the European currency
union. The 16 members of this group are not only represented in the ESCB’s
General Council. More importantly, they form the ESCB’s institutional core,
54
Willing
Yes No
Core insiders
(France, Germany, Italy, Spain) Semi-permanent
1 3
Normal insiders outsiders with and
(Maastricht Convergence Criteria)
Yes (Austria, Belgium, Finland, Greece, without treaty-based

Ireland, Luxembourg, the opt outs
Netherlands, Portugal) (Denmark, Sweden, United Kingdom)
New insiders
(Cyprus, Malta, Slovenia, Slovakia)
Able
Temporary outsiders
keen to join
(Bulgaria, Czech Republic, Estonia,
No Romania)
2
Hungary, Latvia, Lithuania, Poland,
Candidate countries as
(potential) future outsiders
(Croatia, Turkey, Former Yugoslav
Republic of Macedonia)
4
Figure 2.1. Groups of ESCB membership
Source: Own design.
which is responsible for governing the Eurosystem through the ECB’s Govern-
ing Council and its Executive Board. The 2004–7 EU enlargement boosted a
further sub-division of this first formal group as it created the new informal
(conceptual) sub-group of ‘new insiders’.
‘Core insiders’. The first informal (conceptual) sub-group of ‘core insiders’ is
made up of (old and large) EU Member States (Germany, France, Italy, Spain)
that are powerful enough to seek some kind of political leadership within EMU
and the ESCB and, thus, to construct some sort of de facto differentiation
amongst the ‘insiders’ (see chapters by Dyson, Howarth, and Quaglia). This
sub-group could be eager to advance as a possible directoire (cf. below) of the
‘core’ Europe group of ‘insiders’. ‘Core insiders’ long for a more stable and
permanent institutional representation and influence within Eurosystem insti-
tutions and the ESCB in general, ‘hoisting their national flags’ within the ECB’s
Executive Board in terms of continuing occupancy of seats. During the first
decade, France, Germany, Italy, and Spain are examples for ‘core insiders’.
Treaty provisions on the governing bodies of the ESCB seem to support this
development as they provide opportunity structures for differentiation. ‘Core
insiders’ might use these treaty provisions on the functions of the ESCB accord-
ing to their national interests and monetary policy priorities to steer the ESCB.
55
‘Normal insiders’. This second informal (conceptual) sub-group consists of

Eurosystem members that are not powerful enough to secure strong, sustained
representation within ESCB and Eurosystem institutions. Their relative position
within both the ESCB and European economic governance is based on their
national size and economic relevance. This sub-group is made up of smaller old
Eurosystem members, notably Austria, Belgium, the Netherlands, and Portugal,
which, due to more limited economic and political weight, do not belong to the
sub-group of ‘core insiders’ (see chapter by Maes and Verdun).
‘New insiders’. This third informal (conceptual) sub-group is composed of new
and comparatively small EU Member States that only recently became Euro-
system members, namely, Cyprus, Malta, Slovenia, and Slovakia. Members of
this sub-group are assumed to be inexperienced in the institutional, political,
and economic logics of the ESCB and the Eurosystem and, hence, as needing a
period to get acquainted with the system and its rules to become ‘normal
insiders’. Moreover, they are in part less advanced in domestic economic per-
formance, de facto limiting their influence within the system, although no
treaty-based barriers exist to their integration into the two other sub-groups of
‘insiders’.
OUTSIDERS OF THE EUROSYSTEM (MATRIX: BOXES 2 AND 3)

The second formal group of the ‘willing, but not able’ and the ‘able, but not
willing’ is composed of EU Member States that are not (yet) Eurosystem mem-
bers. The 11 members of this group are represented only in the ESCB’s General
Council, not within the ESCB’s institutional core responsible for governing the
Eurosystem. Depending on their (economic) distance from the Maastricht
convergence criteria or on their (un-)willingness to join the Eurosystem, these
‘outsiders’ can be arranged in different informal (conceptual) sub-groups. As
with the ‘insiders’, the formal group of ‘outsiders’ was affected by the 2004–7
enlargement that initiated further differentiation by the creation of the new
sub-group of ‘temporary outsiders keen to join’.
Additional to this group are two informal (conceptual) sub-groups of states
that are not members of the EU but that are influenced by ESCB decisions.
‘Temporary Outsiders Keen to Join’ (Matrix: Box 2). This first informal (con-
ceptual) sub-group is made up of two clusters. The first cluster is constituted
by new EU Member States, such as Lithuania, that are not yet economically
advanced enough to become Eurosystem members. They are, however, on
their way to fulfil the Maastricht convergence criteria with target dates for
euro entry from 2010 onwards. The second cluster consists of new EU
Member States like the Czech Republic, Estonia, Hungary, Latvia, Poland,
and Romania that are in need of more substantial reforms to comply with
the Maastricht criteria and to align with the ESCB and Eurosystem institu-
tions (see chapters by Greskovits and by Epstein and Johnson). Dates for the
56
adoption of the euro have been self-set to 2012 onwards (European Com-
mission 2007).
‘Temporary outsiders keen to join’ still have to adapt to the ESCB’s institu-
tional architecture. Moreover, they need to put noticeable efforts into domestic
reforms to stabilize national economic performance in order to meet the Maas-
tricht criteria and to become ‘insiders’.
‘Semi-permanent Outsiders Without a Treaty-based Opt Out’ (Matrix: Box 3). This
informal (conceptual) sub-group comprises EU Member States that are not
Exchange Rate Mechanism II (ERM II) members, are not attempting to fulfil
the Maastricht criteria, have not obtained any derogation in the treaties, and are
not pushed towards Eurosystem membership by the EU. Currently, Sweden
alone forms this sub-group that de facto does not have to fulfil the Maastricht
criteria. Yet, in case of tedious and problematic accession processes amongst
‘temporary outsiders’ to the Eurosystem, this sub-group could serve to pool
those frustrated with accession preparation.
‘Semi-permanent Outsiders With a Treaty-based Opt Out’ (Matrix: Box 3). This
last informal (conceptual) sub-group is made up of EU Member States, like
Denmark (ERM II member) and the United Kingdom (non-ERM II member)
that are not required to join the Eurosystem and that have officially negoti-
ated Treaty opt outs (see chapters by Marcussen and Goodhart). So, de jure,
members of this sub-group do not have to fulfil the Maastricht convergence
criteria. Accession to the Eurosystem strongly depends on domestic political
constellations and priorities. Due to their strong economic performance, these
EU Member States potentially act as role models for non-Eurosystem member-
ship, establishing feasible reasons for ‘temporary outsiders’ to remain ‘semi-
permanent outsiders without a treaty-based opt out’, that is, following the
example of Sweden.
Additionally, two more informal (conceptual) sub-groups of ‘outsiders’ can be
identified. They will, however, not form focus of the analysis in this chapter.
These two sub-groups are constituted by states that are neither EU nor ESCB or
Eurosystem members. They, nevertheless, have institutional links to the ESCB
and are affected by Eurosystem and ESCB decisions as, for example, they are
candidate states to become EU members or partners of international economic
interaction, such as global economic players or international economic and
financial fora.
‘Candidate Countries as (Potential) Future Outsiders’ (Matrix: Box 2). This infor-
mal (conceptual) sub-group consists of states that officially applied for EU
membership like Croatia, Turkey, and the Former Yugoslav Republic of Mace-
donia. They are or might be on their way to (sooner or later) becoming EU
members and are, hence, also affected by Eurosystem and ESCB decisions as
well as by the Maastricht convergence criteria. Additionally, they have to adapt
their national political and economic systems to become ESCB members by the
57
date of their (potential) accession to the EU. Thus they have to adapt ex ante to
the ESCB’s institutional architecture and functional particularities.
‘Global Players’. Global economic players, such as Brazil, China, India, Japan,
and the United States (including international fora such as G7/8, G8þ, and
the IMF), which have a substantial impact on global economic development,
make up this final informal (conceptual) sub-group (see chapter by Woolley).
They also affect and are affected by a strong/weak euro as part of the global
economy and, thus, also by Eurosystem and ESCB decisions strengthening or
weakening the euro. Their relation to the Eurosystem especially influences
foreign-exchange operations and the external representation of the EU on the
international arena.
Patterns of Institutional Differentiation: Relations of ‘Insiders’

and ‘Outsiders’
Patterns of institutional differentiation in the ESCB reflect this structural dif-
ferentiation amongst formal and informal (sub-)groups of ‘insiders’ and ‘out-
siders’. The ESCB’s institutional differentiation not only creates ‘insiders’ and
‘outsiders’, it also tends to empower different sub-groups of ‘insiders’ differently
in its political practice.
The ESCB is assumed to stimulate institutional differentiation between the
two formal groups of ‘insiders’ and ‘outsiders’, resulting in different patterns of
differentiation co-existing within the system. These patterns of institutional
differentiation find further expression in the informal (conceptual) sub-groups
of ‘insiders’ and ‘outsiders’.
This sub-division of ‘insiders’ and ‘outsiders’ causes a substantial degree of
institutional differentiation in the ESCB in the form of a ‘Europe of concentric
circles’, as ‘insiders’ and ‘outsiders’ are represented differently in the ESCB’s
governing bodies, in other words are differently empowered to govern and
influence ESCB decisions. The need and search for institutional leadership
within a ‘core Europe group of the able insiders’ suggest the possibility of a de
facto steering group, that is, a ‘directoire’ of the powerful ‘insiders’, enforcing,
stabilizing, and trying to steer the decision-making capacity of the system
(Figure 2.2). This chapter argues that the logics and dynamics of the co-exist-
ence of these three patterns of institutional differentiation in the ESCB encour-
age this development.
EUROPE OF CONCENTRIC CIRCLES OF ‘INSIDERS’ AND ‘OUTSIDERS’

The two formal groups of Eurosystem ‘insiders’ and ‘outsiders’ ensure a pattern
of a Europe of concentric circles in the ESCB, involving an institutional hierarchy
in participation rights within the governing bodies of the system (Art. 10–12
58
ESCB‚ Core Europe ESCB–

of the able/‘directoire Europe of concentric
Outsiders
of the powerful’ circles of ‘insiders’
Temporary outsiders keen to join and ‘outsiders’
Semi-permanent outsiders without treaty-based opt out

Semi-permanent outsiders with treaty-based opt out
Insiders
Core insiders
Normal insiders
New insiders
Candidate countries as (potential ) future outsiders

ESCB and beyond –
The international Global players
central banking
community of
concentric circles
Figure 2.2. The ESCB—‘Europe of concentric circles’ led by a ‘core Europe of the able’
with traces of a ‘directoire of the powerful’
Source: Own design.
Protocol No. 18 TEC) Above, this pattern was further elaborated by the defi-
nition of different informal sub-groups of ‘insiders’ and ‘outsiders’. A differen-
tiation in terms of power and influence follows. At the same time, the
boundaries of the ‘insider’ and ‘outsider’ groups are ‘permeable’ through EU
accession and the adoption of the entire EU acquis by acceding states.
Within the treaties, this differentiation is formally enshrined in the separ-
ation between ‘Member States without a derogation’ and ‘Member States with a
derogation’ (Art. 122 TEC). The provisions of the Lisbon Treaty were designed to
make more visible the treaty-based opportunity structure for a Europe of concen-
tric circles, that is, differentiation between ‘insiders’ and ‘outsiders’, by explicit
legal provisions. It differentiates explicitly between ‘countries whose currency
is the euro’ (‘insiders’) and those ‘Member States with a derogation’ (‘outsiders’).
It will insert new articles on both country groups into the treaties to ensure the
proper functioning of EMU (Art. 136–138 TFEU). The Treaty amendments
related to ‘countries whose currency is the euro’ refer to the Stability and
Growth Pact (SGP), the Broad Economic Policy Guidelines (BEPG), and the
Euro Group (cf. below), enhancing their visibility. In the case of ‘Member States
with a derogation’, the new provisions (Art. 139–144 TFEU) include a precise list
59
of elements that shall not apply to this group, enumerating them more expli-
citly and in more detail than Art. 122(3) TEC of the Nice Treaty. This develop-
ment seems to point to a strengthening of treaty-based opportunity structures
for a Europe of concentric circles.
‘Core Europe of the able’

With the group of ‘insiders’, the ESCB carries traces of a core Europe (Schäuble
and Lamers 1994; other labels are ‘Avantgarde’, Chirac 2000; ‘L’Europe pionnier’,
Juppé 2000; and ‘Centre of Gravity’, Fischer 2000). It shows signs of institutional
and constitutional deepening by a group of ‘willing and able’ Eurosystem
members. Although, from the start of EMU, they were supposed to attract
‘outsiders’ to follow, some semi-permanent outsiders like Denmark, Sweden,
and the United Kingdom officially declined from doing so.
Analysis of the ESCB’s institutional architecture seems to support this con-
clusion. The institutional centre of this ESCB core Europe group is provided by
the ECB. To carry out the tasks of the ESCB, the ECB is equipped with quasi-
legislative (Art. 110(1, 2) TEC) and regulatory/control powers (Art. 110(3) TEC)
whose execution and implementation is strongly influenced by the ECB
Executive Board’s power to shape Governing Council decision-making
(McNamara 2006: 177). The treaties provide the ECB with the means to
make binding and directly applicable regulations and to take decisions (bind-
ing to those whom they address) necessary to carry out the tasks entrusted to
the ESCB under the TEC and the Protocol No. 18, as well as to make recom-
mendations and to deliver opinions (both instruments being non-binding)
(Art. 110(1, 2) TEC). Related decision-making and decisions are prepared by
the ECB’s Executive Board. Underlining its dominant position are the add-
itional competences of the ECB ‘to impose fines or periodic penalty payments
on undertakings for failure to comply with obligations under its regulations
and decisions’ (Art. 110(3) TEC), to ‘require credit institutions established in
Member States to hold minimum reserve on accounts with the ECB and
national central banks in pursuance of monetary policy objectives’ (Art. 19
Protocol No. 18 TEC).
Within the ESCB’s institutional architecture, the core Europe element is
already in the treaties, given that only ‘insiders’ are represented within the
two central ESCB governing bodies, the ECB’s Governing Council and the
Executive Board (Art. 107(3) TEC, Art. 10 and 11 Protocol No. 18 TEC). Due to
its responsibility for the implementation of the Euro Area’s monetary policy, as
well as its competence to give necessary instructions to national central banks
(NCBs) and to prepare the meetings of the Governing Council (Art. 12 Protocol
No. 18 TEC), the Executive Board is the key guarantor of the implementation of
the system’s tasks (Issing 2008: 62). This dominant position as the central
decision-shaping body of the ESCB derives from the fact that it not only
60
implements monetary policy decisions but also exercises considerable agenda-

setting power, is involved in policy formulation (McNamara 2006: 175 and 177)
and is given a high degree of authority amongst the ESCB governing bodies.
Underlining the assumption of existence of an ESCB core Europe group,
‘outsiders’ are represented only in the ECB’s General Council (Art. 45 Protocol
No. 18 TEC). It disposes of fewer powers and contributes ‘merely’ to statistical
data collection, reporting activities of the ECB, establishing necessary rules for
standardizing the accounting and reporting of operations undertaken by the
NCBs, laying down the conditions of employment of ECB staff, and performing
advisory functions (Art. 47 Protocol No. 18 TEC).
So, ‘insiders’ and ‘outsiders’ are represented differently, potentially resulting
in a differentiated participation within the ESCB’s governing bodies: ‘insiders’
are represented and involved in the Executive Board/Governing Council/
General Council, while ‘outsiders’ partake only in the General Council. Yet,
due to the supranational character of the body, the ‘insiders’/‘core insiders’
representation within the Executive Board seems to be more supranational
than national in character. Moreover, as a majority of ECB expert subcommit-
tees also convene in EU-27 composition2 (even though two compositions, Euro
Group and EU-27, are possible), this effect, however, can be assumed to be
partially counterbalanced in working-level practice.3
In EMU’s ‘living practice’, the Euro Group (comprising Eurosystem members’
finance ministers, the European Commission, and the ECB) formed the central
Eurosystem body for informal exchange amongst ‘insiders’ as well as for Euro
Area decision-shaping over the first decade of the euro. As such, it provided
‘insiders’ with an additional opportunity structure to strengthen core Europe
patterns within EMU. The 2004–5 newly established Euro Group presidency
offers the impression to, hence, be a sign for this pattern of institutional
differentiation within the political practice. The turn of the ‘living practice’
into an element of the system’s ‘legal architecture’ is exemplified in the Lisbon
Treaty, which establishes a new protocol in order to ‘lay down special provisions
for enhanced dialogue between the Member States whose currency is the euro’
(Protocol No. 3 TEU/TFEU). By doing so, it is to establish a formal treaty basis for
the institutional aspects of the Euro Group’s informal meetings, including the
participation of the European Commission and the ECB as well as the election
of a president of the Euro Group for two-and-a-half-year term. As a conse-
quence, the treaty-based differentiation between ‘insiders’ and ‘outsiders’,
that is, the Europe of concentric circles, can become more visible in EMU,
potentially transforming the Euro Group into an institutional indication of
the core Europe group of ‘insiders’ in supranational monetary policy-making.
Yet, given the size of the Euro Group and its foreseeable enlargement in the
future, it remains open whether it will evolve as quickly as the ECB’s Executive
Board into the key constitutional or institutional nucleus for the evolution of
Euro Area decision-shaping and -making.
61
‘Directoire of the powerful’

Over the first decade of the euro, the ESCB informal (conceptual) sub-group of
‘core insiders’ seems to have sought more permanent institutional influence
within the ESCB’s governing bodies (including more power over appointments
to the ECB’s Executive Board) in order to shape the ESCB’s development on
their own terms. This pattern can be perceived to have led to a certain element
of guidance of the ESCB by ‘core insiders’, suggesting a ‘directoire of the power-
ful’ within the core Europe group in conceptual terms. Such a directoire (Hill
2006) is defined by stronger intergovernmental cooperation between a few
large and powerful ‘core insiders’ (EU-3, EU-5), excluding smaller ‘insider’-states
by definition.
The ESCB’s treaty foundations create the opportunity for this ‘directoire of the
powerful’ in the institutional representation of certain ‘insiders’, for a long period
predominantly ‘core insiders’, simultaneously within the ECB’s Executive Board
(Art. 11 Protocol No. 18 TEC), and the Governing Council. Via the six members of
the Executive Board, certain ‘(core) insiders’ were to a certain extent de facto
‘double represented’ in the ECB Governing Council. In analytical terms, the
practice of the same four states (Germany, France, Italy, and Spain) retaining
seats in the Executive Board over the years suggests such an element of a directoire.
However, this national ‘capture’ of the ECB’s Executive Board has been balanced by
the fact that Executive Board members, regardless of her or his national socializa-
tion, have acted as supranational ECB actors rather than as national representa-
tives. So, features of national ‘capture’ seem to be noticeable, yet, further empirical
research concerning the ‘living’ ESCB still has to uncover whether these features
constitute such a de facto directoire trend within the Executive Board.
Institutionally counterbalancing the influence of ‘core insiders’ vis-à-vis
other sub-groups of ‘insiders’—hence, counterbalancing the trend towards a
directoire element within the ESCB’s institutional architecture—is, moreover,
the fact that within both the Executive Board and the Governing Council the
personality and expertise of members is perceived to be more decisive for
exerting influence than their respective country affiliation.4 Nevertheless, par-
ticularly due to its agenda-setting power, and given that other bodies and actors
followed its decisions on the implementation of the ECB monetary policy, the
Executive Board turned out to be a prominent target for ‘core insiders’ to
institutionally anchor a directoire element within ESCB decision-shaping. It
can be assessed to have formed a central target for the institutional covetous-
ness of ‘core insiders’ within the ESCB.
In relation to the ECB’s Governing Council another element of an ESCB
‘directoire of the powerful’, based on differentiation according to economic
performance, can be found within the ‘legal/formal’ ESCB. This trend is exem-
plified in the reform of voting rules before formal accession of new members
(Berger 2006; Eijffinger 2006). The treaty-based principle of ‘one member,
62
one vote’ is kept only until the point in Eurosystem ‘widening’, when
the Governing Council consists of more than 21 members (Art. 10(2) Protocol
No. 18 TEC), that means until the entry of Slovakia in 2009. Thereafter, only
15 voting rights are attributed to the NCB governors, who are members of the
Governing Council. The six members of the Executive Board keep one vote
each. Special rotation rules are applied to the exercise of the voting rights by
the NCB governors, who are divided into two/three groups (Art. 10 Protocol
No. 18 TEC). From more than 15 to 22 governors, they will be allocated to two
groups (ibid.). From 22 governors onwards, three groups will be established
(ibid.). These different groups are defined ‘according to a ranking of the size of
the share of their [the governors’] national central bank’s Member State in the
aggregate gross domestic product at market prices and in the total aggregated
balance sheet of the monetary financial institutions of the Member States
which have adopted the euro’ (ibid.). Acting by a two-thirds majority of all
members, the Governing Council can, however, ‘decide to postpone the start
of the rotation system until the date on which the number of governors
exceeds 18’ (ibid.). With this treaty-based pre-definition of voting rule adap-
tation, differentiation is, hence, already introduced by the treaties, pointing at
a treaty-based opportunity structure for the development of a directoire based
on economic indicators and performance.
Functional Differentiation
The functional dimension of differentiation ties in with the basic institutional
differentiation between ‘insiders’ and ‘outsiders’. Within the ESCB, ‘insiders’
take on different functions from ‘outsiders’, especially in the implementation of
ESCB decisions. As a consequence, ‘insider’ NCBs are affected differently by the
ESCB than those of ‘outsiders’ in terms of obligation to take part in supra-
national policy-making and implementation.
MONETARY POLICY-MAKING
The core function of the ESCB is European monetary policy-making. Art. 105
to 124 TEC lay down the treaty foundation of monetary policy and the role of
the ESCB in it. The core objective of the ESCB is to ‘maintain price stability’
and to ‘support the general economic policies in the Community’, while not
losing sight of its aforementioned core objective (Art. 105(1) TEC). In the light
of this priority and ‘the principle of an open market economy with free
competition, favouring an efficient allocation of resources’ (ibid.), the main
tasks of the ESCB are (1) the definition and implementation of the European
monetary policy, (2) the conduct of foreign-exchange operations, and (3) the
holding and management of the EU Member States’ official foreign reserves
63
(Art. 105(2) TEC). Within the ESCB, the ECB is the predominant institution to
safeguard this particular European monetary policy-making paradigm (Issing
2008: 85 ff.). It is exclusively and independently responsible for monetary
policy decisions (Art. 105(2) TEC; Begg 2007: 36; Issing 2008: 115 ff.) and,
hence, symbolizes ‘the institutionalization of a monetary sovereignty’ (Le
Heron 2007: 11) within EMU. The main instruments of the ECB in this context
are guidelines, recommendations, and opinions at the request of EU institu-
tions, as well as decisions and regulations on European monetary policy. The
Lisbon Treaty groups monetary policy-making for Member States whose cur-
rency is the euro under the ‘exclusive competences’ of the Union (Art. 3 TFEU)
and formally integrates the ECB into the EU’s institutional framework (Art. 13
TEU).
The ESCB’s monetary policy function exerts strong implementation pressure
on ‘insiders’, while ‘outsiders’ are affected to a lesser degree and more indirectly
(especially via markets). ESCB monetary policy decisions, taken by ‘insiders’
within the Governing Council, are directly binding for ‘insiders’ who have to
implement them on behalf of the ESCB. ‘Outsiders’ influence European mon-
etary policy-making via their integration into the General Council (Art. 45
Protocol No. 18 TEC), focusing on advisory functions, statistical data collection,
reporting activities of the ECB, etc. (Art. 47 Protocol No. 18 TEC).
FISCAL POLICY-MAKING
The ESCB is characterized and affected by the ‘asymmetry between monetary
and fiscal policy in the Euro Area . . . , with the ECB setting a predictable policy
based on price stability in the area as a whole and the member states setting
fiscal policy individually subject to the joint arrangements of the Broad Macro-
economic Guidelines and the SGP processes’ (Mayes and Virén 2007: 172).
Under the SGP (Art. 104 TEC), both ‘insiders’ and ‘outsiders’ have to keep
their national fiscal policies in line with the provisions of the pact to avoid
violations through excessive deficit spending in order to lower the costs of
supranational monetary policy-making by maintaining fiscal stability (Mayes
and Virén 2007: 160). In case of non-compliances or breaches, however, only
‘insiders’ face the risk of financial sanctions, given that special rules apply to
‘outsiders’ (Art. 122(3) TEC). Under the pact, ‘insiders’ have to prepare annual
National Stability Programs (NSPs), outlining their efforts to comply with the
pact, such as a budgetary policy that guarantees sustainability of public finances
and adheres to the treaty-based GDP threshold, policies to implement the
objectives of the NSP, and main underlying economic ideas. These NSPs form
the basis for the supranational surveillance process, for recommendations that
aim at bringing excessive deficits to an end within a given period, and for
possible sanctions in case of failure to do so.
64
In contrast to this strong ‘hand-tying’ impact on ‘insider’ budgetary policies,

‘outsiders’ are less strongly affected. They do not face financial sanctions in case
of non-compliance with the SGP (Art. 122(3) TEC). They are, however, required
to meet the convergence criteria, to generally follow the rules of the SGP and to
prepare annual National Convergence Programs (NCP), outlining the same
aspects as ‘insider’ NSPs. ‘Outsider’ NCPs form the basis for possible recom-
mendations in case of breaches of the pact, obliging them to end excessive
deficits as in the case of the United Kingdom in January 2006 (Council of the EU
2006: 6). As a consequence of the requirement to comply with the pact, even
‘outsiders’ are thus no longer entirely free to pursue their own budgetary and
fiscal policy preferences.
PAYMENT SYSTEM OVERSIGHT

Another function of the ESCB is the promotion of a smooth operation of euro
payment systems (Art. 105(2) TEC). This function aims at stabilizing euro
payment systems to prevent systemic risks and the transmission of shocks, at
maintaining and increasing payment systems’ efficiency, at ensuring security of
the payment instruments, and at supporting the implementation of supra-
national monetary policy.
To fulfil these ESCB objectives, the ECB and NCBs are competent to ‘provide
facilities . . . to ensure efficient and sound clearing and payment systems within
the Community and with other countries’ (Art. 22 Protocol No. 18 TEC) and
‘operate in the financial markets by buying and selling outright (spot and
forward) or under repurchase agreement and by lending or borrowing claims
and marketable instruments, . . . [and to] conduct credit operations with credit
institutions and other market participants’ (Art. 18 Protocol No. 18 TEC).
Additionally, the ECB and the NCBs have the ‘power to give advice and deliver
opinion, pursuant to Articles 4 and 34.1, third indent, ESCB Statute can also be
employed to this end’ (Smits 1997: 297). Moreover, the competence to open
accounts and the ESCB’s external competences are assessed to add to the
competences within this sector of payment system control (ibid.). The ECB is
competent to make regulations in this sector.
As the exercise of payment system oversight influences the stability of the
Eurosystem and the implementation of supranational monetary policy, the
institutional differentiation along the lines of ‘insiders’ and ‘outsiders’ follows
from the way in which ‘insiders’ are affected more strongly by cross-border
payment activities within the Eurosystem than ‘outsiders’. While ‘core insiders’
within the Executive Board shape the area by developing and preparing policies
and decisions—such as related to the Trans-European Automated Real-time
Gross settlement Express Transfer (TARGET) System, the Single Euro Payments
Area (SEPA), or the Correspondent Central Banking Model (CCBM)—‘insiders’
65
take the decisions within the Governing Council. ESCB members—regardless of

their status as ‘insiders’ and ‘outsiders’—are free to participate.
BANKING SUPERVISION
The ESCB is also responsible for ‘the prudential supervision of credit institu-
tions and the stability of the financial system’ (Art. 105(5) TEC). However, this
function is assessed not to belong to the core tasks of the ESCB (Smits 1997:
319) and of central banking in general (Stadler 1996: 118). The ESCB’s and its
Banking Supervision Committee’s role within the sector is of mainly coordina-
tive and consultative character (Schüler 2003: 4). National institutions respon-
sible for banking supervision, thus, co-exist with the ESCB in this functional
sector and partake in the ECB’s Banking Supervision Committee. Based on Art.
14(4) Protocol No. 18 TEC, NCBs that were in charge of this function before
EMU continue performing it also within the ESCB. Via the ECB, the ESCB is,
moreover, integrated into international activities in the field, such as the Basel
Committee on Banking Supervision, the European Securities Committee, or
Committee of European Banking Supervisors (see Moran and Macartney’s
chapter).
From ‘a financial integration perspective, the main priority [of this area] is
to remove any supervisory obstacles to cross-border finance, notably via
enhanced supervisory cooperation and convergence’ (Papademos 2005). The
ECB advises and is consulted by the European Commission, the Council, or
institutions of EU Member States concerning the focus and ‘implementation
of Community legislation relating to the prudential supervision of credit
institutions and to the stability of the financial system’ (Art. 25(1) Protocol
No. 18 TEC). If so decided by the Council (Art. 105(6) TEC), the ECB may take
over particular tasks related to banking and financial supervision except for
insurance undertaking. So, the competences and powers of the ECB and the
ESCB depend on the Council. Thus, in this functional area, the ECB holds a
weaker position than in supranational monetary policy-making.
Within this area of functional differentiation, the institutional differenti-
ation alongside ‘insiders’ and ‘outsiders’ is relevant only insofar as the ECB’s
tasks related to banking supervision formally concentrate on credit and other
financial institutions within the Eurosystem. Yet, in practice, ‘the financial
integration process . . . has involved a substantial increase in cross-border bank-
ing’ (Papademos 2005). As a result, ‘cross-border banking broadens and deepens
banking markets, increases liquidity and risk sharing and thus strengthens the
overall resilience of the European financial system’ (ibid.). Hence, also ‘out-
siders’ are integrated into banking supervision activities of the ECB given that
economic risks are spread across the different groups of Eurosystem members.
As a result, the formal differentiation within the Eurosystem according to its
legal basis—alongside the lines of ‘insiders’ and ‘outsiders’—seems to a certain
66
extent to be compensated, given that not only ‘insiders’’ banking systems are
exposed to such risks due to increased cross-border activities at many levels of
the economic system.
FOREIGN-EXCHANGE OPERATIONS AND EXTERNAL

REPRESENTATION
Based on Art. 105(2) TEC, the ESCB is responsible for the conduct of ‘foreign-
exchange operations consistent with the provisions of Article 111’. This ‘task
concerns intervention in the foreign exchange markets and the other oper-
ations which may be necessary for or conducive to the primary objective of
price stability’ (Smits 1997: 197). In contrast to its strong position in supra-
national monetary policy-making, where final decision-making powers lie
with ESCB governing bodies, its powers to make decisions in foreign-ex-
change operations are more limited and shared with the Council. Based
on Art. 111(1, 2, and 3) TEC, the ECOFIN Council holds the power to
conclude formal agreements on an exchange-rate system in relation to non-
Community currencies, to formulate general orientations for exchange-rate
policy in relation to non-Community currencies, and to decide on arrange-
ments for the negotiation and conclusion of formal agreements on mone-
tary or foreign-exchange regime matters. Exercising these competences, the
Council can act on a recommendation from the Commission and after
consulting the ECB or on a recommendation from the ECB. So, in this area,
the ESCB takes over a more operative function (Stadler 1996: 116), although
the ECB is assessed to have ‘a large measure of discretion within general
orientations for exchange rate policy to be issued by the Ecofin Council’
(Smits 1997: 197).
Adding to its tasks in foreign-exchange operations is the ESCB’s competence
to ‘hold and manage the official foreign reserves of the Member States’ (Art. 105
(2) TEC; Art. 30 and 31 Protocol No. 18 TEC). The NCB contribute to this
function of the ESCB not only because they are ‘allowed to perform transac-
tions in fulfillment of their obligations towards international organizations’
(Art. 31(1) Protocol No. 18 TEC). At the same time, if their transactions exceed
certain limits to be established by the Governing Council, they are subject to
approval by the ECB ‘in order to ensure consistency with the exchange rate
and monetary policies of the Community’ (Art. 31(2) Protocol No. 18 TEC).
Moreover, the ‘contributions of each national central bank shall be fixed in
proportion to its share in the subscribed capital of the ECB’ (Art. 30(2), 31
Protocol No. 18 TEC). Furthermore, each ‘national central bank shall be
credited by the ECB with a claim equivalent to its contribution’ (Art. 30(3), 31
Protocol No. 18 TEC).
Adding to its outreach into the international arena is the ESCB’s (external)
representation within the international (financial) system (Art. 6 Protocol
67
No. 18 TEC), which is taken over by the ECB President or his nominee (Art. 13
(2) Protocol No. 18 TEC). Based on this competence, the ECB ‘and, subject to its
approval, the national central banks [without prejudice to Art. 111(4) TEC]
may participate in international monetary institutions’ (Art. 6, 23, and 31
Protocol No. 18 TEC). NCBs may join these efforts (Art. 23 and 31 Protocol
No. 18 TEC). In external representation, opportunity structures offered by the
treaties open a certain area of potential conflict. According to Art. 111(4) TEC,
positions ‘of the Community at international level as regards issues of particu-
lar relevance to economic and monetary union and on its representation’ are
decided upon by the ECOFIN Council by qualified majority. In the past, this
allocation of competences to different institutions in the field, that is, the
Commissioner for economic and monetary affairs, the Euro Group president,
and the ECB president, partially resulted in the EU having to orchestrate a
chorus of several voices within its external representation in financial matters
(DIE ZEIT 2007).
Changes regarding the procedure to establish and decide upon the EU’s
external representation introduced by the Lisbon Treaty (Art. 115a TFEU)
might rebalance the weight of the EU institutions in external representation
in financial matters. The new articles of the Lisbon Treaty seek to ensure a more
uniform external representation by stating that the ‘Council, on a proposal
from the Commission, may adopt appropriate measures to ensure unified
representation within the international financial institutions and conferences.
The Council shall act after consulting the European Central Bank’ (Art. 115a(2)
TFEU). In decision-taking on these issues only members whose currency is the
euro, that is, ‘insiders’ may partake in voting. So these provisions create a new
opportunity structure for further institutional differentiation within the ESCB,
favouring ‘insiders’.
More specific forms of bi-/multilateral international relations are established
through a number of regular and ad hoc high-level, ‘closed-door’ seminars,
including members of the ESCB Governing Council and their respective
national counterparts. By these means, the ESCB establishes direct contacts
between ‘insiders’, ‘outsiders’, and international financial actors. Regular
high-level seminars are held with representatives of Russia, the Barcelona
Process countries, accession countries, Latin America, and South-East Asia. Ad
hoc seminars link the ESCB with their counterparts in West Africa/South Africa
and Gulf Group countries. Moreover, contacts are established with countries of
the Middle East, neighbouring countries, emerging economies in Asia, the IMF,
G7/8, as well as G8þ (i.e. ‘Global Players’). Contacts to European non-EU
Member States, that is, Norway and Switzerland, are held via other inter-
national fora, given that they, especially Switzerland, have long before EMU
been ‘part of the club’ through their membership of the Bank for International
Settlements (BIS). Contacts with Norway, on the other hand, are said to be not
as close and less frequent.
68
Conclusion: Co-Existence and Co-Evolution of Three Distinct

Patterns of Differentiation
Apart from its structural differentiation into Eurosystem ‘insiders’ and ‘out-
siders’, the ESCB is characterized by two key dimensions of differentiated
integration: functional and institutional. The functional dimension comprises
different policy areas, in which the ESCB performs different functions and
holds different decision-making competences vis-à-vis other supranational
and national institutions. The ESCB holds strongest competences in supra-
national monetary policy-making. In the external representation of the Euro-
system in international organizations, the authority of the ECB to decide on the
representation of the ESCB within international cooperation (Art. 6 Protocol
No. 18 TEC) partially interferes with the external representation of the EU in
financial matters by the European Commission and the Council of the EU. Here
the Lisbon Treaty, if adopted and implemented to the letter, might lay the
ground for a more uniform representation of the EU. In payment system
oversight and banking supervision, in which the Council holds a more power-
ful position, ESCB competences strongly focus on the practical conduct of
policies as well as on the operation of policies.
The institutional dimension of differentiation seems to display a dynamic
co-existence and co-evolution of three different patterns over the first decade
of the euro: a Europe of concentric circles (‘insiders’ and ‘outsiders’), a ‘core
Europe group of the able’ (‘insiders’), and a ‘directoire of the powerful’ (‘core
insiders’).
The legal basis of the ESCB stimulated both ‘insiders’ and ‘outsiders’ to
engage in institution building and shaping. It motivated both groups to adapt
to supranational monetary policy-making and to follow the implications of the
ESCB. In consequence, a scenario of ‘outsiders’ steadily moving towards
the centre of the ESCB’s institutional architecture and towards integration
into the Eurosystem is feasible.
This chapter has provided insight into the impact of the ESCB on these two
different groups of members. With respect to the functional dimension of
differentiation, constraints derive from the ESCB’s policy-related decisions.
These constraints can be assessed to impact differently on ‘insiders’ and ‘out-
siders’. With respect to the institutional dimension of differentiation, the ESCB
showed traces of separation between ‘insiders’ and ‘outsiders’. At the same time,
the system also motivated ‘insiders’ and ‘outsiders’ to engage in the system and
its decision-making through the General Council. However, ‘insiders’ addition-
ally engaged in the Governing Council and the Executive Board in order to
shape decisions. So, in political practice as well as within the treaty-based
foundations, ‘insiders’ and ‘outsiders’ form the essential building block of the
differentiation of the ESCB’s institutional design. The differentiation amongst
ESCB members results in several concentric circles: As a consequence of
69
different speeds of rapprochement, ‘insiders’ form the ESCB ‘core Europe group
of the able’. ‘Outsiders’ are arranged around this core Europe group. The overall
result is the ESCB as a Europe of concentric circles. Within the core Europe
group of the ESCB, a ‘directoire of the powerful’ can, in analytical conceptual
terms, be assumed to form the institutional nucleus of the system.
Elements of institutional differentiation have been found within both the
treaties (‘legal architecture’) and seem to be visible also in its political reality
(‘living practice’). The treaty-based reform of voting rights and rules in the
enlarged Governing Council and a certain de facto ‘double representation’ of
some Member States (Germany, France, Italy, and Spain) in the ESCB’s govern-
ing bodies provide evidence of this process. Provisions of the Lisbon Treaty on
the Euro Group, as well as on the two groups of ‘countries whose currency is the
euro’ and those ‘with a derogation’, additionally strengthen the treaty-based
foundations of differentiation. These provisions show that the ESCB is based on
a legal foundation that provides for opportunities for the development of a
Europe of concentric circles, led by a ‘core Europe group of the able’ and guided
to a certain extent by a ‘directoire of the powerful’ (Figure 2.2).
These patterns of differentiation have, however, not induced a strong ten-
dency towards the development of one ‘Core Europe group’ or one particular
differentiation feature for the political system of the EU in general. Quite
contrary to such a ‘standard differentiation’, the number and forms of opt
outs from the overall system—that is, the variation of differentiation—have
even increased since the creation of EMU. So, the institutional architecture of
EMU has not provided for a standard differentiation design for membership
across policy areas. The opt outs from the Treaty of Prüm or the Lisbon Treaty
indicate at such variations of differentiation not directly following the EMU
model.
The most significant impact of EMU differentiation might have been more
indirect: it served as an example that, even in highly relevant policy fields,
membership did not have to imply equal rights and obligations for all EU
Member States. In this way, it might have softened concerns of the ‘community
orthodoxy’ and changed perceptions to view forms of differentiation as accept-
able solutions to enhance European integration in areas, in which not all
Member States are willing or able to follow. In the wake of the Irish referendum
on the Lisbon Treaty, a renaissance of this perception of differentiation con-
cepts as mechanisms to unfetter blockades can be observed (Dahrendorf 2008;
Habermas 2008; Hierlemann 2008: 4).
Yet, another expectation related to EMU differentiation did not materialize:
In the 1990s, some proponents of the idea of a ‘Core Europe’ (especially
Schäuble and Lamers 1994) regarded EMU not just as a mere example or role
model for differentiation. They perceived differentiation within EMU to serve
as a strategic ‘door opener’ to a more federal and integrated Europe of the
willing and able Member States. EMU members were expected to move ahead
70
towards closer integration also in other policy fields. They were, thus, assumed
to develop into a certain constitutional ‘avantgarde’ of European integration as
a whole. With the enlargement of EMU and in the light of the outcome of
the Dutch, French, and Irish referendums, EMU differentiation did, yet, not
provide for the basis of a more integrated group of EU members, that go ahead
also beyond monetary and economic integration.
Notes
1. The approach of the chapter is based on the research method of the Jean-Monnet Chair
for Political Science at the University of Cologne regarding the comparative analysis of
the ‘legal architecture’ (written, treaty-based provisions) and the ‘living practice’ (its
reality in practice) of and within the EU. Additionally, new institutionalism (Bulmer
1994, 1997: 4; Hall and Taylor 1996: 6; Jachtenfuchs and Kohler-Koch 2004: 101;
Knodt 2005: 18; March and Olsen 2005: 4 ff.; Peters 2000: 4 ff.; Stone Sweet and
Sandholtz 1998: 16) serves as an explanatory element for the evaluation of the impli-
cations of the ESCB for ‘insiders’ and ‘outsiders’ both within the ‘legal/formal ESCB’
(written provisions) and the ‘living ESCB’ (its reality in practice).
2. Out of the seven to nine annual meetings of the International Affairs Committee
two to three are held in EU-27 composition (i.e. one out of three meetings is held in
this extended composition). Moreover, there are regular contacts between ECB and
NCB (e.g. Bank of England) officials, partially also on a rather informal/personal level.
ERM-II links with Denmark for instance are held via the Currency Board meetings.
3. Information provided by ECB officials interviewed for this chapter.
4. Perception of ECB officials interviewed for this chapter.
71
3
The European Central Bank: The Bank
That Rules Europe?
David Howarth
The power of the European Central Bank (ECB) is rooted in its independence
established in the Maastricht Treaty of 1992. This power is reinforced through
the bank’s monetary policy credibility—achieved through meeting its price
stability mandate, while resisting political pressures to manipulate monetary
policy to other ends. In turn, credibility contributes to the ideational power of
the ECB, which is rooted in widespread support for price stability, one of the
core objectives of Economic and Monetary Union (EMU). The ECB’s relative
power, as one of the two leading central banks in the world, is determined by
the relative size of the Euro Area economy and the growing importance of the
euro as an international reserve currency. It is the leading face of the Euro Area
abroad and a new and important presence in several international economic
fora. The ECB is effectively the ‘captain’ of the team of Eurosystem (Euro Area)
national central banks (NCBs) as well as the wider European System of Central
Banks (ESCB)—which includes all European Union (EU) NCBs. It is responsible
for coordinating the policy making of Eurosystem NCBs in a range of areas and
NCB discussions on inflation forecasts.
However, there are clear limits to the ECB’s power. It controls neither
exchange-rate policy nor prudential supervision. Limits have been placed
upon its international role. The ECB must work with governments to build
support for low inflationary policies and maintain political support for EMU.
The ECB is one of the most consistent voices in favour of structural reform in
the European Union (EU), yet there is little the bank can do to enforce reform
in the short term. Furthermore, the ECB must share many core central banking
operations with Eurosystem national central banks (NCBs). This chapter
explores the confines of European Central Bank power.
73
The European Central Bank: The Bank That Rules Europe?
Monetary Policy Power
The basic power of the ECB is to define and implement the monetary policy
of the Euro Area. The ECB enjoys unrivalled goal-setting and operational
independence in the pursuit of its price stability goals, and its Governing
Council members enjoy ad personam independence. The Bank is further
sheltered from political interference by the need for the unanimous
approval of member states to change the Treaty provisions on independ-
ence. The Statute of the ECB and the ESCB (principally Article 3) sets out
the tasks of Eurosystem NCBs as ‘to define and implement the monetary
policy of the Community’; ‘to conduct foreign exchange operations’; ‘to
hold and manage the official foreign reserves of the member states’;
‘to promote the smooth operation of payment systems’; ‘and to contribute
to the smooth conduct of policies pursued by the competent authorities
relating to the prudential supervision of credit institutions and the stability
of the financial system’. The ECB can make regulations (Article 110(1) TEC),
principally with regard to the operation of the ESCB and can impose fines
or periodic penalty payments for failure to comply with obligations con-
tained in its regulations and decisions (Article 110(3) ). This competence
applies notably with regard to the reserves that credit institutions should
hold with the ECB and the prudential supervision of credit institutions—
although the Council of Ministers must first establish the broader frame-
work of rules on these matters.
The ECB’s Governing Council (comprising 6 Executive Board members and,
in 2009, 16 NCB governors) is the monetary policy committee of the Euro
Area. It formulates the monetary policy of the Eurosystem with the aim of
maintaining price stability as the Governing Council defines it, including
decisions relating to specific monetary objectives, monetary strategy, key
interest rates, and the supply of Eurosystem reserves (Article 12.1, ESCB Stat-
ute). The Governing Council adopts the internal rules of the ECB and may
decide by two-thirds of the votes cast to modify operational methods of
monetary control. It exercises advisory functions vis-à-vis other European
Union bodies. Moreover, it has the power to form opinions on its own initia-
tive on the economic policies adopted by the European Union and member
state governments on matters which fall within its jurisdiction, crucially with
regard to the pursuit of ‘stability-oriented’ economic policies.
The six-member Executive Board implements the Eurosystem’s monetary
policy—giving necessary instructions to the NCBs—in accordance with the
guidelines and decisions established by the Governing Council. It decides
upon the precise instruments to be used. It also prepares the meetings of the
Governing Council. The Executive Board may have certain additional powers
delegated to it by the Governing Council (Article 12, ESCB Statute).
74
Power and Credibility

The power of the ECB relies to a large extent upon the credibility and legitim-
acy of its monetary policy (see the chapter by Eichbaum in this volume).
Despite widespread pessimism about the longevity of EMU and the rapid
drop in the value of the euro during the first three years of EMU, the ECB has
had considerable success in achieving credibility thanks to its successful pur-
suit of its price stability mandate. The ECB is frequently seen as the ‘the most
predictable central bank’—a virtuous reputation in central banking, where
controlling expectations about future inflation is seen as crucial in increasing
the effectiveness of monetary policy. Its monetary strategy was modelled
largely on that used by the respected Bundesbank and was overseen by
Otmar Issing, Chief Economist at the ECB from 1998 to 2006 and former
director at the Bundesbank. The two-pillar strategy combined an analysis of
conventional price and growth indicators with money supply and credit data.
Many economists and central banking officials are sceptical with regard to the
analytical usefulness of monetary aggregates as a core part of the ECB’s mon-
etary strategy (OECD 2007). However, this scepticism has not undermined the
credibility of the ECB’s policy. The bank has maintained a tight interest-rate
policy, successfully targeting inflation that is ‘below but close to 2 per cent’
over the medium term, even though the actual figure has been frequently just
above the target. Yet it appears to have been more flexible with regard to M3
growth, which has regularly far exceeded the bank’s official reference value of
4.5 per cent.
During its first decade, the ECB had to deflect regular criticisms of its
monetary policy from national politicians and economists. Criticism became
particularly vocal with regard to the strong euro from 2003 and its perceived
impact upon exports. The ECB was regularly attacked for its pursuit of low
inflation, and its tight monetary policy was regularly juxtaposed with
the accommodative interest-rate policy and dual mandate of the US Federal
Reserve—as in the months following the September 2001 attacks on New York
and Washington and following the onset of the credit crunch in the autumn of
2007.
The size of the Euro Area—the second largest economy in the world—and
the confidence of financial markets in the credibility of ECB monetary policy
have reinforced the euro’s position as the world’s second international reserve
currency. There are debates as to the degree to which the euro can challenge
the position of the US dollar as the leading international reserve currency.
However, the euro’s present position works not only to bolster the position of
the ECB as an international actor (in the IMF and other international eco-
nomic fora) but also to strengthen its position in relation to national govern-
ments and EU institutions in European economic governance.
75
Transparency and Credibility

In several respects, the ECB lacks transparency compared to the US Federal
Reserve and the Bank of England. Notably, the ECB has opted not to publish its
minutes, principally for fear that NCB governors would come under pressure at
home to justify where they had stood in debates. Yet, the ECB has achieved a
credibility-enhancing transparency with the markets. The ECB president gives
the only press conference following interest-rate setting meetings, thus avoid-
ing the potential for cacophony that could arise if the NCB governors were
allowed this responsibility. Moreover, like the Federal Reserve and the Bank of
England, the ECB discloses the formal macroeconomic model its uses for
policy analysis (Eijffinger and Geraats 2006), which most economists applaud
for reducing private-sector uncertainty about the ECB’s policy making process
and making monetary policy actions more predictable (Geraats 2005, 2006).
There remains criticism of ECB transparency. To many economists, its interest-
rate setting process and economic analysis remain too opaque (OECD 2007: 7).
Limits to ECB Power Over Monetary Policy

The ECB does not have complete control over all aspects of European monetary
policy. The Council of Ministers (the Council of Economics and Finance minis-
ters, Ecofin) is given limited powers over monetary policy and the management of
Eurosystem NCBs. These powers are de facto exercised by the Euro Group, con-
sisting of the finance ministers of only the member states participating in the
Euro Area. Lacking a legal personality, the Euro Group must have Ecofin confirm
all its decisions. The Council can adopt complementary legislation concerning
the operation of the entire ESCB in a limited number of areas, by qualified
majority voting on a recommendation from the ECB after consulting the Com-
mission or by unanimity acting on a proposal from the Commission and after
consulting the ECB (Article 42, ESCB Statute). In both situations the European
Parliament must be consulted. These areas include, inter alia the ‘basis for the
minimum and maximum reserves to be held by national credit institutions with
the ECB, and the maximum permissible ratios between these reserves, as well as
the appropriate sanctions in the case of non-compliance’ (Article 19.2); the limits
and conditions on any increase to the ECB’s capital (Article 28.1); and further calls
for foreign reserve assets beyond the limit set in the ESCB Statute (Article 30.4).
(See Howarth and Loedel (2005) for a more exhaustive list and analysis.)
Ecofin (the Euro Group) is thus empowered to influence future develop-
ments of the operation of the ESCB, even though it is unable to modify the
objectives or tasks of the ESCB or the provisions regarding its independence. It
is responsible for setting the rate at which currencies of the new Euro Area
member states are irrevocably fixed in relation to the euro, while the European
Council makes the final decision on entry on the basis of a recommendation
76
from the Commission. Notably, Ecofin is responsible for the establishment of

exchange-rate agreements with third countries and has final say over most
aspects of external monetary policy. However, when performing these tasks,
Ecofin must consult the ECB, attempt to reach a consensus, and respect the
goal of price stability. The organization of co-ordination in the area of external
monetary policy is discussed in greater detail below.
Lack of Control Over Prudential Supervision
During the 1991 Intergovernmental Conference on EMU, it was decided to

strongly limit the ECB’s potential role in the area of prudential supervision. As
noted above, the Maastricht Treaty grants the Eurosystem NCBs the responsi-
bility ‘to contribute to the smooth conduct’ of prudential supervision and the
monitoring of financial stability. The so-called BCCI Directive (96/25/EC of 29
June 1995) lays the foundations for cooperation (exchange of information)
but does not contain specific provisions or institutional arrangements to this
end. The ECB must be consulted on the adoption of EC and national legisla-
tion relating to prudential supervision and financial stability and has the right
to perform specific tasks concerning policies relating to this supervision.
Moreover, the Maastricht Treaty establishes a simplified procedure (Article
105(6) TEC) that makes it possible, without amending the Treaty, to entrust
specific supervisory tasks to the ECB.
The precise role of the ECB in prudential supervision remains the subject of
ongoing debate. It is not unusual that the ECB lacks control over banking
supervision, in that the central banks in many advanced industrialized coun-
tries do not have this power or share it with ministries of finance (more often
there are completely separate institutions responsible for supervision). How-
ever, the Euro Area is rather unique in that the areas of jurisdiction over
monetary policy and over banking supervision—which remains nationally
based—do not coincide. ECB Executive Board members thus argue in favour
of improved cooperation between Eurosystem central banks (including the
ECB) and national banking supervisors on the grounds that central banks are,
because of their responsibilities, necessarily concerned with the health of the
banking system, and central bank credit control is managed in ‘a situation that
is generated by problems of interest to the supervisor’ (Padoa Schioppa 1999a;
see also Duisenberg 2002; ECB 2001a, 2001b; Padoa Schioppa 1999b).
The Basle Committee on Banking Supervision assumed the task of pro-
moting cooperation between the ECB, the NCBs, and national supervisory
authorities. To give the EU members of this Committee a more specifically
Eurosystem profile, their gatherings were officially labelled the Banking Super-
vision Committee of the ESCB. The ECB has sought to develop this cooper-
ation further: to ensure that the system of national supervisors can operate as
77
effectively as a single authority when required, in particular when dealing with

local or national banking problems which may have wider effects.
ECB Executive Board members tend to argue in favour of transferring full
supervisory powers to the NCBs rather than centralizing them in the ECB. The
emphasis placed on the role of NCBs as opposed to the ECB is due in large part
to their role managing the TARGET payment system, which gives the NCBs
much greater awareness than the ECB could ever have of the situation of the
banks. The precise role of the ECB in the handling of solvency crises remains
unsettled, and the lack of crisis management capacity of the Eurosystem has
been criticized (see IMF 1998).
The 2002 decision by the German government not to grant the Bundesbank
full control over prudential supervision dealt a blow to hopes of an eventual
transfer of supervisory powers to NCBs and the ECB (Engelen 2002a and b). In
the new Federal Agency for Financial Market Supervision, the Germans opted
instead for the British single regulator model. Shortly, thereafter, the British
and Germans further shored up the central role of national prudential super-
visors by supporting the conclusions of the Lamfalussy Committee on the
regulation of European securities markets (Quaglia 2007a). The Brown-Eichel
plan (subsequently approved by the Council) proposed the creation of an
umbrella EU financial-sector supervisory body which would seek to improve
coordination between national regulatory authorities. The creation of such a
Lamfalussy-style committee structure for banking and insurance markets was a
blow to the existing ESCB Banking Supervision Committee, and ECB President
Duisenberg warned that a sideline role of the ECB in bank supervision would
risk violating the Maastricht Treaty (Engelen 2002a).
The ECB asserted the need for its improved control over banking supervision
and unease at the regulatory arrangements in place during the worsening
international credit situation of 2007–8. Executive Board members expressed
the concern that warnings about threats to the Euro Area’s financial systems
might not be passed on fast enough at times of crisis because of the fragmented
regulatory system in the EU and the insufficient cooperation and exchange of
information both between supervisory authorities in different member states
and between them and central banks (Stark 2008c). Executive Board members
(Bini Smaghi 2008) claimed that the effective conduct of the Eurosystem’s
liquidity-boosting operations from August 2007 relied upon the ECB’s access
to necessary information concerning the liquidity and solvency problems of the
markets and institutions. They argue that banking supervisors needed to
strengthen their cooperation to ‘exert strong pressure on financial institutions
to disclose in a prompt and coherent fashion their balance sheet situations’
(ibid.). The ECB also argued that member states—Germany has been frequently
cited—must be required to remove all national legislative obstacles preventing
supervisors from providing information to the ECB about specific banking
institutions.
78
A Developing but Limited International Role
Since the Delors Committee began meeting in 1988, there has been debate about
the role to be played by the ECB in the external representation of the Euro Area in
international fora. This issue links into the broader problem of the division of
responsibilities among EU institutions over the major elements of economic
policy and the respective roles of the Council (Euro Group), the Commission,
and the ECB in external representation (Henning and Padoan 2000; McNamara
and Meunier 2002). Where the Council represents the Euro Area externally, ECB
representatives nonetheless engage in the preparation of Euro Area positions for
meetings in international fora within the EU’s Economic and Financial Com-
mittee, prior to these positions being finalized in the Euro Group.
The ECB made its initial demands for right to external representation on the
basis both of Treaty provisions that stipulate that the ‘Community’ express a
single position in external monetary policy, and of ESCB Statute provisions
(Article 6) that allow the ECB to decide how Euro Area NCBs shall be repre-
sented by the ECB and/or by Euro Area NCBs, on matters falling into its
jurisdiction (Padoa Schioppa 1999c). Thus in central banking fora, the partici-
pation of the ECB has been straightforward. For example, the ECB president
participates in the meetings of the G-10 Governors organized in the context of
the BIS and in the committees under the aegis of the governors, notably the
Basle Committee on Banking Supervision and the Committee on the Global
Finance System. Eurosystem finance ministers also have an interest in ECB
participation in intergovernmental fora. For example, the potential success of
(eventual) international exchange-rate cooperation [under the aegis of the
Group of 8 (G-8)] or concerted intervention in the currency markets relies
very much on both ex ante and ex post internal Euro Area co-ordination that
ensures that the ECB will be willing and able to implement the policy bargain.
The ECB’s status at the IMF is limited to that of observer. Its representative
attends and has the right to speak at meetings on the role of the euro in the
international monetary system, multilateral surveillance of the Euro Area and
individual countries within the zone, international capital market reports, and
world economic and market developments. The ECB has the right to send a
representative to IMF Executive Board meetings when agenda items are recog-
nized by both the ECB and the IMF to be of mutual interest for the performance
of their respective mandates. The representative can also be invited to other
Executive Board meetings, although s/he does not have the right to attend. The
official Euro Area representative on the IMF Executive Board is the Euro Group
chair. The ECB also obtained observer status in the meetings of the G-10
Ministers and Governors, which are organized in connection with the IMF
Interim Committee meetings. Although, the ECB’s role is limited compared
to that of the member state governments, its presence may help to unify
the views of the EU participants on particular matters. Moreover, the ECB’s
79
observer status does not mean that it assumes a passive role. ECB and Euro Area
NCB representatives have taken strong, outspoken positions on major inter-
national monetary, financial and other economic issues (see Issing 1998 for one
early example).
ECB membership of the OECD, another intergovernmental institution, was
also out of the question. However, the organization deals with issues—notably
surveillance of the Euro Area—relating to the tasks assigned to the Eurosystem.
In February 1999, the OECD Secretary General confirmed that the ECB would
be allowed to participate in the work of the relevant committees and working
groups as a member of the EC delegation alongside the European Commission.
The ECB can make use of its presence in both the IMF and OECD to emphasize
the need for ongoing structural reform in the Euro Area (Stark 2008b). In the
G-8, the ECB president replaces Euro Area NCB governors during the first part
of finance minister meetings when monetary matters are discussed. In the
G-20, the ECB president attends in addition to the NCB governors from the
four member states with the largest economies.
The ECB has called for the reinforcement of the ECB’s position in these
international fora. Duisenberg (2000b) further argued for the gradual but
fundamental adaptation of the traditional institutional framework of inter-
national relations on the grounds that the existing framework—based on the
representation of national governments—‘was not tailored to the involvement
of monetary unions, nor to the advent of the Eurosystem, and more generally
the [Euro Area], as a new actor in international relations’. With regard to Euro-
system representation in international fora where both ministers and bank
governors are represented (G-8 Finance, G-20), Duisenberg focused on the
capability to speak with one voice (if and when appropriate) and a clearer Euro
Area political counterpart for the ECB. Instead of the four Euro Area member
state finance ministers (in the G-8 and G-20), he preferred a single Euro Group
representative with a higher profile. He wanted to overcome the co-ordination
problems among Eurosystem member states on external monetary policy.
Given the diverse circumstances of bilateral economic relations with third
countries, the EU finance ministers did not set arrangements for Euro Area
representation. The presence of the ECB in these bilateral discussions is now
left to the Euro Group chair. The ECB has forged and reinforced bilateral
relations with other central banks on issues of mutual concern, including
operational facilities, financial stability and the provision of technical assist-
ance. Notably, since November 1999 it has become involved in the EU
enlargement process by providing assistance to the central banks of central
and eastern European candidate countries to prepare them for participation in
the ESCB following accession and their eventual participation in the Eurosys-
tem. In addition to central banks, the ECB has developed contacts with other
relevant foreign institutions, such as banking supervisory authorities, local
banking associations, stock exchanges, and national public administrations.
80
Power in Relation to NCBs
The ECB’s relatively small Executive Board and its weight on the Governing
Council (6 out of 21 places, or less than third) demonstrate an important
feature of the Eurosystem. Compared to other federal banking systems, the
Eurosystem is relatively decentralized: NCBs have more sway collectively than,
say, representatives from the Federal Reserve District Banks. This reflects prac-
tical reality: the NCBs are well-established, whereas the ECB is a fledgling,
small institution. Eurosystem NCBs perform several operations vital to the
operation of the Euro Area: notably, they conduct foreign-exchange oper-
ations and ensure the smooth operation of payment systems (including TAR-
GET). The NCBs hold and manage the official foreign reserves of the member
states (of which they can provide up to 40 billion euro to the ECB) and hold
the capital of the ECB (just under 4 billion euro). However, NCBs must follow
the regulations, guidelines, and instructions of the ECB in these and several
other areas: buying and selling securities and other claims; borrowing and
lending securities; dealing in precious metals; conducting credit operations
with banks and other financial institutions based on adequate collateral; act-
ing as fiscal agents for public entities (although they may not grant them credit
facilities or buy their debt instruments directly from them). The ECB can also
engage in these activities. The precise role of the ECB in relation to the NCBs
depends on the kinds of open market operations selected (with regard to aim,
regularity and procedures). NCBs are able to perform tasks beyond those
specified in the ESCB Statute, except if the Governing Council decides that
these activities interfere with the work of the ESCB. The ECB alone attends
Euro Group meetings and Ecofin Councils. However, Eurosystem NCBs (and
ESCB NCBs) will occasionally attend informal meetings of Ecofin with varying
degrees of participation as well as meetings of the EU’s Economic and Financial
Committee when macroeconomic policy coordination issues discussed dir-
ectly impinge on them. In 2003, Euro Area NCBs lost their right to sit in
Economic and Financial Committee meetings—much to the opposition of
several NCBs, including the Bundesbank (Dyson 2008c)—which has reinforced
the importance of the ECB in European economic governance.
The degree to which the Eurosystem is centralized will develop over time.
The important role of the NCBs in ECB decision-making (in the working
groups, committees, and the Governing Council) reflects the ongoing import-
ance of the analytical—including statistical—resources available in the NCBs
and in particular the largest. The relative dependence of the ECB on the NCBs
has reduced over the past decade, nonetheless the US Federal Reserve remains
better endowed analytically than the ECB and less reliant on the state reserve
banks. The importance of the NCBs in ECB decision-making encourages a
combination of collaborative and competitive work (Goodfriend 1999;
Hochreiter 2000; Mayes 1998, 2000). In their attempt to have an impact on
81
Governing Council decision-making, each NCB governor will use the resour-
ces of his own NCB to provide the necessary information and strengthen his
position in the ongoing debate with other NCBs and the ECB Executive Board
on appropriate policy and the way that the Euro Area economy works. The
development of the ECB’s autonomous analytical capacity in relation to that
of the NCBs will be important in determining the level of centralization in
Eurosystem policy making. The ECB has already become the most important
centre for monetary policy research in the EU (see below) hiring some of the
best monetary economists from NCBs.
Members of the Governing Council are expected to speak with one voice on
the basis of the agreed-upon forecasts, although there is no legal requirement to
do so. Efforts have been made to ensure a tight coordination of official state-
ments on ECB monetary policy: the President is spokesperson in the official
press conference following the bi-weekly meetings, while the other members of
the Council have to explain Eurosystem policy in the member states in their
own languages. There have been a number of incidents where different NCB
governors made ambiguous remarks between Governing Council meetings
that led to false predictions of monetary policy decisions (Louis 2002). How-
ever, there has yet to be a publicly expressed substantive difference of opinion
between members of the Governing Council. Another potential source of
divergence in the public expression of policy is the separate national forecasts
published by the independent NCBs. Varying NCB forecasts could send differ-
ent signals to market operators about the development of ECB policy. However,
it is the role of ECB working groups and committees to iron out differences and
ensure coherence in all the forecasts of the Euro Area prior to their publication.
The relative importance of the NCBs in the Eurosystem also arguably reflects
the highly decentralized nature of the EU political system and the problematic
legitimacy of the EU in the eyes of many member state citizens. Arguably,
European citizens are more likely to accept ECB monetary policy if they know
that they are represented, however indirectly and unofficially, by NCB gover-
nors, and that policy is designed in the fora of working groups, committees, and
the Governing Council, where NCB experts and officials predominate. This
concern was of great relevance to discussions in the ECB in 2002–3 on Govern-
ing Council reform in the context of Euro Area enlargement (see below).
The ECB Executive Board has been very cautious in its interventions into the
operation of NCBs. One of the most controversial developments during the first
decade of EMU was the Banca d’Italia Governor Antonio Fazio’s handling of the
takeover battle for Banca Antonveneta. Despite much criticism, the ECB Execu-
tive Board initially took a ‘hands-off’ approach and warned of a dangerous
precedent for ESCB independence if the Italian government used legislation to
remove Fazio (Financial Times 16 September 2005). The ECB finally adopted a
much tougher tone in mid-December 2005, after it was made public that Fazio
had received gifts from the former head of a major Italian bank. President Trichet
82
warned that, in accepting gifts, the Italian governor might have breached the
ECB’s code of conduct (Financial Times 17 December 2005). However, the ECB
has no investigative powers and was unable to pursue matters further. Ultim-
ately, Fazio’s resignation saved the ECB further damage to its credibility and the
danger of public battles between Governing Council members.
Independent but in Search of Dialogue
Although the ECB regularly insists upon its independence and directly chal-
lenges political leaders who call this into question, it needs to maintain a
constructive dialogue with democratically elected officials. The ECB does
this in its dealings with the Euro Group of Euro Area finance ministers. The
ECB also maintains direct relations with the European Parliament (EP), not-
ably in terms of ex-post facto reporting and questioning. The EP must be
consulted on appointments to the ECB Executive Board. It receives and
debates the ECB’s annual report and requests that the president and other
Executive Board members appear before the Committee on Economic and
Monetary Affairs (TEC Article 113) (see, for example, Duisenberg 2000a).
Overall, however, the EP has little say over the ECB’s management of monetary
policy. As Dyson (2000: 69) notes, the model of ECB–EP relations is no match
for US Federal Reserve–Congress relations, where a well-staffed and financed
Congressional committee maintains constant scrutiny over the central bank.
The ECB is not responsible to the EP or other EU institutions; none have the
power to dismiss ECB Executive Board members on the grounds of unsatisfac-
tory performance in fulfilment of the Bank’s own goals (Taylor 2000).
However, there are signs that the ECB has been responsive to the concerns of
the European Parliament and that a certain form of ECB accountability has
developed (Jabko 2003; Magnette 2000). While the Treaty and the ESCB Stat-
ute establish no specific appearance requirements, the EP succeeded in obtain-
ing Duisenberg’s agreement that he would appear before the Committee on
Economic and Monetary Affairs four times a year. This accountability has been
good for the ECB’s legitimacy. The wide-ranging review of the ECB by the
Committee on Economic and Monetary Affairs can ensure that the Bank’s
technical decisions are subject to scrutiny from beyond the ESCB. This review
can increase awareness and widen support for the Bank’s underlying policies
and principles. Accountability to the EP has also arguably induced improve-
ments in ECB transparency, despite the absence of formal disclosure require-
ments (Jabko 2003). For instance, (nonbinding) EP resolutions on the ECB
Annual Report have repeatedly urged the ECB to be become more transparent,
and the publication of the ECB’s macroeconomic projections appears to have
been triggered by the quarterly ‘monetary dialogue’ between the ECB and the
Committee on Economic and Monetary Affairs.
83
Intervention in Government Policy
The ECB has actively promoted structural reforms with the aim of reducing the
public-sector debt burden, in Governing Council member speeches, press
conferences, monthly bulletins, and annual reports. It has consistently
defended the Stability and Growth Pact, criticized the suspension of the
Excessive Deficit Procedure with regard to France and Germany in 2003, and
sent strong warnings about the dangers of watering down the Pact in the
March 2005 reform (Howarth and Loedel 2004). For the ECB, the Pact is a
vital tool to entrench a stability culture in the Euro Area and to avoid conflict-
ual relations with profligate governments. The ECB’s pro-reform agenda has
been challenged by government and opposition politicians in several member
states and labour leaders.
Research and Analytical Capacity
Under the leadership of Otmar Issing, who worked as an academic economist

for over 30 years prior to joining the Bundesbank, the ECB developed an
impressive research capacity. In addition to its own expanding research staff,
the ECB funds a visiting researcher programme to attract some of the best
monetary economists in the world. One of the direct effects of the ECB’s own
research capacity was the development of the New Area-Wide Model—the
principal inflation forecasting model—by the staff in DG Research for simula-
tion tasks and scenario analysis. The model is also regularly used to produce
research papers that are presented in academic conferences and central bank
workshops, thus providing a constant quality check (Trichet 2007b). The ECB
has funded policy-relevant research that is not yet available at universities
or other research institutes. With the Centre for Financial Studies at the
Goethe University of Frankfurt, the ECB runs the Research Network on Capital
Markets and Financial Integration in Europe. The ECB has also led and
co-ordinated the research efforts of Eurosystem NCBs through four networks
on Monetary Transmission, Inflation Persistence, Wage Dynamics, and the
Euro Area Business Cycle, the latter also involving the Bank of England and
the Centre for Economic Policy Research. In addition to internal and open
seminars given by staff and invited speakers, the ECB has become a major
venue for conferences on monetary policy and other economic matters of
direct relevance to monetary policy. The dissemination of research at the
ECB is achieved through the publication of research papers, presentations at
international workshops and conferences, and the publication of the ECB’s
own Working Paper Series. In 2006, 137 working papers were released, with 90
papers authored or co-authored by ECB staff, considerably more than the
output of the US Federal Reserve.
84
There were concerns that, following the departure of Issing and with the
decision to divide the management of Directorate Generals economics and
research, the latter would lose influence on policy making and resources.
However, Lucas Papademos, the Executive Board member in charge of DG
research since 2006, sought to allay fears by directing it ‘to focus more on
policy-related issues’ (Financial Times 1 June 2006). With a PhD from the
Massachusetts Institute of Technology and a stint as an academic at Columbia
University, he has a strong background in academic economic research.
Internal Reform
Unlike several NCBs in the Eurosystem, which have had to undergo painful
internal cuts and significant reform, the ECB expanded its staff number every
year since its creation. It remains a comparatively small and efficient central
bank. At the end of 2007, 1,375 members of staff (full-time equivalent) were
employed on permanent or fixed term, up from 1,217 staff members at the end
of 2003. This number is dwarfed by the number employees working in the
largest Eurosystem NCBs. However, the ECB’s capacities have been increased
considerably, and in some areas (notably, research) its reputation has over-
taken that of the other Eurosystem NCBs.
Despite the ECB’s reputation for efficiency, bank management had to coun-
ter a great deal of publicly expressed discontent from ECB staff who com-
plained that it suffered from poor management, was too bureaucratic, and
failed to communicated with its employees (Financial Times 5 November
2003). In October 2003, the ECB approved internal reforms aimed at improv-
ing working conditions, communication with staff, and management train-
ing. A 2003 audit of the bank’s information technology services by McKinsey,
the consultancy group, found severe management failure in the IT depart-
ment’s project planning, causing heavy budget overruns and major delays
(ibid.). Trichet dedicated his first years as president to engineering reform
throughout the bank and, in IT, saw off strikes by staff, who were concerned
about the potential redundancies resulting from reorganization.
Euro Area Enlargement and Governing Council Reform

The most controversial internal reform undertaken by the ECB was the adop-
tion of a new rotation system for voting in the Governing Council. The
complicated nature of the new system has been criticized by many observers,
including the well-known monetary economist Daniel Gros (2003). According
to the reform agreement, the number of NCB governors exercising a voting
right is to be capped at 15, while all governors are to continue to attend and
be able to speak at meetings. When the number of NCB governors in the
85
Governing Council exceeds 15 voting rights is to be exercised on the basis of a

rotation system, designed to ensure that the NCB governors with the right to
vote are from member states which, taken together, are representative of the
Euro Area’s economy as a whole. Consequently, the NCB governors are to
exercise a voting right with different frequencies depending on an indicator
of the relative size of the economies of their member states within the Euro
Area. Based on this indicator, NCB governors are be allocated to different
groups.
Initially, two rotating groups are established (as took place on 1 January 2009
following the accession of Slovakia to the Euro Area). The governors from the five
member states with the largest economies (currently, Germany, France, Italy,
Spain, and the Netherlands) form one group, possessing four votes (and thus
each have a voting frequency of 80%). The governors from the other member
states form the second group, sharing 11 votes. Once the total number of mem-
ber states in the Euro Area increases beyond 22, three groups are to be established
with members of the third group possessing the lowest voting frequency. The
members of the Executive Board are to preserve their permanent voting rights.
In 2003, the European Parliament opposed the reform on the grounds of its
complicated nature but also because it was felt that population size should have
been a factor determining membership of the rotating groups. Many econo-
mists and central bankers have also attacked the reform because it does not cut
down the number of Governing Council members, which was already consid-
ered to be too many to allow for efficient monetary policy making (see, for
example, Baldwin et al. 2001; Berger et al. 2004; Buiter 1999; de Haan et al.
2005; Eijffinger 2006). Some argue for a system emulating the Federal Reserve
Board, with the ECB Executive Board possessing a larger percentage of the total
vote to allow for more efficient policy making (de Haan et al. 2005; Eijffinger
2006; Favero et al. 2000). Others see an entirely centralized system—the cre-
ation of a Monetary Policy Board detached from the member state NCBs—as
the only effective way to resolve the efficiency problem (Baldwin et al. 2001).
It can be argued (see Dyson 2008; Howarth 2007) that concerns with the
efficiency and credibility of monetary policy making were secondary in the
design of the rotational groups. More relevant were the corporate interests of
the existing 12 NCB governors who agreed the reform—none of whom would be
placed initially in the third group. Moreover, legitimacy concerns may have
directed the reform. Ensuring representation according to national economic
size was potentially important to the legitimacy of ECB policy making, even
though this undermined the treaty-established ad personam status of the NCB
governors. At the same time, the decision to grant all NCB governors the right to
attend and speak at Governing Council meetings, and the imposition of rota-
tion—albeit at different frequencies—on all governors (from the Maltese to the
German), allowed the ECB to claim that the reform respects the principle of
equal treatment.
86
Conclusion
EMU embodies ‘the triumph of technocratic elitism over the idea of political
democracy’ (Dyson and Featherstone 1999: 801). The ECB can be said to be the
principal victor in terms of real power, determining most aspects of monetary
policy for the world’s second largest economic entity. The burgeoning research
and analytical capacity of the ECB has reinforced its power, in relation both to
European and national political officials and to the Eurosystem’s NCB. Cred-
ibility also brings power, and the ECB can be judged to have achieved a
considerable amount of credibility thanks to the consistency of its monetary
policy and its ability to adopt greater transparency in explaining this policy to
both financial markets and democratically elected officials.
The democratic legitimacy of the ECB remains contested by some politi-
cians. However, Governing Council members insist upon its legitimacy. They
argue that the ECB’s mandate was established by democratically elected gov-
ernments and is more tightly circumscribed than a dual mandate including
growth and employment alongside price stability; that public support for both
EMU and the goal of price stability remains high; and that the bank has been
accountable to democratically elected officials and the public—without com-
promising its independence—through the efforts of Executive Board members
to explain bank policies regularly to members of the European Parliament,
governments and the public in speeches, press conferences, and other public
appearances.
The title of this chapter makes direct reference to the title of a much earlier
work that focuses upon Bundesbank power (Marsh 1992). On 1 January 1999,
the ECB supplanted the Bundesbank as the leading central bank on the Euro-
pean continent. To the extent that we can claim that the ECB ‘rules’ Europe, it
does so differently from the Bundesbank in the era of the European Monetary
System. The ECB sets the interest rates for 15 member states and for states in
the Exchange-Rate Mechanism (ERM-2), as well as having a strong influence
on interest rates for those satellite economies whose currencies shadow the
euro (see the chapter by Umbach and Wessels). Yet, NCB governors participate
in the setting of these rates—which was certainly not the case prior to 1999,
when the Bundesbank was notoriously hostile to interest-rate coordination
and set rates to meet its statutory mandate of domestic price stability. Even
though the ECB’s rates might not be entirely appropriate to the economic
conditions of many individual Euro Area member states, they are not the
reflection of economic developments in a single member state. The ideational
power of the ECB is at least as great as that of the Bundesbank: the former is
the guardian of price stability in Eurosystem and one of the world’s most
visible promoters of the virtues of low inflation. The augmentation of the
ECB’s research capacity reinforces its ideational power, and it is supported
by the Eurosystem NCBs which all share the same mandate. However, the
87
Bundesbank’s influence lay not only in its success in maintaining low inflation
but also, to a large extent, on the comparative size and strength of the German
economy. The ECB manages the monetary policy of a far larger economic
entity—clearly a source of its great clout both at home and abroad—but
the Euro Area is, in its great diversity, less economically successful than pre-
unification Germany, a fact that inevitably undermines the power of the ECB’s
anti-inflationary message.
This chapter has shown that the power of the ECB is limited in several
important respects. The resistance of member state governments limits the
ECB’s influence in European economic governance, national macroeconomic
policy, and prudential supervision. Despite the ECB’s important international
profile, EU member states are unlikely to modify its observer status in the IMF
and OECD. The resistance of Euro Area NCBs also prevents the extension
of ECB activities into several core central banking operations. International
developments—and notably the rise of China and India—will limit both the
relative economic importance of the Euro Area and, eventually, the import-
ance of the euro as an international reserve currency. Increasingly complicated
financial markets—notably the rise of derivatives and hedge funds—have
undermined the credibility of ECB monetary policy and will no doubt con-
tinue to do so.
88
Part II
Eurosystem ‘Insider’ Central Banks
4
National Banks of Belgium and the
Netherlands: Happy with the Euro
Ivo Maes and Amy Verdun
Financial integration and monetary union have affected the functions, struc-
tures, and powers of European central banks. The scope and content of central
bank policies have changed, as has the central focus of the policies. With the
creation of the European System of Central Banks (ESCB) and the Eurosystem,
European national central banks have become part of a collective system in
which monetary policy is set centrally by the Governing Council. The ESCB
consists of the European Central Bank and all the EU national central banks
(NCBs). The Eurosystem comprises the ECB and the NCBs of EU Member States
that have adopted the euro. Given that they are now part of a larger system that
sets monetary policy of the euro area, as such, the individual national central
banks of the Eurosystem have no sovereignty to set independent national
monetary policies as had been the case in the past.
In this chapter, the cases of the National Bank of Belgium (NBB) and De
Nederlandsche Bank (DNB) are analysed with a view to what has changed in
these central banks of medium-sized European Union member states since the
onset of Economic and Monetary Union (EMU). Both central banks played a
significant role in the creation of EMU. The National Bank of Belgium played a
pace-setting role in the EMU process, whilst De Nederlandsche Bank played the
role of gate-keeper (Maes and Verdun 2005). Since the start of EMU, how have
these roles of these two central banks changed, both within their domestic
context and within the Eurosystem? The core functions of a central bank—
monetary policy, issuing banknotes, managing the gold and foreign-exchange

Ivo Maes wrote the section on the National Bank of Belgium and Amy Verdun the one on de
Nederlandsche Bank. The authors would like to thank all those who contributed to this project,
especially Kenneth Dyson and Martin Marcussen, the participants at the Cardiff EU-Consent
workshop, 2007 UACES (Portsmouth), and British Academy/EU-Consent conference. Amy
Verdun thanks some officials and the services of De Nederlandsche Bank, especially C.C.A. van
den Berg. The usual disclaimer applies.
91
National Banks of Belgium and the Netherlands: Happy with the Euro
reserves, and organizing the flow of payments—now take place within a Euro-
pean framework, the Eurosystem, in which the National Bank of Belgium and
De Nederlandsche Bank fully participate. Besides their role in the European
context both central banks also play an important role in their countries’
domestic socio-economic affairs. In this way, they are now ‘hybrid’ institutions,
performing both European and national functions. Both the anticipation of the
creation of EMU and actual experience of EMU led to changes in the Belgian
and Dutch central banks. Increasingly, there is a growing attention towards
financial stability, in line with the globalization and growing complexity of
financial markets and institutions. The National Bank of Belgium and De
Nederlandsche Bank are evolving towards more knowledge-oriented tasks and
are putting more emphasis on cost control and modern management tech-
niques. In sum, these two central banks adjusted their objectives and organiza-
tion following the creation of EMU. More than before, they focus on policies
that support monetary and financial stability.
The National Bank of Belgium
The Pre-Euro National Bank of Belgium

The National Bank of Belgium had a ‘monetarist’ orientation and played a pace-
setting role in the EMU process (Maes and Verdun 2005). It argued for European
exchange-rate stability and monetary cooperation as a catalyst for economic
convergence. However, it was also convinced of the necessity of parallel pro-
gress in the economic and monetary areas.
The National Bank of Belgium was from the outset at the core of the EMU
process as Governor Hubert Ansiaux, who was also the chair of the Committee
of EC Central Bank Governors, became a member of the Werner Committee in
1970 (Maes 2006). In his memoirs, Pierre Werner (1991) characterized Ansiaux
as the chef de file of the ‘monetarists’ in the Committee. Later, at the time of the
creation of the European Monetary System (EMS), Governor Cecil de Strycker
was the chair of the Committee of EC Central Bank Governors. The National
Bank of Belgium was involved in the elaboration of the well-known ‘Belgian
compromise’ (with a role for both the parity grid and the divergence indicator
in the exchange-rate mechanism, cf. Ludlow 1982).
The EMU process was relaunched in the second half of the 1980s with the
Delors Committee (Verdun 1999b). Governor Jean Godeaux was described by
Jacques Delors (2004) as one of the ‘grands enthousiastes’ of EMU in the
Committee. The Committee of EC Central Bank Governors further prepared
the Maastricht Intergovernmental Conference, especially the draft Statutes for
the future European Central Bank. The Committee of Alternates, chaired by a
Director of the National Bank of Belgium, Jean-Jacques Rey (son of Jean Rey,
92
the second President of the European Commission), played a crucial role. Later,
Rey chaired the Monetary Policy Sub-Committee of the European Monetary
Institute (EMI), which prepared the Euro Area’s single monetary policy.
With its support of European monetary integration the National Bank of
Belgium was in line with Belgium’s traditional pro-European orientation (Maes
2002). However, there were also differences of opinion at the National Bank of
Belgium. Some took a more pragmatic view, regarding Europe as primarily a
framework for the stable exchange-rate policy, to ensure discipline in the econ-
omy. For others, who were more in favour of a federal Europe, the real goal was a
common European monetary policy, both to secure increased influence over the
monetary policy stance and as a step towards political union.
The National Bank of Belgium influenced the EMU process primarily via two
channels: the Belgian authorities and the central banks of the European Union
(Smets, Michielsen, and Maes 2003). At the Belgian level, the National Bank of
Belgium helped to formulate Belgium’s ideas and positions. Its expertise was a
particularly important asset. The National Bank of Belgium also played a role in
the world of the European central banks. This was particularly in evidence at
times when the Governor was chair of the Committee of EC Central Bank
Governors, or when representatives of the National Bank of Belgium chaired a
committee or working group (cf. supra).
From a Weak Currency to the Anchoring of the Belgian Franc to the D-Mark
For the National Bank of Belgium, the Snake and the EMS were the beacons
of monetary and foreign-exchange policy (Buyst, Maes, and Pluym 2005). It
was hoped that a European anchor would have the effect of imposing discipline
on domestic economic policy and wage-setting. At first that seemed a vain
hope.
Although the early 1970s were a boom period, the seeds of Belgium’s eco-
nomic problems were sown in this period. Not only was inflation gathering
speed, nominal wages were also clearly rising faster than prices. The budgetary
situation in Belgium was also worsening. In 1981, the public deficit totalled
more than 15 per cent of Gross Domestic Product (GDP). This led to discussions
between the National Bank of Belgium and the Finance Ministry on ways of
financing the deficit. Whilst the National Bank of Belgium was sharply critical
of fiscal policy, in practice it often consented to a monetary financing of the
deficit. Moreover, the government intervened in interest-rate policy (Buyst,
Maes, and Pluym 2005). Thus, in September 1979, the government commis-
sioner exercised his right to suspend an increase in the discount rate, intended
by the Council of Regency (the highest decision-making body, composed of the
governor, the directors, and 10 regents) of the National Bank of Belgium. One
week later, when the situation in the foreign-exchange market had not
improved, the minister consented.
93
In December 1981, a new coalition government of Christian Democrats and

Liberals came to power. A key element of its programme was a devaluation
combined with accompanying measures. The February 1982 devaluation was
clearly designed as a one-off operation. It was accompanied by a series of
measures to prevent inflation from getting out of hand. The spectre feared by
Belgian policymakers was a ‘devaluation–inflation–devaluation’ spiral, as pre-
viously experienced by other countries.
The Luxembourg government was ‘dismayed’ at the devaluation announce-
ment by the Belgian government. The Luxembourg authorities asked for the
Belgian and Luxembourg gold and currency reserves to be split. New negoti-
ations on the monetary association followed. The Luxembourg authorities
dropped their request for a division of the reserves, but the limit on the
Luxembourg franc banknote issue was increased.
The devaluation and the recovery policy brought a rapid improvement in the
external position of the Belgian economy. The balance of payments current
account was restored to equilibrium in 1984. In the periodic EMS realignments
during the mid-1980s, the Belgian franc generally held an intermediate pos-
ition between the strong currencies and the weaker ones. Thanks to the
improved performance of the Belgian economy, it gradually became possible
to align the Belgian frame more closely to the D-Mark (Godeaux 1989). On 16
June 1990, the Belgian franc was officially pegged to the D-Mark. This new
exchange-rate objective also strengthened the National Bank of Belgium’s
autonomy in relation to the government on interest-rate policy.
Preparing for EMU

The Maastricht Treaty, with its convergence criteria, clearly pointed the way to
EMU. The Belgian authorities’ strategy was designed to ensure early fulfilment
of the criteria concerning price stability, exchange-rate stability, and long-term
interest rates. By qualifying sooner on these criteria Belgium hoped to distin-
guish itself clearly from other countries with a high public debt/GDP ratio (such
as Italy). Crucial to this strategy was the exchange-rate policy, anchoring the
franc to the D-Mark.
In 1993, the ERM exchange-rate crisis put Belgium’s EMU strategy in serious
jeopardy. The storm on the foreign-exchange markets reached its peak in
October 1993, when the Belgian franc was trading at 6.5 per cent below its
central rate against the D-Mark. The National Bank of Belgium defended the
exchange rate. It put up the official interest rate from 6.7 per cent in mid-July to
10.5 per cent at the beginning of September. It also intervened in the currency
markets on a massive scale. With the approval of the ‘overall plan for employ-
ment, competitiveness, and social security’ in November 1993, the Belgian
government took new measures to tighten up fiscal policy and to restrain
incomes. In the closing months of 1993, the franc strengthened again.
94
During the 1990s, the independence of the National Bank of Belgium was not
only reinforced through the more ambitious exchange-rate objective. There
were also significant reforms, in line with a growing Europeanization of the
National Bank of Belgium.
Belgium was in a unique position in the EU, since the National Bank of
Belgium had the power to determine the interest rate on short-term treasury
paper, albeit after ‘consultation’ with the Finance Ministry; the responsibil-
ities of the monetary and fiscal authorities were intertwined. In January 1991,
the money market and the instruments of monetary policy underwent fun-
damental reform, thereby ending the intermingling of the National Bank of
Belgium’s responsibilities with those of the Finance Ministry. The reform
made the issue of treasury certificates the exclusive domain of the Treasury.
Auction techniques were introduced. Henceforward, the market would deter-
mine the interest rate on treasury paper. As in other EU states, the National
Bank of Belgium’s new range of monetary policy instruments was based on its
function as the bank of banks. The National Bank of Belgium influenced
market interest rates indirectly, via the volume of its lending to financial
institutions and the interest rate charged. The state’s credit line was signifi-
cantly reduced. Furthermore, the state could only take out new loans in
foreign currencies if that did not conflict with monetary and exchange-rate
policy.
During the 1990s, the statutes of the National Bank of Belgium were further
adjusted in line with the provisions of the Maastricht Treaty. The law of 22
March 1993 granted the National Bank of Belgium greater autonomy in the
conduct of monetary policy. Limits were imposed on the supervisory powers of
the Finance Minister and the government commissioner. In addition, the
National Bank of Belgium was absolutely prohibited from lending money to
the government. Pursuant to the law of 22 February 1998, the basic law of the
National Bank of Belgium was further amended, introducing the principle that
the National Bank of Belgium formed an integral part of the ESCB.
In Belgium, preparations for the introduction of the euro were made by the
‘General Commission for the euro’, which was created in order to prepare
the introduction of the euro in Belgium. It had two tasks. It had to encourage
the various sectors of the economy to prepare for the advent of the euro, and it
had to monitor the cohesion of the measures in order to prevent the adoption of
conflicting strategies. The first General Commissioner, who was at the head of
the General Commission, was National Bank of Belgium director Guy Quaden.
When he was appointed Governor in March 1999, a few weeks after the intro-
duction of the new currency, he was succeeded by National Bank of Belgium
director Jan Smets. The National Bank of Belgium also provided the secretariat for
the General Commission.
The start of stage three of EMU also brought the abolition of the Belgian–
Luxembourg monetary association. From then on, Luxembourg had its own
95
central bank, the Banque Centrale du Luxembourg, which plays a full part in
the Eurosystem. The Luxembourg branch of the National Bank of Belgium was
taken over by the Luxembourg central bank.
On 1 January 2002, the euro banknotes were introduced in the 12 states of
the Euro Area. It was a logistical operation without precedent in monetary and
financial history. Since the National Bank of Belgium has its own printing
works, it printed banknotes which were placed in circulation on that date. In
total 550 million notes were printed. After a brief dual circulation period, the
Belgian franc notes ceased to be legal tender on 28 February 2002.
The National Bank of Belgium in the Eurosystem

From 1999 decisions on the single monetary policy were centralized. Most of
them are taken by the Governing Council of the European Central Bank. The
Governor of the National Bank of Belgium attends the meetings in a personal
capacity. In performing his duties, the Governor is strictly independent. Yet
Belgium has more influence over monetary policy now than before the intro-
duction of the euro, when the Belgian franc was anchored to the D-Mark, and
Belgium had no say in the interest-rate decisions made by the Bundesbank.
National autonomy was thus exchanged for a share in supranational decision-
making power, a practical illustration of how the effect of European integration
can be seen as a means of restoring power of decision, certainly for a small state
like Belgium.
One might argue also that with the new policy regime of EMU the power and
influence of the National Bank of Belgium in Belgium have been strengthened
(e.g. central bank independence, no monetary financing of budget deficits).
However, the absence of foreign-exchange crises (certainly an important benefit
for the Belgian economy) can sometimes make it more difficult to convince other
actors to adjust policies, as the ‘drama’ and sense of urgency of exchange-rate
crises are not there any more. The absence of foreign exchange tensions was even
cited as one of the reasons for the long negotiations to form a government in
2007.
This greater role in monetary decision-making, as well as the ‘new competition
for ideas in the Eurosystem’, led to a strengthening of the Research Department
of the National Bank of Belgium (a general tendency in the Eurosystem, see the
chapter on research by Marcussen in this volume). The Department prepares,
twice monthly, a briefing for the Governor, before the meetings of the Govern-
ing Council. Moreover, it participates in the Monetary Policy Committee of the
Eurosystem, as well as several working groups. The Research Department also
prepares the projections for Belgium for the biannual Broad Macroeconomic
Projection Exercise of the Eurosystem. Furthermore, this policy work is based
on more fundamental economic research. Also, at the level of the Eurosystem,
research networks have been set up, for instance, on inflation persistence and
96
wage dynamics, in which the National Bank of Belgium participated actively.

In 2000, the National Bank of Belgium started a series of Working Papers and
a series of academic conferences. One of the objectives of research at the National
Bank of Belgium is also to strengthen links with the Belgian academic commu-
nity, for instance, through common research projects.
In the implementation of monetary policy the principle of subsidiarity
applies. One of the Eurosystem’s basic operating principles is a high degree of
decentralization. The National Bank of Belgium, like the other national central
banks, therefore remains the contact point between Belgian financial institu-
tions or economic agents and the Eurosystem. However, the concept of decen-
tralization has evolved since the Eurosystem was first formed, with some central
banks now offering services to the other central banks of the Eurosystem (like
TARGET 2). The National Bank of Belgium played a pioneering role here (Qua-
den 2007). A first example concerns banknotes. The National Bank of Belgium
developed an IT tool which manages the flows of banknotes and coins both
within the National Bank of Belgium and between the National Bank of Bel-
gium and the financial institutions (or the cash transport firms). This applica-
tion, called CASH, has yielded significant productivity gains and increased
transaction security. The National Bank of Belgium makes this application
available for use by the other central banks. In 2006, a partnership was con-
cluded with De Nederlandsche Bank and the Banque centrale du Luxembourg,
joined by the Bank of Finland in March 2007.
The second example concerns the implementation of monetary policy. The
credit granted to financial institutions has to be backed by appropriate collat-
eral. The National Bank of Belgium developed a new IT system for the efficient
management of that collateral. This platform—called ECMS (Euro Collateral
Management System)—permits almost totally automated management of this
collateral and improves the service provided for financial institutions. A part-
nership has been concluded here, too, between the National Bank of Belgium
and De Nederlandsche Bank.
In Belgium, since the 1930s, the responsibilities of the National Bank of
Belgium had been separate from those of the Banking Commission, which is
responsible for banking supervision or ‘micro-prudential’ supervision (Maes
and Périlleux 1993). Recently, the National Bank of Belgium acquired a greater
role in prudential matters, especially ‘macro-prudential’ issues, which relate to
the stability of the financial system as a whole.
The National Bank of Belgium has traditionally been involved in the stability
of the financial system via its responsibility for payment instruments. It is in
fact via the payment systems that a crisis in one financial institution threatens
to affect other financial institutions, and hence the stability of the financial
system and economic activity in general (Lamfalussy 2003; Moran and McCart-
ney in this volume). Also, as the bank of banks, responsible for providing
liquidity for the financial system, the National Bank of Belgium performs a
97
macro-prudential function. In the past few decades the National Bank of

Belgium has also been involved, via its international role, in developing new
prudential rules at international and European levels.
With the law of 17 December 1998, the National Bank of Belgium was given
an explicit legal basis for exercising macro-prudential supervision. On 1 January
1999, the National Bank of Belgium took over the functions of the Rediscount
and Guarantee Institute, especially the management of the ‘Protection Fund for
Deposits and Financial Instruments’. The Protection Fund’s task is to give
financial compensation to depositors and investors who have suffered damages
following the bankruptcy of a credit institution or investment undertaking
(Vandeputte, Abraham, and Lempereur 1981).
The law of 2 August 2002 fundamentally reorganized prudential supervision
in Belgium (Buyst and Maes 2008). As part of that process, the Banking and
Finance Commission and the Insurance Supervision Office were merged on 1
January 2004 to form a single supervisory body, the Banking, Finance and
Insurance Commission (BFIC). Moreover, stronger links were established
between the National Bank of Belgium and the Banking, Finance and Insurance
Commission. Thus, three members of the National Bank of Belgium’s Board of
Directors are members of the Banking, Finance and Insurance Commissions
Board of Directors. In addition, a Financial Stability Committee was established
in 2003. It comprises the members of the National Bank of Belgium and Bank-
ing, Finance and Insurance Commissions boards of directors, and is chaired by
the Governor of the National Bank of Belgium. It deals with all matters of
common interest, such as the overall stability of the financial system, the
coordination of crisis management, and the management of synergies between
the two institutions. A Financial Services Authority Supervisory Board was also
set up in 2004, combining the Banking, Finance and Insurance Commission
supervisory board and the National Bank of Belgium’s Council of Regency.
However, the Banking, Finance and Insurance Commission retains its powers
of micro-prudential supervision and autonomy of decision. The Law of 2 August
2002 also obliged both institutions to cooperate and to pool resources in order
to realize synergies.
Several factors contributed to these changes. The liberalization and global-
ization of the financial markets made the financial system more open and more
competitive (Maes 2007). Furthermore, the ever-accelerating pace of financial
innovations makes it more difficult to assess and locate the risks. Crucially,
during the last decades, there were several mergers of banks and insurance
companies in Belgium, leading to the formation of large ‘bank assurance’
groups. The emergence of very large financial institutions also means that a
problem in one large institution could have systemic implications. All these
factors are tending to blur the boundaries between macro- and micro-pruden-
tial supervision. Moreover, with the introduction of the euro, certain arguments
against giving national central banks prudential responsibilities, such as the
98
loss of monetary policy credibility in the case of a bank failure, have lost
importance.
The start of the third stage of EMU coincided with an important renewal of
the Executive Board of the National Bank of Belgium (in March 1999). Gov-
ernor Alfons Verplaetse retired and was replaced by director Guy Quaden. In
2000, Governor Quaden launched a strategic management exercise which
was triggered by the fundamental changes brought about by the single cur-
rency, as well as the spread of new information and communication technolo-
gies and the concentration in the commercial financial sector. The exercise led
to a strengthening of the National Bank of Belgium’s research capacities and
communication capabilities, as well as cost control and modern management
techniques.
Traditionally, the National Bank of Belgium devoted much attention to
macro-economic research. As already mentioned, to participate fully in the
Eurosystem, the National Bank of Belgium strengthened its research capacities.
Moreover, as a monetary authority it plays a key role in the definition of macro-
economic policy in Belgium. Indeed, the National Bank of Belgium’s role as an
advisor on economic policy has an institutional basis. In the first instance, this
role is expressed in the Council of Regency, where the social partners are also
represented. The Council of Regency’s discussions, which are based on reports
prepared by the National Bank of Belgium, help to achieve social consensus
in Belgium. With EMU, a crucial issue for the National Bank of Belgium is
the coherence between the single monetary policy and economic policy in
Belgium.
An important result of the strategic revision was also the strengthening of the
communication capabilities of the National Bank of Belgium. In 2000, a Com-
munications Service was created, which reports directly to the Governor. It
included also the museum, which was revamped and extended.
It is also noteworthy that during the final three decades of the twentieth
century, the National Bank of Belgium was entrusted with various tasks which
cannot be classed as strictly central bank functions. Indeed, they fall outside
the domain of the ESCB. The reasons are related both to the competences of the
National Bank of Belgium and to the weaknesses of other institutions in the
Belgian state. Most of these functions concern the collection and circulation
of information. The range of functions performed by the National Bank of
Belgium is larger and more diverse than that of most other central banks in
the Eurosystem. Thus, the National Bank of Belgium is a key player in the
provision and analysis of micro-economic information. The law of 24 March
1978 gave the National Bank of Belgium the task of establishing the Central
Balance Sheet Office, whose function is to collect and publish the annual
accounts of firms. The Central Office for Credits to Enterprises, established in
1967, collects data on lending in the Belgian economy. In the 1990s, the statis-
tical functions expanded as, at the request of the legislature, the National Bank
99
of Belgium took over a substantial part of the activities of the National Statistical
Institute, in particular the compilation of the national accounts.
Furthermore, cost control and modern management methods became more
important. For instance, the agency network was greatly reduced. Of the 43
provincial branches, 20 were closed between 1974 and 1984. In 1999, a second
streamlining operation was launched. Since March 2005, the National Bank of
Belgium has only seven establishments outside Brussels. Also, modern manage-
ment methods were introduced, like master plans and a stronger emphasis on
skills management.
There have also been considerable changes in the workforce. The number of
employees peaked on 1 January 1987 at a nominal total of nearly 3,300 units.
After that the size of the workforce declined sharply. Yet the advent of monetary
union did not lead to a significant reduction in traditional activities, whilst new
tasks were added. Thanks to productivity increases and restructuring, the work-
force contracted. On 1 January 2008 the nominal total had fallen to around
2,250 units, a decrease of nearly one third compared to 1987. This was accom-
plished without dismissals, but recruitment became very selective. In line with
the trend towards more knowledge-based tasks, the proportion of staff in
managerial and supervisory positions rose from 11 per cent in 1970 to over 20
per cent in 2008.
De Nederlandsche Bank
De Nederlandsche Bank (DNB) has been the central bank of the Netherlands
since 1814, making it one of the older central banks in Europe. Throughout this
period its role changed from being commercially involved to serving as a public
institution, completely abandoning its commercial activities and acting instead
as lender of last resort, and dealing with its three core tasks: managing currency
circulation, formulating and implementing monetary policy, and banking
supervision (Vanthoor 2005). European integration has always been part and
parcel of the modern DNB, and when possible the DNB took action to support
the European integration objective.
The DNB in the 1960s–80s

Throughout the late 1960s and 1970s the Dutch monetary authorities favoured
close monetary cooperation with other EEC member states. They made alliances
with the Germans on policies for further economic and monetary integration.
The Dutch were keen to ensure that macro-economic integration was well
developed before moving towards deeper monetary integration. The Dutch
and German governments both belonged to the ‘economists’ camp in the
well-known debate between ‘economists’ and ‘monetarists’ on how best to
100
obtain further monetary integration. Nevertheless, they favoured closer Euro-

pean co-operation in this area. They backed the exchange-rate agreements that
were established to promote monetary and trade stability in Europe, such as the
Snake and the ERM of the European Monetary System whilst at the same time
promoting an EMU based on ‘economist’ principles (Verdun 1990, 1996, 2000).
In the late 1970s and early to mid-1980s the Dutch economy suffered from
low economic growth, rising unemployment, and lack of competitiveness (see
also Szász 1988: 208–9). The Dutch monetary authorities reacted to this situation
by deciding, among other things, to follow a strong currency policy and closely
follow German monetary policies (see Verdun 2002: 241–2, see also Wellink
2008). They aimed at securing fixed exchange rates between the Dutch guilder
and the D-Mark. This policy objective was maintained until the launch of
the euro in 1999. By 1999 the Dutch exchange rate vis-à-vis the D-Mark had
been the most stable of all ERM currencies over a period of two decades.
The Dutch central bank was influential in the relaunch of EMU in the late
1980s and early 1990s particularly during the Intergovernmental Conferences
(IGCs) that led to the Treaty on European Union which was signed in Maas-
tricht. The Dutch government, headed by Prime Minister Ruud Lubbers, held
the rotating presidency of the EC at a key moment in the history of EMU, when
the IGCs preparing the Maastricht Treaty revisions were negotiated in the
second half of 1991. The Dutch worked very hard at getting a workable com-
promise that would satisfy all member states, and the DNB played an important
role in this process. The DNB was one of the few central banks that had a record
similar to that of the Bundesbank, and was already in these early years all but
completely independent.
During the 1980s, the DNB had a record similar to that of the Bundesbank in
that it kept inflation rates low, the exchange rate stable, and managed to secure
this solid record throughout that decade. As such, the DNB was a strong
institution during the negotiations leading up to incorporating EMU in the
Treaty on European Union. One of the roles of the DNB was to keep on board
the German monetary authorities, who were interested in an EMU that would
be built on a price stability objective. The Dutch EU presidency in 1991 needed
to find the wording that would be acceptable to even the most sceptical ones,
the United Kingdom and Denmark. The end result was the successful incorp-
oration of EMU into the Treaty on European Union with an opt out for the
United Kingdom and Denmark. Furthermore EMU would only start with those
countries who could meet the convergence criteria.
The DNB: from Maastricht to Frankfurt

Although incorporated in the Treaty, EMU was by no means completely settled
in 1991. The interpretation of the convergence criteria remained a hot political
topic throughout the 1990s. The Bundesbank and the German Ministry of
101
Finance were concerned that, once EMU was fully operational, some states
might return to their old practices of high public borrowing and high rates of
inflation. The Dutch monetary authorities were among those most supportive
of these German concerns and thus spoke up about the concerns that the
Germans had. As was already touched upon above, the Dutch–German rela-
tionship had been carefully crafted throughout the 15 years prior to signing of
the Treaty on European Union (Szász 1988, 2001). Also, the German govern-
ment had to perform a careful balancing act between being pro-active on what
it considered important, and not seeming to be too dominant within the
broader European context. In particular, the DNB supported the Stability and
Growth Pact, which both the DNB and the Bundesbank considered to be a
crucial instrument in securing stability in EMU after the adoption of EMU
(Heipertz and Verdun 2004, 2005).
The strong record of the Dutch central bank (DNB 1997) and its close rela-
tions to the German Bundesbank and the stability culture, put the then Presi-
dent of the Dutch central bank, Willem Duisenberg, in an excellent position to
be put forward as the first President of the European Central Bank. Duisenberg
personified the new institution in more than one way (De Haas and Van
Lotringen 2003). He had been an advocate of European monetary integration
since the early days and had ample international experience. Duisenberg had
worked with the International Monetary Fund from 1965–9, and then for a year
as an advisor to the Director of DNB. Thereafter he was appointed Professor of
Macroeconomics at the University of Amsterdam. He left academia to become
the Finance Minister in the social–democratic government (1973–7). These
were turbulent years for the Netherlands. After his years in the political arena
Duisenberg spent a few years in the private sector as vice-president of the
Rabobank (a Dutch commercial bank). In 1982 he became the President of De
Nederlandsche Bank, a post he kept until he left the position to head the
European Monetary Institute in July 1997 and then the European Central
Bank from its first day in June 1998.
During his years as President of the Dutch central bank Duisenberg managed
to secure a stable exchange rate to the D-Mark and to keep inflation rates low. As
part of this strategy he closely followed German monetary policies. But, con-
trary to many other countries in the 1990s, the Dutch–German exchange rate
did not come under pressure at any time, and the Dutch–German exchange rate
stayed stable when others were stretched to a +15 per cent band in 1993. Since
the start of the idea of creating EMU, the DNB worked hard to make sure that
EMU would be based on the same firm principles the DNB had itself worked
long and hard on to achieve.
In 1991 De Nederlandsche Bank’s three main tasks were managing currency
circulation, formulating and implementing monetary policy, and banking super-
vision. As DNB looked towards a future role in the Eurosystem where monetary
policy would be set centrally, it realized that changes were needed to ensure that
102
it was capable of effectively supporting this ECB monetary policy and of sec-
uring the overall financial stability of the Netherlands in this new context.
In preparation for entry into stage three of EMU, the adoption of the euro,
and become integrated into the Eurosystem and the ESCB, a few changes were
made. First of all, the Dutch parliament passed a change to the Bank Act. The
Dutch central bank had effectively operated as an independent central bank,
even though, formally, the Minister of Finance had the power to instruct the
DNB (in Dutch ‘aanwijzingsrecht’). But this power had been rarely used (e.g. in
1945); indeed, according to the new Bank Act of 1948, it was to be used only in
ultimum remedium—as a last resort, which never happened after 1948 (Vanthoor
2004: 164–7, 201–11). In 1998 the Bank Act was subsequently changed so as to
remove this power to comply with the requirement of the ESCB that the
national central banks have to be completely independent.
In 2002 another important change was made. Pensions and Insurance Super-
visory Authority (Pensioen- en Verzekeringskamer ‘PVK’), which traditionally
had been a separate institution, was transferred to DNB, which had a major
impact on the institutional structure of DNB. A new Act was put in place to
replace the older one (which had been in place for 50 years). In 2004 the merger
between DNB and the Pensions and Insurance Supervisory Authority was
complete.
Other restructuring that took place in light of joining EMU included the
closing of seven branches of DNB—a decision taken in 1996 leaving only the
main office and four branches open (Apeldoorn, Eindhoven, Hoogeveen, and
Wassenaar, DNB 1999: 147). The branches had as one of their tasks to verify the
authenticity and the state of banknotes. Following a decision in 2003 to dele-
gate some of those tasks to commercial banks, DNB was witnessing a downward
trend in the number of banknotes the branches were checking—still as much as
1.8 billion notes in 2004, whereas this number was down to 1.1 million notes in
2007 (DNB 2008a: 95). Given the lower workload, three of the four branches
closed on 1 July 2007 and with Apeldoorn (the former seat of the PVK) due to
close in 2010, only the headquarters in Amsterdam will remain (DNB 2008a:
120). In the years to come the DNB will still check between 600 and 800 million
banknotes per year mainly to intercept counterfeits; the banking sector will
examine and re-circulate the rest. Even though there was a reduction in the
workload over this period regarding checking for counterfeits, DNB expects a
higher workload when second generation banknotes will be introduced. In
these early years DNB would still determine itself from which press to order
banknotes (5 euro banknotes from France: Oberthur technologies; the 20 euro
bills came from the Dutch printer Joh. Enschede, DNB 2008a: 95). DNB states in
its 2007 annual report that it is expected that banknotes will be centrally
ordered by the ECB in the years to come. Furthermore, a reorganization of the
divisions and number of staff in each division was reviewed and changes were
made to reflect the new reality of EMU.
103
Once a member of the Eurosystem, the Dutch central bank became embedded
into this new structure and became responsible for some tasks. An example of
this joint sharing of tasks is the management of official external reserves. In
1999 part of the reserves of national central banks was transferred to the ECB. In
that year the DNB transferred 5 per cent of gold and reserves (2 million euro).
These reserves belong to the ECB but are managed by the national central
banks, based on instructions and rules set by the ECB (DNB 2000a: 179). In
addition, the Dutch central bank still holds reserves that have remained its
property. Here too, ECB rules and regulations are in place as to how the DNB
may manage these reserves: in some cases, it needs to ask prior approval from
the ECB for certain investments (DNB 2000a: 179). Finally, there are some tasks
of the DNB that have not changed because of its becoming a member of the
Eurosystem. For instance, in banking supervision, the DNB is responsible to the
national Minister of Finance.
The Bank Act of 1998 also changed some aspects of the checks and balances.
Similar to what has been envisaged in the Treaty on European Union, the
President of De Nederlandsche Bank is responsible for presenting an annual
report, which is subsequently discussed in parliament. Furthermore, the Bank
Act envisages that either of the two chambers of parliament could request to
meet with the DNB President to be given information about DNB policies and
decisions. However, the President of DNB remains independent at all times. In
the context of monetary policy setting, the DNB President is not obliged to
inform the House of Parliament whether he voted and or how he voted in
monetary policy decisions taken in Frankfurt [see Bank Act 1998, Article 18 (2)
that stipulates that the President may be asked to provide information without,
however, compromising the confidentiality of the monetary policy decisions].
When the Bank Act was revised, it was seen as very important to recognize the
historic tradition of the DNB’s integral role in Dutch society. A Bank Council
(‘Bankraad’) continued to perform this task. The members of the Bank Council
are appointed for a period of four years and represent the composition of Dutch
society. Its function is to be a sounding board for the DNB’s Governing Board.
Another aspect of embedding the DNB in society was the regular communica-
tion between its President and the Minister of Finance. For many years the two
have had weekly luncheons in which financial and economic matters are
discussed. Article 18 of the Bank Act envisages that the Bank and the Minister
should maintain regular contact. Thus the weekly lunches were kept intact so as
to ensure this regular communication (DNB 2000a: 180).
Discussions on corporate governance in the Netherlands led to a law named
after the chairperson of the committee (Morris Tabaksblat) who oversaw the
formulation of a new law. The so-called ‘Code Tabaksblat’ (Dutch Corporate
Governance Code) consisted of 21 principles of sound corporate governance
and 113 best practices. After having been discussed by parliament it was for-
mally adopted on 9 December 2003. The code stipulates that, as of 2004, all
104
companies that are listed on the Dutch stock exchange have to provide details
on their corporate governance in their annual report. The Dutch central bank,
of course, formally fell outside this law as it is not a listed company. Further-
more it felt that its Bank Act of 1998 for the most part already adhered to the
principles of good governance and best practices. Nevertheless, DNB decided to
change its statutes so as to reflect the Code Tabaksblat. These changes to the
statutes included among other things that the Supervisory Board will periodic-
ally review its own performance as well as that of the Governing Board; that the
Supervisory Board will draw up a profile of its size and composition; and that
the profile of the Supervisory Board will in due course be advertised on the
website. On 13 March 2007 DNB’s statutes were adjusted to reflect the stipula-
tions of the Code Tabaksblat. The annual report of 2003 for the first time
included a chapter (albeit an extremely short—two paged—chapter) on ‘cor-
porate governance’. Every annual report since has included a substantial chap-
ter on corporate governance, reporting on best practices, cost performance,
meeting targets and objectives, etc. Many of the items reported in this ‘corpor-
ate governance’ chapter of the annual reports conform to what is often cap-
tured under the header of ‘New Public Management’ practices. To give an
example, the annual report reporting over the year 2007 indicated the cost
target for expenses on personnel as having been 167.2 million euro, whereas
the actual expenses had been 168.4 million (up from the 162.7 in 2005 and
168.0 in 2004). Elsewhere in the report DNB reported on how in its recent
assessment the 2004 merger had met the objective of enhancing efficiency by
cost saving of 25 million euro (DNB 2008a: 29). One of the objectives had been
to keep full-time equivalent (FTE) staff of the new merged DNB on or below the
level of the DNB prior to the merger, which has been achieved. Back in 2001
personnel in both organizations were 1,683 FTE in DNB and PVK 177 which
changed to DNB 1,672 and PVK 231 in 2003. By the end of 2004 after the two
institutions merged the total FTE for the new DNB was 1,774. Since that date
there has been a gradual decline in FTE: 1,685 in 2005; 1,630 in 2006; 1,566 in
2007.
In its aim to increase transparency, DNB, besides publishing an annual report,
also issues quarterly bulletins and a statistical bulletin, as well as a host of other
publications (including a laymen publication ‘DNB Magazine’). In 2000, the
use of external communications was revised to reach out more to the general
public (e.g. increased use of the website first created in 1997—completely
revamped in 2004).
The DNB as Part of the Eurosystem: In Search of a New Purpose

With the entry of the DNB into the Eurosystem and the ESCB a number of
important changes occurred. As of 1 January 1999 monetary policy was set in
Frankfurt (albeit with the DNB President present and voting on monetary
105
policy decisions). The DNB was quick to note that, contrary to what the Dutch
media suggested, it did not completely lose or transfer sovereignty. Indeed, as
one interview partner put it: ‘Before EMU we were just following policies made
in Germany; after we joined the ESCB we once again became part of the group
of people that were setting monetary policy’ (personal interview with DNB
official, Amsterdam, August 2006). In fact, the Dutch central bank had been
successfully shadowing German monetary policies and thus, effectively, had
not used its national sovereignty to set independent monetary policies (see also
Wellink 2008). However, the DNB president Nout Wellink takes part in the
deliberations and voting of the governing council that sets monetary policy. In
this context, the President Wellink has been stressing the importance of price
stability and a stability culture in monetary and budgetary policy, very much
following in the footsteps of ECB president Duisenberg. President Wellink has
continued along the lines set out in the earlier years as to the direction of
monetary policy for the Euro Area. Of course, since entering stage three of
EMU the Dutch central bank president has one vote on the governing council,
whereas in the 1970s, 1980s, and 1990s the Dutch central bank president
mostly followed German monetary policies without having a say over it.
The Treaty on European Union stipulates that monetary policy is a common
responsibility of the European System of Central Banks. Following the prin-
ciples of the Treaty, the DNB defined its new function as support for the
monetary policy by providing background information and statistics; in other
words, an accurate assessment of market sentiments and expectations
(Vanthoor 2005: 326). National central banks carry out a number of tasks that
are not necessarily part of the EU Treaty. In some states these tasks are the
responsibility of an independent regulatory agency that may or may not be the
central bank. The Bank Act of 1998 (Articles 3 and 4) captured the tasks of DNB
as follows: define and implement monetary policy; conduct foreign-exchange
operations and manage official foreign reserves; provide for the circulation of
money (banknotes); promote the smooth operation of the payment system;
contribute to the supervision of credit institutions and the stability of the
financial system; collecting statistical data and producing statistics. Let us
bunch a few of these tasks together and discuss them in turn: (1) to ensure
financial stability; (2) banking supervision; and (3) economic advisor to the
government. Changes have occurred in each of these areas.
The EU treaty stipulates that the ESCB shall facilitate the conduct of policies
by the authorities related to the stability of the financial system. These author-
ities are still predominantly national, but the ESCB can provide information,
best practices, and networking.
The DNB has responded to the new monetary environment by focusing more
attention on this aspect of its role. For instance, it produces a biannual Over-
view of Financial Stability (OFS) in the Netherlands (see DNB 2008b). However,
many of the changes in this role relate directly to policies set out by the ECB,
106
whereas others are the result of developments in the financial markets. Recent
developments in the real economy suggest that there has recently been less
supervision by central banks (than before the start of EMU) because in recent
years much of the liquidity creation stays outside the control of central banks.
The system therefore is more vulnerable than before to stress. To prepare itself
for possible future shocks, the DNB and the Belgian Banking Finance and
Security Commission and the Belgian central bank signed a memorandum of
understanding in 2006 that envisages close coordination in case of a financial
crisis. Likewise in February 2007 DNB and the Dutch minister of Finance agreed
to consult one another in case of a financial crisis (DNB 2007: 121). For
example, during the 2007–8 credit crunch the DNB took rapid action. It shar-
pened its control on liquidity (DNB 2008a: 61). Even though there was no risk
of a similar development in the Netherlands (there is no sub-prime market for
mortgages, by law, mortgages may not be more than 30% of the debt of a
household, and only 1% of households have a mortgage interest rate set for
less than five years, DNB 2008a: 63), the Dutch financial sector still experienced
some of the fall out of the sub-prime crises, as some banks and investors had bad
debt.
In the Netherlands banking supervision has been the responsibility of the
central bank. The creation of the ESCB was no reason to change this role.
Although the start of EMU had virtually no impact, a number of changes to
banking supervision have been made related to EU directives (Vanthoor 2006:
340). Two directives came into force in July 2002: the Act on the Supervision of
the Credit System (which covers the issuing of electronic money since 1 July
2002); and the Money Transactions Offices Act (simultaneously repealing the
1995 Exchange Offices Act) (DNB 2003: 109). In 2002 a crucial change was
made. The Pensions and Insurance Supervisory Authority, which traditionally
had been a separate institution, was transferred to the DNB, producing a major
impact on the institutional structure of DNB. A new Act was put in place to
replace the older one (which had been in place for 50 years). The new Act
envisages that the Pensions and Insurance Supervisory Authority become part
of the DNB and the new merged organization be named DNB. The latter
supervises the entire financial sector (including pensions, insurance, collective
investment schemes, exchange offices, and the like, Vanthoor 2006: 340–1). In
2004 this merger was completed. The aim of the merger was to reinforce the
grip on financial stability, and to enhance the efficiency and effectiveness of
supervision.
Since the creation of EMU the Dutch central bank has been more actively
promoting its ability to comment on the state of the Dutch economy and on
the policies of the government. It is placing more emphasis on research (cf.
DNB 2000b: 25, 29). Also, it has been more focal on socio-economic consult-
ation committees and been more outspoken in the media. Furthermore, the
traditional weekly ‘lunches’ of the President of DNB and the Minister of Finance
107
have kept their important place. The President informs the Minister of Finance
about strategic direction of the ECB but they also have conversations about the
policy mix of budgetary and fiscal policies on the one hand and monetary
policy on the other. They also discuss the situation in the financial system
(including the payment system). DNB President also has a seat on advice
committees such as the Social Economic Council in which employers and
trade unions are also represented and that gives advice to the government on
socio-economic policy matters. DNB President Nout Wellink also has a seat in
the Council on Economic Issues (Raad voor Economische Aangelegenheden,
REA). Overall the role of DNB has not so much contracted but rather changed.
In 2007, the so-called ‘Holland Financial Centre’ (HFC) was created, in which
DNB actively participates (DNB 2008a: 61). HFC is an organization that seeks to
strengthen an international open financial sector in the Netherlands, whilst
maintaining international best practices and keeping costs under control (DNB
2008a: 62). The DNB also seeks to increase transparency in its operations.
Conclusion
Financial integration, technological change, and monetary union have affected

the functions, structures, and powers of European central banks. Both the
National Bank of Belgium and De Nederlandsche Bank played significant roles
in the creation of EMU. The National Bank of Belgium played mainly a pace-
setting role in the EMU process, whilst De Nederlandsche Bank focused on a
role as gate-keeper. During the last decades, the Europeanization of the two
central banks gathered momentum. With the EMU process accelerating, the
independence of both central banks grew, both in a formal way (adaptation of
central bank legislation in line with the Maastricht Treaty) and because of the
hardening of the exchange-rate objective. With EMU, the core functions of a
central bank—monetary policy, issuing banknotes, managing the gold and
foreign-exchange reserves, and organizing the flow of payments—take place
within a European framework, in which the National Bank of Belgium and the
De Nederlandsche Bank fully participate. Thus, the National Bank of Belgium
and the De Nederlandsche Bank retain the functions of central banks, although
they now share them with the other central banks of the Euro Area.
Thus in their own ways these two central banks played an important role in
Europeanizing central banking in Europe and in creating EMU. Over time their
differences were reduced and convergence became the name of the game. In so
far as National Bank of Belgium and De Nederlandsche Bank power are con-
cerned, the creation of the ESCB and their participation in the Eurosystem,
ironically, enabled them to regain some power lost by their own de facto ‘tying
one’s hands’ (following German monetary policies through their exchange-rate
objective). With the Belgian and Dutch national central bank president now
108
having a voice in the voting, these two actors have, in a certain sense, gained
power.
Furthermore, the National Bank of Belgium and De Nederlandsche Bank play
an important role in their respective states’ socio-economic affairs, in line with
their expertise and their special place between the public sector and the finan-
cial world, and in providing both a national and European anchorage. So, both
central banks have become ‘hybrid’ institutions, performing both European
and national functions. Furthermore, the National Bank of Belgium and De
Nederlandsche Bank are evolving towards more knowledge-oriented tasks and
are putting more emphasis on cost control and modern management tech-
niques, a general convergence among central banks.
A noteworthy area is financial stability, where both the National Bank of
Belgium and De Nederlandsche Bank have been given more responsibilities,
something that contrasts with the evolution in certain other states like
Germany and the United Kingdom. So, regarding the responsibilities with
respect to financial stability, Belgium and the Netherlands show that there is
no convergence among the European central banks.
109
5
Bank of France: The Challenge
of Escaping Politicization
David Howarth
Prior to 1994, the Bank of France could be described as the quiet giant of
European central banking. Most comparative studies of central bank independ-
ence rank the pre-1994 Bank of France as one of the more dependent in its
relationship to government. While responsible for the range of operations
typical of central banks and exerting potentially considerable influence on
policy making, the Bank was very much in the policy making shadow of the
Treasury direction of the Ministry of Finance, which held ultimate control over
most aspects of monetary policy and considerable influence in prudential
supervision (Goodman 1992; Prate 1987). Establishing its subordinate position
in republican policy making, the 1936 and 1945 acts that nationalized the Bank
placed it under the ‘tutelle’ of the Prime Minister’s office. While in a weak
position in relation to the Treasury, the pre-independence Bank and its Gover-
nors firmly asserted the importance of defending the value of the national
currency during periods of strong inflationary pressure and refused to accede
to certain demands that touched upon the limited range of areas under the
Bank’s control according to legislation (see Prate 1987 for examples). The
Treasury had direct say over monetary policy and dominated credit provision
until the financial market liberalization that took place from 1985 onwards. The
end of the encadrement du credit system—by which the state directed credit
provision—and liberalization enhanced the relative power of the Bank by
increasing the importance of interest-rate policy, over which the Bank had
considerable influence by virtue of its unrivalled capacity to monitor French
money supply and inflation (Goodman 1992).
Europeanization has had a significant impact on the power of the Bank of
France since the 1970s. The operation of the Exchange Rate Mechanism (ERM)
of the European Monetary System (EMS) and the strong (stable) franc policy of
the second half of the 1980s and the 1990s reinforced the importance of
111
Bank of France: The Challenge of Escaping Politicization
interest-rate policy and currency reserve management, also controlled by the

Bank, although the need to follow closely German monetary policy effectively
limited Bank of France (and French government) margin of manoeuvre
(Howarth 2001). The German insistence on the privileged position of the EU
central bank governors in the negotiations on EMU also reinforced the position
of the Bank Governor in relation to the Treasury. Governor Jacques de Larosière,
former head of the IMF, played a crucial role in the discussions on EMU leading
to Maastricht both as a credible interlocutor of the Bundesbank and through his
efforts to convince President Mitterrand and others of the need to accept
German demands on independence (Howarth 2001).
This chapter will show that Europeanization since 1993—the independence
of the Bank of France in 1994 and the transfer of monetary policy powers to
the European Central Bank (ECB) in 1999—had a clear and direct impact on the
power and roles of the Governor and the members of the Conseil de la Politique
Monétaire (CPM), but a less obvious impact on the organization and responsi-
bilities of the Bank itself. Independence and the 1999 transfer have also had a
direct impact upon the Bank’s role in public life. Well over a decade since
independence, monetary policy remains more politicized in France than in
most Eurosystem member states, thus bucking the trend of apoliticization
(Marcussen chapter). In terms of the Bank’s core operations, however, political
hostility has created only marginal difficulties.
The Difficult Move to Independence
The failure to move towards apoliticized monetary policy in France is due to

history and the politically motivated claim that the monetary policy pursued
by the independent Bank of France and then ECB has had a negative impact
upon the French economy. Following the Second World War, opposition to the
delegation of policy-making powers to autonomous agencies was embedded in
a new Republican consensus (Fabre Guillemant 1998). Briefly, there are four
additional sources of French aversion to central bank independence:
the negative perception of the experience of independence prior to the Second
World War, when economically powerful private interests were seen as domin-
ating monetary policy; the belief that control over economic and monetary
policy should not be separated; the perception—rooted in the history of French
political economy—that low inflationary economic policies could be main-
tained by democratically elected officials guided by enlightened bureaucrats
and advisers; and power considerations within the French administration,
notably opposition to independence in the Treasury and the elite network of
the Financial Inspectorate.
On various occasions prior to independence, the Bank Governor asserted to
governments the importance of price stability and the need to maintain the
112
value of the currency (Koch 1983; Mamou 1988; Patat and Lutfalla 1986; Prate
1987; Valance 1996) and occasionally did so in very stern terms. Yet between
1944 and 1994, the Bank Governor rarely intervened publicly in economic and
monetary policy and, when he did, could be sorely rebuked and even replaced,
as in 1974 (Prate 1987: 210–11). The precise nature of government control and
the legal status of the Bank were not defined in the laws on nationalization.
Assertions of autonomy depended upon the personalities involved and the
degree to which governments diverged from the goal of monetary stability. A
January 1973 law clarified Bank powers and granted it greater scope to modify
its monetary mechanisms. The 1973 reform set out certain basic principles,
allowing the Bank’s General Council free rein in their practical application.
However, the reform did not eliminate ultimate State control over monetary
policy. Various requests from the Bank of France to gain greater autonomy were
opposed by governments and the Treasury (Prate 1987). Pre-1994 relations with
the Treasury and debates on monetary policy have been frequently described as
difficult, with the Treasury maintaining the final say and considerable influence
(Koch 1983; Mamou 1988; Prate 1987).
There was strong political opposition to independence right up to the signing
of the Maastricht Treaty in 1991. None of the political parties supported the
concept of central bank independence (Balleix-Banerjee 1999). Yet, public
opinion was generally in favour of the EMU project and the transfer of monet-
ary policy to the European level. The prioritization of European objectives
resulted in French government support for EMU and tolerance of central bank
independence. In the context of global ideological trends in favour of inde-
pendence, EMU created an historic opportunity to overcome strong domestic
political and institutional resistance. Moreover, the rapid move to independ-
ence at the start of Stage II of the EMU project (1 January 1994) was justified as
building confidence in the franc in the context of record levels of speculation,
not the desirability of independence per se.
The support threshold necessary to pass legislation on independence was
raised even further because the French Constitutional Council initially blocked
legislation in 1993 on the basis of a constitutional provision that effectively
prevented the delegation of policy-making powers to an independent body. The
support of three-fifths of the members of both chambers of parliament was also
necessary to modify the constitution to achieve independence. Moreover, two
core elements of EMU found in the Maastricht Treaty that block governments
from soliciting the central bank on monetary policy and establish price stability
as the primary objective of monetary policy were removed from the French law
on independence.1 They were successfully challenged by parliamentarians in
the Constitutional Court on the grounds that they contradicted the constitu-
tional principle that the government defines the policy of the country. None-
theless, the real effect of removing these core elements of the EMU bargain from
the French law was negligible because they applied by virtue of the provisions
113
found in the Maastricht Treaty. In the Monetary and Financial Code, which
replaced the 1993 law at the start of 2001, the wording of the Statute of the ECB
and the ESCB was incorporated and the goal of price stability established as
primary for the Bank of France. As with the ECB, no requirement of transpar-
ency was imposed upon the Bank of France. Article 3 of the 1993 law grants the
CPM the power to determine the conditions according to which its minutes
could be made public. The non-renewable, nine-year fixed terms of the six
external CPM members and the renewable, six-year fixed terms of the Governor
and deputy governors (with an age limit of 65) provided a much stronger
guarantee of personal independence than was previously the case—when no
guaranteed fixed term was provided.2
Politicized Monetary Policy in the Post-Independence Era
Despite the broad support for the EMU project in the French political class and
consistent public support for EMU, leading French government and opposition
politicians have refused to desist from politicizing monetary policy. From early
1994, Government politicians have repeatedly ‘scapegoated’ the Bank of France
and then the ECB for French economic difficulties—worsened by high interest
rates and then a strong euro. A surprising number of both government and
opposition politicians have been persistent in their challenge to ECB goals and
independence, particularly during electoral periods. Several recent examples
can be provided. As Finance Minister, Sarkozy, called for the ECB to adopt a
Federal Reserve–style target that includes economic growth (Financial Times, 11
June 2004), comments that he repeated as presidential candidate3 and then
President. Proposal 89 of Ségolène Royal’s 2007 Socialist Party presidential
electoral programme called for the inclusion of an employment creation ob-
jective in the ECB’s statute.4 In December 2006, when criticizing the ECB’s
decision to raise its interest rate, Royal insisted that the Bank be ‘submitted to
political decisions’ because it is not its job ‘to order [commander] the future of
our economies’.5
Politicized Appointments to the Conseil de la Politique Monétaire

The French law on independence provided less protection against overtly
political appointments than the TEU. Members of the Bank’s CPM did not
have to have any monetary policy experience—the legal requirement was that
proposed candidates have experience and recognized competence in monetary,
financial, and economic spheres. This opened the way for highly partisan
political appointments, with limited or no technical understanding of monet-
ary policy and central banking—unusual in the Euro Area—which was the
norm from 1993 to the early 2000s. Moreover, the process of appointment of
114
the CPM members created the possibility of strongly divergent perspectives on

monetary policy-making and a less orthodox Bank leadership than that of the
pre-independence Bank of France. Initially (from 1994 to 2002), there were six
‘external members’ and three ‘internal members’. Every three years the Presi-
dent and the prime minister selected two external members from a list of six,
with two nominees presented by each of the presidents of the National Assem-
bly, the Senate, and the Economic and Social Council. However, given the reach
of the President’s and prime minister’s influence it can be assumed that at least
some of the nominees were pre-approved. On one occasion, the President of the
Senate complained publicly that his preferred nominee was not appointed. The
President alone selects the three ‘internal members’: the Governor and two
deputy governors. Table 5.1 demonstrates that few of the CPM members had
any direct experience of monetary policy making, and few had or have any
training in the field.
In the first CPM selected in 1993, only one deputy governor had worked
previously in the Bank. Four of the first six external members of the CPM
could be labelled uncontroversial supporters of the strong franc policy and
EMU. However, the two members nominated by the Euro-sceptic president of
the National Assembly, Phillipe Séguin, were known opponents of both the
strong franc policy and EMU (see Table 5.1). Three of the following four
appointees (between 1994 and 1997) held similar opposing positions. In
1997, in a very overt demonstration of his dislike for Bank independence
and the strong franc policy, President Chirac appointed Jean-René Bernard
and Pierre Guillen to the CPM—both leading conservative opponents of the
Maastricht Treaty and the EMS with strong links to senior neo-Gaullist (RPR)
politicians. Chirac ignored the preferences of the centrist and pro-EMU presi-
dent of the Senate, René Monory, who complained to the press. Thus, from
1997 to 2000, five of the six external members, the majority of CPM members,
had previously been opposed to EMS membership, the strong franc policy,
central bank independence, EMU, and the Maastricht Treaty. All six had
opposed EMU. Members of this anti-EMS majority called publicly for a rapid
drop in French interest rates (Le Monde, 29 November 1996; 21 October 1998).
In November 1996, two of the externally appointed members, Marchelli and
Gérard, publicly expressed their disapproval of the EMU convergence criteria
and argued in favour of an additional criterion emphasizing employment
levels (Le Monde, 22 and 29 November 1996). Given the necessity of respect-
ing the French government’s commitments to the inflation and interest-rate
convergence criteria of the Maastricht Treaty, the members of the CPM were
unable to modify French policy in any significant way. Moreover, the CPM did
not modify its monetary policy strategy (established in 1994) of 2 per cent
inflation and M3 targeting, which corresponded to Bundesbank practice.
Since 1999, the appointments to the CPM have been less controversial and
115
116
Table 5.1. Appointments to the Bank of France’s Conseil de la politique monétaire (1994–2007) and Comité Monétaire (2007–present)
Party Professional Monetary, financial, or Relative Position on the EMS

affiliation background economic experience monetary policy and EMU
experience (1–5)*
Appointments prior to 1999

Name and term dates
Jean-Claude Trichet (1993–2003) RPR (loosely) Treasury Head of Treasury 3 ?
Hervé Hannoun (1993–2006) PS Bureaucrat Ministerial cabinet 4 For
Denis Ferman (to 2000) N/A Bank of France Bank of France 5 ?
Michel Sapin (1994–5) PS Politics Minister 3 For
Jean Boissonnat (1994–6) RPR Journalism Writings 1 For
Bruno de Maulde (1994–6) RPR (loosely) Public administration IMF, stock exchange regulator 3 For
(financial)
Jean-Pierre Gérard (1994–9) RPR Business Head of company 0 Against
Denise Flouzat (1994–9) RPR University Economist (Asia focus) 2 Against
Michel Albert (1994–2002) RPR Business/bank/bureaucracy Bank 1 Against EMU/pro-strong
franc policy
Paul Marchelli (1995–2000) RPR White collar Unionism CGC 0 Against
Jean-René Bernard (1997–2005) RPR Ministry of Finance/business/ Vice-President bank 3 Against
banking
Pierre Guillen (1997–2005) RPR Industry Industry/CNPF 0 Against
Appointments since 1999

Name and date of appointment
Raymond Douyère (2000–9) PS Politics Head of Financial Committee 1
Michele Saint-Marc (2000–9) RPR Academia Trained monetary economist 4, but theoretical,
not practical
Jean-Pierre Landau (2006–) UDF Bureaucracy/cabinet International (IMF, EBRD) 2
Christian Noyer (2003–) RPR/UDF Treasury ECB Vice-President 5
Phillipe Auberger (2007–) RPR/UMP Politics Head of Financial Committee, 3
National Assembly
Monique Millot-Pernin (2007–) RPR/UMP Expert-Comptable Accountancy 0
Henri de Richemont (2009–) RPR/UMP Politics/Lawyer None 0
François Caluarin (2009–) RPR-UMP Business Company Head 0
*
This is an approximate, unscientific, figure based on a consideration of the members’ professional careers.
more pro-Maastricht. Nonetheless, they remain noteworthy for their highly

political character.
Political allegiance also likely determined the appointment of both Trichet
and Christian Noyer as governors (in 1993 and October 2003, respectively).
Both had previously served in ministerial cabinets in centre–Right govern-
ments. Trichet had been the head of Minister of Finance Edouard Balladur’s
cabinet (1986–8). Balladur was Prime Minister at the time of Trichet’s appoint-
ment. Noyer was a technical advisor to Balladur as Finance Minister and then
head of the cabinet of two centrist (UDF) ministers of finance in the 1990s,
Edmond Alphandéry and Jean Arthuis. There was some speculation in the
French press (Le Monde, 8 October 2003; 23 October 2003) that the two other
leading candidates for the post of governor in 2003 (Hervé Hannoun, the first
deputy governor and the candidate publicly endorsed by Trichet as his preferred
successor, and Jean-Pierre Jouyet, then Treasury director) lost out in large part
because of their proximity to the Left.
The two Bank governors of the post-independence era—Trichet and Chris-
tian Noyer (since 2003)—were former heads of the French Treasury (respect-
ively, in 1987–93 and 1993–5) with strong links to the Financial Inspectorate—
the financial administrative elite—although Noyer himself is not a member.
The result is the continuation of a long-standing tradition according to which
Bank legitimacy relies upon credible leadership and reputation for managerial
and policy making competence that can only be secured through a high-flying
career in the French Ministry of Finance. It is unlikely that this situation will
change for many years to come. Senior Bank of France officials whose careers
have been entirely within the Bank lack this legitimacy, the personal contacts of
top-level Ministry of Finance officials and a public profile. However, the strong
career links between the governors and the Treasury (Ministry of Finance)
should not indicate a lack of autonomous judgement. Direct experience in
central banking has not been prized as a criterion of a strong nominee for
governor. Moreover, Noyer’s appointment to the ECB’s Executive Board in
1998 was unusual, although acceptable according to the ECB statute given his
experience in the area of monetary policy. He was the only member of the ECB
Governing Council (then 18 members) with no prior direct professional or
academic experience in central banking.
The Bank as the Public Defender of Sound Money’ and Structural Reform
Prior to independence, Bank of France governors were known for their criticism
of government policy, especially during the Fourth Republic. However, most
refrained from commenting publicly on government policy-making. Following
independence, the Bank had to accommodate itself to a more active and public
role in promoting a ‘stability culture’ in France which is one of the clearest
expressions of increased bank power since 1994. Governor Trichet made several
117
thinly veiled attacks on the economic and monetary policy statements of

presidential candidates in 1994 and 1995 and regularly critiqued government
economic policy decisions which appeared to menace the pursuit of ‘sound
money’ policies, the move to EMU, and respect for the Stability and Growth
Pact (Aeschimann and Riché 1996; Milesi 1998). Trichet repeatedly criticized
the lack of sufficient structural reforms in France. He attacked the new Plural
Left’s brief freeze on deficit cutting (Le Monde, 25 June 1997), the 35-hour week
policy (Le Monde, 13 December 1997), and in 1999 its handling of the unex-
pected budget windfall: ‘How is it possible to have a windfall when we have
debts’ (cited in Patat 2003: 110, ft. 1, author’s translation). Indeed, in his final
public letter to President Chirac as Governor, Trichet urged the President to
push for lower public spending and undertake structural reforms (Financial
Times, 3 August 2003). In June 2004, in response to Sarkozy’s attack on the
ECB for targeting a very low inflation rate, the Bank of France published a
response by Governor Noyer defending the policy in several leading news-
papers (Le Monde, 13 June 2004). Noyer’s concern about rising French govern-
ment deficit and debt were expressed publicly on several occasions. Most
notably, the Bank joined forces with Insée (the national institute for statistics
and economic studies) and the national court of auditors (the Cour des comptes)
to produce a succession of reports in June 2004 to express dismay at the state of
public finances and to insist on the need for ongoing structural reform. The
personal style of the Governor is likely to be of some significance in determining
the public profile of the Bank of France. Since his appointment in 2003, Christian
Noyer has intervened much less in the national debate on government spending
and economic policy than his predecessor.6
The Bank attempted to respond to government attacks on its monetary policy
by appealing directly to the French public. A 1998 poll by Sofres (27–29 May),
undertaken on behalf of the Bank of France and published in the Le Monde
newspaper, showed that 58 per cent of French people approved of the strong
franc (or stable franc) policy, a result that nearly matched the results of a June
1996 poll (56%) which was also published with the 1998 results (Le Monde, 2
July 1998). Moreover, four years after independence, 74 per cent of those polled
had a positive impression of the Bank (5% ‘very much’ and 69% ‘rather posi-
tive’), which is an accomplishment for an institution that was rarely in the
public eye prior to 1994. The relatively strong economic growth of 1998 no
doubt helped boost these support figures. Only 15 per cent had a negative
opinion (12 ‘rather negative’ and only 3 ‘very negative’) with 11 per cent
‘without opinion’. On the strong/stable franc policy, only 15 per cent were
opposed to the policy and 27 per cent did not have any opinion. French public
opinion was thus supportive (or at least tolerant) of the need to maintain low
inflation. Trichet, as Governor and then as ECB president, used these polls on
several occasions to defend ECB policies within France. The polls also suggest that
French public opinion has been at odds with the French political class.
118
Ongoing Debate on the Bank’s Powers
The Bank of France holds all the responsibilities typical of national central
banks in addition to several less typical or atypical roles. Since 1999, the Bank
ensures the smooth operation of the payments system and the security of
financial transactions; monitors the security of the banking system and the
stability of the financial markets; conducts bank inspections; runs the commit-
tee responsible for granting licenses to new credit institutions and allowing
bank mergers; contributes to the drafting of regulations on credit institutions;
collects and analyses French monetary, financial, and economic data, including
balance of payments data; produces three annual growth and inflation fore-
casts; manages French exchange reserves, including gold; and provides banking
services to individual clients. Independence and EMU have had only marginal
impact on these core responsibilities of the Bank. The services of the Bank—
notably the Macroeconomic Studies directorate—provide the Governor with
quality expert advice on the state of the national and international economy
and price developments. Since 1999, they do so to enable him to make compe-
tent recommendations on Euro Area monetary policy. The Bank also has a
range of atypical roles, two of which it has developed or been assigned since
1999. It provides—uniquely in the Eurosystem—a port of entry to non-EU
banks that want to set up euro-accounts; and it provides advice on personal
debt management.
Prudential Supervision
The Bank of France has long been the centre of intelligence in the French state
on the national banking sector and the financial markets. Prior to 1994, the
Treasury’s control over prudential supervision—via the Banking Commission
chaired by the Governor of the Bank of France but under the ‘tutelle’ or control
of the Treasury—rested on expertise within the Bank. The latter provided most
of the salaried staff to the Banking Commission on temporary secondment
(approximately 400 officials at any time) and most of the detailed information
about the banking sector by carrying out operational supervision. In 1994, the
autonomy of the Banking Commission from the government was established
in law, while the Treasury’s influence was retained through a single vote on the
Banking Commission’s governing board of seven members (five of which are
nominated by the Minister of Finance). In terms of the day-to-day operation of
banking supervision, little changed because of Bank of France independence.
However, the elimination of the Treasury’s ‘tutelle’ ensured the reinforcement of
the Governor’s leadership position as Commission president with a deciding vote.
This leadership role has been seen in dealing with major problems in the
French banking sector, as in the difficulties at Société Général of unprecedented
losses caused by a single trader. In January 2008, the head of the bank, Daniel
119
Bouton, met with Christian Noyer who, in effect, chaired a secret crisis com-
mittee that also included the head of the Financial Market Authority (Gérard
Rameix) to decide how to deal with the massive fraud in the bank and when to
make the information public. For a period of five days (19–23 January), in his
capacity as President of the Banking Commission and Governor, Noyer dis-
cussed the difficulties with Bouton and Rameix without informing the govern-
ment (let alone other members of the Banking Commission). Despite the Bank’s
long-standing role in prudential supervision, prior to independence the Governor
never played such a central role in the management of a major banking crisis.
Some (Cour des Comptes 1996) see the continued influence of the Ministry of
Finance, via the selection of five Banking Commission board members and the
voting position of the Treasury representative, as unacceptable. Other observers
would prefer the elimination of the Commission altogether and the transfer of
prudential supervision (indeed, all responsibility for monitoring the financial
markets) to the central bank, as in the Netherlands and Belgium. France is one
of the few countries in the world with shared control over prudential supervi-
sion that involves several public bodies, including the Ministry of Finance. The
French Court of Auditors (Cour des Comptes) (1996 and 2005) and the National
Assembly’s and Senate’s Finance Committees (Auberger 1996) have called for
the full transfer of prudential supervision to the Bank of France as one possible
preferred option.
However, transfer to the Bank of France is not the only recommended option.
Both the Cour des Comptes (1996) and the National Assembly’s Finance Com-
mittee (Auberger 1996; Le Monde, 29 June 1996) called for increased autonomy
and capacity for the Banking Commission: the removal of the Treasury repre-
sentative; the diversification of the recruitment of the Commission’s staff (thus
decreasing the reliance on the Bank of France); the increased representation in
the Commission’s decision-making body of members with direct experience in
the banking or business sectors (since 1993, only two of the seven members of
the Commission necessarily have expertise in the banking and financial sector);
the reinforcement of the collegial body in relation to the Commission’s Secre-
tariat (dominated by the Bank of France officials) so that the collegial body can
gain greater direct control over the process of banking supervision; and the
assignment of legal personality to the Commission so that it can pursue bank-
ing supervision cases in the courts if necessary.
Thus, the future reform of prudential supervision in France will not neces-
sarily result in a reinforced role for the Bank. An option closer to the British
and German models of an autonomous agency might be preferred. Nonethe-
less, the National Assembly’s Finance Committee (1996) also accepted the
logic of maintaining a strong link between the central bank and the Banking
Commission: ‘The role of the Bank in adjusting the liquidity of the entire
banking system imposes on the Bank a surveillance role of the liquidity of
financial institutions. There is thus a certain logic in assigning Bank of France
120
officials the job of prudential control of banks’ (Auberger 1996, author’s

translation). Banking supervision officials within the Bank (interviews 28
January 2008) insist that the present organization of supervision works well
and that full transfer to the Bank is not necessary. Rather, a clarification of
certain rules of intervention (as with the difficulties in the Socie´té Générale)
would be helpful. Another option is the transfer of prudential supervision to
the ECB or, at least the transfer of supervision over financial institutions with
a strong presence in other EU member state markets. Senior officials in the
Bank of France were opposed to this transfer as unnecessary. However, the
unofficial position in the bank has shifted and there is growing support for
the transfer of some responsibility for prudential supervision to the ECB
(interviews 28 January 2008).
Other Roles
Since 1984, the Bank of France Governor has held the presidency of the CECEI
(Comité des établissements de crédit et des entreprises d’investissement), the body in
charge of granting individual licenses and authorizations to credit institutions
and investment firms and responsible for approving banking mergers, and 1 of
12 votes on the Committee (another is held by the Treasury Director). Since the
CECEI’s creation in 1984, the Bank has been one of its principal sources of
information and advice, in addition to the Financial Markets Authority (Autorité
des Marchés Financiers), the French stock market regulator. Moreover, since 1984
the Bank has been in charge of the CECEI’s Secretariat. As such it prepares the
examination of applications submitted to the Committee. Independence has
not had any significant impact on the role of the Bank in this body.
Since 1994, the Bank has also had full responsibility over surveillance of the
security of the payment systems, a responsibility possessed prior to 1994 under
the ‘tutelle’ of the Minister of Finance. From 2001, the Governor gained control
over the presidency of the newly established Observatoire des cartes de paiement.
The Bank’s legitimacy in these areas—banking supervision, financial sector
supervision, payments systems, and credit cards—rests upon its unrivalled
monetary, financial and economic data, and well-established capacity for an-
alysis. It also exercises a range of functions that in other EU member states are
either conducted by the state or left to the private sector. The Bank manages the
circulation of fiduciary money, provides a service to analyse local economic
development, and is engaged in personal debt management for individuals
faced with excessive debt. This unwanted responsibility for personal debt man-
agement—‘surendettement’—was imposed on the Bank in 2006 by the govern-
ment, which pays the bank for the service. Personal debt management became
the central role of 1,300 bank staff members—approximately 10 per cent of the
total—and several of the regional branches that were not closed in the ‘down-
sizing’ from 2003 to 2006, which also explains why staff and branch cuts during
121
this period were not as large as initially intended. This new social role consists
of helping those who are refused bank accounts/credit to sort out their financial
affairs. The relatively large number of responsibilities assigned to the Bank of
France—and ‘surendettement’ in particular—has attracted criticism from the
Cour des Comptes (2005) which has called for the Bank to be allowed to concen-
trate on its core tasks.
Down-Sizing at the Bank of France
Prior to 2004, the Bank was not a model of cost-effective public-sector manage-
ment, which weakened the strength of its calls for structural reform and public-
sector staff cuts. The Bank has long suffered from a problem of over-employment
and very generous social provisions for its staff including a special pension
regime. Prior to independence, the Bank engaged in hesitant cuts, watered
down in the face of determined union action and the opposition of local
politicians, who baulked at staff cuts in regional branches or their closure. Bitter
and lengthy strikes were sparked by reform attempts in 1974 and again in 1987,
which led to the resignation of one of the deputy governors. The weakness of
New Public Management ideas in the French administration also helps to ex-
plain the failure to adopt efficiency enhancing reforms—such as the outsourcing
of certain technical functions as in Sweden—which could have also achieved
staff cuts. In 2003, the total staff (included seconded staff) reached 15,755.
Independence and the transfer of monetary policy in 1999 exposed Bank inef-
ficiency to greater public and government criticism. This criticism intensified
when, in 2002 and 2003, the Bank ran deficits. In February 2003, a Bank of
France report called for the closure of three-quarters of its regional branches (166
out of 211), over a period of three years, with 3,200 job cuts (out of 9,000 in the
branches), amounting to nearly one-third of the Bank’s annual budget. A second
report called for the elimination of services for individual clients.
Cuts have been significant but were less ambitious than those initially called
for by the Bank’s own management and other government sources: from 2003 to
end-2006, 2,200 jobs were cut leaving 13,500 staff and 120 branches were closed
(less than the three-quarters called for) leaving 91 branches. The dilution of cuts
allowed the Bank to avert major strikes. Firings were avoided with early retire-
ment packages, which transferred costs onto pension provision. However, the
Bank achieved an operational profit in 2006 for the first time in many years.
Sixteen of the remaining 91 branches were transformed into ‘local economic
observatories’, debt management centres, or money sorting centres. In Decem-
ber 2005, after 18 months of difficult negotiations, the Bank achieved a major
reform to its special pension plan. Further cuts are likely. In its 2005 report, the
Cour des Comptes recommends the closure of additional branches and insists that
the Bank remains over-staffed and suffers from a particularly high unit labour
122
cost in relation to other comparable administrations and from excessively gen-

erous social policies. While it is difficult to present the Bank of France as a model
of public-sector reform, some observers, notably trade-union officials represent-
ing Bank staff, have pointed to the Bank’s strong financial position since 2005—
due to cuts, the strength of its investments, and the sale of gold—to argue that
the internal reform was excessively brutal, stretching the staff available for some
Bank services—notably debt management (Le Monde, 19 January 2006).
The Cour des comptes (2005) and the Finance Committee of the National
Assembly also criticized the continued existence of the Conseil de la Poli-
tique Monétaire, a body without an obvious role following the transfer of
monetary policy to the ECB at the start of 1999 and the independence of the
Bank Governor in determining his stance on ECB monetary policy. Respond-
ing to these criticisms, in 2002 the government reduced the number of
external members to four and then, in 2005, to two. In 2007, the de Villepin
Government adopted a law transforming the CPM into the Comité Monétaire
(Monetary Committee) consisting of seven members (Governor, two dep-
uties, and four independent ‘experts’, nominated by the presidents of the
National Assembly and Senate). The independent ‘experts’ are paid only
expenses, and their advisory role is emphasized. The ‘experts’ can also hold
other posts (although not in parliament and government), whereas the
external members of the CPM could not. The Monetary Committee has
continued to attract criticism as an unnecessary body. Officially, it is respon-
sible for examining monetary developments, analysing the implications of
Eurosystem monetary policy and adopting necessary measures to transpose
ECB decisions into the Bank of France. In 2008, Senator Jean Arthuis, the
former financial minister, unsuccessfully sought an amendment to the Eco-
nomic Modernisation Law, with the explicit aim of eliminating the Monetary
Committee. The negligible relevant specialist knowledge of the external
members of the Committee remains a problem; only one of the current four
external members has any prior professional experience linked to monetary
policy. The members are also part of Bank’s General Council and thus perform a
more general managerial role. The public and media presence of the Monetary
Committee members is also very limited—a noteworthy difference from the
members of the Bundesbank’s Executive Board, not to mention the Bank of
England’s Monetary Policy Committee.7
The Failure to Develop the Bank’s Research Capacity
The Bank of France has long possessed a strong capacity for data collection and
analysis, which Bank officials argue is unrivalled by other Eurosystem central
banks. Through its regional offices, the Bank collects detailed monetary,
financial, and economic data and information on French companies that is
123
unavailable to other French and international institutions, and thus has an

unrivalled understanding of price developments in France. This data is analysed
within the well-staffed and resourced Macroeconomic Studies Directorate of the
Bank to produce a detailed monthly update on the state of the French economy.
The Bank’s capacity to produce growth and inflation forecasts distinguish it from
many of its peers, which as in Italy and the UK, rely on Ministry of Finance
forecasts. The Macroeconomic Studies Directorate also includes staff who analyse
international economic trends. Interlocutors at the Bank claim that the credibil-
ity of their Governor’s discourse in ECB Governing Council meetings on the
impact of international economic developments and the development of prices
depends on this analytical capacity and gives the Governor more influence in
relation to his peers. There are, however, obvious chinks in the mail of the Bank’s
analytical armour, as demonstrated by the lead role assumed by the Bundesbank
and Banca d’Italia in developing and managing the shared computer platform
for TARGET 2—which suggests their superior expertise.
In November 2007, for the first time, the Bank published its own updated
growth forecast for the year (2007), which in effect updated and corrected the
government’s own forecast. Bank staff see this development as a small but
significant assertion of the Bank’s independence (interviews 28 January 2008;
30 January 2008). In early 2008, the Bank published for the first time its own
growth forecast for the year ahead (the Bundesbank began the same practice for
Germany in late 2007). Bank of France staff argue that different analyses by the
Ministry of Finance and the Bank of France, based on their individual models,
result in different forecasts and mutual and productive criticism. The publica-
tion of Bank of France figures also serves as a useful counterpoint to politically
manipulated government figures. The government, relying on Ministry of
Finance analysis of data collected by the national statistical agency, INSEE,
publishes the more optimistic upper range economic growth figures, whereas
the Bank of France publishes a ‘forchette’ of upper and lower forecasted rates.
Given the Bank’s monthly economic studies, it is also in a better position to
provide accurate forecast updates than the government.
In juxtaposition to its capacity to conduct statistical and macroeconomic
analysis, the Bank is very weak in academic research output, which in turn
weakens the intellectual power of the Bank in the ‘competition of ideas’ in the
Eurosystem and its weight in discussions on growth and inflation forecast
models. Although a research division was first created in the bank in 1909,
there is little tradition of academically oriented research at the Bank. According
to one leading historian of the Bank (Olivier Frietag, interview 28 January 2008),
the Bank’s hierarchy has had little respect for academically oriented research. No
top official in the Bank has a background in advanced economic research. Many
are graduates of the elite Ecole Polytechnique: they possess a strong ana-
lytical capacity that is not, however, academically and theoretically oriented.
Bank careers are developed through practical training in a diverse range of the
124
Bank’s activities. With more open recruitment and career progression proced-
ures in place, this situation may change with time. There have been no powerful
directors of research, who might have been able to attract increased resources.
Moreover, the governors, drawn from the Ministry of Finance, possess little
academic training and thus limited appreciation of the importance of academic
economic research. Governor Noyer, with his experience of top-quality research
at the ECB, might be different in this regard, but his appointment did not result
in any significant increase in research capacity at the Bank. The small number of
Bank staff members with PhDs is in marked contrast to the central banks in
many other countries. Several Bank officials also commented on the historic
weakness of economic research in France—and notably the weakness of market-
oriented research—and the tendency for some of the country’s best academic
economists to seek training and employment in the United States.
Those working in the Research Directorate of the Bank claim (interviews 28,
30, 31 January 2008) that, following independence, the Bank directors recog-
nized that the lack of research output damaged the credibility of the Bank as an
independent policy making authority and its influence within the Eurosystem.
They deliberately set about to increase the output of research publications that
could be accessed outside the Bank. However, the officials interviewed also
note that the desire to gain a reputation for the production of academically
excellent research has not been supported by a willingness to provide increased
financial resources. The financial difficulties of the early 2000s and the power
of trade unions that have made the reallocation of resources from the branches
to the centre difficult provide additional explanations for this failure. The more
academically oriented output of the Bank is limited; the number of peer-
reviewed academic journal articles published by Bank staff remains very low
in comparison to central banks in the other large EU member states. The
reputation of the Bank’s research in international banking and academic circles
is very weak. It has few research staff: in 2008 only approximately 17 full-time
researchers work in the Bank’s Research Directorate and publish work in aca-
demic journals. The Bank organizes relatively few conferences, although the
number has increased since 2000 and four were held in 2007 and 12 in 2008. It
is not yet seen as an important centre of debate, discussion on macroeconom-
ics and monetary economics. There is some concern for this weakness in
French political circles. A French Senate report (May 2001) criticized the con-
tribution of the Bank to economic research.
The Bank has undertaken a partial response with a small increase in the
number of research staff, although repeated requests from the head of the
Research Directorate for more researchers have been rebuffed. Increased efforts
have been made to develop links with academic institutions notably through
the co-hosting and co-funding of conferences. In early 2008 the Bank was in the
process of finalizing a link with an internationally renowned research centre on
firms at the University of Toulouse, through which the Bank will finance and be
125
associated with top-level academic research—albeit research that is not con-

nected to monetary policy. In 1995, the Bank of France created a research
foundation which provides funding for visiting scholars researching on mone-
tary, financial and banking economics and conferences. The funding, however,
has been limited to date. Since 1997, the Foundation has allocated just over one
million euros to 48 research projects (to 2008) undertaken by academics from
universities based in a number of countries.
All the interlocutors at the Bank accepted that their employer suffers from a
weak presence in both national and international discussions and debates on
economic developments, despite the occasional interventions of the Governor.
Since 1994, the Bank has made some efforts to improve its public profile with
new publications, targeted principally at financial journalists and economists
working in central banks and the financial sector. The Bank began a working
paper series in 1994 (Notes d’ Étude et de Recherche, NER) published in French and
English, with Bank staff writing in a personal capacity but subject to quality
validation by other qualified Bank staff. Only one paper was published in 1994
and none in 1995, but the number has increased considerably since then, with
23 published in 2006 and 30 in 2007. By April 2008, 203 working papers had
been published. The working papers are written by the full-time researchers but,
more often, by officials who engage in applied research for the Bank (forecast-
ing, macroeconomic, balance of payments, and statistical analysis) in the
Macroeconomic Studies Directorate. From 2002, annually or biannually, the
Bank publishes a Revue de la Stabilité Financière, with papers by Bank staff, other
French and foreign public- and private-sector officials and leading academic
economists, writing on major financial and monetary issues for a non-academic
audience, principally finance sector professionals. For example, the April 2007
issue focused on the impact of hedge funds on financial stability and included
articles by top central bank officials (from the Federal Reserve Board, ECB
Executive Board, and national central banks), leading economists from the
London School of Economics and University of Chicago, and major private-
sector financial companies.
The present first deputy governor, Jean-Pierre Landau, with experience in the
European Bank for Reconstruction and Development (EBRD) and inspired by
Bank of England practice, has been a key advocate of improving the commu-
nication strategy of the Bank. In 2006, he launched what the Bank labelled its
‘publicly oriented’ economic debate series: ‘Debats Economiques’ Occasional
Papers series (five to date). In 2007, the Bank also launched ‘Documents et
débats’ (only one to date on whether the euro was inflationist) to address
major economic issues in a ‘simple but serious manner’ but also ensure acces-
sibility to a wider audience (interview 28 January 2008). No other editions are in
the pipeline, however, because of Bank sensitivities about covering controver-
sial topics (interviews 30, 31 January 2008). The head of publications at
the Bank (interview 30 January 2008) believes that not enough is done to
126
disseminate the impressive data that it collects, for example on national

companies. Other efforts have been made to increase the public presence of
bank officials in national economic debates. Deputy Governor Landau served
on the Attali Commission, examining reforms to stimulate French economic
growth. The head of the Macroeconomic Studies Directorate, Gilbert Sette, is a
serving member of the Prime Minister’s Council for Economic Analysis.
Conclusions: Europeanization, Power, and Convergence
The operations of the Bank of France have been shaped by Europeanization

since the 1970s. The strong franc policy of the 1980s and 1990s, the increased
importance of interest-rate policy and currency management, owed a great deal
to the influence of the German preference for ‘sound money’ and the low
inflation bias of the EMS and the EMU project. Intensified international finan-
cial pressures through increased capital flows and the rising exposure of the
French economy to non-EU investment further increased the importance of
interest rate and currency management. Thus, both Europeanization and inter-
national pressures encouraged convergence to the German standard and
increased the power of Bank of France in relation to the Treasury prior to
independence. The EMU project was the catalyst for independence which in
turn enhanced the role and power of the Bank of France governor in a range
of bank activities—notably in his chairmanship and voting role on banking
supervision and financial sector accreditation and competition—and in
national and EU-wide public debate on economic policy and structural reform.
Europeanization brought about convergence in the monetary policy strategy of
the Bank of France, which—emulating the Bundesbank—in 1994 adopted a two
pillar monetary policy targeting inflation and M3 (rather than the M2 targeted
previously). EMU has allowed the Bank to engage in some specialized oper-
ations. Notably, it provides, uniquely in the Eurosystem, a port of entry to non-
EU banks that want to set up euro-accounts. However, apart from the obvious
transfer of monetary policy to the ECB, Europeanization since 1994 has had
only limited impact on the core operations of the bank.
As the pre-EMU Bank of France lacked the policy making, research, and public
role possessed by the Bundesbank and the Banca d’Italia, EMU did not result in
the diminished power and status that the German and Italian central banks
have suffered in the domestic context because of the transfer of monetary
power and research capacity to the ECB. Prior to 1994, the Bank of France
sought to influence monetary policy decisions decided upon by the Treasury.
However, the power of both French institutions were constrained by the need
to follow monetary policy set by the Bundesbank. Attempts by the French
government in 1993 to challenge the anchor role of the Deutschmark in the
ERM failed (Howarth 2001). Since 1999, the Bank of France Governor is free of
127
both Treasury control and Bundesbank diktat. France has lost monetary auton-
omy but the Bank of France has gained an important autonomous voice in
setting Eurosystem monetary policy.
Independence transformed the Bank of France into an autonomous public
actor able to express views on—and often indirect criticism of—government
policy. The Bank has made some—albeit limited—effort to increase its publi-
cation output. The Bank’s publication of its own growth forecasts—undertaken
by few EU NCBs—can be seen as an expression of its independence. Yet the
Bank’s public role has been limited since 1999, which is surprising given its
independence, the diversity of its roles, and its relative size—it employs more
people than any other EU NCB. All officials interviewed at the Bank agree that
the independent Bank of France, as a non-majoritarian institution, should be
cautious in its public role and in its dealings with government and, while
recommending reform, should refrain from direct criticism of government
policy. Since 1999, Europeanization has allowed the Bank to side-step much
of the persistent politicization of monetary policy and central banking in
French politics: French politicians direct most of their antagonism at the
ECB. However, French governments have continued to express frustration
with activities of the Bank of France when they contradict government prefer-
ences—as with the handling of the difficulties at the Société Générale. Based on
its 1996 and 1998 opinion polls, the Bank appears to have achieved a measure
of public support for its operations, at least in monetary policy. However, these
polls are now dated, and the Bank has not revealed if it has undertaken more
recent soundings of public opinion on its operations since the transfer of
monetary policy in 1999.
There has been a limited degree of convergence with the operations found
in other Eurosystem central banks. With independence and the loss of mon-
etary policy making powers, the Bank of France has faced intensified pressure
to downsize and staff cuts have been significant. However, typical of French
public administration, the Bank of France has long suffered from overstaffing,
inefficiencies, and failed reform efforts due to a strong trade union presence.
When staff cuts came they were diluted and far less severe than those faced by
the Bundesbank. The Bank maintains the largest staff of the EU central banks
and the greatest diversity of roles. The Bank’s currently (to 2009) stable
financial situation enables it to resist pressure from the government and the
Cour des Comptes to downsize further in the near future, unless the Bank
manages to shed unwanted tasks, notably ‘surendettement’. On the core oper-
ations of the Bank, Europeanization has had a limited effect of convergence.
Unlike the Banca d’Italia which has shed its atypical roles, the Bank of France
continues to perform a range of functions not held by most other EU central
banks and has gained some responsibilities since 1994—for example on ‘sur-
endettement’. There is some pressure from elements within the French admin-
istration to reform banking supervision to move to either an autonomous
128
regulatory body as in the UK and more recently Germany or the full transfer of
supervisory powers to the central bank as in Dutch/Belgian model. However, the
sui generis French system of banking supervision is likely to persist for some time
given that it has already survived over a decade and a half of high-profile bank
failures and the Treasury is reluctant to surrender its role. The failure of the Bank
of France to reinforce its research capacity is particularly surprising given the
relevance of research to national central bank influence in the Eurosystem. Some
Bank of France officials suggest (interviews 28 January 2008; 30 January 2008)
that the impressive data collection and analysis and the relative importance of
the French economy in the Euro Area ensures the Bank sufficient influence.
Notes
1. Law no. 93-980, 4 August 1993. LOI no. 93-980 du 4 août 1993 relative au statut de la
Banque de France et à l’activité et au contrôle des établissements de crédit.
2. Prior to independence, Governors had no guarantee of longevity and no fixed mandate
of sufficient length to protect their independence. Nonetheless, Bank Governors gen-
erally occupied their post for long periods: seven years for Jacques de Larosiere (1987–
93) and six years for Renaud de la Genière (1978–84). Even so, politics intervened
regularly. The Socialists removed De la Genière, and Olivier Wormser had only a short
mandate.
3. ‘Sarkozy wants ‘‘protective EU’’ to offset globalisation’, Euroactiv.com, Friday, 23 February
2007, updated Wednesday 28 February 2007, http://www.euractiv.com/en/elections/
sarkozy-wants-protective-eu-offset-globalisation/article-161948, accessed on 10 March
2007.
4. The Socialist candidate appears not to have noticed that the ECB already has this as a
secondary goal.
5. The precise wording that the Socialist 2007 presidential candidate used was ‘soumise à
des décisions politiques’ (Le Monde, 22 December 2006).
6. Bank officials interviewed and journalists have put this down to Noyer’s personality,
described as lacking the charisma of Trichet, timid, secretive, and averse to risk (Le
Monde, 23 October 2003). Difficult internal reform at the Bank—of which Noyer had to
take charge immediately following his appointment—might have encouraged him to
engage in a less public role. Indeed, Trichet, as ECB president, has been more actively
engaged in French public debate, appearing several times on high-profile French
television and radio talk shows to deflect blame for French economic difficulties
from the ECB’s monetary policies and the strong euro and to call for further domestic
structural reform.
7. In a rare exception to this absence from the media, the four external members of the
Monetary Committee published a short newspaper article (written collectively) on
possibilities open to France and the Bank of France to respond at the national level
to the financial crisis (‘Solutions à la crise: commençons en France’, Le Monde, 21
March 2008). One looks in vain for biographical information on the Bank of France’s
website for information about these four officials which suggests their negligible role.
129
6
German Bundesbank: Europeanization
and the Paradoxes of Power
Kenneth Dyson
The creation of the Eurosystem in 1998–9 represented a critical juncture in the

history of the German Bundesbank, of a kind not experienced by any other
national central bank. Under German law it retained some independent inter-
national and national responsibilities. The Bundesbank acted as banker for the
German government, participated in banking supervision, managed Ger-
many’s foreign exchange reserves, decided on gold sales, and represented
Germany in the International Monetary Fund. However, with the disappear-
ance of the D-Mark and the loss of its monetary policy-making responsibility
to the ECB, the Bundesbank had irrevocably ceded power and status. It lost its
international status as the second most important central bank in the world
and its premier central banking status in Europe through management of
the anchor currency of the Exchange-Rate Mechanism (ERM), the so-called
‘D-Mark Zone’ (Apel 2003; Heipertz 2001; Loedel 1999a). In a complex
reshuffling of power the Bundesbank lost relative power over other actors in
European monetary policy making, whilst—paradoxically—the ECB repre-
sented a unique extension of its structural power over the terms of debate
through institutionalization of the ECB on the basis of Bundesbank ideas
and practices. The Bundesbank could claim to be the model on which the
ECB had been designed (Dyson and Featherstone 1999; Heisenberg 1999;
Kaltenthaler 1998).
Domestically, the Bundesbank could no longer be characterized as the
‘fourth branch of government’ (Kennedy 1991: 3) or a ‘state within the state’
(Berger and De Haan 1999). Its symbolic importance as the embodiment of
post-war German economic success in delivering a ‘hard’ currency, around
which Germans could retrieve lost pride, and its model character as a European
central bank in securing price stability seemed destined to be consigned
to historical memory and nostalgia. In becoming an integral part of the
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German Bundesbank: Europeanization and the Paradoxes of Power
Eurosystem and ceding its core responsibility for monetary policy making to
the ECB, the Bundesbank faced difficulties in claiming to be primus inter pares
amongst NCBs, let alone ‘the bank that rules Europe’ (Marsh 1992). Its presi-
dent has only one voice and vote amongst 21 in the Governing Council of the
ECB, and its core role in the Eurosystem was defined as ‘partnership’ (Deutsche
Bundesbank 2004).
The Bundesbank’s claim to a Vorreiterrolle in the Eurosystem had to rest on
more than just its unique role in the history of European monetary unifica-
tion, the relative size of the German economy (accounting for over 40% of the
total euro cash in circulation), its weight as the biggest subscriber to the capital
of the ECB, and its past superior experience and reputation in managing
stability-oriented monetary policies and securing a ‘stability culture’. More
challengingly, to be a convincing model, the Bundesbank had to invest and
renew its remaining functions with high-quality research in order to establish
a reputation for top-quality expertise in the new competition of ideas within
the Eurosystem (Remsperger 2002, 2004; Weber 2006a). It focused on refine-
ments to the ECB monetary policy strategy (notably its ‘monetary’ pillar,
which had been relegated to second pillar status in 2003) and to analysis of
risks in financial stability. In addition, the Bundesbank concentrated on
excelling in the more ‘nuts-and-bolt’ areas of modernizing cash management,
developing and managing platforms for new pan-European payment and
settlement systems (TARGET2 in particular), and banking supervision (notably
in negotiating and applying Basle II). This challenge derived not just from a
more competitive environment of policy ideas but also from the past reliance
of the Bundesbank on its monetary policy performance rather than the quality
of its analytical economic modelling, compared for instance to the Banca
d’Italia. Its traditional advocacy of a principles-based approach exposed it
to critiques of a lack of analytical capacity. In this respect, Axel Weber’s
appointment as president was important.
The Bundesbank could draw on its strengths in representation of Germany’s
economic and financial size and its sense of a special vocation to safeguard the
Bundesbank legacy of stability to the Euro Area and to promote a long-term
culture in financial markets. However, in its new core functional areas, and
constraining its development of quality research, it could lay claim to neither
the glamour and the gravitational attraction nor the autonomy of action that it
had earlier enjoyed in its monetary policy-making function. It faced a new
difficult challenge of credibility building across a range of functions to which it
had earlier accorded a relatively low strategic profile. In meeting this challenge
the Bundesbank’s room for manoeuvre was tightly constrained by a more assert-
ive Federal Finance Ministry and by an ambitious ECB Executive Board. Its flank
was exposed to German political claims, especially from Social Democratic
Federal Finance Ministers, that central bank independence was a less relevant
principle outside monetary policy making, for instance, in banking supervision.
132
This radical change to its functions, and to the structure of opportunities and
constraints within which it operated, exposed the Bundesbank to new, continu-
ing public questioning and need to justify its existence. Along with internal
reforms and downsizing (between 1991 and 2007 from 16,500 to 11,160 staff
and from 202 to 47 branches), it produced profound, disquieting effects on
institutional self-confidence and morale and heightened internal conflicts. The
Bundesbank experienced a period of defensiveness, introversion, and identity
crisis that further threatened its capacity to rebuild credibility and to project a
strong shaping presence in the Eurosystem. The ECB could offer higher salaries
and more challenging posts to attract the young stars of central banking, on the
Bundesbank’s doorstep in Frankfurt; whilst the Bundesbank had to make big
staffing cuts and in 2006 lost the inducement of special salary bonuses.
The Bundesbank’s problems came to a head under the presidency of Ernst
Welteke (1999–2004) when internal dissensions over structural reform, and
also over use of its gold reserves, along with setbacks to its ambitions to
develop its role in banking supervision and financial stability, distracted and
weakened the institution within the Eurosystem. The resignation of Welteke
proved a cathartic experience, after which Axel Weber sought to develop a
sharper profile by consolidating the bank around himself in a more centraliz-
ing style than ever before and by pursuing a new image of the central bank as a
leader in public-sector modernization. However, the age of powerful Bundes-
bank presidents like Otmar Emminger (1977–80) and Hans Tietmeyer (1993–8)
was ended. Centralizing Bundesbank internal reforms to support the new
personal responsibility of the president in ECB monetary policy and to exped-
ite internal managerial reforms failed to halt the decline in Bundesbank profile
or to restore team spirit.
The Bundesbank’s central problem in redefining a new identity was how to
adjust to a major reconfiguration of its power relationships at international, EU,
and domestic levels. EMU was just a part of this reconfiguration but one that
accelerated adjustment pressures. The following five developments coincided:
. A marked increase in the rate of innovation, in complexity and in opacity
in global financial markets. Market developments included the growth in
derivative contracts and options, the use of new investment vehicles by
banks to offload risk finance, and the emergence of hedge funds and private
equity companies as major non-bank players in creating liquidity. These
developments confronted the Bundesbank with mounting pressures to be
less cautious in its attitudes to financial market liberalization, with new
challenges in controlling money supply growth and in monetary analysis,
and with new systemic risks to financial stability. This context made the
Bundesbank keen to protect the traditional German three-pillar financial
system of commercial, cooperative, and public savings banks. It sought to
frame financial market liberalization as promoting consolidation within
133
each pillar (welcoming the Commerzbank take over of the Dresdner Bank
and Deutsche bank of the Postbank); whilst ensuring that retention of the
‘narrow’ bank concept in the latter two pillars would help retain a strong
element of long-term culture in German financial markets that would
support a high savings rate.
. The impact of IT and new public management ideas on the provision of
central banking services, notably in on-line banking, electronic payment
systems, and internal performance-related practices. The Bundesbank was
forced to reconsider its essential core functions, which functions could be
in whole or part outsourced to the private sector, notably in cash man-
agement, and above all staff cuts and less hierarchical working.
. The loss of its role as the ‘bank that rules Europe’ in monetary policy
making (Marsh 1992) to the ECB and the ECB directorate’s ambition to
centralize functions like banking supervision and payment systems. The
Bundesbank had to review its central functions once deprived of the
central operational rationale for its intellectual leadership role in Euro-
pean central banking.
. The loss of its international profile in G7, the IMF, and the BIS. The
Bundesbank had to strengthen its international bargaining power by
working harder to secure EU-wide coordination, for instance, over IMF
reform or over Basle negotiations on reform of banking supervision. Its
intra-European networking skills and coalition building assumed an even
greater importance.
. The release of the German federal government—and the Federal Finance
Ministry in particular—from the policy constraint of a strategy of needing
to ‘bind in’ the Bundesbank to its European economic and financial policies,
once EMU was achieved. Especially on the political Left, which came to
power in 1998, German politicians who had resented Bundesbank domestic
power were ready to exploit its loss of domestic political leverage. With the
first centre–Left federal coalition government in post-war history, the Bun-
desbank faced new ideological challenge. In 1998–9 the Bundesbank
was confronted with the combative Social Democratic (SPD) party chair
Oskar Lafontaine as new Federal Finance Minister and as advocate of neo-
Keynesian ideas. Although more supportive, Hans Eichel (1999–2005) and
Peer Steinbrück (2005–) placed the Bundesbank under new political pressure
with reform of the Stability and Growth Pact, reforms of domestic banking
supervision, pressures for gold sales in 2002–3, and even cuts and removal of
special salary bonuses. From 1998 the Bundesbank faced the combination of
varyingly suspicious SPD finance ministers with the challenges listed above.
In terms of visible power relationships the winners were global financial
players, the ECB, and the German Finance Ministry. To add to its domestic
134
difficulties, the 2002 Bundesbank reform weakened the Bundesbank’s strong

political roots in the German federal structure. Its once powerful domestic
political constituency was, in consequence, eroded on two fronts, federal and
Land. It lost powerful monetary policy instruments and domestic political
stature as a core player in the German ‘semi-sovereign’ state (Katzenstein
1987). In consequence, the post-euro Bundesbank is the story of an institution
whose capacity to shape its operating environment—to play domestic ‘semi-
sovereignty games’—has been eroded. It no longer possesses its former
capacity to prevail in domestic conflicts (cf. Berger and De Haan 1999;
Duckenfield 1999b; Heipertz 2001).
Europeanization and Power
EMU had paradoxical effects on Bundesbank power. On the one hand, EMU
collectively empowered central bankers at the EU level to safeguard economic
stability on the basis of an Ordo-liberal paradigm of stability-oriented policies
inspired by the Bundesbank (and of an institutional design close to that of its
more decentralized predecessor, the Bank deutscher Länder, 1948–57). In con-
sequence, the post-euro Bundesbank stressed a fundamental continuity in its
special role as the ‘guardian’ or ‘night watchman’ of stability: its Wächterrolle in
the Eurosystem. Central to all its activities remained the mission of ‘construct-
ing stability’, both in Germany and in the Eurosystem. This mission led it to act
as an advance protagonist of the ECB in asserting the institutional and policy
attributes of stability against threats: whether from opponents of a predomin-
ant role for monetary analysis and money supply growth in ECB monetary
policy; from proposals to exclude or marginalize NCBs in banking supervision
and financial stability functions; from attacks on ECB independence in succes-
sive Treaty and institutional reform proposals; or in principled resistance to
reform of the Stability and Growth Pact (Deutsche Bundesbank 2005a, c). In so
doing, it often took up tougher positions than ECB directors. Over the period
1999–2006, Jürgen Stark, its vice-president (earlier chief German negotiator of
the Pact and later ECB Chief Economist), encapsulated this role. His departure,
like that of Edgar Meister in banking supervision, ended the continuity of
personnel at the executive board level with the Tietmeyer Bundesbank.
On the other hand, EMU disempowered the Bundesbank at domestic, EU,
and international levels. The effects were most striking in relations with the
Federal Finance Ministry (especially over banking supervision reforms in 2002
and 2007 and over reducing salary bonuses in 2006); with certain Land
governments over the nomination of executive board members (notably in
2006–7 when the Bundesbank had to accept a board member it had opposed);
and with the ECB and some other national central banks in the Eurosystem
(in the competition for policy ideas). Compared to the US Federal Reserve, the
135
ECB, and the Bank of England, the Bundesbank lost ground in the IMF and G7
(over financial stability issues) and looked increasingly to achieving common
positions in the Euro Group and ECOFIN. Unlike in constructing EMU, the
Bundesbank was cast into the position of defending the European monetary
constitution, the ‘monetary’ pillar of the ECB’s monetary policy strategy,
central banks’ role in banking supervision and financial stability, and even
retention of extra pay allowances for its staff.
The history of the Bundesbank and the euro reflects the paradox between
two types of power: power as the capacity to act in the service of its functions
and power as dominance of one actor over others. Paradoxically, in diminish-
ing its power over other central banks, the Bundesbank collectively empow-
ered EU central banks to more effectively promote economic stability within
the EU. EMU is the story of the Bundesbank’s institutional self-abnegation of
power ‘over’ others for the superior aim of enhanced collective central banking
power ‘to’ deliver a socially valued outcome—economic stability in Europe (on
these two forms of power, see Morriss 2006). The legacy of its shaping power
over the institutional design of the Eurosystem left intact (even if recurrently
challenged) the Bundesbank’s power in two of three dimensions—the power
to frame how other actors defined their interests in EMU and the power of
agenda setting (and keeping issues off the agenda). At the same time the Euro
Area reduced the visible face of Bundesbank power in being directly able to
change what others did (on the distinction between these three dimensions of
power, see Lukes 2005). This self-abnegation testifies to a long-term European-
ization process in the Bundesbank, in which accommodation trumped inertia
and resistance to the implications of European market and political integra-
tion for monetary policy.
This process of Europeanization and the outcome of accommodation testi-
fied to a distinctive conjunction of factors at work both in EMU and in
Germany. The Bundesbank was embedded in a broad domestic political con-
sensus about the primacy of European unification in German long-term
national interests and about the vital role of monetary union in that process.
Debate focused on timing and conditions, not on principle. The Bundesbank
was from 1958 onwards a pivotal player in EU central banking, its positions
refined and propagated by Emminger. EU central bankers had in turn low
collective action problems as a result of both the emerging high professional
consensus in monetary economics about price stability by the 1980s, conse-
quent on the collective experience of the Great Inflation of the 1960s and
1970s, and the habits and practices of intensive cooperation in various EU and
international fora. Accordingly, EU central bankers readily achieved solidarity
around the Bundesbank’s detailed prescriptions for European monetary and
currency union, presented to and incorporated in the report of the Delors
Committee (Dyson and Featherstone 1999). These low collective action costs
in EU central banking combined with determined, resolute, and consistent
136
political leadership, not least by the German Federal Chancellor and his astute
political skills in ‘binding in’ the Bundesbank, to facilitate EMU (Dyson 1998).
Both the process and the outcome of EMU illustrated that the power
that mattered to the Bundesbank was the professional capacity to shape out-
comes—a socially beneficial form of power—rather than the more instrumen-
tal power of the Bundesbank over others in gaining their compliance. The
Bundesbank focused on whether the Treaty and institutional conditions were
right to safeguard the collective professional capacity to deliver price stability.
With respect to power relationships, it was concerned to retain influence
within the Eurosystem and thereby ensure the Eurosystem’s ability to shape
the long-term expectations and behaviour of market players, price and wage
setters, and governments. The new asymmetrical power of the ECB within
European economic governance [what Dyson (2000) calls the ‘ECB-centric’
Euro Area] compensated in part for the diminished asymmetrical power of the
Bundesbank in German economic governance. After 1998–9, on issues like
Treaty revision, the application and reform of the Stability and Growth Pact
and exchange-rate coordination, the post-euro Bundesbank assigned a special
role to itself in speaking out loudly and clearly against any attempts to weaken
the collective capacity to deliver price stability. Through Stark, in particular,
it specialized in ‘voice’ on behalf of the policy paradigm that it had collectiv-
ized, notably against recurring French suggestions for European ‘economic
government’ (Hirschman 1970).
The Pre-Euro Bundesbank: Europeanization by Stealth
The Bundesbank is like whipped cream—the more one stirs it, the firmer
it gets.
Wim Duisenberg
The Europeanization of the Bundesbank was a long-term, difficult, and at

times painful process for a proud, self-confident institution. Its effective out-
come in the creation of the Euro Area depended on negotiations that achieved
an ‘uploading’ of Bundesbank ideas and practices of central banking to the
EU level. The result was an intellectual and institutional ‘fit’ of the Eurosystem
and the Bundesbank. Underpinning this process was a powerful conjunction
of Bundesbank-led argument and persuasion with mostly implicit political
threat of domestic German ratification difficulties. The persuasive capacity of
the Bundesbank derived from its superior performance in delivering a strong
and stable currency and from the association of this performance with
the record of sustained growth of the German economy and its resilience in
the face of shocks like the oil crises of the 1970s. Its status amongst central
banking professionals as the EU model was largely unquestioned. Equally,
137
the dependence of the Bundesbank’s domestic power on a widely shared

‘stability culture’ (not on a constitutional anchoring of its independence—
which was only secured in statute law) gave it a veto position in EMU negotia-
tions. Hence, in contrast to prevailing norms of German EU behaviour, the
Bundesbank—symbolized by Tietmeyer—could play hard in negotiations. The
constraint in doing so was loyalty to the political position of the German
federal government, whose Chancellor and foreign minister insisted that
EMU was pre-eminently a political project.
In consequence, Bundesbank officials could negotiate from strength in EU
fora like the EC Monetary Committee and the Committee of Central Bank
Governors: notably in defining core ideas of EMU were Emminger as vice-
president ( (1970–7) and president (1977–9) and Tietmeyer as vice-president
(1991–3) and president (1993–9). Emminger was the defining intellectual
presence in the background of the Werner Committee deliberations (as was
Tietmeyer, alternate member and then in the Federal Economics Ministry), as
well as in the European Monetary System negotiations in 1977–9; whilst
Tietmeyer played a similar role in the Maastricht negotiations and in the
work of the European Monetary Institute in preparing stage three (on details
see Dyson 1994; Dyson and Featherstone 1999).
This Bundesbank power over EMU was recognized and embedded in the
German federal government’s paramount political strategy of ‘binding in’ the
Bundesbank at all points in EMU negotiations (Dyson 1998). The risks inher-
ent in pursuing alternative strategies were highlighted in the gold revaluation
crisis of May–June 1997 and the subsequent political victory for the Bundes-
bank and humiliation for Finance Minister Theo Waigel (Duckenfield 1999a).
Not least, the opposition SPD stood ready in the Bundesrat to block any
proposal to alter the Bundesbank Act to compel a gold revaluation. The
strategy of ‘binding in’ was designed to accommodate the enormous public
support for the competence and effectiveness of the Bundesbank in ‘safeguard-
ing the currency’. Historical memory of the painful personal and political
consequences of hyper-inflation in the 1920s and 1940s left a deep footprint
in German public opinion. In consequence, the guiding strategic principle for
the German government was to ensure that the new single currency was ‘at
least as stable as the D-Mark’. Political credibility in securing this principle
depended on Bundesbank support. Hence in intergovernmental negotiations
at the European Council and ECOFIN levels the federal government stressed its
distinctively narrow ‘win set’ in domestic outcomes and ceded shaping power
over institutional and technical details of EMU to the Bundesbank.
The combination of a political strategy of ‘binding in’ the Bundesbank
throughout EMU negotiations with its institutional reputation as the model
EU central bank laid the foundations for a Europeanization process in which
accommodation—even to a relatively large Euro Area—triumphed over resist-
ance or inertia. Even so, the process had its moments of risk when the
138
challenges of inertia and resistance threatened to derail EMU. They included

the following:
. The continuing insistence of the Bundesbank that its obligations to inter-

vene to support currencies in the ERM were secondary to its domestic
statutory mandate under the 1957 Bundesbank Act to ‘safeguard the cur-
rency’. This position had its origins in the Bundesbank’s unhappy memories
of the strains created for its mandate by the Bretton Woods system. Release
from this system had enabled the Bundesbank to more autonomously and
effectively pursue its mandate (Emminger 1986). The famous Emminger
letter in 1979 on this point became the reference point for the Bundesbank’s
resistance to open-ended interventions during a succession of difficult ERM
crises, notably in March 1983, January 1987, September 1992, and July 1993
(Dyson 1994 for details). Only a broadening of the bands in 1993—insisted
on by the Bundesbank—saved the ERM and kept EMU alive.
. The divided counsels inside the Bundesbank on the role of its president Karl-
Otto Pöhl in the Delors Committee in 1988–9. Aware that he was being
boxed in, Pöhl had to be persuaded to accept the invitation to join and then
to play a constructive role (Dyson and Featherstone 1999 for details).
. The damage limitations on EMU after the German federal government
overruled the Bundesbank’s recommendations for delay in German–German
currency union in 1990 (Marsh 1992: 196–227). This crisis, linked to Pöhl’s
resignation, cast serious doubt on the Bundesbank’s trust in the federal
government in EMU negotiations (Duckenfield 1999b).
. The hesitations that surfaced in the Bundesbank after 1993 on the adequacy
of the excessive deficit procedure in the Maastricht Treaty to provide an
effective support for a stability-oriented monetary policy inside stage three.
The German agenda-setting on the Stability Pact, with insistence on a tight
framework of rules and sanctions, was designed to overcome these hesitations.
. The domestic gold revaluation crisis in 1997 (Duckenfield 1999a for
details). The Bundesbank mobilized public support behind the principle
of central bank independence to resist the proposal of Waigel, Federal
Finance Minister, to revalue the gold reserves, in part to offset the fiscal
deficit. A panic move to help Germany meet the fiscal convergence criteria
threatened to provide an incentive for the Bundesbank to oppose the
transition to stage three in 1998–9 and for the opposition SPD to seek
political advantage by aligning itself with defence of the Bundesbank.
The enduring loyalty of the Bundesbank to the EMU process, despite these
periodic crises, reflected in part acceptance of the primacy of EMU as a political
project, in part a shared mind-set that favoured European economic and
political unification, and in part its influence in the process and over the
content of EMU during all these crises (except German unification).
139
What factors formed the pre-euro Bundesbank’s character? First and fore-
most, the Bundesbank prided itself on being the most independent of EU
central banks (Loedel 1999b). This pride had its origins in a distinctive German
Ordo-liberalism that favoured a principles-based approach to monetary policy,
reliance on monetary rules, scepticism about formal analytical economic
modelling, and central bank independence to deliver a long-term predictable
framework of price stability free from short-term political pressures (Nicholls
1994; Weber 2006b). The historical roots lay in the nightmare memories of
hyper-inflation and its corrosive political and economic effects. The earlier,
more decentralized Bank deutscher Länder scored two notable victories over
Chancellor Konrad Adenauer: when he tried to stop an interest-rate increase:
in 1950 during the Korean War crisis; and, most famously, in May 1955 when
in his Guerzenich speech Adenauer decried its damage to ‘the small fry’. In
July 1956 the cabinet rejected Adenauer’s proposal to move the planned
Bundesbank from Frankfurt to Cologne, close to the political capital Bonn.
These practical and symbolic political victories for Wilhelm Vocke, president
of the Bank deutscher Länder, and Ludwig Erhard, Federal Economics Minister,
were the context for securing its independence in ‘safeguarding the currency’
in the Bundesbank Act of 1957 (Deutsche Bundesbank 1999; De Haan 2000).
Later Chancellors avoided repetition of Guerzenich.
Bundesbank pride was reinforced by the relative success of Germany in
avoiding the worse effects of the Great Inflation of the 1970s and in being a
pacesetter in devising a monetary rule in 1975 as a domestic discipline once
the Bretton Woods system had collapsed (Emminger 1986). In the 1980s the
Bundesbank’s reputation was further reinforced by mainstream American aca-
demic research in monetary economics that established a relationship be-
tween central bank independence and price stability and sustained growth
without boom and bust. The principle of central bank independence remained
the bedrock of its negotiating strategy on EMU and of its post-euro role in
consolidating stability.
In the context of an Ordo-liberal orthodoxy that rejected or at least substan-
tially qualified Keynesian demand management, monetary policy possessed
an enduring primacy in both macro-economic policy and in the activities of
the Bundesbank not seen in any other EU state or central bank (Dyson 1999).
The importance of its monetary policy role grew with the Bundesbank’s pace-
setting role in the ERM, based on the ‘anchor’ role of the D-Mark, along with
its long domestic record of independence. The monetary policy capacity of
other EU central banks remained undeveloped because they either lacked this
independence in setting interest rates (like the Bank of England) and/or were
constrained in monetary policy autonomy by ERM membership, becoming
monetary policy ‘takers’. This ‘benchmarking’ role in European monetary
policy meant that the Bundesbank director responsible for economic policy
enjoyed an unusually powerful internal position, with a large prestigious
140
economic policy division. Examples included Emminger, Helmut Schlesinger,

and Otmar Issing. In this way, Bundesbank power was projected onto the
European level. Characteristically, the vice-president was responsible either
for economic policy (like Emminger and Schlesinger) or for international
policy (like Tietmeyer).
In contrast, other central banking functions—notably banking supervi-
sion—assumed a secondary importance and prestige. The reigning Bundes-
bank view was that responsibility for banking supervision might produce
conflicts of interest for monetary policy and undermine discharge of respon-
sibility for price stability. Faced with financial difficulties in the banking sector
the Bundesbank might be tempted to inject liquidity in circumstances that
increased inflationary risks and be drawn into ‘moral hazard’. Hence the
Bundesbank was content to formally delegate key activities to an independent
agency attached to the Federal Finance Ministry, the Berlin-based Federal
Banking Supervisory Office (Bundesaufsichtsamt für das Kreditwesen, BaKred).
In practice, BaKred worked closely with the Bundesbank.
To the irritation of successive presidents, the Bundesbank combined its
European and global commitments and its reputation as a model central
bank with a pronounced provincialism. This provincialism reflected the firm
political roots of the Bundesbank council and organization in the German
federal system, the hostility to creating a single powerful German financial
market centre in Frankfurt, and the state central banks’ tendency to protect
the interests of the public savings banks and hence to be cautious on financial
market liberalization. The result was potential tension between the president
and the executive board, on the one hand, and the presidents of the state
central banks, on the other, about just how best to reconcile domestic respon-
sibilities with European and international obligations. Pöhl, in particular, was
a sharp critic of this ‘mismatch’ between international and European respon-
sibilities and provincialism, arguing that some Bundesbank council members
lacked adequate professional expertise in monetary policy.
The potential for this mismatch to spill over into conflict was mitigated by
the primacy that Bundesbank thinking gave to building a framework for
international and European monetary coordination ‘from below’ through
domestic discipline in delivering economic stability. There was, in short, a
firm bias to give primacy to domestic responsibility for ‘safeguarding the
currency’ as the basis for wider exchange-rate stability based on sound domes-
tic fundamentals. Exchange-rate stability was a residual of sound converging
domestic policies rather than a prime cause of domestic stability.
This bias to European and international coordination ‘from below’ reflected
another distinctive characteristic of the Bundesbank: the absence of a signifi-
cant domestic historical context of Keynesian economic thought. The
Bundesbank represented the central domestic institutional embodiment of
a distinctive German ‘Ordo-liberal’ tradition of economics. ‘Ordo-liberalism’
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advocated a ‘principles-based’ approach to economic policy, with regulation

to ensure open competitive markets and central bank independence in the
service of economic stability as the guiding principles. These principles made
the monetarist notion of money supply targeting appealing to the Bundes-
bank as an apolitical frame of reference unlike the discretionary use of a range
of macro-economic indicators, including forecasting, in which it placed little
reliance. Hence in the 1970s the Bundesbank was a leader in adapting
US monetarist ideas as the key frame of reference for its monetary policy
(Johnson 1998). Despite much external criticism, which often ignored its
non-mechanistic use of monetarism, it remained the main EU central banking
advocate of the primacy of this monetary instrument as the basis for a more
secure long-term orientation to securing price stability (Gerberding, Seitz, and
Worms 2005).
Following the Maastricht Treaty negotiations the Bundesbank council
signalled its critical distance in a statement of January 1992 that underlined
the challenges ahead both in achieving sufficient economic convergence and
in deepening solidarity through more political union if EMU was to be sus-
tainable. In addition to highlighting ‘bottom–up’ convergence through sound
domestic policies, it argued for a strong political framework to secure competi-
tive markets at the EU level—about whose existence the Bundesbank remained
sceptical (Deutsche Bundesbank 1992). This bias to a cautious ‘wait-and-see’
approach was shifted by the Maastricht Treaty ratification in 1993, by the 1993
ERM crisis centring on the French franc, and by the January 1994 launch of
stage two of EMU and the birth of the European Monetary Institute (EMI).
They forced internal recognition of the professional as well as political dangers
of being reactive to events and of the need for a more comprehensive and
pro-active Bundesbank engagement in a project with a clear political timetable
and a changed institutional context. This engagement was symbolized by
its new high-level European steering committee in October 1994, designed
to ensure German influence over the detailed design of stage three.
Between 1994 and 1998 the context changed with the European Monetary
Institute as an emerging new intellectual powerhouse in negotiation of the
design of stage three. The Bundesbank participated very actively in negoti-
ations on such issues as the role of money in monetary policy strategy, min-
imum reserve requirements, longer-term refinancing, and seigniorage. It
pursued two fundamental principles—central bank independence and con-
tinuity with pre-EMU as vital to long-term credibility—and paid close atten-
tion to domestic political need to safeguard the specific interests of the
German three-pillar financial system (commercial, cooperative, and public
savings banks) and in particular retain the critical support of the German
savings banks in the transition to stage three of EMU. However, the Bundes-
bank had to make compromises in what was a consensus-driven process. It
was able to secure a role for money, but as one pillar of monetary strategy;
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minimum reserve requirements to stabilize money market interest rates, but

with banks remunerated at market interest rates; and longer-term refinancing
as part of open market operations, but without the subsidy element of dis-
count rates below market rates. These compromises stemmed from a broad
emerging consensus, shaped by strong Bank of England positions, that mon-
etary policy instruments should avoid competitive distortions, giving
some banks a competitive advantage over others. They also accorded with
pragmatism in the Bundesbank’s understanding of monetary aggregates
and in its recognition of the principle of a ‘level playing field’ in European
competition policy.
In the process of designing stage three, Tietmeyer combined an intellectual
ascendancy on detailed technical issues, which derived from a much-longer
association with EMU than any of his peers, with highly accomplished negoti-
ating skills and an intense focus on, and commitment to, the negotiations. He
was flanked by his Chief Economist, Issing, in preparation of the ECB monetary
strategy, and in the EC Monetary Committee by Stark, State Secretary in the
Federal Finance Ministry (notably on negotiation of the Stability and Growth
Pact). Issing’s appointment as the first ECB Chief Economist and Stark’s ap-
pointment as vice-president of the Bundesbank in 1998 testified to an ongoing
axis of Bundesbank centrality in promoting stability in the Eurosystem.
The new internal primacy to Europeanization of the Bundesbank’s work
post-1993 reflected the determination of the Bundesbank not to lose its grip
on the detailed technical issues in transition to stage three and not least to
ensure that operational empowerment of the EMI in monetary policy during
stage two was kept off the agenda. Equally, the ERM crises of 1992–3 had
revealed the risks of political exposure to the Bundesbank and the limits of
its statutory mandate. Tietmeyer sought to avoid any association with an
image of ‘sabotaging’ EMU and forcing the federal government to renege on
a central EU treaty commitment. His fundamental Europeanism was revealed
in his aversion to the high political costs for Germany and for the EU from a
failure of EMU that could be credibly attributed to the Bundesbank. As a
seasoned German official he recognized that the federal government
was ultimately responsible for foreign and EU policies; the Bundesbank was
responsible for ensuring that the design of EMU was technically correct.
The Post-Euro Bundesbank
Three Bundesbank Presidents: The Routinization of Charisma

The transformed context of the post-euro Bundesbank was reflected in the
differing qualities and experiences of its presidents, who were offered fewer
prospects to bask in the public limelight. The context neither favoured nor
143
called for charisma. Tietmeyer’s retirement in August 1999 was recognized as

the end of an era of ‘great’ Bundesbank presidents; Ernst Welteke’s dramatic
resignation in April 2004 represented the worst crisis in its history and was
symptomatic of a traumatic period; whilst the appointment of Axel Weber
signalled a period of tougher, more centralized but low-profile management of
change. Only Tietmeyer merited comparisons with Vocke, Karl Blessing,
Emminger, and Pöhl.
Welteke and Weber had to face new, recurring, and uncomfortable questions
about whether the Bundesbank was redundant and, if not, whether it was too
costly and inefficient and best reduced to being no more than a ‘think tank’
(Denkfabrik) (e.g. Stürmer 2005; Weber 2005a). These questions highlighted its
problems in encouraging public interest in its remaining operational tasks and
thus profiling its identity and securing its influence on domestic economic
policies (cf. Fabritius 2004). Welteke talked boldly about creating a ‘new’
Bundesbank, including a new engagement with promoting Frankfurt as the
German and Euro Area financial centre and with using gold sales to increase
Bundesbank profits and finance a new role in supporting the Lisbon agenda of
education and research. In contrast, aware of the internal Bundesbank dissent
provoked by these initiatives and external political constraints, Weber stressed
both continuity in its prime concern with strengthening its role in monetary
policy and price stability and developing its expertise in financial stability in
the context of the new challenges from financial market changes. The credit
and insolvency crisis of 2007–8, symbolized by the rescues of the IKB, the
Sachsen Landesbank, the Westdeutsche Landesbank (WestLB), and—most sys-
temically serious of all—Hypo Real Estate, increased further the stress on the
interdependence of monetary and financial stability.
Initially, the Bundesbank was protected by the ‘halo effect’ of the Tietmeyer
presidency, both his personal legacy in negotiating EMU on German terms and
his continuing high international profile in the 1998–9 financial crises, lead
role for G7 and IMF in proposing the new Financial Stability Forum, and
engagement in IMF reform debates. The active Tietmeyer/Stark role at inter-
national and European levels helped to temporarily mask the scale of change.
Moreover, the gap between monetary union in 1999 and currency union in
2002 created a hiatus in change. As work on currency conversion was incom-
plete and absorbed Bundesbank attention, Tietmeyer could limit himself to
beginning internal work on structural reform proposals (chaired by Stark).
His legacy was approved by the Bundesbank council of two reform models
(centralized and decentralized) in June 1999. Tietmeyer was also able to coun-
ter the critical positions on the EMU institutional and policy arrangements
taken by Lafontaine as SPD Federal Finance Minister (October 1998–March
1999). Lafontaine’s abrupt resignation, before Tiemeyer’s retirement, relieved
the short-term pressure on both the Bundesbank and the ECB.
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Welteke was left to walk the political minefield of Bundesbank reform. He

was initially protected by a two-year timetable as the Bundesbank, especially
its large state central banks, were busy ensuring a smooth efficient currency
conversion for January 2002. He could also use this European deadline to help
force change. However, senior Bundesbank officials and some state central
bank presidents were less than enthusiastic about Welteke’s appointment,
especially his close political association with Eichel, who had been prime
minister of Hesse and who had nominated him. Although past president of
the Hesse state central bank, Welteke was neither a professional central banker
(like Emminger) nor a high-profile international economic figure (like Pöhl,
Tietmeyer, and Stark) nor a professional economist (like Schlesinger or later
Weber). His combination of a provincial with a political background (as
economics and finance minister in Hesse) added to internal Bundesbank
fears that he would lack both the international and European experience and
weight and the intellectual capacity to profile the Bundesbank effectively in
the Eurosystem, especially in the crucial area of monetary policy. Stark
emerged as the strong figure on the larger stage of IMF, G7, and Eurosystem
and the one whom many felt had been deprived of the post that was rightly his
because he did not have the right ‘party book’ in 1999. In consequence,
Welteke felt that he lacked strong internal support.
Welteke’s period was characterized by immersion in the domestic politics of
Bundesbank structural reform. This issue generated powerful internal conflicts
that made agreement on future strategy in the Bundesbank council impos-
sible, which in turn further undermined morale (Engelen 2002a, b). It also
provoked criticism that he failed to make time to strengthen the profile of the
Bundesbank in the ECB (though structural reform was a condition of, as much
as a diversion from, this task). Even when internal reform was agreed, mainly
on terms acceptable to Welteke, his attempts to fill out his concept of the ‘new’
Bundesbank with ideas elicited more suspicion and opposition than support.
He proposed a more flexible, profit-oriented management of the large Bundes-
bank reserves on a more commercial model. In addition, he proposed that gold
sales might be used to establish a new fund to invest in the future, specifically
in education and research. In these ways, he sought to associate the Bundes-
bank with ‘modernization’. Both proposals met internal Bundesbank resist-
ance on the grounds that the central bank was exposing itself to political
interference in reserve management. Colleagues sought to rally around
a staunch defence of the principle of central bank independence as essential
if Welteke and the Bundesbank were to strengthen their position in the
Eurosystem. The Bundesbank position on gold sales hardened in 2003.
The risks of being seen as unreliable on stability within the Eurosystem were
a factor in limiting Welteke’s desire to carve out a new role for the Bundesbank
in actively promoting Frankfurt as an international financial centre and the
financial centre of the Euro Area. This was the rationale for the abortive
145
proposals to locate BaFin and the Committee of European Banking Supervisors

(CEBS) in Frankfurt and for strengthening ties with Frankfurt University in
research on financial markets and monetary policy. Welteke’s Hesse back-
ground proved a catalyst for political opposition to his centralizing ambitions,
especially from Bavaria, and articulated within as well as outside the Bundes-
bank. His views on the need for a strong German financial centre in Frankfurt,
reflected in his preference for a centralized Bundesbank reform model and a
shift of financial supervision activities, provoked hostile reactions. Internally,
this initiative exposed a dilemma: on the one hand, financial market integra-
tion consequent on the euro was sharpening a competition of financial
centres, in which the Bundesbank as the German central bank could not be
neutral. On the other hand, its image as a reliable guardian of stability in ECB
monetary policy depended on not being seen as captive to particular market
players. The Bundesbank’s stability image in the Eurosystem’s monetary policy
(continuity) trumped a new image as a promoter of Frankfurt.
Just as the Bundesbank hoped to settle down to a period of stability after
currency union and internal reforms, crises multiplied in 2003. The Brown-
Eichel proposals for reform of EU financial market regulation and supervision
undermined the Bundesbank strategy of using the ECB as an axis for develop-
ing its profile in European banking supervision. Eichel put the Bundesbank
under pressure to sell gold. Subjected to the excessive deficit procedure, the
German government precipitated a crisis of the Stability and Growth Pact. It
thereby undermined one of the core German contributions to the design of
the EMU. In addition, German negotiators in the European Convention
agreed to proposed changes to the European monetary constitution that
threatened the Bundesbank position that the Maastricht settlement on EMU
must be left intact. Singly and together, these conflicts amounted to a Bun-
desbank belief that the German government was undermining its capacity to
act as guarantor of stability-oriented monetary policies. Relations with the
Schröder government deteriorated sharply. Stark advocated most strongly a
clear consistent Bundesbank line: no change to the monetary constitution and
no reform of the Stability and Growth Pact (just its application) (Deutsche
Bundesbank 2005a).
Against this gloomy background, the crisis in March–April 2004 over Welteke’s
‘hotel-costs’ affair (paid for by a leading German bank), and subsequent
resignation, and associated allegations of property scandal, tarnished the
reputation of the Bundesbank and plunged it into its worst-ever institutional
crisis (Einecke 2004). Given its fear that Schröder would use this opportunity
to parachute in a Berlin colleague to discipline the Bundesbank, Weber’s
appointment was a collective relief.
Although without much managerial experience, Weber was a highly
respected financial and monetary economist. His priority was not to look
for new roles for the Bundesbank but to focus on strengthening its core
146
operational functions, especially in monetary policy, through more high-

quality research (Weber 2007). The ‘Strategy 2012’ and the portfolio allocation
in 2006 affirmed this approach. The priorities were symbolized in Weber
taking direct responsibility for monetary policy and research (shifting
Hermann Remsperger to international affairs) and with Franz-Christoph
Zeitler, the vice-president, focusing on banking supervision. Weber intensified
cost reductions so that the Bundesbank could argue credibly about structural
reforms as itself a pacesetter in the public sector. His insistence on a unified,
tightly organized management was made more acceptable in the light of the
lessons of the 2004 crisis. However, it provoked much internal unhappiness
not just because of job cuts but also because it was unclear how the research-
driven approach could be made to work in the context of competition for
the bright stars from the better-resourced, neighbouring ECB (including the
rumour that Weber might move to the ECB as chief economist). Weber’s
incentive for consolidating and even reducing involvement in some functions
(e.g. privatizing cash management) was to create more space to invest in
research capacity.
The departure of Stark in 2006 and retirement of Edgar Meister in 2007 were
symbolic of the final disappearance of the shadow of the Tietmeyer era and
gave Weber a fresh opportunity to refashion the Bundesbank in his own image.
In Weber the post-euro Bundesbank had found a leadership personality
and style that suited its more humdrum range of functions.
Living with an Ambitious Federal Finance Ministry and Disgruntled

Länder: Internal Reform and Banking Supervision
In seeking to carve out its post-euro identity the Bundesbank faced the challenge
that the creation of the Euro Area unleashed new opportunities and incentives
for the Federal Finance Ministry to strengthen its roles in macro-economic
policy coordination within the federal executive, in fiscal policy co-ordination
within the larger federal system, and in financial market supervision. Its only
partial success had much to do with the strength of veto players in the German
semi-sovereign state with its complex sharing of powers. The most notable
development was a major transformation in the relative power of the Bundes-
bank and the Federal Finance Ministry, exemplified in reforms to German bank-
ing and financial market supervision. With EMU in place the Finance Ministry
was liberated from the strategic requirement to ‘bind in’ the Bundesbank to its
key policy positions. Faced also by the political difficulties of fiscal consolidation
in a federal system it had an incentive to return regularly (in 2003 and in 2006)
to the issue of selling Bundesbank gold reserves as a source of revenue. Strikingly,
it was not deterred by the memory of the Finance Ministry defeat on the gold
revaluation issue in 1997 (Duckenfield 1999a).
147
In addition, the Bundesbank’s internal centralizing reform and subsequent

job cuts left many Länder governments unhappy with the Bundesbank.
Although opinion polls suggested that it remained second only to the Federal
Constitutional Court in the respect in which it was held by the public, it had
fewer political friends. This diminished respect was demonstrated in 2007
when the Bundesrat sought to appoint the head of the State Chancellery of
Baden-Wuerttemberg against the opposition of the Bundesbank executive
board. The political as well as legal resources of the Bundesbank in playing
the German semi-sovereignty game had diminished.
Welteke’s close personal and political relations with Eichel were seen as
a great bonus for the Bundesbank directorate to gain support for a smaller,
more centralized, and streamlined structure, in which the nine Länder cen-
tral banks would lose their independence and the Bundesbank council be
abolished. Frictions mounted when presidents of the Länder central banks—
who were Bundesbank council members—offered public opinions about
ECB monetary policy though the president, and not they, was responsible
as the ECB Governing Council member. The problem was intensified by the
overhang of effects from the Bundesbank’s expansion consequent on
German unification and the introduction of the D-Mark in the six new
federal states.
In 1999–2000 Bundesbank discussions with the Federal Finance Ministry
focused in parallel on two issues: the two internal structural reform models
(centralized and decentralized) endorsed by the Bundesbank council; and the
future of banking supervision. Welteke pressed the case on Eichel, his former
political colleague from Hesse, for the centralized reform option—to more
effectively support his role in the ECB Governing Council—and for centraliz-
ing banking supervision in the Bundesbank—to expand and develop Bundes-
bank functions and to lay the basis for a more effective role in financial
stability as compensation for losing monetary policy. The complex outcomes
caused shock waves in the Bundesbank.
In January 2001 Eichel linked the two issues in interrelated legislative
proposals. Although in part they offered what the Bundesbank directorate
sought, they were also a surprising setback to its ambitions. In his proposed
amendment to the Bundesbank Act Eichel accepted the directorate’s idea of a
small, centralized, and single-tier governing board (to be nominated only by
the federal government) and the replacement of the Länder central banks by
dependent regional offices. This attack on the federal principle underpinning
the structure of the Bundesbank triggered the fierce opposition of Länder
governments, notably Bavaria. The proposal involved abolition of the execu-
tive boards of the Länder central banks, the removal of a major source of Land
political patronage, and an end to the remaining tasks of the Bundesbank
council. Welteke was happy but faced the bitter opposition of six Länder
central bank presidents and a deeply divided Bundesbank council.
148
In a linked reform, Eichel proposed that responsibilities for supervision of

banking, insurance, and securities markets—which had been divided amongst
three federal regulatory bodies—should be merged in a single new Federal
Financial Services Supervisory Authority (Bundesanstalt für Finanzdienstleis-
tungsaufsicht, Bafin) under the supervision of the Federal Finance Ministry.
Modelled on the British Financial Services Authority, this proposal had the
strong backing of the big commercial banks and was justified in terms of an
objective sponsored by Welteke—strengthening Germany as a modern finan-
cial centre and as a regulatory model in the Euro Area. It was also influenced by
the BaKred’s proposal for a stronger role in banking supervision in the wake of
the Hypo-Bank scandal of the 1990s. However, the objective was pursued in
terms that ran counter to Bundesbank interests. Taken by surprise and fearing
that the Finance Ministry sought its exclusion from banking supervision, the
Bundesbank gained ECB support for its view that central banks must be
intimately involved in banking supervision, not just because of their trad-
itional authority and expertise but also so that they could effectively discharge
their responsibility for identifying risks to financial stability. Through its
regional offices, only the Bundesbank had the appropriate structure for the
detailed operational aspects of banking supervision in a highly decentralized
and complex banking structure.
Eventually, compromise was reached under which the Bundesbank retained
responsibility for the operational aspects of banking supervision. This respon-
sibility mattered because Basel II offered opportunities for staff expansion to
take on new tasks in banking supervision. It also ensured that the Bundesbank
remained a major player in the ESCB arrangements for EU-wide coordination
of banking supervision: Meister of the Bundesbank directorate chaired the
ESCB Banking Supervision Committee (BSC). However, the Bundesbank failed
to get BaFin transferred to Frankfurt.
From January 2001 to passage of the two bills in March 2002 Welteke faced
a serious internal crisis. Eichel’s preference for the centralizing reform
option brought down the wrath of many colleagues in the Bundesbank
council because it strengthened the European role of the Bundesbank to
their cost. Simultaneously, Eichel weakened Welteke by his reform proposals
for banking supervision on behalf of a modern supervisory system that
recognized the closer integration of markets rather than the special charac-
ter of banking.
Faced with political opposition from state governments in the Bundesrat,
the federal government made concessions to secure the passage of the two
bills. First, the rights of the Bundesbank to share in banking supervision with
BaFin were more clearly recognized, especially in conducting more detailed
checks on individual credit institutes, notably the smaller banks, and in main-
taining a role in international and European convergence and cooperation.
However, decision-making rested with BaFin. Second, the new single-tier
149
executive board of the Bundesbank was to be slightly larger (eight rather than
six) and to be nominated half by the federal government and half by the
Bundesrat. This return to a plurality of nominating bodies represented a
concession to the Länder and was justified as better securing the Bundesbank’s
independence.
Once the single-tier executive board was in place in 2002, internal restructur-
ing around a few dedicated service centres and staff reductions gathered pace.
They were reinforced in Weber’s ‘Strategy 2012’, which planned 9,000 staff in
2012: down 40 per cent from 15,600 in 2001 and from 18,000 in 1992, and
double the average for the Eurosystem national central banks. Weber also sup-
ported the proposal in 2006 to reduce the executive board to six, with federal
government and Bundesrat still nominating half each (and the CDU/CSU insist-
ing on the states having the right of proposal for vice-president). These changes
fitted his model of a lean, efficient Bundesbank and his strategic view that its
tough calls for domestic structural reforms to labour, product, and service mar-
kets lacked credibility if it showed lack of will and capacity to reform itself. The
Bundesbank had to be a model of structural reform in the public sector.
Banking supervision remained a continuing source of tensions with the fed-
eral government. The Bundesbank sought to raise its profile both in Basle II and
in the ECB-based Banking Supervision Committee. It actively engaged in the
Basle II negotiations on behalf of the distinctive German interests in protecting
the credit position of small and medium-sized firms. It also sought to innovate in
regulation of liquidity requirements of banks in the context of the new capital
standard. In developing a ‘principles-oriented’ approach, the Bundesbank gave
banks the choice between adopting a standard formula and using their own
internally developed liquidity risk measurement and management methods
(according to certain requirements). The Bundesbank presented this twin-track
approach as a model for EU-wide harmonization of banking supervision.
A further setback for the Bundesbank was the failure of its proposals, backed
by other NCBs, to strengthen the role of the BSC in promoting banking
supervisory convergence and cooperation within the ESCB as well as in stabil-
ity analyses of the European banking systems. Meister, the Bundesbank dir-
ector responsible for financial stability and its first chair, identified the BSC as a
potential platform for the Bundesbank to raise its profile in EU-wide banking
supervision. However, no sooner was BaFin agreed than Eichel, in a joint
proposal with Gordon Brown, proposed a comprehensive reform of European
financial supervision in April 2002. ECOFIN decided to extend the committee
structure established already for securities supervision to banking. The CEBS
began work in 2004 to advise the European Commission on preparation of
banking directives, to ensure their consistent application, and, increasingly, to
encourage convergence in supervisory rules and practices. It fell outside the
umbrella of the ESCB, which focused on macro-prudential issues, and symbol-
ically was located in London, not Frankfurt. The Bundesbank unsuccessfully
150
opposed this reform as too insensitive to the national, regional, and local
distinctiveness of banking structures. Once again the Bundesbank found itself
on the defensive against Federal Finance Ministry proposals.
The Bundesbank had been inhibited by its strategic commitment to retain
banking supervision as a national responsibility and prevent its centralization
in the ECB, which was sought by members of the ECB Executive Board, includ-
ing its president. The rationale for this insistence on the principle of subsidiar-
ity was the sheer complexity of different banking structures in Europe, their
particular heterogeneity in Germany, and hence the need for locally based
expertise. The Bundesbank also doubted that EU states were prepared to cede
political authority to the ESCB to deal with financial system issues. At the same
time it feared that ECOFIN might seek to establish a pan-European FSA at
collective cost to the central banks, ECB, and NCBs. The CEBS was not the
worst-case scenario. The Bundesbank not only failed to prevent a sharing of
powers with BaFin in CEBS but also failed to prevent CEBS’s location in London.
The Bundesbank held up the centralization of banking supervision in the
Dutch central bank as the preferred model and rejected the British FSA model
as undermining the capacity of the central bank to safeguard financial stability
through the early warnings provided by a detailed operational knowledge of
the banking system. Although it tried to make the German ‘dual’ system work,
it argued that it was too complex and involved an unclear division of respon-
sibilities and lack of transparency in the process. The Bundesbank argued that
BaFin officials tended to duplicate its work and were too removed from the
details, whilst tacitly supporting claims by many banks that BaFin lacked
the subject-matter competence of Bundesbank officials (a situation that
reflected the centralized operation of BaFin and the regional operation of
the Bundesbank).
In the coalition agreement of 2005 the Grand Coalition committed to a
further reform of banking supervision. The Bundesbank argued for a reform to
differentiate more clearly its role from BaFin and to avoid its officials being
drawn into the BaFin orbit. For this reason it rejected the proposal that the
Bundesbank be given a seat in the management board of the reconstituted
BaFin and sought more responsibility in banking supervision.
The Federal Finance Ministry reform proposals in 2007 occasioned major
alarm. They prioritized the removal of the supervision of investment funds
(many linked to banks) from the Bundesbank to BaFin on the ground that they
should not be classified as ‘credit institutes’. This reform, which aimed to
eliminate dual supervision, reduced the scope of the Bundesbank’s involve-
ment. In a critical opinion the ECB argued that the reform undermined the
Bundesbank’s capacity to safeguard financial stability within the Eurosystem.
More seriously, the Finance Ministry wanted to strengthen its own role by
bringing BaFin closer within its own orbit and subjecting both BaFin and the
Bundesbank to its own supervisory authority. The Bundesbank argued that
151
this proposal amounted to a major assault on central bank independence and

reflected the Finance Ministry’s intent to remove the Bundesbank from a
significant role in banking supervision. The ministry countered by pointing
out that in 2000 the Bundesbank had accepted that banking supervision did
not fall within the framework of central bank independence. In turn, the
Bundesbank argued that banking supervision was a crucial aspect of the larger
function of securing the financial system against risks, that financial stability
and monetary policy were complementary functions (a point strengthened by
the 2007–8 credit and insolvency crisis), and that correspondingly the Treaty-
sanctioned independence of the Eurosystem was at stake. Again, Bavaria
assumed the leading political role in challenging this proposal and making it
into a major coalition issue.
CDU/CSU opposition (including support for concentrating responsibility in
the Bundesbank), combined with the credit crisis in August 2007, and the
collapse of the IKB and the Sachsen Landesbank, led Steinbrück to withdraw
the proposals (though not reform of supervision of investment funds and not
reform of the management structure of BaFin). The Bundesbank gained a
reprieve whilst the federal government considered the implications of the
2007 banking crises. Whilst the Finance Minister remained opposed to ideas of
strengthening the Bundesbank’s role in banking supervision, the elevation of
the issue into a ‘grand coalition’ matter produced a much less radical outcome
that sought a clearer division work with BaFin. In the wake of the new banking
crises of 2008, especially Hypo Real Estate, the CDU/CSU again returned to the
proposal that banking supervision should be centralized in the Bundesbank.
The 2001–2 and 2007—reforms signalled a shift in power between the
Federal Finance Ministry and the Bundesbank. The Bundesbank was forced
to fight to retain existing functions rather than being allowed to develop them
on the lines of the Dutch and Irish central banks. By 2007 Weber was placing
less reliance on the Bundesbank gaining new functions than on developing its
monetary policy role within the Eurosystem; by 2008 he saw the deepening
financial market crisis as a catalyst to strengthen the ‘money and credit’ pillar
as a stabilizing element in a more long-term–focused monetary policy that
would focus on dampening the financial cycle (a more symmetrical monetary
policy) (Weber 2008b). Focusing on this function enabled it to escape the
political constraints of the domestic ‘semi-sovereignty game’ in favour of the
professional games of semi-sovereignty in European central banking.
Strengthening the Bundesbank in Eurosystem ‘Semi-Sovereignty’ Games:

Strategic Consolidation Around Research
The Bundesbank worked its way with difficulty to a consensus around a
revamped strategy in 2006, in part because of delayed and painful structural
reforms, and in part because of greater Federal Finance Ministry assertiveness.
152
The new sense of urgency that was imparted by the crisis of 2004 proved
useful to Weber. More fundamentally, however, the nature of the strategic
consolidation reflected the Bundesbank’s weakened position in domestic
semi-sovereignty games and its emerging recognition that the primary stra-
tegic requirement to overcome this handicap was to strengthen its position
in Eurosystem ‘semi-sovereignty games’. It had to re-earn credibility and
reputation in this new professional context.
The pre-euro Bundesbank’s domestic power and professional identity was
bound up with its leadership of European monetary policy. The post-euro
Bundesbank’s domestic power and professional identity was dependent on
its perceived competence in the Eurosystem as a key source of innovative
ideas and best practices across its range of functions: banking supervision,
payment and settlement systems, cash management, and—crucially—ECB
monetary policy strategy. In ensuring a clear Bundesbank imprint on the
ECB it had advantages other than just an original Bundesbank-shaped design:
physical proximity to the ECB; the number of former Bundesbank officials
working for the ECB (82 were seconded at senior levels in 2007); and the
presence of former Bundesbank directors as successive ECB chief economists
(Issing and Stark).
The decentralized structure of the Eurosystem offered an incentive to excel in
the competition of ideas. Inspired by New Public Management ideas, internal
Bundesbank reforms highlighted strengthening its five roles in applied
economic research; in quality of its financial stability analysis and promoting
the values of a long-term culture in German financial markets; in developing
stress indicators for systemically important banks; in leading operationally
and strategically on European cashless payment systems (TARGET2 and
TARGET2S); and in pioneering in efficient cash management (through the
cash electronic data interchange procedure and multi-denomination banknote
processing). The strategic cycle from 2008 to 2012 focused on ‘raising the
Bundesbank’s profile’ in these ‘core business areas’.
Already, under Welteke in 2000, the Bundesbank set up its Economic
Research Centre, along with a scientific advisory council, as the new focus
for its research activities. This Centre managed the macro-economic structure
model, forged links with applied academic research in universities and outside
research institutes on monetary policy and increasingly financial stability
issues, and sought to raise the Bundesbank’s profile in ESCB policy issues,
especially monetary analysis, the dynamics of wage setting, and analysis of
household financial situations. Weber (2006) highlighted two papers: on the
continuing value of monetary indicators in predicting Euro Area inflation
(Hoffmann 2006); and on improving the quality of monetary indicators
(Greiber and Lemke 2005). The Bundesbank focused on strengthening its
profile in the ECB Governing Council by arming Weber not just to defend
the ‘monetary’ pillar against sceptics but also in refining the contents of this
153
pillar to enhance its use as a long-term framework for identifying inflationary

risks from money supply growth.
In reconfiguring its functions under Weber the Bundesbank had to avoid
suggestions that its academic president was transforming it into a ‘think tank’
by emphasizing that its analytical work served its operational roles. This
analytical strengthening was justified as necessary to deal with new, inter-
related challenges: incorporating a stronger European perspective into its
work so as to fulfil its obligations within the new Eurosystem; using IT and
New Public Management to modernize its central banking operations; and
coping with the rapid changes and closer integration in global financial mar-
kets. The Bundesbank was to become a Vorreiter in becoming a Europeanized,
modernized, and market-focused central bank, notably compared to its
French, Italian, and Spanish equivalents.
Research-based strategic consolidation focused on the following:
. Strengthening the monetary policy-making role of its president in the
ECB Governing Council, especially following the criticisms of the ‘mon-
etary’ pillar by those working with neo-Keynesian macro-economic
models at the November 2006 Fourth ECB Central Banking Conference.
These criticisms were heard even from inside the ECB, as well as from
inside the Banque de France and Banca d’Italia. The Bundesbank faced a
difficult intellectual challenge as money supply growth repeatedly
exceeded its reference values and the ‘monetary’ pillar was relegated to
second place in the 2003 review of monetary policy strategy. The intellec-
tual case for the role of money had to be reformulated.
. Increasing the expertise and quality of Bundesbank representation in
international, European, and national committees monitoring the stabil-
ity of the financial system and investing in the new Bundesbank financial
stability reports. Financial stability assumed a new importance both to
compensate for loss of monetary policy making and in response to the
increased complexity of financial markets and the associated risks to
central banking operations.
. Differentiating its role from that of BaFin in banking supervision and
internalizing as much operational supervision as possible.
. Reinforcing its reputation as a catalyst in the European integration process
by a leading role in developing and managing an efficient euro cashless
payment and settlement system and in developing the Single Euro
Payments Area (SEPA).
. Opening cash management operations to the private sector and enhan-
cing efficiency of banknote processing (Weber 2006a).
With the notable exception of banking supervision (and cash management

reforms which produced trade-union opposition) this strategic consolidation
154
avoided domestic semi-sovereignty games. Particularly in relation to cashless

payment systems, SEPA, and monetary policy it involved the more comfort-
able realm of professional European-level semi-sovereignty games, where it
adopted the principle: ‘as much integration as possible, as much decentraliza-
tion as necessary’ (Weber 2005b). Here the Bundesbank was playing the game
of promoting European integration, a game that had broad domestic political
support. The situation was more problematic in banking supervision where its
corporate interests were thinly veiled behind its professional arguments about
the virtues of decentralization.
A notable example of Bundesbank task expansion around European integra-
tion was in helping provide the infrastructure that interconnects central
banks, the banking industry, stock markets, and financial markets through
TARGET2 and the TARGET2 Securities—T2S—proposal. These cashless indi-
vidual payment and securities settlement systems were provided through a
single shared platform for the Eurosystem. With the Banca d’Italia and the
Banque de France, the Bundesbank assumed responsibility for developing and
operating this platform, including its legal framework and business organiza-
tion. The Bundesbank was responding to the fact that the largest group of users
was German, and German interest required that it be one of the first states to
switch to TARGET2. The same three central banks, along with the Banco de
Espana, cooperated in the T2S initiative that would use the TARGET2 platform
for securities settlement.
Voting Rules, Treaty Change, and Stability and Growth Pact Reform
The triple processes of Euro Area enlargement, of drafting the Constitutional/
later Reform Treaty, and of Stability and Growth Pact reform created strong
incentives for Bundesbank engagement in safeguarding European stability
culture. In the case of the two latter, the Bundesbank’s principled opposition
opened up tensions with some members of the ECB executive board. Common
to its positions was the stress on retaining the ‘monetary constitution’ of
Maastricht. Retaining the Stability and Growth Pact mattered not just as a
discipline on other EU governments but also as an external means of compen-
sating for the loss of the Bundesbank’s domestic capacity to discipline the
German federal government for lax fiscal behaviour through monetary policy.
EU enlargement was linked to evidence that the Bundesbank model
remained an important influence on the establishment and reform of national
central banks in east central Europe, like the Czech Republic and Poland
(Rentzow 2002). The Bundesbank was also a major source of technical advice
and training to accession state central banks on such matters as payment
systems, banking supervision, and financial market stability. This role was
formalized in its restructured Centre for Technical Central Bank Cooperation
(Deutsche Bundesbank 2005d). However, enlargement was also a source
155
of new challenges. On behalf of the Bundesbank, Stark strongly opposed

proposals for a diminished role for national central banks in the powerful
Economic and Financial Committee, which prepares for meetings of, and
advises, ECOFIN. In 2003 it was agreed that, in the interests of a more efficient
committee in the wake of EU enlargement, NCBs would only attend when
issues involved their tasks and expertise. Stark saw this change as weakening
the capacity of the Bundesbank to address German fiscal policy problems at
the EU level. Stark also stressed the strictest application of the ‘nominal’
convergence criteria to the new member states, with added attention to ‘real’
convergence in GDP per capita.
Similarly, EU enlargement provoked an anticipatory reform of the govern-
ing council of the ECB in 2003 (for details Dyson 2008c). The outcome—a
rotation system—was supported by the Bundesbank. It retained the principle
of ‘one man/one vote’ that the Bundesbank had proposed in the Maastricht
Treaty negotiations whilst differentiating by size in voting rules. The negoti-
ations kept off the agenda the issue of a smaller ECB monetary policy com-
mittee that the Bundesbank feared would centralize too much power in the
ECB directorate. The Bundesbank would be in the large state grouping of five,
with four out of five voting in rotation (a voting frequency of 80%) once there
were 18 NCBs in the governing council.
However, it was reform around a lowest common denominator that satisfied
no particular interest inside the ECB (Dyson 2008c). Members of the German
Bundesbank, and leading German politicians, were critical of an outcome that
did not involve a permanent right to vote of its president, as for the New York
Fed in the US system and that would see the share of the large NCB group in
the total vote fall. Domestic critics viewed the outcome as a further threat to
the primacy of ‘stability-oriented’ policies at a time when this primacy was
being tested by the troubles of the Stability and Growth Pact.
In pursuit of what it defined as its special historical role in the Eurosystem as
the guardian of stability culture, and again led by Stark, the Bundesbank
played an active role in ensuring that the European Convention (2002–3)
and the subsequent IGC did not challenge and undermine the Maastricht
Treaty principles on which the ESCB had been designed. The Bundesbank
viewed the Convention’s final Draft Treaty of July 2003 as highly problematic
(Deutsche Bundesbank 2003). The commitment in the EU objectives to ‘non-
inflationary growth’ was replaced by ‘balanced growth’; only the ESCB was
obliged to maintain price stability. Guarantees of independence for the NCBs
within the ESCB were weakened. In addition, the ECB lost its special status as a
sui generis institution and was to become an EU body. These proposals were
seen as reducing the centrality of price stability, creating opportunities to
weaken central bank independence, and facilitating moves to ex ante coordin-
ation of monetary with other EU policies. On this last point, the Bundesbank
took a stronger stance than the majority in the ECB Governing Council.
156
In contrast to the original draft, the final document signed in October 2004 lay
down not only ‘balanced growth’ but also ‘price stability’ as EU objectives. The
Bundesbank was notably active on this issue.
German breaches of the Stability and Growth Pact from 2001, the crisis of
November 2003 over the German federal government’s mobilization of sup-
port in ECOFIN to avert the next stage in the excessive deficit procedure, and
subsequent discussion about reform of the Pact highlighted the diminished
power of the Bundesbank. It illustrated a more assertive Federal Finance
Ministry, no longer needing to ‘bind in’ the Bundesbank to its positions. Led
by Stark, who had been chief negotiator of the original Pact with Tietmeyer,
the Bundesbank adopted a position of fundamental opposition to reform
(Schäfer and Hagelueken 2005). It identified the problem as a failure to apply
its provisions. The Schröder government sought flexibility in both its terms
and its application so that the Pact would function not just to flank the ECB
monetary policy but also to give governments greater scope for using public
spending and tax policies to facilitate painful domestic structural
reforms. Unlike the Federal Finance Ministry, the Bundesbank was very dissat-
isfied with the final outcome in the 2005 reform (Bundesministerium der
Finanzen 2005; cf. Deutsche Bundesbank 2005c).
Conclusion
Monetary union transformed the Bundesbank into the most Europeanized

institution in Germany; whilst, to a greater extent than the Bank of France
and Bank of Italy, internal reforms helped it to carve out a new role as a model
for domestic public-sector modernization. These two transformations were
crucial to the credibility of its domestic advocacy roles. It promoted the
Europeanization of other German institutions: in particular, those responsible
for fiscal policies (including constitutional reforms to the federal system to
enable an effective national stability pact), for collective bargaining (more
flexibility to compete on unit labour costs), and more generally for economic
policy advice (so that the Euro Area became the frame of reference)
(e.g. Deutsche Bundesbank 2005b). In addition, it became the champion of
domestic public-sector modernization. However, the Bundesbank’s own Euro-
peanization and modernization remained difficult ‘works in progress’. Its
internal transitional problems weakened its capacity to be an influential player
in the Eurosystem.
The loss of the Bundesbank’s authority over monetary policy and migration
of associated expertise to the ECB was the central factor in its diminished
power. This decline was apparent in its power over other domestic actors,
notably the Federal Finance Ministry, and over other NCBs. To characterize
its position in the Eurosystem, Zeitler (2007: 3), vice-president (2006–),
157
resorted to a sporting metaphor: ‘Earlier we were the only player on a small

pitch. Today we are part of a team and the pitch has grown in size.’ Extending
this metaphor, the Bundesbank felt that it lacked adequate off-pitch support,
above all from the federal government in fiscal policy and in banking super-
vision. The Bundesbank was weakened in domestic semi-sovereignty games,
and this domestic weakening undermined its capacity within the Eurosystem.
Nevertheless, power moves in complex, shifting ways. In certain respects the
Bundesbank retained and even increased its power. Whilst it suffered declining
relative power over others, it focused on a Wächterrolle over its unique histor-
ical, intellectual, and legal legacy to the Eurosystem. This ‘guardianship’ role
reflected the Bundesbank’s ongoing indirect structural power—now collectiv-
ized—to effect policy outcomes through the Treaty mandate of the ECB. The
key tests of whether this structural power would endure were represented in
the ECB monetary policy strategy (especially the role and significance of its
‘monetary’ pillar) and in Treaty changes to the ‘monetary’ constitution
(Deutsche Bundesbank 2003). The revised monetary policy strategy and the
Constitutional/Reform Treaty changes suggested that this power remained
intact—though the ‘monetary’ pillar was now secondary to the ‘economic’
pillar. Monetary policy decisions were also consistent with a Bundesbank
trajectory for the Euro Area (Smant 2002). In addition, the gold sales issue
reflected its continuing ability to defend its independence in managing the
foreign exchange reserves. Although no longer able to benefit from the ‘bind-
ing in’ strategy of the federal government, it could count on partisan veto
players threatening Bundesrat veto of government proposals. No less signifi-
cantly, the Bundesbank retained the support of German public opinion as the
most reliable, expert, and independent economic policy institution: and,
consequent on its centralizing restructuring in 2002, it was released from the
former constraints of the federal system on its internal reforms.
This enduring structural power and release from domestic constraints could
not hide the reality that the post-euro Bundesbank was a more humdrum
central bank and, in a dissimilar way to other Eurosystem ‘insiders’, had
been substantially disempowered. It was confined to developing its role in
technical areas like implementing ECB monetary policy, euro payment, and
settlement systems, modernizing cash management, and operational aspects
of banking supervision. Any more heroic pretensions to intellectual leadership
were constrained by the Bundesbank’s less glamorous formal powers. It had
limited success in developing its macro-economic research capacity to
strengthen its intellectual power in the Eurosystem or its influence in domestic
economic debate; in helping promote Frankfurt and Germany as a financial
centre (London remained pre-eminent); in becoming the lead domestic actor
in banking supervision (the Federal Finance Ministry favoured BaFin); or in
shaping the development of financial market supervision at the EU level or
debate about IMF reform and global financial stability. In macro-economic
158
research it was overshadowed by the economic research capacity of the ECB

(though the appointment of Axel Weber as president in 2004 strengthened its
reputation). The federal government further undermined its gravitational pull
by cutting back special Bundesbank salary bonuses. Compared to the Federal
Finance Ministry, it had few levers of power to assist Frankfurt as a financial
centre. Eichel seized the initiative to sweep key decision-making in banking
supervision into a new integrated financial services authority on the British
model; whilst Steinbrück sought to further limit the Bundesbank’s role. The
potential for leadership in European banking supervision through the ESCB
was frustrated by Eichel’s sponsorship of the new CEBS. Although its inter-
national role in the IMF remained, it was more dependent for influence
on coordinating policies in the Euro Group and ECOFIN. Against this
background, central banking talent tended to drift away to the ECB.
Not least, the prestige of the Bundesbank as a privileged economic policy
adviser to the federal government had fallen. No longer was it necessary to
bind in the Bundesbank to economic policy proposals. Possibly the clearest
testament was the powerlessness of the Bundesbank’s opposition to the Schrö-
der government’s support for a more flexible Stability and Growth Pact. Symp-
tomatic of its strategic interest in strengthening its visibility in German
economic policy debate, above all vis-à-vis the Finance Ministry, was the
publication of the Bundesbank’s own projections of German economic devel-
opment from late 2007. This move aimed to capitalize on greater public trust
in the Bundesbank to avoid politically motivated economic projections and to
project its role in the Eurosystem to domestic audiences.
159
7
Bank of Greece: Latecomer,
Uphill Adjustment
George Pagoulatos1
Why should the Bank of Greece warrant particular attention? In the early 1990s,
Greece posted the worst record among all EU member states in terms of deficits
and inflation. The story of Greece’s EMU accession is the uphill adjustment
course of the most laggard of EU-15 economies, steered successfully by the
country’s central bank, the Bank of Greece. Thus, Greece was a latecomer in
the Euro Area. It was the only state that wanted but could not enter in 1999 and
remained in the antechamber for two more years before finally managing to
accede alone in 2001, into stage three of EMU. This late accession was not a
function of weak will but of acutely problematic initial macroeconomic condi-
tions, testifying to the intensity of the adjustment enterprise and the scale of the
final achievement. The Bank of Greece steered this arduous monetary adjust-
ment course, led by Governor Lucas Papademos, who subsequently became
vice-president of the European Central Bank. The wide initial gap between
capabilities and expectations, and the central bank’s leading role in bridging
the gap, makes Greece a particularly revealing case study. The Bank of Greece
offers a hard case of successful application of the orthodox EMU adjustment
strategy, led by a rigorous and consistent disinflationary monetary policy.
The Bank of Greece (BoG) historically underwent three main evolutionary
stages, following closely the European trend. Initially, a strong central bank
was founded in 1928, in order to establish the monetary guarantees that would
safeguard the interests of international creditors. The BoG was one of the
central banks established by the League of Nations Financial Committee,
endowed with the exclusive right to issue currency, a strong orthodox mon-
etary and exchange-rate policy orientation, and important statutory guaran-
tees of legal independence (Mazower 1991: 103 ff.; Pepelasis-Minoglou 1998).2
Subsequently, in the early post-war period, the Bank was subjected to extensive
161
Bank of Greece: Latecomer, Uphill Adjustment
financial intervention, seeking to combine monetary stability under the

Bretton Woods system with the provision of targeted credit to sectors and
activities deemed to be conducive to economic development. As had occurred
in other countries such as France or Spain, in 1946 the Bank of Greece was
subsumed under a governmental Currency Committee, which undertook all
responsibility for exchange-rate, monetary, and credit policies. The Currency
Committee was abolished in 1982, but the post-war interventionist apparatus
persisted for a few more years, until a piecemeal process of deregulation began
in 1987. Subsequently into the 1990s the Bank was gradually freed from
government intervention and vested with full institutional autonomy in the
process of preparing to join the EMU institutions.
While the chapter will focus on this latter third period of central bank
convergence under the EMU programme, it is worth noticing the crucial
impact of the European political economy context on every major stage of
the BoG’s historical development. But before examining the external ‘push’
factors of central bank change, we shall take a closer look at the domestic
context within which the BoG operated.
Although the definitive driving force in transforming the central bank’s role
into one of full institutional independence came from the external EMU
framework, its impact was mediated by the domestic structural, institutional,
and politico-economic context.
Two main arguments will be advanced:
(a) Domestic economic governance failures and the institutional features of
the domestic capitalist and politico-administrative system over the years
generated significant demand for a more influential role of the central
bank (Quaglia 2005a).
(b) The BoG’s widely perceived success (defying negative expectations) in
navigating the Greek currency into the Euro Area endowed it with
formidable political capital, which, however, in the new post-accession
EMU framework, was not to remain entirely intact.
The Politico-Administrative System, National Capitalism, and

Patterns of Economic Governance
By the time of initiation of EMU and the Maastricht Treaty of 1993, the long-
standing and structural features of Greece’s political economy corresponded to
what has been broadly, albeit impressionistically, identified as a Southern Euro-
pean model. Several—though certainly not all—of the main patterns of the
Greek system may be generalizable across Southern Europe: a post-war tradition
of far-reaching financial intervention, with a traditionally credit-based, under-
developed financial system (Zysman 1983), weak, mostly state-controlled and
162
domestic-oriented banks, and a use of state-administered credit for a combin-

ation of developmental and political purposes. In addition, these countries
exhibited a lack of proper social concertation in a version of parentela pluralism,
distinguished by party/government control over the unions, the latter domin-
ated by wider public-sector representatives (Pagoulatos 2003a: 160 ff.). The
private business sector had been traditionally dualistic and protected, losing
significant ground in terms of productivity growth and international competi-
tiveness during the high-inflation, post-1973 period until the early 1990s.
The extensive though ineffective state control over the economy and society
has been rooted in structural features of the politico-administrative system, the
Greek state being characterized as a ‘colossus with feet of clay’ (Sotiropoulos
1996). Public administration has been the principal target of party political
patronage, intensified in the framework of an adversarial parliamentary sys-
tem. Two parties (centre–right New Democracy and socialist PASOK) have
alternated in government since the 1974 transition to democracy. For the
first two post-authoritarian decades, party competition was characterized by
intense politico-ideological polarization in a centrifugal two-party system,
where differences between the two parties were deliberately magnified, espe-
cially on the part of PASOK. It was only after 1993–4, with the socialists’ return
to power, that the two parties converged over a commonly shared objective of
acceding to EMU. Since then the two-party system has acquired strong centri-
petal tendencies. Each party, while in power, attempted to colonize the bur-
eaucracy with clientelistic appointments, not just in the higher echelons but
throughout the public sector. It was only as late as 1994 that a general exam-
ination process of entry to the public administration was instituted, and even
after that occasionally circumvented. As a result of such patterns, the Greek
state overall fell short of an elite civil service that could vest public policy with
higher consistency and continuity, filtering out excess politicization.
Policy discontinuity had been a steady feature of economic policymaking
until the early 1990s, marking not only government alternation in power but
often policies under the same government. Dismal economic performance had
been another feature, especially between the late 1970s and early 1990s,
reaching its worst in 1989–90, when a prolonged electoral climate, three
consecutive national elections within less than a year, and successive coalition
governments had raised the public deficit and inflation to record levels in 1990
(Figures 7.1 and 7.2). Under government control, the BoG in the post-
authoritarian period was forced to accommodate expansionary or at best
‘stop-go’ macroeconomic policies. The political identification of price stability
with the mostly Right-wing or authoritarian post-war governments blunted
socio-political reflexes against inflation. By the second half of the 1970s, a
considerable section of the Greek public and body politic even positively
identified a more lax and inflation-accommodating macroeconomic stance
with progressive politics.
163
40
38
Elections 1981
36
34
32
30
28 Elections 1985
26
24 Elections 1989
22 Elections 1977
20
18 Elections 1990
16 Elections 1993
14
12
10
8 Elections 1996
6
4
2
0
1975 1980 1985 1990 1995 1999
Inflation (CPI) Money Supply (M3) annual change

Deficit (-) of General Government (% GDP)
Figure 7.1. The Greek electoral cycle: fiscal and monetary expansion, 1975–99
Sources: Pagoulatos (2003a); Ministry of National Economy (1998, 2001); Bank of Greece (1993–
2001).
35
30
25
20
15
10
5
0
1960 1970 1980 1990 2000
−5
−10
−15
−20
Inflation (CPI) Nominal saving deposit interest rate
Short-term bank lending interest rate Short-term bank-lending deposit
Real lending interest rate rate spread
Figure 7.2. Greek inflation, interest rates, and short-term bank-lending deposit rate
spread, 1950–2000
Sources: Pagoulatos (2003a); Bank of Greece (1992, 2000); Ministry of National Economy (2001).
164
After 1974, monetary authorities relied extensively on crawling peg or cur-

rency devaluation as means of recovering the losses of competitiveness under
conditions of high inflation. After exceeding 25 per cent in 1973, double digit
inflation persisted for three decades, peaking in 1980–1, 1985, and 1989–90, all
key moments of the electoral cycle (Figure 7.1). Indeed, electoral cycles in the
exercise of monetary and fiscal policy were evident throughout the period in
question, exacerbating inflation and deficits in the aftermath of national elec-
tions. Given its obvious lack of independence, the BoG was not to be blamed
for the monetary policy failure. It stood however to receive much of the credit
for the successful EMU adjustment that was about to follow in the 1990s.
Overpoliticization, bureaucratic inefficiency, prolonged economic policy
failure, and declining trust in the two main parties’ capacity to spearhead
Greece out of its economic crisis by the early 1990s had created favourable
conditions for a more active and autonomous policy role of the BoG in
bringing about macroeconomic stabilization. The conditions of intense and
prolonged macroeconomic instability, and the fear that Greece was bound to
miss the EMU train and become marginalized in the EU, led business and
socio-economic groups from the beginning of the 1990s and throughout the
decade to demand greater effectiveness in curbing the high levels of inflation.
This also generated positive political capital for the BoG. Non-governmental
actors, especially business, aspired to enter the framework of stability and
predictability associated with a strong European currency. The transition
cost of getting there (high lending rates) was not an adequately discouraging
factor: business owners also held financial assets such as government bonds
and repos, whose value increased during transition. Except for the commu-
nist and post-communist Left, trade unions (mostly leaning towards the
socialist PASOK) also partook in the bi-partisan consensus over EMU accession
(Pagoulatos 2003a: 129–30).
Thus in the early 1990s, two important, causally related processes were
simultaneously witnessed: first, a long tradition of economic policy failure
rooted in persisting patterns and domestic structural features; and, second,
the emergence of a clear, tangible, and widely shared programmatic objective
(EMU accession), whose desirability was proportionate to the gravity of
Greece’s perceived economic failure and fear of EU marginalization. The dis-
junction between policy desideratum and reality generated demand for a
leading BoG role in pursuing nominal macroeconomic adjustment, even
more so given the primacy of monetary stabilization in the entire EMU con-
vergence programme.
Along with the demand conditions, the supply factors were there. The main
supply factor was, of course, the EMU programme of central bank independ-
ence. A second supply factor operated at the domestic level and had to do
with the government itself. The BoG institutional weakness of the 1970s and
1980s fostered the conditions for its drastic strengthening in the 1990s as
165
precondition for the successful exercise of monetary policy. It derives from the
orthodox literature that governments may well have a positive interest in
allowing their central bank a significant degree of autonomy, institutional
independence being considered a factor enhancing central bank credibility
and effectiveness in combating inflation (Cukierman 1992; Giavazzi and
Pagano 1988; Gilardi 2002). This is even more the case with governments
plagued by inadequate resources, poor policy effectiveness, and questionable
credibility. Of particular concern to state actors is the issue of creditworthiness:
harsh market penalties (in the form of higher premiums) await borrower
governments lax in combating inflation. For these reasons, the dominant
orthodoxy held, it is desirable for democratic governments to have one macro-
economic policy instrument which can respond exclusively to the technical
requirements of the economy, and to achieve that it is in their interest to
extend a significant degree of central bank autonomy (Woolley 1985: 334).
By the early 1990s prolonged macroeconomic instability was turning into
serious political liability. The socio-economic demand for currency stability in
the face of persisting high inflation ended up empowering the central bank,
leading government to entrust it with more decisive control over monetary
instruments in pursuit of disinflation. Thus, domestic economic policy failure,
rooted in enduring patterns and structural factors, created favourable condi-
tions for a bolder, active BoG involvement in the EMU adjustment process.
The growing distance between the emboldening pace of European economic
integration and Greece’s lagging policy performance in meeting its challenges
during the 1980s and early 1990s generated a vacuum of economic policy
leadership. Bolstered by the rapidly rising importance of central banking
after Maastricht, and the favourable economic, politico-institutional, and
ideational conditions in the EU, the Bank of Greece rushed to fill the void.
From Interventionism, Through Liberalization, to Independence

to the Eurosystem
The Bank of Greece: Resource Superiority and Policy Continuity

Since its establishment the BoG was endowed with ample finance and a
consistently high quality of human resources. The governor’s seat has been
normally held by high-level technocrats, who overall exhibited significant job
tenure and continuity (Table 7.1). A combination of undisputed technocratic
competence, a consistent appearance of political neutrality, flexibility in deal-
ing with government, and a long-standing career with the BoG have historic-
ally proven strong assets for survival from government changes.
The sheer number and quality of the BoG staff always placed it in a position
of unrivalled superiority compared to any other government agency or bank
166
Table 7.1. Bank of Greece governors, 1946–2008
Appointment year Governor Previous office held
1946 Georgios Mantzavinos BoG Deputy Governor

1955 Xenophon Zolotas BoG Co-Governor
1967 Dimitrios Galanis BoG Deputy Governor
1973 Constantinos Papayiannis One-time Finance Minister
1974 Xenophon Zolotas BoG Governor
1981 Gerasimos Arsenis UNCTAD official
1984 Dimitris Halikias BoG Deputy Governor
1992 Efthymios Christodoulou Alternate Economy Minister
1993 Ioannis Boutos Ex-Coordination Minister, MP
1994 Lucas Papademos BoG Deputy Governor
2002 Nicolaos Garganas BoG Deputy Governor
2008 Georgios Provopoulos Former Commercial Bank CEO
institution. Career tenure and favourable employment circumstances of the

higher-ranking personnel, their similarity of academic backgrounds, closeness
of technocratic views and professional attitudes, considerable exposure to
European policy milieus (especially since Greece’s 1981 entry to the EC), and
considerable stability in service have all been factors enhancing the Bank’s
effectiveness in formulating policy. Such conditions have been rather atypical
in the Greek civil service, where remunerations have been lower, working
conditions poorer, recruitment mostly non-meritocratic, and promotions
more subject to party political criteria (Spanou 1998).
Consistency and continuity characterized the Bank’s policy orientation over
the years, not unrelated to the exposure of BoG staff to similar epistemic
influences. Evident in the similarity of content and style of the governors’
annual reports, continuity owed much to the fact that the Bank was tradition-
ally able to develop its own internal hierarchy. Successive BoG administrations
relied strongly on the same infrastructure of economic advisors, department
directors, and deputy directors for the formulation of policy. As a result, when
the surrounding conditions became conducive for a major monetary policy
shift, the BoG commanded all the necessary resources for shaping policy, knew
what its policy objectives were, was willing to pursue them, and was able to do
so effectively by keeping its policy realm relatively under control.
Liberalization as Precondition for Monetary Policy Effectiveness

The introduction referred to a third stage of BoG evolution defining its course
towards institutional independence and EMU accession. Three sub-stages
can be distinguished: first, transition to institutional independence via credit
deregulation (1987–94); second, steering EMU convergence (1994–9—1999
being the year of the EU Council decision on Greece’s EMU entry—coinciding
with stage two); and, third, 2000–present, with official participation in pre-
paring stage three of EMU, the launch of the euro, and life in the Eurosystem.
167
The BoG course to institutional independence, monetary stability, and EMU

accession began with pursuing a vital precondition of monetary policy effect-
iveness: domestic credit liberalization. Direct state-administered interest rates
(over 90 different categories existed in the early 1980s) prevented the central
bank from applying its monetary policy. Usually fixed at low levels in order to
benefit favoured recipients including predominantly the government, nom-
inal interest rates rose much more slowly than inflation, and remained nega-
tive in real terms through most of the 1973–87 period (Figure 7.2). Monetary
stabilization required the central bank to be able to raise real interest rates to
European levels and above, and that was predicated on interest rate liberaliza-
tion (Figure 7.3).
Two facets of the financial regime got in the way of central bank policy
effectiveness: credit intervention and its lack of institutional autonomy. The
BoG’s political dependency, government control over the majority of the
banking system, and the obligatory bank investment requirement in govern-
ment securities, all amounted to a soft budget constraint that enabled the
heavy politicization of economic intervention in the late 1970s and especially
through the 1980s.
Credit intervention had rendered monetary policy highly inflexible by
multiplying the political cost of either monetary stabilization or the return
to a less discretionary regime. Thus, following PASOK’s 1985 re-election, after
which an alarming balance of payments shortfall, a galloping public deficit,
and inflation in the 20 per cent area was revealed, the BoG prioritized
credit deregulation as a vital precondition for obtaining monetary policy
18
16
14
12
10
8
6
4
2
0
−2 1980 1990 2000
−4
−6
Greece EU average
Figure 7.3. Real short-term interest rates: Greece and EU, 1980–2000
Sources: Pagoulatos (2003a); IMF (2000); Ministry of National Economy (1998, 2001).
168
effectiveness. The European single market programme (dictating the abolition

of a range of subsidies granted through the credit system) and a post-election
EC balance of payments support loan (incorporating measures of credit
deregulation among its terms) offered the crucial opportunity (in the form of
an external constraint) for the BoG to initiate a gradual programme of financial
liberalization. This was concluded in the first half of the 1990s, amounting to
what the Financial Times characterized as a ‘silent revolution’.
As part of the European single market programme, the prospect of capital
liberalization in the EU (which for the countries of the periphery, including
Greece, had to be completed by 1994) necessitated far-reaching domestic
financial reform. For the right sequencing to be followed, domestic credit—
including interest rate—liberalization had to precede external capital liberal-
ization. Several important, mostly preparatory, measures were taken during
1985–7, but the seminal act of liberalizing the lending rate was implemented
in June 1987 (Figure 7.2). Rising real interest rates testified to the restrictive
direction of monetary policy, which led macroeconomic adjustment.
Although the 1985 stabilization programme was abandoned in 1987, it was
the first systematic move towards the orthodox economic adjustment orien-
tation that would prevail throughout the 1990s. The gradual deregulation
process was slowed down for electoral purposes in 1988–90 but acquired new
momentum with the 1990 rise of the centre–Right New Democracy govern-
ment. A key element of this piecemeal ‘revolution’ was the momentous mon-
etary policy shift from direct to indirect monetary control.
The BoG discourse of the 1980s–90s illustrates the argument underpinning
the policy shift. It recognized that the emergence of persistent fiscal deficits
and inflation after the 1970s had dramatically altered the conditions for the
effective exercise of monetary policy. Direct credit controls, the post-war state’s
leading stabilization instrument, were becoming increasingly incapable of
stabilizing the economy: as public deficits were pushing money supply growth
upwards, it was hard to control credit supply without changing the interest rate
levels. However, as administered interest rates were subject to political bargain-
ing, they prevented the central bank from applying its own interest rate policy.
Special obligatory investment ratios and the borrowers’ recourse to the infor-
mal credit markets precluded the central bank’s exercise of effective monetary
control (BoG 1987: 37). Government securities forced upon the banking
system at a government-determined interest rate forestalled the central
bank’s exercise of open market policy. Without open market operations (buy-
ing and selling government securities), the central bank was unable to control
effectively the interest rate. Only a developed money market, according to the
underlying central bank view, would allow effective control of monetary
aggregates by enabling the central bank’s regular unobstructed response to
short-term liquidity changes (BoG 1987: 42). Domestic financial liberalization
was thus deemed necessary to allow the central bank to employ its indirect
169
monetary policy instruments more effectively towards disinflation, and

respond more flexibly to the restrictive conditions of international markets.
External Pressures and Transmission Belts

The two major reform projects of the BoG in the 1980s and 1990s (financial
liberalization and monetary reform culminating in Euro Area accession) were
both externally induced and domestically demanded, brought about as a
result of converging pressures and the pull factors already mentioned.
Gradually, from the second half of the 1980s, the international and Euro-
pean disinflationary regime was internalized into domestic economic policy-
making and institutional design. Various transmission belts cooperated in
bringing about adjustment to the disinflationary international regime and
the neo-liberal–leaning economic paradigm of the 1980s, helping transform
external pressures into domestic policy output.
In one of the various proposed typologies, Europeanization mechanisms
have been classified using a two-dimensional framework and distinguishing
between material versus cognitive, and direct versus indirect (Dyson 2002b: 13
ff.). Material mechanisms involved processes of hard or softer regulation and
harmonization, for example, the Exchange-Rate Mechanism of the EMS (direct)
and market interdependence or the threat of capital flight (indirect); cognitive
mechanisms referred to the vertical diffusion of ideas of the sound finance
paradigm (Dyson 2000, 2002) (direct) and the horizontal emulation of ‘best
practices’ in central banking through processes of elite networking (indirect).
These processes operate as transmission belts in passing international policy
pressures and blueprints into the national policymaking system. Sector-level
developments underlay the broader epistemic shifts towards greater profession-
alization and ‘scientization’ in the banking and financial communities, as
argued by Marcussen in this volume. Adjustment was a Europe-wide phenom-
enon, though implemented with different timing, sequencing, and scope.
Cross-national variation resulted from dissimilarity of institutional endow-
ments, domestic economic conditions, and socio-political context.
Over the 1980s and into the 1990s, South European financial intervention
(in Greece as well as Italy, Spain, and Portugal) was dismantled by liberaliza-
tion (Pagoulatos 2003b). The European single financial market programme,
complemented by EMU, represented an affirmation of the rising importance
and power of the internationalized financial sector and central banks (Dyson,
Featherstone, and Michalopoulos 1995). Moreover, the new strict ‘sound
finance’ orientation satisfied the typically inflation-averse European bankers.
This paradigm shift incorporated the additional dimension of elite network-
ing and peer pressure within the European expert community of central
bankers. Long before the negotiation of the Maastricht Treaty, the central
banks of EC member states had developed numerous informal cooperation
170
practices and networks, cultivating their mutual relations (Andrews 2003).

These practices evolved rapidly in the 1990s. From the second half of the
1970s, in view of Greece’s prospective entry into the EC in 1980, expert
contacts and exchange between BoG officials and technocrats and their Euro-
pean counterparts became more systematic. The interaction of EC with Greek
government and central bank officials was intensified after the 1985 EC bal-
ance of payments support loan and the European single market programme.
The domestic expert banking community became increasingly subject not
only to the fashionable monetarist ideas of the time but also to the personal
influence of their peers. By the mid-1970s the idea that ‘money matters’, the
case for banking competition and the perception that credit regulation
was responsible for serious ‘rigidities’, ‘distortions’, and ‘misallocation of
resources’ (terms that were to prevail in the Greek banking discourse of the
1980s) had already captured the minds of European central bankers and were
being elevated to virtual monetary orthodoxy.3
International monetary instability, combined with growing levels of capital
mobility, eventually necessitated a more or less universal shift of Western
countries to disinflation over the 1980s. The Greek domestic response to the
international momentum of financial liberalization and disinflation was
delayed, initiated only well into the second half of the 1980s, mediated as it
was by domestic socio-political factors. Thus the initial response was inertia, if
not retrenchment. But at that initial stage external pressure was still mostly
ideational or structural and indirect (related to the changing international
economy) and had not yet been vested with the force of hard conditionality.
Such became the case after the European single market programme, the bal-
ance of payments support loans of 1985 and 1991, and finally the EMU
programme.
The Decade of Adjustment (1990–2000)

The April 1990 election brought to power a neo-liberal–leaning, centre–Right
New Democracy government, whose official ideological and political pro-
clamations contained unambiguous commitment to liberalization and macro-
economic adjustment. So the EC, whose pressure by that time had intensified,
found a cooperative partner. By 1990 the bulk of credit deregulation was
completed, though specific loan categories were still being subsidized. For
three consecutive years before 1990 monetary targets had been overshot,
with liquidity expanding due both to the abolition of credit controls and to
the swelling government deficit. In 1990 the BoG’s restrictive monetary policy
was closely adhered to—facilitated by the 1990 Stock Exchange boom, which
alleviated demand previously exerted on the credit system.
The non-accommodative monetary policy inaugurated in 1990 (‘hard
drachma’ and high real interest rates) continued with new vigour under the
171
PASOK governments of Andreas Papandreou in 1993 and Costas Simitis in

1996. Garganas and Tavlas (2001: 45 ff.) single out 1994 as the actual transi-
tion year to the ‘hard drachma’ policy regime, with 1991–4 being the transi-
tion phase to an increasingly effective monetary policy. Throughout the
1990s, the EMU roadmap sustained an overall ambitious reform momentum,
anchored on a sequence of tangible, measurable, and increasingly feasible
steps, at the end of which lay the prize of euro accession. Euro Area accession
was contingent on the participation of national currencies in the Exchange-
Rate Mechanism (ERM). The combination of liberalized capital movements
and stable exchange rates necessitated the full alignment of national monet-
ary policies behind the ERM, even for those EC/EU member states that had
not yet entered the ERM. By 1998, when Greece joined the ERM, there was a
growing sense of attainability of the EMU nominal convergence targets.
Greece was officially admitted to the Euro Area in June 2000 and joined on
1 January 2001.
The importance of the external constraint factor cannot be exaggerated
(cf. Dyson, Featherstone, and Michalopoulos 1995; Featherstone 2003). The
successful drachma devaluation in March 1998 and ERM entry, in an envir-
onment of free capital movements (fully liberalized after spring 1994) and
high interest rate differentials, led to massive inflows of mainly short-term
capital. Apart from causing a liquidity surplus in the interbank market,
which necessitated sterilization operations by the BoG, these inflows posed
constant threat of a reverse outflow at the first signals of a government
retreat from its announced policy targets. The imminence and salience of
this external constraint exercised a most potent suasion for economic adjust-
ment. The BoG viewed the ERM as a stabilizing framework on inflationary
expectations, wage bargaining, and pricing behaviour and as a reinforcing
factor for policy credibility, allowing consistent stability-oriented monetary,
fiscal, incomes, and structural policies (Voridis, Angelopoulou, and Skotida
2003: 34).
The Monetary Policy Shift and the Political Ascendance of the BoG
Over the 1990s, financial liberalization and monetary adjustment led to
macroeconomic convergence in three closely related ways. First, as men-
tioned, financial liberalization was the sine qua non precondition for allowing
monetary policy to become assertive and carry the brunt of stabilization.
Liberalization allowed the introduction of new instruments of monetary man-
agement. It enabled the BoG to rely flexibly on open market operations,
seeking to influence short-term interest rates in the interbank market as its
main intermediate goal. Second, financial liberalization generated flexible
conduits of intermediation: mostly short-term government securities markets
and the associated distribution channels such as mutual funds. After the
172
government had shifted away from deficit monetization, they allowed for
public deficits to be absorbed by private investors. Third, the greater role of
private investors in public deficit financing subjected government to stricter
discipline in its monetary and fiscal policies (OECD 1995: 58–60).
In its annual reports of the early 1990s, the BoG mentioned the balance of
payments, GDP growth, and banking liberalization as additional secondary
objectives to the reduction of inflation. Following other central banks, however,
it was already succumbing to the appeal of monetary targeting. After capital
movements were fully liberalized in 1994, the BoG adopted an exchange-rate
intermediate target (publicly announced on an annual basis), alongside its
monetary target. Progressively the monetary target was de-emphasized, and
the BoG after 1997–8 endorsed a version of inflation targeting, setting the
ultimate inflation objective for two years ahead (Bank of Greece, various years;
Voridis, Angelopoulou, and Skotida 2003).
Until 1994, the BoG was clearly not independent (Pagoulatos 2003a).4 After
1994, when the Maastricht-imposed abolition of the monetary financing of
government deficits entered into force, the BoG satisfied all the formal criteria
of economic independence. Finally, in the context of full statutory harmon-
ization with the Eurosystem, law 2548 of December 1997 (‘Provisions relating
to the Bank of Greece’) granted the BoG complete institutional independence
and stipulated that ‘the primary objective of the Bank of Greece shall be to
ensure price stability. Without prejudice to this primary objective, the Bank
shall support the general economic policy of the government.’ The law estab-
lished BoG independence from any government instructions or advice, exclu-
sive authority in the exercise of monetary policy, a six-year renewable term for
the governor and deputy governors, and a Monetary Policy Council (compris-
ing the governor, the two deputy governors, and three additional members).
The Monetary Policy Council, which began to operate in 1998, was assigned
responsibility for decisions pertaining to monetary policy definition and
implementation and to the conduct of exchange-rate policy, the operation
of payment systems, and the issue of banknotes.
The primacy of the euro accession objective, in an adverse environment of
large deficits and a tradition of lax monetary and fiscal policies, endowed the
central bank with extraordinary political authority. The BoG has been widely
credited for Greece’s accession to the Euro Area. Crucial after 1994 was the
presence at the helm of Professor Lucas Papademos, a widely respected mon-
etary economist and pragmatic proponent of the orthodox mix of drastic
disinflation and fiscal overhaul, combined with growth-enhancing structural
liberalization.
Thus the cross-party political adoption of euro entry as a ‘national object-
ive’, combined with the acute macroeconomic conditions, led to a momen-
tous increase of central bank power. In sum, the gains of central bank
authority in the domestic socio-political system were a combined result of its
173
endowment with formal institutional independence after 1994 and the suc-
cessful implementation of the Euro Area accession mission.
Financial System Transformed

Although monetary austerity implied burdensome restrictions on their liquid-
ity, Greek commercial banks were able to benefit in the high interest-rate
period that followed liberalization by retaining wide interest-rate spreads,
indicative of the sector’s persisting oligopolistic structure. The ‘hard drachma’
policy that followed banking liberalization until ERM entry was a boon for the
(sheltered) financial sector, allowing banks to reap sizeable profits from a
growing volume of financial transactions in a steadily appreciating (in real
terms) national currency. Higher interest rates served not just the ‘public’
objective of disinflation but also eventually the commercial banks’ preference
for market-determined interest rates. The large volume of bad loans accumu-
lated by the state-controlled section of the Greek banking system necessitated
a central bank strategy of enhancing bank profitability, in view of the Second
Banking directive and the subsequent capital adequacy standards of the Basle
framework (Pagoulatos 1999).
In the aftermath of liberalization, and despite competition by non-bank
financial institutions, Greek commercial banks overhauled their portfolios,
solidified their capital bases, and reaped remarkable profits by colonizing the
new financial markets and institutions. Liberalization (especially after 1994
when capital movements were freed) advanced banking interests by lifting
imposed obligations and restrictions, and releasing opportunities for profit.
Government recourse to public debt markets enhanced the banks’ bargain-
ing power, given their role as principal buyers of government paper. They
were able to place their assets in risk-free government securities, and nego-
tiate not only market rates but also other significant concessions, such as
underwriting privatization schemes and financing large-scale infrastructure
projects.
Euro Area membership entailed far-reaching transformations. Among
others, the transition from a high-inflation to a low-inflation economic envir-
onment generated certain long-term financial markets (such as fixed-interest
mortgages or long-term debt instruments) that were non-existent or dormant
during the inflationary period. As EMU convergence was realized in Greece,
the yield curve for government securities was extended to 20 years, a marked
improvement over the conditions until just 1998, when only short-term
maturities were issued. EMU consolidated the disintermediation shift of the
1980s and 1990s: that is, the shift from bank lending to transactions in
securities. In Europe as well as in Greece, the movement from bank-based
towards increasingly securitized finance was followed by growing ‘equitiza-
tion’ from the late 1990s.
174
Equity capitalization in Greece rose from 2 per cent of GDP in 1985 to 15 per
cent in 1994 up to 169 per cent in 1999, then receding to 98 per cent in 2000
following the decline of stock prices (Capital Market Committee 2001: 40). As
in continental Europe, financial liberalization in Greece has notably increased
the role of the capital market but has not as yet reversed the financial system’s
bank-based character. Liberalized banking competition is thus the main after-
math of financial deregulation, involving important efficiency as well as sys-
temic safety implications. These shape the novel environment in which the
BoG’s supervisory responsibility is exercised. Liberalization increased bank
competition in interest rates, though with a significant time lag. Falling lend-
ing rates and more aggressive banking competition animated demand for
credit, which had been suppressed by the high interest rates over much of
the 1990s. Consumer credit grew at an average annual rate of about 40 per cent
over the period 1994–2000, but the ratio of consumer credit to GDP in 2000
was only 4.5 per cent in Greece compared to 10 per cent in the Euro Area
members. Similarly, the corresponding ratio for mortgage lending in 2000
stood at about 8 per cent compared to the EU average of 40 per cent. By
2006 the figures were converging to Euro Area standards.
On the assets side, banks developed trading activities and securitization
operations (including fees opportunities for advising and underwriting),
while the fall of traditional deposits from the 2000s was countered by the
rise of money market mutual funds and other liabilities (Belaisch et al. 2001).
Income from the management of investment and pension funds controlled by
the larger banking groups has been assuming important proportions in Greece
and throughout the Euro Area. In 2000, the majority of mutual funds operat-
ing in the Greek market were banking group subsidiaries. Moreover, the copi-
ous windfall income achieved from securities trading, especially during the
Greek stock market boom of 1998–9, allowed banks previously burdened with
bad debts to clean up their portfolios and list very high profits.
Under the Eurosystem: A Redefined Role

Surrendering monetary policy to the ECB allowed the BoG to focus on its other
areas of institutional responsibility. The new role entailed increased emphasis
on two main areas: banking supervision (an area of weakness in the past), and
research and information. The BoG developed communication policies of
public dissemination and systematic promotion of special studies and research
initiatives. It also undertook a new set of responsibilities for the more efficient
functioning of the Eurosystem, involving mainly the modernization of mater-
ial and technological infrastructures, the establishment of collaboration net-
works, and their staffing with personnel of high quality and expertise.
The BoG has always relied on an elite research department, but Euro Area
accession placed renewed emphasis on the recruitment of high-level technocratic
175
personnel of postgraduate and PhD level. As Dyson and Marcussen underline

in this volume, the Eurosystem brought a major adaptation of the central bank’s
mission towards stronger research and data analysis. The staff training
programmes reveal the novel areas of BoG interest as part of the Eurosystem:
the operation and security of information systems; the global understanding and
evaluation of Greek and international capital and money markets; the operation
and efficient use of new financial instruments in risk management; foreign
exchange management; e-banking risks; new international accounting stand-
ards; and effective banking supervision.
Facing these new circumstances, the BoG restructured its Economic Re-
search Department to respond to its obligations under the Eurosystem to
improve the analysis of current economic developments and participate in
drafting economic projections. In 2000 a separate Statistics Department was
created, under which came several services formerly belonging to the Eco-
nomic Research Department. Thus the BoG acquired two distinct Departments
specializing in research. Both have been staffed with expert scientific person-
nel, producing a significant number of BoG publications. Over the last few
years, the Governor’s Annual Report has been visibly upgraded, in both vol-
ume and quality, and two publications have been added (Monetary Policy
Annual Report and Monetary Policy Interim Report), all officially submitted
to the Greek Parliament. As part of central bank accountability, the BoG
Statute (Article 5B) provides that the Governor, when asked, shall appear
before the competent parliamentary committee to report on BoG-related mat-
ters. The BoG has expanded its statistical and economic bulletin series,5 and in
2003 a new series of BoG Working Papers was launched (around 20 academic
and policy-oriented papers in English are published annually).
The Information Systems Department was restructured. The BoG launched
the Electronic Secondary Securities Market and created a Help Desk Unit, an
Information Systems’ Security Unit, and an Alternative Information Technol-
ogy Centre. The Information and Communications Office, assigned with
mastering the Bank’s website, was upgraded in 2002 into the Communication,
Press and Management Section within the Administration Department. This
latter change was justified as part of the ECB strategic plan of improving
national central bank communication policies, in a twin effort to facilitate
the understanding of monetary policy and Eurosystem functioning and to
promote the ECB principles of openness, transparency, and accountability.
With the surrender of national monetary policy to the ECB, the responsibil-
ities of the BoG Monetary Policy Council were reduced to a mere analysis of
monetary and economic policy developments and of the domestic impact of
monetary policy. The BoG contribution in the monetary policy domain is thus
confined to implementing ECB guidelines and supervising the payments sys-
tem. Here too organizational restructuring followed institutional and policy
change. Initially, in 2000, the Monetary Policy and Banking Department
176
acquired an office assigned with the oversight of payment systems, aiming to

safeguard the latter’s integrity and credibility. In 2003, the Monetary Policy
and Banking Department was abolished, and its operations were subsumed
under the newly established Financial Operations Department and Depart-
ment for the Supervision of Credit and Financial Institutions (see Figure 7.4).
The BoG structure was affected by the transfer of exchange-rate policy to the
ECB. Its operations and activities were partly re-oriented from international
markets and transactions to the Eurosystem, aiming to strengthen the cooper-
ation networks of Euro Area central banks at the expense of a more independ-
ent international orientation. In 2000, a Risk Management, Performance
Measurement and Foreign Exchange Liquidity Section, and an International
Markets Research and Analysis Section were created under the Foreign
Exchange Department. In 2003, the International Transactions Department
was abolished, and the Foreign Exchange Department was restructured into
Financial Operations Department. This new department was upgraded, under-
taking the exchange-rate policy-related responsibilities of the recently abol-
ished Monetary Policy and Banking Department, and assuming a broader role
within the Eurosystem. The office for the Oversight of Payment Systems was
upgraded into a fully fledged Payment Systems Department, while a novel
Strategic Planning and Organization Department was created.
Banking liberalization shifted the central bank’s approach in banking super-
vision from emphasizing compliance with administrative regulations to
focusing on the risks involved in the functioning of the banking system.
Mirroring the evolution of regulatory standards under the Basle capital ade-
quacy framework, the central bank’s supervisory agenda addresses not only
solvency, liquidity, and concentration of risks but also matters of effective
corporate governance of credit institutions in terms of good administrative
and accounting organization and internal control structures.
The scope of the BoG supervisory responsibility grew following the expan-
sion of non-bank financial market institutions subject to its supervisory juris-
diction. In addition to commercial banks, its responsibility includes special
credit institutions (e.g. the Loans and Consignment Fund and the Postal
Savings Bank), cooperative banks, leasing, factoring, and financing companies
and exchange bureaux. The Capital Market Committee supplements the BoG
in supervising the financial sector.
Geographical expansion through cross-border banking mergers and acqui-
sitions further enhanced the importance of the supervisory function. Indica-
tively, the size of the banking system in 2000 involved a total of little less than
500 branches of Greek banks and their subsidiaries. By that time Greek banks
had just started to expand dynamically into South-eastern Europe. By 2007,
total branches of Greek banks in the Balkans had risen to 2,100, an indica-
tion of the breadth and complexity of the supervisory task. As Moran and
Macartney observe in this volume, the central bank thus acts as a significant
177
178 Shareholders’ General Meeting

General Council
Monetary Policy Council
Administration
Governor: N. Garganas
Deputy Governor: P. Thomopoulos Banking and Credit
N. Paleokrassas Committee
Department for the

Strategic Planning and Financial Operations
Supervision of Credit Administration Department
Organisation Department Department
and Financial Institutions (14 Sections)
(6 Sections) (10 Sections)
(22 Sections)
Government Financial
Payment Systems Information Systems
Operations and Accounts Cash Department
Department Department
Department (9 Sections)
(3 Sections) (13 Sections)
(10 Sections)
Economic Research
Statistics Department Internal Audit Department Printing Works Department
Department
(11 Sections) (3 Sections) (7 Sections)
(15 Sections)
Technical Services
Legal Department Internal Relations Division Accounts Department
Department
(4 Sections) (2 Sections) (5 Sections)
(6 Sections)
Figure 7.4. Bank of Greece organization chart, 2007

agent of cross-border institutional and policy transfer—in the South-eastern

European region.
Conclusion: A Changing Political Role and the

‘Paradox of Depoliticization’
The turn of the century finds the BoG part of a different balance between state
and financial system, in a novel political economy. The banking system is no
longer government-controlled and forced to subsidize developmental or redis-
tributive priorities, but free to operate along profit-maximizing lines. The
central bank is vested with full political independence, is institutionally pro-
hibited from participating in the primary market for public debt, and is offi-
cially endowed (as part of the Eurosystem) with a statutory commitment to
price stability. The government has no channel of access to preferential credit
by taxing the banking system, but is forced to finance its deficit by resorting
to the internationalized money markets. On the ascending side in terms of
importance and bargaining power are financial markets, banks, financial
investors, institutional stockholders, and bondholders. Disinflation becomes
a principal normative determinant, given that both government and the
private-enterprise sector as deficit units rely exclusively on liberalized financial
markets able to demand constantly higher returns, and given the supreme
bargaining power of the (typically inflation-averse) creditors within the
system.
Since the second half of the 1980s and especially over the 1990s, the BoG
steered the structural transformation of the Greek financial system and the
momentous change of monetary policy that landed an erstwhile problematic
economy at the monetary core of the EU. The prize of the BoG’s leading role in
the economy’s nominal adjustment process was its own institutional inde-
pendence, if only short-lived, as its ‘sovereign’ policymaking authority was
surrendered to the Euro Area. The BoG was transformed to national-level
executive branch of an independent European supranational institution. For
an economy with a long track record of monetary instability, such surrender of
monetary independence meant that much more was to be gained than lost.
However, significant structural, organizational, and functional transform-
ations of the BoG have been associated with this development.
The BoG continues to operate as a custodian of the national economy,
authoritative source of independent technocratic assessment of economic
conditions, and par excellence ‘objective’ economic advisor to the government.
In the initial climate of euphoria that followed successful accession to the Euro
Area, the BoG enjoyed public visibility, cross-party respectability, and consid-
erable popularity. The latter was soon to recede as life under the euro gave rise
to a new generation of problems. Its institutional role as part of the Eurosystem
179
renders the BoG a representative of the orthodox central banking doctrine that
(given the commitment of ECB monetary policy to price stability and of
national fiscal policy to flanking budgetary discipline and fiscal sustainability)
economic growth can only result from structural reforms, that is, most prom-
inently market liberalization, labour-market flexibility, and far-reaching pen-
sion reform. The BoG has been the most persistent advocate of wage
moderation and structural reforms in these politically controversial policy
areas, consequently becoming the target of widespread political attacks, to
an extent unseen in the past. Susceptibility to such political hostility is further
aggravated by the central bank being perceived as a banking system ally and
apologist of its galloping profitability. Being the flipside of the rapidly increas-
ing indebtedness of Greek households, bank profits and what is perceived as
the BoG’s ‘neo-liberal agenda’ are becoming a focal point of political oppos-
ition from the Left and the populist Right.
We are thus faced with what we might call ‘a paradox of central bank
depoliticization’. Before acquiring independence the central bank was subject
to the government’s politicized macroeconomic governance. While being
used as an instrument in the service of the government’s objectives, the central
bank was nonetheless rarely accused of pursuing a politico-ideological agenda,
not least because the government absorbed the political heat of such oppos-
ition. As an independent institution, however, and especially as executive arm
of the ECB, the national central bank becomes the domestic focal point of
opposition against what a significant part of the political spectrum regards as
‘monetarist’ and ‘neo-liberal’ economic policy. In other words, the national
central bank’s depoliticization, by way of independence from national gov-
ernmental political objectives, has subjected it to far greater political contro-
versy than it had ever elicited during its long period of supposed
‘politicization’. The answer to this apparent paradox is, of course, that, for all
its technocratic robustness, central banking orthodoxy is not distributionally
neutral: it affects socio-economic interests in different ways, it involves gains
and losses.
Notes
1. The chapter has benefited from the research assistance of Christos Triantopoulos.
2. The 1928 Charter provided for a five-year term of BoG governors and for an inde-
pendent arbitration commission to resolve disputes in case of disagreement between
BoG and government, and seriously restricted the BoG’s direct or indirect financing of
government or public enterprises.
3. The book of Halikias (1978) (BoG governor for 1984–92) is representative of the
monetarist-leaning central bank orthodoxy.
4. Until 1994 the BoG satisfied only 3 of the 10 generally accepted formal criteria of
political independence. Among the formal criteria of economic independence, until
180
end 1993 only the discount rate criterion was satisfied (but then, the discount rate
was of minimal importance anyway in a regime of administered interest rates). In
terms of formal political independence, Grilli, Masciandaro, and Tabellini (1991)
ranked the BoG over the central banks of Britain, Portugal, Japan, Belgium, and
New Zealand and at the same level as those of France and Spain. However, in overall
pre-1994 formal independence, the BoG was outranked by all, except Portugal and
New Zealand.
5. Economic Bulletin (since 1992), Monthly Statistical Bulletin (since 1999), Monthly
Statistical Bulletin of Economic Conjuncture (since 1997), and Monthly Bulletin of
Regional Economic Conjuncture Macedonia-Thrace (since 1999).
181
8
The Banca d’Italia: Between
Europeanization and Globalization
Lucia Quaglia
The Banca d’Italia is one of the largest central banks in the European Union
(EU). It is a relatively powerful player in the Eurosystem, which it joined when
the third stage of Economic and Monetary Union (EMU) began in 1999. In an
interview released in the run up to the third stage, its Governor, Antonio Fazio,
expressed his concerns about Italy’s membership of the single currency, argu-
ing that it would be a ‘purgatory’ (Financial Times, 10 November 1998).
This chapter addresses the question of what have been the main changes
experienced by the Banca d’Italia as a result of Europeanization and globaliza-
tion over the last 20 years, but with the focus on the most recent period, from its
entry into the Euro Area. To what extent has the Italian central bank been able to
resist or mediate external pressure for change, namely, Europeanization and
globalization, and how has it adapted to them? Has this led to convergence of
institutional structures, policy templates, and roles performed by the Banca
d’Italia? How has its power in national, EU, and international monetary and
financial matters changed after the establishment of European monetary union?
The chapter is organized according to a temporal sequence, taking a dia-
chronic perspective in order to explain continuity and change over time. As
Europeanization is a long-term incremental process, its direct and indirect
effects should be traced and assessed over time. The chapter first examines
the independence, internal governance, legitimacy, policies, and atypical roles
performed by the Banca d’Italia prior to the establishment of European mon-
etary union. The second part examines these issues with reference to the
period after the creation of monetary union. These sections, which help to
trace institutional and policy convergence over time, also discuss the institu-
tional context and power relations in which the central bank is embedded.
Finally, the chapter explores the role of the Banca d’Italia in the Eurosystem,
including the interactions with the European Central Bank (ECB), and its
183
The Banca d’Italia: Between Europeanization and Globalization
interactions in the international system, first and foremost in central banking

networks dealing with banking supervision. Its international role is necessarily
less important than its position in the Eurosystem, given that the Banca
d’Italia, unlike the German Bundesbank, was not one of the top three world-
wide players. The concluding section elaborates further the themes of Euro-
peanization, convergence, and power.
The Banca d’Italia has undergone significant changes in the last 20 years,
and the pace of change has quickened in the last decade or so, first and
foremost as a result of preparation for Euro Area entry and then membership.
However, certain policies, such as banking supervision, have been only mar-
ginally affected by Europeanization, limiting the process of convergence.
Globalization has also promoted convergence, especially through the struc-
tural power exerted by financial markets and the ‘power of ideas’ (paraphras-
ing Hall 1989), that is the spread of a specific policy paradigm centred on
central bank independence and price stability. In certain instances, the Banca
d’Italia has been able to resist or at least to delay externally triggered conver-
gence. Indeed, the Italian central bank seems to have experienced some diffi-
culties in re-designing its role in the Eurosystem and adapting to membership,
difficulties that re-shaped its power relations at the national and EU levels. It
has been a difficult, delayed process of Europeanization for the Italian central
bank, a process that is far from complete, but which was given extra momen-
tum by the appointment of a new Governor in 2005.
The Banca d’Italia Prior to European Monetary Union
The Banca d’Italia has often been described as the least independent among
the group of independent central banks or, to put it another way, as the more
independent within the category of the dependent central banks (Financial
Times, 22 November 1989). Indeed, until the changes introduced in the early
1990s in preparation for monetary union and discussed in the following
section, in economists’ rankings the Banca d’Italia used to be awarded fairly
high scores as far as political independence (especially, personnel independence)
was concerned, but scored rather low on economic independence (Alesina and
Summers 1993; Cukierman 1992; Grilli, Masciandaro, and Tabellini 1991).
The Bank’s personnel independence was safeguarded by the legal provisions
and established practices for the appointment of the Executive Board (Diret-
torio), the length of its members’ tenure in office, and difficulties of dismissal,
as well as by the distribution of power within the Bank. The procedures for the
appointment process and the practices that developed over time, as well as the
position of the Governor, as discussed below, very much limited the power of
the political authorities in selecting the top management of the Bank,
strengthening its independence.
184
Before the 2005 reform, legislation limited the direct influence of the polit-
ical authorities in the appointment process of the Governor and the other
members of the Executive Board. The Executive Board consists of the Gov-
ernor, the Director-General, and three Deputy Directors-General. In 2006 the
number of deputy directors-general was raised from two to three, so as to have
an odd number of members. Prior to 2005, the nomination of all four members
of the Executive Board, including the Governor, was proposed by the Board of
Directors (Consiglio Superiore). It had to be approved by a decree of the presi-
dent of the Republic, acting on the proposal of the prime minister together
with the Treasury minister, after discussion in the Council of Ministers. Fur-
thermore, the practice of internal appointments to senior and top positions in
the Bank generally prevailed. Hence the Governor was generally chosen from
among deputy governors, and deputy governors were normally chosen from
among senior officials at the Bank.
Moreover, before 2005, all four members of the Executive Board were
appointed sine die, that is, their mandate was open-ended and there was no
age limit. In practice, since the Second World War the longest period for
governors to have remained in office was for a decade or more, like other
members of the Executive Board. The same body that proposed the appoint-
ment of the members of the Executive Board, the Board of Directors, could
repeal their appointment through a joint decision-making procedure, involv-
ing the government and the President of the Republic (Finocchiaro and Con-
tessa 2002). However, the members of the Board of Directors are elected by the
holders of the Bank’s capital quotas by a secret vote in a process apparently
immune from interference from the government of the day, generally follo-
wing the proposals put forward by the Bank itself (interviews, Rome, March
2002).
The appointment of the members of the Executive Board for life, together
with the distribution of power within the Bank, as determined by its govern-
ance structure, contributed to make the Governor a powerful figure. Until
2005, the Banca d’Italia was one of the most centralized and hierarchical
central banks in Europe. The distribution of power within the Bank was very
much skewed in favour of the Governor. He had wide powers and discretion, in
that all responsibilities in monetary, exchange-rate, and supervisory policies
were concentrated in his hands.
In contrast to this relatively high personnel independence, the economic
independence (in economists’ studies also referred to as ‘instrument’ inde-
pendence, see Cukierman 1992; Grilli, Masciandaro, and Tabellini 1991) of
the Bank was low and was completed only in 1993, when the overdraft
account of the Treasury at the central bank was closed down, in order to
prepare for the final stage of monetary union. Nonetheless, the financial and
organizational independence in terms of economic resources available to the
central bank was and is remarkable. For example, Bank officials are among the
185
best-paid civil servants in Italy, and the Governor is one of the best-paid
governors in the world. This is important because it has allowed the central
bank to attract and retain high calibre, well-trained officials, who, in turn,
have provided the Bank with advanced economic knowledge. In the macro-
economic field, this is a clear instance of ‘when knowledge is power’ (Haas
1990).
The other side of central bank independence and power is its accountability
and legitimacy. Until the 2000s, the legitimacy of the Banca d’Italia had hardly
ever been questioned in Italy, for a variety of reasons. Before the statutory
changes introduced in order to comply with the Maastricht Treaty in the early
1990s, the Banca d’Italia was not legally independent of the government.
Hence the issue of accountability was not very significant. Moreover, the
Banca d’Italia could rely on widespread domestic public acceptance of its
activities and the policies that it delivered. Public opinion surveys reveal that
the Banca d’Italia was the most trusted institution in Italy. Indeed, the intan-
gible assets of the Bank, such as expertise in monetary and financial matters
and a distinctive operational culture, were important in fostering public sup-
port, as were some of the atypical roles performed by the central bank over
time, as elaborated below.
Let us now look briefly at the power of the Banca d’Italia in the main policies
in which it was involved before the establishment of the Eurosystem: monet-
ary policy, exchange-rate policy, and financial stability.
Monetary Policy
Before the changes implemented in the early 1990s in preparation for monet-
ary union, power in the conduct of monetary policy in Italy was formally
shared between the Treasury and the central bank. It should be noted that,
before the amendments introduced in order to comply with the Maastricht
Treaty, the Italian central bank was not assigned the statutory objective of
maintaining price stability. On the one hand, in practice, the Bank had a
preponderant power in the conduct of monetary policy, because it had the
technical expertise, macroeconomic credibility, and knowledge of the market
that until the early 1990s the Treasury (or any other governmental body)
lacked (Quaglia 2005a). On the other hand, the Bank’s power in monetary
policy was de facto limited by the conduct of fiscal policy, which, unlike
monetary policy, was in the hands of the political authorities, negatively
affecting the economic independence of the Bank.
Together with the institutional arrangements for central bank independ-
ence, monetary policy is the domain in which the impact of economic ideas,
in the form of ‘policy paradigms’ (cf. Hall 1993) has been greatest in promoting
convergence in Europe and worldwide (Dyson 1994; Marcussen 2000; McNa-
mara 1998). In the 1980s, the monetary policy paradigm at the Bank changed
186
substantially, switching from a Keynesian approach to a stability-oriented one,

whereby the main objective of monetary policy became the fight against
inflation. The spread of stability-oriented economic ideas led to a gradual
(and at times difficult) convergence of monetary policy towards the German
model, outlined by Dyson (this volume). Such convergence can also be seen as
a ‘downloading’ effect of Europeanization, prior to the establishment of Euro-
pean monetary union and triggered by Italy’s membership of the European
Monetary System (EMS).
Exchange-Rate Policy
Italy joined the technical part of the EMS, the Exchange-Rate Mechanism
(ERM), in 1979. Afterwards, exchange-rate policy became a key component
of the monetary policy strategy followed by the Banca d’Italia, whereby the
quantity of money (M2) was the intermediate target and the exchange rate was
a ‘quasi final objective’ (Sarcinelli 1995). Hence, the ERM was used by the
Italian central bank as a mechanism to foster macroeconomic convergence,
first and foremost convergence of monetary policy and inflation performance
(Ciampi 1990). Exchange-rate policy was crucial in this strategy, deploying
‘Europe’ (to be precise ERM membership) as an external constraint, which
augmented the decision-making power of the Bank domestically, shielding
the conduct of monetary policy from political interference.
Before European monetary union, decision-making power in exchange-rate
policy was shared between the Banca d’Italia and the Treasury. The Bank was
responsible for the day-to-day management of the exchange rate, while the
government decided on the exchange-rate regime, and the Treasury, together
with the Bank, was involved in parity realignment in the ERM. De facto, the
domestic power of the Bank in exchange-rate policy went well beyond what
was prescribed by legal provisions, for the same reasons as in monetary policy:
advanced macroeconomic knowledge, market expertise, and limited Treas-
ury’s technical capabilities.
However, the external power of the Bank in exchange-rate policy was cur-
tailed by the dominant role of the Bundesbank, which was the ‘leader’ of the
ERM (on the functioning of the ERM, see Giavazzi and Giovannini 1989;
Giavazzi, Micossi, and Miller 1988). In other words, the other central banks
in the system had largely to adapt to the Bundesbank’s monetary policy, which
indirectly influenced the conduct of the monetary and exchange-rate policies
in other European states.
Participation in the EMS, which was an exchange-rate regime based on an
adjustable peg, produced a major shift in Italian exchange-rate policy and
monetary strategy. In short, Europeanization effects were at work well before
the establishment of monetary union. From the first half of the 1980s onwards
realignments of the lira never fully compensated for the inflation differentials
187
between Italy and the low-inflation states within the ERM (Ciampi 1990).
Furthermore, from 1987 to 1992, no realignments took place, leading to an
appreciation of the lira in real terms (Gaiotti and Rossi 2003,). It was the so-
called ‘strong’ exchange-rate policy (or ‘hard currency’ option) coupled to a
relatively tight monetary policy.
The withdrawal of the lira from the ERM in September 1992 reversed the
exchange-rate policy followed by the Italian authorities during the 1980s. The
subsequent floating lira became an important element of the Italian strategy,
fostering an export-led boom, which in turn sustained Italian economic
growth in a phase of fiscal retrenchment and slow growth in the EU. The lira
re-entered the ERM in November 1996, which was essential to fulfil the nom-
inal convergence criteria in order to join monetary union in the first wave in
January 1999.
Those critical of Euro Area membership argue that the loss of competitive-
ness that affected Italian goods and services and the deficit in the balance of
payments since the late 1990s suggest that, as far as variables in the real
economy are concerned, Italy was not ready for European monetary union.
Not enough ‘real’ convergence had taken place in preparation for the final
stage of EMU. Governor Antonio Fazio and some of his close advisers were
leading proponents of this ‘Eurosceptic’ interpretation of Italy’s membership
in European monetary union (Quaglia 2004). In an interview released shortly
before the beginning of the final stage Fazio argued that Italy was not ready for
European monetary union because in particular structural reforms had not
been carried out (Financial Times, 10 November 1998). A senior official at the
Bank interviewed in 2001 likened Italy’s performance in the Euro Area to a
medium-weight boxer fighting a match against a heavy-weight opponent
without proper training (interview, Rome, June 2001).
Financial Stability
The Banca d’Italia is responsible for the systemic stability of the financial
sector, including all financial intermediaries; the prudential supervision of
banks and securities market intermediaries; the oversight of relevant markets
for monetary policy; and the oversight of the payments system. Financial
supervisory tasks have not substantially changed with European monetary
union. The main change took place in 2005, as discussed below, in that until
that date the Bank had been responsible for safeguarding competition in the
banking sector. Overall, as compared to other European central banks prior to
monetary union, the Banca d’Italia had extensive and largely discretionary
power concerning banking policy and prudential supervision. Indeed, it was
the only central bank in Europe in charge of competition policy in the banking
sector. This almost unchecked power became evident in 2005, as elaborated
below.
188
Other Roles
Besides the three core central banking policies (monetary policy, exchange-
rate policy, and financial stability and supervision), the Banca d’Italia has
performed a variety of services for the government. However, they have been
reduced over time, as a certain degree of convergence of the ‘other functions’
performed by central banks has taken place in the Eurosystem. The Bank used
to act as banker to the government, a function that came to an end in 1993 and
was ruled out by the EMU provisions in the Maastricht Treaty. Nowadays the
government has a non-interest–bearing deposit at the Bank, and the overdraft
facility has been closed. The Bank used to manage the public debt, in conjunc-
tion with the Treasury, but in the 1990s this task became the competence of
the Treasury alone. The Bank manages the payments system, a task that is
shared with other central banks in the Eurosystem (see below). All banks based
in Italy are obliged to keep a non-interest–bearing deposit at the Bank, which
acts as lender of last resort. In addition, the Banca d’Italia has often acted as an
adviser to the government on a variety of matters.
Over time the Banca d’Italia has performed other functions that can be regarded
as ‘country-specific’, that is to say, result from the configuration of the Italian
socio-economic and political system. It was a ‘strong’ central bank in a ‘weak’
state (cf. the Banque de France). This meant that the Banca d’Italia acted outside
the traditional boundaries of a central bank, performing certain functions that
should arguably have been carried out by other parts of the Italian state apparatus
or civil society. This situation strengthened the power of the central bank, but also
made its functions more complex. Once in European monetary union some
of these functions came to an end, so that the Italian central bank has converged
towards practices of other central banks. At the same time, as we see below,
some new self-assigned roles have been taken on board by the central bank.
A Strong Central Bank in a Weak State

For most of the post-war period, the Banca d’Italia acted as an ‘economic
counter power to the government’. For all the reasons mentioned above,
notably central bank personnel, financial, and organizational independence;
its access to advanced macroeconomic expertise, and knowledge of the finan-
cial markets, the Bank was a strong institution in a weak state. The state was
composed of fragmented political institutions, and the executive had limited
political capacity, which was further weakened by frequently changing coali-
tion governments. There was an inclination on the part of government, and
politicians more generally, to let the Bank make difficult decisions, supposedly
on technical rather than political grounds (Quaglia 2005a). This was part of a
larger picture, where the tacit acknowledgement of the absence of strong
political institutions fostered policymaking by technocrats, several of whom
moved to important political positions in the 1990s.
189
Until the early 1990s, the Banca d’Italia had a near monopoly of expertise in
Italy, a trend that continued in the 2000s, even though the Treasury augmen-
ted its technical capabilities from the 1990s onwards. The Bank has been at
the forefront of the development of Italy’s ‘economic culture’. Its Research
Department has been the research centre par excellence in the economic field in
Italy. The Bank has awarded scholarships for post-graduate education abroad.
Many of these award holders later joined the Bank. The cutting-edge economic
expertise enjoyed and deliberately developed by the Banca d’Italia was a clear
case of ‘when knowledge is power’ (Haas 1990) for several reasons. First, at the
domestic level, the wider implications of certain ‘technical’ decisions taken by
the central bank were not always understood, a priori, by the government and
the political class, which did not have direct access to technical knowledge
(Quaglia 2005b). Second, the Italian central bank’s strategy to strengthen its
informal power in international and EU policy fora was to deploy the ‘force of
argument’ (or of ‘numbers’) as a way to tip the balance in the policy discus-
sions in certain directions and to persuade other macroeconomic authorities.
As argued below, the quality of economic knowledge and the calibre of experts
to which central banks have access has become an important source of infor-
mal power in the Eurosystem.
The Banca d’Italia has also been a breeding ground for talented civil servants
and the financial elite. It has ‘exported’ credibility, expertise, and personnel for
the conduct of Italian economic policy to other parts of the Italian state
apparatus, the private sector, and international organizations. Interestingly,
the Bank has been the ‘exporting’ institution, whereas central banks in other
countries more usually ‘import’ senior officials from outside (cf. the Bundes-
bank and the Banque de France). This was also an indicator of the power
(power of appointment, technocratic power) enjoyed by the Bank.
The Banca d’Italia has represented a ‘credible interface’ for Italy with the
outside world—the ‘power of credibility’. Since the post-war period it has
interacted with foreign institutions (i.e. other monetary authorities and inter-
national organizations) and, more generally, has kept contacts with the out-
side world. After the upgrading of technical capabilities and human resources
at the Ministry of the Treasury, which led to the ‘empowerment’ of the Treas-
ury (later reformed into the Ministry for the Economy), the function of exter-
nal economic representation and credible interface between the domestic
arena and the international environment has largely been taken over by this
Ministry.
Adapting to the Euro Area: The Crisis of 2005
A set of institutional reforms that formally increased central bank independ-

ence took place shortly after the Treaty on European Union (TEU) was signed
190
in Maastricht. These reforms fostered institutional convergence towards the

German model of central bank independence (see Dyson, this volume) among
all the members of the Eurosystem. In 1992, the Banca d’Italia was granted
exclusive power to set interest rates without approval from the Treasury. In
1993, the Treasury’s overdraft facility at the Banca d’Italia was transformed
into an interest-bearing deposit that must always be in credit. Legally, such
changes were needed to comply with the EMU provisions contained in the TEU.
They also completed the economic independence of the Italian central bank.
In approaching the final stage of EMU, the Banca d’Italia had to undergo
further formal institutional changes in order to comply with the EMU institu-
tional and policy templates. These stipulated that the members of the Board of
Directors were to be appointed for five years, rather than three, as had previ-
ously been the case; the Treasury minister’s power to suspend or abrogate the
deliberations of the Board of Directors falling within the competence of the
European System of Central Banks (ESCB) was abolished; and the Treasury
minister’s approval of deliberations concerning the investment of reserves was
abrogated (Law decree N 43, March 1998, issued to permit the integration of
the Banca d’Italia into the ESCB).
Another set of reforms to internal governance, policy competences, and
personal independence took place in 2005, in the wake of a scandal that
involved Fazio. The Law on Savings had been in the making since 2002 and
was eventually adopted in December 2005. It introduced a fixed-term mandate
for the Governor and the Executive Board and modified the procedures for
appointing and dismissing them. The reform increased the power of the
government in the appointment procedures, in that the members of the
Executive Board (including the Governor) are appointed by a presidential
decree, acting on the proposal of the prime minister, followed by a deliber-
ation of the Council of Ministers, having consulted the Board of Directors. In
other words, after the 2005 reform the Board of Directors is only consulted—its
opinion is not legally binding. Since 2005 each member of the Executive Board
has a six-year mandate, which can be renewed only once and can be repealed
by the government after consultation with the Board of Directors—here again
the opinion of this body is no longer binding.
Moreover, the ownership structure of the central bank was changed, so that
only the state and public bodies are allowed to hold shares of the bank’s
capital. Before 2005, and as a consequence of the process of privatization of
the banking sector that unfolded in Italy in the 1990s, private banks had held a
large part of the central bank’s shares.
The decision-making process within the Banca d’Italia was made more
pluralistic in 2005, so that decisions with external implications for the Bank
are no longer to be taken by the Governor alone, as it had been the case in the
past, but are instead taken by the five members of the Executive Board, through
a formal voting procedure. In other words, power is no longer concentrated
191
in the hands of the Governor. This procedure of collective decision-making by

the Board does not apply to decisions concerning the activities of the ESCB/
Eurosystem, where the Governor votes in her or his personal capacity.
Notably, during the drafting of the Law on Savings, which amended central
banking legislation, the Italian government requested the ECB’s legal opinion
three times (May 2004, October 2005, and December 2005, see CON/2004/16;
CON/2005/34; CON/2005/58.). In its opinion issued in October 2005, the ECB
suggested the introduction of the principle of collegiality for the Executive
Board’s decision-making on measures related to non-ESCB tasks and the intro-
duction of a fixed-term mandate, renewable once, for all members of the
Executive Board. This suggestion was eventually incorporated into the rele-
vant legislation in December 2005. The ECB also repeatedly highlighted the
need for ensuring that the planned transfer of the Banca d’Italia’s share capital
to the state was compatible with the provisions of the TEU concerning the
avoidance of monetary financing and the need for sound fiscal policy (Quaglia
2008a).
The adaptation of the governance structure and the internal organization of
the central bank to membership of the Eurosystem has so far been very limited.
Within the Economic Research Department, four of the five existing sectors
have been given competences for the analysis of Euro Area data. Also, add-
itional structures, such as the Monetary Policy Coordination Committee and
the Euro Policy Liaison Office, have been created, with co-ordination tasks on
issues relating to the Euro Area and the Eurosystem monetary policy. Another
new internal structure is a division to co-ordinate the whole set of activities
related to the ECB Governing Council, which puts together the dossier for the
Governor and for an accompanying person, generally from the Economic
Research Department, for the meeting of the Governing Council in Frankfurt.
The Bank has approximately 8,000 employees. There have been no substantial
cuts in staff numbers in preparation for or after Euro Area membership. How-
ever, this status quo has begun to change after the appointment of the new
Governor, Mario Draghi, in 2006, and there are plans in place for a reduction
in personnel as well as an internal reorganization of the Bank, as elaborated
further below.
When the legal independence of the Banca d’Italia was increased in the run-
up to the final stage of EMU, there was hardly any domestic debate on the need
to step up the procedures for accountability. Moreover, unlike central bank
independence, central bank accountability was not subject to a process of
convergence, and there were no ‘European templates’ to be adopted at the
domestic level. The Bundesbank itself could hardly provide a model, given
that its procedures for accountability were not particularly robust. The pro-
cedures for central bank accountability were beefed up in Italy by the reform in
2005, following the Fazio affair, which brought to the fore the high degree of
discretion and low level of accountability of the top officials at the Bank, first
192
and foremost the Governor, who had the ultimate decision-making power at
the Bank.
As a result of the changes introduced in 2005 in order to step up the
transparency and accountability of the central bank, written justifications
for decisions taken, especially in the supervisory field, have to be provided
by the Bank, and the minutes of the meetings of the Executive Board have to
be kept. The report on supervisory activities is due twice a year, not once a year.
Since 1999, the monetary policy in the Euro Area is conducted by the ECB
and the Eurosystem, which very much adopted a German model for the
conduct of monetary policy and central bank independence (Dyson 2000).
The Banca d’Italia participates in policy formulation and implementation as a
member of the Eurosystem. Similarly, exchange-rate policy is conducted at the
Euro Area level. For these two policies convergence has been complete. On the
one hand, the Banca d’Italia has lost the power to conduct these policies at
the national level. On the other hand, this power is now shared with the ECB
and other participating central banks at the Euro Area level.
In contrast, financial stability and financial supervision remain largely
national competence, even though the mechanisms for institutional cooper-
ation in the EU and the Euro Area have been stepped up. Unlike in monetary
policy and exchange-rate policy, ‘positive integration’—characterized by spe-
cific EU models or provisions to be adopted by the member states—has been
minimal in the EU as far as financial supervision is concerned. Even within the
Eurosystem, different institutional frameworks and policy paradigms persist.
This is not only because financial systems vary remarkably across Europe, but
also because, unlike the stability-oriented paradigm in monetary policy, based
on central bank independence, there is not a benchmark institutional model
or widely accepted technical framework in financial supervision (Busch 2004).
It should also be noted that the Banca d’Italia during the Fazio governorship
opposed any expansion of the ECB’s competence in the supervisory field (Sole
24 Ore, 16 February 2002), and by closing ranks with some other national
central banks, it was successful in doing so.
At least until the 2000s, the Banca d’Italia had traditionally been regarded as
an effective supervisor, which also made the Bank intellectually powerful in
European and international supervisory networks and fora. Except for the
bankruptcy of Banco Ambrosiano in 1981, there were no major financial
scandals in Italy in the 1980s and 1990s. Hence Italian policymakers had no
need to consider alternative supervisory models. However, the early 2000s
proved to be a more turbulent period, with the insolvency of the Argentinean
bonds, the financial collapse of Cirio in 2002, and Parmalat’s insolvency in
2003. Although these episodes could hardly be attributed to systematic super-
visory failures, they triggered a heated debate about the configuration and
allocation of supervisory responsibilities in Italy and weakened public confi-
dence in the existing supervisory framework.
193
In 2005, two episodes threatened the credibility and reputation of the

central bank, weakening its ability to resist changes, which were incorporated
at the 11th hour in the Law on Savings. The cases made the headlines across
Europe because they involved foreign banks and related to two proposed
takeovers of Italian banks in 2004–5: one of Banca Nationale del Lavoro by a
Spanish group, Banca Bilbao Vizcaya Argentaria; and the other of Banca
Antoniana Popolare Veneta (Antonveneta) by ABN Amro. In both cases Gov-
ernor Fazio intervened to block the foreign takeover bid, while endorsing
counterbids launched by two Italian banks, Banca Popolare di Lodi and Uni-
pol, respectively.
Both foreign banks involved in the attempted takeovers complained to the
European Commission, which had given its authorization on the grounds that
the bids did not jeopardize competition in the banking sector. An antitrust
enquiry launched by European competition Commissioner, Neelie Kroes, was
dropped on the grounds of lack of conclusive evidence. The European internal
market Commissioner, Charlie McCreevy, also expressed his concern in a
letter to Governor Fazio in 2005 (Financial Times, 18 February 2005).
Pressure from other EU member states, EU bodies, and financial markets,
hence a mixture of Europeanization and globalization effects, coupled with
sharp domestic criticisms, led to the resignation of Fazio in the autumn 2005,
followed by a change of competition policy in the banking sector in Italy (see
Quaglia 2008b). The reform, which was inserted in the Law on Savings, basic-
ally left untouched the extensive supervisory powers of the central bank.
However, banking competition policy was transferred to the Competition
Authority, which had been established by law in 1990 and is separated from
the central bank. Whereas the Banca d’Italia would conduct its evaluation of
mergers and acquisitions by taking into account ‘sound and prudent manage-
ment issues’, the Competition Authority would base its assessment on the
impact of mergers and acquisitions on competition (my translation, Law
262, December 2005).
Moreover, the crisis prompted the EU to legislate on this matter. After the
controversial foreign takeovers in Italy and a similar case in Poland, Commis-
sioner McCreevy proposed to amend the existing EU banking directive with
a view to limit the discretion of the competent national authorities in au-
thorizing (or denying) foreign takeovers and more generally entry of foreign
banks into national markets. The amendment was approved and consti-
tutes an interesting instance of how events at the national level affect EU
developments.
The Banca d’Italia has always paid a considerable amount of attention to the
configuration and development of the financial system in Italy, especially in
the banking sector. It performed an ‘educational function and protective role’
vis-à-vis the Italian banks. This self-appointed role became more prominent
after the establishment of European monetary union, partly because the Bank
194
had lost some core functions and partly because foreign banks, largely as a
consequence of EMU and more generally financial globalization, tried to
penetrate the Italian market in the 2000s. The Banca d’Italia reacted by endea-
vouring to protect the italianita’ delle banche (basically, Italian ownership of
the banks operating in Italy). As part of the Bank’s ‘grand design’ for reshaping
the banking system in Italy, Governor Fazio consistently opposed foreign
shareholdings and never authorized a foreign takeover, in an attempt to
prevent, or at least to slow down, foreign penetration of the Italian market
(Financial Times, 11 February 2005; 17 February 2005; 31 March 2005). The
Bank’s official explanation was that this strategy was designed to give the
domestic banking system time to adjust and to become competitive inter-
nationally. Critics (e.g. the Financial Times was particularly vocal on this)
argue that it was economic protectionism, coupled with dirigiste attitudes.
Mario Draghi, former vice-president and managing director of Goldman
Sachs (an international investment bank), based in London, and former
Director General of the Italian Treasury in the 1990s, took over from Governor
Fazio in 2006. From the outset, Draghi gave clear signals of change, albeit
emphasizing the continuity of the prestigious tradition of the Bank of Italy.
Following the new rules agreed in 2005, three new members of the Executive
Board were appointed: they all had considerable international experience and
were either internal to the Bank, or had spent a considerable part of their career
there. Besides changes at the level of the senior management, the approach
adopted by the new governor and the Executive Board can be summarized as
more openness, accountability, and efficiency. The priority was to regain
‘credibility’.
The first objective was to open up and modernize the Italian financial sector,
in marked contrast to the approach taken by Fazio. Draghi was keen to
encourage mergers in the banking sector, making clear that, if banks’ execu-
tives failed to take the initiative, he would not oppose foreign takeovers. The
second objective was to rationalize the Bank’s structure and its resources by
initiating the process of closing down the existing delegations in EU capitals,
but strengthening the Bank’s delegations in the United States and Japan.
Third, Draghi expressed positive attitudes to membership of the Eurosystem,
seeking to specialize the Bank of Italy on specific activities. Finally, in the new
management style, there has also been deliberate emphasis on accountability
and transparency. For example, given the fact that Draghi was a former execu-
tive at Goldman Sachs, when taking office he announced that he would
abstain from any decisions involving his former employer for one year.
Despite the appointment of Draghi in 2005 and the changes that have
gradually taken place since then, unlike the Swedish central bank (see Marcus-
sen, this volume), the Banca d’Italia, like the Banque de France (see Howarth,
this volume) has not embraced a new public management approach, which
emphasizes performance indicators, monitoring, outsourcing, and so on. It
195
might therefore be seen as closer to the Banque de France as a laggard in this

respect. There are two explanations for this: no major impulse has come from
the top management of the bank for the adoption of new public management
practices, and several changes introduced so far had to be negotiated with
public-sector trade unions, which are not very receptive to new public man-
agement doctrines.
The Role of the Banca d’Italia in the Eurosystem

and in International Central Banking Networks
The Banca d’Italia is the third largest central bank in the Eurosystem and has
been eager to remain an influential actor there. Among the national central
bank governors, Fazio was one of the most determined to safeguard the com-
petences of national central banks within the Eurosystem—or, to put it
another way, to limit the competences and power of the ECB and its Executive
Board in Frankfurt.
The contributions of the Banca d’Italia to the design and setting up of the
ESCB, Eurosystem, and ECB are not comparable to those of the Bundesbank,
which largely provided the institutional and policy templates for the ECB
(Dyson 2000). However, three types of inputs can be identified. First, the
Banca d’Italia seconded a considerable number of officials to the ECB head-
quarters in Frankfurt when the ECB was established. This was important in the
early years of the ECB, when it was in the process of hiring its own staff. Some
of the Italian officials seconded to Frankfurt subsequently returned to the
Banca d’Italia, and the ECB has established procedures to hire its own staff,
also at senior level, even though the number of senior officials initially
employed by national central banks remains high.
Second, the Banca d’Italia played an important role in the establishment of
the Trans-European Automated Real-time Gross Settlement Express Transfer
System, or TARGET, which was completed in 1999. TARGET was created by
interconnecting 12 national euro real-time gross settlement systems and the
ECB payment mechanism and is used for the settlement of central bank
operations, large-value euro interbank transfers, and other euro payments in
real time. In October 2002, the Governing Council of the ECB decided to
establish TARGET 2 in preparation for the enlargement of the Eurosystem,
based on a single shared platform for the central banks that decided to join it
and were willing to give up their own national real-time gross settlements
platform. The central banks of Italy, France, and Germany, building on their
expertise in payment systems, offered to provide the technical platform in
2002, and the ECB Council accepted in 2004. TARGET 2 is operational and the
Banca d’Italia is also involved in the setting up of TARGET 2 Securities, a
system for the clearing and settlement of securities in the Euro Area.
196
Third, the Banca d’Italia is an important source of technical knowledge

in the Eurosystem. The number of research staff at the Banca d’Italia is the
highest among European central banks, ex equo with the Bank of England
(St-Amant et al. 2005). Moreover, this is not a relatively recent trend, even
though the Bank considerably expanded its research staff in the period 1996–
2003 as part of a deliberate strategy to strengthen the Bank’s influence within
the Eurosystem and in ECB decision-making (cf. a similar strategy followed by
the Bundesbank). A study of the quantity, quality, and relevance of research in
36 central banks in developed countries since 1990 indicates that the number
of journal articles published by members of the Banca d’Italia is one of the
highest, with an upward trend post-1999 (St-Amant et al. 2005). Moreover, the
Banca d’Italia, the Bank of England, and the ECB are the sole non-American
representatives among the top 10 central banks in quality-adjusted output
(i.e. publications in top-quality academic journals) (Quaglia 2008a).
Adaptation to membership of the ESCB has been relatively difficult for the
Banca d’Italia, especially among the top-level management, notably in the
case of Governor Fazio and some of his closer advisers. The Governor and other
senior officials were rather sceptical of Italian membership of the single cur-
rency, even though no formal statement was ever made in this respect (Quaglia
2004). More generally, senior officials were intent on safeguarding the role of
the Banca d’Italia within the Eurosystem. Some high-calibre officials (often the
most outward-oriented) have left the Bank to take up senior positions in
international organizations, at the ECB, at the Treasury, and in private
banks. In terms of personnel employed and internal organizational structures,
no major restructuring has taken place since joining monetary union,
although this began to change after the appointment of Draghi as Governor
in 2006.
Outside the Eurosystem, the Banca d’Italia is part of international networks
dealing with banking supervision, first and foremost the activities of the Basel
Committee on Banking Supervision (BCBS). Within this committee, which
brings together banking supervisors from 13 states, the Banca d’Italia tends to
be an intellectually powerful member, although its structural position in the
network is not comparable to those of the Federal Reserve or the Bundesbank.
The influence of the Banca d’Italia in the BCBS has been strengthened by the
fact that, unlike the Bundesbank and the Bank of England, the Banca d’Italia,
with its extensive supervisory powers, is the sole representative for Italy.
Moreover, the Banca d’Italia has a considerable amount of expertise in this
field and has generally been regarded as an effective supervisor, given the
absence of significant banking crises in Italy in the last two decades.
The role of the Banca d’Italia in the BCBS, for example, during the negoti-
ations of the Basel II agreement, has not substantially changed as a result of
European monetary union, especially as the ECB and the European Commis-
sion participate in the meetings in Basel as observers, without decision-making
197
power, which rests with the national central banks and the national supervis-
ory authorities sitting on the BCBS. This status quo might, however, change if
the composition of the BCBS is amended or if the ECB is given new compe-
tences in the supervisory field.
In the negotiations of both the Basel I and the Basel II Accords, the Banca
d’Italia endeavoured to make sure that issues that were important for the
competitiveness of the Italian banking system were taken into account. On
certain issues, the Banca d’Italia forged an effective alliance with the Bundes-
bank, given their similarity of interests (interviews, Rome, July 2006; Frank-
furt, January 2006), such as preventing negative effects of the Basel II
agreement on small and medium-sized enterprises (Wood 2005), which are
widespread in both Italy and Germany. During the negotiations, German and
Italian policymakers co-operated on this matter—for example, by conducting
joint studies—and achieved positive results, with the final draft of Basel II
regarded as providing favourable treatment for small and medium-sized en-
terprises. Another important goal of the Italian, British, and German author-
ities was to make the new accord less pro-cyclical, in which they were
successful, as becomes obvious when the first draft of the accord is compared
with the draft eventually agreed in 2004.
Conclusion: Europeanization, Power, and Convergence
This chapter examined the evolution of the Banca d’Italia between European-
ization and globalization. These two processes promoted institutional and
policy convergence, and redefined the power of the Italian central bank,
domestically, internationally, and in the EU. The chapter argued that conver-
gence of institutional and policy templates has mainly been imposed by
external factors, such as European monetary union and Eurosystem member-
ship, EU legislation, other (non-legally binding) international agreements,
pressure exerted by the financial markets, and international circulation of
ideas in the form of policy paradigms.
Some of these factors were at work well before the establishment of Euro-
pean monetary union, reminding us that Europeanization and globalization
are long-term phenomena and can be better understood by taking a dia-
chronic perspective. These external factors triggered changes that affected
both the institutional framework of central banking in Italy and the main
policies conducted by the central bank, though to a different extent. Some
policies, first and foremost monetary and exchange-rate policies, have con-
verged completely in the Euro Area, whereas others, above all financial super-
vision, have not converged significantly, and divergence persisted across the
EU/Euro Area. Overall, the atypical roles performed by the Banca d’Italia
converged, leading, not without some hitches, to a ‘normalization’ of central
198
banking in Italy. Persistent divergence in certain domains, such as financial

supervision, is explained by the specific tangible and intangible assets of the
central bank, the distinctive configuration of the Italian system of governance,
and the lack of specific policy templates at the EU level.
Membership of the Eurosystem reconfigured the power of the Banca d’Italia.
On the one hand, it has diminished the power of the central bank domestic-
ally, given the fact that monetary and exchange-rate policies are decided at the
Euro Area level. On the other hand, even before European monetary union,
the room for manoeuvre left to national central banks operating in the ERM
was relatively limited, as they largely had to follow the policy set by the
Bundesbank. At least in monetary union they have a voice (and, to date, a
vote) in the decision-making process.
After the establishment of European monetary union, there has been a
genuine difficulty in defining a new role for the Banca d’Italia, partly because
several special functions performed by it have been transferred to other parts
of the state apparatus, and partly because it has lost many of its traditional
functions to the ECB. The adaptation of the Banca d’Italia to monetary union
in the early years of the project was rendered more difficult and/or slowed
down by the rather Eurosceptic attitudes of Governor Fazio and other senior
officials, for the decision-making power was concentrated in his hands. It was
a delayed (and at times difficult) process of Europeanization.
In the Eurosystem, the Italian central bank has taken a leading role in the
development of the payments system and the clearing and settlement of
securities, provided (or seconded) personnel to the ECB, especially at senior
level, and stepped up its technical capabilities in economic knowledge, which
can be an intangible source of power in the Eurosystem—a strategy that was
fully embraced by Draghi when he took over from Fazio in early 2006. Unlike
his predecessor, Draghi displayed a different, more positive approach to mon-
etary union and a more constructive engagement of the Bank with the Euro-
system. Building on the legislation passed in late 2005, he also set in motion
overdue reforms to the Bank and its policies at the domestic level.
Acknowledgements
I wish to thank the editors, Charles Goodhart, John Woolley, and the participants in the
workshops in Cardiff and at the British Academy for their comments on an early draft of
this chapter.
199
Part III
‘Temporary’ Outsiders: Pace Setters
and Laggards
9
Estonia, Hungary, and Slovenia:
Banking on Identity
Béla Greskovits
A powerful new institution, the independent central bank, emerged rapidly

from the transformation of inherited financial systems in postcommunist Cen-
tral and Eastern Europe (CEE). Its power entailed the ability to define macro-
economic stability as a policy priority, institutionalize it against rival
preferences, and shape economic performance in line with its own agenda.
However, rather than converging on a single uniform model, the new central
banks adopted varied institutional features. They also diverged in terms of their
performance and central bankers’ identities.
In section two, this chapter examines variation of central bank power across
the cases of Estonia, Hungary, and Slovenia on four dimensions. First, new
monetary authorities differ in the extent to which they have retained the
traditional functions of a central bank. Second, there are differences in central
banks’ ‘interaction across different political-economic arenas’ (Iversen and
Pontusson 2000: 2), especially with fiscal authorities, industrial relations re-
gimes, and commercial banks. Third, diversity in institutional interactions
reflects variation in the degree to which the monetary authority is divorced
from the political system. Finally, these configurations shape central bank
capacity to affect economic performance.
Central bank power also exhibits variation over time. Importantly, the rela-
tive speed at which central bank independence (CBI) had been instituted, and
macroeconomic stability restored, contrasts with the difficulties of compliance
with the Maastricht convergence criteria for euro entry.
The chapter asks three questions. What were the sources of central banks’
power after communism? In what way have these sources of power influenced
their refashioning as varied configurations of institutions, performances, and
identities? Have the origins of their power and the institutional features
adopted in the course of preparing for EU membership had a bearing on the
political economy dynamics of preparing for euro entry?
203
Estonia, Hungary, and Slovenia: Banking on Identity
Answers are sought through a comparative analysis of political opportunity

structures defined by three main trials of transformation: Europeanization,
economic challenges, and nation building. Section three argues that adoption
of central bank independence, the main task of preparing the monetary regime
for EU accession, could advance fast because—and to the extent—of its compati-
bility with domestic agendas of nation building and monetary stabilization.
Section four tests this proposition in the context of the new political oppor-
tunity structures after EU accession, shaped by growth-driven inflation, hith-
erto pent-up demands for welfare, and public concerns about losing national
currencies. It argues that Europeanization after EU accession is delayed because
preparation for euro entry is less compatible with national agendas than central
bank independence had been. The conflict manifests itself in different forms in
new and old nation states. The Estonian central bank lacks not only the means
of inflation control in a fast-growing economy but also the political support for
shifting to less minimalist monetary coordination. Equally controversial is the
prospect of abandoning the Estonian currency as it is considered as a loss of
national identity. Losing national currency and policy autonomy are less feared
in Hungary. However, there, demands for welfare and security come into con-
flict with public-sector retrenchment and reform required for euro entry com-
pliance. From east central Europe Slovenia fulfilled the conditions of euro entry
first. This unique success is traced to the embeddedness of monetary coordin-
ation in neocorporatist institutions, which helped to accommodate and dis-
tribute adjustment costs in a balanced and politically acceptable manner, both
before and after EU accession.
Alarmed by the danger of repetition of negative experiences of some
insiders, rather than encouraging new entrants, the European Central Bank
(ECB) has scrutinized and questioned their capacity to secure sustainable macro-
economic stability. As a result, some new EU members may join the camp of
semi-permanent outsiders, not least because of their central banks’ clustered,
partial, and increasingly contested route to the euro. The chapter concludes
with some lessons for the study of central bank convergence, power, and
Europeanization.
Ascendance of Central Bank Independence after Communism
By EU accession in 2004, Estonia, Hungary, and Slovenia advanced far in

institutionalizing central bank independence (Feldmann 2006; Greskovits
2006; Silva-Jáuregui 2004). Central bank governors were appointed to their
legally well-protected and generously remunerated positions for six years,
exceeding the length of terms granted to elected governments. Governors
gained significant, albeit varied influence over appointments of their deputies
and monetary council members. Professional credentials became a condition
204
for appointments to executive positions. Internationally well-connected, size-

able research departments enabled the monetary authorities to become sources
of trusted macroeconomic data, analyses, and forecasts. Increasingly, EU-com-
pliant acts limited and ultimately abolished central banks’ role in financing
fiscal deficits.
Adopting the legal standards and norms of European central banking coin-
cided with success in macroeconomic stabilization. Over the 1990s all three
central banks accomplished challenging tasks. In Estonia and Slovenia these
included disentangling the national monetary authority from quasi-federal
structures, ending galloping inflation and introducing new convertible na-
tional currencies, the Estonian kroon and Slovene tolar, which replaced the
multiple-currency regimes of the Soviet rouble, Yugoslav dinar, and German
D-Mark. Management of inherited foreign debt was an important issue in
Hungary. Similar as they are on the above dimensions, these central banks
differ in a number of crucial aspects.
Configurations of Institutions and Performances

The three central banks differ in how far they accommodated the traditional
functions of a central bank. The currency board mechanism adopted by the
Bank of Estonia prevented the central bank from influencing money supply
through interest-rate policies and acting as lender of last resort. Money supply
has been determined by foreign currency reserves, and the central bank refused
to bail out troubled commercial banks and industrial firms. In contrast, both
the Bank of Slovenia and the National Bank of Hungary have retained the right
to control interest rates and function as lenders of last resort. The economic
consequences included varied tolerance for non-performing loans and varied
access to new credits. While Estonian firms were not allowed to accumulate ‘bad
debts’ and faced a credit-crunch in the first half of the 1990s, Hungarian and
Slovene firms enjoyed longer ‘grace periods’ in case of non-payment and had
easier access to new credits (Table 9.1).
The varieties of capitalism literature help to capture other differences.
Authors in this tradition propose that ‘Political economies are complex systems
of interlocking institutions that mutually reinforce and condition the effects of
each other’ (Iversen and Pontusson 2000: 19). Arguably, interaction with three
key institutions—fiscal authorities, business and labour organizations, and
commercial banks—matters most for central bank independence and its eco-
nomic impact.
Independent central banks have acted in tandem with ministries of finance
to (re)produce macroeconomic stability through coordinated, prudent monet-
ary and fiscal policies in Estonia and Slovenia. In contrast, recurrent conflicts
between the monetary and fiscal authorities have tended to undermine
efficient macroeconomic coordination in Hungary. It was only in exceptional
205
Table 9.1. Non-performing loans, and domestic credit to private sector

and households in Estonia, Hungary, and Slovenia, 1993–2006
1993 2000 2006
Non-performing loans (% of total loans)

Estonia 3.5 (1994) 1.3 0.2
Slovenia 13.8 (1994) 9.3 5.6
Hungary 29.6 3.1 3.0
Domestic credit to private sector (% of GDP)
Estonia 11.1 23.3 78.4
Slovenia 22.1 37.8 67.1
Hungary 20.7 30.1 54.6
Domestic credit to households [of which mortgage lending] (% of GDP)
Estonia n.a. 7.1 [4.7] 38.7 [32.1]
Slovenia n.a. 11.3 [1.7] 17.0 [4.5]
Hungary n.a. 3.3 [1.1] 18.5 [13.9]
Sources: EBRD Transition Report (2001, 2006, 2007, London).
moments, such as the stabilization package of 1995, that Hungarian fiscal and
monetary policies could be coordinated.
As to central bankers’ interaction with social partners, business associations,
and trade unions, varieties of capitalism scholars identified patterned variation
within the club of OECD economies. They argue that ‘the effects of monetary
policies cannot be understood without paying attention to the conditioning
influences of wage bargaining structures and processes’ (Iversen and Pontusson
2000: 12). If wage bargaining is centralized and coordinated, social partners
concerned about the economy-wide levels of inflation and unemployment are
likelier to respond to central bank signals with wage restraint. Such response
pre-empts the need for overly restrictive monetary policies. In turn, highly
decentralized, fragmented industrial relations regimes make such accommoda-
tion unlikely (Franzese and Hall 2000: 178–9). Adapted to east central European
cases, the varieties of capitalism approach help to identify important differ-
ences. Central bank policies in Slovenia, just like in many West European states,
have been backed by centralized and coordinated neocorporatist institutions of
social partnership. In contrast, central banks in Estonia and Hungary (and all
other east central European states) have operated against the background of
highly fragmented, decentralized industrial relations regimes, and monetary
policy has remained exogenous to atomized wage bargaining. Generally, the
interplay between central banks and the regimes of industrial relations has
developed in rather ‘un-European’ directions in the region (Table 9.2).
Both the Bank of Estonia and the National Bank of Hungary interact with
commercial banking sectors, which, to much larger extent than Slovene banks,
have undergone almost complete privatization to transnational investors.
Again, the almost complete transnationalization of commercial banking ex-
hibits striking divergence from what Europeanization of this sector would mean.
206
Table 9.2. Employer organization, union density, and pattern of wage bargaining
in Estonia, Hungary, and Slovenia, 2002–3
Private Union Wage bargaining Wage bargaining

employer density index of index of
organization (%) 2002 centralization coordination
(%) 2002 of 2003 2003
Estonia 31–40 11–20 0.25 0.17

Slovenia 91–100 41–50 0.43 0.63
Hungary n.a. 11–20 0.26 0.28
EU-15 average n.a. n.a. 0.45 0.47
Source: Visser (2005). Index of centralization: maximum 0.71 (Austria), minimum 0.13 (U.K.). Index of
coordination: maximum 0.64 (Finland), minimum 0.11 (Lithuania).
Foreign dominance in the banking sector of most EU old member states has
been the exception rather than the rule. It is only in Luxembourg and Greece
where foreign banks’ power compares with the situation in east central Europe
(Claessens, Demirgüc-Kunt, and Huizinga 1998; Table 9.3).
However, the un-European ownership pattern proved helpful in the course of
‘extreme ‘‘top-down’’ Europeanization that has required a rapid alignment of
financial sector regulation with EU regulations as part of the accession process’
(Mohácsi Nagy 2006: 259). Foreign banks have deepened domestic financial
markets and rapidly ‘imported’ high standards of management and governance
in Estonia and Hungary, while the coordination of Slovene banking sector has
remained somewhat rudimentary and less transparent. At the same time, in the
former two countries foreign subsidiaries’ ability to borrow from their parent
institutions has impaired the effectivity of changing reserve requirements as a
monetary policy instrument.
Table 9.3. Transnationalization of commercial banking in Estonia,

Hungary, and Slovenia, 1988–2006
1988–95 2001 2006

average
Estonia
Number of foreign banks in total (%) 43 57 86
Foreign bank assets in total (%) 35 98 99
Slovenia
Foreign bank assets in total (%) n.a. 15 30
Hungary
Foreign bank assets in total (%) 61 67 83
EU-15 average
Number of foreign banks in total (%) 30 n.a. n.a.
Foreign bank assets in total (%) 20 n.a. n.a.
Sources: Claessens, Demirgüc-Kunt, and Huizinga (1998): table 1; EBRD

Transition Report (2007).
207
The above institutional configurations reflect variation in the degree to

which the monetary authority is sheltered from governmental and partisan
efforts to exploit or impair central bank independence. Indeed, the paths
leading to central bank independence have differed in terms of radicalism and
political contestation. In Estonia the divorce of the monetary authority from
the political system is more complete than in Slovenia, let alone Hungary. The
Bank of Estonia’s hegemony in macroeconomic coordination has not been
challenged since the adoption of the currency board in 1992. Central bank
independence and its political implications have been somewhat more contro-
versial in Slovenia. However, after an eruption in the first years of independ-
ence, the debates later largely subsided. Hungary’s advance towards central
bank independence has been gradual, partial, and provoked recurrent party-
political struggles.
Overall economic performance seems to reflect the above institutional
patterns. Measured by combined rates of inflation and unemployment, the
Slovene configuration of central bank independence, institutionalized social
partnership, and cooperative fiscal institutions performed best. In comparison,
the Estonian and Hungarian patterns, which combine fragmented industrial
relations with uncontested versus challenged central bank independence and
cooperative versus conflicting fiscal institutions, respectively, appear as inferior
(Table 9.4).
Compatibility Between International and Domestic Agendas

Interpreters of the rapid ascendance of central bank independence tend to split
into two groups. International Political Economy approaches question that
central bank independence in east central Europe followed a domestic eco-
nomic rationale, and stress the role of the region’s quest for international
creditworthiness, reinforced by advocacy of the central bankers’ transnational
community (Johnson 2006; Maxfield 1997). Accordingly, the process of
refashioning the inherited authorities as independent central banks ‘by and
for international actors . . . occurred without the need to build extensive do-
mestic support for the new institutions’ (Johnson 2006: 91). However, the
assumption of a missing domestic economic rationale and political support
for postcommunist central bank independence sits uneasily with facts.
Table 9.4. Economic performance of Estonia, Hungary, and Slovenia, 2004–6
Estonia Slovenia Hungary
Inflation rate (2004–6 average) 3.8 2.9 4.8

Unemployment rate (2004–6 average) 8.0 6.4 7.0
Inflation and unemployment (2004–6 average) 11.8 9.3 11.8
Source: EBRD Transition Report (2007).
208
The salience of a domestic rationale, namely, taming high inflation and

ending chaotic multiple-currency regimes and economic recession in these
small states, is highlighted by authors in Comparative Political Economy
(Ennuuste et al. 2004; Feldmann 2006). Central banks could hardly have ac-
complished these tasks without strong domestic support. Indeed, in the Baltic
states a ‘largely home-grown stability culture that has been well-established
since the early transition’ brought about widespread support for the extreme
version of central bank independence manifested in the currency board ar-
rangements (Feldmann 2006: 128). This view is supported by facts on the
amazing political careers of Siim Kallas, Einars Repse, and Ivan Tosovsky, Esto-
nian, Latvian, and Czech central bank governors who founded and/or led
political parties, and became ministers of finance or even prime ministers of
their states.
Although not denying the salience of international factors, national politics
must be brought back in especially as the rapid shift to central bank independence
implied social welfare losses. Polányi’s ideas on the original role of central
banking under the gold standard system clarify the crucial link between central
bank independence and national politics. ‘[T]he great institutional significance
of central banking lay in the fact that monetary policy was thereby drawn in the
sphere of politics’ (Polányi 1957 [1944]: 197–8). In Polányi’s term, independent
central banks served as buffers in relation to the international gold standard
system, since ‘[c]ompletely monetized communities could not have stood the
ruinous effects of abrupt changes in the price level necessitated by the main-
tenance of stable exchange rates unless the shock was cushioned by the means
of an independent central banking policy’ (ibid. 194).
The social risks associated with abandoning central banks’ buffer role imply
that the de-politicization of monetary policy after the collapse of communism
could not be anything but an inherently political process. International actors
could press for and contribute to its emergence, but were unlikely to set in
motion and consolidate it on their own. Features of domestic polities must have
had a bearing on how fast, and through what trials, errors, and compromises,
central bank independence could advance. What then were the characteristics
of central bank independence and power after communism?
This chapter proposes that central bank independence, the single most im-
portant focus of monetary regimes’ Europeanization before EU accession, could
advance relatively fast in east central Europe because of its compatibility with the
domestic agenda of ending crisis, monetary stabilization, and nation building,
which empowered central bankers no less or even more than their international
connectedness. (For a similar argument on the popularity of the gold standard
in the age of nation building, see Helleiner 1999.)
However, ‘objective’ economic challenges and constraints capture only part
of the story. Notwithstanding their actual seriousness, recession, inflation, and
monetary chaos must first be perceived as critical, with identified causes and
209
remedies, before they can prompt publicly supported extraordinary measures.

Revisiting his path-breaking study of successful small states in postwar Europe,
Katzenstein (2003: 11) asserted that ‘[A]n analysis that focused only on the
objective data of economic openness missed the crux of the matter. Small size
was a code for something more important . . . it was concealing an underlying
and politically consequential causal connection. What really mattered politic-
ally was the perception of vulnerability, economic and otherwise.’ What were
the politically consequential perceived vulnerabilities of postcommunist small
states?
Central Bankers as Nation Builders, Social Partners,

and Partisans
The majority of east central European countries had to build new nation states.
All of them faced recession, inflation, and chaos, and wanted to ‘return to
Europe’. This section traces their initial decisions empowering or limiting the
power of central bankers to past legacies and their perception as either assets or
threats from the viewpoints of national independence, economic success, and
the perspective of Europeanization.
Estonia
Since inherited institutions and skills of monetary coordination were absent in
Estonia, central bankers’ power could not originate from public trust in their
professional competence. Given that the rapid shift to a national currency with
fixed exchange rate and a currency board mechanism, backed by a constitu-
tionally enshrined balanced budget provision, led to massive social dislocation,
the sources of political support for such radical measures are far from trivial.
Their support could not purely stem from international backing, as crucial
decisions had been taken in 1992 before massive external pressure or assistance
could materialize. Indeed, former Estonian prime minister Mart Laar (2002:
114) recalled that ‘[i]n the Spring of 1992 the International Monetary Fund
(IMF) initially urged Estonia to postpone monetary reform until its technical
capabilities were more advanced.’ The engagement of émigrée policy advisors is
noted in the literature. However, the fact that Estonia’s exclusive monetary
reform committee included Jeffrey Sachs’s doctoral student Ardo Hansson
(hardly a senior representative of global academic or financial circles at the
time,) seems less a proof of powerful external influences than of a pre-existing
domestic consensus favouring radical solutions.
Since the technicalities and risks of monetary policy had been hardly intelli-
gible for politicians, let alone ordinary citizens, the origins of such consensus
are puzzling. ‘The fact that politicians that outwardly supported the currency
210
board were at the same time sure that after monetary reform the central bank
would continue to deliver ‘‘cheap credits’’ to inefficient factories and collective
farms indicates that many politicians probably never understood exactly what
they supported’ (Laar 2002: 121–2). How then could a socially particularly
costly variant of a ‘stability culture’ (Dyson 2002a) sink roots in Baltic soil?
The answer points to its close fit with ‘sentiments of wider resonance’,
especially the ‘collective commitment to nationhood . . . and independence’ (Landes
1991: 49, emphasis added).
According to Anderson (1991: 7, emphasis added), ‘regardless of the actual
inequality and exploitation that may prevail in each, the nation is always conceived
as a deep horizontal comradeship’. Regained freedom to ‘imagine’ and craft a
national community has enjoyed immense popularity in the Baltics over the
whole period of transformation (Lagerspetz and Vogt 2004). Stability culture
and trust in its guardians, the currency board, a balanced budget, and central
bankers, could become a cornerstone of national identity, especially as meas-
ures to foster national independence and transformation have been introduced
as part and parcel of the same policy package.
The link among identity politics, the monetary regime, and tolerance for
social hardship has been reinforced by the issue of a new currency, a core
means and symbol of sovereign statehood (Laar 2002: 125). The enthusiasm
with which the stable kroon was received elevated the symbolic status of the
monetary authority, and enhanced the popularity of central bankers as nation
builders. Institutional insulation of monetary policy resonated well with the
public sentiment that the cause of national independence ought to be removed
from the everyday struggles of democratic politics. It was on these grounds that
the Bank of Estonia governor in 1991–5, Siim Kallas, could build political
capital around his role as ‘father of the national currency’. Still in office, in
1994 he founded the Reform Party that came in second in the 1995 parliamen-
tary elections and remained politically influential afterwards (Smith 2002).
Kallas became minister of finance (1999–2002), prime minister (2002–3), and
Estonia’s EU Commissioner (2004).
‘De-politicization’ of monetary coordination has not been buttressed by
democratic means alone. In the early 1990s Estonia introduced restrictive
citizenship laws that deprived many ethnic Russian ‘losers of the transform-
ation’ of the right to oppose radical transformation by democratic vote
(Smith 2002). These measures muffled conflicts and relieved central banks
and other sites of public policy from losers’ pressures.
Identity politics cemented the hegemony of stability-oriented institutions in
yet other ways. Estonian policy makers refused to help troubled industrial firms
and banks by subsidies and grace periods for restructuring bad debts (Table 9.1).
Lack of protectionism, however, could be more easily justified on grounds of
perceived vulnerability of the national economy to post-colonial influences. In
Laar’s words, after 1940 a ‘large Soviet military garrison and the continued
211
influx of Russian speaking colonists who acted like a ‘‘civilian garrison’’ re-
placed the lost population. In order to effect colonialization, rapid industrial-
ization was launched by Moscow’ (Laar 2002: 37). By implication, after
independence, since most managers and workers were ethnic Russians, radical
de-industrialization could be perceived as a means of de-colonialization. The
imminent atrophy of business and labour organizations has not been viewed
as too painful a loss, even if it led to highly fragmented industrial relations that
impaired the prospects for socially embedded coordination, and reinforced
exogenous monetary policy as the ‘only game in town’.
Furthermore, faced with the banking crises of the early 1990s and the tasks of
bank privatization, the Bank of Estonia acted as a substitute police force.
The government soon found out that it was not possible to compete against the influx of
Russian organized crime into Estonia with a police force which was still in the process of
being built up. And so the government had no alternative other than to try to weaken
organized crime by introducing a series of economic measures designed to cut its sources
of income and prevent its entry into the banking sector.
(Laar 2002: 191–3)
In consequence, the Bank of Estonia urged the demise and bankruptcy of banks
with suspicious portfolios by the abrupt withdrawal of public assets and setting
strict prudency standards. It also encouraged acquisitions by Western banks,
which rapidly emerged as ‘absolute market leaders’ (ibid.).
Slovenia
Since Slovenia faced a triple transformation to nation state, democracy, and
capitalism (Offe 1991), some factors that empowered Estonian central bankers
have been at work in Slovenia too. The new currency fostered identity through
its national imagery, replaced the cacophony of a multiple-currency regime
with ‘unity in ‘‘economic language’’ ’, and consolidated the ‘trustworthiness
of the institution that issued it or guaranteed its value’ (Helleiner 2003: 101,
112–13). However, the Bank of Slovenia has never acquired the unchallenged
hegemony of its counterpart in Estonia.
Unlike policy makers in Estonia, Slovene monetary strategists opted for a
separation between policies to achieve independence and to foster transform-
ation. ‘In the belief that the new country could start as a genuine market
economy’ banks and industrial firms were granted grace periods, subsidies,
and loans to adjust and restructure (ibid.). Over the 1990s, administrative
barriers hindered foreign takeover, especially in the banking sector. Consistent
with the above, macroeconomic independence had been sought by a ‘prag-
matic economic policy and a floating exchange rate system for the new cur-
rency . . . It was hoped that such a policy would result in smaller output losses
and lower unemployment by allowing some inflation’ (Mencinger 2004: 78).
212
This approach continued in the face of external advice. Although the same team
of foreign advisors, led by Sachs, proposed similar remedies to the economy’s
woes in Slovenia as in Estonia, namely, fixed exchange rates, radical stabiliza-
tion, liberalization, and privatization, their suggestions were ‘stubbornly
rejected’ in Slovenia (Mencinger 2004: 76).
Due to gradualism in commercial bank transnationalization, reserve require-
ments remained effective tools at the Bank of Slovenia’s disposal until (and
even beyond) the early 2000s when recurrent EU pressures ultimately forced
Slovenia to grant private and foreign capital freer access to its banks (Lindstrom
and Piroska 2007: table 1.3). Ironically, then, resistance to some of the top–
down pressures of accession Europeanization in the banking sector helped the
Bank of Slovenia to succeed in the main task of membership Europeanization:
full compliance with the Maastricht convergence criteria.
To a large extent, the divergence of Estonian and Slovene paths can be traced
to differences in legacies and their perceptions. First, in contrast to Estonia,
Slovenia did not have to build institutions of macroeconomic coordination
from scratch. Second, Slovene gradualists generally ‘considered the legacy of
the past an exploitable advantage’ (Mencinger 2004: 76). Domestic policy
makers’ credibility was enhanced by their competence acquired in the last
decades of Yugoslav communism when ‘many economists studied abroad,
acquiring a solid understanding of Western economics, and were therefore
not easily awed by foreign advisers’ (ibid.)
An important Yugoslav legacy was the long experience with workers’ self-
management that added a level of participatory decision making unknown in
other east central European states. Independent Slovenia embraced this legacy
and developed it into a system of negotiated industrial relations. Especially after
the initial recession removed from power the Right-wing coalition that won the
first parliamentary elections, ‘political exchange between centre-Left govern-
ments and organized economic interests became a permanent feature and the
key mode of interest concertation, giving social legitimacy to market reforms’
(Stanojevic 2003: 290). Centralized institutions of industrial relations strength-
ened cooperative social partners and mitigated the costs, and facilitated the
political acceptance, of stability-oriented monetary policies. In essence, encom-
passing social partnership has become the expression of a Europeanized and
inclusive variant of nationalism that did not perceive Slovenia as permanently
threatened by enemies from within and without.
For all these reasons, central bank independence and power emerged in the
context of a power-sharing arrangement with other important economic interests
and institutions. Above all, Slovene central bankers’ power originated from
their negotiated relationship with social partners. On the one hand, central
bank independence has become part and parcel of an inclusive and balanced
national agenda that successfully resisted external pressures for radicalism. On
the other hand, as Slovene nationalism unambiguously favoured a ‘return to
213
Europe’, bottom–up Europeanization proved to be much less divisive than in

other east central European states.
Hungary
The Hungarian route to central bank independence is distinguished from the
Estonian path by its gradualism, and from the gradualist Slovene path by fierce
partisan struggles around central bank independence. Since the Hungarian
nation state and national currency survived communism, central bankers
could not pose in the role of nation builders. Nor could they gain power as
the monetary guardians of encompassing social partnership, as Hungary lacked
such institution. Essentially, Hungarian central bankers’ power depended on
partisan struggles mitigated by top–down pressures for Europeanization.
Similarly to Slovenia, Hungary inherited foundations of macroeconomic
coordination. Importantly, a two-tier system that separated the central bank
from commercial banks had been put in place as early as the second half of the
1980s. Indeed, from the early 1980s, market-oriented economic reforms and
the management of accumulated huge foreign debt had facilitated the integra-
tion of Hungarian financial technocracy into international networks. Fellow-
ships, conferences, debt negotiations, lobbying for new external resources,
education, and training grants were as important in fostering such linkages as
Hungary’s early IMF and World Bank membership. New skills were developed
during this integration process, such as familiarity with the logic of stabilization
programmes, statistical and analytical capacities, and negotiating with foreign
creditors and investors, skills that were even more badly needed after 1989.
One consequence was that Hungary’s shift to the monetary coordination of a
market economy could be relatively organic, gradualist, and ‘home-grown’,
similar to that of Slovenia. While the role of foreign assistance was more
accentuated before than after the collapse of communism, the task of main-
taining international creditworthiness has remained an important driving force
of the National Bank of Hungary’s Europeanization. Given the imperative of
foreign debt management, the reluctance with which central bank independ-
ence was adopted seems surprising.
The apparently weak support for a stability culture can be traced to the
fact that Hungarian elites and publics have not perceived the overarching
social purpose of transformation in terms of national identity or social
partnership. For historical reasons, the popular legitimating principle of
Hungarian capitalist democracy has been public social provision that typically
contradicted macroeconomic stability (Bohle and Greskovits 2007; Kornai
1996). As in the other two cases, initial choices take us far in understanding
the difference.
Hungarian reformers were well aware of the social hardship coming with
economic collapse and market reforms, but could not fall back upon identity
214
politics, gain support on nationalist grounds, and muffle protest by disenfran-

chising large parts of the affected population, as Estonia did. At the same time,
they shied away from offering institutionalized voice to trade unions and the
losers of reforms, the way Slovenia did. Rather, fearful of losers’ protest, Hun-
garian reformers decided to offer compensation in the form of relatively gener-
ous, targeted social protection packages in order to overcome opposition to
reforms (Vanhuysse 2006).
Prime minister Ferenc Gyurcsány’s words before the spring 2006 elections
capture the structural roots of implied imbalance. ‘A labour-friendly but anti-
capitalist policy is an oxymoron . . . Labour-friendly policies can only succeed
if they also foster entrepreneurship. If we overshoot in supporting workers, we
are left without jobs. If we overdo supporting entrepreneurs, we are left without
social peace. During the transition Hungary has been stumbling from one
extreme to the other’ (Interview, Népszabadság, 24 February 2006).
Hungary’s ‘stumbling’ has been closely linked to the issue of social protection
and its conflicts with macroeconomic stability, which has been mostly unsuc-
cessfully guarded by the National Bank of Hungary. The routine of buying
acquiescence through welfare spending and industry subsidies at the expense
of sound finances had lasting consequences for party competition. Rival mass
parties usually stressed the intrinsic relationships between economic and wel-
fare protectionism, promised both kinds, and, once in power, tried pragmatic-
ally to implement some mix at the expense of fiscal overspending and/or lax
monetary policies. This complex and contradictory agenda left its mark on
bureaucratic politics.
While top–down pressures for Europeanized macroeconomic coordination
empowered the National Bank of Hungary and supported fiscal reforms, ad-
vances on both accounts were subordinated to partisan considerations, reflecting
short-term electoral risks and opportunities. First, political struggles over the
control of the ministry of finance and the central bank recurred over the 1990s
and early 2000s. Delegation of power for fiscal centralization, rationalization,
and adjustment depended crucially on the extent to which prime ministers
governed cohesive legislative majorities and perceived finance ministers as
brothers-in-arms rather than rivals in politics. Institutional reforms could ad-
vance in the former but were watered down or stalled in the latter cases
(Greskovits 2001; Haggard, Kaufman, and Shugart 2001).
Second, Hungary’s muddling towards central bank independence reflected
efforts of partisan control, which impaired the coordination of fiscal and mon-
etary policies even after EU accession. Ironically, steps towards central bank
independence made the monetary authority an even more attractive target for
partisan capture both from the ranks of incumbent parties and the opposition.
Appointments of new National Bank of Hungary governors and efforts to
strengthen central bank independence occurred in a revealing sequence. ‘Un-
reliable’ governors were not allowed to enjoy the longer terms in office, legally
215
better-protected jobs, and enhanced policymaking authority guaranteed by the

more and more Europeanized central bank laws. Rather, advances to stronger
central bank independence typically favoured and empowered their ‘party-
loyalist’ successors.
Hence, the replacement of president György Surányi by Péter Ákos Bod of the
MDF (Hungarian Democratic Forum) in 1991 coincided with the passing of the
first National Bank of Hungary Act, which limited (though without entirely
abolishing) the central bank’s role in financing fiscal deficits. Surányi could not
stay because he signed the Democratic Charter, a left–liberal protest leaflet
against the rise of extreme–Right forces under the centre–Right government.
Similarly, Gyula Horn’s Left-led coalition started its term in 1994 by replacing
Bod with Surányi, whose authority was not questioned as long as the Horn
government was in power. Although Surányi served his term, by its end in 2001
he was vehemently attacked, on grounds of alleged serious mismanagement of
the National Bank of Hungary’s office in Austria, by prime minister Orbán’s
minister of finance, Zsigmond Járai. While Surányi helped to prepare the new
act of June 2001 that further strengthened central bank independence, and
declared direct financing of the public deficit by the National Bank of Hungary
no longer possible, the new EU-compliant law empowered his successor Járai.
Járai became in turn the prime example of a central banker blamed with the
abuse of his sheltered position for partisan political advantage. Ironically, then,
while over the past one-and-a-half decades Hungary succeeded in creating the
legal institution of central bank independence, it had to wait until 2007 to have
a central bank president whose personal independence and non-partisanship
appeared credible to, and could be accepted by, the whole political community.
Prior to 2007 National Bank of Hungary presidents were typically viewed as
advocates of partisan agendas.
Passing and Failing the Euro Entry Test
How have the increasing pressures for sustainable compliance with the Maas-
tricht convergence criteria affected the fortunes of central banking around, and
especially after, EU accession? This section argues that central banks’ origins in
terms of power and the institutional features adopted in the course of preparing
for EU accession have had an impact on the dynamics of Europeanization after
membership.
In the early 2000s, all three central banks optimistically prepared for joining
ERM II in 2004 and changeover to the euro in 2007. However, only Slovenia
could introduce the euro as planned. The Bank of Slovenia mastered this task by
utilizing the same neocorporatist institutions that had shaped and helped its
Europeanization during the accession period. Uniquely in the region, in April
2003 Slovene social partners signed an encompassing pact on future wages and
216
income policy ‘with important provisions on issues such as employment,

training, social dialogue, equal opportunities and taxation . . . Undoubtedly,
this social agreement, with its ambitious objectives and comprehensive agenda,
matches the ‘‘social pacts’’ reached in ‘‘old’’ Member States with the aim of
coordinating the whole adjustment process in the course of joining the euro-
zone’ (EIROnline 2004: 19).
In contrast, in 2007 the Estonian government admitted that it would not be
able to keep inflation within the Maastricht limit. Indeed, in 2007 the Baltic states
ended up as EU leaders in inflation rates, and the financial community became
increasingly concerned about the possibility of their ‘crash-landing’. Estonia thus
remained in ERM II and by early 2008 lacked a target date for euro entry.
It is tempting to explain this fiasco by the discouraging demonstration effect
of the ECB’s refusal to endorse Lithuania’s Euro Area membership in 2006.
However, the ECB’s uncertainty and negative signals have not caused but rather
responded to the Baltic states’ apparent inability to counter accelerating inflation
and mounting current account deficits, which were fuelled by rising energy and
food prices, and especially firms’ and households’ hitherto pent-up domestic
demand (EBRD Transition Report 2007, London). Central bankers have been
clear about the reasons. Bank of Latvia’s governor Ilmars Rimsevics expressed
scepticism about the possibility of curbing domestic demand by fiscal restric-
tion since both Latvia and Estonia already run sizable budget surpluses. Both
Rimsevics and Bank of Estonia governor Marten Ross complained about lack of
control over the expansionary credit policy of their states’ Scandinavian and
German banks associated with a housing and real estate boom (Farkas 2008: 68;
Table 9.1). The ECB, then, seems to have serious reasons for scrutinizing new
members’ capacity for sustained macroeconomic stability.
After repeated postponements, by 2007 Hungary even lacked a new target
date for entering ERM II. This is less surprising as the partisan and bureaucratic
struggles for control over fiscal and monetary coordination, which character-
ized the transition period, further intensified after Hungary’s EU entry. The
strategies and arguments used by rival advocacy coalitions (Sabatier 1991)
have been thoroughly shaped both by ‘top–down’ and ‘bottom–up’ processes
of Europeanization. Mainly ‘top–down’ compliance requirements affected the
competition for power over monetary policy, since they empowered the presi-
dent of the National Bank of Hungary and allowed him to use the increasingly
critical Convergence Reports of the ECB and the European Commission to
buttress his own position. In contrast, struggles over fiscal and exchange-rate
policies have been stronger affected by a divisive process of ‘bottom–up’ Euro-
peanization, in which domestic actors instrumentalized a variety of European
models, such as the European mixed economy or the European Social Model, to
strengthen their positions in electoral and party competition (Greskovits 2006).
Despite repeated calls for emulating West European practices (Bruszt, Oblath,
and Tóth 2003), Hungarian macroeconomic stability could not be backed by an
217
encompassing social pact. Government disinterest, business strength, and la-

bour weakness obstructed the institutionalization of a social partnership. Shar-
ing of adjustment burdens has thus been left entirely to the process of
democratic competition, with troubling consequences for economic perform-
ance and ultimately political balance.
In autumn 2006, a huge fiscal deficit and public debt forced Hungary to
implement a radical programme of macroeconomic stabilization and public-
sector reform and retrenchment. The appointment of independent András
Simor as National Bank of Hungary president in 2007 paved the way for ending
the trench warfare between the central bank and the Ministry of Finance.
However, since the attempted termination of the social contract provoked fierce
political and social resistance and undermined political stability, the belated
cease-fire among Hungary’s top policy makers may fall short of restoring macro-
economic balance.
The difficulties encountered by most east central European states on the road
to euro entry can be ultimately traced to the crucial differences between the
political opportunity structures shaping Europeanization before and after acces-
sion. First, the ‘heroic’ times when central bankers successfully fought high
inflation and chaotic multiple-currency regimes by introducing new national
currencies are over. However, while ordinary citizens had strong reasons to
support the cause of taming galloping inflation, it is far less trivial for them
why compliance with the Maastricht criteria ought to be viewed as a basic
public good. Instead of further nominal convergence, it is now real convergence
of output, employment, and living standards that East Europeans demand.
Second, the prospect of ‘de-nationalization of money’ (Helleiner 1999) implied
by euro entry fuelled fears of losing national identity—just as earlier in older EU
member states. However, ‘[n]ational currencies do not have the same meaning
for national identity in all countries’ (Verdun 1999a: 208). In east central
Europe, it is in the new states where the link between money and nation
appears to be strongest. Accordingly, the conflict between preparations for
euro adoption and national agendas manifested itself in different forms in the
new Estonian and the old Hungarian state (Table 9.5).
The Eurobarometer data reveal interesting cross-country variation of citizens’
hopes and fears about the euro. To the extent that low inflation remains
important for them, a large majority of Estonians and a sizable minority of
Hungarians expect euro entry to undermine price stability, at least in the short
run. Furthermore, a large majority of Estonians and more than half of Hungar-
ians are sceptical about the euro’s impact on real convergence: rates of growth
and employment. Hungarians’ relative optimism is less puzzling when their
despair and dissatisfaction with the ongoing radical welfare-state retrenchment
and confusion about its rationale is factored in.
While identity gains and losses seem to matter little for ‘materialist’
Hungarians, Estonians appear as more ‘idealist’ in expressing their hopes and
218
Table 9.5. Hopes and fears about the euro in Estonia, Hungary, and Slovenia (% of answers)
Dominantly expected euro zone entry date Estonia Slovenia Hungary

(09/07) (09/06) (09/07)
2012 (2008 2007 2013 (2012

in 2006) in 2006)
Happy about the euro 30 72 48

Material gains and losses
Ensure price stability 40 24 58
Increase prices when introduced 89 63 72
Improve growth, employment 30 31 49
Identity gains and losses
Feel more European 40 68 30
Lose national identity 51 35 30
Lose control over economic policy 37 30 28
Trust in European Institutions versus National 75 89 91
Central Bank for information about the
changeover to the euro (%)
Sources: Introduction of the Euro in the New Member States. Flash Eurobarometer November 2006, 2007. The
Gallup Organization—European Commission. Country Scorecards.
fears about the euro mainly in terms of identity. In concrete terms, more than
half of Estonians are concerned about loss of national identity (and a third
about loss of control over economic policy) associated with the changeover to
euro. Only a minority of Estonians expects to feel more European after the
adoption of Europe’s single currency. In the light of recent incapacity to sustain
macroeconomic stability, the fact that Estonians trust their central bank signifi-
cantly more than EU institutions as a source of reliable information on the euro
is no less ironic than Hungarians’ trust in EMU as an engine of fast growth and
employment. Nonetheless, such puzzles of trust and mistrust seem to support
those who believe in the power of ideas and even of misperceptions.
For the above reasons, the EMU project appears to be less compatible with
national agendas than central bank independence had been, and this conflict
impairs its public acceptance and political support. Bearing this in mind, it is less
than surprising that the euro has lost popularity all over the region. In Septem-
ber 2007 only less than half of Hungarians and hardly a third of Estonians were
happy with the prospect of having euro as their official currency (Table 9.5).
Indeed, in 2008 inflation accelerated and social protest intensified even in
Slovenia. A general strike in March 2008 signalled a possible end to wage
moderation and the strength of demands for convergence in real wages.
Conclusions
What do these cases reveal about central bank convergence, power, and Euro-
peanization? They show that the convergence of postcommunist central banks
219
on the norms and standards of central bank independence paralleled and inter-
acted with processes of divergence. Varied configurations of central bank respon-
sibilities and policy instruments have emerged, along with distinctive patterns
of dominance, involving collaboration or rivalry with fiscal authorities, indus-
trial relations regimes, commercial banks, and political parties.
It follows that, although independence became a common key aspect of
central bankers’ identity and institutional power, their profile also responded
to particular political opportunity structures, placing them in the varied roles of
nation builders, social partners, and partisan agents. Accordingly, central bank
power has been as much shaped by perceived national vulnerability and
other sentiments of wider resonance, such as trust in social partnership or
demands for social welfare, as by their demonstrated technocratic competence
and international connectedness.
The chapter offers some lessons for students of Europeanization. One finding is
about its dynamics over time. Central banks’ origins of power and institutional
features adopted in the course of Europeanization before EU accession have had an
impact on the dynamics of Europeanization afterwards. In the case of Slovenia, the
former process reinforced the latter. Institutionalization of social partnership
during the transition period helped the Slovene central bank to complete Euro-
peanization by rapid euro entry. In the Estonian case, the opposite influence is
evident. Success in nation building and Europeanization leading to accession
empowered the central bank as Estonia’s most reputed economic institution.
However, public trust backfired after EU accession, since the central bank delayed
necessary institutional adjustment, even if on the route to euro entry the currency
board appears to be dysfunctional as the guardian of stability.
Finally, the chapter’s findings confirm earlier research on the interplay of
Europeanization processes across varied policy issue areas (Bohle and Greskovits
2006). Europeanization of economic policies is not a ‘seamless web’. Rather,
advance in one issue area might undermine or delay advance in another, and
thus simultaneous compliance ‘with everything’ might prove to be either
impossible or undesirable.
220
10
Czech Republic and Poland: The Limits
of Europeanization
Rachel Epstein and Juliet Johnson
The Czech Republic and Poland underwent rapid economic transformation in

the first decade of post-communism, which included embracing international
standards of central bank independence and the depoliticization of monetary
policy. However, they have shown much less appetite for adopting the euro
since acceding to the European Union in 2004. ‘Europeanization’ in terms of
meeting, or even striving to meet, the criteria for euro entry has been incom-
plete. We argue that two broad conditions explain both the relative suscepti-
bility of Czech and Polish central bankers and politicians to international
financial institutions’ advice on central bank independence and price stability
and these states’ more recent resistance to rapid adoption of the euro: the
uncertainty of domestic actors and the credibility of international institutions’
policy prescriptions.1 Given the presence or absence of domestic uncertainty
and credibility, external actors have either more or less authority to define the
contours of domestic policy debates and privilege particular institutional
arrangements. The Czech Republic and Poland faced similar measures on
actor uncertainty and the perceived credibility of international institutions’
policies over time and thus rapidly institutionalized central bank independ-
ence while procrastinating on euro entry.
Actor uncertainty, a domestic variable, manifested itself in Poland and the
Czech Republic in the search for policy and technical guidance early in the
transition. The first post-communist Czech and Polish leaders were uncertain
in the sense that they had never before managed a transition from state
socialism to capitalism or governed a market economy. They therefore looked
to international institutions for guidance as to what constituted best practice.
New parliamentarians and the public had little sense of how institutional
relations in the financial sector like central bank independence would
affect distributional outcomes. In addition, there was considerable technical
221
Czech Republic and Poland: The Limits of Europeanization
uncertainty. Even once politicians had decided to emulate Western models,

turning socialist-era mono-banks into two-tiered systems anchored by effect-
ive central banks required extensive legal and economic expertise that mono-
bank bureaucrats lacked. As international institutions imparted this technical
advice, they also had the opportunity to prioritize central bank independence
and price stability above competing policy aims.
While domestic uncertainty explains Czech and Polish openness to central
bank independence and price stability in the first decade of transition, the lack
of uncertainty among domestic actors more than a decade later helps explain
their scepticism towards euro entry. By the early 2000s, Central and East Euro-
pean (CEE) politicians and central bankers were very familiar—in part from
more than a decade of direct experience—with the costs and benefits of a
range of monetary and exchange-rate policies. Moreover, although Czech and
Polish central bankers were keener to adopt the euro sooner than many of their
political counterparts, even central bankers questioned the wisdom of the
Maastricht convergence criteria (Dyson 2007; Johnson 2006).
The perceived credibility of international institutions’ prescriptions, an
international variable, has also varied over time in the Czech Republic and
Poland in ways that help explain the institutionalization of central bank
independence and the rejection of rapid euro entry. We assess the ‘credibility’
of international institutions’ policies in two ways: the extent to which differ-
ent international institutions endorsed similar policy prescriptions, and the
consistency between what international institutions prescribed for target
states and what the Western states themselves actually did. Post-communist
transition began at precisely the moment when a Western consensus around
central bank independence and low inflation was crystallizing (Maxfield
1997). The consistency between international institutions’ simultaneous urg-
ings that the Czech Republic and Poland adopt central bank independence
and what the majority of Western states were doing—which was themselves to
move monetary policy out of the political fray—left little argumentative space
for east central European states to deny the credibility of central bank inde-
pendence (Epstein 2006). The EU’s decision to make the institutionalization of
central bank independence a firm requirement for EU accession further
emphasized its importance to the international community.
But while the credibility of international institutions on central bank inde-
pendence was high in the 1990s, the same cannot be said for the euro. First,
Sweden, Denmark, and the United Kingdom had all opted out of joining the
euro, albeit on varying legal grounds.2 Second, the Maastricht convergence
criteria for euro entry and the Stability and Growth Pact have both been
undermined by the failure of some members to meet the criteria or to stay
within the confines of the Pact. Ongoing criticism of the ECB from France and
Italy has also called into question the desirability of a single monetary policy
for Europe. Third, while many international institutions presented a united
222
front in pushing post-communist states to adopt central bank independence

and price stability, no such consensus or shared stakes existed on when and
how the east central European states should adopt the euro.
Moreover, mixed messages from the ECB itself undermined the credibility
of the euro in east central Europe. Although these states promised to enter
the Euro Area as a part of EU membership, the ECB has used the toughest
interpretation of the convergence criteria to evaluate their adoption bids—
much tougher than was used in Western Europe (Johnson 2008). When
compared with Greece’s compliance with the convergence criteria, for ex-
ample, Lithuania’s 2006 exclusion from the Euro Area based on a slightly
higher than prescribed inflation rate appeared somewhat arbitrary. Tensions
between the ECB and CEE states have continued, with Slovenian inflation
in the post-Euro adoption period calling into question the ability of post-
communist states to sustain the necessary macroeconomic criteria. Such
doubts did not ultimately prevent the European Commission’s positive
recommendation in May 2008 that Slovakia was qualified to join the euro
zone on 1 January 2009. There had been ongoing disagreement between
European officials and Slovak leaders over the sources of inflation and need
for greater fiscal consolidation and structural reform. Finally, as of the time
of writing, the Czech Republic was considering a delay in euro adoption of
another decade or more, underlining how politically problematic the euro
zone had become in CEE.
Greskovits (in this volume) offers a competing explanation based on vari-
ation in domestic conditions, arguing that the institutionalization of central
bank independence and the adoption of the euro have been more or less
compatible across cases with nation-building goals and national identities.
But we believe that our explanation, which draws on both domestic and
international forces, better explains pro-central bank independence and
Euro-sceptic outcomes in east central Europe. Partisan disagreement over
central bank independence and the euro, as evidenced in Poland, Hungary,
and the Czech Republic, can neither confirm nor disconfirm an identity-based
explanation. Moreover, domestic uncertainty and international credibility are
quite good at explaining change over time. Looking beyond the Polish and
Czech cases in this chapter, both Romania and Ukraine had much lower levels
of domestic actor uncertainty at the outset of transition and consequently
showed much less willingness to embrace central bank independence early on.
Although Romanian identity did not change during the 1990s, the measure on
actor uncertainty did—with the victory of the Democratic Convention of
Romania over the communist successors in 1996. With uncertain actors in
office and central bank independence enjoying broad international credibility,
Romania began to institutionalize central bank independence much more
strongly in the late 1990s than previously (Epstein 2008).
223
Central Bank Internationalization: Independence

and Price Stability
By the time the Berlin Wall fell in 1989, a hard-won consensus had devel-
oped among international financial institutions, governments, and central
banks in the advanced industrial democracies on the importance of central
bank independence and price stability. As a result, during the early years of
transition, international institutions presented a unified policy front to post-
communist governments. A wide range of external actors such as the IMF,
the World Bank, USAID, the Bank for International Settlements (BIS), and
central banks such as the Bundesbank and the Bank of England came to-
gether to encourage post-communist states to create independent central
banks. They not only promulgated the twin mantras of central bank inde-
pendence and price stability, but also provided the technical assistance and
training necessary to put these ideals into practice. This assistance included
everything from IMF missions and resident experts to sophisticated training
programmes designed for post-communist central bankers. For example,
approximately 4,500 central bankers from the 10 post-communist states
that would later join the EU took part in training courses at the Bank of
England’s Centre for Central Banking Studies (CCBS), the Joint Vienna Insti-
tute (JVI), and the IMF Institute between 1991 and 2000 (Figure 10.1). The
Polish and Czech central banks were among the leading recipients of this
training. By the end of 1993, over 300 of their central bankers had already
taken a CCBS, JVI, or IMF course.
The EU itself did not become significantly involved with central bank
transformation until later, when EU enlargement came onto the agenda
and the European Central Bank (ECB) began operations. The ECB then
worked to harmonize the relevant accession-state legislation with the EU
acquis communautaire (which requires a high level of central bank independ-
ence), to improve central bank operations, to upgrade payment and settle-
ment systems to EU standards, and to ensure consistency of statistics and
IT infrastructure and applications with current EU members. EU accession
conditionality reinforced domestic commitment to these efforts, but the
possibility of future EU membership did not represent the initial or primary
impetus for change. The transformation of post-communist central banks
into independent guardians of price stability thus represented not so much
Europeanization as internationalization, with central banks adapting to
an established international model. As we discuss below, in Poland and
the Czech Republic the concerted, credible efforts of international institu-
tions to promote central bank independence practically guaranteed success
in the face of domestic uncertainty over appropriate post-1989 policy
choices.
224
800
700
600
Number of participants
500
400
300
200
100
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IMF JVI CCBS
Figure 10.1. Central bank participants in CCBS, JVI, and IMF institute courses, 1991–
2000
Source: Data provided to the authors by the CCBS, JVI, and IMF.
Poland
By the close of 1997, the National Bank of Poland (NBP) was among the most
independent central banks in the world (Cukierman, Miller, and Neyapti
2002). Two sets of legislation, in 1990 and 1997, as well as the adoption of a
new constitution in 1997 that supported central bank independence and price
stability resulted from domestic political conflicts in which Polish supporters
of central bank independence prevailed. The internationalization of Polish
monetary and bank regulatory policy was in turn linked to international
institutions’ consistent involvement in Polish economic reform. Indeed, a
transnational coalition overpowered a serious challenge to central bank inde-
pendence in the mid-1990s, which led to further institutionalization of inter-
national norms towards the end of the decade.
Polish actor uncertainty was strongest in the first four years of the transition
when post-communist states experimented with approaches to macroeco-
nomic stabilization and the introduction of markets. There is evidence of
Polish uncertainty regarding how to structure the central bank and of the
225
influence that such uncertainty afforded international institutions. Already in

1989, Poland passed the ‘Banking Act’ and the ‘Act on the National Bank of
Poland’—two pieces of legislation converting the socialist-era mono-bank into
a two-tiered banking system modelled on Western, capitalist principles. In
that instance, the US Agency for International Development (USAID) provided
detailed advice on the legislation (Stirewalt and Horner 2000). The World
Bank’s 1991 Financial Institutions Development Loan (FIDL) also shaped the
central bank’s role in the economy in so far as it required the curtailment of
subsidized and directed credit (World Bank 1997b). The Enterprise and Finan-
cial Sector Adjustment Loan (EFSAL) of 1993 was similarly designed to define
and limit the central bank’s funding authority by shielding the central bank
from pressure to bail out banks or enterprises undergoing restructuring (World
Bank 1997a). This last loan also guaranteed IMF and World Bank officials’
access to the NBP’s supervisory activities in order to help ‘contain systemic
risk in the banking sector and to support the NBP’s larger objective of price
stability’ (Borish and Company Inc. with Triumph Technologies Inc. 1998).
The Polish case shows not only a willingness to call on international insti-
tutions to deal with policy uncertainty but also a tendency to rely on external
expertise to train central bankers. One long-serving head of bank supervision
in Poland recalled that there were initially sharp disagreements between NBP
bureaucrats and international institutions on everything from the need for
bank supervision to government deposit insurance (interview with Śleszyñska-
Charewicz). In addition, before her tenure as the central bank’s chairwoman
and her intense exposure to the international financial institutions’ counsel,
Hanna Gronkiewicz-Waltz supported executive authority over the central
bank. That international institutions prevailed in all of these debates demon-
strates the significant power of external actors in defining best practice—in
part because of domestic actor uncertainty, but also because the international
financial institutions had strong credibility—not least because of the evolu-
tion of standard practice in the West.
The international institutions also forged strong personal and intellectual
ties in Poland in the early years, both with the central bankers and with
members of various post-Solidarity governments. This transnational coalition
of central bank independence and price stability supporters proved crucial to
stronger institutionalization of these principles in law and in the 1997 Polish
constitution. For, beginning in the mid-1990s, after the Democratic Left Alli-
ance (the SLD, the communist successors) prevailed in the 1993 parliamentary
elections and formed a governing coalition with the Polish Peasant Party (PSL),
central bank independence came under attack.
Finance Minister Grzegorz Kołodko first called into question the NPB’s
policies and governing structure. Although Kołodko defended central bank
independence in principle, he took exception to the practice of central bank
independence in Poland. Arguing in the press that the central bank president’s
226
responsibilities were ‘not confined to those of God and History’ but were also
to ‘society and the national economy’, he took aim at what he called ‘exces-
sively restrictive monetary policy’.3 He also lamented the fact that power
within the NBP was, in his view, dangerously centralized with respect to
monetary policy and bank regulation. Finally, Kołodko complained that the
Ministry was never consulted on major central bank policy shifts (interview
with Kołodko). As a potential remedy to these perceived problems, the SLD–
PSL coalition tabled legislation to increase political control over the central
bank (particularly through appointments), remove its regulatory authority,
and loosen limits on central bank lending to the government.4
The government’s legislation drew an immediate and negative reaction
among Poland’s external advisors. At this point international actors had no
more central bank independence-related conditionality agreements pending,
while EU membership was not explicitly tied to the nuances of central bank
governance at that time. Lacking any ‘hard’ tools of enforcement, IMF, World
Bank, and USAID representatives turned first to their Polish allies, including
those who had been heavily influenced by international financial institutions’
training. A transnational coalition comprising international financial institu-
tions’ officials, Gronkiewicz-Waltz, Śleszyñska-Charewicz, and politicians
from the Freedom Union party (chaired by Leszek Balcerowicz) worked to-
gether to perfect arguments in defence of central bank independence to pre-
sent to the public and the Sejm. In addition, the international financial
institutions contributed to alternative legislation to insure that legal changes
would reflect international trends towards greater central bank independence.
The Freedom Union ultimately put forward that legislation. Finally, in public
settings, the international financial institutions and the EU lobbied heavily
against the SLD–PSL legislation, which undermined its legitimacy in Poland.
After more than a year of political conflict, the Freedom Union’s central
bank independence-preserving legislation prevailed, while the SLD–PSL pro-
posals were ‘quietly shelved’.5 This was a surprising outcome, not least because
the SLD–PSL coalition had an overwhelming majority in the Sejm. But it is
explicable because of the overwhelming rejection of the SLD–PSL legislation
by the international financial institutions and the EU. Given their unified pro-
central bank independence position and the increasing consistency in West-
ern practice, Poland’s external advisors had enormous credibility. Although
Poland’s EU membership or access to financial assistance was not at stake, the
potential reputational costs of violating international norms were sufficiently
threatening to cause Poland’s communist successors to relent. In 1997, the
Sejm approved a new constitution in which central bank independence was
further institutionalized, including clarifying the president’s role in selecting
the NBP chair and banning government borrowing from the central bank.6
Thus central bank independence was institutionally stronger in the wake of
the conflict (Cukierman, Miller, and Neyapti 2002: 242).
227
Czech Republic
As in Poland, Czech policy makers turned to international models and assist-
ance to transform their central banking institutions. The November 1989
Velvet Revolution initiated a sharp break with the previous regime, bringing
to power individuals with a strong commitment to political democracy and
economic liberalization. Like the NBP, the Czech National Bank (CNB) quickly
became one of the world’s most independent central banks (Neyapti 2001).
The CNB took advantage of foreign expertise and encouragement to transform
itself into a formidable, capable institution. As a result, again like the NBP, the
CNB later defeated a serious challenge to its independence. By the time the
Czech Republic entered the EU, the CNB had already become a respected
member of the international central banking community.
The transition empowered a small circle of neo-liberal Czech economists
such as Václav Klaus, then a leading figure in the Civic Forum, and Josef
Tošovský, named governor of the Czechoslovak State Bank (CSSB) in January
1990. These individuals had internalized the international central banking
consensus through their studies and experiences abroad in the 1980s, and
looked to international institutions to legitimize and assist efforts to transform
the CSSB along these lines. Beyond this small circle, however, few domestic
actors held strong opinions about central bank independence, and its ramifi-
cations were not widely understood. Therefore, its international legitimacy
and clear break from the communist past made implementing the initial
changes relatively uncontroversial.
An interim central banking law came into force on 1 January 1990, but did
not include central bank independence. Uncertain policy makers quickly
brought international expertise to bear upon the process of revision. The
IMF and the World Bank advised the government on drafting a new Law on
the CSSB during 1990–1, one modelled heavily on the Bundesbank. This law,
which passed nearly unanimously on 20 December 1991, and took effect on 1
February 1992, established central bank independence and made currency
stability the CNB’s primary aim (Mataj and Vojtı́šek 1992). As a leading
Czech economist noted, ‘passage of the Act in this form confirms how rapidly
a political consensus has been achieved regarding the positive significance of
central bank independence on currency stability in this country’ (Pospı́šil
1996). After the Velvet Divorce separating the Czech and Slovak Republics,
the new Czech constitution and Act on the CNB (both of which came into
force on 1 January 1993) further institutionalized the CNB’s economic role and
independence, and transferred the rights and duties of the CSSB to the CNB.7
The CNB also kept most high-level personnel from the CSSB, making the
transition from CSSB to CNB nearly seamless in the Czech Republic.
The CSSB under Tošovský’s leadership also took advantage of international
technical assistance and training. As Vladimir Valach, CSSB first deputy
228
chairman, observed, ‘On 1st January 1990, development became much faster.
The whole top management of the new federal Central Bank changed. . . . I got
the chance to be at the centre of an unrepeatable process of bank reform, of the
ferment of seeking new routes, approaches and mechanisms’ (Valach 2004).
The CSSB sought these new approaches in the West. One Czech central banker
stated strongly that ‘We didn’t hesitate. We knew we had to join the West. . . .
In the CNB, these changes are Tošovský’s work. He constituted the bank as a
typical Western European bank. He took the structure, methods, and technical
ways of the West and put them in the CNB’ (personal interview, 2000). With a
lack of experience and training, the central bankers relied heavily on the
assistance efforts of international institutions and central banks (Czech
National Bank 2003; Tůma 2004). By the mid-1990s, the CNB had firmly
adopted the norms and practices of the international central banking commu-
nity. As in Poland, the CNB’s international support would prove vital in defend-
ing central bank independence against a domestic political attack.
The CNB’s formerly secure status became politicized after an exchange-rate
crisis in May 1997 forced the CNB to abandon its exchange-rate peg and signifi-
cantly raise interest rates. The ensuing economic turmoil contributed to the
resignation of Prime Minister Václav Klaus (by then head of the Civic Democratic
Party, ODS) and his temporary replacement by CNB governor Tošovský in Decem-
ber 1997. Tošovský led a caretaker government until Miloš Zeman’s newly elected
Social-Democratic (CSSD) minority government took power in July 1998. Cir-
cumstances surrounding the 1997 events turned both Klaus and Zeman against
the CNB. Klaus blamed the CNB’s tight monetary policy for the 1997 crisis and his
own political troubles, while Zeman blamed the same restrictive CNB policies for
the Czech Republic’s slow post-crisis recovery (Bönker 2006; Klaus 2000).
Ironically, Zeman and Klaus used the need to harmonize the Act on the CNB
with the EU acquis in 2000 to rein in the independence of the central bank. In
preparing the Act’s amendment, Klaus’s ODS introduced new limitations on
the CNB, including a requirement to set the inflation target in consultation
with the government, to get parliamentary approval of the CNB budget, and to
get governmental approval of the president’s choice for the CNB governor and
board. Zeman’s government accepted Klaus’s proposals in June 2000. The IMF,
ECB, and European Commission all spoke out against the draft amendment, as
did the CNB and President Václav Havel. Nevertheless, the CSSD and ODS-
dominated parliament not only passed the amendment, but overrode Havel’s
veto. The revised Act on the CNB took effect in January 2001. It briefly seemed
as if central bank independence had suffered a devastating blow in the Czech
Republic.
The influence of international institutions ultimately foiled Klaus and
Zeman’s efforts, however, as the CNB’s protected constitutional status and
EU accession pressures undid the amendment’s damage to central bank inde-
pendence. The first strand unravelled as Zeman unwittingly pushed his luck
229
with the CNB. In November 2000, Tošovský resigned from the CNB to head the
Financial Stability Institute at the Bank for International Settlements, and
President Havel appointed Zdenek Tůma as his replacement. The Zeman
government appealed the appointment to the Constitutional Court, arguing
that the appointment should have required governmental approval. In re-
sponse, the Constitutional Court not only rejected the government’s petition,
but declared that the portion of the amendment on appointments violated the
CNB’s independence and was thus unconstitutional. The 1993 Constitution’s
protections for central bank independence, inspired by international experi-
ence and advice, had successfully shielded the CNB from this challenge seven
years later. Then, under pressure from the EU—which argued that the other
ODS-sponsored parts of the 2000 amendment contradicted the acquis—a new
amendment fully restoring the CNB’s previous status came into effect in May
2002. In the end, the Act on the CNB protected the CNB’s independence,
changed its primary objective to price stability, and prohibited it from provid-
ing short-term credit to the government. As a result, like in Poland, Czech
central bank independence emerged from this challenge strengthened both in
law and in practice.
The Limits of Europeanization: Partial and Delayed Compliance
The prevailing international norms of central bank independence and price

stability became institutionalized in Poland and the Czech Republic because of
the consistency of international institutions’ advice and actions, and the post-
1989 uncertainty of domestic actors. With the euro, however, the situation
was reversed. By the time the east central European states joined the EU,
domestic policy makers had developed their own expertise in macroeconomic
affairs and had no need or desire to rely on outside advisors. In addition, while
politicians generally agreed on the desirability of EU accession (for which
central bank independence was a prerequisite), no such political consensus
existed on euro entry. Once EU accession had been successfully accomplished,
east central European politicians also grew more assertive and confident in
their dealings with EU institutions. More importantly, international actors not
only gave inconsistent policy advice regarding the euro; the actions of Euro
Area authorities undermined the attractiveness of the Euro Area. As a result,
they lacked credibility with Polish and Czech policy makers on whether,
when, and how to adopt the euro.
Not only had there been open dissent among West European countries
about the Euro, ECB policy, and the Stability and Growth Pact, as well as
notable opt-outs by influential states (the UK, Denmark, and de facto Sweden).
Also, international actors sent mixed messages to east central Europe on euro
entry timing. On the one hand, the IMF, OECD, World Bank, and international
230
investors pushed the east central European states to develop euro entry strat-
egies, with firm time commitments, even before these states had become EU
members (Bönker 2006). On the other hand, the ECB strongly discouraged the
new member states from pursuing rapid euro entry. ECB president Jean-Claude
Trichet even argued, somewhat pedantically, that east central European states
were akin to young but underdeveloped athletes seeking to join a ‘champion
league’ before they were fit.8 Given existing troubles in the Euro Area, and the
increased risks of financial instability that expansion would present, the ECB
was wary of bringing in new members who may not be completely prepared.
Western central bankers and economists have sent similarly mixed messages.
Some advocated rapid adoption or even unilateral euroization (Breuss, Fink,
and Haiss 2004; Buiter 2004; Eichengreen 2003; Schoors 2002), while others
urged great caution and lengthy postponements (Begg 2006; Dumke and
Sherman 2000; Égert, Gruber, and Reininger 2003; Krenzler and Senior Nello
1999). On institutionalizing central bank independence, there were never
such disagreements among external advisors to east central Europe.
International actors faced perhaps the greatest credibility challenge regard-
ing the mandated process of euro adoption: fulfilling the Maastricht conver-
gence criteria. Although EU accession states committed to joining the Euro
Area at some future date, there is no fixed timetable or deadline for doing so.
The European Commission and the ECB insisted that the east central European
new member states meet the Maastricht criteria to the letter before Euro Area
accession. However, other external actors widely criticized the criteria as being
too restrictive, especially the requirement that the fast-growing prospective
Euro Area members both maintain very low inflation rates and remain in the
ERM II pegged exchange-rate regime for at least two years. The ECB has
explained this requirement as the best method available for ascertaining the
appropriate convergence rate between national currencies and the euro to
prevent destabilization upon entry to the euro zone or after. But despite this
rationale, an IMF report otherwise praising the ECB argued that ‘the Maastricht
criteria—specifically the inflation criterion together with the exchange rate
stability criterion—could be overly binding for the CECs’ (Schadler et al. 2005).
Moreover, unlike with central bank independence, in the case of euro entry
the central bank internationalization and Europeanization processes conflict.
Best practice in international central banking calls for inflation-targeting
monetary policy regimes. Both Poland and the Czech Republic became infla-
tion targeters in 1998, well before their 2004 EU entry. Indeed, the ECB itself is
an informal inflation targeter. Entering ERM II would force east central Euro-
pean central bankers to revert to a less flexible peg.
In short, international institutions have little credibility with Polish and
Czech policy makers on the euro entry issue because of their inconsistent
advice and actions regarding the desirability, timing, and mechanisms of
adoption. This lack of credibility left the door open for domestic debates
231
about the euro in Poland and the Czech Republic, battles which confident east
central European policy makers, central bankers, academics, and populaces
were by that time relatively well-equipped to wage.
Poland
Whereas international institutions exercised substantial authority over central
bank structures and the terms of debate concerning central bank independ-
ence and price stability from 1989 until 1997, external actors, and particularly
the EU and ECB, largely failed to facilitate Poland’s rapid convergence with
Euro Area membership criteria. Although monetary indicators have been
moving in the right direction, fiscal measures have not. Because of the absence
of domestic actor uncertainty and lack of euro credibility by the late 1990s and
early 2000s, the contours of conflict on this issue evolved, not between polit-
ical parties, but instead between the central bank and politicians—from across
the political spectrum. Central bank–government conflict has essentially
resulted in a stalemate with no immediate prospects for euro entry. This
development occurred because Poland’s central bankers, who generally favour
euro entry, are no longer empowered by international institutions’ credibility,
changing the domestic balance of power. In the battle with successive govern-
ments, central bankers have become relatively weaker on the question of
European monetary integration.
Since 1997 when the NBP’s independence was strengthened, the central
bank has been in a strong position to pursue EMU convergence on the mon-
etary side, even as it has had virtually no power to persuade politicians to meet
the fiscal requirements. NBP governors Gronkiewicz-Waltz until 2000 and
Leszek Balcerowicz (2000–7) have been inflation hawks (along with their
Monetary Policy Councils, a result of the 1997 legislation). Between 1997
and 2004, the central bank at times used restrictive monetary policy to try to
negotiate out of successive Polish governments commitments to fiscal austerity
(Zubek 2006). One such episode became so heated that the centre–left SLD–
UP–PSL governing coalition threatened in 2001 and 2002 to limit the bank’s
independence, a proposal that ultimately went nowhere (Epstein 2002).
Motivated in large measure by the perceived benefits of macroeconomic
stability and the structural reforms that EMU convergence would require,
the Polish central bank has been a strong supporter of early euro entry. Indeed
in 2002, Balcerowicz had plans for Poland to join ERM II by 2004 in hopes of
adopting the euro by 2007. That timetable, as well as subsequent central bank
aspirations, fell by the wayside.
While the central bank has been eager, politicians have been unwilling to
undertake the structural reforms that would cut annual government outlays,
even though the 1997 constitution limits government debt to the 60 per cent of
GDP prescribed by the Maastricht convergence criteria. For Poland, the state’s
232
enormous distributional obligations make such structural reforms particularly

problematic politically (Rhodes and Keune 2006). Exacerbating pressure on the
government to engage in social spending has been very high unemployment,
which neared 20 per cent in 2004. Moreover, although Poland’s finance min-
isters have sometimes formulated fiscal ‘stabilization’ packages in order to align
with the Maastricht criteria, when it came to implementation, governments
consistently violated their terms (see Zubek 2006 for details). And, as noted
above, because the European Commission and the ECB were not pushing for
rapid nominal convergence (and in some cases actively discouraged rapid
convergence for Poland), Polish cabinets have perceived themselves free to
delay euro entry.
Since Poland’s EU accession in 2004 and the victory of the centre–right Law
and Justice Party (PiS) in the 2005 elections, this general pattern of political
conflict has been recurring. PiS and its coalition partners, more than their
predecessors, articulated a nationalist and Euro-sceptical political platform.
This scepticism included public government doubts about whether euro entry
would benefit the Polish economy. It also led to the halting of further privat-
ization, and thus to potential privatization revenue. But, although in many
respects the rhetoric out of Warsaw became more hostile to euro entry during
PiS’s tenure (with the government refusing to discuss full monetary conver-
gence until 2009), macroeconomic measures did not deteriorate.
With respect to monetary policy, for example, Poland stayed on track. In
2004, the first Monetary Policy Council adopted a target inflation rate of 2.5
per cent. The second Monetary Policy Council (which took office in 2004 and
remains until 2010) retained this policy and, because it was largely successful,
reduced a key interest rate to its lowest level ever: 4 per cent in 2006. Citing
inflationary pressure thereafter, rates climbed back up to 4.5 per cent in 2007,
but this was similar to the ECB’s own rate-setting. Poland also managed
to contain overall levels of debt below the constitutional and Maastricht limit.
Only on deficit spending has Poland remained consistently out of compliance.9
Whether the AWS-led government in the late 1990s, SLD-led in the early
2000s, or PiS-led in 2005–7, the lack of Europeanization is clear in that in every
case politicians prioritized short-term political exigencies over the possible
long-term benefits of rapid euro entry. Whether the Civic Platform, which
prevailed in the October 2007 elections, will prove more Euro-friendly
depends on two factors. First is whether European institutions become more
consistent in their support of Polish entry. Second is whether these same
European institutions can convince Polish central bankers that ERM II is the
correct mechanism through which to demonstrate ‘euro readiness’—a mech-
anism about which there is substantial doubt (Buiter 2004). In September 2007
NBP governor Sławomir Skrzypek expressed his scepticism by stating that he
would again ask the EU to reduce the mandatory two-year term in ERM II,
citing the precedents of Ireland and Spain.10
233
Czech Republic
The Czech experience with the euro shares much in common with that of
Poland. International actors lacked credibility on this issue in the Czech
Republic, and so could do little to effectively support the Czech National
Bank in its push for early euro entry. As in Poland, the CNB retained its
reputation as an inflation hawk, but Czech politicians could not maintain
conservative fiscal policies. The CNB also faced an additional obstacle in the
person of Vaclav Klaus, a long-time Euro-sceptic and CNB foe, who used his
influence to undermine the CNB’s early euro entry efforts. As a result, not only
did the CNB lose a key battle over early euro entry in 2004–5, but the CNB itself
became divided over how quickly to introduce the euro.
The independent CNB under both Tošovský and Tůma avidly pursued mon-
etary convergence with Europe. Since moving to its inflation targeting regime
in 1998, it has kept a tight hold on monetary policy, to the chagrin of many
Czech politicians, academics, and businesspeople. Geršl (2006) found in a
survey of articles in the leading Czech financial newspaper from 1997 to
2005 that every government comment expressing dissatisfaction with the
CNB signalled the CNB to ease monetary policy. The signals from other
interest groups did the same: the financial sector (70%), employers (100%),
unions (100%), and ‘others’ (96.5%). The CNB resisted this pressure, and by
2002 Czech inflation met the Maastricht convergence target.
In contrast, the Czech Republic began running significant fiscal deficits after
the 1997 crisis, reaching a high of 11.3 per cent in 2003—the largest deficit
among the prospective EU new member states. The CNB felt powerless to
restrain politicians on its own, so it promoted early euro entry to impose fiscal
discipline on the government (Johnson 2006). However, the CNB found itself
in a relatively weak position to fight for the euro, because of both the lack of
outside support from the ECB and its own sharp criticism of the Maastricht
criteria, especially ERM II.11 In short, the CNB berated the government for not
meeting one set of the Maastricht convergence criteria, while itself challen-
ging the legitimacy of another. This position did not raise the credibility of
either the CNB or the euro entry process.
Without useful levers of international influence, the CNB faced difficulty in
rallying domestic support for its euro entry campaign from either of the largest
Czech political parties. The leftist CSSD generally approved of Europe but
preferred higher social spending than meeting the Maastricht fiscal criteria
would allow. On the other hand, while Klaus’s centre–right ODS party sup-
ported fiscal rectitude, it also had a deep Euro-sceptic streak. Klaus in particular
often berated European ‘socialism’ and questioned the efficacy and desirability
of the Euro Area. To make matters worse for the CNB, Klaus succeeded Vaclav
Havel as Czech president in February 2003, ironically giving him the sole
appointment power over the CNB governor and board members that he had
234
fought to take away from the presidency just a few years earlier. Finally, the
divided electorate repeatedly forced Czech parliamentarians to form tenuous
governing coalitions or to rule as minority governments, with little mandate
for or ability to implement fundamental policy reforms. As a result, the
appropriate timing of euro entry became an issue of heated political debate,
with conflict coming to a head over the Czech euro entry strategy.
In its draft strategy of December 2002, the CNB ambitiously suggested 2007
as the Czech Republic’s target entry date.12 Although new CSSD Prime Minis-
ter Vladimı́r Špidla was willing to use the Maastricht criteria as an excuse for
stepping up fiscal reforms, many in his own party failed to support him. The
government also feared making a euro entry strategy public until after the June
2003 Czech EU referendum, given the relatively Euro-sceptic Czech public
(Bönker 2006). As a result, months of discussion followed, during which the
CNB criticized the Špidla government for badly missing its fiscal deficit targets
and not taking the Maastricht criteria seriously. President Klaus hit back by
criticizing the CNB’s inflation targeting as ‘fiction’ and stating that it would be
‘unwise’ to adopt the euro.13
In September 2003, the CNB and the government finally agreed on a revised
strategy, one which represented a significant compromise for the CNB.14 It
stated that joining the Euro Area in 2007 would not be possible because ‘the
current outlook . . . does not indicate that the public budget deficit criterion
will be fulfilled by [June 2006]’, and it revised the expected entry date to 2009–10
at the earliest. Even this agreement proved unsustainable, however, and tensions
grew as the government continued to spend in excess of the promised targets.
Persistent high deficits exacerbated by another spate of pre-election spending in
mid-2006 finally forced a complete revision of the strategy in August 2007.
Despite the protests of CNB governor Tůma and Finance Minister Miroslav
Kalousek, the revised strategy did not set a new target date for euro entry. ODS
Prime Minister Miroslav Topolanek said that he refused to set a date because
his tenuous government –with 100 ODS deputies plus their smaller coalition
partners facing off against 100 CSSD opposition deputies—could not ensure
long-term compliance with its plans for fiscal reform.15
Not only did the CNB lose the political battle over early euro entry, but its
pro-euro stance has been undermined from within. When the terms of three
CNB board members expired in February 2005, President Klaus replaced them
with close allies and fellow Euro-sceptics. Klaus did so again in November
2006, when he replaced two more outgoing board members with like-minded
economists. Afterwards, only Governor Tůma and Vice-Governor Niedemeyer
remained from the seven-member board that had approved the CNB’s initial
ambitious euro strategy in 2002. Once on the board, the Klaus appointees
publicly spoke with great wariness about the euro. For example, Mojmir
Hampl urged caution and argued that successful euro entry did not represent
a meaningful measure of a country’s economic health.16 Faced with challenges
235
from without and within, Tůma simply stated that the timing of Czech Euro-
Area entry is now ‘a political decision’.17
Convergence and Central Bank Power
The Czech and Polish central banks have, in a surprisingly short period of
time, converged with European central banks in terms of internationally
accepted norms and practices. Both eagerly defend central bank independence
and their inflation-targeting regimes. Both have developed sophisticated eco-
nomic modelling and research capabilities. Both have ensured that their
states’ central banking legislation, payment systems, statistical departments,
and so forth substantially comply with international best practice and
EU/ESCB requirements. The international consensus on the value of these
developments and international assistance to achieve them made it possible
to transform these central banks. Importantly, this transformation took place
primarily immediately after the transition when domestic actor uncertainty
was at its height.
In addition, because central bank independence was firmly institutionalized
in this early era, and reinforced by international practice and pressures, it
became difficult for domestic political leaders to overturn it later. The com-
bination of the institutionalization of central bank independence, the devel-
opment of extensive economic expertise within the central banks, and the
active support of an influential transnational community of central bankers
sharing the same beliefs and responsibilities, have dramatically increased the
domestic power of east central European central banks. In a short period of
time, they moved from simple communist-era accounting bureaucracies to
prestigious and influential domestic economic policy makers.
But ironically, internationalization also gave east central European central
bankers the tools with which to challenge certain aspects of Europeanization.
Polish and Czech central bankers critique European practices with great
authority. They are not willing to accept ECB arguments in favour of the
inflation criterion or ERM II membership at face value, and they forcefully
upbraid the EU for not enforcing the fiscal rules of the Stability and Growth
Pact. Moreover, they are wary of giving up their flexible inflation-targeting
regimes without the promise of rapid euro entry in return. In short, they
behave just as national central bankers in Western Europe or in North America
would. In this sense, the NBP and CNB have experienced significant conver-
gence with Europe.
Yet, although Czech and Polish central banks have gained enormous stature
at the international level, their power has not increased commensurately at
either the European or domestic levels. The east central European central
bankers have been unable to alter the terms of debate on euro entry and will
236
clearly remain (and be treated as) junior partners at the ECB and in the ESCB.
As a result, Czech and Polish central bankers have defended early euro entry,
but without international support and, increasingly, without as much enthu-
siasm. Although the CNB and NBP promote the positive aspects of euro entry
in order to press fiscal restraint on their governments, the central bankers
themselves appreciate very well the arguments both for and against entering
the euro in the near term. They resent the ECB and EU for their inflexibility
and inconsistency on the Maastricht convergence criteria, and have become
more reluctant to spend their limited political capital on shooting at a moving
goalpost.
This situation in turn ultimately threatens the power of European central
banking. The EU and ECB are divided between the ‘in’ Euro-Area states and the
‘out’ states. For European central bankers to speak with a common and power-
ful voice in the face of increasing challenges to central bank authority from
politicians and markets, and for east central European central banks to retain
their hard-won domestic influence and credibility, the EU cannot afford to
long exclude the largest of its new member states from the ‘euro club’.
Notes
1. For further elaboration on these variables across a range of issues, see Epstein (2008).
2. The UK and Denmark have legal ‘opt-outs’ negotiated into the Maastricht Treaty.
Sweden is under obligation to join, and plans to hold a referendum on the issue in
2012.
3. G. Kołodko, ‘Central Bank Responsibilities: Not Only to God and History’, Polish
News Bulletin, 6 September 1994. Also see ‘Between Inflation and Recession: A
Dispute over Interest Rates’, Polish Press Agency, 30 September 1994.
4. See the ‘Central Bank Facing Changes’, Polish News Bulletin, 20 September 1995; and
K. Kowalczyk, ‘The NBP’s Fortress’, Polish News Bulletin, 5 October 1995.
5. K. Bobinski, ‘Survey—Poland: The Central Bank’, Financial Times, 26 March 1997: 4.
6. See the Constitution of the Republic of Poland, Article 227 and Article 220–2.
7. 1993 Constitution of the Czech Republic, Chapter 6, Article 68.
8. J.-C. Trichet, ‘Looking at EU and Euro Area Enlargement from a Central Banker’s
Angle: The Views of the ECB’, speech at the Diplomatic Institute, Sofia, 27 February
2006.
9. This data come from Economist Intelligence Unit: Poland, 10 July 2007.
10. ‘NBP Head Skrzypek Expects Euro Adoption Not Before 2012, Wants Fast ERM II
Path’, Poland Today, 25 September 2007.
11. See Z. Tuma, ‘Europe’s Club of Nations Needs a Rule Change’, Financial Times,
4 January 2007.
12. Czech National Bank, ‘The Czech Republic and the Euro—Draft Accession Strategy’,
23 December 2002, www.cnb.cz.
237
13. ‘Klaus Says Deflation in Czech Rep Not Good, Blames CNB’, CTK Business News,
22 April 2003.
14. The Czech Government and the Czech National Bank, ‘The Czech Republic’s Euro-
area Accession Strategy’, September 2003, www.cnb.cz.
15. ‘Czech Euro Strategy Says Public Finances Still Hamper Adoption’, CTK Business
News, 27 August 2007.
16. ‘Czech Central Banker Urges Patience in Shift to Euro Zone’, Dow Jones International
News, 19 October 2007.
17. ‘Czech Central Banker: Euro-Zone Entry Is Political Decision-Report’, Dow Jones
International News, 5 November 2007.
238
Part IV
‘Semi-Permanent’ Outsiders
11
Bank of England: Learning
to Live with the Euro
Charles Goodhart1
1997 was a climacteric year for the Bank of England, and for political
developments in the UK. In early May, the Labour Party won a resounding
General Election victory. Thirteen years of Conservative government came to a
crashing end, marked in the years since 1992 by internal infighting between
euro-sceptics and euro-philes.
Within a week the incoming Chancellor of the Exchequer, Gordon Brown,
had awarded the Bank of England operational independence,2 and within
two weeks had stripped it of its role in both banking supervision and debt
management.3
Prior to the departure of the UK from the Exchange Rate Mechanism in
September 1992, the Bank had been one of the more subservient central banks,
in the sense that the key (interest rate) decisions for determining macro-monet-
ary policy were taken by the Chancellor, often after consultation with the Prime
Minister. The Bank could, and did, advise on these, in private and behind the
scenes, and was often influential; but the politicians and, especially, the Treasury
kept pressure on the Bank not to reveal publicly when the Bank’s advice differed
from the action taken. The Bank was discouraged from publishing its own
forecast, (for fear of commentators focussing on discrepancies between the two,
Bank and HMT, forecasts), and its Quarterly Bulletin Assessments were submitted
to, read, and sometimes censored by HMT.
Changes in Core Purposes: The Bank and Euro Entry
In the 1980s and 1990s, the Bank had three core purposes (CP). As articulated in
the Annual Report of 1997, they were the following:
1. Maintaining the integrity and value of the currency. Above all, this
involves securing price stability as a precondition for achieving the wider
241
Bank of England: Learning to Live with the Euro
economic goals of sustainable growth and employment. The Bank does this
by influencing decisions on interest rates, on the basis of economic and
financial analysis of development both at home and abroad; by participating
in international discussions to promote the health of the world economy;
by implementing agreed policy through its market operations and its deal-
ings with the financial system; and by maintaining confidence in the
note issue.
2. Maintaining the stability of the financial system, both domestic and
international. The Bank seeks to achieve this through supervising individual
institutions and markets; through monitoring the links between financial mar-
kets; through analysing the health of the domestic and international economy;
through co-operation with other financial supervisors, both nationally and
internationally; and through promoting sound and efficient payment and
settlement arrangements. In exceptional circumstances, the Bank may also
provide or organise last resort financial support where this is needed to avoid
systemic damage.
3. Seeking to ensure the effectiveness of the UK’s financial services. The
UK needs a financial system that offers opportunities for firms of all sizes to
have access to capital on terms that give adequate protection to investors, and
which enhances the international competitive position of the City of London
and other UK financial centres. The Bank aims to achieve these goals through its
expertise in the market place; by acting as a catalyst to collective action where
market forces alone are deficient; by supporting the development of a financial
infrastructure that furthers these goals; by advising HM Government; and by
encouraging British interests through its contacts with financial authorities
overseas.
So long as the Bank remained subservient, its ability to influence, and its
contribution to, CP1 (i.e. to maintain price stability) remained limited. Not
surprisingly therefore, it invested more of its energies into CP2 (maintaining
financial stability), and CP3 (enhancing the efficiency and role of the UK’s
financial system in general, and of the City of London in particular). With the
abolition of exchange control, the ending of the building societies’ cartel, and of
restrictive practices in the London Stock Exchange (Big Bang) the 1980s was the
heyday of CP3. The government was strongly supportive, but the Bank played a
major effective role (David Walker being one of the key protagonists in the
Bank). During the 1970s and 1980s, banking supervision (CP2) became the
fastest growing part of the Bank, though a series of crises—fringe bank crisis,
1973–4; Johnson-Matthey Bank failure, 1984; Barings, 1995; and BCCI, 1991—
seriously tarnished its reputation in the eyes of many external commentators.
After the UK had been forced out of the ERM, the then Chancellor, Norman
Lamont, adopted the strategy of inflation targetry in October 1992. This new
242
strategy was announced and implemented with remarkable speed after the ERM
exit. But, after the relative failures of the government’s earlier monetary target-
ing strategy (the Medium-Term Financial Strategy, MTFS, 1979–85) and of its
external peg strategy (1988–92), the government itself had little credibility left.
As an expert, non-political institution the Bank did have credibility. So Lamont
turned to the Bank to provide independent support, by now requiring it to
publish its Inflation Report (without any prior censorship). A few years later,
Ken Clarke as Chancellor reinforced this by having the Governor’s advice
published verbatim in the ‘Ken and Eddie show’ (Eddie George being the then
Governor). All this is detailed at much greater length in Goodhart (2008).
But these changes to the role and status of the Bank were comparatively
small, in contrast to the devolution of operational independence to the Mon-
etary Policy Committee of the Bank of England in May 1997. Suddenly this
elevated the role of CP1, and the decision on interest rates, to primacy in the
Bank. Meanwhile, the removal of banking supervision to the Financial Services
Authority simultaneously led to a downgrading in the importance of CP2.4
At a stroke, the role of the Bank had been shifted from one in which they
were akin to central banks on the Continent (such as the Banca d’Italia and
Banco de España), with little role in macro-monetary policy because of the
ERM, but a large role in banking supervision, to bring it to a position like the
Bundesbank, with monetary policy autonomy and a much lower profile on
financial stability issues.
Amongst continental central banks the Bundesbank was the ‘big loser’ in the
shift to the European System of Central Banks (ESCB). But, if the Bundesbank
had opposed the creation of the ESCB, it is doubtful whether the German
people, or their legislature (Bundesrat and Bundestag), would have approved
it. Largely in order to gain the (reluctant) assent of the Bundesbank to the
launch of the ESCB (and the euro), the Bundesbank was, in effect, enabled
to shape the ESCB and ECB in its own image (or so it is widely believed in the
UK). This involved features such as almost total independence from govern-
ment, (indeed much more so than the Bundesbank had), considerable goal
independence to decide its own definition of price stability, a prominent ‘mon-
etary’ pillar, and a collegiate, consensual approach to decision-making.
All this was quite at odds with the British approach, which followed on
from the initial New Zealand model in many respects. This latter model allowed
the Bank of England operational independence, but no goal independence,
emphasizing the focus on an inflation target, set by the Chancellor. Decision-
making was to be individualistic, and, so the British contend, much more
transparent than that of the Governing Council of the European Central
Bank. These differences of viewpoint are highlighted in the entertaining
papers by Buiter (1999) and Issing (1999). The then Chancellor, Gordon
Brown, is believed to be (justly) proud of the constitutional structure that he
243
set out for the Bank and for the conduct of monetary policy, as codified by the
Bank of England Act 1998. He, and many others in the UK, believes this struc-
ture to be superior to the German model adopted for the ECB. That may be one
of the reasons for Brown’s supposed coolness towards joining the Euro Area.
Be that as it may, by his regime change in May 1997 Brown revised the role of
the Bank from one in which its position and status would not be greatly altered
by entry into the Euro Area to one in which it too would be a ‘big loser’.
Everyone knew this, at least at the back of their minds. Nevertheless the Bank
prided itself, and rightly so, on the professionalism, expertise, and independ-
ence of its staff. Whatever the implications for the Bank itself, the case—the
benefits and disadvantages—of UK entry into the euro were carefully and fairly
laid out by its economic research staff, notably its Chief Economists, John
Flemming followed by Mervyn King. I was not myself working in the Bank in
those years, but my (reasonably well-informed) understanding was that there
was much the same balance of euro-philes and euro-sceptics in the Bank, both
after 1997 as well as before, as in the intelligentsia as a whole.
There were two major reasons why the Bank would have found it extremely
difficult to have expressed an overt view/position on the merits of euro entry,
prior to the government itself coming to a decision on the economic merits of
the case. First, it was a major, strategic political decision. As public-sector
officials, the Bank had to be prepared wholeheartedly to implement whatever
people and government decided to do. Taking a clear, overt position could leave
the Bank in a very exposed position if the decision went the other way. Second,
there was an obvious potential conflict of interest, especially after May 1997.
The Bank’s own role would now have been dramatically affected by entry.
Under these circumstances any public position-taking, especially if advocating
staying outside, could have been attacked as self-seeking.5
So, from a fairly early stage, certainly by 1997, the Bank’s strategy was
decided. The Bank would not give any view on the overall question, whether
or not UK entry into the Euro Area would be desirable. Thus, in his speech to the
British/Swiss Chamber of Commerce on 12 September 2000, the Governor
Eddie George said the following:
But let me make clear, from the outset, that monetary union is fundamentally a political
rather than an economic issue. It necessarily involves the deliberate pooling of national
sovereignty over important aspects of public policy, in the interest not just of collective
economic advantage, but of a perceived wider political harmony within Europe.
As a central banker, I have nothing to say about the politics of monetary union—that’s for
elected politicians and clearly political opinion is divided—not just in the UK—about how
far and certainly how fast to go in the sensitive matter of pooling national sovereignty.
But monetary union is also an economic issue and that is my concern.6
He went on to outline the economic pros and cons,7 but neither he, nor any of
the other spokespersons for the Bank in these years, like Howard Davies and
244
David Clementi, successive Deputy Governors; Ian Plenderleith and John

Townend, respectively, then Executive and Deputy Directors; ever tried to
reach a conclusion about the balance of advantages and disadvantages. The
two-handed economist, ‘on the one hand and on the other’, appeared up-front
in this context. Some close observers of Governor George felt that he may
have placed slightly more emphasis on the disadvantages, especially ‘one size
fits all’ than on the countervailing advantages, but that would have been a
subjective, personal judgement, in the ear of the beholder. And views about the
balance of the pros and cons varied from person to person, as in the wider
community.
There were many, especially in Anglo-Saxon countries, who drew the

(incorrect) inference from the difficulties of the Exchange Rate Mechanism in
1992–3, and the UK’s exit from it, that the Eurosystem would never start, and, if
it should start, would rapidly beak down. In an associated vein, many wonder
245
whether the views of the Bank (and Treasury) were tilted against euro entry
by that experience. In my view both suppositions were mostly, perhaps
entirely, mistaken. Bank (and Treasury) officials were good enough economists
to know that a single currency is a much more robust regime than a pegged
exchange rate. The former cannot be subject to speculative attack. Once
adopted, it can only break apart, if some internal segment makes a (political)
decision to do so.
The problem with a single currency is, instead, that it may condemn some
parts of the zone to long-lasting inflationary, or deflationary, pressures in the
face of asymmetric shocks. That is why issues of whether the UK economy had
converged to its Continental neighbours, and of the flexibility of adjustment
mechanisms, figured so large in the commentaries and discussions, both in the
Bank and in the Treasury.
Through all this, the Bank’s strategic position remained constant; that the
issue of entry was primarily a political matter, on which it would be inappropri-
ate for the Bank to comment. There were, of course, economic advantages
and disadvantages. The Bank would enumerate and report these, but would
246
consciously abstain from reaching any conclusion about the overall balance of
pros and cons. In this respect, the Bank’s position was, rather nicely, the mirror-
image reverse of that taken up by the government, and in particular by the
Chancellor. For the Labour government, the political and constitutional issues
pointed, fairly clearly, to a case for UK entry into the Euro Area. Instead, the issue
for them was primarily economic.
The Five Economic Tests for Euro Entry
As Ian Plenderleith stated in a speech to the conference organized by the

International Centre for Monetary and Banking Studies on ‘the International
Monetary System after the Decision on EMU’ in Geneva on Friday, 7 Novem-
ber 1997:
The Government’s conclusions, as the Chancellor of the Exchequer set them out in his
statement to Parliament on 27 October, began by addressing three issues of principle. It
concluded first that, in principle, a successful single currency within a single European
market would be of benefit to Europe and to Britain. Second, to share a common
monetary policy with other Member States represents a major pooling of economic
sovereignty; but, while this constitutional issue is a factor in the decision, it is not in
the Government’s judgment an overriding one. Rather it signifies that in order for EMU
to be right for Britain the economic benefit should be clear and unambiguous. If, in the
end, a single currency is successful, and the economic case is clear and unambiguous,
then the Government believes Britain should be part of it. There is a third issue of
principle, namely popular consent, which the Government has reiterated will be tested
through a referendum.
The UK Treasury has published its assessment of five economic tests that define whether a
clear and unambiguous case can be made for the UK to join EMU. These are: whether
there can be sustainable convergence between Britain and the economies of a single
currency; whether there is sufficient flexibility to cope with economic change; the effect
on investment; the impact on the UK’s financial services industry; and whether it is good
for employment.
Applying these five economic tests leads the Government to the following clear conclu-
sions. British membership of a single currency in 1999 could not meet the tests, so that
joining at the start of EMU is not in the country’s economic interests. The Government
will therefore be notifying our European partners, in accordance with the Maastricht
Treaty, that we will not seek membership of the single currency on 1 January 1999. The
Chancellor emphasised that there is no need—legally, formally or politically—to re-
nounce our option to join for the period between 1 January 1999 and the end of the
current Parliament; nor would it be sensible to do so. But he concluded that, barring some
fundamental and unforeseen change in economic circumstances, making a decision
during this Parliament to join is not realistic. It is therefore sensible for business and the
country to plan on the basis that, in this Parliament, the Government does not propose to
enter a single currency.
247
The basic economic rationale for not joining the euro, as set out then in 1997,
was that sustainable and durable convergence with the rest of the prospective
Euro Area had not yet been achieved. In particular, short-term interest rates on
the Continent were around 3–4 per cent, compared with over 7 per cent in
Britain. HMT’s accompanying paper, setting out the five tests that Britain would
have to pass before joining the Euro Area, noted that Britain had more non-EU
trade, more home loans at variable interest rates than its partners, and that it
was the only oil exporter in the EC. Those factors made it hard for the UK’s
economic cycle to match those on the Continent, and for its interest rates to be
the same. Moreover, sterling had appreciated strongly at this time, and was
expected by many to fall back shortly, so there was a disinclination to lock in a
high real exchange rate. So, there was quite general approbation of the decision
to defer the decision, though The Economist (1 November: 31) grumbled that
not enough was being done to promote convergence. Nevertheless, many euro-
philes were encouraged by the generally pro-European tone of the 27 October
statement, while the euro-sceptics were cheered by the actual decision to stay
out, if only for the time being.
Anyhow, these same five economic tests gained a totemic importance for the
Chancellor, and, without his imprimatur, it was generally accepted that the
promised referendum on entry would have no chance of success. His October
statement ruled out British entry for the life of that Parliament, but no longer.
So when Labour was re-elected in 2001, shortly thereafter a major exercise for
the Treasury became to subject these same five tests to much more detailed
248
scrutiny. This was a major analytical study, in which a large number of outside
academic economists (including me) participated. Note, however, that the Bank
did not participate in this exercise,8 and was neither used, nor sought to be
involved, as an official adviser.
At the same time as the ‘five test’ exercise was being conducted, preparations
had to be run in tandem to consider the practical implications, if the decision
went in favour of UK entry. Having been marginally involved myself in the
former exercise as an outsider, my own impression was that the write-up of
those tests which might not prove favourable was left very much in an ‘either/
or’, ‘on the other hand/on the other’, mode until the last moment. Officials did
not know, nor could they presume to guess, the outcome in advance. So,
practical preparations for possible entry continued to be made until June 2003.
These practical preparations for possible UK entry under the government’s

policy of ‘prepare and decide’ were also led by HM Treasury. The Bank was
involved in the key committees chaired by HMT, and was delegated the
responsibility by HMT for co-ordinating preparations in sterling wholesale
markets. This was done through the City Euro Group (CEG), which the Bank
249
proposed, established, and chaired, and which represented all the City’s main
constituencies. CEG met regularly between 1999 and 2005, and still meets
once a year (to discuss developments in the Euro Area, such as infrastructure
projects, rather than euro preparations). As a result of cooperation with the City
through CEG, the Bank was able to publish a change-over plan in sterling
wholesale markets in Practical Issues, and keep it up-to-date on the Bank
website. This is discussed in much more detail in the next section. The Bank
also contributed to the UK National Changeover Plan and the regular reports
to Parliament coordinated by HMT.9
The conclusion of the five test study—UK Membership of the Single Currency:
An Assessment of the Five Economic Tests, June 2003—effectively repeated the
negative conclusion about sustainable convergence (and flexibility) that
had been made in October 1997. Thus the concluding, and crucial, paragraph
6.6, p. 228, reads as follows:
Overall the Treasury assessment is that since 1997 the UK has made real progress towards
meeting the five economic tests. But, on balance, though the potential benefits of in-
creased investment, trade, a boost to financial services, growth and jobs are clear, we
cannot at this point in time conclude that there is sustainable and durable convergence or
sufficient flexibility to cope with any potential difficulties within the euro area. So, despite
the risks and costs from delaying the benefits of joining, a clear and unambiguous case for
UK membership of EMU has not at the present time been made and a decision to join now
would not be in the national economic interest.
In the immediately following years the Euro Area grew more slowly than the
UK. Also, London reinforced its position as the leading capital market centre for
the Euro Area, despite being an ‘out’. Moreover, the sterling exchange rate
against the euro became rather stable (till 2007–8), even while the paths of
interest rates in London and Frankfurt continued to diverge. For all these, and
other, reasons advocacy in the UK for entry into the Euro Area waned, indeed
largely disappeared. The lobby group in favour of entry, Britain in Europe,
wound itself up.
Through all this discussion, the Bank had consciously kept to the side lines
on the wider issue of whether the UK should enter, or not. There was, however,
a more operational, educational, and technical field, related to the establish-
ment of the Euro Area into which the Bank flung itself with enthusiasm and
conviction.
The Bank and the City of London: The Co-Ordination

Unit for Europe
London is the largest international financial centre in the world; New York and
Tokyo are perhaps bigger overall, but the predominant part of their business is
250
domestic, rather than international. London had become, by the 1990s, the site
of much of the financial intermediation involving its European partners. So,
whether in, or out, of the euro, much of the business undertaken in legacy
currencies in London would have to switch onto a euro basis when the Euro
Area commenced on 1 January 1999.
That this change-over to the euro would be important for the City, and
essential to get right, was not fully recognized by commercial institutions in
the early years. As early as 1995 from senior conversations across the City,
Bank officials all too frequently heard that, even if the euro started, about
which there was considerable scepticism in the City, the UK would not be a
member ‘and so we don’t need to do anything’. The Bank, notably the Gov-
ernor Eddie George, and John Townend, George’s Alternate at the European
Monetary Institute, were convinced that this view was wrong. The Alternate’s
Committee was charged with responsibility for all the technical preparations
for the euro. Because of this work which was just beginning, Townend was well
placed to understand precisely how the euro was going to be introduced, both
at the retail and at wholesale levels, as decisions were taken—strictly by the
EMI Council but the Alternate’s Committee was very influential. So George
asked Townend to write a paper for circulation to senior executives across
the City, to explain why practical preparations in the London wholesale
markets were as critical as on the Continent, whether or not the UK was to
become an initial member of the euro. Hence the first Practical Issues was
published in May 1996. It was only a dozen pages long but went to 200 or so
senior people across the City and was influential in helping to serve as a wake-
up call. From that point on, the euro responsibility came gradually to domin-
ate Townend’s Bank role.
As another indication of the delayed recognition in the City, and the appre-
ciation of the euro’s importance in the Bank, Howard Davies, then Deputy
Governor, stated in his speech to the Futures and Options Association Inter-
national Derivatives Week Conference on 4 June 1997, that
The assessment was that relatively few market participants in London had made serious
preparations for EMU, and seemed unsure of how to proceed. Only 6 per cent of brokers
and own account traders had made contingency plans for the introduction of EMU. But
this survey was undertaken in April of last year, and I am confident that the responses
would be different today.
Certainly a lot of work has been done in the London market, co-ordinated and steered by a
team in the Bank, to ensure that London is as well prepared as other European centres for
EMU. And our assessment now, which I believe is shared by the EMI and the Commission,
is that London is as well prepared as most if not all European centres.
I can assure you that the Bank of England itself will be ready for EMU on 1 January 1999,
whether or not the UK is a member. We will be able to offer euro accounts and euro
settlement facilities. We have taken the lead in work on market conventions across
251
Europe. EMU is likely to bring harmonisation of conventions such as day count and
frequency of coupon payments among Europe’s bond markets, and the London market is
ready to do that.
Prior to 27 October 1997, when the decision to enter the Euro Area was deferred
into the next Parliament, the Bank had to work under the assumption that
entry was a real possibility, despite the agreement by both main political parties
to submit any proposal to join to a referendum, and the continuing apparent
majorities in the opinion polls against joining. Opinions can change. A note
outlining the main features of the Bank’s work, pre-October 1997, is contained
in the Bank’s Annual Report and Accounts for 1996.10
The 27 October statement did not, in the event, slow down work on prep-
aration for the euro, especially in wholesale markets in London. In any case,
there remained a need to prepare in advance, should Britain eventually decide
to join. ‘Prepare and decide’ was the then common watchword.
Thus John Townend in his Bank of Wales lecture, 29 October 1997, on ‘The
U. K. and the Euro’, stated that
The other condition for London to thrive as a financial centre after EMU begins is that it
must be well prepared for the introduction of the euro. The Bank of England is playing a
substantive role in the preparations in two complementary ways. First, through our
participation in the work of the EMI, we aim to make sure that the design of EMU is
capable of being delivered in a technical sense. I referred to this earlier.
Our other role is to co-ordinate the preparations for the introduction of the euro across
the financial sector, to the extent that co-ordination is required. The Bank’s role in helping
the financial community to prepare for the euro was recognised and reconfirmed by the
Chancellor this summer when he launched his complementary initiative to begin pre-
paring the business community for the euro. In addition to making our own internal
preparations at the Bank, we play a co-ordinating role in the financial community in three
main ways:
. First, our job is to ensure that the necessary infrastructure is developed in the UK to
allow anyone who wishes to do so to use the euro in wholesale payments and across
the financial markets from the first day of EMU.
. Second, we aim to promote discussion between the EMI, national central banks and
market participants across Europe about practical issues on which the market is
seeking a degree of co-ordination.
. And, third, we provide information: for example, through our quarterly series of
editions on Practical Issues Arising from the Introduction of the Euro, which is
distributed to around 32,000 recipients across the City and beyond, including
many (I hope) to Wales and 4,000 directly abroad. And following the successful
symposium we held early this year, we are planning to hold a further symposium,
next January at the Bank, on London as the international financial centre for the
euro.11
252
This work needed to involve at differing times many of those working in

various operational parts of the Bank, (though the Monetary Analysis wing
serving the MPC was less affected). In order to pull this work together, and to
take the lead in the Bank’s educational, and Core Purpose 3 (City efficiency),
role the Governor introduced a new and separate group in the Bank, initially
called the Euro Preparation Division, but renamed the Co-ordination Unit for
Europe some time after the 27 October 1997 Statement. The work of this unit
was directed by John Townend, from its start until his retirement in June 2002
(to climb mountains in the Himalayas). Townend became a Director of the
Bank, with special responsibilities for Europe at the start of 1999, promotion
that derived in part from the considerable success of the wholesale market
change-over to the euro on 1 January 1999. He had previously been a Deputy
Director of Market Operations, under Ian Plenderleith, in that part of the
Monetary Stability wing that had taken over the functions of what had
once been the Chief Cashier’s Department, undertaking the market oper-
ations and home finance issues of the Bank. But Townend had already be-
come ‘Mr. Europe’ in the Bank. Before taking on this role, while still heading
253
Market Operations, he had also been the Governor’s Alternate on the EMI
Council, which means that he did the main donkeywork, together with Ste-
phen Colllins, the second Alternate. Prior to the 1998 establishment of the
ECSB, the EMI was the main centre for the technical preparations for EMU.12
The role of the Co-ordination Unit, as set out in the Annual Report of 1999,
was to be
responsible for co-ordinating the Bank’s work on Europe, which is carried out by each of
the Bank’s main operational areas. It takes a lead on the issues that affect the Bank as a
whole but which do not fall within the ambit of any of the operational areas. It is also
responsible for co-ordinating the Bank’s involvement with the European Central Bank,
other EU central banks and the EU Economic and Financial Committee. It maintains
contact with, and provides technical information to, financial institutions operating in
euro markets and with responsibility for euro infrastructure.
The Coordination Unit was a relatively small part of the Bank, involving not
much more than about 1 per cent of the total staff, and of its direct costs, see
Table 11.1 and Figure 11.1, taken, respectively, from the Bank’s Annual Reports
in 2000 and 2001.
Despite being small, the senior staff13 in the Unit were of very high quality,
including top-class officials such as Bill Allen, who became Director for Europe
after John Townend’s retirement in June 2002, Stephen Collins, Jon Carr, and
Paul Richards, a financial expert in the City who was seconded to the Bank in
February 1997 and joined full time in 2002.
In the first year of the existence of the Euro Preparation Division, 1996–7, its
main function was to prepare for possible UK entry. But after the 27 October
1997 Statement its most immediate task was primarily an educational and
co-ordinating exercise to prepare the City of London, and indeed the Bank
itself, for the change-over to the euro on 1 January 1999, though of course it
also continued preparations for euro entry until after 2003.
Table 11.1. Bank of England expenditure budget
1999/00 1999/00 2000/01

Budget Out-turn Budget
Business units
Monetary Analysis and Statistics 16.5 16.9 18.9
Financial Market Operations 43.6 41.3 45.7
Financial Stability 8.1 8.4 8.9
Co-ordination Unit for Europe 1.3 1.3 1.4
Centre for Central Banking 1.5 1.3 1.5
Studies
Printing Works 39.5 37.7 34.5
Registrar’s Department 4.0 3.8 3.6
114.5 110.7 114.5
254
Numbers of Staff by Area 2000 and 2001 (Chart 1)
Monetary Analysis & Statistics

Banking & Market Services
Market Operations
Financial Stability
Co-ordination Unit for Europe
Centre for Central Banking Studies
Printing Works
Registrar’s Department
Personnel, Audit & Secretary’s Department
Property Services and Security
Finance & Central IT
Secondees, etc.
0 100 200 300 400 500 600
2000 2001
Figure 11.1. Bank of England: numbers of staff by area, 2000 and 2001
As already noted, the City of London was the largest financial centre affected
by the change-over in wholesale financial markets from legacy currencies to the
euro at its launch at the beginning of 1999. The Bank was integrally involved in
co-ordinating the preparations in the City for the launch of the euro. Although
individual firms were responsible for their own preparations, the Bank sought to
achieve a consensus where a common approach was required, and to communi-
cate the results across the market as a whole (e.g. through the early editions of
Practical Issues Arising from the Introduction of the Euro in 1997 and 1998). The Bank
was also concerned to ensure that large firms and the financial infrastructure in
the City were prepared for the ‘conversion weekend’ at the beginning of 1999. In
the run-up to the conversion weekend, during the weekend itself, and in its
immediate aftermath, the Bank kept in regular contact with all the key firms in
the City to check that they were ready, and in case there were any problems. In
the event, the change-over went without any significant hitches, as the City was
well prepared. The change-over to the euro in wholesale markets was one of the
largest operations ever undertaken in the City. The Bank’s involvement was
consistent with its ‘CP3’ role at the time.
The details are set out in the early editions of Practical Issues. These were
widely used, not only in the City, but also across the Euro Area. Indeed the
circulation list of Practical Issues was literally global, issuing some 32,000 copies,
by far the largest circulation of any Bank publication. The other central banks in
Europe helped and co-operated in the publication of Practical Issues, but none of
them published anything comparable in quality or circulation. Many experts
(including European Commissioner Mario Monti) regarded Practical Issues as
equivalent to ‘the Bible’ for the wholesale euro launch in 1999, which was
remarkable given the likelihood, later confirmed, that the UK would be an ‘out’
central bank.
255
The Bank also monitored the retail banking change-over in the Euro Area
between 1999 and 2001 and the issue of euro notes and coin and withdrawal of
legacy national notes and coin at the beginning of 2002. This was consistent
with the UK’s policy of ‘prepare and decide’; and it was felt that there was a one-
off opportunity to learn from the experience of the Euro Area, particularly in
the large countries, before memories faded. The Bank was in a unique position
to learn these lessons because of its own responsibilities and its good relations
with the national central banks (NCBs) in the Euro Area. The details are set out
in later editions of Practical Issues (1999 to 2002), to which a number of NCBs
contributed.14 The issue in May 2002 provides a very comprehensive account of
the completion of the retail banking change-over and of the issue of euro-
currency, together with drawing some lessons for subsequent entrants, whether
the UK or not.
In this largely educational role, much of the work of the group involved the
dissemination of advice about the practical issues arising from the euro, in the
256
pamphlets that they published, mostly via the web on the Internet, semi-
annually. Prior to 1 January 1999, this publication was entitled Practical Issues
Arising from the Introduction of the Euro, but once the euro was introduced in
January 1999, the title had to be shortened to Practical Issues Arising from the
Euro; it was more familiarly known throughout as Practical Issues. There were
some 18 issues circulated by November 2002.
Much of the work involved was somewhat technical, concerned with
the details of the new systems and market processes involved. For markets to
work, it is, however, essential to get such details exactly right. However,
I doubt whether the readers of this book want to be taken through them in
any detail, and those that do can directly consult the Bank of England’s
website.15
For the reasons already stated, the Bank and the City of London played a key
role in the conversion of wholesale markets to the euro in January 1999. The
subsequent adoption of euro-currency, notes, and coin, in January 2002,
a technical triumph, had much less impact on the ‘out’ countries.
Once it became clear in June 2003 that the UK would remain ‘out’ for the
foreseeable future, (which in economics is a rather short horizon of about 2/3
years!), interest in the subject waned, and Practical Issues ceased. During the
257
years of ‘prepare and decide’ much had been done to assess the implications of
the UK’s potential entry for retail markets and the currency change-over. This
was pulled together in a stand-alone document, dated September 2005, entitled
Publications on Europe: City Guide to a UK Euro Changeover.16
The conversion weekend in January 1999 represented the high point of the
work of the Euro Co-ordination Group. Although no one knew, with any
assuredness, what the outcome of the ‘five tests’ exercise would be until the
last moment, the different and rather better trajectory of the UK economy than
of its Continental partners, the belief of the Chancellor that the institutional
structures for monetary and fiscal policies that he had created in the UK were
superior to those in the Euro Area, and the continuing (opinion poll) majority
against entry made entry increasingly unlikely. After June 2003 it rapidly dis-
appeared as a current issue. Yet, under slightly different circumstances that need
not have been so, and, should circumstances change (as they will), the issue of
UK entry might revive. Who knows? If so, the preparatory work done in the
Bank on the retail side and for the currency change-over would come in very
useful.
Whither Now?
Despite the UK being an ‘out’ country, relationships between the Bank and both
the NCBs and the ECB of the Eurosystem have remained mostly good. The Bank
still plays a (minor) role in the ESCB through its membership of the General
Council of the ESCB, though, of course, the key macro-monetary decisions are
taken by the Governing Council, from which the ‘outs’ are excluded. The
members of the Governing Council of the ECB would welcome the ‘outs’ to
join them, and hope that it will happen soon.
One must assume that it is somewhat galling for the Euro Area members to
have the main capital market of the Euro Area sited in London, in an ‘out’
country. There are, I believe, suspicions that a few of the rare areas of discord
have related to a disinclination in the Euro-Area members to give London an
easy ride. An example was the initial discussions of how the ‘out’ countries
might link into the Euro-Area TARGET payments system, though this latter is a
tortuous and technical matter with which I am not personally familiar.
With domestic price stability being the main monetary objective, both in
the Euro Area and in the UK, and with floating exchange rates, the key
requirement both for the Eurosystem and the Bank of England has been to
keep their ‘own houses in order’, and both have achieved that. Within the
wider international political scene, the ECB and its President wield even more
weight and influence than the Bundesbank and its President used to do; but,
equally, the governors of the NCBs have a diminished role. If the UK were to
join the Euro Area, the Bank would become a small fish in a much bigger pool.
258
Meanwhile, the importance of London as the main international financial

market, notably for euro business, and the relative success of the UK’s macro-
monetary policies, gives the Bank and its Governor a platform and a weight in
international monetary discussions considerably above its comparative stand-
ing in terms of national GDP.
But the Bank’s primary focus is not so much on international issues, but to
achieve its inflation target, as set for it by the Chancellor. To do this the MPC
varies interest rates. It can do so because the exchange rate is allowed to float,
although in practice remaining rather stable against the euro in recent years. In
the interest rate setting exercise, the Euro Area is just part of the ‘Rest of the
World’ (ROW), important because it is the UK’s largest trading partner but
perhaps less so than the United States, whose fluctuations tend to drive
the world economy. In this exercise the Bank has been both independent and
extremely successful, when measured by the record of inflation (and output)
outcomes.
In comparison in recent years, the other historical functions of the Bank have
been removed (debt management, bank supervision) or have played a lesser role
than in former years. Until the credit crisis of 2007–8, there had been no
systemic financial crisis in recent years, and so not much public role for the
financial stability wing of the Bank. Quite what a central bank charged with
responsibility for contributing to the maintenance of financial stability, but
with no supervisory functions, should do—outside of crisis periods—remains
unclear.17 Unlike the MPC, there are virtually no instruments for a companion
Financial Stability Committee (or Board) to wield, and precious little economic
analysis, theory or useful forecasts to inform such a committee on how to vary
such instruments (if any) that they may have. That leaves them with the
Financial Stability Review report, describing current developments and recording
current, subjective concerns, with little, or no, ability to forecast and not much
quantitative measurement.
Even more important in this context, Core Purpose 3, relating to the
enhancement of the efficiency of the UK financial system, has been quietly
dropped in recent years. No doubt the private sector should (normally) take the
lead in such structural innovations, though the ECB appears not to think so in
its (controversial) TARGET2S proposal for handling Euro Area capital markets’
securities settlements centrally. Its mission statement includes the objective of
promoting financial integration.
The Co-ordination Unit for Europe was essentially a CP3 exercise. Its disso-
lution, and the recent structural changes in the Bank, effectively represents a
bet that the UK will remain outside the Euro Area for future planning purposes.
So far that bet looks rather good.
If that bet went wrong, however, there would be serious internal, practical,
staffing problems for the Bank.18 Its primary focus, for the MPC to set interest
rates on UK grounds, would disappear in an instant, to be replaced by the need
259
to advise the Governor on conditions in the Euro Area more widely at the
monthly ECB meeting, one vote amongst many, perhaps 1 in 25. The idea
that the Bank could fashion for itself a special position in the ESCB, rather as
the Federal Reserve Bank of New York has in the Federal Reserve System is, in my
view, highly unlikely. Why should the ESCB transfer any special operational
role from Frankfurt to a ‘Johnny-come-lately’ in London; anyhow such oper-
ations now mostly get done in cyberspace.
With their macro-monetary policy roles much diminished, national central
banks within the Eurosystem and the ESCB have, naturally enough, been
hanging on, like grim death (an apposite analogy?), to such supervisory and
CP3 (financial efficiency) roles as they found themselves left with. But, as
already noted, the Bank has either been stripped of, or has abandoned, most
of these in its focus on CP1.
If the UK should join the euro, it could be argued that the optimal size of the
Bank of England would be two persons,19 the Governor and her/his secretary.
The building on Threadneedle Street could easily be put to other uses.
Notes
1. My thanks are due to Bill Allen, Jon Carr, Stephen Collins, Nigel Jenkinson, Paul
Richards, and John Townend for advice, assistance, comments, and suggestions. All
interpretations and errors, however, remain my own. I also want to thank Mrs.
Margot Hone for permission to reproduce her husband’s, Basil Hone’s, excellent
cartoons, which had previously appeared in the Bank of England’s publication,
Practical Issues, under the pseudonym, Ben Shailo. Finally, I want to thank Marina
Emond for excellent secretarial assistance.
2. From then onwards the Monetary Policy Committee of the Bank of England, chaired
by the Governor, and consisting of four other internal Bank officials and four external
members, (appointed by the Chancellor), were delegated the power to set the short-
term policy interest rate, without direction or interference from politicians. The MPC
was not, however, given goal independence. The MPC’s goal, of achieving an infla-
tion target, was set for it by the Chancellor.
3. Neither of these structural changes had any connection, as far as I am aware, with
wider European developments.
4. Indeed it remains to this day unclear exactly what is the prudential role and functions
of a central bank retaining responsibility for overall financial stability but without any
supervisory operations, though it certainly has some, notably oversight of the pay-
ments systems.
5. If the Government had decided that the economic case had been met, the Bank would
most likely have been pressed to state whether it agreed with that, or not. It is, of course,
an untestable counterfactual, but I, and most others, believe that the Bank would have
assessed the balance of economic advantage then dispassionately and analytically
without giving any weight to the implications for its own future status and position.
260
6. George used almost identical words in his speech on 11/04/2000.

7. There became something of a well-rehearsed litany on this topic. Amongst the pros
mentioned were the following:
Nominal exchange-rate certainty (Townend, 29/09/87; Davies, 04/06/97; George, 23/
09/97; George, 26/03/98; George, 12/02/2000; George, 11/03/2000; Townend, 16/03/
2001; George, 31/05/2001).
Broader, more liquid financial markets (George, 11/03/2000; George, 12/09/2000;
Townend, 16/03/2001; George, 31/05/2001).
Lower transactions costs (George, 23/09/97; Townend, 29/09/97; Townend, 16/03/
2001; George, 31/05/2001).
More price transparency, competition, and hence dynamism (George, 23/09/97;
Townend, 29/09/97; George, 26/03/98; Townend, 16/03/2001; George, 31/05/2001).
Amongst the cons were the following:
Asymmetric conditions, ‘one size fits all’ (George, 23/09/97; Townend, 29/09/97;
George, 26/03/98; George, 11/04/2000; George, 12/09/2000; George, 24/10/2000;
Townend, 16/03/2001).
Limited adjustment mechanisms (George, 23/09/97; Townend, 29/09/97; George, 26/
03/98; George, 11/04/2000; George, 12/09/2000; George, 24/10/2000).
Some points to notice are
That the Governor especially placed so much emphasis on nominal exchange-rate
certainty. There was much less emphasis on greater transparency and competition
leading to any dynamic productivity enhancement.
One of the additional arguments sometimes made for euro entry was that that could
be necessary to safeguard and advance the cause of further European (political) union.
Since this latter was primarily a political question, it was not discussed by the Bank.
8. There is one minor qualification to this. Dr. Peter Westaway had by this time left the
National Institute of Economic and Social Research for the Bank. He was seconded by
the Bank to HMT for this exercise; this was not because of any expertise gained at the
Bank, but because of his prior modelling work at NIESR, which models played a role in
this overall exercise (see, for example, Annex A of the Assessment of the Five Tests);
where Westaway is mentioned (e.g. HMT 2003: 229, 232), reference is made to his
NIESR former work, not to his current Bank position.
9. My thanks for the information in this last paragraph, as also for much more of this
Chapter, are due to Paul Richards.
10. If a reader should like a copy of this, it is available as Annex A of the original draft. The
annexes were omitted from the book Chapter to save space.
11. Also see Annex B, available on request from the author.
12. ‘The Bank continues to play a full role in all of the technical preparations for EMU at
the European Monetary Institute (EMI) in Frankfurt and in the European Union (EU)
Monetary Committee. Much of the preparatory work undertaken at the EMI was
brought together in a document specifying the operational framework for the single
monetary policy in Stage 3, published in January 1997. The Bank welcomed the
publication of this document and its substance. There are only a small number of
areas where it has not proved possible to reach a unanimous view among central
261
banks: one of these relates to the need for reserve requirements on the banking
system and another to the terms of access of non-euro area Member States to intraday
liquidity within TARGET (the proposed interlinking of Real-Time Gross Settlement
payments systems). Other topics on which national central banks have been heavily
engaged with the EMI include the drafting of the legal Regulations on the euro, the
design of the revised Exchange Rate Mechanism (membership of which will be
voluntary), the specification of euro banknotes and the specification of the statistical
requirements for EMU.’ Annual Report (1997)
13. The junior staff were no doubt top-class too, but I never got to know them.
14. Once again, I am entirely indebted to Paul Richards for the information in these last
couple of paragraphs.
15. In order to give readers a slight flavour of what went on, the Contents Pages of the
December 1998 issue provide an idea of the scope of the change-over, Annex C, and
the opening five pages of the June 1999 issue, Annex D, give a good, general account
of what occurred and the Bank’s role in it. These, again, are available from the author
on request.
16. The first three contents pages also available as Annex E, on request from the author.
17. That should not be taken to imply that I think that it has no useful role. It can try to
analyse the nature of systemic risks and threats to the overall financial system and to
promote solutions to collective action problems and other sources of market failure
that strengthen financial resilience and are justified on cost–benefit grounds. A few
examples would be analysis of networks, especially of the payments systems, of the
resilience of market and funding liquidity, and—on the risk reduction side—ap-
proaches to strengthen the wholesale payment systems and to improve the access
to funding and the use of standing facilities in stressed conditions.
18. Although less so than for several national central banks within the Euro Area, which
entered the Eurosystem with a far more bloated staff size than the Bank of England
has achieved.
19. This is, of course, hyperbole. London would become, even more than it already is, the
financial centre of the Euro Area. The Bank of England would have access to market
intelligence, e.g., about financial stability issues that the ECB should want to know.
But the Bank would need to become much smaller with a focus totally different from
its present one.
262
12
Denmark and Sweden: Networking by
Euro-Outsiders
Martin Marcussen
Both Denmark and Sweden have a paradoxical relationship to the European

Union. Their populations clearly favour international cooperation in general
and membership of the EU in particular. They are also among the most
informed about matters related to European integration overall. Still, although
public support for the euro seems to have increased over the last 15 years, the
two countries’ populations belong to the most EMU-sceptical in the EU. Only
about half of their populations thinks it would be a good idea to replace their
national currencies with the euro, the Danes being slightly more positive than
the Swedes (Figure 12.1).
In addition, while we are dealing with states in which the issue of introducing
the euro has been put to public referendums on various occasions, we see
almost no day-to-day public debate about the euro, or about the EU as such.
The national debates oscillate between almost complete silence about everyday
activities in the EU, on one hand, and very intensive campaigns preceding EU
referendums, on the other. In Denmark, the euro was rejected in a referendum
in 1992; in 1993, a so-called opt-out from the stage three of EMU was adopted;
and in 2000 the euro was rejected once again in a referendum. In Sweden, the
euro was rejected once in the 2003 referendum (Table 12.1). With turnouts well
beyond 80 per cent, the majority against the euro in both countries was around
53–56 per cent. In Sweden, the political elite has sworn not to put the euro on
the agenda before 2010, and among the four Danish EU opt-outs (defence
cooperation, police cooperation, European citizenship, and the euro), the euro
opt-out is generally considered to be the most difficult hurdle to overcome in a
future referendum. Yet, in Sweden as well as in Denmark, the political elite
remains generally in favour of entering the Euro Area.
However, public debate is only one face of the EU in these countries. The
other face is the professional and pro-active diplomatic European activities that
take place continuously—but which are typically hidden from the attention of
263
Denmark and Sweden: Networking by Euro-Outsiders
60
55 Denmark
50
45
40 Sweden
35
30
25
-2
-2
-1
-2
-2
-2
-2
-2
-2
-2
-2
-2
-2
-2
-2
-2
04
98
90
05
95
06
93
01
02
03
99
07
94
96
00
97
20
19
19
20
19
20
19
20
20
20
19
20
19
19
20
19
Figure 12.1. Public support for the euro in Sweden and Denmark
Sources: Standard EuroBarometer, EB43-EB67.
the broader public. Underneath the surface, Danish and Swedish civil servants
are negotiating their ways through and beyond the EU labyrinth, creating cross-
national networks of contacts and adapting their institutions to the reality of
European integration (Jacobsson, Lægreid, and Pedersen 2004; Lindahl and
Naurin 2005; Vifell 2006).
In line with the rest of the book, this chapter focuses exclusively on this
second and hidden face of European integration processes: the everyday life of
central bankers who continuously are forced to negotiate their ways in Euro-
pean decision-making. Central bankers in Denmark and Sweden are in a very
particular situation because their domain—monetary and financial policies—is
exempted from European integration while, at the same time, highly inter-
woven into the European macro-economic organizational field. This situation
distinguishes these two small central banks that traditionally have been deci-
sion-takers from a third euro-outsider, the Bank of England, which has a com-
pletely different historical legacy and tradition of working on the global level as
a decision-maker and with a different position in Europe interlinked with
the City of London (see Goodhart’s chapter in this volume). In this light, the
Swedish and Danish central bankers, more urgently than is the case with the
Bank of England, need to compensate for being Euro-outsiders (Marcussen
2007a). The paradox is that Danish and Swedish central bankers, despite their
Table 12.1. Referenda in Denmark and Sweden on EMU
Yes No Turnout Result
Denmark
2 June 1992: Referendum about the Maastricht Treaty with 49.3 50.7 83.1 Rejected
a protocol in which the Danish government promises to
organize another referendum before adoption of the Euro
18 May 1993: Referendum about the Maastricht Treaty with 56.7 43.3 86.5 Accepted
a declaration stating that the Danish government has
obtained an opt-out from the third stage of EMU
28 September 2000: Referendum about abolishing the 46.9 53.1 87.5 Rejected
opt-out and introducing the Euro
Sweden
14 September 2003: Referendum about introducing the Euro 42 55.9 82.6 Rejected
264
semi-permanent position as euro-outsiders, have to formulate and implement

their monetary and financial policies as integrated parties on the European
macro-economic organizational field. How do they do that? Thus, the central
question concerns the ways in which the Danish and Swedish central banks cope
with being euro-outsiders.
Over the years, a very dense institutional framework has been established
between the euro-insiders, with an obvious acceleration since the mid-1990s
(see Umbach and Wessels, and Howarth in this volume). Seen from the point of
view of the euro-outsiders, such a dense institutionalized network of euro-
insiders is characterized by the strong, regular, and formalized ties between
network members, recurrent, long-term patterns of face-to-face relationships,
and a large degree of proximity, homogeneity, and reciprocity. Over time, the
Euro-insiders begin to constitute a distinct policy community, and the institu-
tional framework of the Euro Area provides a sense of belonging to its members,
giving meaning to both collective and individual actions and driving its mem-
bers by smoothing out and facilitating interaction (Puetter 2006). Dense rela-
tions and heavy embeddedness are furthermore likely to increase trust and
cohesion among in-group members. They reduce transaction costs and minim-
ize the need for control and monitoring, while improving the quality of deliv-
ery and performance. They also facilitate collaboration, cooperation, and
exchange, not least easing and speeding up circulation of information and
diffusion of best-practices within the group. In other words, the network litera-
ture provides a set of reasons for why euro-outsiders would strive to become
euro-insiders, or at least relate actively to the euro-insiders.
However, there are caveats to the general argument about the attractiveness
of being a fully integrated member of the euro-network. First, it comes out
clearly from studying the relationship of the Bank of England to the Euro
Area (see Goodhart in this volume) that the attraction of the Euro Area network
varies considerably from one function to another. The resource dependencies
between the actors differ in financial market integration, financial stability and
supervision, and the planning and execution of monetary policy. In Britain and
in Sweden, ECB monetary policy seems to have no attraction at all. In contrast,
Swedish central bankers seem to pay much attention to European efforts at
creating some sort of a ‘European Organization for Financial Supervision’
(Ingves 2007), whereas in Britain central bankers are highly alert to European
financial regulation. Second, the attractiveness of the euro-network may
depend on the extent to which socialization and mutual learning in the Euro
Area foster some sort of ‘group-think’ among the euro-insiders that prevents
innovation. A main text-book argument for entering the Euro Area has been
that being an insider promotes discipline around a set of commonly agreed
rules of appropriateness, such as those enshrined in the Stability and Growth
Pact. However, if it is generally perceived among the euro-outsiders that
those inside the Euro Area have become less, not more, inclined to undertake
265
necessary reforms, then the attractiveness of the Euro Area network may de-
crease (see Epstein and Johnson in this volume).
In a historical perspective, both the Danish and Swedish central banks have
been involved in formal and informal international cooperation for the pur-
pose of maintaining a stable exchange rate (Table 12.2). Over the last 150
years, stable exchange rates and participation in some kind of cooperative
framework have been the rule rather than the exception. Seen in that perspec-
tive, the current position of the Danish and Swedish central banks as euro-
outsiders is abnormal, all the more so for Sweden than for Denmark, which in
1999 chose to link its currency to the euro within the framework of the
Exchange Rate Mechanism II (ERM II).
The question about how Danish and Swedish central bankers cope with
being euro-outsiders highlights the role of organizational reform and how
they implement networking strategies to compensate for their exclusion from
the euro-club. The chapter adopts both an ‘outside-in’ perspective (on the
impact of European monetary integration on Danish and Swedish central
bank institutions) and an ‘inside-out’ perspective (on the network strategies
pursued by these two euro-outsiders in the European macro-economic organ-
izational field). The conclusion is that, on both these levels of analysis, Euro-
peanization has taken place, but that Europeanization takes different forms in
Sweden and in Denmark. Whereas the Danish central bank copes with Euro-
outsiderness by modernizing its organizational culture while essentially main-
taining its structural features intact, the Swedish central bank has been in a
constant reform process over the last 10–15 years, profoundly altering its
structures, relations, and functions in line with a global trend of public-sector
modernization. Whereas the Danish central bank is opening up and increas-
ingly engaging actively in all sorts of central bank networks in Europe and
elsewhere, it suffices for the Swedish central bank to exploit the large networks
it has built up over the last 75 years. Thus, it is hard to observe any kind of
convergence between the two banks. However, in their different ways, both
Table 12.2. The Danish and Swedish central banks in successive cooperative currency
arrangements
Cooperative currency arrangements Sweden Denmark
ERMII 01.01.1999–present
ERM 17.05.1991–19.11.1992 01.01.1979–01.01.1999
Snake Cooperation 03.1972–29.08.1977 19.02.1972–01.01.1979
Smithsonian Agreement 19.12.1971–19.03.1973 19.12.1971–19.03.1973
Bretton Woods 31.08.1951–23.08.1971 12.12.1946–23.08.1971
Interwar Gold Standard 01.04.1924–27.09.1931 01.01.1927–29.09.1931
Classical Gold Standard in the form of 27.05.1873–02.08.1914 01.01.1875–06.08.1914
a Scandinavian Currency Union
from 01.01.1877
Sources: Jonung (2000); Mikkelsen (1993); Olsen and Hoffmeyer (1968); Svendsen and Hansen (1968).
266
central banks remain powerful, legitimate, and independent political author-

ities in their respective domestic contexts. They play considerable roles in
defining the direction and content of macro-economic policy-making. So far,
therefore, the Danish and Swedish central banks have not lost out as a result of
their euro-exclusion. This stands in sharp contrast to some of the euro-insider
central banks, of which the Bundesbank is the obvious example (see Dyson in
this volume).
The Danish Central Bank
For a long period before, during, and after the Second World War, the former
Social Democratic Minister of Finance, Carl Valdemar Bramsnæs, was Danish
central bank governor (1936–49). Written correspondence, board minutes,
and personal diaries retrieved from the archives of the Danish central bank
show clearly that Denmark had no permanent and strong network of inter-
national contacts to exploit during these years. In addition, the Danish central
bank had no significant international capacity. There was not much travelling,
and the Danish central bank governor did not seem to be informed about,
interested in, or participating in international policy formulation or exchanges.
One of the few links to the outside world was to neighbouring Sweden, where
the Riksbank had become a member of the Board of Directors of the Bank
for International Settlements (BIS). Not being at ease with other foreign
languages, the link to the Riksbank and its governor, Ivar Rooth, allowed com-
munication on the basis of the mother tongue and between two relatively
similar political and administrative cultures. Thus, occasionally and almost
randomly, the Danish central bank received scattered information about cen-
tral bank business in Europe and policy issues in general. For instance, during
the Second World War, Denmark was isolated from, and mostly unaware about,
negotiations taking place in Bretton Woods. The Danish diplomat, Henrik
Kauffmann, who during the years of German occupation of Denmark walked
the corridors of Washington, did not formally represent the Danish govern-
ment and was only present during the Bretton Woods negotiations in his
personal capacity (Lidegaard 2005). In short, before the Second World War,
the Danish economic governance structures including the central bank and
the Ministry of Finance seemed to be sheltered from international develop-
ments and influence (Østergaard 1998).
During the 1950s and 1960s, Svend Nielsen (governor 1950–64) focused
his attention on the US and British central banks. The perception inside the
Danish central bank was that the locus of decision-making power was placed in
organizations such as the International Monetary Fund (IMF) and that par-
ticularly the British and American central banks constituted gateways to infor-
mation. With the establishment of the Marshall Plan and the Organization for
267
European Economic Cooperation (OEEC), a pattern of international contacts

was established constituting a very sparse portfolio of network ties. The net-
work strategy seemed to be that since Denmark was not, and had no aspiration
of becoming, centrally located in the international network of central bankers,
the Danish central bank should concentrate on cultivating contacts with actors
who were located in these central positions. After the Second World War, the
BIS fought hard to re-establish its credibility and legitimacy which had been
badly damaged during the war as a result of allegations about buying and
selling looted gold from Germany (Toniolo 2005). As a result, the BIS was not
perceived to be the most central organization on which to focus attention.
Thus, during Nielsen’s period as governor, the BIS did not figure in his mindset,
and the Scandinavian connection became overshadowed by the Anglo-Saxon
connections.
From the mid-1960s, the number of European forums in which central
bankers could gather on a regular basis increased drastically (Marcussen
2006c). Denmark became a member of the European Monetary System (EMS),
and Erik Hoffmeyer (governor 1965–94), consequently, participated actively in
the Basel-based Committee of EC Central Bank Governors. However, there were
no illusions that the important decisions were made in the European institu-
tions (Marcussen 2008). The idea that the Committee of Central Bank Gover-
nors should develop a club mentality and consequently become a motor for
European monetary integration was mostly ‘wishful thinking’, according to
Hoffmeyer (Hoffmeyer 2000: 14). As a result, over three decades, attention was
directed at the local hegemon of the Exchange Rate Mechanism, the German
Bundesbank. Here power was located in European monetary cooperation. In
continuation of the strategies traditionally pursued by Danish central bank
governors, sparse resources were concentrated on the regular cultivation of
good and stable links with the most powerful actors in the most relevant
monetary regimes (on the Bundesbank, see Dyson in this volume).
The result of the second referendum on the Maastricht Treaty in May 1993,
when Denmark got a formal opt-out from the third stage of EMU, challenged
the traditional network strategy which focused mainly on cultivating contact to
the regional hegemon. The possibilities were slim that Denmark would be able
to enter the euro on 1 January 1999. Moreover, since August 1993 the fluctu-
ation bands of the ERM were widened to + 15per cent, as a result of which the
Danish central bank stood de facto alone in the defence of the stable currency
policy. On 13 August 1993, Governor Hoffmeyer issued a press release stating
that he intended to stick to a much narrower fluctuation band, in practice
+ 2,25per cent. With Denmark in ERM II, the ECB promised that, if a situation
arose that threatened to push the Danish currency out of these much narrower
bands, it would intervene immediately and in an unlimited fashion, provided
that such an intervention would not make it more difficult for the ECB to
realize its objective of keeping inflation low in the Euro Area as a whole. This
268
‘guarantee’—or ‘security net’, as it is sometimes called in Denmark—has been

evoked once, in the autumn of 2008.
From 1993, the Danish central bank started to develop a diversification
strategy, which implied a multiplication of unilateral ties to central bank actors
inside and outside Europe. Increasingly employees were seconded to inter-
national economic organizations and other national central banks as part of
their individual career planning. Inside the Eurosystem, the Danish central
bank and other euro-outsiders worked diplomatically in many contexts to
obtain observation status in the forums from which they were excluded. In
general, a new internationally oriented communication strategy was imple-
mented, and participation in the many different central bank forums world-
wide was prioritized. This line has been broadly continued. The intensification
of contacts to the outside world can be illustrated by registering the extent to
which Danish central bank personnel participate in meetings in the ESCB
committees (Figure 12.2).
Figure 12.2 shows that the Danish central bank participates in the various
committees and sub-committees to various degrees. Generally, over the last four
years, the level of attention paid to ESCB committees and the intensity with
which Danish central bank officials participate in their meetings have in-
creased. In particular, the Market Operations Committee, which assists the
Eurosystem in carrying out monetary policy operations and foreign exchange
transactions, and in managing the ECB’s foreign reserves and the operation of
ERM II, plays a more central role for Danish central bankers.
The ESCB Banking Supervision Committee has always been relatively open
for Euro-outsiders. As noted by Moran and McCartney in this volume, banking
supervision is not a prime competence of the ECB. Supervisory issues are dealt
with by national supervisory authorities and in other European and inter-
national forums. In contrast to the Banking Supervision Committee, the Mon-
etary Policy Committee goes to the heart of key ECB competences. It advises on
the formulation of monetary and exchange rate policies in general and is
responsible for the projections of macro-economic developments in the Euro
Area. Interestingly, also in this area the Danish central bank is increasingly
involved in ESCB work. Among other important committees, the participation
of the Danish central bank in the International Relations Committee and
the Payment and Settlement Systems Committee has been intensified. The
International Relations Committee assists ECB work in forums such as
the IMF, OECD, and BIS, and the Payment and Settlement Systems Committee
advises on the operation and maintenance of TARGET, general payment sys-
tems policy, and oversight issues, and issues in the field of securities clearing
and settlement.
Unlike the Riksbank, the Danish central bank has no official opinion about
being a euro-outsider, though Bodil Nyboe-Andersen (governor 1995–2005)
and Niels Bernstein (governor 2006–) helped to consolidate a life outside the
269
May 2004
External Communications Committee

International Relations Committee
Banking Supervision Committee
Payments Systems Committee
Market Operations Committee
Monetary Policy Committee

Internal Auditors Committee
Accounting Committee
Bank Note Committee
The Legal Committee

The General Council
Statistics Committee
Budget Committee
IT-Committee
March 2008
External Communications Committee
International Relations Committee
Banking Supervision Committee
Human Resources Conference
Payments Systems Committee

Market Operations Committee
Internal Auditors Committee
Monetary Policy Committee

Accounting Committee
Bank Note Committee

The Legal Committee
The General Council
Statistics Committee
Budget Committee
IT-Committee
Participation in per cent: 75−100 50−75 25−50 0−25
Figure 12.2. The Danish central bank’s participation in ESCB committee work, 2004 and
2008
Source: Danmarks Nationalbank, May 2004 and March 2008.
Euro Area in their own ways—simply by not explicitly engaging in public

debate about the issue, by minding their own business. With the help of
consenting politicians, monetary policy and all related issues have been en-
tirely depoliticized in Denmark, as a result of which the option of letting the
Danish currency float like the Swedish currency is never mentioned as a realistic
alternative to the fixed exchange rate policy.
The Danish central bank has not engaged in radical organizational reforms
since the Second World War. In fact, the central bank law has remained basically
the same since 1936. However, consecutive governments implemented a pro-
found change in the macro-economic policy paradigm from 1982 onwards
270
(Table 12.6). Fixed exchange rates, low inflation, and stable budgets became the
solid pillars of Danish macro-economic policy (Marcussen 2002). In addition to
structural reforms in the labour market, a permissive consensus seemed to have
developed around traditional central bank ‘sound policy’ values. Inside the
Danish central bank, formal changes have been minimal. In 1998, a so-called
‘information office’ and a website were installed, underlining a felt need to
respond regularly and systematically to inquiries. In the following years, a
number of regular publications were streamlined, in terms of both form and
content, thereby appealing to a larger readership.
The number of employees has, overall, remained relatively constant. How-
ever, the composition of employees has changed. Slowly but steadily, an
increasing number of university-educated economists define the central
bank, replacing employees from other lower-educated branches. The bank has
quite a low turn-over rate and the average years of service seem to be very high
(13–15 years on average; 21–2 years at top level). The number of employees
with more than 25 years of service amounts to 20 per cent. A survey conducted
among the employees concluded that employment satisfaction is high. In
addition, the Danish central bank has for many years figured among the 15
most popular workplaces in Denmark for newly graduated economists (www.
universumeurope.com). From 2000, a personnel directive was adopted empha-
sizing the importance of employee satisfaction and human resource develop-
ment. Increasingly, emphasis is placed on education and skill-upgrading
of employees. Over the last decade, the budget consecrated to education and
training has increased manifold. Interestingly, the Danish central bank actively
encourages its younger economists to take a stage in one of the many inter-
national financial institutions. On average 15–20 persons are permanently on
leave from the bank, spending time in an international organization.
From 2000, like many other public organizations, the bank explicitly stated
its basic values. One central element is to safeguard traditions while attemp-
ting to engage in renewal. Another central value is to provide services to the
public. Transparency becomes central in that regard (see Jabko in this volume).
The level of transparency institutionalized in the Danish central bank does not,
however, measure up with other euro-outsiders such as the Swedish Riksbank
and the Bank of England, nor does it compare with the ECB (Figure 12.3).
The Danish governor does not have an obligation to explain his policies in
parliament, and no minutes are released from decision-making forums. Inside
the Danish central bank, this relatively low level of transparency is explained by
the fact that the Bank on a day-to-day basis is demonstrating to the world that it
is pursuing a stable currency objective within the framework of the ERM II.
Since the markets can observe directly whether the Bank is succeeding or not,
it is argued that there is not much more to tell the financial markets.
This argument stands in contrast to central banks, such as the ECB, the
Bank of England, and the Swedish Riksbank, which manage floating currencies
271
14
12
Danmarks Nationalbank
10 Sveriges Riksbank
8 Bank of England
ECB
6
4
1998 1999 2000 2001 2002 2003 2004 2005
Figure 12.3. Central bank transparency, 1998–2005

The transparency index is constituted by the following five elements: political transparency (open-
ness with regard to policy objectives), economic transparency (openness concerning information used
for monetary policy), procedural transparency (openness about the ways in which policy decisions are
being made), policy transparency (prompt disclosure and explanation of decision made), operational
transparency (openness in relation to the implementation of the policy actions). Minimum score is ‘0’,
maximum score is ‘15’.
Source: Dincer and Eichengreen (2007: 41).
and which implicitly or explicitly target inflation. To a much greater extent

these central banks need to inform the public about what they are doing to
meet this target, simply because it is much more difficult to evaluate how
successful they are.
In terms of organizational structure, the number of departments has
remained relatively constant over the years at 16–17. Very few people have
been dismissed over the last decade as a result of streamlining the organization
and outsourcing of functions. As regards the internal allocation of resources, no
resources have been invested in a distinct research department. This too stands
in sharp contrast with the Riksbank as well as with many other central banks
around the world, where research seems to constitute a major source of author-
ity and legitimacy (see Marcussen in this volume). A certain tendency towards
decentralization has taken place in recent years. Decisions about promotion, for
instance, are now being made in the various departments rather than in the
executive board.
The Danish central bank explains the ‘non-reforms’ by the fact that it under-
took the major part of its reforms earlier than the world trend (Pedersen 2006:
10). For instance, the last regional branch was closed in 1989. In addition, the
costs of running the bank are, in international comparison, quite low. This is
taken to be an indication of the continuous streamlining which is taking place
in a gradual manner, rather than through large-scale reforms and outsourcing.
In addition, the Danish central bank is cheaper in operational costs because it is
normally regarded to be more labour-demanding to run a system of inflation
targeting such as the Swedish Riksbank than to tie one’s currency to the euro.
Finally, although the salaries of the employees in the Danish central bank are
272
Table 12.3. Staff costs in the Danish and Swedish central banks
2004 (1) Annual (2) Staff costs (2)/(1) Relative Staff costs per Index of
salary in per employee price employee per PPP-corrected
industry per year level year in Dkr., staff costs
in Dkr. in Dkr. PPP corrected
Danmarks 309.000 529.000 1.7 100 529.000 100

Nationalbank
Swedish Riksbank 277.000 536.000 1.9 89 602.000 114
Source: Pedersen (2006: 12).
higher than in manufacturing, they are among the lowest in European central
banking (Table 12.3).
Reforms or not, the Danish central bank governor has for years topped the
rankings of the most trusted and most powerful decision-makers among Dan-
ish elites (Berlingske Nyhedsmagasin, various years). The Danish central bank
governor does not have to face continuous contestation like, for instance, the
president of the ECB. He or she rarely has to stand up and defend his actions in
order to remain a recognized and legitimate public authority in the Danish
society. In contrast to Sweden, the Danish governor receives a relatively
modest salary (Table 12.4) while tending to remain much longer in office
(Table 12.5).
Table 12.4. Danish and Swedish central bank governors’ salaries, 2003 (US$)
Lars Heikensten Sveriges Riksbank $241.000

Bodil Nyboe-Andersen Danmarks Nationalbank $253.000

Membership of the Board of the Bank for International Settlements adds another $90.000 to the salary.
Source: www.centralbanknews.com, 18 August 2003; annual reports.
Table 12.5. Average tenure in the Danish and Swedish central

banks
Denmark (employment to the age of 70) Sweden (5 year terms)
Bramsnæs (1936–49) Rooth (1929–48)

Nielsen (1950–64) Böök (1948–51)
Hoffmeyer (1965–94) Lemne (1951–5)
Nyboe-Andersen (1995–2005) Åsbrink (1955–73)
Bernstein (2006–) Wickman (1973–6)
Nordlander (1976–9)
Wohlin (1979–82)
Dennis (1982–93)
Bäckström (1994–2002)
Heikensten (2002–2005)
Ingves (2006–)
Average tenure: Average tenure:
17.25 years 7.6 years
273
The Swedish Central Bank
For the Swedish Riksbank, the 1930s constituted a formative decade that had
lasting impact on its international strategy. In those years, political, entrepre-
neurial, and academic elites were driving forces in the construction of broad,
diversified, world-wide networks of contact. Ivar Rooth (governor 1929–48)
drove the creation and helped cultivate a large portfolio of formal and informal
contacts. At an early stage, he was the only Scandinavian central banker who
engaged himself actively in the formative period of the BIS. Rooth’s personal
archive at the Riksbank shows the ways in which he emphasized international
contacts. During his very first months as governor he travelled among the
major European capitals with a view to personally securing good relationships
with the most important players in the field. Detailed travelling notes demon-
strate how he deliberately assembled a portfolio of preferred contacts that could
be activated in the future if need be. In the following two decades, while
working hard to maintain established links, a large amount of new persons
and institutions were added to his personal network.
The direct and indirect results of this work were many. At the most basic level,
Rooth simply obtained information about opportunities and threats on the
international financial scene. During the first years, for instance, he obtained
a privileged position in observing the financial unrest emanating from the
United States; he gained inside information about the plans for the new BIS
(referred to as the ‘International Bank’ in those early days); and he even entered
an operational partnership with the Bank of England about an informal mutual
early warning system in the event of interest rate modifications. Indirectly,
Rooth inspired confidence in his partners abroad. This comes out clearly
when members of the BIS Board were to be selected from among the share-
holders of the organization. Many central bankers stood up to defend his
candidacy in the closed process. In addition, during the Second World War,
by representing neutral Sweden, Rooth was able to function as an effective and
trusted channel of communication between central bankers from Allied as well
as from aggressor countries. Over the years, the web of central bankers around
Rooth grew larger and became increasingly intimate and personal in character.
During the Second World War, he often ran a personal risk in travelling through
war-torn Europe to maintain and expand essential contacts.
Per Jacobsson, another Swedish economist, occupied for many years the
influential role of Head of the Monetary and Economics Department at the
BIS. Rooth paved the way for his international career, which started at the BIS.
Whereas Rooth was respected and liked for his integrity and social intelli-
gence, Jacobsson was highly valued for his academic skills. As the main author
of almost two decades of annual reports for the BIS, Jacobsson travelled the
world as a very knowledgeable and effective consultant (Jacobsson 1979).
Thus, he was actively involved in Jean Monnet’s modernization plan in
274
France; in Ireland’s struggle to establish a set of credible financial institutions,

including a central bank; and in Bretton Woods where a new international
financial order had to be spelled out in operational detail. If Rooth was the
diplomat, Jacobsson seemed to be the fixer. After the Second World War,
Sweden became a member of the IMF quite late, but once a member, Rooth
stood out as a natural candidate for the important and influential post as its
managing director. Just as Rooth was able to run the IMF during a couple of
years in which the organization established itself as a legitimate world player, so
Jacobsson replaced him as managing director (1956–63) when the organization
was in need of innovation.
Rooth and Jacobsson were not the only high-flying Swedes on the global
financial scene during these years before, during, and after the Second World
War. In other international organizations, Swedes took central positions. Dag
Hammarskjöld who was secretary-general of the UN (1953–61) is an obvious
example. More importantly, the networks established by Swedish central
bankers during the 1930s until the1950s have remained in place. With a central
location in the BIS, Sweden took part in the Group of Ten, for instance. With
G10 membership, access to the OECD Working Party 3 (WP3) and the Interim
Committee of the IMF (later referred to as the International Monetary and
Financial Committee, IMFC) was assured, and so on. The work of Rooth and
Jacobsson helped to lay the path that could be followed by their successors.
During the 1970s and 1980s, with the building up of European monetary
cooperation, another layer of contacts was added on top of an already very
dense constellation of Riksbank contacts. When Bengt Dennis (governor
1982–93) was forced to withdraw the Swedish krone from the ERM in Novem-
ber 1992 (Dennis 1998), there were no direct consequences for the Riksbank’s
network strategy. The network could hardly be any wider or more diversified.
Unsurprisingly, therefore, the modern Riksbank is closely knit together with
other central banks from all around the world, the European scene being one
among others. At one level, there are the annual meetings of the G10, BIS, and
IMF, involving the participation of the central bank governors, sometimes
joined by their economic and finance ministers. At a second level, the gover-
nors and their deputies participate in the more numerous meetings related to
board work in the BIS and the IMF, the General Council of the ECB, the
informal ECOFIN meetings in Brussels, and the International Monetary and
Financial Committee of the IMF, as well as the Nordic central bank meetings. At
a third level, a very large number of committees in various areas require the
attention of a large range of central bank personnel. These forums include
Working Party 3 and the Economic Policy Committee of the OECD, the Eco-
nomic and Financial Committee of the EU, a series of committees within the
framework of the ESCB, and the Basel Committee in the BIS. A simple count of
the international forums in which the Riksbank is represented on a regular
basis concludes that on an annual basis the Riksbank’s personnel prepares for
275
200 4
180 3.5
160
3
140
120 2.5
100 2
80 1.5
60
1
40
20 0.5
0 0
ESCB BIS Brussels Norden OECD IMF Eurostat G10 Others
# meetings 177,5 74,5 36 18 14 9 8 4 13
# meeting forums 49 31 10 17 8 5 4 2 13
Meeting intensity 3,62 2,4 3,6 1,05 1,75 1,8 2 2 1
Figure 12.4. Busy Danish and Swedish euro-outsiders

Source: Own data.
meetings in no less than 139 forums, amounting to 354 meetings (Figure 12.4).
These data are only rough indicators of international networking for they
ignore the informal dimensions of trans-national central bank cooperation.
But it clearly underlines the fact that euro-outsiders, like Sweden, need not be
excluded from international cooperation.
Whereas the Danish central bank has not engaged in radical institutional
reforms since the Second World War, the Swedish central bank has gone
through comprehensive modernization programmes since the end of the
1980s (Table 12.6). Already in 1988, the Swedish central bank stood out as a
first mover among central banks in the world. A reform of the Riksbank act
granted the governor more legal autonomy, thereby leading a world-wide trend
of central bank reform in that direction. Having left the ERM in November
1992, the Riksbank in 1993 explicitly declared an inflation target (IT) regime.
Given that the first to declare an explicit inflation target were the Reserve Banks
of New Zealand in July 1989 and of Australia in April 1993 (see Eichbaum in this
volume), the Bank of Canada in February 1991, and the Bank of England in
October 1992 (see Goodhart in this volume) the Riksbank was again among the
first movers in what a decade later became a distinct global fashion. At about
the same time, but initially without success, initiatives were taken to grant the
Riksbank even more legal autonomy. A new central bank law was not adopted,
however, till 1998 and entered formally into force in 1999.
Also, in the area of central bank transparency the Riksbank took the lead
(Figure 12.3). Inflation reports are regularly published; press releases explain
monetary policy decisions; the minutes of the meetings of the Directorate are
276
Table 12.6. Two worlds apart: institutional reforms in the Swedish and the Danish
central banks
Denmark
1982 The government declares its support for a fixed exchange rate regime.
A so-called ‘sound policy’/‘stability-oriented’ macro-economic policy strategy is being pursued,
implying sound money (low inflation) and sound finances (balanced budgets)
Sweden
1982 The government announces a 16 per cent devaluation within the framework of the ERM
1988 A new Riksbank Act:
The chairman of the Governing Board is no longer appointed by the government, but by the
other seven members of the Board.
The Governor’s term in office is made longer (five years) than that of the rest of the Board and the
parliament (three years, at the time).
There is no indication of the objective for monetary policy-making.
1991 The government declares that low inflation is an overriding goal for stabilization policy.
1992 November: After repeated speculative attacks against the Swedish currency the Riksbank
abandons the pegged exchange rate policy.
1993 January: The Riksbank declares an explicit inflation target.
February: A parliamentary committee presents a proposal for a new Riksbank Act, including a
price stability objective for monetary policy and increased central bank independence. The
proposal does not achieve enough political support and is not formally presented to the
parliament.
October: The first internal Inflation Report is published.
1995 January: Sweden becomes a member of the European Union.
November: The first Inflation Report signed by the Governor is published.
1997 The Riksbank starts to publish its inflation forecasts and Financial Stability Reports.
1997 A new proposal for a price stability objective and increased central bank independence is
presented, this time based on broad political consensus.
1999 An amended Riksbank Act comes into effect.
Source: Heikensten and Vredin (2002: 9); Hoffmeyer (1993).
made public two weeks after the meeting; and the governor meets with the
Parliamentary Financial Committee twice a year. Interestingly, today’s central
banking in Sweden very much resembles the experience of the 1930s (Berg and
Jonung 1998). In 1931–7, Sweden declared an explicit inflation target with a
view to anchoring expectations. In addition, the Riksbank produced regular
reports spelling out the details of monetary policy, and Ivar Rooth met regularly
with the Parliamentary Banking Committee to explain and defend his decisions.
Finally, the media gave wide coverage to monetary policy-making, thereby
emphasizing yet another aspect of central bank transparency.
Today, Riksbank personnel talk about ‘a clash of reform cultures’ between the
prominent idea in Sweden that a central bank that demands reforms elsewhere
in the economy ought to be a first mover and show the way for the others and
the continental perspective, according to which central bankers are classical
institutions with long established traditions that ought to be maintained and
protected from outside involvement (though see Dyson in this volume on Axel
Weber and the Bundesbank). For this reason alone, very few Riksbank managers
feel attracted by the European way of running central banking and often indicate
that it would be easier to sell European monetary cooperation to the Swedish
277
population if the continental model would actively engage with modern man-
agement philosophies, thereby constituting a lodestar.
Within the Swedish central bank, these structural and policy reforms implied
considerable organizational and procedural changes. Over the decade from
1997 the organization and culture of the Riksbank have been completely over-
hauled. Competences were gradually transferred from the top level manage-
ment to the individual departments. The number of departments has been
reduced from 16 to 11 in 2000 and then again from 11 to 7 in 2004. The
regional offices were closed down, and a considerable number of employees
in these offices as well as in the Riksbank building have been dismissed. For
instance, in 2003 the Board of the Riksbank decided that the number of
employees (FTEs) would be reduced by 10 per cent over a three-year period
(Figure 12.5). Regular attitude surveys among bank staff have been carried out
since 1997. Not surprisingly, a recent survey concludes that the employees in
the units that have been cut down ‘tend to have more negative impressions’ of
the Riksbank and its governor (Sveriges Riksbank 2007: 52). Towards the end
of the 1990s, the Riksbank used to be one of the most attractive workplaces in
Sweden for newly graduated economists. This is no longer so. The Riksbank has
dropped out of Universum Communication’s ranking of the top-15 most popu-
lar workplaces for economists in Sweden (www.universumeurope.com).
All managers of the Swedish central bank have been going through intensive
management training with particular focus on communication and output per-
formance. The official corporate culture statement in 2002 is based on openness,
competence, cooperation, overall view (whole of government), initiative, and
800
750
700
650
600
550
500
450
400
350
1992 1993 1994 1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006
Sweden 754 709 664 669 460 488 501 450 420 429 404
Denmark 593 578 589 592 586 579 566 556 552 563 559 544 536 516 515
Figure 12.5. Development in staff numbers (FTEs) of the Danish and Swedish central
banks
Source: Annual Reports from the Swedish and Danish central banks.
278
respect. The Executive Board adopted a so-called strategic plan in 2005, with
strategic targets emphasizing quality, efficiency, and confidence, and in 2006
this plan was turned into a ‘new vision’ for the Riksbank. By constantly compar-
ing itself to other central banks as well as other public authorities and private
corporations, and by constructing an organization prepared for change, the ‘new
vision’ is supposed to be transformed into reality. Over the years, the central bank
has, by example and choice, taken a lead in the discussion among central banks
about central bank efficiency. The point of departure is that central banks are not,
like private corporations, exposed to market competition as a result of which
other efficiency-enhancing mechanisms have to be installed. Completely in line
with values associated with the New Public Management doctrine, the recom-
mendation is to reduce the number of tasks entrusted to central bankers. These
tasks should focus on the efficiency of the payment system and maintaining price
stability, on spelling out precisely when an outcome has been achieved (by
introducing inflation targeting, for instance), and on improving the
transparency of the organization thereby allowing for internal and external
evaluations of the bank (Blix, Daltug, and Heikensten 2003). In short, the Riks-
bank seems to have closely followed mainstream advice about central bank
modernization (Marcussen 2009; Mendzela 2002, 2003, 2006).
Managing a Role as Euro-Outsiders
In the absence of Euro Area membership, which compensation strategies have

been adopted in these two Scandinavian central banks? Clearly, tremendous
internal and constitutional reforms have been undertaken in Sweden. The
ongoing reform programmes implemented since 1997 have fundamentally
altered the central bank on almost all dimensions. Such policy and constitu-
tional reforms have been largely absent in the Danish case. If anything, mainly
informal changes have taken place. Gradually, the composition of employees
has been altered. Today, the Danish central bank is a ‘knowledge organization’
like any other central bank. A quite substantial amount of the budget is being
spent on education and human resource development. In addition, increased
emphasis has been placed on establishing a more differentiated relationship to
other international actors in central banking. For instance, young employees
are being encouraged to take up positions in international financial organiza-
tions, and travel activity has increased. In short, there is a strategy to cultivate
international contacts and consolidate lines of information.
In contrast to the Swedish central bank, the Danish central bank does not
automatically obtain information through central positions in the IMFC, the
BIS Board, the G10, and other major international decision-making centres. As
a result of its already very wide networks, the Riksbank does not seem to need
further expansion and diversification with regard to external networking. In
279
Table 12.7. Danish and Swedish strategies of coping with being euro-outsiders
Sweden Denmark
Networking Little change as a result of Euro-outsiderness Large change as a result of Euro-

outsiderness
Sweden already did diversify its international From having few links, DK started
relations before EMU deliberately to cultivate
diversification after EMU
Organizational Large formal changes—modernization Little formal change—but some change
reform programmes: managementization, in organizational culture (informal
transparency, and accountability change)
contrast to the Danish central bank, it has traditionally been very well integrated
into international financial circles (Table 12.7). In short, being in the same
position as euro-outsiders does not imply convergence in the ways in which
structural reforms are undertaken and international networking is
being diversified. Formulated differently, the fact that the two banks do not take
part in substantial elements of European monetary integration does not mean
that Europeanization has not taken place. Both central banks have changed, but
in quite different ways and in conjunction with broader global reform trends.
Over a 70-year period, the Danish central bank altered its networking strategy
to a much larger extent than the Swedish Riksbank. The Riksbank seems to
have consistently followed an internationally oriented diversification strategy,
establishing strong as well as weak ties with a large number of relevant actors,
inside and outside Europe. The Danish central bank was gradually internation-
alized after the Second World War, but for many years it strategically linked
itself to what it perceived to be the most powerful actor on the scene of global
finance (first Sweden, then Britain and the United States, and finally Ger-
many). With its non-membership of the Euro Area, it opened up, and diversi-
fied its links to other actors, thereby trying to compensate for its lack of
information. In recent years, despite being a euro-outsider, the Danish central
bank also put much more emphasis on committee work in the ESCB context. In
principle, Denmark has only access to committee work in the so-called
extended composition. On occasions, however, Denmark has received specific
invitations to participate in committee work in standard composition. Clearly,
when it comes to voting in these committees, Denmark does not participate. In
addition, the analytical capacity of the Danish central bank has been boosted
by, for instance, increasing the ratio of employees with a formal education in
economics. Over recent years, more PhDs are being employed by the Danish
central bank.
Traditionally, the Riksbank has been accustomed to being present in inter-
national economic organizations. Denmark was always a decision-taker, not
Sweden. The Riksbanks has always been part of the powerful G10—a forum of
decision-makers. The only problem faced by the Danish central bank is that it is
280
no longer sufficient to be linked to a local hegemon with a view to obtaining

information. In the Euro Area, monetary decision-making is collective, and not
formally based on the discretion of a local hegemon. Euro-insiders get infor-
mation easily, whereas, depending on the issue-area, euro-outsiders have in-
creasing difficulty in obtaining basic information. Therefore, a new network
strategy has been implemented by the Danish central bank—not to get more
and better information than in the 1980s but to avoid being totally excluded
from information flows.
The creation of the Euro Area and the consolidation of a position as semi-
permanent euro-outsiders through various referendums underpinned reforms
that were already on their way in these two central banks. In Sweden, so-called
modernization reforms mirror global management fads implying operational
autonomy, modern management methods, technocratization, transparency,
and accountability. In Denmark, the reforms have manifested themselves not
in new regulation or procedures but in a new culture and redefined relations
with the public. It is a paradox, however, that the central bank that has altered
its network strategy to the greatest extent is the one that has undertaken the
least amount of institutional reforms to support its new network strategy.
Thus, even though the Danish and Swedish central banks as euro-outsiders
have found ways to compensate for their exclusion from the Euro Area, the
ways in which compensation takes place vary considerably. It seems that path-
dependency offers some explanation for the different strategies over the dec-
ades running from the Second World War, but so does more recent economic
history. Thus, in the early 1990s, Sweden was exposed to one of its most severe
economic shocks. This shock opened a window of opportunity, allowing for
considerable reforms that turned Sweden into a first-mover in management
reform in general and central banking in particular. Neither before nor since
has it been possible to undertake such wide-ranging reforms without encoun-
tering resistance from at least some members of the Swedish Parliament. This
stands in sharp contrast to the Danish administrative apparatus, including the
central bank, which has not been challenged in the same way. In Denmark,
there has not been an obvious opportunity for a reform-coalition to drive
through change that went beyond a consensus about sound macro-economic
policy-making. The passive linking of the national currency to the euro in the
ERM II has not served as a reform catalyst either. As illustrated above, the ERM II
is a continuation of a very long Danish tradition of being involved in a stable
currency regime. In both countries, therefore, exclusion from the Euro Area
served from the mid-1990s to help consolidate a path that had already been laid
out and that explains why Europeanization materializes so differently in these
two central banks.
The status of euro-outsiders seems to correlate quite significantly with two
other trends. One concerns the widespread belief among the euro-outsiders in
the value of pursuing a stability-oriented macro-economic policy. Another
281
trend seems to be that Euro Area exclusion at least has not hindered, maybe
even encouraged, processes of micro- as well as macro-innovation in central
banking. Thus, in both Sweden and Denmark central bank stability-oriented
values constitute the locus around which all national debates oscillate. Inde-
pendent from the choice of currency regime, in both Sweden and Denmark it is
uncontested that wage-negotiations, public spending-programmes, and private
investments should support, not threaten, the underlying stability of the econ-
omy. Low inflation, public budgets in surplus, and a sustainable balance of
payments seem to constitute deep core values among the major political parties
and other opinion makers. The euro-outsider status has not diminished this
particular stability-oriented consensus. If anything, it seems to have helped to
further consolidate a basic belief in the value of stability and the role of central
banks in fostering stability. In this context, it comes as no surprise that the
authority and legitimacy of central banks in the respective states is consi-
derable. Central banks in Denmark and Sweden are safely located in powerful
positions right at the centre of macro-economic decision-making. On this
score, the Swedish and Danish central banks seem to differ from continental
European central banks in the sense that these former maintained and even
consolidated their traditional powerful positions in national policy processes,
whereas the latter transferred much of their authority to the ECB together with
the competence of making monetary policy. Even the Danish central bank,
which in reality does not exercise any sovereignty in the area of monetary
policy-making, is perceived as a natural authority on the Danish political scene.
Both Sweden and Denmark rank high in international bench-marks
that value competitiveness, flexibility, and innovation. Their status as euro-
outsiders had as a consequence that economic stakeholders in these two small
and open countries were exposed to risk in a different way from many euro-
insiders. Indeed, euro-insider status has often functioned as a safe heaven for
large as well as small EU member-states, and as an external anchor that can
provide stability and eliminate some key risks. Whether the status as a euro-
insider also eliminates some of the incentives to undertake structural reforms is
debatable (Duval and Elmeskov 2005). It is clear, however, that the status as a
euro-outsider in no way hindered profound structural reforms to labour and
product markets and that these reforms seem to have placed these euro-out-
siders among the most innovative economies in the world. In addition, it is
clear that central banking in Sweden and Denmark has encouraged, and to
some extent created, the right conditions for structural reforms. Continuously,
central bankers have pointed to the necessity of streamlining economic insti-
tutions, have urged politicians, businesses, and trade unions to work together
on these reforms, and have provided economic analysis and data to scientific-
ally underpin economic reforms.
If this kind of continuous reform can be referred to as a form of macro-
innovation relating to the function of the overall economic system, then it
282
may also be relevant to associate being a euro-outsider with micro-innovation,

which concerns the ways in which the direct economic stakeholders have
compensated for their exclusion from the Euro Area. Micro-innovation can
take many different forms (Marcussen 2007a). As we have seen in this chapter,
the Danish and Swedish central banks have engaged in processes of micro-
innovation—such as organizational change and network diversification—in
order to be better able to navigate in an external environment loaded with
risk. In Sweden the central bank has been a forerunner in organizational reform.
In conclusion, on all dimensions central banking in Sweden and Denmark is as
powerful as ever. Central bank power manifests itself in different ways in the
two states, but, in contrast to some national central banks in the Euro Area,
theses euro-outsiders seem to be exploiting their position to the widest pos-
sible extent.
283
Part V
Lessons from Non-European
Central Banks
13
The Political Economy of Central
Banking in Australia and New Zealand
Chris Eichbaum
This chapter examines the political and economic context of central banking
in Australia and New Zealand and seeks to illuminate the causes and conse-
quences of markedly different trajectories of institutional reshaping in the two
nations. The focus is largely on institutional reshaping over the past 25 years
and on patterns of similarity and difference over that period. Both Australia and
New Zealand are classified as Westminster political systems. However, the
former has a federal constitution and a bi-cameral legislature (with the govern-
ing party only infrequently commanding a majority in both houses). The
latter is a unitary state, with a single legislature. Until the 1980s the political
economy of both states reflected what Castles (1984, 1988) termed the ‘politics
of domestic defence’, dominated by recourse to barrier protection through
tariffs and import licensing, and quasi-corporatist, centralized systems of
wage fixing (the ‘wage earners welfare state’). The ‘unmaking of the politics of
domestic defence’ served to liberate the central banks of both states as finance
markets were liberalized and currencies floated (with attendant challenges in
terms of the stability of the financial system), border protection removed, and
wage-fixing systems decentralized (largely by agreement in Australia, and by
legislative fiat in New Zealand during the early 1990s). Central banks in both
states directed policy (or have been tasked with directing policy) to the main-
tenance of price stability, and have, by evolving practice or legislative fiat,
become operationally independent. Fiscal policy has increasingly become
subject to sanction or accommodation by independent monetary policy
authorities. In short, central banks have become extremely influential policy
actors in their own right.
287
The Political Economy of Central Banking in Australasia
In 1989 the Reserve Bank of New Zealand Act gave New Zealand’s central
bank operational independence to pursue a single economic objective—achiev-
ing and maintaining price stability. The 1989 Act repealed legislation
passed in 1964 which had enjoined the Bank to direct policy to multiple
objectives—the maintenance and promotion of economic and social welfare,
and promoting the highest level production and trade and full employment.
Under the 1964 legislation the Bank was required to give effect to the monetary
policy of the government of the day; under the 1989 Act monetary policy is
directed to meeting the terms of a Policy Targets Agreement agreed between
the relevant Minister (typically the Minister of Finance) and the Bank Gov-
ernor. These terms are also incorporated into the Governor’s contract of em-
ployment. The 1989 Act vests full authority for the determination of monetary
policy in the Governor—not in the Board of the Bank or a monetary policy
committee. Under the 1964 legislation the Secretary of the New Zealand
Treasury was a member of the Board of the Bank; that is no longer the case
under the 1989 Act. The role of the Board is to monitor the Bank and the
Governor on behalf of the Minister. In the event of a vacancy in the position of
Governor the Board is tasked with recommending an appointment to the
Minister. Since 1989 a number of central banks have been granted operational
independence, but with a measure of goal dependence—typically the goal has
been that of price stability.
While, from the vantage point of both New Zealand and Australian policy-
makers it is now acceptable to posit a degree of convergence as regards the
practice of central banking, it has not always been so. Indeed, in the 1990s for
New Zealand policymakers (and for those enamoured of the New Zealand
model) it was almost de rigueur to point out the institutional inadequacies of
the Australian arrangements. And in a formal sense at least, those arrangements
(or institutional ‘pillars’) have not changed: the Reserve Bank of Australia is still
enjoined to direct policy towards multiple objectives, it still maintains a
relationship of ‘consultative independence’ with the government of the day,
the Secretary to the Treasury still has a seat as of right on the Board of the
Reserve Bank, and it is the Bank Board (which combines ‘professional’ or
full-time members with individuals drawn from a range of industry sectors)
that is formally tasked with the development of monetary policy. Policy is
informed, to a degree, by an inflation target—a target developed largely by
the Bank itself, a target of an annual rate of inflation of between 2 and 3 per
cent over the cycle. This target was imported into a statement on the conduct of
policy agreed between former RBA Governor Ian Macfarlane and Treasurer
Peter Costello shortly before Macfarlane assumed office in 1996. So far as the
formal statutory arrangements are concerned, the Australian statute remained
largely intact since the tempestuous times of 1945, as have—notwithstanding
remarkable changes in context—the formal institutional arrangements within
which policy has been determined and implemented. But while the trajectory
288
of institutional reform in Australia has been evolutionary and incremental, and,

in the post-War period transacted largely in the extra-legislative sphere, the
same could not be said of New Zealand.
This chapter examines the scope, content, processes, and outcomes asso-
ciated with central bank reforms in Australia and New Zealand. Both have seen
significant reforms to the institutional arrangements governing relationships
between political (and administrative) executives and central banks. In both
cases there has been a move to greater operational independence. In the
Australian context operational independence has not been accompanied by
goal independence to the same degree. In both cases the focus on price
stability has been codified in an agreement between central bank and
government (with a more explicitly contractual basis in the New Zealand
context). In New Zealand, reflecting in no small part the Zeitgeist, changes
were explicitly informed by an ex ante theoretical case, and were made mani-
fest in a ‘first-principles’ and comprehensive approach to legislative change. In
Australia the statutory anchor for the institutional arrangements—the Reserve
Bank of Australia Act 1959 with its dualist charter—remained substantially
intact.
The Dimensions of Difference
There are obvious limits in focusing on differences in the formal (as distinct
from conventional or behavioural) markers of central bank independence. In
the final analysis it is behaviour that counts. But one key issue raised by a focus
on the two Australasian central banks is how to account for and explain
institutional difference—why it is that certain institutions have been shaped
or reshaped in certain ways—and the logic of institutional reshaping. The
extent and specific manifestations of this difference vary over time. The pol-
itical-economy code that shapes or reshapes the institutions of central banking
is suggested by elements of the statutes governing the two Australasian
‘banks of reserve’.
While until 1989 both institutions were formally given status and function
by statutes that did not, in substantive terms, differ significantly in institutional
form, this changed with the passage of the Reserve Bank of New Zealand
Act in 1989. The differences between this Act, and the corresponding Australian
statute, the Reserve Bank Act 1959 are captured in elements of the formal
institutional arrangements which govern the development and implemen-
tation of monetary policy. The charters of the two central banks prescribe the
objective(s) to which policy shall be directed and the governance and
accountability arrangements in pursuit of the objective(s), and, at the level
of policy goals, defines the relationship between the bank and the government
of the day.
289
The functions of the RBA are detailed in section 10 of the Reserve Bank Act,
the wording of which clearly indicates the status of the Board of the Bank in
terms of its statutory authority in both policymaking and governance:
(1) Subject to this Part, the Board has power to determine the policy of the
Bank in relation to any matter and to take such action as is necessary to
ensure that effect is given by the Bank to the policy so determined.
(2) It is the duty of the Board, within the limits of its powers, to ensure that
the monetary and banking policy of the Bank is directed to the greatest
advantage of the people of Australia and that the powers of the Bank
under this Act, the Banking Act 1959 and the regulations under that Act
are exercised in such a manner as, in the opinion of the Board, will best
contribute to:
(a) the stability of the currency of Australia;
(b) the maintenance of full employment in Australia; and
(c) the economic prosperity and welfare of the people of Australia.
(Section 10, Reserve Bank Act 1959)
By contrast, the charter prescribed in the Reserve Bank of New Zealand Act
1989 directs the Bank to a single economic objective:
The primary function of the Bank is to formulate and implement monetary policy
directed to the economic objective of achieving and maintaining stability in the general
level of prices. (Section 8, Reserve Bank of New Zealand Act 1989)1
The Australian statute provides that the Board of the Bank has the power to
determine the policy of the Bank. It is sufficient to note at this point that it is
the Board, and not the Governor alone, in which the power of policymaking
resides, and that, typically, in making appointment to the Reserve Bank Board
successive Australian governments have sought to bring a range of interests to
the task of policymaking, including, at various times and in varying combin-
ations, manufacturing, rural, mining, and employee interests, and academic
economists.
In contrast, the New Zealand policymaking arrangements are premised on a
set of contractual arrangements between the government of the day, through
the Minister of Finance or Treasurer, and the Governor of the Bank, and subject
to the Bank’s primary objective. While the primary objective of monetary
policy is prescribed in the statute, the specific target to which monetary policy
is directed is codified in a policy targets agreement between the Minister and the
Governor. The Governor is tasked with ensuring, ‘that the actions of the Bank
in implementing monetary policy are consistent with the policy targets fixed
under section 9 of [the] Act’ (Section 11, Reserve Bank of New Zealand Act
1989). The Governor is appointed by the Minister on the recommendation of
the Bank’s Board of Directors, (Section 40, Reserve Bank of New Zealand Act
1989), and is duty bound, ‘to ensure that the Bank carries out the functions
290
imposed on it by [the] Act’ (Section 41, Reserve Bank of New Zealand Act 1989).
While the Bank has a Board of Directors, the role of the Board is largely directed
to ensuring that the Governor of the Bank fulfils the terms of the contracted
Policy Targets Agreement.
The statute prescribes the grounds on which a Governor may be removed
from office, either on the initiative of the Minister or on the recommendation
of the Board, grounds which include a failure to achieve contracted policy
targets, and actions inconsistent with the Bank’s primary function (Sections
49 and 53, Reserve Bank of New Zealand Act 1989).
The accountability requirements for both central banks are detailed in stat-
ute, and, in the case of the RBA evolved in ways consistent with the statute, and
have in recent years been codified in an agreement between the Governor and
the Treasurer. Both Banks publish reports or statements on the conduct of
monetary policy, and both appear before committees of the respective parlia-
ments. And both statutes specify the rights of bank and government in policy
determination and in the event of the government of the day requiring the
bank to significantly modify the course of a preferred policy path.
In the case of the New Zealand statute the Reserve Bank Governor and the
government of the day codify agreed policy targets in a Policy Targets Agreement
(which must be consistent with the Bank’s principal target). However,
the government possesses a residual power to direct the Bank to formulate and
implement policy for any economic objective, other than the economic
objective specified in section 8 of the Act (the principal, objective), for a period
(Section 12, Reserve Bank of New Zealand Act 1989). This provision has, to date,
not been activated by any government.2 In the New Zealand context,
however, the possibility of the government seeking recourse to this facility was
raised by the Minister of Finance in 2007. The Australian statute also provides for
an override or disputes procedure. Section 11 of the Reserve Bank Act requires
the Board of the Bank to inform the government of Bank policy from time to
time, and prescribes a process to be followed in the event of a difference of
opinion between the Government and the Bank Board. This process allows the
government of the day, through the Treasurer, to determine the policy to be
adopted by the Bank, but requires that the Parliament (and through the Parlia-
ment, the public at large) be provided with all relevant information relating to
the difference of opinion and the rationale for any government override.
Both central banks have responsibility for financial system stability, and
increasingly are cooperating on a trans-Tasman basis on issues of prudential
regulation and financial stability (the more so given the recent period of inter-
national financial instability). The RBNZ is tasked in statute with using its
powers to promote the soundness and efficiency of the financial system, and
to avoid the significant damage to the financial system that could be caused
by the failure of a registered bank. The approach taken by the bank involves
three pillars—self-regulation, market discipline, and regulatory and supervisory
291
arrangements (Bollard 2005), and these are directed at prevention of financial

crises (e.g. through the prudential supervision of banks and a registration
system for banks directed to ensuring appropriate governance arrangements
and capability, and adequate capitalisation). They are also aimed at correction
and crisis management (ranging from speeches by the Bank’s Governor drawing
attention to any risks, through to the Bank acting as a lender of last resort,
exercising powers by which it may give directions to a registered bank, or direct
foreign-exchange intervention) (Orr 2006). In November 2004 the RBNZ com-
menced publishing a six-monthly Financial Stability Report.
Financial system stability is also a responsibility of the RBA. Significant
changes were introduced to Australia’s financial regulatory arrangements in
1998. These included the establishment of a new regulator, the Australian Pru-
dential Regulation Authority (APRA) and the creation of a Payments System
Board within the RBA. APRA is the prudential regulator of the Australian financial
services industry. It oversees banks, credit unions, building societies, general
insurance and reinsurance companies, life insurance, friendly societies, and
most members of the superannuation industry. For its part the RBA publishes a
half-yearly Financial Stability Review which incorporates the Bank’s assessment
of the soundness of the financial system and potential risks. The Bank also has
responsibility for the Payments System Board, which has authority for payments
system safety and stability and recourse to regulatory powers and instruments.
In the domestic context the RBA is a member of the Council of Financial
Regulators, which is chaired by the Bank’s Governor, and which brings
together the RBA, APRA, the Treasury, and the Australian Securities and
Investments Commission (ASIC). The Council is tasked with contributing to
the efficiency and effectiveness of regulation and the stability of the financial
system. The RBA is also one of the 26 national authority members of the
Financial Stability Forum, established in April 1999 to promote international
financial stability.3
Contrasting Narratives of Antipodean Central Banking
The contrasting trajectories of institutional reform in Australia and New Zealand

provide a useful complement to the meso-historical perspective on central
banks and central banking (see Marcussen, this volume). From the preceding
discussion it is clear that, in terms of the formal statutory provisions, Australian
and New Zealand central banks (but perhaps not central banking practice) can be
viewed as representative of different stages of central banking (ibid.). This con-
clusion is suggested by the dates at which central banking statutes came into
being: the Reserve Bank of New Zealand Act in 1989, and the Reserve Bank of
Australia Act in 1959 (incorporating the charter provided for in the Common-
wealth Bank Act of 1945).
292
With its focus on price stability, and the formal context for relations between
bank and government influenced by agency theory, the Reserve Bank of New
Zealand Act 1989 is very much a reflection of the intellectual climate of the
times. But as we have already noted, Australian central banking continues to
operate according to an institutional scheme reflecting the third stage in the
development of central banking. In some respects the current statutory arrange-
ments—and the Bank’s dualist charter and the structure of its board are most
often cited here—evoke aspects of an earlier Keynesian settlement. Equally,
however, those arrangements are quite consistent with what Blinder (1998)
characterized as ‘modern central banking’.
The somewhat ‘dated’ Australian arrangements could perhaps be excused if
they simply reflected an institutional ‘overhang’ from an earlier time, and if
central bank policy and practice (as articulated by Australia’s central bankers)
was not couched in terms of the formal statutory arrangements. However,
successive governors of the Bank appeared to be quite comfortable operating
with a charter that directs the Bank to multiple objectives, and defended the
Bank’s governance arrangements against the accusation that they compromise
the independence of the institution.4 The chapter considers below the extent to
which antipodean central banking might be exhibiting the characteristics of a
fifth age of central banking.
In order to fully illuminate and account for the patterns of similarity and
difference between central banks and central banking in Australia and New
Zealand—and to complement the standard historical taxonomy of ages
of central banking—two particular drivers need to be factored into the discus-
sion. They are institutional credibility and institutional legitimacy. The argu-
ment (which is more fully developed in Eichbaum 1999) is that a stable
institutional settlement (in essence, a political settlement) requires high en-
dowments of both credibility and legitimacy. Institutional (and policy) cred-
ibility is required to counter the problem of dynamic inconsistency (Kydland
and Prescott 1977). Politically porous institutional arrangements, it is argued,
lack credibility. Opportunistic and discretionary monetary policymaking, con-
ducted with a short-term bias, will cause price setters to factor a risk premium
into forward contracts. Institutional legitimacy has two dimensions. The
central bank and the conduct of monetary policy more generally will be per-
ceived as legitimate where monetary policy balances the need for stable prices
with the needs of non-financial actors with real economy interests (addressing
both stabilization and growth imperatives); and, second, to the extent that they
satisfy tests of democratic governance and accountability (mitigating the per-
ception or actuality of a democratic deficit). Conceived in this way, the ‘equi-
librium’ condition for a stable institutional settlement is one in which
endowments of both credibility and legitimacy are optimized.
The Reserve Bank of New Zealand Act 1989 represented a regime shift of
paradigmatic proportions. But it was a shift that was, at its core, designed to
293
address a significant credibility deficit. The RBNZ, which had de facto since late
1984 enjoyed the kind of ‘independence’ codified in the 1989 Act, was a
significant actor in its own institutional reshaping. It drove the process of policy
formation, and, significantly, mobilized sufficient support within the govern-
ment to ensure that its own preferences as regards the detail of institutional
form prevailed over those advocated by the New Zealand Treasury.
The fact that an incumbent government might wish to limit its own capacity
for discretionary policymaking is, given the behavioural assumptions that
inform the rational choice case for central bank independence, conceptually
somewhat problematic. Some accounts (e.g. Goodman 1992) seek to remedy
this by postulating that an incumbent government will act where it faces the
prospect of imminent defeat and wishes to limit the capacity for discretionary
action on the part of its successor. There is much in the New Zealand case to
support this line of argument. By 1988–9 the fourth Labour Government was
facing the probability of defeat in the 1990 election, and the public justification
for the Act, captured in the political discourse of the time, was one predicated
on the policy failings of earlier governments and the prospect for those
failings informing the conduct of policy under future governments. Faced
with the opportunity to codify its de facto independence in a more durable
form, the government created the conditions for a significant reconfiguration
of the domestic political economy, and for a more independent political role for
the central bank. In so doing, it nurtured a critical mass of support for the kinds
of legislative changes that it initiated in 1988.
Moreover, by zero-basing the process of institutional design, the architects of
the Act—within the government and within the Bank—were able to draw on
the prevailing institutional prescription, one that privileged operationally in-
dependent central banks, tasked exclusively with the achievement and main-
tenance of price stability. For the architects the principal objective was the
restoration of credibility to the conduct of monetary policy. There was not
total disregard of institutional legitimacy. Those most closely involved in the
design of the Act were concerned to arrive at an institutional settlement that
respected the rights of the legislature in a Westminster-style democracy. But, to
the extent that legitimacy was a consideration, it was captured and disposed of
in the contractual nature of the accountability regime, and not viewed as a
consideration in designing either objectives or wider governance arrangements.
The fact that the government retained the right in statute to provide the
governor with policy targets, and, in limited circumstances, to override the
principal objective, was viewed as sufficient.
The dominant economic interests demanded credibility in the conduct and
substance of policy, and the Bank, concerned to administer a further circuit
breaker to inflationary expectations, was also driven by this imperative. In the
context of an environment in which the institutions of the New Zealand state
were being progressively reshaped according to the tenets of agency theory,
294
the vehicle of a contract between the government, as principal, and the central
bank governor, as agent, was readily at hand. The de facto changes in the post-
1984 period shifted the Bank’s position, and the subsequent codification of
these changes in the 1989 Act was informed by the quest for credibility. The
Bank’s stock of credibility had appreciated.
If the New Zealand changes represented a paradigm shift, institutional
reshaping in Australia has been of a more incremental kind, based on the
legislative changes of the early post-War period. Whereas New Zealand entered
the 1980s with institutional arrangements carrying a significant credibility
deficit, the institution of Australian central banking had been subject to a
searching evaluation through the 1981 Campbell Committee Inquiry into
the financial system. Its report recommended the liberalization of the finance
sector (and presaged the floating of the Australian dollar), and, with reference to
the RBA, endorsed the institutional status quo (Bell 2006: 21–5). However, the
1980s, and the early 1990s in particular, were to see a political contest over the
Australian central bank predicated on the allegation of an acute credibility
deficit as the basis for radical institutional change—along the lines of the New
Zealand model. The case for reform rested on the low score of the RBA on the
standard formal indices of central bank independence. The intellectual climate
of the times (no better demonstrated than in the ‘New Zealand model’) privil-
eged an institutional model in which central banks focused exclusively on price
stability, and in which operational independence from government—and
indeed the implementation of monetary policy clearly at variance with the
political interests of incumbent governments—was held to be virtuous. In a
climate in which the quest for low inflation was the only game in town, a
central bank tasked to deliver multiple objectives ‘invited’ a credibility deficit.
The RBA was governed by a Board, in which membership of financial actors was
specifically precluded (and which included a ‘representative of the Treasury’),
and was enjoined to develop and implement policy in consultation with the
government. This credibility deficit was pronounced amongst those actors who
held the assumption of a direct correspondence between statute and behaviour
(which standard textbook accounts implied).
The perception that the Australian institutional arrangements were politic-
ally porous was further encouraged by the imprudent remarks of politicians,
who claimed to be able to influence the conduct of monetary policy. These
politicians were, in the words of the Reserve Bank Governor of the time,
‘chastised’ for these observations, and may well have regretted them. However,
while within the domestic environment financial actors may have been
inclined to dismiss such observations as evidence of political hubris, in overseas
markets such comments merely served to reinforce the appearance of a
systemic weakness in institutional design. There was little, if any, evidence
of direct political involvement in the conduct of monetary policy decision-
making; if anything, the evidence was that ‘political considerations’ influenced
295
the Board of the Bank to time policy changes specifically to avoid the appear-
ance of political influence. However, the prevailing view—particularly in off-
shore markets—was one of a politically porous set of institutional arrange-
ments, and of an increasingly acute credibility deficit.
Two competing political prescriptions were on offer in Australia in the early
1990s. One prescription sought to replicate the New Zealand model; the other,
to effect an increase in institutional and policy credibility without any conse-
quential diminution in the legitimacy of the institution (and without the
requirement to revisit the statutory framework). The second prevailed. Having
moved to a position where both endowments of legitimacy and credibility have
been optimized, the reshaping of the Australian central bank resulted in a
position of relative equilibrium, reflected in a bi-partisan policy settlement.
Two aspects of the on-going institutional reshaping of Australia’s central
banking arrangements have been particularly significant. The first was the
development by Bank and government of an inflation target: of an annual
rate of inflation of between and 2 and 3 per cent over the course of the business
cycle. The development of an inflation target was seen as mitigating the dele-
terious consequences of the credibility deficit, while at the same time being
consistent with the maintenance of the dualist approach suggested by the
Reserve Bank charter. The second was the agreed statement on the conduct of
monetary policy embodied in an exchange of letters between the Bank Gov-
ernor and the Treasurer in August 1996, subsequently reaffirmed in July 2003
and September 2006.
The agreed statement was reviewed following the change of government in
Australia in November 2007. One of the first items of business for the incoming
government was to recommit to an agreed Statement on the Conduct of
Monetary Policy. On 6 December 2007, the new Prime Minister Rudd and
Treasurer Swan released a revised Statement, outlining the ‘mutual understand-
ing on the conduct of monetary policy between the new Government, repre-
sented by the Treasurer, and the Governor as Chairman of the RBA Board’. The
Statement contains a number of new elements. The positions of Governor and
Deputy Governor of the Bank are to be raised to the same level of statutory
independence as the Commissioner of Taxation and the Australian Statistician.
This means that appointments will be made by the government, but that any
termination will require parliamentary approval (now a higher threshold than
applies in the New Zealand legislation, where the formal power to terminate
the Governor’s employment—albeit subject to a number of tests—resides with
the government). In respect of future Board appointments, the Secretary to the
Treasury, and the Governor of the Reserve Bank will maintain a register of
‘eminent candidates’ from which the Treasurer will make appointments to
the Board. These developments were heralded as bringing in a ‘new era of
independence for the RBA’. The Prime Minister and the Treasurer viewed the
revised Statement on the Conduct of Monetary Policy as ‘an important step
296
towards ensuring the appointment processes, debates and decision making of

the RBA are as independent and transparent as possible’.
On 5 December 2007, the RBA announced some modifications to its
arrangements for communicating policy decisions. The Board of the Bank
now releases a short statement each month explaining its monetary policy
decision; the Board’s decision is announced on the same day that the monthly
meeting of the Board is held; and the Board now releases the minutes of
its monetary policy meeting each month. The minutes record the factual
material available to the Board, the Board’s policy assessment and decisions;
comments are not attributed to individual board members (Reserve Bank of
Australia 2007).
Equally, New Zealand’s arrangements have also been the subject of incremen-
tal changes over time. As in Australia, these changes have, in the main, been
prosecuted within the context of existing legislative arrangements. However, if
the narrative of institutional reform in Australia is suggestive of a need to
appreciate the stock of institutional and policy credibility, the contrasting
New Zealand narrative is one more suggestive of the need to achieve a better
alignment between the Bank’s price stability objective and other aspects of
macroeconomic management. Since the 1989 legislation governments of vari-
ous political complexions have at times struggled with (and been tempted to
revisit) the Bank’s resolute (some would say ‘single-minded’ pursuit of price
stability). The Policy Targets Agreement between Bank and the government
carried the burden of codifying the precise nature of the Bank’s policy respon-
sibilities, in the context of the government’s wider policy objectives.
The first Policy Targets Agreement directed the Bank to formulate and imple-
ment monetary policy with the intention of achieving price stability in the year
ending in December 1992. An annual inflation rate in the range of 0 to 2 per
cent was to be taken to represent the achievement of price stability. Although
the target date was later extended to 1993, the Bank met its objective ahead of
time. The current Policy Targets Agreement is somewhat less ‘hard-edged’ and
more flexible, requiring the Bank to keep future CPI inflation outcomes
between 1 and 3 per cent on average over the medium term. Moreover, paragraph
1 (b) of the current PTA reads as follows:
The Government’s economic objective is to promote a growing, open, and competitive

economy as the best means of delivering permanently higher incomes and living standards
for New Zealanders. Price stability plays an important part in supporting this objective.
While the overall scheme of the Reserve Bank Act remains, in terms of the
sentiment (certainly politically, and possibly within the Bank) that is expressed
in the Policy Targets Agreement, there is a tacit acceptance of the need for a
measure of policy dualism and—notwithstanding statutory references to
economic policy objectives in isolation—of the interdependence of economic
and social policy.
297
The New Zealand arrangements have also been the subject of a technical
review, conducted in 2000 by Professor Lars Svensson. On balance the Svensson
report was supportive of the monetary policy regime and the Bank’s conduct of
monetary policy.5 Svensson (2001) did, however, recommend a number of
changes, including to the inflation target and to the Bank’s governance arrange-
ments. They included that
. The Bank’s inflation target be restated as a point target of 1.5 per cent
. A formal monetary policy committee, comprising the Governor and four
other Reserve Bank staff, be formed (with the change to be made at the
beginning of the next term of the Governor)
. Changes to the accountability arrangements and Bank governance, specif-
ically that the Board of the Bank consist only of non-executive directors,
with the Chair of the Board selected by these non-executive directors
(under the 1989 Act the Governor and Deputy Governors were members
of the Board and the Governor the Chair of the Board)6
Svensson’s recommendations regarding changes to accountability arrange-
ments and specifically to the composition of the Board of the Bank were largely
accepted. However, the government chose not to act on his recommendation to
establish a monetary policy committee or to amend the Policy Targets Agree-
ment to provide for an explicit mid-range point target.
While the New Zealand arrangements are unlikely to be revisited in the short
term, recent developments suggest that there is every prospect of a further
refining of those arrangements. Both Australian and New Zealand central
banks, in common with those in a number of other jurisdictions, have been
faced with the challenge of asset-price (house price in particular) inflation (Bell
2006: 181–97 on the Australian case). New Zealand policymakers have, since
late 2005, been exploring whether supplementary policy instruments might be
deployed to complement monetary policy in the task of managing inflation
pressures (RBNZ/The Treasury 2006). And in both jurisdictions there are clearly
on-going challenges associated with the alignment of monetary and fiscal
policy.7
For over two decades the RBA has intervened, as appropriate and necessary, in
the foreign-exchange markets. The policy rationale for recourse to foreign-
exchange intervention dates from the Campbell Committee inquiry into the
financial system, which indicated that, in the absence of a clean float, some
intervention may be required from time to time. On 11 June 2007 the RBNZ
confirmed that, for the first time, it had intervened in the foreign-exchange
market.
In July 2007, with the US/NZ dollar cross rate reaching ‘exceptional’ levels,
the level of political discomfort with the conduct of monetary policy surfaced
again. The Leader of one of the parties supporting the coalition government
298
raised concerns about the Reserve Bank Governor’s implementation of the

Policy Targets Agreement. Reflecting perhaps the pressure emanating from
this source, on 18 July 2007 the Minister of Finance was asked in the Parliament
whether he had given any consideration to using the powers of the Reserve
Bank Act to direct the Bank to formulate and implement monetary policy for
different economic objectives. He replied as follows:
Under section 12 of the Reserve Bank of New Zealand Act there is the power to suspend
the policy targets agreement and to incorporate objectives other than the primary object-
ive outlined within the Act. I have given no specific consideration to that matter, but the
section is clearly there for a purpose and as Minister of Finance I would never rule out its
potential use.
In a speech in August 2007 Finance Minister Cullen signalled his concern with
aspects of New Zealand’s monetary policy framework, noting that
The accepted consensus has been that our monetary policy framework doesn’t have an
impact on long run growth. In other words, monetary policy helps keep the economy
stable by moderating economic cycles, without impacting on the sustainable rate of
growth of the economy.
My overriding concern is that this view no longer holds. . . .
So I think we need to look seriously at the monetary policy framework and whether it can
be made more effective at curing the inflation disease without killing the patient in the
process. (Cullen 2007)
Conclusion: Implications of Antipodean Convergence

and Difference
The Australasian experience provides an interesting case study in the

logics, consequences, and durability of institutional reshaping. In 1989,
New Zealand implemented an institutional reform that was based largely on
the rational expectations model, and that was codified in statute on the
basis of bi-partisan political support. By contrast, institutional reshaping in
Australia was—over the period of the late 1980s and early to mid-1990s, but
less so more recently—much more the subject of partisan contestation. In
both states there is now a large measure of multi-party support for the present
institutional arrangements: a condition of institutional equilibrium and a
settlement of kinds. But in New Zealand the settlement is a somewhat uneasy
one.
As the preceding discussion suggests, the broader institutional frameworks for
the conduct of monetary policy in Australia and New Zealand—by which is
meant the statutory and the less formal or more conventional elements of the
institutional mix—have seen a measure of both convergence and continuing
299
difference. The differences, such as they are, are more marked in the formal or
statutory realm and much less so in the actual conduct of monetary policy and
in relationships between central banks and governments. Australia still ‘of-
fends’ against an earlier orthodoxy by retaining a statute that codifies policy
dualism, by a mode of policymaking by a mixed board of professionals and
‘lay’ representatives, and by continuing to have the Secretary of the Treasury
on that Board. The defining features of New Zealand’s formal arrangements
have already been well rehearsed. They are a single focus on price stability,
policymaking vested in the Governor and in a contractual relationship be-
tween Governor and government that provides operational autonomy for the
former on the basis of goal dependence stipulated by the latter, and a Board
that is tasked principally with oversight of the performance of Governor—as
agent—on behalf of the Minister—as political principal. Both formal regimes
provide for a policy override, but—to date at least—there has been no recourse
to this facility.
Looking closer at the second tier of the formal arrangements—the exchange
of letters in the Australian case, and the Policy Targets Agreement in New
Zealand—one detects a high degree of similarity. Australia’s exchange of letters
in 1996 incorporated an inflation target, developed by the Bank itself as a
means of providing a more explicit (and credible) anchor for monetary policy.
This target remained unchanged for 11 years. It is a soft-edged and medium-
term target that enjoins the Bank, and the government, to direct policy to the
objective of keeping underlying inflation between 2 and 3 per cent, on average,
over the cycle. It bears a striking similarity to the target first incorporated into
the New Zealand Policy Targets Agreement in September 2002, some 8 years
after the Macfarlane/Costello exchange of letters, and 13 years after the passage
of the Reserve Bank of New Zealand Act 1989. The 2002 PTA is, as we noted,
significant also because it locates monetary policy within a wider set of policy
objectives. Although perhaps not policy dualism in the same way that it is
expressed in the charter of the RBA, it is as close as one might come to an
explicit commitment to policy dualism without revisiting the overall scheme
of the Act.
Both Banks produce regular reports on monetary policy: Monetary Policy
Statements in the case of the RBNZ, and Statements on Monetary Policy released
four times a year by the RBA. Both Banks appear regularly before committees of
their respective national legislatures: the RBNZ before the Finance and Expen-
diture Committee of the New Zealand Parliament, and the RBA before the House
of Representatives Standing Committee on Economics, Finance and Public
Administration.
While the election of a centre-right government in 2008 has seen a slight
shift away from the policy dualism that formerly linked economic and social
policy, there is still less distance now between the approaches of New Zealand
and Australia approaches.
300
As Bell (2006: 198) observed:

The RBA has changed in many important ways, but the Bank’s statutory provisions have
not. This suggests that informal institutions and arrangements matter a great deal. The
Bank operates in an invisible force field of institutional incentives and disincentives. It
needs credibility in the markets and elsewhere to operate effectively, and the search for
credibility has preoccupied it. But as its clout and independence have risen has its need to
achieve wider community and democratic legitimacy. This credibility—legitimacy frame,
and the search for balance between the two, is a good way to describe the key institutional
dynamics that enmesh and shape the RBA.
Central banking is, in substance and in form, a particular and different variant of
democratic decision-making (see Marcussen in this volume). In the case of both
the antipodean central banks there has been a progressive move towards depol-
iticization. Indeed the quest for institutional and policy credibility is in large
part about inoculating central banks and the conduct of monetary policy from
the democratic distemper that is evidenced in short-term and electorally oppor-
tunistic decision-making. It is not, however, clear that the Australasian central
banks have embraced, or been embraced by the imperatives of apoliticization
(Marcussen, this volume). Policymaking within the RBA is characterized by a
Board bringing both ‘expert’ and ‘lay’ perspectives to the process. It is clearly
decision-making by committee, but is hardly a new trend (and, as we noted,
offends against the orthodox prescription by providing representation for the
Treasury on the Bank Board). New Zealand in fact moved from decision-making
by committee to one-person decision-making by the Governor alone in 1989.
While this could be seen as at variance with the putative ‘fifth age’ of central
banking, the change reflected the tenets of agency theory and the hard-edged
contractualism of the New Zealand variant of the New Public Management
(Boston et al. 1996). It was also consistent with the orthodox institutional
prescription (Rogoff 1985).
Both central banks embraced the need for a much greater measure of
transparency in the conduct of monetary policy, and a recent decision by
the Board of the RBA will now see minutes of Board meetings released. The
RBNZ publishes three-year forward projections of monetary conditions, but
this is not a practice favoured by the RBA. Accountability arrangements for
both Banks include regular briefings to, and questioning by, committees of
their respective parliaments. Both central banks have adopted inflation tar-
geting of the flexible kind. New Zealand arrived relatively recently, and
through an iterative process of the review and renegotiation of Policy Target
Agreements, at a target almost identical to that developed by the RBA in the
early 1990s. As one of the architects of the Australian inflation target argued,
this target, along with the other pillars of the Australian settlement, has been
less an aspect of science, and more a feature of the ‘art of monetary policy’
(Fraser 1994).
301
What then of the scope, content, processes, and outcomes associated with
central bank reforms in New Zealand and Australia and the lessons that might
be taken from the experience of the antipodean central banks? Clearly con-
text—and, more to the point, differences in constitutional, political, and
economic contexts between Australasian and European central banks—is
vitally important. The two Australasian central banks are national institutions,
notwithstanding the interdependencies associated with the international
qualities of financial markets and, increasingly the governance of those mar-
kets. The ECB is, in charter and function, a supranational institution and one
that operates under a very different governance structure. However, ideas
travel, and benchmarking and policy transfer are integral to central banking,
whether in Europe or in Australasia. Unsurprisingly therefore, the Australasian
experience speaks to the challenges of European central banking.
The first, somewhat self-evident point to note is that central banks are
creatures of politics: if only because, whatever their quasi-constitutional status
in the administrative topography, they are established, tasked, and held
accountable by way of statutes (or treaties).
The second is that endowments of credibility are clearly important in enab-
ling central banks to achieve and maintain price stability. However, though
necessary, credibility may be by no means sufficient as a basis for establishing
an enduring institutional settlement. Institutional arrangements and the con-
duct of policy also needs to meet the test of legitimacy. This test is in part about
the specific nature of inflation targets and the conduct of monetary policy, and
in particular about ensuring that price stability does not come at the cost of
undue variability in output. It is, in other words, about being conscious of trade-
offs. In this sense, one can argue that monetary policy will meet the tests of
credibility and legitimacy if the cure ensures the continuing rude good health of
the patient. But legitimacy is also about other aspects of the institutional mix,
including the governance arrangements for central banks and the wider context
within which central banks, governments, economic actors, and civil society
more generally engage.
In part the legitimacy issues relate to the formal tasking or charters of central
banks, The primary objective of the European Central Bank is to maintain
price stability, operationalized as inflation rates of ‘below but close to 2
percent’ over the medium term. But the ECB charter also directs the Bank,
‘without prejudice to the objective of price stability’ to, ‘support the general
economic policies in the Community with a view to contributing to the
achievement of the objectives of the Community’, and these include a high
level of employment and sustainable and non-inflationary growth.
So what is the nature of the ECB’s charter or mandate—a sole focus on price
stability or a measure of policy dualism? Responding to a question at the ECB’s
monthly press conference in February 2008, its president Jean-Claude Trichet
reflected on the uncertainties facing central bankers (including financial
302
market turbulence and wage pressures) and remarked that, in the face of such
uncertainty,
[W]hat is certain is that we have an anchor. We have only one needle in our compass, as I
have always said, which is that we have to deliver price stability in the medium term.
(Trichet 2008, emphasis added)8
One of the central arguments of this chapter—and to a large extent substantiated

by the Australian and New Zealand experiences—is that a ‘one-needle’ approach
to the conduct of monetary policy may not always be appropriate. This is not to
deny the fundamental contribution that low and stable inflation makes to eco-
nomic—and social—policy outcomes, or the significant credibility gains that
come from anchoring monetary policy in a flexible medium-term target. But,
though necessary, credibility is not sufficient. What then of legitimacy?
In a normative sense, the ECB acknowledges that legitimacy is a necessary
characteristic of central banking institutional arrangements. Juergen Stark
(2008a), a member of the Executive Board of the ECB, argued that ‘the far-
reaching independence granted to the ECB does not mean that it lacks demo-
cratic legitimacy’, suggesting that the principles of democratic legitimacy
needs to be located in the context of constitutional principles or conventions
relating to the separation of powers, the rule of law, and the provisions of the
EC Treaty. His analysis is strikingly evocative of that advanced in support of
the decision to place the RBNZ on an independent footing, where independ-
ence was equated with a single goal of price stability and the operational
independence to pursue that goal. Stark (ibid.) argues that democratic legit-
imacy is the product of robust accountability arrangements; but that such
arrangements are much more efficacious if there is only the one objective:
Problems of accountability could only arise if the ECB—having only one instrument at its
disposal—had the mandate to pursue several objectives. Then, it would have to explain
potential conflicts between the objectives, and, if necessary, to justify its own prioritisa-
tion of objectives in a democratic manner.
But legitimacy is perhaps best conceptualized as having two dimensions:

First, public policy decisions are legitimate if they are, directly or indirectly, the will of the
people. . . . This is often referred to as ‘input legitimacy’ or ‘legitimacy by procedure’.
Second, decisions can be considered legitimate if they meet the justified expectations
and needs of the people . . . a notion which is also referred to as ‘output legitimacy’ or
‘legitimacy by result’. (ECB 2002)
The experience of the Australian and New Zealand central banks suggests that
the imperatives of legitimacy cannot simply be satisfied by procedural or
accountability mechanisms that address the kinds of potential democratic
deficits attendant upon central bank independence. Legitimacy is as much
about what central banks do as how they do it.
303
The narrative of central banking in the antipodes is a tale of two banks

taking markedly different pathways but arriving, broadly, at a common des-
tination. It is a narrative that illuminates a number of the challenges of
institutional design and of the conduct of monetary policy. This chapter has
emphasized the distinction to be drawn between institutional and policy
credibility and legitimacy, has contrasted two different trajectories of institu-
tional reshaping—one radical and the other much more incremental—and has
noted the importance of moving beyond literal interpretations of formal struc-
tures to examine actual behaviour. Given that scholars and practitioners of
central banking share an international currency of ideas, the antipodean
experience speaks to some of the challenges—present and emergent—of central
banking in Europe.
Indeed, the narrative of central banking in the antipodes may ultimately be
a story of a single central bank and of a common Australasian currency
(Holmes 2002; Hunt 2005). If this outcome occurs, there will be important
lessons to be drawn from the scope, content, processes, and outcomes associ-
ated with central banking in the EU.
Notes
1. Moreover a number of other elements of the institutional framework are clearly

subject to this single charter objective. Section 9 of the New Zealand statute requires
the Minister to negotiate policy targets with the Governor, ‘for the carrying out by
the Bank of its primary function. . . . ’ (Section 9 (1), Reserve Bank of New Zealand Act
1989); and the override facility, which we examine in more detail below, requires that
a manifestly public and transparent process be followed in seeking to provide, for a
finite period, that policy be directed to, ‘any economic objective, other than the
economic objective specified in section 8. . . . ’ (Section 12 (1) Reserve Bank of New
Zealand Act 1989).
2. It is noteworthy in this respect that in form and function section 12 of the New
Zealand Act owed a great deal to the Australian legislation. The Australian arrange-
ments were viewed as being consistent with the hierarchical nature of political and
administrative relationships in Westminster-styled systems (thereby addressing, to
some extent at least, the challenge of a democratic deficit—in the final analysis the
views of the government of the day can prevail), providing for operational independ-
ence for the central bank, and requiring transparency in the event of the use of the
override. So far as this third element of institutional form is concerned, while the
institutional regime in which the override or disputes provisions are situated differ,
the guiding principle informing each—transparency of process—is common to both,
and there are common procedural elements.
3. In recent years initiatives have also been taken to strengthen the harmonization and
coordination of banking supervision in an Australasian context. In 2005, a Trans-
Tasman Council on Banking Supervision was established, with terms of reference
304
which cover supervisory co-operation, preparedness for responding to crises that

involve banks that are common to both countries, and whether legislative changes
may be required to ensure Australian Prudential Regulation Authority (APRA) and the
RBNZ support each other in their regulatory responsibilities, at least regulatory cost
(Orr 2006).
4. See Fraser (1996) for an interesting discussion of the institutional pillars underpinning
Australian central banking.
5. As Singleton et al. note, Svensson was, ‘known to be generally sympathetic to the New
Zealand regime and to Brash’s performance as Governor’ (2006: 201).
6. Arthur Grimes, now Chair of the Reserve Bank of New Zealand Board, commented
at the time that, [i]f the same review were applied to the current Australian arrange-
ments, one would expect approval of the monetary policy implementation regime
based on a short-term interest rate. The soft-edged nature of the inflation target would
be regarded as reasonable, although possibly a little vaguely expressed and the central
target of 2.5 per cent may be regarded as somewhat higher than necessary. Further, an
improvement in transparency could be sought through the provision of more
detailed forecasts for macroeconomic and financial variables. The most notable
recommendations are likely to pertain to governance and accountability structures.
In particular, the decision-making structure involving a board of largely non-expert
outsiders would be regarded as close to the worst available arrangement. In addition,
as with the New Zealand recommendations, a non-executive Chair for the Board
would be recommended, with the Board having a monitoring, rather than decision-
making role. (2001: 319).
7. In the New Zealand context decisions relating to the tightening of monetary policy in
March and April 2007 were justified in part by the stimulatory impact of fiscal policy.
The Reserve Bank of New Zealand’s March 2007 Monetary Policy Statement noted
that Government spending had been rising in recent years, that increases in spending
in recent years may have stimulated activity, and that fiscal policy was expected to
remain stimulatory over the next two fiscal years.
8. This comment was interpreted by one observer as marking a significant degree of
difference between European and US central banking (Dougherty 2008).
305
14
The US Federal Reserve and the Politics
of Monetary and Financial Regulatory
Policies
John T. Woolley1
As a model independent central bank in the world’s economic superpower, the

US Federal Reserve System (the Fed) has never been far in the background for
planners of European monetary union and the European Central Bank (ECB).
Since 1980, the Fed has seemed to consolidate a dominant position in US
macroeconomic affairs. A consensus emerged that inflation, widely seen as
the pre-eminent macroeconomic challenge, could be solved only through
steady, but technically supple, politically independent monetary policy (Woolley
1998). While the Fed experienced occasional political challenges to its regulatory
powers and public disclosure, these challenges did not extend to monetary
policy.
However, if the Fed’s power over its policy domain seemed secure, its power to
shape economic outcomes has diminished since 1980. Financial innovation,
which the Fed encouraged through regulatory policy, spread through growing
global capital markets to make the Fed’s macroeconomic job more complicated
and less certain. The Fed has struggled to keep its balance in responding to asset
bubbles and international financial crises. Despite the post-1980s’ increased
stability in inflation, unemployment, and growth, the year 2007 marked the
onset of financial instabilities that clearly surprised Fed officials in their depth
and disruptive potential.
This chapter examines major developments at the Fed in recent decades
bracketed by the crises of late 1979 and late 2007. It focuses primarily on the
conduct of monetary policy in that period of moderation—the strategies used
and the outcomes achieved. However, in the wake of the turmoil in financial
markets arising from innovations in mortgage finance, it also discusses the
Fed’s role in regulation of financial institutions. In late 2007, serious challenges
307
The US Federal Reserve and the Politics of Monetary Policy
emerged for the Fed, arising directly from the failure of financial markets and
regulators to identify and contain financial risks. The Fed, together with the US
Treasury and other agencies, responded aggressively and creatively to those
events, fundamentally, perhaps temporarily, reshaping the US financial indus-
try. Deep criticism seemed certain to yield major reforms of financial regula-
tion. It seems unlikely that these reforms will call into question the Fed’s
fundamental autonomy and authority, but the circumstances pose political
risks for the Fed unlike any since the 1970s.
The chapter focuses on influences on the central bank that have figured
prominently in scholarly writing: the structure of political institutions and the
place of the central bank among these institutions; the varying distribution of
interests and preferences across these institutions; the development of policy ideas
about the conduct of monetary policy; and the changing problems arising from
the developing economic system. Because these influences often interact, they
are to some degree interwoven in the analysis.
The central argument is that, in terms of the usual indicators of central bank
independence, very little has changed about the Fed. In terms of pressure from
other institutions and interests, the Fed’s environment became more benign.
The preferences that were arrayed within and outside the Fed in the 1980s
created space in which the Fed was able to establish not just its own credible
commitment to low inflation but also the political sustainability of this com-
mitment. With respect to issues of disclosure and transparency, the Fed has
been remarkably sensitive to its environment. The linked notions of transpar-
ency and inflation targeting have been welcomed at the Fed, but not officially
embraced precisely because of the legal environment that commits the Fed to
consider both output growth and inflation. The consolidation of European
monetary union and rise of the ECB have clearly affected the Fed, but in
relatively modest ways. By the end of 2007, however, the Fed was shocked by
unanticipated financial crisis.
The dominant policy problem for central banks during this period was how to
manage inflation—the risks of financial collapse seemed remote. In a useful and
comprehensive essay, Blinder (2004) wrote that worldwide in the past 20 years
there have been three developments in central bank behaviour so important as
to justify calling them ‘revolutionary’: (1) increasing policy transparency; (2)
increasing reliance on collective rather than individual decision-making; and
(3) increasing reliance on financial market indicators to guide policy. Blinder’s
second point does not, of course, apply to the Fed, where collective decision-
making has long been the rule. In other essays, Goodfriend (2003, 2005) argued
that the most important developments in US monetary policy were in the realm
of policy-makers’ understanding of the constraints imposed by the working of
the economy. The basic lesson of the early 1980s was that, in an economy of
agents with forward-looking price expectations, the only stable inflation
rate was a low rate, and that could only be achieved as a result of a credible
308
long-term commitment. The most important development, Goodfriend argues,

was the rise of inflation targeting, albeit implicit rather than explicit, as the
core of the Fed’s monetary policy strategy.
This chapter draws on data derived from the transcripts of 197 regular meet-
ings of the Fed’s key policy-making committee, the Federal Open Market Com-
mittee (FOMC), between 1978 and 2001. More details and technical
information about these analyses can be found in Woolley (2007). Briefly,
counts of keywords and phrases used in the FOMC meetings are used to create
indexes that reveal trends in its focus of attention. The analysis uses the ratio of
the number of transcript lines containing index keywords to the total number of
lines in the file. Because some of the results discussed below indicate a pro-
nounced trend over time, it is relevant to note that there is very little trend over
time in the length of FOMC meetings as expressed in lines of text.
Recent Economic Trends and Monetary Policy Stance
A landmark shift in US monetary policy occurred in 1979, under the leadership

of Paul Volcker. In dramatic fashion, the Fed announced that, in order to better
contain inflation, it was shifting focus from controlling interest rates to con-
trolling monetary aggregates. The year 1984 roughly marks the consolidation of
this vigorous anti-inflation policy. Since the mid-1980s, on a wide variety of
indicators, economic policy and economic outcomes in the United States have
become more stable and have remained positive.
Figures 14.1–14.4 recapitulate some of the most important facts about the US
economic context and the stance of monetary policy before and after 1983. The
data in these figures begin in 1964 and extend through the most recent data
available in early 2008. In the latter half of the time-period, all four graphs
reveal a dramatic reduction in volatility, accompanied by average economic
performance that is as good or better than before. The statistics showing the
improved performance are summarized in Table 14.1.
Real GDP Growth. Figure 14.1 shows that, since 1984, there has been less
volatility in real GDP growth rates, and recessions have been less frequent and
less severe, although average growth has not changed.
Inflation. Figure 14.2 plots the so-called ‘headline’ inflation and ‘core’ infla-
tion (net of inflation in food and energy) for the United States as measured by
the Consumer Price Index.2 It also displays the Euro Area inflation index
(Harmonized Index of Consumer Prices) for 1990–2008. As with GDP, since
the early 1980s there has been greater price stability. Core inflation has fluctu-
ated around 2 per cent per year in recent years. Since 2000, Euro Area inflation
has been less volatile than US ‘headline’ inflation.
Unemployment. Figure 14.3 plots the US unemployment rate. The unemploy-
ment rate also declined since the early 1980s and became more stable.
309
0.08
0.06
0.04
Growth rate
0.02
−0.02
−0.04
2/1/1961
2/1/1965
2/1/1969
2/1/1973
2/1/1977
2/1/1981
2/1/1985
2/1/1989
2/1/1993
2/1/1997
2/1/2001
2/1/2005
2/1/2009
Date
Figure 14.1. US real GDP growth over quater year prior, 1964–2007
Source: U.S. Department of Commerce, Bureau of Economic Analysis.
16
14
12
10
Inflation
8 US Headline CPI
US Core
Euroland HICP
6
0
Jan-61 Jan-65 Jan-69 Jan-73 Jan-77 Jan-81 Jan-85 Jan-89 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09
Date
Figure 14.2. US headline and core inflation; Euroland inflation 1964–2007

Sources: CPI: US Department of Labor, Bureau of Labor Statistics. All Urban Consumers NSA, Chg over
12 months; CUUR0000SA0. HICP: European Central Bank, Overall Index, Annaual Rate of Change,
ICP.M.U2.N.000000.4.ANR.
310
12
10
8
Rate
0
Jan-61 Jan-65 Jan-69 Jan-73 Jan-77 Jan-81 Jan-85 Jan-89 Jan-93 Jan-97 Jan-01 Jan-05 Jan-09
Date
Figure 14.3. US unemployment rate, 1964–2006

Source: US Department of Labour, Bureau of Labour Statistics, Civilian Unemployment Rate Seasonally
Adjusted.
25.00
20.00
15.00
Federal funds rate
10.00
Real FFR
Nominal FFR
5.00
0.00
−5.00
−10.00
Jan-61
Jan-65
Jan-69
Jan-73
Jan-77
Jan-81
Jan-85
Jan-89
Jan-93
Jan-97
Jan-01
Jan-05
Jan-09
Date
Figure 14.4. Nominal and real rederal funds rate January 1964–February 2008
Sources: Nominal Rates: US Board of Governors of the Federal Reserve System. Real Rates: Nominal rate
minus the contemporaneous CPI, calculated by author.
311
Table 14.1. Greater US economic stability after 1983
1964–83 1984–2003 Change
Mean Standard Mean Standard Mean Standard

deviation deviation deviation
Real GDP growth rate 0.024 0.023 0.024 0.013 0.000 0.010
Headline inflation (CPI) 6.130 3.450 3.120 1.130 3.010 2.320
Unemployment 6.030 1.890 5.840 1.070 0.190 0.820
Nominal federal funds rate 7.640 3.710 5.670 2.350 1.970 1.360
Data Sources: GDP, US Department of Commerce, Bureau of Economic Analysis; CPI and Unemployment, US.
Bureau of Labor, Department of Labor Statistics; Federal funds rate, US Board of Governors of the Federal Reserve
System.
Federal Funds Rate. The Federal funds rate, or overnight interbank rate, has
been the main monetary policy instrument in the United States. Figure 14.4
plots the monthly average nominal and real Federal funds rate (FFR) from 1964
to 2008. In general, the nominal rate has been more volatile than the real rate.
Following a very volatile period in real and nominal rates in the period 1974–
82, the FFR has become more stable. Since 1983, the real FFR has usually been
between 2 and 5 per cent. However, the real FFR rate was negative, a very
stimulative policy stance, in 1992–3 and again in 2003–4 (contrast especially
the period from 1974 to 1980).
Altogether, these data show an economy that seemed to be functioning
exceptionally well on the aggregate. Missing from these pictures, and from
monetary policy discussions, was a sense that the financial economy was
moving toward a period of crisis.
Federal Reserve Institutions and Policy Responsibilities
The Fed has three main components: the Board of Governors, the District
Banks, and the Federal Open Market Committee (FOMC). Collectively, the
System’s legal authority stems from the Federal Reserve Act.3 In 1978 the Act
was amended in two critical ways. First, it required semi-annual Congressional
testimony on the conduct of monetary policy, later regarded as a core element
in Fed transparency. Second, it codified explicitly the Fed’s obligation to pursue
the goals of long-run growth and price stability.4 This two-goal legislative
mandate has been one important factor in the Fed’s reluctance to embrace
explicit inflation targeting, and is an important source of many contrasts
between the Fed and the ECB.
Uniting all the components of the Fed is a large and exceptionally talented
staff including scores of PhD economists. The intellectual power of the staff
means that the Fed is at the forefront worldwide of discussion and analysis in
relevant epistemic communities. However, interestingly, the Fed has frequently
312
not been among the world’s leading central banks when it comes to institu-
tional innovation and policy leadership. The Fed has resisted almost every
panacea or fad that has swept markets or academia, including Keynesianism,
monetarism, commodity price targeting, the separation of monetary policy
from financial institutions regulation, and inflation targeting. This resistance
reflects an institutional culture of reluctance to interfere with markets and an
inbred scepticism toward fads. It also reflects important preferences in the Fed’s
political environment, especially Congressional insistence on balancing the
pursuit of growth and the fight against inflation.
The Board of Governors is a seven-member board, also called the Federal
Reserve Board (FRB), located in Washington D.C. The members are appointed
to 14-year terms (or portions of unexpired terms) by the US President, with the
consent of the Senate. The Chair is appointed by the President, with the
consent of the Senate, from among the members of the Board, to serve a four-
year renewable term.5 The Board is responsible for setting reserve requirements
for member banks. It also sets the discount rate, that is, the rate at which the Fed
lends directly to eligible financial institutions. The discount rate is changed
upon the request of the Boards of Directors of Federal Reserve district banks.
Policy innovations adopted in December 2007 to address the financial crisis (see
more below) had the interesting characteristic of clearly placing the initiative
for new policy directions in the FRB, not the FOMC.
The FRB also sets and implements regulation of a variety of financial institu-
tions under authority granted by law. While demanding and time-consuming,
Board members have considered these tasks to be far less engaging than mon-
etary policy (cf. Meyer 2004: xvi). Regulations are referred to alphabetically—
Regulation A through Regulation GG. Regulation A, for example, deals with
borrowing at the discount window (i.e. ‘extending credit to depository institu-
tions and others’).6 Regulation C governs Home Mortgage Disclosure for some
lenders. Regulation K covers the operation of foreign banks in the United States.
The Board’s economic staff provide highly influential technical assistance to
the Board and the Federal Open Market Committee. They prepare the crucially
important monetary policy forecast. The Board’s three main economic research
divisions have some 450 staff, of whom about half are PhD economists.7 Fed
staff report to the chair (Meyer 2004: 26–7). By far the heaviest weight of staff
resources resides with the Board rather than the district banks.
The 12 Federal Reserve District Banks are headed by Presidents, appointed by
local boards of directors subject to approval by the Board of Governors of the
Federal Reserve System. Five of the 12 Presidents participate each year as voting
members of the FOMC. Among them is always the president of the Federal
Reserve Bank of New York, who by convention is also always selected as Vice-
Chairman of the FOMC. Voting seats rotate among the other Presidents, but
all of them attend FOMC meetings and participate fully in deliberations. In
some circumstances, not involving formal votes on policy, but in questions of
313
procedure and public openness, the views of all Presidents are considered in
seeking a consensus. The opportunity to participate in monetary policy delib-
erations is a major motivation for becoming a district bank president.
While initially the district banks were dominant in the Fed, by 1935 a series of
reforms had shifted authority to the FRB. Over time, the district banks have
come to be engaged primarily in commercial bank supervision and in the
provision of financial infrastructure services—especially cheque clearing and
currency distribution. In the total 2007 budget of the Fed, the district banks
accounted for about 90 per cent of total expenditures. Of the total district bank
budget expenditures, only about 12 per cent is classified as being involved in
‘monetary and economic policy’ (BGFRS 2007b: tables 1.2; E.3). Of the 19,828
employees at district banks in 2006, only 928 (or 5 per cent) were involved in
monetary and economic policy. However, the district bank economic staff
provide an alternative view of the economy to that taken by the Board staff,
and this diversity of views is generally agreed to be a source of institutional
strength. Historically, some of the district banks have been particularly hospit-
able to insurgent groups of economists, such as the monetarists. White’s (2005)
estimates suggest that about 270 economists are employed by the district banks.
A disproportionate share is located at the Federal Reserve Bank of New York,
with some 15–20 at each of the other banks (Goodfriend 2000: 14). Over 70 per
cent of the articles on monetary policy published by US-based economists in
US-edited journals appear in Fed-published journals or are co-authored by Fed
economists (White 2005).
The district banks have no budgetary autonomy vis-à-vis the FRB. However,
fee-based services delivered by the district banks generate revenues for the banks
as a group that offset nearly half their budget expenditures. The balance of System
revenues is generated from earnings on the assets that are held in the Open
Market portfolio. These earnings far exceed the total expenses of the Federal
Reserve System, and the balance is returned to the US Treasury. This financial
autonomy is one key element in making the Fed independent of Congress.
The Federal Open Market Committee (FOMC) is the locus of decision-making in
open market policy—setting the level of the Federal funds rate and, increas-
ingly, interpreting that action for the benefit of outside observers. The FOMC
meets regularly—now eight times per year—in Washington D.C. in the offices
of the FRB. While there are only 12 voting members, there are many others in
attendance, including non-voting Presidents, Board staff, and district bank
staff. By convention, the Chair of the FRB is selected to be Chair of the FOMC.
All observers concur that the Fed Chair is far and away the most influential
member, as he controls the agenda and the staff (Woolley 1984). Her or his
personal style looms large for most participants. Alan Greenspan, for example,
was famous for opening the policy discussions in the FOMC by offering his
analysis and stating a policy preference. On occasion, Greenspan would use that
opportunity to explicitly ask for Committee support for his preferred policy.
314
Greenspan routinely led a lengthy discussion of monetary policy issues with the
Board on Mondays prior to FOMC meetings. Meyer (2004: 51) suggests this
contributed to the near absence of FOMC dissents by Board governors.
Financial Institutions Regulation and the Fed
Turmoil in financial markets starting in late 2007 highlighted the complex

responsibilities of central banks for addressing financial instability and monet-
ary policy. As lender of last resort, all central banks must balance the risks of
bailing out irresponsibly risky private behaviour (moral hazard) and stabilizing
the overall economic system. At the same time, events have raised the question
of whether a well-informed lender of last resort has a duty to warn forcefully in
advance against unsustainable or irresponsible behaviour—even if actual super-
visory responsibility lies elsewhere. In retrospect, the optimism within the Fed
about the benefits of financial innovation, emphatically shared by Greenspan,
seems to have been far too great.8
Prior to 1980, the regulation of US financial institutions was sharply divided
in terms both of geography and of function. For much of the twentieth century,
there was a sharp distinction between commercial banks and other financial
institutions. Additionally, banks were geographically restricted to conducting
business in a single state. Regulation responded slowly to financial innovations
in the 1970s. However, by 1994, legislation essentially allowed full interstate
banking, and the Gramm-Leach-Bliley Act of 1999 eliminated the separation of
banking from other areas of finance (GAO 2007).
US financial regulatory structure continues to be highly fragmented despite
various efforts to create bridging institutions designed ‘to foster communica-
tion, cooperation and coordination’ such as the Federal Financial Institutions
Examination Council (FFIEC 2006).9 The Fed has regulatory responsibility for
bank holding companies and for state-chartered banks that are ‘member banks’
of the Fed. State-chartered member banks hold only 10 per cent of the assets of
US depository institutions (FFIEC 2006: 23).
However, the Fed’s authority over bank holding companies makes it the lead
for ‘consolidated supervision’ of their activities. As of the end of 2006, US bank
holding companies controlled over 6,000 insured commercial banks, with
about 96 per cent of all insured commercial bank assets in the United States
(BGFRS 2007a: 66). Additionally, the Fed has regulatory authority over the US
operations of foreign banking companies (BGFRS 2007a: 63 ff). Thus, in bank-
ing, the Fed’s regulatory reach is extensive. Along with other regulators,10 the
Federal Reserve Board implements the internationally harmonized banking
capital standards, Basel I and II11 through regulations H and Y.
The Fed’s continued involvement in banking supervision runs contrary to one
idea popular among central bank reformers: separating financial institutions
315
regulation and supervision almost completely from monetary policy. The

views expressed in 1998 by Board member Lawrence Meyer continue to reflect
views in the Fed: ‘I cannot grasp how we could possibly understand what is
happening in banking markets, what innovations are occurring and their
implications, and the nature and quality of the risk exposures and controls so
critical for crisis management and policy formulation without the hands-on
practical exposure that comes from supervision’ (Meyer 1998). This may
explain the Fed’s determined fighting to retain a regulatory role following the
financial institutions reforms of 1999 (Greenspan 2007: 198–9). Additionally,
Fed officials are aware of the potential political benefits of a close relationship
with the banking industry, should challenges arise in Congress.
At the outset of the crisis in late 2007, the Fed did not regulate investment
banks, brokers, and dealers in securities, futures traders, insurance companies,
thrift institutions, or the government-sponsored secondary-mortgage lenders
known as Freddie Mac and Fannie Mae.12 Thus, its authority did not reach to
the derivative contracts and other financial instruments that linked US sub-
prime mortgage lending to a worldwide crisis. Most subprime13 mortgage lend-
ing in the United States was by firms not supervised by any bank or thrift
regulators (Gramlich 2007: 21). In 2005, only 20 per cent of subprime loans
were made by banks or thrifts subject to careful regulatory scrutiny, while
around 30 per cent more had some, but weaker, forms of supervision. Securi-
tized subprime loans created yet another set of financial instruments substan-
tially exempt from public-sector regulation. The securities were assigned risk
ratings by private bond rating agencies, which badly misjudged their risk
(Ip and Hilsenrath 2007; Lucchetti 2008).
Any concerns within the Fed about these new market instruments were largely
hidden from public view prior to the market meltdown of late 2007. Excessive
optimism must have played a part, for the Fed staff have been known for its
belief in the generally beneficial effects of financial innovation (Greenspan
2007: 373–6). While Governor Gramlich spoke publicly on the issue of pre-
datory mortgage lending as early as 2000, he did not address the risks involved
in securitization. In Congressional testimony in April 2005, Greenspan warned
against ‘systemic risk’ flowing from the implicit government guarantees
extended to Fannie Mae and Freddie Mac.14 As late as June 2007, Chairman
Bernanke expressed considerable optimism:
. . . fundamental factors—including solid growth in incomes and relatively low mortgage

rates—should ultimately support the demand for housing, and at this point, the troubles
in the subprime sector seem unlikely to seriously spill over to the broader economy or the
financial system. (Bernanke 2007b)
By the end of August 2007, however, the existence of a widespread crisis was
clear, and Bernanke’s tone became more cautious. He essentially said that
‘nobody saw it coming’.
316
Although this episode appears to have been triggered largely by heightened concerns
about subprime mortgages, global financial losses have far exceeded even the most
pessimistic projections of credit losses on those loans. . . . [T]he difficulty of evaluating
the risks of structured products that can be opaque or have complex payoffs has become
more evident. (Bernanke 2007c)
Given that central banks’ reputation for competence is a significant element in

establishing their overall reputation as credible managers, there is great poten-
tial for damage to the Fed arising out of this profound crisis.
The Fed’s Reaction to the Financial Crisis
Beginning in August 2007, the Fed adopted a sequence of novel and aggressive
intervention strategies intended to address the collapse of markets for certain
kinds of financial instruments.15 When the crisis intensified in September
2008, these novel strategies were expanded further. The Fed’s new measures
had been studied years earlier by the staff as hypothetical responses to two
potential threats: deflation and resulting zero nominal interest rates, or the
sharp reduction in outstanding government debt possible with sustained
budget surpluses.16 These new strategies radically changed the Fed’s balance
sheet, which more than doubled in size and profoundly increased in risk.17
The Fed began in August 2007 by liberalizing the terms of access to the
discount window. In December, the Fed defined new intervention ‘facilities’
that presented a way to address liquidity problems without generally lowering
interest rates. The Term Auction Facility18 (TAF, launched in December 2007)
provided funds through the discount window; the Term Securities Lending
Facility (TSLF, created in March 2008) lends treasury securities to primary
dealers19 in exchange for less liquid securities at rates determined through
auctions. The Primary Dealer Credit Facility (PDCF, created in March 2008)
lends through the discount window to Primary Dealers. At the same time, the
Fed announced an aggressive programme of ‘repurchase agreements’ through
the open market desk.20
By October 2008, near-collapse in credit markets brought another round
of innovations. Some actions, by the Fed alone, were authorized under the
‘unusual and exigent circumstances’ clause of Federal Reserve Act Section 13(3)
which had never been invoked.21 These included the Asset Backed Commercial
Paper Money Market Mutual Fund Liquidity Facility (AMLF, September 2008),
Commercial Paper Funding Facility (CPFF, October 2008), and the Money Mar-
ket Investor Funding Facility (MMIFF, October 2008). The Fed began purchasing
obligations of Fannie Mae and Freddie Mac. The remaining investment banks,
Goldman Sachs and Morgan Stanley, were declared to be ‘bank holding com-
panies’, bringing them under the direct regulatory supervision of the Fed. The
Fed began paying interest on required reserves for the first time.
317
Perhaps most stunning, the Fed and Treasury cooperated in promoting what
was widely called ‘the bailout bill’ to create a $700 billion fund to be used to buy
government equity positions in financial institutions (and indeed, any firm).22
This abrupt reversal of prior free-market rhetoric seemed to have the perverse
effect of telling investors that conditions were far worse than they had previ-
ously thought. Stock markets swooned worldwide and US consumer confidence
hit a record low. Credit markets did show signs of recovery, as spreads between
government and interbank borrowing rates began to narrow.
At the technical level, the Fed’s new strategies were similar to intervention
techniques widely used in Europe. Through loans, swaps, and outright pur-
chases, these programmes replaced billions of dollars of illiquid financial assets
with high-quality treasury securities, all in an effort to keep financial markets
functioning.23
Repeatedly during the crisis, actions were undertaken in close coordination
with the G-10 central banks. On numerous occasions central banks simultan-
eously undertook parallel interventions to address liquidity issues.24 Extraor-
dinary swap lines were created with the ECB, BOE, and SNB; and later expanded
and extended.25 There were additional coordinated interventions conducted by
G-10 central banks.26
Critics were justified in calling the undertaking a bailout of financial markets,
but it was incorrect to suggest there were no costs for the financial institutions and
thus that moral hazard was unquestionably being encouraged.27 Politically, how-
ever, the perception was widespread in the United States that the central bank was
bailing out Wall Street, while ordinary citizens were losing their homes. The future
strengthening of financial regulation in the United States looks quite certain.
Transparency
Public disclosure and communication have come to be seen as powerful mon-

etary policy instruments, distinct from decisions about the interest rate. Begin-
ning in the mid-1960s, the Fed has taken many steps to release more complete
records more quickly. Today, the Fed is one of the most open central banks in
the world, especially with respect to the historical record of the FOMC.
Until May 1999, all these moves, including the decision to release verbatim
transcripts of FOMC meetings, were taken defensively in response to pressure
coming from Congress or the courts. The Fed acted reluctantly to forestall
demands for even greater openness, seeking to preserve the integrity of the
FOMC deliberative process. To deal with the Freedom of Information Act, the
Fed began in 1967 to release the ‘Record of Policy Actions’ only about 90 days
after the each FOMC meeting rather than annually. In response to adverse
Court decisions relating to the Freedom of Information Act and the pending
passage of the Government in the Sunshine Act, the FOMC in 1976 expanded
318
the Record of Policy Actions and discontinued keeping a semi-verbatim record

that had previously been released with a five-year lag.
In 1992, the House Banking Committee began to request information from
the FOMC about meeting records. The inquiry was preparatory to introduction
of legislation to require the creation and preservation of audio–visual and
textual records of FOMC meetings. Tense exchanges continued for months as
House Committee Chair Henry Gonzalez pressed for the creation and immedi-
ate release of FOMC transcripts. Greenspan revealed in October 1993, to the
surprise of just about everyone, the existence of unedited FOMC transcripts
dating back to 1976.
In these circumstances, the Clinton Administration Justice Department
issued new guidance to agencies about implementation of the Freedom of
Information Act. The Administration indicated it would only defend agencies
in court if the information requested would threaten their core functions. In
light of prior court decisions, it seemed unlikely that the Fed could prevail in
asserting that claim with respect to the vast bulk of FOMC transcript records.28
In 1994, the FOMC decided to release the existing transcripts with a five-year
lag, and to release expanded records of committee action—henceforth called
‘The Minutes’. Also in 1994 the committee began what later became a regular
practice—announcing publicly when policy had been changed.29 In 1995, hav-
ing concluded that politically there was no viable alternative, the FOMC agreed
to continue creating verbatim meeting transcripts and to release them with a five-
year lag. The Committee also agreed to continue the ‘prompt announcement’ of
policy changes—which was judged to have been a success. In these actions as
well, the threat of Congressional legislation loomed in the background.30
Starting in May 1999, the Committee released statements after every meet-
ing, even if there were no change in policy. These statements included what was
referred to as ‘the tilt’, which seemed to indicate the likely next move of policy.
Markets were uncertain how to interpret this new information, and subsequent
discussion revealed that FOMC members themselves disagreed about the mes-
sage they were trying to convey. In January 2000 the Committee decided to try
to clarify its intent by referring to the ‘balance of risks’—to indicate what kinds
of adverse developments in the economy seemed most likely. In March 2002
the Committee began releasing information about member votes as part of the
immediate post-meeting press release (rather than only later with the more
complete policy record). Beginning with 2005 the committee accelerated the
release of the policy record (‘The Minutes’) and began to report forecasts for two
years ahead rather than just one. As of late 2007, the FOMC announced a plan
to release forecasts more often, to extend their forecasting horizon to three
years, and to include inflation projections (Bernanke 2007d). These changes
from 1998 forward have primarily reflected the desire of FOMC members to
increase the efficiency of policy—an idea that gained momentum due to turn-
over in the FOMC membership.
319
The Fed’s Institutional Power and Independence
Central bank independence is commonly cited to ‘prove’ the policy importance

of institutional structure. In recent years, measures of central bank independence
have been incorporated in vast numbers of cross-national and time-series stud-
ies (Bernhard 1998; Cukierman 1992; Franzese 2002). Studies have frequently
found that increasing central bank independence is associated with reduced
inflation.
By all measures, the Fed is a very independent central bank, but since 1978
these indexes show no variation in the Fed’s formal institutional status. Blinder
(2004) observed that since 1989 more than two dozen countries have increased
the degree of central bank independence, while none have moved in the other
direction. In contemporary advanced industrial countries it is taken for granted
that central banks are independent, so that institutional status no longer can
account for variation among central banks in their policy behaviour. Thus, in a
cross-national study, Cecchetti, Flores-Lagunes, and Krause (2005) conclude
that decreased GDP volatility is not robustly correlated with central bank
independence. In short, institutional change at the Fed cannot help us under-
stand the changes in US monetary policy since 1979.31
Relations with Other Political Institutions and the Media
Two factors shape the Fed’s relationships with other political institutions and
with the media. First, when conservative (i.e. Republican) politicians control
any one of the House, Senate or Presidency, they are in a position to veto any
legislative initiatives hostile to the Fed (Krehbiel 1998; Morris 2000). Second,
when the economy is doing well, the Fed’s political environment has been
benign, no matter what the distribution of partisan preferences.
Since the Carter administration (1977–80), Democrats have had unified con-
trol of Congress and the Presidency for only two years, 1993–4. That is, Repub-
licans controlled at least one veto point at all other times. Although the Reagan
Presidency (1981–8) saw ample tension between the administration and the
Fed (Greider 1987; Woodward 2001), the relatively supportive political context
provided the political cover that the Fed needed in order to establish the notion
that a credible low-inflation policy could yield acceptable rates of employment
and economic growth.
Congress
One relevant indicator of Congressional interest is the proportion of all hear-
ings in both House and Senate dealing with monetary policy, inflation, prices,
interest rates, and price controls.32 Consistent with the notion that a good
320
economy yields benign monetary politics, hearings peaked in the tumultuous

years of 1979–81, followed by a period of relative stability. There was no upsurge
in Congressional hearings in the Democratic-dominated 1993–4 period, even
though interest rates increased substantially.
The FOMC transcript data provide a fine-grained look at the Fed’s reaction to
its environment. One naı̈ve expectation would be that, as an independent
central bank, the FOMC would conduct its policy essentially without reference
to Congress or the President. That would, of course, be quite incorrect.
The transcript data confirm that extensive Congressional hearings arouse
substantial attention inside the Fed. In 1992–3 the demands of a single com-
mittee chair with respect to information, discussed above, provoked lengthy
FOMC discussion. In 1995–6, after Democrats lost control of Congress, Repub-
lican Senator Connie Mack introduced legislation to repeal the Humphrey-
Hawkins Act and to assign the Fed a single goal of price stability.33
While FOMC members favoured Senator Mack’s bills, they debated whether
their benefits were worth the risk that the ultimate legislative product might be
worse than the status quo. The legislation was never even referred out of
committee, illustrating nicely the difference between the power to initiate
and the power to veto. But it did provoke an interesting discussion inside the
FOMC about the virtues of inflation targeting and about the appropriateness of
explicitly emphasizing a single target despite a legislative mandate to pursue
multiple objectives (more below).
Another glimpse of Fed/Congress relations can be gained from the Congres-
sional testimony by Fed officials between 1996 and 2007.34 Of the 239
instances of testimony during that period, none involved legislation to reform
the Fed’s budget, transparency, appointments procedures, monetary targets,
etc. Including routine and recurring policy testimony, only about 20 per cent
of all Fed testimony dealt with monetary policy. The rest addressed financial
regulation, fiscal policy, and international financial developments—apparently
with more prescience than was evident at the Fed.
The Administration
Classic studies of the politics of macroeconomic policy in the United States
have been based around two assumptions. First, Presidents dominate macro-
economic policy. Second, Democrats seek to reduce unemployment, while
Republicans try to reduce inflation (Bartels and Brady 2003; Hibbs 1977).
There are many accounts from studies of US monetary policy of Presidents
and their advisors trying to influence monetary policy, usually in an expan-
sionary direction, and commonly as a presidential election approaches
(Woodward 2001).
The FOMC transcripts show that the Administration and fiscal policy get
regular attention from the FOMC, more so than Congress, with more frequent,
321
sharper upswings (Woolley 2007). This record belies any notion that the Fed’s
inflation responsibilities, independence, and power enable it to be indifferent
to fiscal policy. Increases in FOMC attention to the Administration are linked to
major new budget and taxing initiatives generated from the White House. For
example, in 2001, FOMC members devoted a lot of time to discussing Bush
administration fiscal policy and its likely effects on the economy.
The Media
Increased media attention to policy problems and institutions often presages
policy innovation (Baumgartner and Jones 1993). The pattern of attention to
the Fed and monetary policy by major US newspapers since 1978 has essentially
followed the path of inflation—trending steadily downward. A combined count
of articles reporting on monetary policy by three leading newspapers, Wall
Street Journal, Washington Post, and New York Times, from 1977 to 2006 reveals
a steady decline during the period (Woolley 2007). From a journalistic perspec-
tive, monetary policy became less interesting and less newsworthy.
In summary, in recent years the political environment of the Federal Reserve
has been very benign. It is a near-certainty that this flows from macroeconomic
performance that has been good and steady. With the financial crisis and
economic slowdown of early 2008, joined with the context of a Presidential
election year, Congressional and media attention has increased dramatically as
one would expect.
Policy Problems and How They were Understood
The heart of discourse inside the FOMC has to do with the conduct of monetary
policy in response to inflation and economic output. This is where the policy
action really is, and it is where we would expect to see considerable change during
this period, given accounts by informed ‘insider’ observers like Blinder and Good-
friend. The results from the FOMC transcripts confirm that important changes
occurred. Over time, there was less focus on the details of the implementation of
policy—interest rates, money supply targeting, etc.—and more on understanding
and steering the primary targets—inflation and growth of output.
Inflation and Inflation Targeting

Many observers have suggested that the Fed is institutionally obsessed with
inflation. Recall that one often-repeated characterization of Fed behaviour is
that since 1994 it has engaged in ‘implicit’ inflation targeting.
My examination of the FOMC transcripts clearly confirms the FOMC’s
increasingly intense focus on inflation. Since 1978, as inflation rates have
322
0.120 16
14
0.100
Reference lines/Total lines
12
0.080
Inflation rate
10
Infl References
0.060 8 Recent Core CPI
10 per. Mov. Avg. (Infl References)
6
0.040
4
0.020
2
0.000 0
17/1/1978
17/1/1980
17/1/1982
17/1/1984
17/1/1986
17/1/1988
17/1/1990
17/1/1992
17/1/1994
17/1/1996
17/1/1998
17/1/2000
Date
Figure 14.5. References to inflation, FOMC meetings

Source: Author’s calculations, see Woolley (2007).
declined and stabilized, the proportion of meeting time devoted to inflation has
at least doubled (see Figure 14.5). In the initial period from mid-1978 through
mid-1983, attention to inflation declined roughly as the observed core rate of
inflation declined. However, the increasing core rate from 1984 to 1990, while
modest by standards of prior history, was accompanied by large increases in
FOMC concern. In this period, the FOMC was determined to demonstrate the
credibility of its own commitment to stable, low inflation. From then on, the
Fed’s rhetorical responses to inflation became, by historical standards, hyper-
sensitive. This may be expected in an institution intent on building a credible
commitment to maintaining low rates of inflation.
As early as 1978, the FOMC discussed a proposal from district bank presidents to
set long-term targets for the monetary aggregates as a way of trying to influence
long-run expectations about inflation, especially on the part of people engaged in
contract negotiations throughout the economy (FOMCT, 18 April 1978). Objec-
tions were based on the fear that their instruments were insufficient to assure that
they could hit the target—and the result for Fed credibility would be worse.
Nearly a decade later, another district bank president argued explicitly for
inflation targets (FOMCT, 15 December 1986). He argued that, given the prob-
lems with relying on the monetary aggregates as guides to policy, announcing
long-run targets for inflation would be an effective way of communicating more
clearly with the public. However, despite some expressions of interest, the topic
was dropped with little extended discussion.
323
A few members continued to raise the issue from time to time. Partly in
response, in February 1995, at a time when related legislation had been
introduced in Congress, Chairman Greenspan organized an FOMC discussion
on the topic, with ‘pro’ and ‘con’ statements from members in order to be able
to define a Fed position on anticipated Congressional legislation on inflation
targets. The debate in the FOMC was framed as one between considering a
single goal as opposed to multiple goals. Again, the argument was made that
setting such a target would not be credible and, thus, would undermine Fed
reputation. Doubts were expressed that the Bundesbank had, in practice, either a
single overarching price stability objective or that its alleged credibility actually
bought it much of a reduced cost of fighting inflation. Greenspan concluded
the discussion by observing:
We now understand why this Committee has had difficulty confronting this issue. It is
because we are as split down the middle as we could possibly get. . . . My own impression
is that even if we now locked into law a fixed inflation rate—say, 2 per cent or 1 per cent—
and the Congress voted for it with a large majority, in the first recession everyone would
be arguing to go in a different direction. . . . You may recall that a couple of years ago, we
all basically said we were going to have to move early on the up side or we would not
achieve anything resembling price stability. Now, I submit to you that is exactly what we
did. . . . But that objective is not being implemented in a straight line because we have
recognized, and I think correctly, that the Congress would not give us a mandate to do
that. . . . We [sh]ould always be moving in the direction of price stability, recognizing that
we would not do so in a straight line because I do not think we have the philosophical,
cultural, or political support in this society for that. (FOMCT, 1 February 1995: 58)
The committee returned to the issue again in late 1999 and in 2000. In June 2000,
Greenspan again ended the discussion by arguing that the claims for the benefits
of inflation targeting were empirically dubious and the practice politically risky.
‘It is too soon’, he stated, ‘to make a judgment as to whether official inflation
targeting actually works’ (FOMCT, 27 June 2000: 84). Moreover, Greenspan
observed that attempting to get agreement within the FOMC to pursue a specific
price level, without regard to the cost of getting there, would be too divisive.
With the appointment of Ben Bernanke as Chair in February 2006, the Fed,
for the first time, was headed by someone whose reputation was almost exclu-
sively as an academic.35 All Fed Chairs starting with William McChesney
Martin (1951–70; Burns 1970–8; Miller 1978–9; Volcker 1979–87; Greenspan
1987–2006) had been distinguished by their pragmatic, eclectic approach to the
conduct of policy. They emphatically were not partisans for any panaceas
popular in academia. Bernanke, by contrast, was known as an advocate of
inflation targeting long before entering public life (e.g. Bernanke and Mishkin
1997). In September 2006, Bernanke was joined on the Board by Frederic
Mishkin, a long-time academic collaborator and inflation targeting advocate.36
It seems likely that there was an understanding involved in Bush’s appoint-
ing in quick succession long-time Fed staff ‘baron’ and Greenspan advisor
324
Donald Kohn as Fed Vice-Chair in May 2006, followed a few weeks later by the
appointment of Mishkin as governor.37 Kohn was known to financial markets
and was understood to be a critic of inflation targeting. In May 2006, Bernanke
appointed Kohn to head a committee to study how the Fed communicates with
financial markets. Its work eventually generated a consensus in favour of
announcing longer-term forecasts, similar to practice at the ECB and the Bank
of England.38
Output and Employment

The flip side of the stereotype of the Fed as obsessed with inflation is that it is
relatively indifferent to output and the real economy. Some would assert that
the world of money is a world of nominal events, and there is no enduring way
to stimulate the real economy through the use of monetary policy. Thus central
bank discussions of output are pointless. Based on the FOMC transcripts, this
kind of stereotype is not only badly wrong, but it became increasingly wrong as
the post-Volcker era evolved. Substantial and increasing FOMC discussion
focused on questions of output and growth (see Figure 14.6). Discussion of
output appears to get only about half the volume of attention given to inflation.
Nevertheless, as FOMC discourse has become increasingly focused on inflation,
the proportionate emphasis on output has been maintained.
Europe and Globalization

Neither Blinder (2004) nor Goodfriend (2005) discusses globalization and
increasing financial integration as issues for monetary policy. Several high
officials at the Fed have recently written or spoken about the implications of
globalization for monetary policy, including Chair Bernanke (2007a), Board
Vice-Chair Kohn (2005), and Board member Mishkin (2007b). All agree that
globalization is not, thus far, a big deal for US monetary policy. Globalization
of financial markets ‘has not materially reduced the ability of the Federal
Reserve to influence financial conditions in the United States’ (Bernanke
2007a: 4). However, it has made financial conditions more complex. Addition-
ally, the impact of globalization on the US inflation rate is mixed, and ‘there
seems to be little basis for concluding that globalization overall has significantly
reduced inflation in the United States’ (Kohn 2005: 6). Moreover in recent
years, inflows of capital from abroad have probably helped reduce the interest
rate for long-term debt—complicating the ability of policy-makers to draw
information about inflation expectations from the yield curve.
In the FOMC transcripts, international matters are a focus of attention
second only to inflation. Drivers include large shifts in the exchange rate and,
especially prominent at the end of the data series, international financial crises.
The transcripts are also interesting with respect to American perceptions of an
325
0.080
0.070
References/ Total lines
0.060
0.050 Reference to Output

10 per. Mov. Avg.
0.040 (Reference to
Output)
0.030
0.020
0.010
0.000
17/1/1978
17/1/1979
17/1/1980
17/1/1981
17/1/1982
17/1/1983
17/1/1984
17/1/1985
17/1/1986
17/1/1987
17/1/1988
17/1/1989
17/1/1990
17/1/1991
17/1/1992
17/1/1993
17/1/1994
17/1/1995
17/1/1996
17/1/1997
17/1/1998
17/1/1999
17/1/2000
17/1/2001
Date
Figure 14.6. References to output and [un]employment, FOMC meetings

emerging Europe, both in the details of specific comments and in the broad
trends in discourse in the FOMC.
The FOMC received staff briefings from time to time that mentioned the
Maastricht process and progress toward European monetary union, but Maas-
tricht was hardly a big issue in its discussions. The first references one can
find from FOMC members (as opposed to staff) reveal a plainly sceptical tone—
dubious about the politics of monetary union; dubious about the political will
required to meet the criteria specified for monetary union; and uncertain about
where the project was really going. In 1994 members discussed the implications of
the creation of the European Monetary Institute for the Bank for International
Settlements. Would the BIS ‘be effectively neutered’?39 Would the problem of
meeting the Maastricht convergence criteria provoke an economic slowdown in
Europe?40 In 1995, the FOMC heard that moves toward European monetary union
were a source of uncertainty, and would lead to increased market volatility.41
In 1996, the FOMC was briefed that France and Germany will likely lead ‘a
small band’ into full economic and monetary union.42 Again in 1996, doubts
were expressed that the future ECB and the euro could match the standard of
value achieved by the D-Mark. Therefore there was a need for the FOMC to
think clearly about ‘what kinds of arrangements we will want to have with that
central bank.’43 Also in 1996, participants asked whether the French were
fiddling the Maastricht criteria and whether this will get the blessing of the
European Commission.44
Doubts begin to recede in 1997, when the FOMC was advised that European
monetary union was likely to begin on schedule with 11 participants, but
326
the fiscal criteria in the Maastricht Treaty would be ‘missed or fudged’ by most.45
In mid-1998, they were told ‘jitters’ about the introduction of the euro were ‘out
of the way’, and there was a risk that the US dollar would decline against
European currencies.46 In September 1998, the FOMC was briefed on technical
issues concerning the exchange of D-Mark-denominated assets for euro-denom-
inated assets. In December 1998, it was noted that the Fed and the ECB are likely
to maintain official interest rates for the early months of 1999, which should
provide ‘a very good background for a successful introduction of the euro’.47 It
was noted in February 1999: ‘The weekend conversion to the euro went quite
smoothly. . . . ’48 In August 1999, the FOMC were reminded, unfavourably, of the
strong market response to statements made by ECB president Duisenberg.49
The discussions inside the FOMC about Europe, as revealed by systematic
keyword searches, have two important characteristics: First, in the period 1978–
82, over half the references to institutions or actions located in the European
continent (including the UK) referred to a specific country, central bank, or
currency. As is illustrated in Figure 14.7, from August 1998 forward, in a striking
change, 80 per cent of those references were exclusively to ‘European’ institu-
tions.50 Europe became a reality for the FOMC.
Second, the frequency of FOMC references to institutions or events located in
the European continent increased continuously from 1992 to the end of 2001.
In short, not only did FOMC participants substitute ‘euro-talk’ for discussions
1.0
0.9
Proportion of ‘Euro’ References
0.8
0.7
0.6
Series1
0.5
10 per. Mov.
Avg. (Series1)
0.4
0.3
0.2
0.1
0.0
17/1/1978
17/1/1979
17/1/1980
17/1/1981
17/1/1982
17/1/1983
17/1/1984
17/1/1985
17/1/1986
17/1/1987
17/1/1988
17/1/1989
17/1/1990
17/1/1991
17/1/1992
17/1/1993
17/1/1994
17/1/1995
17/1/1996
17/1/1997
17/1/1998
17/1/1999
17/1/2000
17/1/2001
Date
Figure 14.7. ‘Euro’ references (EMS, EMU, ECB, Euro) as share of FOMC references to
European countries and institutions (e.g. Bundersbank, Bank of France, Germany,
France)
327
0.003
0.025
References/Total lines
0.002
all europe
0.015
10 per. Mov.
Avg. (all
0.001 europe)
0.005
0
17/1/1978
17/1/1979
17/1/1980
17/1/1981
17/1/1982
17/1/1983
17/1/1984
17/1/1985
17/1/1986
17/1/1987
17/1/1988
17/1/1989
17/1/1990
17/1/1991
17/1/1992
17/1/1993
17/1/1994
17/1/1995
17/1/1996
17/1/1997
17/1/1998
17/1/1999
17/1/2000
17/1/2001
Date
Figure 14.8. All references to european currencies, central banks, or countries, FOMC
meetings 1978–2001
of individual European countries, but also the prominence of Europe in FOMC

discourse shot upward (Figure 14.8).
Conclusions
US economic performance in the period from 1979 to 2007 was quite good—
economic growth remained strong and was less volatile; inflation dropped and
became more steady; unemployment fell and also became more steady. In part,
the ‘good news’ for policy-makers reflected little more than good luck. In part, it
reflected conscious choices and adjustments that policy-makers made. Both the
luck and the choices were conditioned by political alignments that facilitated
good (or poor) choices. Mainstream analysts, however, failed to anticipate the
growing risks that convulsed the economy in 2008.
The Fed’s control over the key monetary policy instrument, the Federal funds
rate, was never seriously criticized, much less contested. In short, the Fed’s
power over its monetary policy instruments has hardly been greater. While
economic performance, as measured by outcomes, was quite good, a close
observer will see that the Fed has been surprised repeatedly by developments
in capital markets and foreign-exchange markets. Despite a determination to be
ahead of the game in fighting inflation, policy-makers have nonetheless been
reactive, and that is certainly true with respect to their Congressional audience.
328
There were dramatic changes in the way policy was discussed and conceptu-
alized inside the FOMC. Monetarism and monetary targeting bloomed and
faded. Discussion of indicators of real output increased dramatically. Attention
to inflation soared, despite objective evidence that inflation was well under
control. Europe became a reality for the FOMC and of increasing importance.
While Europeanization mattered at the Fed, the Fed did not look to Europe or
the ECB for inspiration or guidance at a technical level. Nonetheless, many
within the Fed have followed with great interest the ECB’s engagement with
inflation targeting and the different approaches to transparency at the ECB,
Bank of England, and elsewhere. These projects are viewed with great sympathy
at the Fed, but, as reflected by the statement of Alan Greenspan quoted above,
the Fed has been sceptical about inflation targeting on empirical grounds and
cautious given the US legal context. The clear misgivings about US policy from
the European side have had to do with the fear that the Fed is mistakenly
unleashing a round of inflation.
The crisis of 2007–8 showed that the world’s leading central banks shared
quite similar understandings of their context, and similar optimism about the
pricing of risk in financial markets. Central banks responded in coordination
using very similar techniques. It is hard to imagine more compelling evidence
of ‘convergence’ than what is offered in these events. This convergence is
driven by the profound globalization of finance, which spread primarily US-
originated securitized mortgages to financial institutions worldwide. The Fed is
at the heart of this process, but it is not clear as of today, that the Fed weighs
very heavily the impacts its policies create outside the United States.
The crisis also illustrated clearly that Fed’s unilateral power of action in
cleaning up after financial crises is not in question—although in sorting
through the wreckage after the still-unfolding crisis is over, conditions may
change. The challenge for coming years will be for private markets, central
banks, and financial regulators across the world to devise means to expose
and control financial risks. The magnitude of the crisis, despite the Fed’s rescue
efforts, assures that the United States will see a searching examination of
financial regulation.
Notes
1. I appreciate the helpful comments on previous drafts from the editors, Michael Moran,
Randall Henning, Benjamin Cohen, and Robert Franzese. The work benefited from the
research assistance of Andrea Haupt and David Weaver.
2. In recent years the Federal Reserve has regarded the deflator of Personal Consumption
Expenditures (PCE) as a more accurate measure of inflation. The CPI and PCE are
highly correlated.
3. US Code Title 12, Chapter 3.
329
4. The Full Employment and Balanced Growth Act of 1978, also known as the Hum-
phrey Hawkins Act, revised the Employment Act of 1946. The 1946 Act had stated
that the government’s goals, and only by implication the Fed’s, were ‘to promote
maximum employment, production and purchasing power’.
5. For many years, the term of the chairman happened to be renewable during a
presidential election year. However, starting with Bernanke, the terms are aligned to
the middle of the Presidential term.
6. The regulations are codified in the Code of Federal Regulations (CFR) title 12, Banks and
Banking and include parts 201 through 233. The CFR is officially updated yearly, and
is now available online: http://www.access.gpo.gov/nara/cfr/cfr-table-search.html#
page1.
7. Division of Research and Statistics, the Division of Monetary Affairs, and the Division
of International Finance. Other divisions also employ PhD economists. http://www.
federalreserve.gov/research/default.htm.
8. In October 2008, Greenspan admitted in Congressional testimony that he had mis-
takenly presumed that the self-interest of banks and other financial institutions
would be sufficient to protect shareholders. See Kara Scannell and Sudeep Reddy,
‘Greenspan Admits Errors to Hostile House Panel’, Wall Street Journal, 24 October
2008. [http://online.wsj.com/article/SB122476545437862295.html.]
9. The FFIEC, created in 1978 by the Financial Institutions Regulatory and Interest Rate
Control Act, is intended to create common standards for financial institutions exam-
inations among the Federal Reserve System, the Federal Deposit Insurance Corpor-
ation, the National Credit Union Administration, the Office of the Comptroller of the
Currency, and the Office of Thrift Supervision.
10. Office of the Comptroller of the Currency, the Federal Deposit Insurance Corpor-
ation, and the Office of Thrift Supervision.
11. The Basel Committee on Banking Supervision (previously the Standing Commit-
tee on Banking Regulation and Supervisory Practices) was launched in 1975 by
G-10 central banks at the Bank for International Settlements (BIS) in Basel. Now,
the Committee includes representatives from Belgium, Canada, France, Germany,
Italy, Japan, Luxembourg, the Netherlands, Spain, Sweden, Switzerland, the
United Kingdom, and the United States. Countries are represented by their
central bank and/or also by other authorit(ies) with formal responsibility for
the prudential supervision of banking. The United States and UK have been
driving forces in the Basel process (Calomiris and Litan 2000); http://www.bis.
org/bcbs/index.htm.
12. Freddie Mac: Created in 1970 as Federal Home Loan Mortgage Corporation; Fannie
Mae: Created in 1938 as Federal National Mortgage Association; 1989 legislation
severed Fannie Mae’s supervision by the Federal Home Loan Bank Board.
13. ‘Subprime’ is not precisely defined. Generally, subprime mortgages have adjustable
rates following a fixed low rate for the first two years. The adjustable period is typically
28 years—the so-called 2/28 mortgage. The down payment may be zero. Borrower
income may not be documented fully or at all. By contrast ‘prime’ mortgages involve
a substantial down payment of 10 to 20 per cent of the home price, no low introduc-
tory rate, and careful documentation of borrower income.
330
14. ‘Regulatory reform of the government-sponsored enterprises’ Before the Committee

on Banking, Housing, and Urban Affairs, US Senate 6 April 2005, http://www.
federalreserve.gov/boarddocs/testimony/2005/20050406/default.htm.
15. In Fed-speak, ‘pressures emerged abruptly’ in August, reflected in ‘the elevated level of
unsecured term interbank rates’. The spread between the US Overnight Index Swap
rate and the Libor rates increased dramatically in mid-August. See Federal Reserve
Bank of New York (2008).
16. See especially Ahearne et al. (2002) and Federal Reserve System (2002), Small and
Clouse (2004) for historical studies. Gaithner (2008) usefully summarizes the new
actions. Also see Federal Reserve Bank of New York (2008), and ‘Forms of Federal
Reserve Lending to Financial Institutions’, http://www.newyorkfed.org/markets/
Forms_of_Fed_Lending.pdf.
17. These data are reported weekly in what is called the H.4.1 release: http://www.
federalreserve.gov/releases/h41/. From October 2007 to October 2008, various forms
of direct lending to financial institutions and others increased by over $500 billion. A
programme of securities lending to dealers grew by over $250 billion. ‘Other’ lending,
which by May 2008 was about $30 billion, most maturing within 15 days, by October
became over $400 billion, with nearly a quarter maturing in over 90 days.
18. The TAF opened with auctions of $20 billion for 28 days, and was increased in
October 2008 to auctions of $150 billion for 85 days. The minimum bid rate was set
to equal the expected future FFR, thus initially it was at least 25 basis points lower
than conventional discount window lending.
19. Primary Dealers are investment banks, not the commercial banks regulated by the
Federal Reserve.
20. ‘Operating Policy Statement’, Federal Reserve Bank of New York, 7 March 2008,
http://www.newyorkfed.org/markets/operating_policy_030708.html.
21. According to section 13(3), dating from 1932, the Fed is authorized to make loans to
‘any individual, partnership, or corporation’ in ‘unusual and exigent circumstances’,
if ‘adequate credit accommodations’ cannot be secured from other banking
institutions.
22. The Emergency Economic Stabilization Act of 2008 (HR 1424); PL 110-343. Passed on
3 October 2008. Preliminary outlines of the plan were made public only around
September 19.
23. By April 2008, the Fed had replaced nearly half of the risk-free Treasury securities in its
portfolio (i.e. over $300 billion of securities) with risk-bearing securities; an unsus-
tainable trend. Source: Author’s calculation from the Federal Reserve’s H.4.1 Statistical
Release.
24. These ‘repo’ transactions provide temporary liquidity. The announcement of the
Bank of Canada is here: http://www.bank-banque-canada.ca/en/notices_fmd/2008/
not110308.html.
25. From March 2008: http://www.federalreserve.gov/newsevents/press/monetary/
2008-0311a. htm; from October 2008: http://www.federalreserve.gov/newsevents/
press/monetary/20081013a.htm.
26. For example: http://www.bankofengland.co.uk/publications/news/2008/017.htm;
http: // www.federalreserve.gov/newsevents/press/monetary/20080926a.htm.
331
27. From their peak values in 2007, NYSE financial stocks had fallen some 45% by
November 2008. Lehman Brothers stock went from $65 þ to $0 in seven months.
Bear-Stearns stockholders lost something like 90% of the value of their investments in
a matter of days. Banks took losses estimated at over $200 billion (Bloomberg 29
March 2008). Collateral for loans and advances through the Fed’s discount window
for non-government securities without current market prices have been valued at 70
to 85 of par, which is a substantial allowance for risk by the Fed. See http://www.
frbdiscountwindow.org/discountmargins.cfm?hdrID¼21&dtlID¼83.
28. Especially the rulings in Merrill v. FOMC 585 F 2d 778 (1977) The ‘domestic policy
directive’, the instructions to the Open Market Desk were distinguished from the
transcripts and accorded greater confidentiality by the Supreme Court. FOMC v.
Merrill 443 US 340. Department of Justice statement may be found here: http://
www.usdoj.gov/oip/foia_updates/Vol_XV_2/page3.htm.
29. The 1994 move to a tighter policy stance came after a long period of stable policy and
was the first tightening action in nearly five years.
30. Greenspan, FOMCT, 31 January 1995, p. 21: ‘It is my impression that House Banking
Committee Chairman Leach has been holding off on any legislative initiatives in this
area on the grounds that we are going to do it ourselves . . . if we don’t set our own
policy, there will be real interest in that committee in trying to do something.’
31. We might not expect to find policy-makers in truly independent institutions regularly
pondering their independent status. In 1981, arguing for immediate public release of
the policy directive, Governor Henry Wallich suggested that his colleagues should
‘look at what other central banks do’. The Bundesbank, he observed, calls a press
conference every time they take action and explain what they are doing. ‘How could
that be?’ responded another Governor. Wallich answered, ‘Well, I guess they are an
independent central bank’ FOMCT, 2 February 1981.
32. These data are at: http://www.policyagendas.org/datatools/toolbox/analysis.asp.
33. Mack’s legislation was known as the ‘Economic Growth and Price Stability Act’. In
104 it was S1266/HR2445; in 105 it was S611/HR 1396; in 106 it was S1492.
34. This testimony is archived on the FRB website.
35. Bernanke joined the Board as a Governor in 2002, then resigned in 2005 to become
Chairman of the Council of Economic Advisors. Arthur Burns had much more public
involvement.
36. Mishkin was research director at the Federal Reserve Bank NY from 1994 to 1997.
37. Mishkin and Kohn were both under consideration as possible appointees as Vice-
Chairman (Ip 2006).
38. Bernanke’s appointment followed a precedent of assigning similar tasks to the FRB
Vice-Chairmen including Roger Ferguson, Alan Blinder, and David Mullins.
39. Greenspan, FOMCT, 20 July 1994 conference call.
40. Governor Lindsey, FOMCT, 6 July 1995.
41. Staff advisor Truman, 26 September 1995.
42. Staff advisor Truman, 21 May 1996.
43. President Jordan, 2 July 1996.
44. Colloquy between Governor Lindsey and Staff advisors Truman and Fisher, 24 Sep-
tember 1996. Truman opined, ‘The question, Governor Lindsey, is whether we
are talking about high politics or grass root politics and that is another source of
332
uncertainty. The high politics may bring it about. The question is whether the grass
root politics will follow the high politics.’
45. Staff advisor Truman, 2 July 1997.
46. Staff advisor Hooper, 30 June 1998.
47. FOMC Vice-Chair McDonough, 22 December 1998.
48. Staff advisor Fisher, 2 February 1999.
49. Staff advisor Fisher.
50. That is, EMU, EMS, ECB, or any word or phrase with ‘euro’ in it.
333
Part VI
Convergence and Divergence
15
Financial Supervision:
Internationalization,
Europeanization, and Power
Michael Moran and Huw Macartney
Three Faces of Convergence/Divergence
Understanding central banking in the European Union since the introduction of

the euro turns critically on one question that is central to this volume: how far has
the experience of monetary union been accompanied by convergence? It also
raises a further vital political question: what is all this doing to the way power is
wielded in central banking? Our opening question immediately brings us to
others: how far convergence, if it is occurring, is traceable to the introduction of
monetary union; how far, if it is occurring, it is characteristic of those systems that
have joined the Euro Area; and, alternatively, how far does it embrace those
occupying varying positions outside the Euro Area. As Marcussen’s discussion of
Sweden and Denmark in this volume shows, formal Euro Area membership need
not be the key consideration—a good deal of convergence can take place inde-
pendent of these formalities. His chapter also alerts us to an important point that
shapes much of what follows here: ‘convergence’ or ‘divergence’ has many faces,
and, in attempting to estimate change, we need at least some notion of how to
explore these different faces. That is particularly so in the case of financial market
regulation and supervision because, as we shall see, there are complex connec-
tions between wider market conditions, the organization of regulatory institu-
tions, and the understandings that underpin both perceptions of the significance
of market change and the purpose and workings of regulatory institutions.

We are grateful for many helpful comments offered in the British Academy Workshop of
November 2007, at which drafts of chapters were presented; to the editors for their acute
comments, and their patience; and above all to Lucia Quaglia for numerous perceptive com-
ments and characteristically generous sharing of information.
337
Financial Supervision
These last remarks provide the shape of what follows, for they allow us to
make a distinction between three different faces of change that deeply affect
supervisory worlds: the structural, the institutional, and the epistemic. The
structural face of convergence/divergence refers to changes in the scale, organ-
ization, and trading patterns of financial markets and in the key actors in those
markets. The extent to which, for instance, convergence is, or is not, taking
place through the cross-national integration of markets is obviously a crucial
underlying force—though not necessarily a determining force—in the extent
to which regulatory and supervisory institutions are being reshaped. The insti-
tutional face of convergence/divergence refers to the extent to which institu-
tions responsible for regulation and supervision are coming to resemble each
other in their structures and responsibilities and, at the most developed, the
extent to which European Union–level institutions are appearing. Finally, the
epistemic face refers to the extent to which the creation of an epistemic com-
munity of banking regulators has been hastened in the age of the euro; the
extent to which, if it has been hastened, that process can be traced to the
experience of European monetary integration; and the extent to which an
epistemic community characterizes the borders of either the EU as a whole or
the Euro Area?
These distinctions are important for one obvious analytic reason: that we
should not expect the three faces of convergence/divergence to change in unison,
or even to vary in the same direction. But they are also important for substantive
(historical) reasons. Structural convergence, and the supervisory issues that it
raises, is hardly the creation of the age of the Euro Area. Likewise, the organization
of supervision neither dates from the establishment of the Euro Area, nor is it
confined to the Euro Area or the EU. On the contrary, for a long time the key arena
of supervision has lain, and continues to lie, in the Basel Committee on Banking
Supervision of the Bank for International Settlements. That is a natural and
unavoidable outcome of structural convergence in global banking markets
(Basel Committee on Banking Supervision 2003, 2007). Perhaps most important
of all, the epistemic community of central bank regulators and supervisors has a
long history—and, as Marcussen’s work (2007b, and in this volume) shows, may
indeed be subject to a process of convergence that is more or less independent of
anything that is happening either in the EU or in the Euro Area.
Of these three faces of convergence/divergence, the epistemic face is the most
important, for it affects the exercise of ‘soft’ power (Nye 2004). Power in cross-
national banking supervision is ‘soft’ because governance operates via dispersed
networks, not hierarchically authoritative institutions; because compliance is
the product of negotiation; and because the ‘soft technology’ of bank regula-
tion depends on the development of shared understandings about the pur-
poses, the techniques, and the substantive rules of banking supervision. All
these reasons help explain why it makes sense to speak of an epistemic com-
munity in cross-national banking supervision and regulation.
338
Reflecting on the language root of the complex concept of ‘epistemic’ com-

munity clarifies what this means. An epistemic community is a knowledge
community: that is, it is unified by a common acceptance of what constitutes
appropriate knowledge about its regulatory and supervisory world and, by
extension, by agreement about an appropriate language in which to discuss
this world. The growth of epistemic convergence therefore does not necessarily
imply the growth of a substantive consensus about what the substance of
banking supervision arrangements should amount to. On the contrary, our
case confirms Marcussen’s picture (2007b and this volume) of the growth of
an intellectual world where central banking discussions are conducted in the
language of science: arguments are validated by appeals to evidence which can
be scrutinized for confirmation or disproof. This growth moves policy debate
from reliance on practical experience to reliance on evidentially backed claims.
In so doing it also replaces tacit knowledge accrued from practical experience,
only available to insiders, with knowledge available in public domains. In
‘modernizing’ central banking it creates a special new politics of transparency
and accountability (Blinder 2004; Jabko in this volume). It is consequently as
likely to decrease as to increase substantive agreement about how to conduct
banking supervision, for it has the hallmark of scientific exchange: it can
be contested by anyone equipped with technical skill, rhetorical capacity,
and access to (increasingly easily accessible) data. In this world power is
‘soft’, therefore, because ‘evidence, argument and persuasion’ are central to
the exercise of influence over policy outcomes (Majone 1989).
The chapter contends that an analysis of central banking—within wider
processes of financial internationalization—reveals the degree of soft power
accorded to central bankers. Whilst we highlight the remaining specificities of
national politics and the slow pace of institutional convergence, the extent of
epistemic convergence within the central banking community reveals the
importance of banking elites and common (scientized) language to our under-
standing of the dynamics of convergence.
We examine these three faces of convergence/divergence—structural, insti-
tutional, and epistemic—in turn. We then use them in a case study of the first
great regulatory crisis of the system, that following the US ‘sub-prime’ crisis of
2007. The chapter begins, however, with a brief organizational summary of
regulatory arrangements in the age of the euro.
Organizing Bank Regulation and Supervision in the

Age of the Euro
The formal arrangements governing the supervision of EU financial systems

have been neatly summarized as follows: ‘The banking model adopted by
the EU is the universal banking model, which permits banks to undertake
339
investment banking activities, while leaving it to national banking regulators to

control financial conglomerates, the ownership structure of banks, and their
relationship with industry’ (Dermine 2006: 59). The legal framework for this
arrangement is contained in key clauses of the Maastricht Treaty of 1993, which
simultaneously allocates supervision to the national sphere but leaves open a
residual responsibility for financial stability to the European Central Bank.
According to Article 105(2),
The basic task to be carried out by the ECSB (European System of Central Banks)
shall be:
. To define and implement monetary policy of the Community

. To conduct foreign-exchange operations consistent with the provisions of Article 109
. To hold and manage the official foreign reserves of the Member States
. To promote the smooth operations of the payment systems (emphasis added).
Article 105:5 fleshes out this last provision:
The ECSB shall contribute to the smooth conduct of policies pursued by the competent
authorities relating to the prudential supervision of credit institutions and the stability of
the financial system.
But Article 105:6 sets boundaries to the exercise of any powers by the ECSB that
might intrude into the competence of national supervisory authorities:
The Council may, acting unanimously on a proposal from the Commission and after
consulting the ECB and after receiving the assent of the European Parliament, confer
upon the ECB specific tasks concerning policies relating to the prudential supervision of
credit institutions and other financial institutions with the exception of insurance under-
takings.
In Dermine’s (2006: 61) words again ‘The Treaty is explicit on the principle of
decentralization and allocation of regulatory powers and supervisory powers to
national central banks. It is only in very special circumstances, and with unan-
imity in the European Council, that the ECB will be allowed to regulate or
supervise financial institutions.’
This formal picture of decentralization needs to be qualified in three ways.
First, the pattern of financial supervision at national level is a complex patch-
work, often plagued by coordination problems—evident in the crisis of 2007,
examined below. It is a curious mix of different historical institutional legacies
(central bankers); of different private and public partnerships (depositor protec-
tion schemes); and the diffusion of independent regulatory agencies, such as the
UK Financial Services Authority (FSA), dating from 1997, and the German
Bundesanstalt für Finanzdienstleistungsaufsicht (BaFin), dating from 2002 (for
overview, Kahn and Santos 2004). What is more, the patchwork is becoming
more complex with the accession of new EU member states carrying a wide
range of institutional histories and supervisory traditions (Johnson 2006;
340
McDermott 2007). This institutional mess obviously creates opportunities for

the ECB to intervene.
Second, even under the formal statement of institutional arrangements, the
ECB is endowed with an advisory role in the regulatory process, and we shall see
that there are good grounds for believing that this role is important in the
process of epistemic convergence. Third, even under the established nationally
based supervisory arrangements, the supervision of cross-border banking has
developed important coordinating institutions. Two particularly significant
examples are described in detail by Quaglia (2007a,b). The first is the European
Banking Committee, a Commission-chaired, ‘level-2’ Committee under the
Lamfalussy procedure, established in 2005, underpinned by a number of work-
ing parties, and concerned principally with aspects of the transposition of the
Basel 2 agreement (see below) on capital adequacy standards. The second is the
Committee of European Banking Supervisors, established in 2004, which is
composed of representatives of national banking supervisory authorities. Qua-
glia’s summary catches exactly the significance of this two-part committee
structure: it is instrumental in the creation and strengthening of the epistemic
community of bank regulators. Hence ‘it advises the Commission . . . as regards
the preparation of draft-implementing measures in the field of banking activ-
ities. . . . It contributes to the consistent implementation of EU directives by
issuing ‘‘standards’’ and ‘‘guidelines’’ and to the convergence of member states’
supervisory practices. . . . Finally, it promotes supervisory co-operation, includ-
ing through the exchange of information’ (Quaglia 2007b: 12).
It will be plain even from this brief account that the organization of regula-
tion and supervision is more complex than can be comprehended from the
formal arrangements alone; we need to explore the different faces of the system,
the task of the next section.
Structural, Institutional, and Epistemic Convergence
The growing extent of structural convergence in financial markets is virtually a

truism—one of the key features of the modern financial services revolution. In
contrast, the degree of integration of both institutions and market practices
between the national banking systems of the EU has lagged behind integration
in many other important markets (see Véron 2007). In the last 15 years, how-
ever, ‘Europeanization’ has accelerated significantly, creating a broader struc-
tural convergence that lies behind ‘headline’ cases like the acquisition of Abbey
in the UK by Gruppo Santander. The most up-to-date summary comes from
ECOFIN in 2007:
Integration in EU banking markets is foremost taking place at wholesale level and
through the cross-border consolidation activity of a limited number of larger banking
341
groups. Out of approximately 8700 licensed banks in the EU, 46 large banking groups
with cross-border activities (both wholesale and retail) have emerged. They represent 58
per cent of total EU banking assets and more than one quarter of their assets (over 14
per cent of total) are in other Member States. 21 of these groups have significant
operations outside their home country. . . . In the Member States which acceded in
2004, on average 70 per cent of banking assets are foreign-owned and the market
share of foreign banks often exceeds 50 per cent.
(Economic and Financial Committee 2007b: para. 22)
It is precisely this history of growing structural convergence which has given

rise to an extended debate about the extent of, and desirability of, institu-
tional convergence. The formal institutional structure of the regulatory and
supervisory system has been striking for its lack of institutional convergence.
It is a hybrid (Kahn and Santos 2004) which formally assigns the ECSB only a
subsidiary and advisory role in the prudential management of the system. As
we have seen, it is charged with a responsibility to promote the smooth
operation of payment systems; its Banking Supervisory Committee is the
most important forum where the national banking supervisors meet to
consider issues of coordinated management; and, as we saw above, it has
established a presumptive right to an advisory role in supervision discus-
sions. Meanwhile, the organization of banking supervision remains heavily
biased to national institutions, and, as we noted above, there is considerable
diversity in the way that individual EU states organize their supervision
arrangements.
It is striking how far this contrasts with both the expectations of the Lamfa-
lussy ‘Wise Men’ (2001) and academic prediction (Lee 2005). Whilst stipulat-
ing that increased cooperation between national regulators was the most
obvious immediate solution to banking supervision, the Wise Men (2001:
95, emphasis added) contended that future developments might engender ‘a
Treaty change, including the development of a single EU regulatory authority’.
Lee (2005) argued that, precisely as a result of national diversity, regulation
would become increasingly centralized. But there have proved to be two
obstacles to institutional convergence, both of which are important for our
argument. First, banking regulation remains a highly sensitive national policy
area: we shall see that in the 2007 crisis domestic political calculations over-
rode everything. Second, a substantive consensus on how to supervise banks
remains elusive. Epistemic convergence does not imply increased substantive
agreement on regulatory options.
These assertions have been further compounded by former ECB director
Padoa-Schioppa’s recently rejected proposals for a European financial author-
ity. Following a review of the Lamfalussy Process he suggested that, whilst
current arrangements were a dramatic improvement on its predecessor,
‘current arrangements for co-ordinating national supervisory activities are
overly complex and burdensome’ (Padoa-Schioppa 2007). His solution: an
342
‘integrated supervision of EU-wide groups, resting on a complete pooling of

information and the enhancement of the powers of the colleges of supervisors’
(ibid.). Significantly though, and as our argument suggests, his proposals were
rejected within ECOFIN where national interests continue to override collective
Eurozone concerns (Economic and Financial Committee 2007a).
That said, there is not only considerable diversity in the way the component
parts of the EU and the Euro Area manage supervision, but also in the way they
approach the task of managing the stability of the banking system in crisis
conditions—in other words, of organizing the ‘lender-of-last-resort’ role, trad-
itionally the way central banks have both tried to create trust in the stability of
banking institutions and, when that trust breaks down, stood behind individ-
ual institutions. There is no Euro-Area-wide capacity to provide a ‘lender-of-last-
resort’, because whilst ‘the ECB can manage overall liquidity through monetary
operations . . . the arrangements put in place in the Eurosystem, namely the
pre-specification of what the ECB can accept as collateral, make it impossible for
the ECB to meet the liquidity needs of an illiquid financial institution that runs
out of assets qualifying as a collateral according to the established list’ (Kahn
and Santos 2006: 352).
Within states there is also some diversity in how this role is managed. In most
cases, responsibility is assigned to member-state central banks, but even here
there is national diversity. Germany, for instance, has a specialized liquidity
consortium, the Liquiditäts-Konsortialbank GmbH, ‘a private company jointly
owned by the central bank and the private banks’ (Kahn and Santos 2006: 52).
It is precisely this diversity which led to calls in 2007 for the creation of a more
uniform, centralized system of inspection and regulation (Véron 2007). We will
return to this issue in considering the crisis of autumn 2007.
This simple sketch of modes of convergence suggests that there is a consid-
erable disjunction between the first two faces, the structural and the institu-
tional. Whilst, by the wider standards of the European economy, the banking
industry has been a laggard in structural convergence, in recent years the degree
of convergence has increased considerably. By contrast, there is considerable
‘stickiness’ in the development of the institutional system, with regulatory and
supervisory responsibility and authority continuing to reside at the national
level. It is precisely this apparent disjunction—and, of course, attempts at
empire building—which has led to calls for the enhancement of capacity at
the EU level (Véron 2007). Both the institutional ‘stickiness’ and the empire
building are precisely what we would expect from standard neo-institutional
rational choice theory.
Easily the most striking feature of European banking regulation is the
increasing degree of epistemic convergence. There are four indicators. First,
European central banking exemplifies the signs of epistemic transformation
highlighted by Marcussen in this volume: the shift from an image of banking
regulation as primarily a ‘practical’ activity, involving the mobilization of the
343
tacit knowledge of those with business experience to the rise of those who
claim a professionalized, systematic knowledge of bank regulation. The most
developed version is the emergence of the profession of bank regulator,
either in specialized divisions within central banks or in ‘non-majoritarian’
regulatory organizations like the United Kingdom FSA. Whilst there exists no
single policy paradigm, there is a high degree of homogeneity within the
‘community’ of banking regulators. It is composed predominantly of trained
research economists and specialists with PhDs in financial economics. For
example, the Committee of European Banking Supervisors (CEBS) comprises
46 active members from respective national regulatory agencies. Of this num-
ber, three are professors at the universities of Amsterdam, Portugal, and
Vienna (Arnold Schilder, Pedro Duarte Neves, and Andreas Ittner), whilst
a further three are university lecturers (Rumen Simeonov, Jukka Vesala, and
Mihaly Erdos). At least eight of the members hold PhDs, whilst a further three
have postgraduate qualifications in economics. Of the remaining mem-
bers, the majority are trained research economists. This is clearly a ‘scientific’
community.
Second, the creation of the ECB has itself been a major contribution to this
epistemic convergence, for it functions as a highly technocratic institution: a
big employer of the professionally qualified; a big supplier of standardized data
conforming to agreed technical forms; and a major disseminator—through its
working paper publications, its monthly review, and its twice-yearly Financial
Stability Review—of bodies of data. Just how far the discussion of regulatory
issues is now encapsulated in a highly technical language that the profes-
sionals use to communicate is illustrated by a passage in the June 2007 issue
of the ECB Financial Stability Review. A boxed study offers an elaborately
modelled account of banking and insurance risks, which covers three pages.
It introduces the features in the following way:
From a financial stability perspective, it is useful to decompose the risks faced by the
financial sector into systematic, sector-specific and idiosyncratic components. The aim
of this Box is to apply a latent factor model framework to achieve such a decompos-
ition for both the banking and insurance sectors. Principal component analysis is a
dimension reduction technique that makes it possible to approximate large multivar-
iate datasets with a limited number of factors which account for the largest share of the
changes in the original data. The variance of the data can be explained by a model of
unobserved factors that are common to all or most of the variables, and an idiosyn-
cratic component which corresponds to variable-specific factors. In this way, each
variable can be represented as a linear combination of common factors plus idiosyn-
cratic ones. (ECB 2007: 115)
This scientific turn is not confined to the ECB. In states within the Euro Area
the very creation of the ECB has led to significant changes in goal definition
for those domestic institutions that carried out the central banking functions
now performed at supranational level. The consequence has been a major
344
adaptation in mission—a turning to data analysis and research. As Marcussen

notes (this volume, Chapter 17), with the advent of the euro national central
banks in the Eurosystem have turned increasingly to research, investing in
specialized personnel, in part to compensate for the disappearance of some
historically important functions.
Third, this new spirit of scientific rationality is being used to forge an
epistemic community of supervisors and regulators via the institutional
developments described earlier: the creation of networks of advisory commit-
tees that engage with the most technical details of regulation. The advisory
committees help create the institutional networks that are the necessary under-
pinning of the epistemic community, along with the specialized language
that gives the community its epistemic character. In this process they reflect
the wider epistemic transformation of central banking since, as we saw, they
are in part concerned with transmitting concepts from the wider inter-
national epistemic community of central bankers, in the form of the trans-
formation of the Basel (II) framework rules. The words of the European
Commission exactly catch the rise of a world where participants speak a
common technical language, and work to solve regulatory problems in that
language:
Increasingly, standards and best practices are set and defined at global level, for example
on accounting, auditing and banking capital requirements. Considering the size of the EU
market, and Europe’s experience in pragmatically uniting the legitimate call for harmon-
ised rules and the diverging needs of different markets/cultures/players, the EU must have
a leading role in standard setting at global level.
(Commission of the European Communities 2005: 15)
Fourth, the politics of enlargement for the new EU accession states—notably

those in the former command economies—have seen a considerable expan-
sion of the range of this epistemic world, principally through the activities of
the ECB as an evangelist of responsible banking regulation. The ECB has built
and consolidated its sources of prudential capacity and expertise. In the pro-
cess it has been able to act as a significant agent of institutional and policy
transfer of central banking supervisory expertise. The ECB has also been able to
offer institutional support to embattled central bankers in the accession states.
This support has been necessary because the success of the attempt to extend
the epistemic central banking community has in some individual national
cases confronted the raw politics of economic and political change in states
still attempting to make a painful transition to democratic capitalism (e.g.
Johnson 2006).
This sketch of convergence and divergence in the age of the euro suggests
three obvious conclusions. First, and most important, our opening suggestion is
plainly vindicated: it is not possible to speak of convergence as if it were a
unified phenomenon. Structural convergence has been moderately encouraged
345
by the new monetary regime, and more importantly by the long-term

consequences of the Maastricht Treaty. Second, in comparison with struc-
tural convergence in other sectors, that in banking remains modest. Institu-
tional convergence—in the sense of the creation of authoritative institutions
charged with responsibility for supervision—has been much more limited.
Indeed, the tendency in some cases to create specialized independent regula-
tory agencies in response to regulatory crises has, if anything, increased the
diversity of the institutional patchwork that is concerned with bank regulation
across the EU. Third, the most significant form of convergence is epistemic in
character, and it has both social and intellectual aspects. Socially, it consists of
the creation, and strengthening, of networks joining regulators across national
domains; intellectually, it amounts to the creation of a shared language that
expresses regulatory issues in a technically complex discourse.
We have argued that, whilst the phenomenon of epistemic convergence is
part of a wider global phenomenon, it has been given a considerable impetus
since the creation of the Euro Area. One conclusion that might be inferred from
this argument is that the functional effectiveness of banking regulation is
assured because of the capacity of epistemic convergence to compensate for
any lack of institutional coordination. But, as the brief account of the 2007–8
banking crisis shows, this cannot be safely assumed.
The Crisis of 2007–8: Convergence or Divergence?
Regulatory systems rarely change radically without being subjected to some

intense external stress. ‘Crisis’ in regulatory change has a double significance:
it marks, usually, a moment of dramatic failure in regulatory arrangements;
and it marks what ‘crisis’ exactly means—a turning point, when all kinds of
established ways of doing things are suddenly abandoned. It has that double
significance because it constitutes a moment of great danger, where averting
the danger often means abandoning existing institutional practices and
modes of thought. In other words, crisis is a moment for policy creativity,
involving sharp increases in levels of institutional and epistemic conver-
gence. What is most striking about the crisis of 2007 is the absence of these
features. It did indeed produce radically new ways of thinking about the
problem of bank regulation, especially in the national system that was most
publicly and intensely affected by the crisis; but the extent of institutional and
epistemic learning at the systemic level of either the EU or the Euro Area has
been slight. To this judgement must be attached an obvious caveat: at the time
of writing the story of the crisis is still unfolding, and what is more is
being written from the outside. We cannot yet know how far the continuing
unravelling of the crisis, or reflections on the crisis by policy actors, will impel
change.
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The character of the crisis has been concisely summarized by the Vice-Presi-
dent of the ECB as follows:
The month of August (2007) was characterised by a substantial increase in financial

market volatility and a reappraisal of risk. The financial market turbulence was trig-
gered by a series of events which intensified tensions in the US subprime mortgage
market. This resulted in an adjustment of investors’ attitudes towards risk—a dimin-
ished appetite for risky assets—and led to an increase in uncertainty about financial
market conditions and prospects. Market volatility rose sharply in almost all asset
classes. Stock markets tumbled, as investors sold equities and moved funds into safe-
haven investments, like government bonds. Several investment funds holding asset-
backed securities—with subprime mortgage elements—suspended withdrawals. At
roughly the same time, a number of European banks made public their direct and
indirect exposures to the US subprime mortgage market. These exposures were some-
times sizeable but were not sufficiently significant to materially impact the soundness
of core financial institutions. In addition, several banks, especially in Europe, were
subject to rumours about severe losses stemming from exposures to mortgage-backed
securities. (Papademos 2007)
Banking crises usually spring from wider problems in the macro-economy, and
this crisis fits that pattern. Its origins lie in the financial history of the United
States in the new millennium: an age of cheap money, intense competition
between financial institutions, and a continuing history of financial innov-
ation; in other words, an extension of the now quite familiar history of the
financial services revolution. That competition opened up new markets, in
particular the notorious market in ‘sub-prime’ mortgage-backed loans, when
poor credit risks were encouraged to take out property-backed mortgages—
often on the basis of fraudulent declarations of ability to repay loans. The
extent of bad debt problems in that market became clear in spring 2007. The
mechanism by which these problems were more widely, indeed internation-
ally, transmitted shows one aspect of convergence that we identified earlier:
structural convergence. The growth of internationally integrated markets in
securitized debt led to the packaging of these sub-prime loans at attractive
rates. It was the packaging, and therefore the aggregation of these dubious
loans into securitized bundles, that left many financial institutions with com-
mercial paper that was of dubious worth—or in some cases actually worthless.
That in turn led to a climate revealed in any anatomy of financial crises: a crisis
of trust between actors in markets, an unwillingness to do business in this
atmosphere, and a consequential inability of some institutions to finance
their loan books. As always in financial crises, there were two elements which
interacted in complex ways: a ‘real’ crisis as some institutions discovered
that large parts of their loan book were worthless, or of considerably less
worth than imagined, since the value of the paper which had been securitized
had been greatly overvalued; and a crisis of trust encompassing a much wider
range of institutions as, in conditions of non-transparency, institutions
347
declined to deal with, especially to loan to, each other, in the absence of good
information about the scale of systemic problems.
The mechanism by which this was transmitted to Europe was the global
organization of this market in securitized paper. August saw bailouts for two
German banks, arranged in an ad hoc fashion by the Bundesbank, and disclos-
ure of serious losses at a range of other institutions in France and the Nether-
lands. In the same month the ECB, in its role as system manager, made the
largest injection of funds into the market since the ‘9/11’ crisis of 2001. In
September the crisis prompted the first public bank run in the United Kingdom
since the nineteenth century when customers queued outside the branches of
Northern Rock, a former building society converted into a bank with a large
mortgage property-backed loan book financed by borrowing on the inter-bank
market. The crisis of 9 August caused a sharp change in behaviour in the inter-
bank loan market; Northern Rock found it increasingly difficult to fund its
borrowing, and was obliged to reveal that it had turned to the Bank of England
for assistance. This announcement prompted a collapse of confidence in the
bank on the part of large numbers of individual investors, who queued to
withdraw their money. Repeated assurances from the elite of the domestic
regulatory community (the governor of the Bank of England, the Chancellor
of the Exchequer, and the head of the Financial Services Authority) failed to
convince depositors. Only the announcement on day five of the crisis that the
Exchequer—that is, the full resources of the state—stood behind Northern
Rock, and would guarantee all £28 billion of its deposits and, by implication,
the deposits of all other banks in the UK, saw an end to the public panic, though
not to Northern Rock’s problems, as a further loosening of the terms of
assistance in October showed (Bowers and Inman 2007). The exact connection
between the contagion of panic and real problems with the worth of Northern
Rock’s loan book has still to be established at the time of writing.
The crisis shows that structural convergence is now particularly important,
though it is not clear that we can identify an independent Euro Area effect.
The signs of this convergence are plain both in the development of integrated
markets dealing in the tainted paper, and in the rapid spread of the contagion of
panic across markets in different national jurisdictions.
In contrast, the crisis shows the persistence of institutional divergence. This
was naturally the case in the instance of the UK, which has remained outside
the Euro Area, and where the management of the crisis was largely determined
by domestic political pressures. In the case of the Euro Area, the diversity of
institutional responses is also striking. The epicentre of the crisis, the two
German banks that went under, was largely managed domestically, by ad hoc
coalitions organized principally by the Bundesbank.
The organization of the British crisis is particularly striking, for here we are
talking about the dominant banking centre in the EU. As we have noted, the
UK was not the only national system to experience crisis, but what makes the
348
case special are two considerations: the UK—or rather the City of London—is
the linchpin of the European banking system; and the crisis of Northern Rock
was peculiar in its public character, its scale, and its prolonged form. It
involved a complex system of bureaucratic politics between four institutional
actors: the Bank of England, as central bank responsible for the orderly con-
duct of the markets; the Financial Services Authority, the responsible regula-
tory body; the Treasury, which in the end was the only effective ultimate
guarantor because the resources of the state stood behind it; and other key
actors in the core executive, notably the Prime Minister, anxious that the crisis
not fatally damage public confidence in the capacity of the Labour Party to
manage financial markets. In part this bureaucratic politics involved the
familiar search for some means of effective coordination under the pressure of
a crisis which demanded rapid response, and the equally familiar ‘blame game’
which is played in all regulatory disasters.
But above all what is striking about the UK crisis is the way its attempted
resolution was prescribed by the high politics of the core executive. The
Treasury’s guarantee to cover all the deposits was prompted by the fear that
otherwise New Labour would experience its own ‘Black Wednesday’, the cur-
rency crisis that destroyed public confidence in the financial capacity of the
Conservative Party for more than a decade. What is more, the institutional and
epistemic faces of the UK system after the crisis were largely conditioned by
the domestic UK context. The intellectual content of the debate about the
regulation of systemic stability has been dominated by the interests of small
and medium-sized depositors: in the crisis-driven guarantee by the Chancel-
lor, as he desperately sought to avoid meltdown at the height of Northern Rock
panic, that all deposits would be safeguarded by the state; in the subsequent
ad hoc extension of the generosity of the deposit protection scheme; and in the
announcement that this is indeed only ad hoc, contingent on a review of the
scale of the whole scheme. The Chancellor has now foreshadowed the legisla-
tion that will be introduced to reform the system in the spring of 2008. It is still
not clear who the big winner will be. The Chancellor’s initial thoughts advan-
taged the Financial Services Authority, which would be given more statutory
control over the banking system (Parker and Strauss 2008). But the most recent
intervention in the debate about blame—the report of the House of Commons
Treasury Select Committee on the affair—is scathing in its judgement of FSA
regulatory incompetence (Treasury Committee 2008).
This interpretation is confirmed by the tentative scheme announced in
January 2008 to rescue Northern Rock through a convoluted public–private
partnership—a package designed to avoid tainting the Labour government
with the stain of nationalization of a major financial institution. Likewise the
institutional face of the crisis has been dominated by the ‘blame game’: the
attempt to blame the present administration for the allegedly uncoordinated
character of the present system; the attempt to avert blame, notably by the key
349
actor in the core executive, the Prime Minister, who is the official author of that
system; and the attempt by the different institutional actors (the central bank,
the Financial Services Authority, the Treasury) to shift blame between each other.
If structural convergence, and institutional divergence, was the mark of the
crisis, the epistemic face of the crisis is remarkable for its lack of change. Crises
in any regulatory system are important because they typically force actors to
think in entirely new ways, not just about the management of the particular
crisis, but about the management of the whole system. There is very little
evidence of this here. The ‘don’t panic’ response of the ECB president, Jean-
Claude Trichet, in mid-August 2007—‘I call on all parties concerned to continue
to keep their composure’—catches this resistance to anything epistemically
radical. Likewise the response of European Commissioner Charles McCreevy
after the mid-September meeting held when the Northern Rock crisis was still at
its most intense: ‘We are making progress, but I would not want to put it any
stronger than that. . . . We are moving to the next stage. You can only move as
fast as you are allowed’ (Barber 2007). It is true that as the systemic crisis
intensified in the spring of 2008 central banks were propelled to a more activist
stance in trying to stabilize the system; but this activism was belated, ad hoc
and uncoordinated.
Why is a system which is experiencing significant structural convergence,
and which in the crisis of 2007 suffered so dramatically the consequences of
that structural convergence, showing such an inability to converge institution-
ally and epistemically? The modern age of banking instability began in the early
1970s, and what has been most marked is precisely the capacity of policy actors
to learn from the successive crises—to remake institutions radically, and to
refashion their epistemic worlds. Why is the Eurosystem finding this so diffi-
cult?
Three possibilities suggest themselves. The first may be expressed in the
question: crisis, what crisis? The little local difficulties of summer and autumn
2007 were, after all, managed Trichet-fashion—by a little flexibility. It is, how-
ever, hard to maintain this equable response in the face of problems that
continue to unfold, the collapse of banks, and the first public run on a bank
in the EU’s leading banking member for over a century. A second possibility in
effect derives from neo-institutional theory: that the EU’s institutions are so
laden with veto points that, in McCreevy’s words, ‘you can only move as fast as
you are allowed’. But this is hard to reconcile with the evidence presented
earlier of the dense organized epistemic community, itself linked to wider
global communities of banking regulators, used to confronting problems of
regulation in a well-developed technical language. The ‘scientization’ of cen-
tral banking identified by Marcussen (this volume) has provided regulators
with a set of well-developed intellectual tools. A third possibility is that,
writing still as the crisis unfolds, we are too early to pick up the transform-
ations that may be taking place. It is, indeed, a feature of the transforming
350
power of crisis that even participants may not be aware just how much they are
changing under the pressure of critical events. And, as we have noted, the crisis
has already forced a growth in central bank activism in crisis management.
Soft Power, Banking Regulation, and the Eurosystem
The exercise of power in banking regulation and supervision is necessarily

‘soft’: it depends crucially on the appropriation of effective symbols, special-
ized discourses, and communicative competence. That is what makes the
evolution of epistemic communities so critical. But there is a paradox in the
recent regulatory history of central banking, and it is a paradox which im-
mensely complicates the regulatory life of the Eurosystem.
The story of epistemic convergence is not just, or even mainly, a European
story. The centre of the epistemic community of banking regulators lies in the
Basel Committee. European regulators, though important, are only one sub-
set of the Basel participants. The age of the financial services revolution has
also been the age of the emergence of a highly distinctive epistemic world.
Blinder’s (2004) central banking revolution encapsulates this epistemic trans-
formation. The modernization of central banking has seen the growth of a
more transparent, accessible world, where issues of regulation are expressed in
a technical language widely accessible, both to insiders and to outsiders. Bank-
ing regulation has become more ‘scientific’.
But since the age of the financial services revolution has also been an age of
crisis, collapse, and scandal, we must conclude that regulators have become
less successful at their core task—to ensure financial stability. Over nearly two
decades the transformation of central banking has been accompanied by
success in the search for macro-economic stability, and failure in the search
for prudential stability. Central bankers have become better at helping to
manage whole economies, but worse at managing the prudential stability of
banking institutions. They have become better at talking about the tech-
niques of prudential supervision and stabilization, and worse at practising
those techniques. They live in a world of carefully constructed regulatory
models—and in the world of panic, chaos, and bafflement revealed in the
great crisis of 2007–8.
The Regulatory State is Dead! Long Live the Regulatory State!

Panic, chaos, and bafflement intensified throughout 2008 and culminated in a
global crisis of bank supervision in September–October of that year. The col-
lapse of Lehman Brothers, the American investment bank, on 15 September
2008, led to the final eruption of that crisis. It also produced an astonishing
increase in epistemic convergence in the world of bank regulation. The crisis
351
showed that the distinction alluded to in the preceding paragraph—between

macro-economic stability and prudential stability—is illusory. The two are
bound together. The failure of prudential regulation is a disaster for macro-
economic stability. The new ‘long boom’ in the global economy has abruptly
ended, on foot of which we will experience global recession. This catastro-
phe explains the epistemic convergence. It also explains the form taken by
convergence.
Financial supervision in the first years of the Euro was an attempt to practice
the principles of the regulatory state sketched nearly two decades ago by
Majone: a Madisonian, technocratic ruling order which excluded democratic
politicians in favour of non-majoritarian regulatory institutions. In the crisis of
2007–8 that regulatory state was weighed in the balance and found wanting.
Confronted by crisis the bankers and the technocratic regulators froze, petrified
like rabbits before a stoat. Now, the great agents of transformation are not the
central bankers and financial regulators who until recently reigned supreme.
The agents of transformation are democratic governments driven by fear of the
electoral consequences of macro-economic collapse. The crisis produced rapid
learning and innovation—a common social function of any crisis. But it was
politicians who learnt most rapidly, not central bankers still trapped in the
mind world of the long boom. The epistemic convergence that occurred killed
the old regulatory state—and is creating a new one. Across the capitalist world it
turned banks into public utilities. Every big capitalist economy has taken
significant public ownership stakes in the banking industry. The leader in
innovation was the United Kingdom. That is not surprising, for the UK econ-
omy teetered most precariously on the extraordinary financial pyramid
revealed by the crash of September–October 2008. But the UK was soon fol-
lowed by other major EU economies, by frenzied coordination among the G7,
and then—astonishingly—by the Bush Administration in Washington.
The terms of regulatory discourse were also transformed. It became impos-
sible credibly to use the language of light touch flexible regulation. The crisis is
the precursor of a new wave of controls: more adversarial, more juridified, and
more exposed to the pressures of democratic politics. This is the new regula-
tory state now being born. The regulation of financial markets—and probably
of capitalist economies generally—has been irreversibly transformed into an
object of democratic political struggle. The age of the long boom was also the
age of the scientization of financial supervision—a scientization anatomized
in Marcussen’s contribution to this volume, and in some of the account of EU
supervision offered earlier in this chapter. It may be that powerful interests in
the markets will still be able to capture the regulatory process; but to do so
they will now have to struggle against democratically elected politicians and
the social forces that press on those politicians. Control of trading practices
and of reward systems is no longer in the hands of the markets. As the global
crisis deepens it may even be that the crown jewels of the old regulatory
352
state—central bank independence in setting short-term interest rates—will be

lost to the politicians. This is why the crisis signals more than the end of the
long boom; it also signals the death of one state order, and the birth of a
successor. The Madisonian regulatory state is dead; a more democratic form is
coming into being. Death and rebirth will be accompanied by chaos and
suffering.
353
16
Monetary Policy Strategies
Iain Begg1
Contemporary macroeconomic policy places a premium on achieving stability

and largely eschews active demand management. In the pursuit of macroeco-
nomic objectives, monetary policy has become relatively more dominant over
the last two decades and central bankers have evolved from being shadowy
figures who cultivated their own mystique, such as Montagu Norman at the
Bank of England, in the inter-war years to become—in many eyes—the leading
actors in economic policy-making. Some, such as Alan Greenspan, are revered,
while others (such as European Central Bank President Jean-Claude Trichet)
attract critics as well as fans, but notwithstanding Bank of England Governor
Mervyn King’s stated ambition to make monetary policy boring, none is
ignored.
In parallel, there have been far-reaching changes in the strategies adopted by
the monetary authorities and there is an apparent convergence in approaches,
to the extent that what distinguishes different monetary policy strategies
today can appear minor compared with strategies that were in place 20 or 30
years ago. This chapter argues that the evident convergence has been driven by
a combination of theoretical developments in monetary economics and the
progressive intensification of research input into decision-making, together
with a recognition of the pitfalls of monetary and fiscal laxity. Yet, as Rose
(2007) points out, in the history of monetary policy, changes of strategy have
been frequent and even the variant on Bretton Woods with capital controls
and fixed but adjustable exchange rates only lasted 13 years from 1959–71. It
is, therefore, interesting to speculate on whether the convergence visible today
is likely to endure. Monetary policy strategies clearly continues to evolve,
albeit with pressures for change coming more from within the central banking
community and the academic specialists in the area (see, also, the chapter in
this volume by Marcussen) than from Europeanization as it is usually under-
stood. The credit market turmoil that started in August 2007 may, however, be
a source of new pressures for change insofar as it has raised questions about
355
whether central bankers have focused too much on price stability, to the
neglect of the underlying stability of the financial system.
The chapter sets out what appear to be the main features of the state-of-the
art, delves into why they have arisen, and explores emerging directions
for monetary policy and unresolved debates. It shows that today’s strategies
reflect evolving ideas about what monetary policy can, cannot, and should do,
and that in the EU, at least, there has been an intriguing iteration between
institutional and constitutional changes and the development of strategies.
There may not be a single model of best practice, but it is clear that there are
systematic preferences.
Aims of Monetary Policy
Monetary policy has evolved considerably over the last quarter of a century. In
many parts of the world it has become the primary instrument of macroeco-
nomic policy, with fiscal policy relegated to a supporting role. Price stability
has been elevated to be the principal policy objective, while granting of
independence from political control and various other institutional changes
in central banking, such as resort to monetary policy committees (MPC)
and new approaches to transparency, have come to characterize the broad
approaches deployed (Blinder 2004; Blinder and Wyplosz 2004; Mishkin
2007a; Siklos 2002). In this process, power has shifted from politicians to
central bankers and an intriguing element has been that this transfer has
happened with only limited public debate and, despite occasional rumblings,
has not elicited much opposition.
New ideas about the purpose and scope of monetary policy have been highly
influential, leading in some cases to significant legal and institutional trans-
formations, such as those that altered the role of the Bank of England during
the 1990s (see Goodhart’s chapter in this volume). In others (notably the US
Fed), the effects of new ideas have been more subtle, with substantial changes
of style or emphasis which draw on new thinking about how to conduct
monetary policy, even though the institutional framework has been stable
(see Woolley, this volume). Amidst these changes, it is evident that the manner
in which the European Central Bank (ECB) has been constructed partly reflects
the Bundesbank tradition, but is partly also attributable to the evolving norms
and practices of the central banking community of the advanced nations
(see, also, Howarth’s chapter in this volume).
Bernanke (2004b) suggests that two over-arching frameworks for monetary
policy can be distinguished. Although he draws parallels with the distinction
between ‘instrument rules’ and ‘targeting rules’ common in much of the
literature, he contends that these labels are somewhat misleading and opts
instead for the terms simple feedback policies and forecast-based policies as more
356
accurate descriptions of what lies behind the respective frameworks. The

former are exemplified by well-known options such as the Taylor rule and
are suited to contexts in which information on how the economy is evolving is
incomplete or hard to obtain and validate. Because a simple feedback relies on
a limited range of variables, it can also help to shape expectations, since
economic agents and the monetary authority are privy to similar and readily
understood information. Using forecasts rather than rules to anticipate how
the economy will evolve, including in response to policy changes, necessarily
requires more information as well as judgement on how to interpret risks and
uncertainties. As Bernanke stresses, it also offers better means for making use
of judgements, but has the drawback that the strategy of the central bank is
then more difficult for other actors to interpret. The approach therefore needs
to be complemented by more extensive communication aimed at explaining
the strategy. Despite its layers of complexity, Bernanke argues that the forecast-
based approach is winning over a growing number of central banks and that
this trend seems to have been associated with better results.
The monetary policy-maker has to be alert to underlying variables such as
the capacity of the economy and how it varies over time, the structural
characteristics that may influence when inflation is prone to accelerate and
the rate of interest likely to be consistent with stability (Tucker 2006). He
observes that judgements on such variables are very hard to make, partly
because they cannot be directly observed and partly because, as the economy
itself changes, the relationships between key variables will also change. In
addition, monetary policy has to reflect the conduct of fiscal policy which is
not just a flanking policy, but can (as happened in Germany in the early 1990s)
be a source of inflationary pressures. The character of structural policies—
certainly those affecting wage trends, but increasingly also those that have
bearing on product markets—will, too, shape what monetary policy has to do
(for a survey, see Leiner-Killinger et al. 2007). Tucker also stresses that well-
anchored nominal variables (such as prices) make the task of stabilizing the
real economy easier and he makes the link to central bank credibility by
pointing out that if a cut in interest rates is made, private agents will accept
that what monetary policy is trying to do is to prevent demand falling below
capacity, rather than engineering a short-term boost to demand that will result
in higher inflation in the future. However, he rejects the idea that monetary
policy can fine-tune the economy, preferring to describe what a central bank
can do as ‘rough-tuning’.
Monetary policy also has to be good at anticipating change, and cannot
afford to be largely reactive. Bernanke (2004b: 1) alludes to ‘several reasons for
concluding that good policies must be primarily forecast-based’. These reasons
include the need for pre-emptive policy-making, the importance of taking
account of the changing structure of the economy, and the value of what he
terms a risk-management approach to policy. The second of Bernanke’s
357
reasons is one of the most tricky because of the uncertainty about how the
economy will evolve (see, also, Tucker 2006). While some trends lend them-
selves relatively straightforwardly to prediction, certain structural changes are,
by their nature, much harder to factor into decision-making or to identify as
they happen. In the UK, for example, the wave of immigration following the
2004 enlargement of the EU was bound to have effects on labour market
pressures, but these could not be fully predicted. Breakthroughs that result in
new sources of supply or new ways of producing may result in step-changes,
and it is too easily forgotten that economics is a behavioural rather than a hard
science: consumption or savings patterns will not always respond identically
to particular signals. Bernanke cites the productivity surge in the late 1990s as
such a change.
From Monetary to Inflation Targeting

From the mid-1970s, monetary targeting was in vogue, a shift that can be
attributed partly to the growing influence of ideas rooted in monetarism, and
partly to the search for answers to the empirical phenomenon of the world-
wide surge in inflation from the late 1960s onwards. Monetarist analyses
stressed that expansionary monetary policy does not produce enduring effects
on the real economy, that inflation is costly, and that there are considerable
benefits from having the sort of strong nominal anchor offered by stabilizing
the growth of the money supply (Mishkin 2007a). The approach started to lose
support because of the breakdown of the underlying empirical relationship
between the quantity of money and inflation (i.e. variations in the velocity of
circulation) and the effects of what came to be known as Goodhart’s Law, the
finding that ‘any observed statistical regularity will collapse once pressure is
placed upon it for control purposes’ (Goodhart 2006).
Mishkin also notes that some central banks may have pursued monetary
targeting less vigorously than they should have done if the approach were
to work as advertised. At the same time, the Swiss and German monetary
authorities, despite frequently failing to hit their monetary targets, were
successful in keeping inflation low, an achievement that Mishkin ascribes to
their activism in communicating their aims and strategy to the public. Their
success also established the credentials of independent central banks, paving
the way for the gradual conversion of others as part of the broader paradigm
change. In both cases, too, the message conveyed was that even if there were
slippage in the short-term, it was long-run price stability that mattered.
Mishkin contrasts this consistency of communication with what he describes
as the game playing of the central banks of the UK, Canada, and the United
States which he believes hindered their communication process. For example,
he notes the targeting of multiple aggregates and a willingness to redefine
targets if they were not met, thereby undermining their credibility.
358
Over the last 20 years, dissatisfaction with monetary targeting caused by the
lack of stability of the relationship between monetary growth and prices
(Mishkin 2007a) has been superseded by forms of inflation targeting as the
preferred approach. In essence, inflation targeting shifts the focus from the
intermediate target of monetary growth to the outcome variable—price stabil-
ity. Its emergence as a nominal anchor for policy reflects the conjunction of
new thinking about how to deal with the time inconsistency problem2 and to
manage expectations better. Mishkin (2007a) makes the point that central
bankers can, in practice, cope straightforwardly with time inconsistency prob-
lems by refusing to let the short-term dominate, but if politicians—who typic-
ally have shorter time horizons—are able to instruct the central bank, time
inconsistency will remain. This is one of the reasons why independence of
central banks has become part of the contemporary monetary policy package.
What Should be Understood by Price Stability?

At one level, the core aim of monetary policy is obvious and there is little
dispute about the goal espoused by all monetary authorities of preserving the
value of money by assuring price stability. Price stability is valued as a public
good because the alternative—inflation—is acknowledged to cause welfare
losses. However, price stability is only one component of macroeconomic
stability and it is clear that society only values the former as part of a broader
set of objectives. Buiter (2006) points to a dichotomy between those central
banks which have price stability as their primary mandate and a smaller, but
weighty minority (it includes the US Fed, and the central banks of Australia
and Norway) for which it is not. Among the latter group, real economy aims
are as prominent as nominal stability.
The advantages of price stability are sufficiently compelling for it to be a key
goal of policy and most monetary policy strategies take for granted that this is
so. Uncertainty about price movements undermines the unit of account func-
tion of money, weakening the signalling role of prices, and leads to behaviour
by economic agents that is potentially disruptive. Hence, anchoring price
expectations is a core aim of monetary policy. However, as Bordes and Clerc
(2007) note, there can be departures from short-term trends that cannot easily
be pulled back without triggering sharp fluctuations in economic activity and
it is in this regard that certainty calls for monetary policy strategy also to have
the long-term price level in its sights. A price-level target might be an answer,
but has its own problems, not least the potential for increasing output
volatility. Instead, policy strategy has to map out a trajectory towards the
long-term trend, possibly with reference to intermediate variables such as
monetary aggregates.
While the definition of price stability might be intuitively obvious, Bordes
and Clerc (2007: 268) show that it has distinctive short-term and long-term
359
properties. In the short-term, price stability means anchoring price expect-

ations, whereas in the latter sense, it means ‘the absence of long-term price-
level uncertainty’. They argue that most research focuses on the short-term
anchoring role of monetary policy, but that the ECB monetary policy strategy
can only properly be understood by considering both objectives. In essence,
the distinction between the short- and the long-term hinges on the notion of
the neutrality of money vis-à-vis economic activity over the long-term,
whereas in the short-term fluctuations in money can affect economic activity.
The Inexorable Rise of Inflation Targeting

Rose (2007) documents the steady rise of inflation targeting as the preferred
monetary policy strategy. The start of inflation targeting can be traced to the
decision by the Reserve Bank of New Zealand to adopt it as its monetary
strategy in 1988, even before the 1989 Act that enshrined the new approach
was passed. Its spread since has been quite remarkable and the inflation
targeting approach, in various guises, rapidly became the dominant monetary
policy strategy. Its advantages, apart from providing a way round the instabil-
ity of the velocity of circulation, include the fact that more information will
then be brought into policy decisions, that the target can be more easily
explained to the public, and that a highly visible target (rather than
one subject to vagaries of interpretation) makes holding the central bank to
account more practicable.
He also points out that no country has yet abandoned inflation targeting
(although Finland and Spain replaced their own inflation targeting regimes
when they acceded to the euro area).
Svensson (2007: 187) notes that there is a growing consensus about the
merits, not to mention achievements, of inflation targeting as a monetary
policy strategy, yet he observes that despite the impression that ‘monetary
policy bliss, or something very close to it, may have been reached’, there is still
room for improvement. He identifies three features of ‘good’ inflation target-
ing, while pointing to ways in which these facets of the strategy could be
improved:
. An explicit numerical target for inflation, coupled with the aim of avoid-
ing volatility in either inflation or output. He observes that many central
banks acknowledge that they implement what he calls ‘flexible’ inflation
targeting—that is paying attention to stabilization of the real economy—
but suggests that the aims for the real economy and information about
trade-offs and weightings given to different objectives are neither explicit
nor consistent.
. Targeting forecasts of inflation rather than the inflation rate itself.
However, he is critical of monetary authorities that do not build-in to
360
their forecasts changes in the instrument rate itself, noting that for
private sector agents what shapes their behaviour is expectations of
future rate movements. Indeed, the information conveyed by the current
policy rate is only useful to the extent that it conveys information about
future rate developments.
. A high degree of transparency that simultaneously enhances central
bank accountability and contributes to the effective implementation of
policy. Svensson maintains that if inflation forecasts or output forecasts
do not include the projected effects of policy rate changes that would be
consistent with the optimal instrument rate path, they risk misleading
private agents. He therefore argues for publication of the optimal projec-
tion, including information on the optimal policy rate path.
According to Rose (2007), what is striking about inflation targeting regimes is
that they are the reverse of all three main elements of Bretton Woods: capital
movements are free, exchange rates are free to float, and it is the price level
which is targeted. He also notes that countries have not adopted inflation
targeting because of adherence to a rule-based international system, but have
taken this direction independently, resulting in a system that has grown
in what he describes as a ‘Darwinian’ way. Consequently, Rose (2007: 671)
comments, ‘the key players are central banks; these are now more independ-
ent, accountable and transparent than under Bretton Woods’. He notes,
further, that where Bretton Woods was increasingly criticized by prominent
academic economist, inflation targeting seems to find favour.
Best Practice?
There are, not surprisingly, differing views on the best approach to monetary
policy. Svensson (2006: 2) makes the simple point that
the implementation of best-practice monetary policy takes into account that monetary
policy is actually the management of private-sector expectations . . . [and that] . . . what
matters for private-sector decisions are the private sector’s expectations about future
interest rates. Therefore, the implementation of best-practice monetary policy consists
of announcing and motivating the bank’s forecasts of inflation, the output gap, and,
importantly, the instrument rate. This is the most effective way of managing private-
sector expectations.
Svensson consequently argues that the central bank should have its own view
of the optimal interest rate path, based on its analysis of economic develop-
ments. Whether or how much to divulge about the trend is a matter of
judgement. Indeed, judgement is widely regarded as the key component of
monetary policy strategy—after all why would we need central bankers if the
models they use were sufficient for the right decisions to be made?
361
Observing that the transformation of the monetary environment over the

last two to three decades has been extraordinary, Mishkin (2007a) highlights
six key ideas that have come to be widely accepted by monetary authorities
and against which there is little dissent, although he also notes that his list
shows how far monetary policy has moved since the 1960s—a decade in which
the outcomes of monetary policy were poor. They are as follows:
1. There is no long-run trade-off between output and inflation, with the

implication that monetary policy cannot provide a lasting stimulus to
output, even if it can do so in the short-run. Put another way, this first
tenet is a re-assertion of the statement that inflation is always a monetary
phenomenon.
2. Expectations, especially of financial markets, are critical in shaping the
outcomes of monetary policy decisions, and therefore have to be actively
managed.
3. Inflation, especially beyond low single digit rates, has high costs that
diminish welfare.
4. There is always a risk that monetary policy will be vulnerable to what
Mishkin refers to as the time inconsistency problem—the temptation by
the monetary authority to choose a looser monetary policy in the short-
run, even though it has long-run costs.
5. Independent central banks are able to conduct monetary policy more
effectively than those subject to political control, a corollary of which is
that monetary policy should be de-politicized.
6. A strong nominal anchor is needed to ensure that monetary policy
achieves its desired outcomes.
To the extent that there is an approach that does amount to a ‘state-of-the-art’,

it arguably comprises the following:
. Inflation targeting—perhaps more accurately rendered as inflation-
forecast targeting—in which the aim is to achieve medium-term price
stability.
. Putting a premium on pre-emptive action to ensure that inflation is
unable to take hold, an approach which necessarily means that policy
has to be alert not just to current developments, but also to forecasts of
likely changes.
. Using the short-term interest rate (repo) as the main policy instrument,
but complementing it by using various forms of communication to
signal to economic actors (especially financial markets) what the orien-
tation of monetary policy is to be and to hint at the direction of change
(tightening or loosening).
362
. Awareness of the risks associated with prospective economic

developments.
. A preference for small changes in policy rates and only rare use of
surprises, partly to reinforce a sense of both commitment and credibility,
with the latter a very fragile commodity—as Tucker (2006: 220) notes,
‘credibility needs to be earned and re-earned, over and over again’.
Formally, neither the ECB nor the Fed explicitly targets inflation, and it could
be argued that with the world’s two largest central banks eschewing this
approach, inflation targeting cannot easily be described as a state-of-the-art.
However, the ECB comes very close3 to inflation targeting in the way it defines
its reference value, while the Fed, despite its dual mandate, appears to have a de
facto inflation target that is not that different from those of the ECB or the Bank
of England. Moreover, the fact that the two most prominent central banks
do not conform fully could simply mean that they are ‘behind the curve’.
Institutional Structures
Different facets of the institutional structure within which central banks operate
can affect the approach to monetary policy. They include whether or not the
government retains powers to set operational targets, the power over appoint-
ments, including whether central bank board members can be fired, and the
arrangements for holding the central bank to account. At an operational level,
the composition of the monetary policy committee that makes policy decisions
and the manner in which it functions varies among leading central banks.
All these factors, and more, can have some impact on monetary policy
strategy. The Bank of England, for example, has an MPC with nine members,
five of whom are internal and four external. While Eddie George was Gov-
ernor, he always voted last on interest rate decisions, and always sided with the
majority (and hence, on close decisions, acted as the swing voter). His succes-
sor has sided a couple of times with the minority, a tactic than can itself be a
signal about future intentions if markets assign greater weight to the Gover-
nor’s view. Alan Greenspan, by contrast, signalled his view in advance, argu-
ably defying the rest of the open-market committee to contradict him. The
Governor of the Reserve Bank of New Zealand is the sole decision-maker, but is
advised by a committee, with the result that the decisions are, in fact, more
collegial than the formal arrangements imply, according to Svensson4 (2007).
Point Target or Range?

There are aspects of the detail of implementation of monetary policy that
distinguish different approaches, but they are hardly strategic and hence
need not be analysed in this chapter. But some aspects of decisions frameworks
363
do have strategic ramifications, a good illustration being the form that the
inflation target takes. In some cases, the objective is set in terms of a range,
which can give the central bank some leeway, though at the expense of
increasing uncertainty. Others specify a point target, making it more evident
to private agents when conditions presage a change of interest rates, thereby
enhancing predictability. Some, such as the Fed (not an inflation targeter), do
not disclose a value for inflation, leaving it to be inferred by market actors.
Two central banks that employ very similar approaches are the Swedish
Riksbank and the Bank of England. Both have symmetrical inflation targets
with a 1 percentage point tolerance band. The Riksbank’s framework also
provides for inflation being returned to the target rate within two years of
any deviation from it. Yet, it does allow for the possibility that where a
deviation from target is larger, it may make sense to allow a longer period. So
far, this prospect has been only theoretical. The Riksbank makes clear that,
although it has an explicit target for CPI inflation, it recognizes that there are
other relevant definitions of inflation. It therefore monitors a second con-
sumer price index (UND1X) which strips out from the CPI the effects of
indirect taxes, subsidies, and mortgage payments, and states that it pays
attention to asset price inflation. However, the Riksbank also states that it
distinguishes between inflation measures that bear on the inflation forecast
and the targeted variable itself. Thus it may comment on trends in other series,
but does so as part of its decision on how to meet the CPI target.
The empirical evidence is also revealing in other respects. On the surface, the
ECB should not adopt a Taylor rule, since it has hierarchical objectives in which
price stability has pride of place. Yet, among others, Surico (2003) suggests that
it has come very close to following such a rule, erring if anything on being soft
on the inflation component of the rule. Similarly, Hayo and Hofmann (2006)
suggest that the ECB has given much more weight to the output gap than the
Bundesbank ever did. The fact that central banks have only imperfect
knowledge is, however, highlighted by Issing (2005b) who observes that not
being sure about the true output-level gap or the likely impact of major
institutional developments creates uncertainty and calls for the exercise of
judgement. This renders difficult the use of simple rules—such as the Taylor
rule—that assume the output gap can be monitored straightforwardly.
Central Bank Communication

As explained in greater detail in the chapter in this volume by Jabko, transpar-
ency has become a vital part of the monetary policy toolkit, and is also now seen
as part of the state-of-the-art. But what is meant by transparency and the
manner in which it is used as a technique to achieve monetary policy aims—
as opposed to other motivations such as underpinning accountability—needs
to be examined in detail (Begg 2007). Eusepi and Preston (2007) look at what
364
forms of communication are needed to ensure that monetary policy strategy is

understood by economic agents, and show analytically that more extensive
transparency will be more effective than partial communication in avoiding a
de-stabilizing path for expectations. Thus, it is better for the central bank to
announce not just the inflation target, but also how it will be reached. Publica-
tion of extensive information, including inflation forecasts, is seen by the
Riksbank as part of its monetary policy strategy and it is clear (see Tucker 2006
for a recent exposition) that the Bank of England has a similar viewpoint.
Geraats (2007) shows that how central banks choose to communicate can affect
the role of transparency in a monetary policy strategy. She argues that a central
bank should be precise in communicating its inflation target, but may achieve
better results by fostering a perception of ambiguity in what will induce it to act.
Here the debate on price-level versus inflation targeting is salient. Because
price-level targeting means clawing back any deviation from the target by
aiming for a lower or higher inflation rate in the short-term, it would make
communication of the target more complicated (Tucker 2006). In a simple
example, if the economy were subject to a shock that meant that inflation had
been above a price-level target consistent with an annual rate of inflation of 2
per cent for five years by half a percentage point, the path to bring it back on
course would (in round numbers) imply an inflation rate of 1.5 per cent for the
following five years. Alternatively, it could be two years at 1 per cent to restore
credibility followed by a gradual return to the long-term target rate of 2 per
cent. Explaining a range of values for current inflation to the public would be
significantly more difficult than a consistent 2 per cent inflation target.
Similarities and (Limited) Differences
While there are manifestly differences in approach to monetary policy strategy

among leading central banks, partly because of their traditions and mandates,
what is more striking are the similarities. Independence is critical, in that
monetary policy strategists plainly take a long view and feel no need to court
popularity. Resort to formal rules varies. The Fed is usually described as having
a dual mandate5 which consists of having regard to both price stability and the
level of employment (or unemployment)—in other words, it simultaneously
targets the nominal and the real economy. Yet, there have been repeated calls
for the Fed to adopt an explicit inflation target, and there was considerable
speculation at the end of the Greenspan era about whether Bernanke, who had
seemed in some of his academic writings to be well-disposed to an explicit
inflation target, would seek to implement such a strategy. The dilemma is that
it is not easy to alter a long-established mandate, especially as it will generally
require legislation, and often easier to have a hidden rule, an example of limits
to the power of central bankers.
365
The ECB’s definition of price stability as a reference value of 2 per cent for
HICP inflation for the euro area as a whole is consistent with the practice of the
member central banks in the years leading up to the start of the single cur-
rency, and it has made clear that the target range is above 0 per cent inflation,
then (after an evaluation of its strategy in 2003) further clarified the aim as
being close to 2 per cent. Strictly, though, the ECB does not have an inflation
target and the ECB approach explicitly acknowledges that price stability is a
medium-term goal, thereby allowing for some short-term deviation from the
reference value. Some critics have argued that the ECB reference value is too
restrictive (see, for example, Svensson 2002) and that it would be better if the
ECB adopted a more symmetrical target, as in Sweden or the UK.
The ECB’s two-pillar strategy (Issing et al. 2001) gave considerable notional
weight to the growth of the monetary stock, with a reference value of 4.5 per
cent for annual monetary growth (M3) ostensibly setting a rule for interven-
tion. The ECB’s strategy, described as hybrid by Bordes and Clerc (2006), is
more difficult to explain than pure inflation targeting or monetary growth
targeting. Issing (2006: 6) defends the approach in the following terms: ‘the
two pillars serve the purpose of organising the incoming data in a structured
way basically under the aspect of the relevant time horizon. The cross-
checking is a means of reconciling the shorter-term analysis with the longer-
term perspective leading to a consistent, ‘‘unified’’ overall assessment’.
Even a cursory look at the data suggests that the monetary pillar reference
value is a rule honoured above all in the breach. However, as explained in
Fischer et al. (2006), the Quarterly Monetary Assessment (QMA) undertaken
by the ECB staff, but not made public, is more comprehensive than just looking
at the monetary aggregate, since its purpose is to understand how monetary
conditions bear on price stability. They conclude that the use of the monetary
pillar has allowed more rounded analysis—sometimes referred to as a cross-
check—of inflation dynamics than reliance solely on the economic analysis
pillar and, thus, made for better decisions. Yet, their evidence also suggests that,
although both pillar have tended to point in the same direction most of the
time, the economic pillar has been the more influential overall in interest rate
decisions when, in their words, the monetary pillar gives a blurred signal.
The ECB approach prompts the broader question of whether money matters
in monetary policy-making. In 2003, the ECB appeared to diminish the role of
the monetary pillar, re-branding it as ‘monetary analysis’ and reversing the
order of the two pillars. For the ECB, the monetary pillar provides a cross-
check on price movements in the longer-run, whereas the economic analysis
is considered to be more revealing about the short-run. In fact, most central
banks take some account of monetary growth according to the OECD (2007:
annex to chapter 2, paragraph 2) which comments that ‘only the US Fed does
not put any noticeable weight on money supply’. However, the degree to
which other central banks take account of money is limited (Woodford 2007).
366
By contrast, critics of the ECB suggest that it places too much weight on
monetary aggregates, but the issue is not easy to verify because the ECB has
never signalled an explicit weight and, in all probability, would expect to vary
the weight over time in any case.
Thus, one dimension that distinguishes different strategies is the precise
manner in which money is taken into account. The euro area is adjudged to
have a relatively stable demand for money, which means that it is a relatively
more reliable indicator for policy purposes. The euro area (according to the
OECD 2007) has also had less financial innovation than other currency areas
so that there is less distortion of the relationship between money supply and
inflation, although the OECD reports that the stability of the relationship may
be diminishing, as shown by a less stable velocity of circulation. The housing
market is considered to be a particularly important factor and the OECD cites
evidence that most of the overshoot of M1 in the euro area is attributable to
mortgage lending.
Consensus or Debate
One of the more striking inferences to draw from a review of monetary policy
strategies is how little room there appears to be for debate about the social
welfare aims central banks, with all their power, are trying to achieve, and this
lack of debate pervades approaches to monetary policy. It would scarcely be an
exaggeration to say that most of the discourse is around how to conduct
policy, not why or for whom it is being conducted. Buiter (2006) argues that
to target inflation, even in the flexible inflation targeting manner, is a policy
approach bereft of any microeconomic foundations about what improves
welfare and, with customary robustness, he casts doubt on the consensus
that says inflation targeting and independent central banks are optimal. Simi-
larly, Bean (2007) points to the problem within flexible inflation targeting that
the choice of what weight to give to a real economy variable is ultimately
a normative one, and he notes that some micro-foundations of the approach
ignore legitimate distributive issues of an uneven incidence of unemploy-
ment. The fallout from the 2007–8 credit market turmoil is likely to be another
source of disquiet.
A pointed question posed by Buiter (2006: 24) is whether the strength of the
independence granted to some central banks is such that they are devoid of
incentives. As he puts it:
while many central bankers may be motivated in their approach to the job by a sense of
public service, by duty and by unflinching commitment to the central bank’s mandate,
one would like to see these higher motives reinforced by such primitive but frequently
more reliable motives as the desire for power, prestige, wealth, comfort and leisure. This
problem is especially acute when the monetary policy decision is a group decision; it gets
more severe the larger the monetary policy making committee.
367
For Buiter the problem cannot readily be solved because independence and
accountability are, in many ways, incompatible. However, he argues forcefully
for limiting the tasks assigned to the central bank to monetary policy, exclud-
ing tasks such as supervision of financial intermediaries and control of pay-
ments systems, and he also advises central bankers to avoid commenting on
fiscal or structural policies that are not part of their direct remit.
Beyond Price Stability

One contentious area is whether monetary policy strategy should have
much regard to variables other than price stability. As Bean (2007) points
out, governments might be interested in distributive questions or in regula-
tory ones such as how to curb carbon emissions, but they tend to be tangential
to what monetary policy can plausibly do. Nevertheless, it is pertinent to ask
whether monetary policy strategy should, on occasion, give greater weight to
aims other than price stability, even when the latter is formally identified as
their primary objective. Many central banks, for example, have financial
stability as part of their mandate, notwithstanding Buiter’s concerns
that they should stick to monetary policy and only monetary policy. As an
illustration, financial stability is part of the Swedish Riksbank’s remit, but it
does not regard movements in the repo rate as an instrument for promoting
financial stability, and a statement of objectives on its web-site is at pains to
emphasize this distinction. Even so, the Riksbank gives itself some flexibility,
noting that large corrections may have effects that are better avoided, the
implication of which is that interest changes may be phased in if, for example,
there is undue turbulence in asset prices.
In fact, asset prices could be seen as either a complementary or a distinct
target, and the relationship between monetary aggregates and asset prices is
another of the more contentious areas, with some central banks more willing
than others to countenance policy action to counter an asset bubble. Bean
(2007) suggests that the argument runs as follows: when an asset boom turns
to bust, borrowers’ net worth deteriorates and lenders will react by imposing a
credit crunch with rapid effects on the real economy. A low inflation environ-
ment may, moreover, accentuate the impact. However, Bean argues that inter-
est rate increases cannot regulate a surge in asset prices, will exacerbate the
problems of borrowers, and thus will have a negative impact on activity, all for
uncertain policy gains. The problem may, according to Kohn (2006), be that it
is often difficult to distinguish between ‘normal’ movements in asset prices
that pose no threat to the stability of output and prices, and fundamental
misalignments in asset prices that become a threat to economic (and/or finan-
cial) stability as they unwind. One strategic answer is for the monetary
authority simply to respond to the consequences of the asset movement on
the variables that it usually monitors, while a second approach is to bend
368
policy so as to go beyond such reactions. Another would be to pay more

attention to money.
As the 2007–8 credit market problems have shown, central banks also need
to be vigilant about financial stability (see also the chapter by Moran and
Macartney in this volume). These recent events have highlighted the role of
central banks in providing liquidity to the markets at times when banks and
other financial intermediaries face problems, and may call for a fresh look at
how the ‘lender-of-last-resort’ function is exercised. Central banks have
tended towards ambiguity in how they approach liquidity problems, prefer-
ring not to intervene in ways that inhibit the functioning of financial
markets. But to achieve stable monetary conditions, such intervention may
on occasion be necessary as the differences that became apparent in 2007–8
in how the ECB and the Bank of England confronted this challenge made
plain.
Validation by Performance?
Monetary policy strategies seem to attract only limited debate outside special-
ist circles, and even then the differences of opinion are typically more
about the timing of decisions or the quality of analysis than the underlying
strategies. It may therefore be reasonable for a performance yardstick to be
used to assess them, rather than more politicized judgements. Indeed, it is in
some ways a surprise that inflation targeting has not been more problematic,
given the expectation that while it offered a compelling solution for achieving
price stability, it was likely to be at the expense of greater output volatility. In
fact, most inflation targeters can take comfort from the out-turns. Bean (2007:
15), commenting on the period since the UK adopted inflation targeting
(becoming known as the ‘Great Stability’), observes that ‘the really remarkable
thing is how stable output growth has been’ [emphasis in original]. He accepts
that an absence of shocks and other structural factors that can be characterized
as ‘good luck’ have played a part, but having reviewed a variety of such
other explanations, implicitly favours the view that good policy has played a
considerable part.
This would come as no surprise to Mishkin (2007a) who notes that while
inflation targeting pushes central banks to avoid a focus on short-term real
economy variables, thereby dealing with time inconsistency, it is not incom-
patible with output stabilization over the longer term. He notes, too, that
countries that have adopted full inflation targeting monetary policy strategies
have fared well economically, with no apparent cost in terms of output vola-
tility. However, Mishkin qualifies his praise by noting that prominent coun-
tries that have not adopted inflation targeting have also performed well,
notably the United States,6 and he offers the explanation that these countries
have been able to find alternative strong nominal anchors. Nevertheless, the
369
emerging evidence that Mishkin reviews suggests that inflation targeting may
be better at curbing expectations of inflation and at diminishing inflation
persistence.
In a careful analysis, Rose (2007) finds that despite a floating exchange rate
being a feature of inflation targeting regimes, exchange rate volatility is mar-
ginally lower, on average, than for other monetary regimes. This is not as
paradoxical as it seems in that the inflation targets are typically very similar
(2% CPI, for example, is typical). Rose (2007) also finds that inflation targeting
countries do not seem to be at risk from capital ‘stops’ which arise when short-
term capital flows suddenly desert a country, even though inflation targeting
implies no controls on capital. The obvious explanation is that capital is
attracted to the stability that the monetary regime provides.
There has been some criticism, especially since the launch of the euro, that
price increases have been higher (or perceived to be so) than revealed by the
core inflation index used by the ECB (and the Bank of England). Yet in this
regard, it is important to recognize that highly visible price increases (the
baguette or the café au lait) are offset by falls in the prices of less frequently
purchased items; in other words, the move to the euro has resulted in some
relative price adjustments. While it is probably true that some sellers exploited
the opportunity of the conversion to the euro, it is important to recognize that
the transition is a one-off change.
Concluding Remarks
In shaping contemporary approaches to monetary policy strategy—while rec-

ognizing that non-trivial differences remain—some explanations resonate
more widely than others. Considerable influence can be ascribed to changes
in understanding of what monetary policy can and should do. Many of the
‘big ideas’ have come from outside Europe or from non-euro area countries
and have been pioneered elsewhere: for instance, the time inconsistency
concept or the adoption of inflation targeting in New Zealand. An intriguing
feature of much of the literature on monetary policy strategy is that so many of
the leading protagonists seem to straddle the academic and policy worlds. In
terms of the overall themes of this volume, this establishment of an inter-
national central banking ‘intelligentsia’ suggests that the sound money para-
digm has led European approaches, rather than there being a distinctive
European approach, and the apparent convergence on so many agreed aspects
of monetary policy strategies is striking.
Particularly notable is the strength of the consensus around the view that
inflation targeting (preferably of the flexible variety), buttressed by independ-
ence, is the preferred monetary policy strategy, notwithstanding the ECB and
the Fed—custodians of the two largest monetary areas—not being strict
370
inflation targeters. Dissent from this consensus is rare. Willem Buiter (2006:
39) is a prominent exception, arguing that
flexible inflation targeting . . . is incompatible with the mandate of every central bank
that has price stability as its primary objective. It risks imparting an upward bias to
inflation. It sets monetary policy design and implementation back to before 1989—the
year New Zealand first adopted inflation targeting. The solution is to drop flexible
inflation targeting and replace is with lexicographic or hierarchical inflation targeting.
By this, Buiter means giving price stability pride of place and, by implication,
playing down the weights given to stabilization of the real economy so long as
price stability has not been assured.
However, it deserves to be stressed that central banking is about more than
price stability and, as regards financial stability, recent events have exposed
greater divergences (and, arguably, failures) in approach. It may be, therefore,
that the pursuit of price stability has over-shadowed other dimensions of
stability, notably financial stability, though as Pisani-Ferry et al. (2008) point
out the resilience to shocks of the macroeconomic system as a whole is another
vital facet of stability. Here, European countries may have more in common
with each other than with other parts of the world, especially in the relation-
ship between fiscal policy and monetary policy, though with continuing
ambivalence about how structural policies enter the equation.
It can be argued, further, that today’s consensus on monetary policy strategy
reflects the rather benign conditions that have prevailed in recent years. In-
creased global competition has held down consumer prices and although there
have been periodic swings in oil prices, they have, on the whole, not led to
attempts by wage negotiators to push up nominal wage rates in a compensating
manner, as occurred in the 1970s and 1980s. Immigration to OECD countries
with relatively tight labour markets has probably also played a part, while persist-
ent unemployment in others has meant that labour markets have had some slack.
Nevertheless, there are several areas where reform or refinement of monetary
policy strategies can be contemplated. Some are largely technocratic issues,
such as the degree to which the central bank should seek to present an interest
rate path in both its forecasts and its pronouncements. In 2005, for example,
the Riksbank shifted its forecasting strategy to factor-in changes in interest
rates anticipated by the markets, rather than forecasting on the assumption
of an unchanged repo rate and has since (2007) further refined its approach,
whereas the Bank of England appears to be more hesitant. Other disputed areas
are more political, for example Mishkin (2007a) argues that there four aspects
of monetary policy strategy on which there is debate about the way forward:
. What definition of an inflation target to favour given the distinction
between the price level and the current inflation rate.
. The optimal degree of transparency. At issue here is whether more is
always better, or whether there should be limits to transparency, either
371
to avoid confusing the public or because central bank mystique can still
be a valuable attribute (Geraats 2007).
. How to deal with asset price movement and whether asset prices should
be explicitly targeted, irrespective of any pass through into inflation, or
simply monitored as a potential influence on prices.
. Whether the exchange rate should be treated as a separate aim of policy,
an issue that manifestly came to the fore in the 2007 French election.
There is also some evidence of a renewed interest in how much attention to

pay to money in monetary policy (see, for example, Issing 2006). A further area
for development in monetary policy strategy is in how to exercise judgement
in what Svensson (2007: 190) describes as ‘a disciplined and systematic way
rather than in a completely discretionary and ad hoc way’. Models and
analytic work can provide a strong basis, but can never (Issing 2005b) be
sufficient, and behavioural changes are, by definition, difficult to anticipate.
If, in addition, political economy influences are allowed for, there is good
reason for caution in any presumption that monetary policy strategy has
reached its own ‘end of history’.
Notes
1. The research on which this chapter draws is part of the Integrated Project ‘New Modes
of Governance’ (www.eu-newgov.org), financially supported by the European Union
under the 6th Framework programme (Contract No. CIT1-CT-2004-506392). I am
grateful to Charles Goodhart and the editors of this volume for helpful comments on
a previous draft.
2. The notion that the monetary authority may be tempted to court popularity by
opting for looser monetary policy in the short-term, despite being aware of the
adverse longer-term consequences of igniting inflation.
3. Nevertheless, Pisani-Ferry et al. (2008) argue that it would benefit from fully adopting
an inflation targeting approach.
4. Who, it should be noted, has advised the Reserve Bank that it should have a broader
decision-making committee.
5. In fact the statutory instruction to the Fed identifies moderate long-term interest
rates as a further objective, along with a general duty to promote financial stability
and a sound banking system.
6. More controversially, he also cites Germany, a country which has undoubtedly
achieved enduring price stability, but given the record of that country’s real economy
since the early 1990s, the verdict on other aspects of economic performance may be
less flattering.
372
17
Scientization of Central Banking:
The Politics of A-Politicization
Martin Marcussen
Central banks across the world are embedded in a variety of national contexts
and histories. They are exposed to a multitude of challenges that require
learning and adaptation in very specific situations. Globalization, regional
integration processes, financial crises, wars, and terrorist attacks impact differ-
ently on central banks. In most cases, the central banks feel that flexibility and
change are imperative because of these challenges. Seen in that light, we
would not expect central banks across the globe to display isomorphic char-
acteristics. Although central bankers model each other’s practices, structures,
and ideologies, they do not copy these features one-to-one. Instead, they
translate and convert institutional fashions from other contexts into a format
that resonates with the existing domestic structures, relations, and ideas.
Emulation does not necessarily imply institutional convergence. Indeed, in
preparation for major institutional reform, a comparative study commissioned
by the Reserve Bank of New Zealand concluded that in the 1980s ‘there was
little commonality among central banks in their precise functions, objectives,
or even the question of who should set the objectives. The evidence was that
few central banks at the time had well-defined, stable, objective functions’
(Singleton et al. 2006: 140). Central bankers are therefore commonly regarded
as an ‘oddly assorted bunch’. Many national idiosyncrasies persist that may no
longer have a place, though ‘ . . . these may have deeper roots than many
people assume’ (Deane and Pringle 1994: 338).
Despite the danger of oversimplification, the chapter neglects many of
the differences that exist between central banks. It adopts a meso-historical
perspective on central banks and central banking in order to identify the
conjunctures through which central banking has developed over the last
couple of centuries. In short, at this level of abstraction, the chapter considers
central banking and central banks to be distinct analytical categories, thereby
373
Scientization of Central Banking: The Politics of A-Politicization
neglecting micro-developments. The conception of time with which the chap-

ter works is possibly best described in Fernand Braudel’s notion of moyenne
durée (Hufton 1986: 210–11). In contrast to the longue durée, in which the basic
parameters of human existence are stable, the moyenne durée allows for a level
of analysis which draws our attention to the conjunctural cycles, in this
chapter referred to as ‘ages’, through which central banking and central
banks are developing as a group. In contrast to the courte durée, which is
connected to detailed historical studies of individual and possibly—in a longer
historical perspective—abnormal phenomena, the moyenne durée tends to
neglect idiosyncrasies in central banking, while aspiring to develop theories
about meso-historical dynamics. Thus, the dynamic meso-historical perspec-
tive implies that we are interested in learning from past cycles with a view
to formulating so-called ‘plausibility probes’ about possible future develop-
ments (Eckstein 1975: 108). In other words, the intention is to develop and
forward an argument that intuitively sounds plausible and puzzling.
Thus, the purpose of this exercise is to substantiate a claim about where central
banks are at present and where they are heading. In short, the chapter claims that
central banking may be heading towards a new age, characterized by scientization
and including horizontal bureaucratic extension, external communication, collective
decision making, and outcome management. Max Weber’s concept of rationaliza-
tion describes this development in terms of a striking intellectualization of the
world; an objectification of things and actions via formal analysis and math-
ematical abstraction; a technical mastery via specialized practices and discourse;
and reification of policies, power relations, and institutions. The last part of the
chapter discusses the possible implications that scientization might hold for
central bank governance, knowledge production, and accountability.
Global Trends in Central Banking
It is common practice among central bank historians to distinguish four stages

in the development of central banking (Fischer 1994: 262–329). In the first
stage, governments created special banks to raise loans for themselves, typic-
ally to cover war expenditures. These central banks also assumed responsibility
for issuing and regulating notes. In the second stage, central bankers were
defined as the sort of entities we now recognize as central banks proper.
Central banks started to become banks to other banks, thus accepting respon-
sibility for the stability of the financial system. They were occasionally the
lenders of last resort and were responsible for the management of the external
value of the national currency. In the third stage, many central banks were
nationalized. They were entirely subordinated to their government and
merely implemented the general macro-economic policy. Monetary policy
had multiple goals such as full employment, economic growth, price stability,
374
and a stable exchange rate. Finally, in the fourth stage, central banks were
granted formal autonomy to pursue a single objective, most typically price
stability (see Begg in this volume). They maintained their currency function
and responsibility for the overall stability of the financial system (although
their supervisory functions vary from country to country).
The shift from the first to the second stage can be explained by the gradual
development of private banking and the consequent risk of bank failure. The
government’s bank simply had to take on additional functions to assist
in situations of financial default, sometimes as lender of last resort (see
Moran and Macartney in this volume). The shifts from the second to the
third stage and from the third to the fourth stage can be accounted for by
successive crises in the form of the inter-war economic depression, the two
world wars, and the great inflation of the 1970s. With that background in
mind, this chapter asks the question whether globalization implies that yet
another stage in the development of worldwide central banking is taking
shape. In other words, is there indicative evidence to support a plausible
claim that central banking is moving into a fifth age (Table 17.1)?
The question is whether key trends are so significant and general in scope
that they contribute to laying the foundations for a new stage in the develop-
ment of central banking. Attention will be directed towards a major trend,
scientization, and the way in which scientization is being bolstered by hori-
zontal bureaucratic extension, collective decision making, external commu-
nication, and outcome management.
Scientization
While the 1990s were characterized by a worldwide surge in organizational
reform enhancing the instrument autonomy of central banks, that is, freedom
from being supervised by political authorities in the process of implementing
monetary and financial policies, the 2000s appear to be characterized by
scientization. In the previous decade, monetary and, to the extent that bank-
ing supervision was in the hands of central bankers, financial policy making
were depoliticized. These two policy areas were shielded from what were seen
to be short-term political considerations. The arena for ideological debate and
political deliberation shifted away from the world of central banking towards
other areas of political life. Central banking was institutionally and legally
exempted from ordinary democratic decision making.
In the 2000s, however, central banking is becoming increasingly apoliti-
cized. Max Weber referred to this process as ‘rationalization’: ‘the process by
which explicit, abstract, intellectually, calculable rules and procedures are
increasingly substituted for sentiments, tradition, and rules of thumb’
(Wrong 1970: 26). When ideology is being displaced by science, central
bankers gain legitimacy and authority by basing their views on, and applying,
375
376

Table 17.1. Central banking throughout the ages
First age 1600s–1800s Second age 1873–1914 Third age 1930s–1970s Fourth age 1980s–1990s Fifth age? 2000s
Regime Mercantilism/colbertist Gold standard/Laissez faire Bretton Woods/Keynesian Washington consensus/ Post-Washington
Nationalism internationalism nationalism Monetarist consensus/
internationalism transnationalism
Arena shifting Few state-owned central De facto autonomous Integrated central banking Formally autonomous Scientization
banks central banking central banking
Bureaucratic scope Small—disparate Establishment of basic Building up Building down Building out (alliances)
structures
Decision making Subdued the will of the Discretionary Public service machine Let managers manage. Committees and outcome
principal bureaucracy. Process Business and output management
administration management
Communication Non-existent Non-existent Legalistic—formalistic Techno-speak Transparency
Targets Servicing the state and its Currency stability Multiple goals—internal Monetary targeting Inflation targeting
war-economy and external
the language of science. Human affairs are being reduced to ‘calculable, cold,
hard, ‘‘matter-of-factness’’ ’ lying outside—indeed transcending—the sphere
of political action (Gregory 2007). Scientization implies that power is being
concentrated in the hands of those who master the discourse of science,
scientific ‘techno-speak’. Central banking is becoming a matter for intellec-
tuals, thus implying that it is an elite phenomenon with which elected poli-
ticians would not even consider dealing (Woods 2002: 25–45, 34–7). It is being
dehumanized, eliminating personal ideological and emotional features that
escape calculation. In line with Weber’s portrayal of the ideal typical civil
servant, central bankers are being presented, and sometimes present them-
selves, as passionless machines and specialists without spirit (Marcussen
2006a).
Scientization, which apoliticizes the art of central banking, is fundamentally
different from autonomization, which depoliticizes central banking. Autono-
mous central banking does not imply that media and politicians and other
opinion makers do not care about or pay attention to the métier of central
bankers; scientization does. Autonomous central banking does not imply that
central bankers are automatically considered to be right when they make
decisions; scientization does. And autonomization does not imply that central
bankers are being uncritically listened to as the Delphi oracle, even when
speaking out on matters that lie far beyond the narrow field of monetary and
financial policy; scientization does. For instance, Alan Greenspan’s inclination
to speak out on issues that are formally beyond the authority of the Federal
Reserve was legendary, and he possibly inspired central bankers elsewhere to
do the same (Meyer 2004: 215).
The claim is not that central banking is ‘scientistic’. Genuine science is
open-ended, keeping alive a continuing conversation between theory and
practice, not attempting to close debates and not presenting general, everlast-
ing truths about human affairs. Central banking, on the other hand, appears to
be ‘scientific’, representing a closed scientism which is ‘self-confirming, essen-
tially an ideology or dogma presented in the guise of science’ (Gregory 2007).
Importantly, the argument here is not that scientization and the ways in which
it unfolds are universal phenomena. The meso-perspective adopted in this
chapter is more interested in attempting to identify trends that, at some
point in the future, may end up being more general phenomena in the
world of central banking.
The American Federal Reserve Banks account for more than half of all
published central bank research output (St-Amant et al. 2005: v), but the
European Central Bank (ECB) also qualifies as a research powerhouse. In
terms of full-time researchers, for instance, the ECB has a larger research
directorate than the Department of Economics at the London School of Eco-
nomics and Political Science (Marcussen 2006a: 93). Over its 10 years of
existence, however, it has yet to achieve the level of authority enjoyed by
377
the Bundesbank, the bank on which it was modelled (Jabko 2003). Since the
ECB can still not speak without any visible opposition, the rationalization of
the bank remains incomplete.
Scientization expresses itself in relation to many dimensions of central
banking. Central bankers start to make epistemic alliances with other mem-
bers of the scientific community (‘building out’); coincidence, prejudices, and
discretion are being filtered out of decision making in an ‘instrument rational’
manner (collective decision making); procedures are being instituted to min-
imize haphazard and random reactions to central bank decision making,
so-called ‘irrational exuberance’ (transparency and communication); and
measurable performance is based on few and exact standards (inflation target-
ing). In the following, these components of scientization will be discussed
individually.
Building Out
The first central banks were established more than three hundred years ago,
but the real upsurge in central bank institutions proper took place in the inter-
war years. Since then, the world has witnessed a steady increase in the number
of central bank institutions. Indeed, ‘[if] the fundamental, evolutionary criter-
ion of success is that an organization should reproduce and multiply over the
world, and successfully mutate to meet the emerging challenges of time, then
central banks have been conspicuously successful’ (Goodhart, Capie, and
Schnadt 1994: 91). Today, almost all sovereign states have established a central
bank. It has become a sign of statehood on the same level as a national
anthem, flag, and army (ibid. 26).
With the politicization of central banking in the immediate post–Second
World War period, most central banks were charged with additional functions
and grew considerably in size. Together with the rest of the national public
administration, the number of personnel, departments, sections, and admin-
istrative levels continued to grow. Central banks developed their administra-
tive structure. Integrated central banking could be characterized as a
paternalistic, formalistic, and hierarchical machine bureaucracy in which
employees held steady career prospects and where form and process mattered
more than substance.
The global wave of New Public Management changed all that. Central
bank organizations everywhere underwent considerable trimming—‘building
down’ (Morgan Stanley 2004: xi). To reduce the number of employees became
an objective in itself and a single measure of success of central bank reform.
Modernization became synonymous with downsizing. The administrative and
management culture also shifted. Whereas central banks were regarded as
distinct bodies of public administration in the immediate post–Second
World War period, during the 1980s and 1990s they came to be considered
378
businesses in their own right, or a subspecies of the category of state-owned

enterprises. Managers were asked to manage their business, and each individ-
ual was evaluated on his or her ability to perform, that is, to deliver a certain
kind of output in time according to contractual obligations (BearingPoint
2005).
As a result of scientization and rationalization in the 2000s, this may be
changing. As epistemic communities, many central banks work in entirely
different ways. They are opening up their distinct knowledge networks to
like-minded allies and closing off their relations to the uninitiated (Marcussen
2006b). Organizational boundaries are blurring, as are territorial and cultural
boundaries. Central banks are no longer building up or down; they are simply
‘building out’. They form collegial alliances in the national as well as global
organizational fields. Hierarchies are being broken down, and co-equal central
bankers work closely together from project to project. Interesting and influen-
tial allies are being sought, preferably among those actors on the global
institutional field of monetary policy making who share central bank notions
of rationality. Veritable transnational, epistemic clan structures or communi-
ties may be emerging in the world of central banking. Such a development
does not require fewer personnel (building down): it requires a different sort of
personnel, possessing doctorates in economics and engaging directly and
actively with the scientific community (Apel, Heikensten, and Jansson 2008).
We may gradually see research departments established in central banks. Such
research departments could expand and assume prestigious roles inside central
banks. This could involve central bankers creating scientific working paper
series and financing their own scientific journals, as well as management
being recruited from universities (Marcussen 2006a). Within the central
bank, scientific credentials could thus become effective career-enhancing
factors.
Committee Decision Making

The history of central banking has typically been written with a particular
focus on strong, decisive men, who created, consolidated, and defended
the integrity and autonomy of their institution. One scholar concluded that
‘[t]hroughout the Fed’s history, its power over the economy has depended more
on the political leadership of its chairman than on any other factor’ (Kettl
1986: 193). Bank of England Governor Montagu Norman and a great number
of Fed Chairmen were presented as superhuman beings who constitute strong
elements in the institutional legacies of these two central banks as well as role
models for central bankers around the world. Throughout most of his gover-
norship, Fed Chairman Greenspan simply personified the central bank insti-
tution: not by law, but in practice (Meyer 2004: 50–1, 74–5, 216, see also
Woolley in this volume). Thus, an ordinary member of the Federal Open
379
Market Committee (FOMC), the main decision-making forum of the Federal

Reserve System, holds that ‘[f]rankly, to this day I do not know if I ever actually
influenced a FOMC decision in my five and a half years’ (Meyer 2004: 166). In
other countries, the personal role and responsibility of the central bank gov-
ernor is spelled out in contractual form. The Reserve Bank of New Zealand
offers a case in point: Alan Bollard and, before him, Don Brash were personally
responsible since 1989 for achieving the inflation targets established together
with the Treasury. Because of this personal responsibility, it is also ultima-
tely the Reserve Bank governor, and him alone, who makes decisions about
interest-rate changes. If unable to fulfil these stated objectives, the central bank
governor can be fired by parliament (see Eichbaum in this volume).
The focus on one-person performance may now be changing. Rationaliza-
tion and scientization require that decisions cannot be left to charismatic
individuals. Instrumental rationality (Zweckrationalität) stands in contrast to
value-rational (wertrational), affectual, and traditional forms of social action. It
is therefore simply natural that collective decision making is gaining ground
in the world of central banking. In countries as different as the UK, Japan,
Sweden, Norway, Switzerland, Brazil, and many others, a monetary policy
committee has been established. The same goes for the committee-based
ECB, which thus far has replaced 16 central banks that were formerly run by
individual governors (see Umbach and Wessels, as well as Howarth, in this
volume). There has yet to be a central bank with collective decision making
that has replaced this form of internal consensus building with a one-man
show.
The increased depoliticization of central banking in recent years largely
explains why such a major change in the decision-making mode has taken
place. When central banking was fully integrated into the state apparatus
during most of the Bretton Woods period, there was not much point in
establishing decision making in committees. Governmental orders were not
meant to be discussed, even less criticized. The governor was responsible for
carrying out the decisions of others rather than making informed decisions of
his own. With central bank autonomy flourishing in the 1990s, central banks
were made accountable for efficient and effective decision making. In recent
years, many central banks have shifted to collective deliberation to enhance
the knowledge repertoire behind decisions and, not least, to spread account-
ability between more persons.
Arguments about the decision-making efficiency, in contrast to arguments
about representative democracy, are being applied in favour of collective
decision making in central banks. Indeed, some experimental research dem-
onstrates that committees actually make better and more informed decisions
than individuals (Lombardelli, Proudman, and Talbot 2005). Majority voting
cancels out the worst performers in the committee, and more knowledge is
being shared. When Lars Svensson was asked to evaluate single-governor
380
decision making in the Reserve Bank of New Zealand, he thought change

ought to be made. He ‘ . . . considered it risky for one individual to have so
much power over monetary policy’, and recommended that a monetary policy
committee was established (Singleton et al. 2006: 201).
Transparency and Communication

Many myths about central banking date back to the Classical Gold Standard,
when central bankers constructed the art of central banking in esoteric and
almost religious fashion, keeping the functioning of the central bank temple as
the best kept secret of all (Greider 1987: 54). The legacy is that, as a rule, central
bankers do not interpret their role as consisting of communicating with the
public on a regular basis or explaining their policies. No wonder that ‘central
banks traditionally [have been] surrounded by a peculiar and protective polit-
ical mystique’ (Goodfriend 1986: 64). Speaking about central bankers, Milton
Friedman once observed that they had two principal objectives: ‘avoiding
accountability on the one hand and achieving public prestige on the other’
(Fischer 1990: 1181).
All this may be about to change in many places. Today, there is a ‘general
consensus among central bankers that transparency is not only an obligation
for a public entity, but also a real benefit to the institution and its policies’
(Issing 2005a: 66). Within central banking, arguments related to efficiency
drive the case for central bank transparency and external communication,
rather than arguments about democratic legitimacy and accountability (Begg
2007, see also Jabko in this volume). Although central bankers recognize that
their institution cannot exist in a vacuum cut off from public scrutiny, they
primarily spend their time on making the scientific case for how transpar-
ency can enhance the effectiveness of their monetary policies. In other
words, central banks translate the globally accepted norm of ‘good govern-
ance’ in their own way, which condemns secret and closed bodies of public
administration to fit their own world. By way of targeted one-way commu-
nication, central bankers do not communicate with a view to learning from
or adapting whatever argument may be raised against central bank policies.
On the contrary, such market insensitivity or ‘leaning against the wind’ is
helping central bankers to consolidate their reputation of integrity and
autonomy in the financial markets. When central bankers talk, they do so
with the financial markets, not with the general public. The argument is
simple: central banks depend on financial and monetary markets to be
effective and ‘rational’. If markets are irrational, it will become difficult
for the central bank to lay down a monetary policy strategy that helps it to
reach its stated goals. One way in which the central bank improves the
rationality and effectiveness of the financial markets is that it reveals not
only its policy decisions but also the arguments and data leading to its
381
decisions. The clearer the central bank is about what it is doing and why, the
easier it becomes for the financial markets to form an opinion of how the
short term develops. If the financial markets are clear about the short term,
then, it is argued, the central bank can more easily achieve its objective in the
medium to long term.
Central banks with a long history of policy effectiveness and credibility do
not necessarily need to talk as much as central banks with a low level of
perceived credibility. That is ‘why ‘‘nouveau riche’’ institutions with poor
credibility ‘‘talk,’’ and why institutions that have a great ‘‘wealth’’ of credibil-
ity can afford to whisper’ (Eijffinger et al. 2000: 119). This may explain why a
hitherto unheard of degree of transparency has been adopted in Norway. The
Norwegian Governor, Svein Gjedrem, decided that his quarterly inflation
reports ought to contain projections of interest-rate levels three years into
the future (Financial Times, 26 May 2006). Other central banks plan to follow
the trend in the name of transparency, but critics argue ‘that there is no point
in announcing intentions for the future if that future is clouded in mystery’
(Grauwe 2006).
Increased and improved communication with the external world is closely
connected to the habit of making decisions collectively rather than on an
individual basis. Committee decision making simply helps open the doors to
the inner circles for professional central bank watchers in the financial media,
stock exchanges, and private banks. Transparency is also closely connected to
the next global trend in central banking: inflation targeting. Former Swedish
central bank governor Lars Heikensten (2005: 6) argued that inflation target-
ing is now being conducted ‘almost by necessity with a high degree of open-
ness and clarity’.
Inflation Targeting
Inflation targeting—the notion that the bank, typically together with the
national treasury, determines an acceptable range within which price inflation
is allowed to settle—is now recognized as a worldwide central banking trend
(Mahadeva and Sterne 2000). During the Classical Gold Standard, central
bankers were most interested in external stability in the value of the currency.
By contrast, central bankers in the post–Second World War period were asked
to pursue several objectives simultaneously, such as growth, employment, and
financial as well as price stability. During the late 1970s and the 1980s, many
central banks started establishing monetary targets, which is an arrangement
under which the central bank aims for a certain money supply growth rate (see
Begg in this volume). In the United States, the idea of monetary targets entered
political discourse in 1974, but it took until 1979 before Fed Chairman Paul
Volcker implemented it. It lasted only a couple of years as a watered-down kind
of ‘pragmatic monetarism’ (Kettl 1986: 144, 173). In practice, monetary policy
382
was based on an eclectic application of economic theory. It proved to be

incredibly difficult to determine the exact money supply and its impact on
price levels.
A new era of targeting started when New Zealand, as a first mover, formally
announced an inflation target in 1990. The New Zealanders and outsiders,
having been accustomed to double-digit inflation levels for more than two
decades, thought the first targets agreed in March 1990, 0–2 per cent, seemed
radical. However, the objective was already reached after two years (see Eich-
baum in this volume). A very large number of the world’s central banks have
since adopted explicit or implicit inflation targets (Mahadeva and Sterne 2000:
38). Both as a professor of economics, an ordinary member of the FOMC, and
now as Chairman of the Fed, Ben Bernanke has been an ardent supporter of
inflation targeting (Time Magazine, 23 July 2006: ‘Gentle Ben. Inside the Head
of the Fed’). The IMF is now also taking an active part in diffusing the idea
worldwide. It has therefore entered high on the agenda, not only among the
largest and richest countries in the world, but also—and maybe particularly—
among the poorest and most peripheral countries in the world, such as
Albania, Botswana, Romania, Uganda, and many others.
Former central bankers are sceptical. Paul Volcker, for instance, held that
inflation targeting ‘is a little bit too tight for me. The inflation rate is bound
to go up and down a little bit and it should go up and down a little bit’
(Bloomberg.com, 14 July 2006). Harvard professor Benjamin Friedman is also
extremely reluctant to embrace inflation targeting: ‘By forcing the entire
conversation to take place in terms of only one aspect of economic activity
that the central bank and the government care about . . . inflation targeting
tends to hide what the true objectives of the monetary policy are and there-
fore undermines transparency’ (CentralBankNet.com, 11 February 2005). The
debate is classical in central bank circles; it is one of discretionary policy
making versus rule-based policy making (Fischer 1990). Although inflation
targeting can be understood as ‘constrained discretion’ (King 2004: 5), most
analysts actually consider the explicit focus on one single performance cri-
terion defined within a narrow band of fluctuation as an excessive breach of
the extended discretion for which central bankers have fought over decades
and actually obtained. When Congress established the Fed in 1913, the job
was thought to be relatively automatic. This rule-based automaticity was
supported by monetarist theory from the 1930s and onwards. From the
1960s, however, consecutive Fed Chairmen made it a central feature of
central banking to adopt a discretionary, holistic, eclectic, and pragmatic
approach to monetary policy making, that is, not narrowly focusing on one
single objective maintained within a narrow band (Kettl 1986: 194). Target-
ing was not only considered to be an excessively constraining activity that
could seriously undermine the utility of monetary policy. It was also per-
ceived to be a threat to central bank independence, and, as we have seen, a
383
setback for accountable policy making in central bank circles. Furthermore,

most recently, some of the first-movers in inflation targeting, for instance
Sweden, have in practice interpreted the targets in quite flexible ways. This
has prompted some commentators to ask whether this is the beginning of
the end for inflation targeting (Wolfgang Munchau, Financial Times, 5 June
2006).
However, inflation targeting can be seen as just another key element of
rationalization and scientization. By explicitly and strictly determining the
criteria for success and failure, monetary policy making is dehumanized in
many ways. The scope for discretion and intuition—holistic and pragmatic
central banking—is being narrowed down considerably, thereby confirming
the stereotype of central bankers as passionless machines. The art of central
banking is becoming objectified, thereby concealing the social character of
monetary policy. The interests of real human beings and the political and
power-related structures underlying central banking are being obscured
by scientific and almost ‘divine’ rules. An abstract and complex affair is
simplified and objectified: made a thing rather than a malleable social
relation (reification). Thus, reification may conceal what is actually arbitrary
and socially changeable by representing it as immutably given (Berger
and Luckmann 1966: 106). As such, reification, through scientization and
rationalization, could be considered an excellent form of social control,
since those who have a stake in central banking, ordinary citizens as well
as elected politicians, may be expected to exercise self-control and self-
censorship rather than engage in direct debate or other efforts at politicizing
central bankers.
Scientization and rationalization may challenge our existing understanding
of accountability, legitimacy, and power relations between civil servants and
politicians. This is the subject for the next section, which argues that the
scientization process may have consequences for our conceptualization of
governance, for how and what kind of knowledge is produced, and for political
accountability (Table 17.2).
Table 17.2. The impact of scientization on governance, knowledge,

and accountability
Governance Transnationalization
Governance Communities ! Knowledge Communities
Political Governance ! Knowledge Governance
Knowledge Production
Scientific Pluralism ! Scientific Overlay
Civil Servant—Politician Relationship
Depoliticization ! Apoliticization
External Accountability ! Internal Accountability
384
New Rules of the Game in Central Bank Governance
Scientization implies that governance—the regulation of social behaviour—is

being transnationalized: that a movement from territorial ‘governor communities’
to non-territorial ‘knowledge communities’ is taking place (Table 17.2). Central
bankers have usually been involved in international cooperation. During the
era of the Classical Gold Standard, international cooperation between central
bankers was characterized by ad hoc and informal contacts. Since the Second
World War, international cooperation has become formalized in a large num-
ber of international organizations. It has also become globalized, in view of the
fact that an increasing number of countries are becoming involved with one
another in increasingly complex ways (Marcussen 2006c).
So far, the many forums in which central bankers meet have been defined by
their national members and the territory that they represent. It has been
possible to speak of communities of national central bank governors. Inter-
national central bank forums have had a distinct territorial dimension, larger
or smaller, depending on the number and type of members. International
organizations such as these are fundamentally based on a territorial principle
of organization and governance. This may now be about to change. If scien-
tization is truly taking hold of central banking, and central bankers are mer-
ging to form a transnational knowledge community, territorial borders will
cease to play a role and non-territorial principles of organization and govern-
ance will increasingly define the field. Conflict structures and patterns of
governance within a knowledge community do not respect territorial borders;
they become supra-territorial phenomena (Scholte 2005). Cleavage structures
are defined according to the rules of the scientific game: intra-paradigmatic
quarrels about theory, methods, data, etc. (Fourcade 2006). Knowledge com-
munities are being constructed, partly replacing and partly supplementing or
overlapping with governor communities.
Governor communities consist of central bank governors who represent
clearly demarcated territories. Knowledge communities, by contrast, include
all scientists within a field—whether central bank personnel or not. A know-
ledge community may be broader or narrower in scope than a governor
community, and knowledge communities are more dynamic and porous
than governor communities. Membership of a knowledge community cannot
be inherited in the same way as membership of a governor community. For
instance, the president of the Bundesbank will always be part of the G10, but
he will only be a member of the knowledge community as long as he continues
to contribute to the generation of scientific knowledge.
Transnational knowledge communities will be inclined to exercise ‘soft’
governance to a much greater extent than international governor communi-
ties. Central bankers in knowledge communities are more in the business
of producing rules of appropriateness, standards, and guidelines, that is,
385
normative governance; knowledge and data, that is, cognitive governance; as well
as meaning, common histories, myths about the past, and visions about the
future, that is, imaginary governance (Marcussen 2006b). It is therefore possible
that a movement from political governance to knowledge governance is taking place
as a result of scientization. Political governance can, for the sake of argument,
be simplistically defined as using regulation to solve a concrete societal prob-
lem (Chandler 1958: 260). The practical aspects of problem solving—‘the art of
central banking’—rather than theorizing for the sake of theory—‘the science
of central banking’—have traditionally been central to the business of central
banking. Theoreticians have not been held in high esteem in central bank
circles, and it has been argued that the art of central banking is driven by
intuition and life experience. John Maynard Keynes, for instance, was viewed
among central bankers as a distant theoretician, and Strong and Montagu
Norman feared that people like him would overshadow the ‘practical bankers’
(Jacobsson 1979: 45). However, this may cease to be the case. In contrast to
political governance, knowledge governance can be defined as the production
and dissemination of norms, knowledge, and identity. Central to knowledge
governance is the idea that knowledge production is an objective in itself, that
is, more knowledge is better than less knowledge.
Related to the development of knowledge governance is the question of what
knowledge is and which aspects of knowledge ought to be expanded through
intensified and systematic research. It is possible that scientization within
central banking implies a movement from scientific pluralism to a strategic overlay
of particular research disciplines and approaches. Since many central banks provide
for their own income and to a large degree have a free hand when spending that
money, and as central bankers tend to spend considerable amounts of money
on a few areas of research activity, one would expect to see a more noticeable
expansion of research activity in some areas of research than others. Through
the massive injection of central bank money into research activities in delim-
ited fields of research, many more actors will suddenly become players in the
field of generating knowledge within a particular subset of macro-economic
research. This is already a noticeable phenomenon in the North American
scientific community. Here, central bank research appears to ‘crowd-out’
research on alternative monetary regimes (White 2005: 326). In other words,
the scientization of central banking may cause a bias in research focus, since
very few other sources of research funding, private or public, will be able to
match the cash flow emanating from central bank circles. It is difficult to
predict whether this potential research bias will have enduring consequences
for the development of the economic sciences in particular and the social
sciences in general. However, it is to be expected that the scientific disciplines
of most relevance to central bankers will tend to play a dominant role in the
overall field of macro-economic research (Apel et al. 2008). In consequence, the
central banks have a sort of oligopoly on monetary opinion (White 2005: 327).
386
By the same token, just as specific scientific disciplines can become over-
emphasized by an extraordinary injection of funding, so also can specific
scientific approaches. The new impetus to macro-economic research may
have an impact on the scientific discourse in general and, consequently, also
on which approaches are considered to be marginal or peripheral and which
are considered to be central or important. Indeed, it has been documented that
central banks tend to subsidize research that takes the institutional status quo
for granted (White 2005: 344). Since the new actors in the knowledge game are
relatively well financed, and since it may reasonably be expected that they will
have quite a narrow agenda, central bankers may be able to discipline the kind
of discussions held in certain domains of economic research. Within the field
of research on monetary policy, some voices in the ongoing academic debate
may be strengthened, while others become weaker. If central banking ideas
about obtaining stability via sound money, finances, and institutions have
achieved the status of hegemony, this status can be expected to be further
consolidated by additional funding in its favour.
Within central bank circles, this power to actually influence the entire
research climate and the conditions of research is fully recognized and even
valued. A Swedish central bank governor held that ‘[s]everal of my academic
contacts have stressed how valuable the contact with the central bank world is
for their research’ (Heikensten 2005). For instance, the most recent evaluation
report written by ECB researchers argued that the benefits to be attained by a
central bank from engaging actively in academic research include the fact that
the central bank ‘can stimulate and encourage external research on issues of
interest to the central bank through publications, conferences, and consulting
relationships’ (Goodfriend, König, and Repullo 2004: 5). The ‘research power-
house’, the ECB itself, has ostensibly grasped the overall idea behind the
concept of research management, since it ‘uses its research capacity to encour-
age, coordinate, and lead research efforts of the national central banks of the
Eurosystem’ (ibid. 22). And this is apparently not in vain. The evaluation
concludes that ‘[g]iven its place at the centre of a continental system of central
banks, it is not surprising that the ECB has already had a major effect on
academic discourse throughout Europe’ (ibid. 24).
The scientization of central banking may also have an impact on the power
relationship between civil servants and politicians, typically in favour of the
unelected civil servant, that is, the central banker. As mentioned, one result of
scientization may be a movement from depolitization to apolitization of the civil
servant–politician relationship. First, scientization consolidates the autonomous
status of civil servants by objectifying monetary policy making. It becomes
‘unthinkable’ to start a political argument with a civil servant who possesses
recognized scientific authority. Rather, to boost their own credibility, politi-
cians might instead tend to socialize with and even publicly flatter the civil
servant in question (Marcussen 2006a). The subtle longstanding relationship
387
between the Governor of the US Federal Reserve and the American Congress
can serve as an illustrative, albeit not necessarily entirely representative,
example. Twice a year, in February and July, the Fed’s Federal Open Market
Committee reports to Congress on the conduct of economic and monetary
policies—the so-called Monetary Policy Reports (see Woolley in this volume).
The release of the report is followed up by the Fed Chairman testifying in
Congress before the Banking Committees of both the Senate and the House. As
an example, a transcript of the so-called Humphrey-Hawkins hearings in the
Senate’s Banking, Housing, and Urban Affairs Committee reads as follows:
I have had the privilege over an extended period of time as a Member, as Chairman, as
Ranking Member, to work with Alan Greenspan in his capacity as Chairman of the Board
of Governors, and it is something that I will always be proud of. I will always be proud to
be able to say that I worked with the greatest central banker of the era. . . . I think one of
the great services you provided to this country has been the wisdom of your views and
the credibility that they contain when you have been willing to speak out. . . . In
reviewing the great bankers in world history, I think Alan Greenspan qualifies as the
greatest central banker in the history of the world. (Senator Phil GRAMM, Republican
from Texas, banking.senate.gov/_files/107835.pdf, pp. 1–2)
As always, I welcome [Alan Greenspan] and thank him for the service he gives our
Nation. (Senator Jon S. CORZINE, Democrat from New Jersey, banking.senate.gov/_files/
107835.pdf, p. 5)
Second, scientization may imply that civil servants with recognized scientific
authority are encouraged to engage in policy issues and domains that are not
part of their primary area of responsibility. The functions and responsibilities of
the civil servant grow exponentially with the degree of scientization. This may
take two forms. One is the case where the central banker takes the initiative to
engage in questions related to education policy, public administrative reform,
and even cultural matters. Thus, researchers employed in the ECB do not hesi-
tate to express criticism of the efficiency of the public sector in various European
countries (e.g. Afonso et al. 2003). In an American context, Chairman Green-
span earned a notorious reputation for speaking out on issues lying far beyond
the authority of the Federal Reserve, including politically contentious issues.
Another form is the case where politicians and media alike consult central
bankers on their own about questions that are only marginally related to central
banking. This may take place in various hearings or in other public spheres.
Third, scientization has an impact on the mode and type of communication
taking place in the political sphere. Apolitization through scientization means
that the entire language of the field is changing. In contrast to political and
administrative statements, a major characteristic of scientific statements ‘is
that they are privileged in the sense that, if derived in accordance with scien-
tific procedures, they are considered to give greater assurance of truth. It is
more useful if conclusions on, say, what works and what does not work in
388
government are scientific because scientific propositions are understood to be

more reliable’ (Farmer 1995: 71). In other words, scientized civil servants
become immune to political argumentation, because only the language of
science is a valid means of communication.
All of these considerations suggest that the locus of accountability in central
banking may be about to shift. We may see a movement from external to internal
accountability. Central bankers were formerly accountable to the financial
markets (during the 1990s) and politicians (during Bretton Woods). Now,
central bankers may be increasingly accountable, first and foremost, to their
scientific colleagues within the knowledge community. In knowledge com-
munities, central bankers can only enhance their legitimacy and authority by
complying with a number of scientific standards and by subjecting themselves
to continuous peer review processes. Whereas central bankers were formerly
obliged to communicate broadly with politicians, citizens, and the financial
markets, their communication may be narrowing down to communicating
with their peers. In doing so, they in some cases apply an arcane scientific
terminology that excludes a large number of people, including many econo-
mists. Thus, the current fashion in central bank circles for engaging in a debate
about how central banks should talk or whether it is a good or a bad thing that
central bankers talk should not be interpreted as a general attempt to open the
business of central banking to the broader public or to elected politicians.
The Fifth Age: From ‘Art’ to ‘Science’
Do scientization and rationalization constitute a qualitatively and quantita-

tively new era for central banking? Is central banking developing from being
an ‘art’ to becoming a ‘science’? As emphasized throughout this chapter, Max
Weber pointed to rationalization as a mega-trend in modern society as
embodied in the reality of public administration. Later, Gouldner (1979)
argued that public administration is on its way to becoming fundamentally
scientized. Thus, scientization as a phenomenon is, strictly speaking, hardly a
new, revolutionary phenomenon. It may not even adequately describe the
world of central banking in all detail. However, there may be three solid
reasons for why it is worthwhile to pay attention to elements of scientization
in central banking. A first reason concerns the role of the state in the global-
ized world. As the reality of globalization is taking shape, the state is embark-
ing on new roles and functions; new actors continue to pop up in global
governance; and a multitude of authoritative governance instruments are
being applied. In this situation, the possible scientization of central banking
might serve as an early indicator of what is possibly becoming a more general
phenomenon in global governance, that is, that the production of knowledge,
norms, and identity—rather than the production of traditional, enforceable
389
regulation—is what matters. Scientization can simply be seen as a new mode

of governance in transnational regulation, according to which rational, tech-
nical, and objectified knowledge becomes central for the authoritative alloca-
tion of goods in society.
Second, it is worth paying attention to the nascent scientization of central
banking, because it problematizes the relationship between science producers
and science consumers. The literature on epistemic communities tends to view
these two spheres as separate. According to that argument, scientific know-
ledge is injected into the policy process from outside in situations of uncer-
tainty with a view to helping policy makers construct meaning. The case of
central bank scientization illustrates that those producing science are not
easily distinguished form those consuming science. Science and politics are
not easily disassociated. Central banks do not necessarily produce relevant,
open, debatable, and testable science. But they obtain a certain level of
authority by presenting themselves as true scientists. Likewise, elected politi-
cians appear to have tacitly agreed to leave large trunks of macro-economic
policy making to the discretion of unelected bureaucrats. This delegation of
power can be justified in the name of science, and it conveniently shifts
responsibility for a problematic political arena away from the sphere of inter-
est of elected politicians. The matter is objectified and, therefore, no longer an
art subject to the discretion of individuals; rather, it is a science subject to
generalizable social rules.
Finally, and connected to this latter point, a critical study of the case of
central bank scientization helps us unravel the objectification of power struc-
tures. By doing so, we may better understand why national, regional, and
global governance structures suffer from democratic deficits. If monetary
policy is somehow transcending politics, lifted out of the political game all
together, how can support and demand then be channelled into the formula-
tion, adoption, and implementation of monetary policy? Traditional political
systems analysis simply assumed that policy issues are salient and that con-
cerned individuals and groups would attempt to channel their demands and
support into the political system. Scientization and rationalization suggest
that it may not be the case that interested parties engage in politics at all,
particularly if the contentious issues and procedures are being brought beyond
politization into the world of pseudo science, hidden in techno-speech, and
reserved for the few initiated. Scientization points to the need for uncovering
these processes with a view to repoliticizing monetary policies.
390
18
Transparency and Accountability
Nicolas Jabko
In the contemporary discourse of financial and monetary officials across the

world, ‘transparency and accountability’ are usually lumped together as
paired requirements. The spread of this global ethos is puzzling if we consider
that central bankers not long ago derived pride and authority from their
power to make important decisions outside the public eye. In 1986, Marvin
Goodfriend, a vice-president of the Federal Reserve Bank of Richmond,
acknowledged—and questioned—central bankers’ adherence to a ‘mystique’
of secrecy surrounding monetary policy (Goodfriend 1986). By contrast, trans-
parency and accountability now seem to be the object of a global consensus
about modernity in central banking. Reflecting on his experience as vice-chair
of the US Federal Reserve, Alan Blinder comments at great length upon the
shift toward more transparency as one of three key elements of a ‘quiet
revolution’ in central banking (Blinder 2004: 2–3, 5–33). The question there-
fore is how can we account for this apparently complete turnaround in less
than two decades?
This chapter envisions the emergence of transparency and accountability as
the normative embodiment of a historically contingent balance of power
between central bankers and other actors. It argues that conventional
accounts in terms of economic benefits and of democratic concerns are insuf-
ficient. Beyond the apparent convergence on a new global consensus, the
equilibrium point of the balance of power between central bankers and other
actors varies considerably across political systems. Even though everyone
agrees on the need for ‘transparency and accountability’, there remain many
different ways for central banks to live up to this global ethos. After developing
a critique of conventional explanations, the chapter demonstrates the argu-
ment in the cases of the world’s two most important central banks today—the
Federal Reserve and the European Central Bank.
391
Transparency and Accountability in Historical–Political Perspective
At the most commonsense level, a central bank that lives up to the norm of
transparency is one that makes its decisions in the public eye and renounces
the ‘mystique’ of secrecy. This is the case if central bankers communicate
abundant and timely information about their decisions and about the process
that leads them to make these decisions. A commonsense definition of
accountability is arguably somewhat more demanding. A central bank can
be called accountable if it can be held to account for its decisions—both in
the sense of explaining its decisions and in the sense of taking responsibility
for its decisions. This, in turn, requires a constituency or even perhaps a
political body to which the central bank must be brought to account.
Although these two basic definitions are widely open to discussion, a variety
of techniques that purport to enhance central bank transparency and account-
ability have spread across the world since the 1980s. The most commonly cited
transparency enhancements are the dissemination of inputs to the monetary
policy process (including inflation and other economic forecasts and models
that central bankers use as information for making policy); the publication of
data about the process and output of monetary policy (minutes of monetary
policy meetings, voting records, press conferences, and other central bank
statements about policy trends). The most commonly cited accountability
enhancements—in addition to the above—are the holding of regular parlia-
mentary hearings of central bankers, the holding of increasingly open
appointment (or re-appointment) procedures for central bankers, and more
generally the existence of a regular debate and interaction between central
bankers and various outside constituencies.
The value that is generally ascribed to transparency and accountability in
central banking rests on two conventional rationales—one economic and one
political. The economic rationale puts great emphasis on the need for trans-
parency in order to achieve economic policy goals. According to this reason-
ing, both real changes in the economy and the evolution of economists’
thinking call for enhanced central bank transparency.1 As financial markets
became more global and instantaneously responsive, monetary policy has
become the central avenue not only for ensuring price stability, but also for
macroeconomic demand management. Interest rates are now the main instru-
ment for economic stabilization. In this new context, the expectations of
market actors and the credibility of monetary policy become increasingly
important. Central bankers need the cooperation of market actors in order to
set medium- and long-term interest rates. This in turn would explain the new
emphasis on transparency and the increasing importance of ‘how central
bankers talk’ (Blinder et al. 2002). Transparency is part and parcel of the public
relations strategies that central bankers develop in order to communicate their
intentions to market actors.
392
The political rationale for the new consensus seems to stem from the global
trend of increasingly independent central banks.2 Accountability, in particu-
lar, is a normative requirement in a democratic context. As one central banker
put it, ‘independence and accountability are two sides of the same coin’ (Issing
1999: 505)—or, this is the way things should be from a normative democratic
perspective. The delegation of important policymaking powers to unelected
central bankers raises serious concerns about the compatibility between cen-
tral bank independence and democratic ideals. Some scholars have echoed
these concerns and have questioned whether independent central bankers can
truly be held accountable for their decisions [Berman and McNamara 1999;
Cerny 1999; Pauly 1997; for a rather harsh view from a (British) central bank
insider, see Buiter 1999]. The resonance of such arguments in a democratic
context helps explain, in turn, the insistence of politicians on the norm of
accountability and the willingness of central bankers and financial officials to
adopt it—at least in rhetoric.
Does this conjunction of powerful economic and political rationales mean
that there is now a strong consensus on the need for transparency and
accountability in modern central banking? The problem with this view is
that there are good political reasons to question the strength of the consensus.
How Central Banks Relate to Their Political Systems

Even though everyone pays lip service to transparency and accountability,
different actors push for different versions of the new mantra. In order to see
this, it is important to understand that the concept of central bank transpar-
ency has several meanings and therefore can easily become an object of
contestation among the actors (Begg 2007). Central bankers may generally
welcome increased opportunities for communicating their views to outsiders,
but they are likely to resist when politicians desire to scrutinize (and poten-
tially criticize) their decisions. In the case of accountability, the problem is
even worse because accountability is perhaps the single most important argu-
ment that critics have levelled against what they see as the excessive inde-
pendence of central bankers (see for example Berman and McNamara 1999).
Practical disagreements are compounded by the notorious difficulty of envi-
sioning meaningful accountability from a theoretical perspective—a fortiori in
the absence of meaningful electoral sanctions.3 Therefore, scholars’ sharp
disagreements on the awarding of accountability credentials to central bankers
are perhaps not surprising.4 Although everybody agrees that central bankers
should not be left ‘unaccountable’, there is no normatively neutral definition
of accountability.
Once we envision ‘transparency and accountability’ no longer as a mono-
lithic ideal but as a field of contest, it makes little sense to continue the largely
elusive search for a universally applicable definition or checklist of transparency
393
and accountability mechanisms. Across the world, apparently similar meas-

ures (e.g. the definition of a policy targets, or the practice of parliamentary
hearings) are being introduced for markedly different reasons, following dif-
ferent modalities, and with different effects. This in turn helps understand the
sharp disagreements on the definition and measuring of central bank trans-
parency and accountability. Rather than assuming a homogenous economic
and democratic push for transparency and accountability, the crucial task then
is to assess different distributions of resource endowments among actors, and
their effects on various patterns of central bank transparency and accoun-
tability.
Just as in other movements of modernization in history, the possibility of
retaining one’s differences contributes to explain the attraction and diffusion
of the global model. Each local elite can embrace economic modernity without
however renouncing its distinctive political system and culture. Transparency
and accountability become part and parcel of a broader set of trends—financial
deregulation, central bank independence, the increasing importance of rat-
ings, and new public management techniques of all kinds—that appear to
diffuse on a worldwide scale under the broad label of ‘neoliberal reforms’.
While some of these shifts have massive consequences for the evolution of
the world economy, considerable variation remains possible within a broader-
than-expected spectrum of possible outcomes. Actors thus do not simply
follow the example set by the United States or the IMF—let alone New Zealand
or Sweden. More often than not, they appropriate terms that have gained
global currency for their own idiosyncratic purposes.
Three Sources of Variation in Transparency and Accountability

Three institutional factors stand out as critical sources of variation in central
bank practices between the United States and the EU. These factors usually
encapsulate not only well-entrenched formal characteristics of the political–
administrative system but also culturally accepted, informal ways of doing
things that actors rarely question in normal circumstances.5
The first, and perhaps most obvious, factor is the solidity of the central
bank’s claim to independence. If the central bank’s claim to independence is
(virtually) uncontested, central bankers will be better able to resist what they
feel are overly intrusive forms of transparency and accountability. That is the
case, for example, in the United States, where the Fed’s record of independent
and largely successful monetary policy—with the exception of the 1970s—
protects it against fundamental outside challenges. The European Central
Bank is a situation similar to the Fed, albeit for different reasons. Its independ-
ence is entrenched because of the aura of its German predecessor and model,
and also and above all because of the sheer difficulty of challenging its treaty-
defined statute. The more their claim to independence is institutionally
394
entrenched, the better central bankers will be able to resist forms of transpar-
ency and accountability that might encroach on their independence.
A second factor in explaining variation in transparency and accountability
practices is the power of the legislature to oversee the central bank. Interest-
ingly, the principle of legislative oversight is no longer really contested any-
where. Even when central bankers are independent from the executive branch
of government, it is now generally accepted practice that they must publicly
report on what they do to the legislative branch. But there remains consider-
able variation in oversight power. The US Congress’s claim to oversee the Fed is
virtually uncontested due to its power and prestige within the American
system of government. As for the European Parliament, it started from a
particularly weak position within the EU and had to work hard to assert a
relatively modest claim to oversee the ECB.
The third factor that fosters variation is the capacity of the executive branch
to assert policy leadership in relation to the central bank. Monetary policy
operates in a broader context of economic policies that remain, for the most
part, executive prerogatives. In the United States, the executive claim to eco-
nomic policy leadership stems from the President’s democratic mandate to
implement the policies for which he has been elected, notwithstanding the
important powers of the US Congress in fiscal matters. Executive power at the
EU level is neither unified, nor a straightforward expression of democratic will.
The Euro Group—which brings together the finance ministers of the countries
that have adopted the euro—would be the most likely candidate for policy
leadership on fiscal matters. Yet, it is far from a cohesive body of government
and is therefore largely unable, at this point, to exert genuine policy leadership.
Although each of the above three factors provides only a partial picture of
the institutional context within which the central bank operates, they interact
to produce rather different equilibrium points for transparency and account-
ability practices in the United States and in the EU. The nature of central bank
transparency and accountability practices ultimately depends less on the pres-
ence or absence of specific transparency and accountability provisions than on
local institutional dynamics.
The United States: A Strong Bank in the Midst of Divided Powers
As the Fed acquired growing clout in the determination of US economic

policies since the 1970s, it has also become more forthcoming about its
decision-making process. Against a backdrop of relative stability in the Fed’s
legal and political environment, Woolley’s chapter in this volume highlights
‘considerable change with respects to issues of disclosure and transparency’.6
Perhaps the most obvious and internationally replicated change was the intro-
duction in 1975 of regular and increasingly publicized hearings of Fed officials
395
in Congress. But there were many other changes as well: the publication of
forecasts starting in 1979; the introduction of the Beige Book about regional
economic conditions in 1983; the publication of minutes of Federal Open
Market Committee (FOMC) meetings after 1994; and, most recently, Ben
Bernanke’s pledge to publish ‘enhanced projections’ by FOMC members
about key economic aggregates (Bernanke 2007d). At the same time, the
United States is relatively late in adopting certain measures that have become
accepted practice in many other states and that can be described as transpar-
ency-enhancing, like inflation targeting. The question is what factors pro-
voked these various moves and what is pushing the United States to adopt
its own, relatively singular version of transparency and accountability. When
we examine this question, the evolving political environment of the Fed
looms large in comparison to strictly economic or democratic concerns.
The Fed’s Rise to Prominence and the Mounting Pressures for Transparency
and Accountability
The 1970s were years of turmoil for the Federal Reserve as well as for successive
administrations. As the US economy ran into double-digit inflation figures,
politicians in Congress increasingly questioned the executive branch’s eco-
nomic policies, including the Fed’s. Of course, the Federal Reserve exists by
virtue of an act of Congress, the Federal Reserve Act of 1913. As former Fed
chairman Paul Volcker famously put it, ‘Congress has made us, Congress can
unmake us.’ The Senate also has the power to confirm or invalidate the
president’s appointments of the Fed’s governors and chair. Yet, during the
first few decades of the Fed’s history, Congress deferred to the administration
in matters of economic policies and the Fed had trouble asserting its inde-
pendence.7 Until the 1970s the Fed’s accountability was mostly vis-à-vis the
administration and the Department of Treasury—and thus outside the reach of
Congress.
In fact, the first steps toward the present framework of Fed’s transparency
and accountability stemmed from Congressional efforts to clip the wings of
the executive in matters of monetary policy. After a long period of ‘imperial’
presidency, the 1970s saw a reassertion of Congressional oversight over the
Federal Reserve as well as other executive agencies. Only in the mid-1970s did
Congress start a practice of regular hearings of Federal Reserve Board officials,
in addition to the normal appointment hearings at the Senate. The Federal
Reserve Reform Act (1977) and the Full Employment and Balanced Growth
(Humphrey-Hawkins) Act (1978) reasserted Congress’s oversight role and
redefined the Fed’s mandate. Inflation projections, for example, stemmed
from the Fed’s obligation to publish its ‘prospects for the future’. Court cases
also played a role in prompting the Fed to become more open, especially the
Merrill versus Federal Open Market Committee ruling by the US Supreme Court
396
(following a lawsuit under the Freedom of Information Act), which limited

the Fed’s latitude in withdrawing information from the public eye (Goodfriend
1986). By the time Paul Volcker was appointed Fed chairman in 1979, then, the
Fed was already subject to unprecedented amounts of public criticisms.
Under Paul Volcker (1979–87), the Fed grew its own wings, which created a
new kind of transparency and accountability problem. Volcker asserted the
Fed’s claim to independence more forcefully than ever before. Breaking with
the relatively accommodating monetary policy of the 1970s, he inaugurated a
policy of high interest rates designed to kill inflation. As Volcker established the
Fed as a Washington power broker, however, he also faced a barrage of critics.
The Fed’s harsh medicine of high interest rates was blamed for the recession of
the first Reagan Presidency, and pamphlets against the Fed and its lack of
accountability proliferated. Secrets of the Temple, a best-selling book by journalist
William Greider (1987), expressed the American Left’s widespread suspicion
that the ‘independent’ Fed actually catered for the special interests of Wall Street
rather than for those of the general population. Despite all the criticisms, Paul
Volcker’s Fed was above all widely credited with its successful victory over the
inflationary pressures of the 1970s. Yet, the Federal Reserve’s aloof and secretive
culture was its Achilles’ heel. More important change was brewing on both sides
of the aisle in Congress and within the Federal Reserve Board itself.
After Alan Greenspan took over as chair, the Fed adopted a less confronta-
tional approach but, if anything, gained voice and influence in the US economic
policymaking process—which seemed to magnify the transparency and
accountability problem. Greenspan’s advocacy of fiscal prudence was clearly a
central consideration in the Clinton administration’s decision to adopt a pro-
gramme of deficit reduction in the 1990s. Some members of the Clinton admin-
istration resented this rapid rise to power of a Republican appointee.8 As the US
economy boomed in the late 1990s, Greenspan became the character depicted
in a biography by Bob Woodward (1997) as the ‘Maestro’. He was universally
hailed as the chief architect of an economic policy that ensured both low
inflation and remarkably robust growth, along with dwindling federal deficits.
It is easy to overstate the Fed’s claim to exert policy leadership, however. In
law but also in practice, the Fed is not only ‘subject to the oversight of the US
Congress’ but also ‘must work within the overall objectives of economic and
financial policies established by the government’ (Board of Governors of the
Federal Reserve 2005: 3). Of course, the administration’s prevalence over
the Fed declined after the 1970s and the Fed was never as deferential to the
administration as under Roosevelt. Yet the President retained the power of
appointment, which implies a form of central bank accountability to the
President—especially given the fact that the Fed chair can be reappointed.
Even under Clinton, Greenspan’s seemingly huge influence over government
policies was probably the product of a good cooperation between the Fed and
the administration, rather than of an undue power grab by the Fed. Above all,
397
Greenspan was able to develop a good working relationship with Clinton and
his long-time Treasury Secretary Robert Rubin. Clinton chose to reappoint
Greenspan—and he would presumably have acted differently if Greenspan
had not been a good ‘team player’ (Woodward 1997: 159–60). The adminis-
tration’s claim to policy leadership was reasserted with a vengeance by the
post–2000 Bush administration, when Greenspan endorsed the president’s tax
cuts despite mounting fiscal deficits.
Once again, therefore, the key factor that pushed the Fed to change its
approach to transparency and accountability was really the renewed pressure
coming from a powerful Congress—a structural characteristic of the US polit-
ical system. In the early 1990s, Congress was demanding more transparency
and accountability as a prerequisite to approval of the administration’s fund-
ing of international organizations. In that context, the Fed and some other
federal agencies fell under the same Congressional axe. The single most
important consequence was the 1994 decision to publish minutes of the
FOMC meetings. The consequences of this decision are actually ambiguous.
According to Meade and Stasavage (2008), it may have rigidified the style of
FOMC debates, as participants apparently began to voice their opinions less
freely. Critics would add that the publication of minutes is a rather limited form
of accountability, especially since the minutes are edited and were revealed
only many weeks after the decision. (The delay was shortened to three weeks in
2005.) All this may be true, but it was nonetheless a departure from existing
practice.
Increasingly, and perhaps surprisingly, voices from within the Federal Reserve
System were heard supporting the push for greater transparency and account-
ability. The central bankers were above all concerned not so much about their
own accountability, but about the benefits of explaining monetary policy
decisions to the markets.9 But they also knew there was an outside demand for
more transparency and accountability. Most vocal among them in the 1990s
was vice-chair Alan Blinder, a Clinton appointee to the Federal Reserve Board.10
Blinder’s reasoning was political as well as economic, since he believed that both
the Fed’s democratic credentials and its credibility would be best served by
enhanced transparency and accountability. Originally a product of distinctively
American political pressure coming from the US Congress, the Fed’s conversion
to transparency and accountability was now complete—or was it?
The Debate Over Inflation Targeting and the Problem of the Dual Mandate
Let us examine the substance of the Fed’s transparency and accountability.
One glaring aspect that seems to be missing in the case of the US Federal
Reserve is a clear policy target. There is an interesting political story behind
this absence—one that highlights potential contradictions in the new ethos of
transparency and accountability. And the resistance to this particular step
398
once again comes from the particular political environment in which the Fed
finds itself, namely, as an independent central bank subject to strict legislative
oversight from the US Congress.
The first episode of this story about inflation targeting started as a technical
debate in central banking and economist circles. After the heyday of monet-
arism in the early 1980s, central bankers were looking for a policy target that
would be both an appropriate intermediate goal for monetary policy and a way
to anchor market expectations. Inflation targeting emerged as a potential
solution to this problem in New Zealand and Europe. The Bank of New Zealand
pioneered the use of numerical inflation targets for monetary policy in the late
1980s. The Maastricht Treaty’s definition of price stability as the ‘primary’ goal
of monetary policy in 1992 was a step in the same direction. One of the
benefits of this approach was to enhance the transparency of the decision-
making process. If there were a clear target that everybody could see, central
bank transparency and accountability would be presumably enhanced.
Yet in the United States these international developments toward greater
transparency were controversial because of the so-called ‘dual mandate’ of the
Fed since the 1978 Humphrey-Hawkins Act. The Fed’s task is not only to fight
inflation but also to pursue ‘full employment and balanced growth’ at the same
time. On the one hand, the Fed’s defence of its growth-enhancement mandate
is often largely a matter of rhetoric. There were times when the Fed acted as a
very hawkish inflation fighter—especially under Paul Volcker in the 1980s. The
Fed could argue that it was impossible to make progress on all fronts at the same
time, and thus arguably obfuscate its mandate (e.g. Wyplosz 2001: 5). On
the other hand, the dual mandate also means that the governors are legally
bound to worry about growth as much as about inflation. In the Fed’s recent
history, ‘doves’ who argued that growth should not be sacrificed to the fight
against inflation have been able to invoke the dual mandate in support of the
argument.11 From this perspective, the dual mandate may be argued to ensure
that central bankers are held accountable for the goals set for them by Congress.
The US debate on inflation targeting quickly became partisan. On the
Republican side of the aisle, Congressmen Coney Mack and Jim Saxton argued
that the Fed should have a single hierarchical mandate of price stability,
meaning zero inflation. They favoured not only inflation targeting but a
change in the mandate of the Fed. Others, especially among Democrats,
argued that the mandate should not be changed and the Fed should stay
away from inflation targeting. They feared that an inflation target would assign
more weight to the price stability mandate of the Fed and would authorize the
Fed to disregard its employment mandate. After some hesitations, Greenspan
sided with the second camp in the name of flexibility, and the Mack-Saxton
proposal went nowhere in the 1990s.
The next episode of this inflation-targeting saga started when Ben Bernanke
was appointed chair of the Fed in 2006 and is still being played out. Bernanke
399
came in with a reputation as an advocate of inflation targeting and started

defending a move of the Fed in that direction, in the name not only of policy
effectiveness but also of transparency and accountability. The lines of debate
among economists had changed, since inflation targeting is no longer a rally-
ing cry for inflation ‘hawks’. Many supporters of the dual mandate in US
central banking circles now support ‘flexible’ inflation targeting via a small
but definitely positive inflation target, especially Alan Blinder and Janet Yellen
(see Meyer 2004: 40–3). But the topic remains politically sensitive. In Congres-
sional hearings, Bernanke pledged that any adoption of an inflation target
would be progressive and would not require a change in the mandate. The
Fed’s new communication strategy, unveiled by Bernanke (2007d), introduces
an extended inflation forecast (with a time horizon of three years instead of
two) and additional information about the FOMC members’ views about the
economy. Yet Bernanke stopped short of introducing a formal inflation target:
‘My colleagues and I strongly support the dual mandate and the equal weight-
ing of objectives that it implies.’
This inflation-targeting debate illustrates the importance of Congress in
steering the Fed toward a particular model of transparency and accountability.
For Congress, accountability is not just a concern in and of itself. It is also a
way to assert legislative oversight, to acquire a role in the policy debate, and to
defend its turf against the administration and the Fed. To this day, the Fed’s
mandate remains the dual, non-hierarchical mandate set by Congress in the
1970s, and hard inflation targets are eschewed. No matter how successful its
policies and how powerful its voice in US economic policies, the Fed could not
afford to ignore the argument against inflation targeting—since it came from
Congress. Thus, abstract considerations of efficiency or democracy were clearly
secondary to the institutional framework of central banking in the United
States. The same was true in Europe, but there the institutional dynamics were
remarkably different.
The European Union: A Strong Bank in a (Still) Weak Polity
Central bank transparency and accountability were not paramount concerns

in the late 1980s and early 1990s, when European political leaders designed
the European Central Bank (ECB) as an independent central bank to manage
the new European currency. According to an extensive investigation of this
process, Europe’s economic and monetary union embodied ‘the triumph of
technocratic elitism over the idea of political democracy’ (Dyson and Feath-
erstone 1999: 801). Yet after the ECB started to operate in 1998, its officials
quickly pledged to make the ECB ‘the most transparent and accountable
central bank in the world’ (Issing 1999: 105; see also Padoa-Schioppa 2000:
28). The ECB has therefore developed its own model of transparency and
400
accountability. This model is characterized by extensive but often unilateral

communication. The ECB was the first major central bank to systematically
hold press conferences after the meetings of its Governing Council. Compared
with the Federal Reserve, the ECB has a relatively clear inflation objective, and
Executive Board members also appear before the European Parliament. Yet, the
ECB does not publish a Beige Book, nor the minutes or the voting patterns of
its Governing Council meetings. Let us now turn to the factors that shaped the
development of this model.
The ECB’s Problem of ‘Institutional Loneliness’

On the face of it, the ECB did not really need to go in the direction of transpar-
ency and accountability. The primary purpose of the Treaty of Maastricht was to
create a single European currency under the supervision of an independent
central bank, not to enhance democracy. Central bank independence was
granted quasi-constitutional value, whereas the Maastricht Treaty’s formal
transparency and accountability provisions were scarce. Treaties are the func-
tional equivalent of constitutional documents for the EU, and it requires a
unanimous agreement between the member states to change them. Because
the ECB is a Treaty creature, it is particularly entrenched. And yet the ECB is part
of an EU political system that still lacks the historically produced power and
legitimacy of its constituent member states. This situation is, in a sense, the
exact opposite of the situation in the United States, where the Federal Reserve is
a venerable century-old institution, yet has no constitutional status whatsoever.
As a consequence, EU central bankers could not completely ignore wide-
spread concerns about the EU’s ‘democratic deficit’. After the harsh criticisms
against the Maastricht process, the young ECB needed to restore its democratic
image. As soon as it was established, the ECB started a practice of numerous
press conferences and outreach, by which it attempted to communicate its
policies to the markets, to the general European public, and to other political
bodies. Not only the ECB’s monetary policy decisions but also many key
announcements of monetary policy strategy are announced by way of press
conferences and speeches. In addition to this all-out communication strategy,
the ECB also endeavoured to break out of what one ECB Board member called
its ‘institutional loneliness’ (Padoa-Schioppa 2000: 37). Despite its initial
reluctance to engage in ‘politics’, the ECB increasingly looked for partners to
break its isolation and to enter into a normal dialogue with other bodies.
This eagerness of Europe’s central bankers to restore their democratic image
was met favourably by some other actors. In particular, the European Parlia-
ment saw it as an opportunity to develop for itself something akin to the
oversight function of the US Congress over the Federal Reserve, which mem-
bers of Parliament cited as a constant reference in parliamentary discourse
about the (desirable) ‘democratic accountability’ of the ECB. At the end of
401
2000, the ECB acknowledged that the European Parliament is the only body
‘directly elected by the European citizens and, consequently, plays a crucial
role—the ECB must be accountable to the Parliament for the conduct of
monetary policy. ( . . . .) In this sense, the relations between the ECB and the
European Parliament must be considered as more than a simple statutory
requirement’ (European Central Bank 2000: 54). Early on, therefore, the ECB
started a practice of sending Executive Board members to explain monetary
policy before the European Parliament (see Jabko 2003).
The sheer force of democratic ideals is insufficient, however, to explain the
growing importance of transparency and accountability in the official rhetoric
of both the Parliament and the ECB. Since the Maastricht Treaty did not
explicitly provide for it, an accountability relationship developed progres-
sively as a practical result of interactions between key actors. By the ECB’s
own admission, the hearings ‘contribute to safeguard the independent status
of the ECB. Consequently, it is certainly in the ECB’s enlightened interest to
carry on with such relations’ (European Central Bank 2000: 54). Thus, the
evolution of the ECB’s official position is, for the most part, the result of a
calculation. The expected gains in terms of consolidated independence are
perceived as far higher than the expected costs of acknowledging the European
Parliament’s role as a privileged interlocutor.
In the absence of strong parliamentary powers at the EU level, the ‘dialogue’
is in fact not very constraining. A new routine of quarterly hearings of the
president of the ECB before the European Parliament’s Economic and Monet-
ary Affairs Committee has been established. The main actors looked at foreign
models as sources of ideas, especially the US model. Yet despite the recurrent
reference to the Fed’s accountability to the US Congress, the staging of ECB
hearings is revealingly different from the hearings of the chair of the US
Federal Reserve by Congressional committees. Whereas the chair of the Fed-
eral Reserve stands in the witness box and must answer questions asked by a
small number of Congressmen who sit above him like judges, the president of
the ECB addresses a floor of European Parliament members from a platform
where he is seated next to the chair of the Economic and Monetary Affairs
Committee. Moreover, the ECB president’s hearings only last two hours, and
members of Parliament are only allowed to ask the President two questions,
which he can therefore dodge quite easily. Here again, the difference with the
US situation is striking, since the chair of the Federal Reserve is subjected to a
barrage of questions from Congressmen.
In sum, the ECB and the European Parliament came to an agreement on the
rules of the accountability game because both bodies had a clear interest in
playing that game. Accountability became a terrain of political contest
between two bodies that defended what they had identified as their primary
interests. The ECB wanted more democratic legitimacy, which it could acquire
through good relations with the European Parliament. Conversely, the European
402
Parliament desired a greater say on the conduct of economic policy within the
EU, which it could gain from its relations with the ECB. Thus, in many
respects, the ‘dialogue’ between central bankers and members of the European
Parliament developed into a form of exchange.
The real question is whether the game of central bank accountability
between the ECB and the European Parliament really serves democracy, or
merely the interests of the various actors who play that game. It is important to
realize that both hypotheses could well be valid at the same time. The evolving
debate on central bank accountability represents an interesting attempt to
‘muddle through’ a new democratic practice, yet it is also, and perhaps inevi-
tably, a power play between the main actors—just as in the United States. Despite
the continuous upgrade of its powers since the 1980s, the European Parliament
does not in any sense match the power and prestige of the US Congress. The
European Parliament gained its oversight role over the ECB only by courtesy of
the member states, and, furthermore, this oversight is limited to mere ‘reporting
requirements’. This affects the Parliament’s power to hold the ECB accountable.
The practice of parliamentary hearings has different parameters and results,
despite the superficial similarity between the EU and the United States.
Just as important, there is almost no form of accountability to the executive in
Europe—largely because there is no unified executive able to claim policy
leadership. Thus far, the Euro Group—that is, the caucus of Euro Area finance
ministers within the EU Council—has not asserted very strongly its preferences
vis-à-vis the ECB. This is due to the difficulties of coordinating member govern-
ments’ economic policies, as well as to the extent of ECB independence in the
Treaty. Only with the nomination of Jean-Claude Juncker as the chair of the
Euro Group did this situation begin to change. But the chair has no hierarchical
powers over his colleagues, so his room for manoeuvre is limited. By contrast,
member states are still vested with so much power and legitimacy that central
bankers are very cautious when it comes to accountability toward the member
governments. This also explains the relative opaqueness of the ECB when it
comes to minutes and voting patterns. In the absence of a truly unified EU-level
economic stance, the governors of national central banks refuse to be exposed
to the heat of national debates on their positions within the Governing Council.
Limits and Dilemmas of Transparency and Accountability

A good example of the limits and dilemmas of transparency and accountability
in the EU is the definition of the ECB’s mandate. The Maastricht Treaty defines
‘price stability’ as the primary objective of the ECB, with other objectives like
growth and employment only permissible ‘without prejudice’ to price stability.
The effects on accountability depend on the analyst’s definition of accountabil-
ity. On the one hand, it could be argued that in practice there is almost no
difference of behaviour between the single-mandate ECB and the dual-mandate
403
Federal Reserve. Those who hold this view favour the ECB’s mandate from
a transparency and accountability perspective, which has the advantage of
being clearly hierarchical. From this perspective, the mandate is transparent,
and the ECB is ‘accountable for the fulfillment of its mandate’ (Issing 1999).
On the other hand, it is also possible, and indeed more conventional, to
argue in favour of more open-ended goals for policymakers as a way to reinforce
their accountability. In political theory, the standard conception of account-
ability assumes that there is room left for policymakers to exercise discretion,
and that the evaluation of policies takes place ex post. The existence of mean-
ingful accountability is then opposed to the definition of a strict mandate
(Pitkin 1967). In this conception, therefore, too much transparency can actu-
ally come at the cost of accountability.
Second, the self-definition of their role by central bankers is different in the
ECB and in the United States. While the Fed is an independent central bank, it
has had to live with a particularly broad mandate that includes growth and
employment as well as low inflation. In the Euro Area, the situation is very
different because the ECB’s mandate is narrower—with price stability defined
as a ‘primary objective’. But arguably even more important is the fact that
Eurosystem central bankers have come to see a narrow technical definition of
their task as a guarantee of their hard-won independence. Unlike their Ameri-
can counterparts, they are in an EU sphere where nobody has sufficient
legitimacy to make clear—let alone partisan—policy choices. The conse-
quence is that central bankers attempt to escape political debate and to deny
the existence of difficult trade-offs altogether.
Does an inflation rate ‘below 2 per cent’, namely, the ECB’s unilaterally
chosen ‘reference value’, strictly correspond to the Treaty’s objective of ‘price
stability’? This is debatable—to say the least. In 2003, the ECB chose to specify
its objective and announced a target of ‘below but close to 2 per cent’. The first
remarkable fact is that, unlike the US situation (or the Japanese situation),
there was no unified political body able to really discuss—let alone to dis-
agree—with the ECB on this matter. Despite a formal recognition of the Euro
Group and the introduction of a stable chairmanship during the EU Constitu-
tional Convention of 2002–3, the forums toward which the ECB is supposed to
be transparent and accountable remain ill designed. If this situation ever
changes, it will not be simply because of a universal realization that change
is desirable from the viewpoint of transparency and accountability—some
very serious political obstacles stand in the way.
In addition, it is possible to question, from a substantive perspective, the
ECB’s adherence to a rather rigid conception of central bank independence
and its refusal to engage in a debate about its policy target. While understand-
able in its own terms, given the ECB’s political environment, the absence of
substantive debate is not necessarily the way of ensuring satisfactory standards
of transparency and accountability.12 After all, the fact that price stability and
404
central bank independence are given such high priority in the Maastricht
Treaty must itself be understood as the output of a political process, not simply
as a legal translation of economic rationality. In the French referendum of May
2005 on the EU Constitutional Treaty, one of the recurrent arguments of
opponents was the ‘democratic deficit’ of the EU and specifically the ‘lack of
accountability’ of the ECB. But then, again, there is a gap between a diagnosis
of the situation and a political cure.
Concluding Remarks
Everybody today talks about enhancing central bank transparency and

accountability, but the fact is that institutional designs to ensure these goals
remain quite different. It is not clear that they will deeply converge in the
future, since varieties of transparency and accountability have deep roots, and
no system can claim to be completely coherent and ideal. To be sure, the
frameworks that govern central banking will probably continue to evolve
with a view to achieve more effectiveness and more democracy. But, as we
saw, efficiency-enhancing transparency and democracy-enhancing account-
ability sometimes generate different prescriptions for change. Thus, mutual
emulation will likely continue, but there is no inherent reason to believe that
it will necessarily lead to homogeneity.
In addition, new problems emerge, sometimes very powerfully, and they
do not always call for the same remedies. For example, the financial crisis of
2007–8, with its near-collapses of several banks on both sides of the Atlantic,
highlighted the need for good prudential supervision as well as good monetary
policy. In keeping to the scholarly literature on central bank transparency and
accountability, this chapter has given no attention to financial supervision.
Yet if we briefly consider this question, it is obvious that the requirement for
good prudential supervision may well involve less transparency on the part of
central bankers. This is because transparent decision-making in this area may
create moral hazard. If banks and other financial firms know exactly at what
point and how quickly central bankers will come to their rescue, they might be
tempted to push the envelope and take on excessive risks. Thus, the on-going
redeployment of central bankers’ energy toward the task of prudential super-
vision may also lead to a more sceptical assessment of the requirement for
transparency—at least in this area of central bank operations.
More generally, as John Freeman (2002: 904) puts it, ‘consensus with respect
to the goals of monetary institution is a false perception.’ This raises the possi-
bility that the widespread support for central bank independence, transpar-
ency, accountability, and other holy cows among political economists,
actually indicate a ‘crisis of imagination in institutional design’ (ibid. 906).
Trends that look overwhelming for the progress of modernity may actually be
405
much less seamless than they appear at first sight. As long as there is room for
incoherence within and deviation from the consensual norms, the façade can
nonetheless cover the reality without generating too much cognitive disson-
ance. Only when we stop believing in the reality of the façade will we need to
move to another (consensus) view.
Notes
1. The importance of monetary policy credibility is one way to address the time
consistency problem pointed out by Kydland and Prescott (1977). On the import-
ance of transparency to help central banks achieve their policy objectives and
buttress their credibility, see Geraats (2002), Stasavage (2003).
2. McNamara (2002) lists 38 countries that have made their central banks independent
in the course of the 1990s. Pollilo and Guillen (2005) calculate that more than 80
countries have adopted legal provisions that increase the independence of their
central banks; Marcussen (2005) finds roughly similar numbers.
3. Political theorists have typically conceptualized accountability in the context of
electoral representation and often concluded that it was difficult to achieve in
practice. The addition of power delegation from elected officials to independent
central bankers arguably makes accountability even harder to operationalize. See
Pitkin (1967), Mansbridge (2003).
4. See for example the heated Buiter–Issing and Elgie–De Haan–Amtbrink debates on
the issue of whether or not central banks in Europe had become more accountable in
the 1990s: (Buiter 1999; De Haan and Amtenbrink 2000; De Haan and Eijffinger
2000; Elgie 1998, 2001; Issing 1999).
5. These factors can thus be called institutions in an anthropological sense, like
‘planets fixed in the sky’ (Douglas 1986: 46–7).
6. This change contrasts with Woolley’s (1984: 26) earlier assessment that monetary
policy was ‘made in great secrecy’.
7. For a narration of William Cheshire Martin’s role in securing the Fed’s independence
not from but ‘within the government’, see Bremner (2005).
8. Labor Secretary Robert Reich (1997) was one of the most outspoken critics of Green-
span’s influence on the administration’s policies.
9. According to Woodward (1997: 114, 226–7), Greenspan favoured transparency also
because he thought it magnified his own power. For an early expression of this
concern for the benefits of transparency, see Goodfriend (1986).
10. Blinder (2004: 5–33) offers his own account of his advocacy of transparency within
the Board of Governors.
11. Meyer (2004) cites a 1996 meeting at which Janet Yellen, a member of the FOMC,
boldly challenged Alan Greenspan on this issue.
12. See Stasavage (2003) for an argument that reconciles monetary policy credibility
with a degree of democratic accountability, but on the condition that central bank
independence ceases to be an absolute principle.
406
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Index
ABN Amro 194 asset prices 31

accountability: and monetary policy 368–9, 372
and balance of power consideration 391 Australia:
and Banca d’Italia 186, 192–3, 195 and economic transformation 287
and Bank of Greece 176 and political system 287
and central banks 22 see also Reserve Bank of Australia
domestic state traditions 25 Australian Prudential Regulation Authority
and change in nature of 389 (APRA) 292
and consensus on 391 Austrian Central Bank, and specialization 43
as contested concept 393
and definition of 392 Balcerowicz, Leszek 227, 232
difficulties with 393–4 Balladur, Edouard 117
and democracy 393 Baltic States 217
and European Central Bank 83, 303, Banca Antonveneta 82, 194
400–1 Banca Bilbao Vizcaya Argentaria 194
absence of policy debate 404–5 Banca d’Italia 183–4, 198–9
development of 402 and accountability 192–3, 195
enhancing democratic image 401 pre-EMU period 186
European Parliament 401–3 and Basel Committee on Banking
impact of bank’s mandate 403–4 Supervision 197–8
lack of accountability to executive 403 and central bank cooperation 43
role of central bankers 404 and convergence 198
self-interested motivations 402–3 and credibility of:
and Federal Reserve System 395–6 ‘exporting’ of 190
Congressional pressure 398, 400 regaining of 195
development of 396–7 and crisis in 42
inflation targeting debate 398–400 and domestic banking system 194–5
internal pressure for 398 and EMU accession, unpreparedness
and political rationale for 393 for 188
and Reserve Bank of Australia 291, 300, and European System of Central Banks 197
301 and Europeanization 198–9
and Reserve Bank of New Zealand 291, 298, and exchange-rate policy:
300, 301 as Eurosystem member 193
and sources of variations in: pre-EMU period 187–8
executive policy leadership 395 and financial stability:
legislative oversight power 395 as Eurosystem member 193
solidity of central bank independence pre-EMU period 188
394–5 and globalization 198
and techniques enhancing 392 and governance reforms 191
Adenauer, Konrad 140 adaptation to Eurosystem 192
Allen, Bill 254 appointments 191
Alphandéry, Edmond 117 collective decision-making 191–2
Ansiaux, Hubert 92 ownership structure 191
architecture, and central banks 27 and Governor’s power, pre-EMU period
Arthuis, Jean 117, 123 185
435
Index
Banca d’Italia (cont.) and independence of 243

and independence of: establishment of 241
pre-EMU economic independence 185–6 operational 243
pre-EMU political independence 184–5 and inflation targeting 242–3, 364
and international central banking and influence of 259
networks 197–8 and interest rate policy 259
and legitimacy of, pre-EMU period 186 and monetary policy 241
and monetary policy: and Monetary Policy Committee 243, 259,
as Eurosystem member 193 260 n2, 363
pre-EMU period 186–7 and power of 16
and other functions of, pre-EMU period 189 loss of to Federal Reserve 29
and pre-EMU period 184–6 and Practical Issues 255, 256, 257
and prudential supervision 193–4, 197–8 and prudential supervision 242
pre-EMU period 188 removal of responsibility for 241, 243
and public opinion 186 Bank of Estonia:
and reforms of 190–1 and commercial banking sector 206–7
laggard on new public management 195–6 and currency board 205
and research and analytical capacity 190, and economic transition 210–12
192, 197 and independence of, establishment of
and role in Eurosystem 196–7, 199 204–5, 208
establishment of TARGET 196 and industrial relations regime 206
source of technical knowledge 197 and Maastricht criteria 217
staff secondments 196 and macroeconomic stabilization 205
and staffing levels 192 and nation building 210–12
as strong institution in weak state 189 see also Central and Eastern Europe (CEE)
and transparency 195 Bank of Finland, and specialization 43
Banca Nationale del Lavoro 194 Bank of France:
Banca Popolare di Lodi 194 and central bank cooperation 43
Banco Ambrosiano 193 and Comité des établissements de crédit et des
Bank deutscher Länder 13, 135, 140 entreprises d’investissement 121
Bank for International Settlements 37, 224, and Comité Monétaire 123
268, 274 and communications strategy 126
and monetary policy 31 and Conseil de la Politique Monétaire:
Bank of England: opposition to continuation of 123
and Centre for Central Banking Studies 224 politicized appointments to 113–17
and City Euro Group 249–50 and convergence 128
and communications policy 365 and criticism of government policy 117–18,
and Co-ordination Unit for Europe 253–4, 128
258, 259 and governors of, backgrounds 117
and core purposes of: and image of 21
financial stability 242, 259 and impact of Europeanization 111–12, 127–9
financial system effectiveness 242, 259 and increased power of 127
price stability 241–2 and independence of:
and debt management 241 establishment of 113–14
and Economic and Monetary Union 251–2 fixed terms 114
attitude towards 244–7 opposition to 113
City of London preparations 251–2, 255 sources of aversion to 112
five economic tests for euro entry 247–50 and internal reforms 122–3, 128
monitoring launch of euro 255, 256 and legitimacy of 117
potential impact of euro entry 244, and Macroeconomic Studies directorate 119,
259–60 124
preparations for 249–50, 252–6 and monetary policy 127
and Euro Preparation Division 253, 254 gain in autonomy 127–8
and European System of Central Banks 258, politicized nature of 112, 114
260 and New Public Management 44
and financial crisis (2007–8) 348, 349 and non-EU banks 127
and image of 21 and output legitimacy 24
436
Index
and payment system oversight 121 and political authority of 173–4

and personal debt management 121–2, 128 and political hostility to 180
and prudential supervision 119–21, 128–9 and primary objective of 173
and public opinion 118, 128 and prudential supervision 175, 177–9
and public role of 127, 128 and research and analytical capacity 175–6
and research and analytical capacity 121, publications 176
123–4 restructuring 176
data collection and analysis 123–4 and role of:
publication of growth forecasts 124 changes in 179–80
publications 126–7, 128 factors favouring strengthening of 165–6
weakness in academic research output and staff quality 166–7
124–6 and technological infrastructure 176
and responsibilities of 119 Bank of Latvia 217
and specialization 42 Bank of Slovenia 42
and staffing levels 122, 128 and commercial banking sector 206–7
and structural reform 118 and economic transition 212–14
and subordinate position of, pre- and independence of:
independence 111, 113 establishment of 204–5, 208
and transparency 114 power-sharing context 213
Bank of France, and Conseil de la Politique and interaction with social partners 206
Monétaire (CPM) 112 and Maastricht criteria 216–17
Bank of Greece 42 and macroeconomic stabilization 205
and accountability 176 and monetary policy 205
and communication policy 175 and nation building 212–14
and cooperation with other central banks 171 see also Central and Eastern Europe (CEE)
and decade of adjustment (1990–2000) 171–2 Banking, Finance and Insurance Commission
and EMU accession 161, 172 (BFIC) (Belgium) 98
requirements for 172 banking and financial crises:
and Exchange-Rate Mechanism 172 and European vulnerability 36
and exchange-rate policy 173 and financial stability 37–8
restructuring 177 and impact of 33
and external pressures for change 170–1 see also financial crisis (2007–8)
Exchange Rate Mechanism 172 banking regulation and supervision,
and financial liberalization 168–70, 172–3 see prudential supervision
transformation of financial system 174–5 Banque Central du Luxembourg 42
and Greek political economy: and creation of 95–6
consensus over EMU accession Basel Committee on Banking Supervision 66,
objective 165 77, 330 n11, 351
economic performance 163 and Banca d’Italia 197–8
monetary policy failure 165 and leading role of 338
policy discontinuity 163 BCCI Directive 77
politico-administrative system 163 Bear Stearns 9, 37
Southern European model 162–3 Belgium:
and historical development of 161–2 and economic policy (1970s-80s) 93–4
and independence of 173 and prudential supervision 97–8
and inflation targeting 173 see also National Bank of Belgium (NBB)
and interest rate policy 168, 169 Bell, S 301
and monetary policy: benchmarking, and Eurosystem 44
constraints on 168, 169 Berlusconi, Silvio 6
current role in 176 Bernanke, Ben 316–17, 324, 325, 356–7, 358,
hard drachma 172 365, 383, 396, 399–400
monetary targeting 173 Bernard, Jean-René 115
non-accommodative 171–2 Blinder, Alan 391, 398, 400
and Monetary Policy Council 173 Bod, Péter Ákos 216
and output legitimacy 24 Bollard, Alan 380
and payment system oversight 176–7 Bouton, Daniel 119–20
and policy continuity 167 Bramsnæs, Carl Valdemar 267
437
Index
Brash, Don 380 impact of Economic and Monetary

Braudel, Fernand 374 Union 135–7
Bretton Woods system, and collapse of 48 structural power 158
Brown, Gordon 150, 241, 243–4 and pre-EMU character of 140–2
Brown-Eichel plan 146, 150 and provincialism of, pre-EMU period 141
and prudential supervision 78 and prudential supervision 78
Buiter, W 359, 367–8, 371 post-Euro period 149, 150–2, 159
Bundesbank: pre-EMU delegation of 141
and central bank cooperation 43 and public opinion 148, 158
and challenges facing 132–3 and public questioning of 133
banking system 133–4 and readjustment of 42
changes in global financial markets 133–4 and research and analytical capacity,
domestic political pressures 134 strengthening of 147, 153–4
information technology 134 and responsibilities of 131
loss of international profile 134 and role of 42–3
loss of monetary policy role 134 in post-Euro period 144, 145–7, 153–5
loss of political stature 135 and Stability and Growth Pact 155, 157
New Public Management 134 support for 102
and disempowerment of 7, 10 and staffing levels 133, 150
and domestic stability in pre-EMU period 141 and status, decline in 131
and Economic and Monetary Union: and strained relations with government 146
‘binding in’ strategy 138 and strategic consolidation 154–5
concerns over 101–2 and strengthening of operational
impact on power of 135–7 functions 146–7
role in creation of 137–9, 142–3 and strengthening position in
and Euro Area enlargement 155–6 Eurosystem 153–5
and European Central Bank: and transformation of 157
comparison with 87–8 and Weber’s presidency 146–7, 150–2, 153–5
Governing Council voting rules 156 and Welteke’s presidency 145–6, 148–9
influence on 2, 75, 131, 153
and European integration 155 career incentives, and central banks 24, 32–3
and European System of Central Banks 243 Carr, John 254
and European Union Constitutional/Reform CASH (banknote and coin management
treaty 156–7 application) 97
and Europeanization 157 Central and Eastern Europe (CEE):
and Federal Finance Ministry, changes in and challenges to central bank
relative power 147, 152, 157 independence 42
and financial crisis (2007–8) 348 and convergence 219–20
and ‘Germanization’ of European central and economic performance 208
banking 13 and euro entry:
and high reputation of 140 inconsistency of international
and identity crisis 133 institutions 231–2, 234
and image of 21–2 lack of consensus over 230–1
and independence of, pre-euro period 140 and European Central Bank 223, 224
and institutional crisis 146 discouragement from euro entry 231
and internal reforms 133, 145, 148–50, 153 and Europeanization 204, 220
and Länder central banks 148 and independent central banks:
and monetarism, pre-EMU period 142 commercial banking sector 206–7
and monetary analysis 44 Comparative Political Economy approach
and monetary policy: to 209
approach to 140, 141–2 domestic rationale for 209
primacy of in pre-EMU period 140–1 emergence of 203, 208
and New Public Management 44 Estonia 210–12
and Ordo-liberalism 140, 141–2 factors favouring 209–10
and output legitimacy 23–4 Hungary 214–16
and power of 16 institutionalization of 204–5
decline of 131–2, 157–8, 158–9 interaction with social partners 206
438
Index
international consensus on 224 communication 381–2

International Political Economy approach epistemic convergence 379
to 208 four stages in development of 374–5
international rationale for 208 inflation targeting 382–4
national politics 209 rationalization 375–7
power of 220, 236 scientization 375–8
Slovenia 212–14 transparency 381–2
sources of power 203–4 and historical path dependency 20–1
variations amongst 203 and ideational changes 30–2
and international institutions 224 and institutional legitimacy 22
and Maastricht criteria 216–18 and international context of age of the euro:
Estonia 217 core and periphery central banks 28–30
Hungary 217–18 domestic political incentives 34–6
political opportunity structures 218–19 post-1973 market-driven globalization
Slovenia 216–17 30–4
tough interpretation of 223 and international embeddedness of 13
and macroeconomic stabilization 205–6 and leadership of 379–80
and national identity 218–19 and legitimacy of 22, 23–4, 293, 302, 303
and public opinion and the euro 218–19 and macroeconomic policy 33–4, 49
see also Bank of Estonia; Bank of Slovenia; and modernization through
Czech Republic; National Bank of transformation 24
Hungary; Poland and monetary policy 49–50
Central Bank of Cyprus 42 and national politics 209
Central Bank of Malta 42 and New Public Management 44, 378–9
central banks: and niche roles 14, 42–3
and apoliticization of 375–7, 387 and output legitimacy 23–4
and central banker preferences 24–5, 32–3 as political creations 302
and challenges facing 373 and post-1973 market-driven
and changes in 6–7 globalization 30–4
and common characteristics of 19 and power of 7–11, 15–18
and convergence 11, 18–19 agenda setting 16–17, 49
functional 11–12 Economic and Monetary Union 10–11
temporality 12 euro-outsiders 11
and cooperation 42, 43, 170–1 global financial markets 10
and core and periphery central banks 28–30 strengthening of 9–10
and credibility of 302 vulnerability 17–18, 40, 50
and crisis management 37 and prudential supervision 66, 77, 78
and development of 20, 26–7 and public opinion 50
four stages of 374–5 and rationalization of 375–7, 389
and differentiation in 14 and recruitment processes 24, 32–3
and diversity of 373 and research quality 44
and domestic governance patterns 22–3 and role of 3, 81
strong states 23 and rules 31–2
weak states 23 and socio-cultural changes 32–3
and domestic politics 5 and the state 25–8, 49
as epistemic community 19 and state traditions 21–2
and the euro 47–8 and symbolic power of 27
and European Central Bank 81–3 and transparency 381–2
and European Monetary Institute period 2–3 see also accountability; scientization of central
and Europeanization 4, 49–50 banking; transparency; individual entries
bottom-up process 15 for national central banks
top-down process 14–15 Centre for Economic Policy Research 84
and financial markets 8 Centre for Financial Studies, Goethe
and financial stability 36–8, 369 University 84
and ‘Germanization’ of 13, 15 Chirac, Jacques 115
and global trends in 374–5 Clarke, Kenneth 243
committee decision-making 379–81 Clementi, David 245
439
Index
Clinton, Bill 398 and independence of:

Collateral Central Bank Management 43 constitutional protection of 230
Collins, Stephen 254 curtailment of 229–30
Comité des établissements de crédit et des establishment of 228
entreprises d’investissement (CECEI) restoration of 230
121 and international technical assistance 228–9
Committee of European Banking Supervisors and international training 224
(CEBS) 66, 146, 150, 151, 340, 344 and monetary policy 234
commodity price shocks 38 and power of 236
competitiveness, and differentials in 39–40 Czech Republic:
convergence: and central bank independence 221
and Banca d’Italia 198 credibility of 222
and Bank of France 128 and credibility of international institutions’
and Central and Eastern Europe 219–20 policies 222
and central banks 18–19 and economic transformation 221
functional 11–12 and euro entry:
temporality 12 conflict over 234–6
and Czech National Bank 236 delay in adoption 223
and Economic and Monetary Union 337 inconsistency of international
and epistemic convergence 338, 343–5, 346, institutions 231–2, 234
351–2, 379 lack of credibility 222–3
creation of epistemic community 345 resistance to 221, 222
creation of European Central Bank 344–5 and uncertainty 221–2
European Union enlargement 345 see also Czech National Bank (CNB)
professionalization 343–4 Czechoslovak State Bank (CSSB) 228
and euro outsiders 280, 337
and Europeanization 11 Danish Central Bank:
functional 11–12 and authority of 282
and financial crisis (2007–8) 346 and basic values of 271
institutional divergence 348–9 as euro outsider 264–5
lack of institutional and epistemic absence of official opinion on 269–70
convergence 350–1 and European Central Bank 268
nature of crisis 347 and European System of Central Banks 269, 280
responses to 348 and Europeanization 266
structural convergence 348 and Exchange-Rate Mechanism 268
transmission of 348 and exchange-rate policy 266
and institutional convergence 338, 342–3, and human resource development 279
346 and international cooperation 266
obstacles to 342 and micro-innovation 283
and monetary policy 355, 370–1 and minimal organizational reform 270–1,
Banca d’Italia 186–7 279, 281
and National Bank of Poland 236 explanation of 272–3, 281
and reaction to financial crisis (2007) 329 and network strategy:
and structural convergence 338, 341–2, Bundesbank 268
345–6 characteristics of 279–81
Correspondent Central Banking Model development of 280
(CCBM) 65 development of Anglo-Saxon
Costello, Peter 288 connections 267–8
Council of Ministers, and monetary policy 76 diversification of 269
creativity, and financial market power 18 intensification of contacts 269, 279
credibility, and institutional stability 293 lack of 267
Cullen, Michael 299 participation in ESCB 269, 280
Czech National Bank (CNB): and power of 283
and convergence 236 and public standing of 273
and euro entry 234, 237 and research and analytical capacity 272, 280
conflict over 234–6 and role of 267
and Europeanization 236 and stability culture 281, 282
440
Index
and structural reform 282 and Exchange-Rate Mechanism 266, 268

and transparency 271–2 and innovative economy 282
and workforce 271 see also Danish Central Bank
Danmarks Nationalbank, see Danish Central Bank Dennis, Bengt 275
Davies, Howard 244, 251–2 domestic politics:
De Nederlandsche Bank (DNB) 91, 100 and political incentives 34–6
and Bank Council 104 and shifting blame to European Central
and banknote checking 103 Bank 5
and branch closures 103 Draghi, Mario 192, 195, 199
and communications with government 104 Duisenberg, Wim:
and corporate governance 104–5 on Bundesbank 137
and Economic and Monetary Union: and career of 102
adjustment to 92 and external Eurosystem representation 80
preparation for 103 and prudential supervision 78
role in creation of 101
supportive of German concerns 101–2 Ecofin (Council of Economics and Finance
and functions of 108 ministers):
financial stability 106–7 and European System of Central Banks 76
government advisor 107–8 and monetary policy 76, 77
prudential supervision 107 Economic and Monetary Union (EMU):
and gate-keeping role 91, 108 and Bundesbank’s role in creation of 137–9,
and Holland Financial Centre 108 142–3
as hybrid institution 92, 109 ‘binding in’ strategy 138
and independence of 103, 108 and differential integration 41–2, 46–7, 53
and management of external reserves 104 and European integration 70–1
and monetary policy: and international context of:
increased influence over 106, 108–9 core and periphery central banks 28–30
support for 106 domestic political incentives 34–6
and New Public Management 105 post-1973 market-driven globalization
and pre-EMU period 100–1 30–4
Dutch-German cooperation 100–1 and motives behind 40–1
exchange-rate policy 101, 102 and power of central banks 7, 10–11
functions of 102 and scepticism over 5
solid record of 101 and stage three of 2
support for exchange-rate agreements 101 and triumph of technocratic elitism 87
and role in Dutch society 104 Eichel, Hans 134, 145, 146, 148, 149, 150,
and specialization 42, 44 159
and Stability and Growth Pact, support Emminger, Otmar 133, 136, 138, 139, 141
for 102 energy price shocks 38
and staffing levels 105 epistemic communities:
and Supervisory Board 105 and central banks 19
and supervisory functions 103 and epistemic convergence 338, 343–5, 346,
and transparency 105, 108 351–2, 379
decentralization: creation of epistemic community 345
and Eurosystem 2–3, 81, 97 creation of European Central Bank
and prudential supervision 339 344–5
deflation, and financial crisis (2008) 38 European Union enlargement 345
Delors, Jacques 92 professionalization 343–4
Delors Committee 79, 92, 136 and European Central Bank 27
Denmark: and prudential supervision 339
and euro entry: Erdos, Mihaly 344
elite support for 263 Erhard, Ludwig 140
rejected in referendums 263 Estonia, and stability culture 210–12
as euro outsider 41 see also Bank of Estonia
and European Union: euro:
diplomatic activity within 263–4 and European identity 3
relationship with 263 and European integration 3
441
Index
euro: (cont.) and financial crisis (2007–8) 348

as structural break 2, 3, 45–6 and General Council of:
central banks 47–8 central bank cooperation 43
European integration 46–7 role of 61
part of a trend 48–9 and Governing Council of:
Euro Area: role of 74
and cross-national crisis management 4 voting rules 62–3, 85–6, 156
and external representation, European and increased influence of smaller states 96,
Central Bank 79–80 106, 108–9
and networks within 265–6 and independence of 3, 4, 73, 74
and political weakness of 3 credibility of 5–6
Euro Collateral Management System (ECMS) 97 and inflation targeting 363, 364
Euro Group of Euro Area finance ministers: and initial scepticism about 1–2
and core Europe 61 and interest rates 87
and European Central Bank 83 and internal reforms 85
and monetary policy 76 Governing Council voting 85–6
European Banking Committee 340 and lack of supportive political context 4
European Central Bank (ECB): and legitimacy of 87, 303
and accountability 25, 83, 303, 400–1 as missionary institution 3
absence of policy debate 404–5 and monetary policy 31, 32, 63–4, 74, 87, 366–7
development of 402 changing global context 38–9
enhancing democratic image 401 credibility of 75
European Parliament 401–3 criticism of 75
impact of bank’s mandate 403–4 impact on insiders/outsiders 64
lack of accountability to executive 403 limits to power over 76–7
role of central bankers 404 monetary growth 366–7
self-interested motivations 402–3 transparency 76
and Bundesbank’s influence on 2, 131, 153 two-pillar strategy 366
comparison with 87–8 and national ‘blame-shifting’ 5
credibility ‘borrowed’ from 5 and New Public Management 44
monetary policy 75 and output legitimacy 30
and Central and Eastern Europe 223, 224 and policy dualism 302, 303
discouragement from euro entry 231 and power of 87
and central banks 81–3 foundations of 73
and competences of 60, 74 limitations of 73, 88
and constraints on international role 30 and preparations for 2
and context of establishment of 1 and price stability objective 3, 5, 302–3
and credibility of 73, 75, 87 definition of 366
and cross-national crisis management 4 and prudential supervision 66, 151, 269, 339,
and Danish Central Bank 268 340
and decoupling from US Fed 13–14, 48 lack of control over 77–8
and dialogue with elected officials 83 and Quarterly Monetary Assessment 366
as epistemic community 27 and reforming agenda 84
and epistemic convergence 344–5 and research and analytical capacity 44, 82,
and Euro Group of Euro Area finance 84–5, 87
ministers 83 and Stability and Growth Pact 84
and European Parliament 83, 401–3 and staffing levels 85
and European Union enlargement process 80 and supra-national character of 28
and Executive Board of: and transparency 76, 83, 400–1
central decision-making body 60–1 absence of policy debate 404–5
directoire of the powerful 62 development of 402
prudential supervision 78 enhancing democratic image 401
role of 74 impact of bank’s mandate 403–4
and external representation 67–8, 79–80 role of central bankers 404
International Monetary Fund 79–80 self-interested motivations 402–3
Organization for Economic Cooperation and Treaty mandates of 3, 5, 302
and Development 80 European Commission 3
442
Index
European Council 76 and prudential supervision 66, 339, 342

European Court of Justice 3 impact on insiders/outsiders 66–7
European Exchange-Rate Mechanism (ERM) 1 European Union:
European identity, and the euro 3 and age of the euro 46–7
European integration: directives of 107
and differential integration 41–2, 46–7 and external representation 68
and Economic and Monetary Union 70–1 European Central Bank 79–80
and the euro 3 and prudential supervision 194, 338–9
as structural break 46–7 European Union Constitutional/Reform Treaty,
and increased influence of smaller states 96, and Bundesbank 156–7
106, 108–9 Europeanization:
and motives behind 40–1 and Banca d’Italia 198–9
and state power 41–2 and Bank of France 111–12, 127–9
European Monetary Institute (EMI) 2, 142 and Bundesbank 157
European Parliament: and Central and Eastern Europe 204, 220
and European Central Bank 83, 401–3 and central banks 4, 6, 49
and monetary policy 76 bottom-up process 15
European Securities Committee 66 convergence 11–12, 18–19
European ‘Snake’ 48–9 power of 7–11, 15–18
European System of Central Banks (ESCB): top-down process 14–15
and Banca d’Italia 197 and Czech National Bank 236
and Bank of England 258, 260 and Danish Central Bank 266
and Banking Supervision Committee 77, 78, and ‘Germanization’ of European central
150, 269, 342 banking 13, 15
and Bundesbank 243 and institutional convergence 342–3
and core Europe group 60–1 and meaning of 14
directoire of the powerful 62–3, 70 and mechanisms of:
Euro Group 61 direct vs indirect 170
and Danish Central Bank 269, 280 material vs cognitive 170
and differential integration 69–70 and National Bank of Poland 236
and Ecofin 76 and Riksbank 266
and external representation 67–8 and structural convergence 341–2
and fiscal policy 64 Eurosystem:
impact on insiders/outsiders 64–5 and benchmarking 44
and foreign exchange operations 67 and central bank cooperation 42, 43
and functions of 339 and core Europe group 60–1
and insiders and outsiders: directoire of the powerful 62–3, 70
candidate countries as potential Euro Group 61
outsiders 57–8 and decentralization 2–3, 81, 97
core insiders 55 and differential integration 41, 46–7
differential representation of 60–1 and external representation 67–8
Europe of concentric circles 58–60, 70 and fiscal policy 64
global economic powers 58 impact on insiders/outsiders 64–5
insiders 54–5 and foreign exchange operations 67
new insiders 56 and insiders and outsiders:
normal insiders 56 candidate countries as potential
semi-permanent outsiders with opt out 57 outsiders 57–8
semi-permanent outsiders without opt core insiders 55
out 57 cross-national networks 265–6
temporary outsiders keen to join 56–7 differential representation of 60–1
and Market Operations Committee 269 Europe of concentric circles 58–60, 70
and membership of 91 global economic powers 58
and monetary policy 63–4, 106 insiders 54–5
impact on insiders/outsiders 64 new insiders 56
and Monetary Policy Committee 269 normal insiders 56
and payment system oversight 65 semi-permanent outsiders with opt
impact on insiders/outsiders 65–6 out 57
443
Index
Eurosystem: (cont.) and Federal Reserve District Banks 313–14

and insiders and outsiders: (cont.) presidents of 313–14
semi-permanent outsiders without opt responsibilities of 314
out 57 revenues of 314
temporary outsiders keen to join 56–7 and financial autonomy of 314
and membership of 91 and financial instability 307
and niche roles central banks 42–3 and globalization 325
and payment system oversight 65 and independence of 320
impact on insiders/outsiders 65–6 and inflation targeting 308–9, 322–5, 329,
and prudential supervision 66 363, 365
impact on insiders/outsiders 66–7 debate over 398–400
and rules 44–5 and influences on 308
and state transformation 26 and monetary policy:
and state/central bank relationship 26–8 economic context 309–12, 328
Eurosystem Mission Statement (2005) 45 Federal funds rate 312, 328
Exchange Rate Mechanism(ERM) 41, 48–9, 172 Volcker’s changes to 309
exchange-rate policy 33 and Monetary Policy Reports 388
and Banca d’Italia 187–8, 193 and power of 13, 16, 307
and Bank of Greece 173, 177 and prudential supervision 307, 313,
and Danish Central Bank 266 315–17
and De Nederlandsche Bank 101, 102 and reaction to financial crisis (2007) 317–18,
and European System of Central Banks 67 329
and monetary policy 372 and relationship with other institutions 320
and National Bank of Belgium 94–5 the Administration 321–2
and national loss of 39 Congress 320–1, 388
and Reserve Bank of Australia 298 media 322
and Reserve Bank of New Zealand 298 and research and analytical capacity:
and Riksbank 266 Board of Governors 313
strength of 312
Fannie Mae 316, 330 n12 and resistance to fads 313
Fazio, Antonio 82–3, 183, 188, 191, 194, 195, and shift of power from Bank of England 29
197, 199 and statutory basis of 312
Federal Banking Supervisory Office (BaKred, and transparency 318–19, 395–6
Germany) 141, 149 Congressional pressure for 398, 400
Federal Financial Institutions Examination development of 396–7
Council (FFIEC) 315 inflation targeting debate 398–400
Federal Reserve System: internal pressure for 398
and accountability 395–6 financial crisis (2007–8)
Congressional pressure for 398, 400 and character of 347
development of 396–7 and deflation 38
inflation targeting debate 398–400 and epistemic convergence 351–2
internal pressure for 398 and Federal Reserve System 317–18, 329
and Board of Governors: and institutional divergence 348–9
appointments to 313 and lack of institutional and epistemic
regulation of financial institutions 313 convergence 350–1
research capacity 313 and regulatory state 352
responsibilities of 313 and responses to 346, 348
and challenges facing 307–8 and structural convergence 348
and dual objectives of 312, 365, 399 and transmission of 348
and economic output 325 and United Kingdom 348–50, 352
and Europe 326–8 financial institutions, and market power 18
and Federal Open Market Committee 309 financial market regulation and supervision,
economic output 325 see prudential supervision
Europe 326–8 financial markets, and central banks 8
globalization 325 financial stability:
inflation 322–5 and European central banks 36–8
role of 314–15 and monetary policy 369, 371
444
Index
Financial Stability Forum 37, 292 Holland Financial Centre (HFC) 108
fiscal policy: Horn, Gyula 216
and Eurosystem 64 Hungary, see National Bank of Hungary
impact on insiders/outsiders 64–5
and monetary policy 357, 371 inflation:
Flemming, John 244 and management of 34
France: and persistence of differences in 12
as core insider 55 and threat of 38–9
and opposition to bank independence 112, inflation targeting:
113 and Bank of England 242–3, 364
and politicization of monetary policy 112, and Bank of Greece 173
114 and central banking 382–4
and prudential supervision 119–21, 128–9 and criticism of 367, 371
see also Bank of France and European Central Bank 363, 364
Freddie Mac 316, 330 n12 and features of 360–1
Freeman, John 405 and Federal Reserve System 308–9, 322–5,
Friedman, Benjamin 383 329, 363, 365
Friedman, Milton 381 debate over 398–400
and form of target 363–4, 371
G7/G8 group of countries 37 and International Monetary Fund 383
George, Eddie 243, 244, 245, 251, 363 and performance of 369–70
Gérard, Jean-Pierre 115 and Reserve Bank of Australia 288, 296,
Germany: 300, 301
as core insider 55 and Reserve Bank of New Zealand 14, 297,
and prudential supervision 78 301, 360, 383, 399
and soft power 2 as reverse of Bretton Woods 361
see also Bundesbank and Riksbank 276, 364, 384
Gjedrem, Svein 382 and rise of 360
global financial markets, and central banks 10 and scepticism over 383
globalization: and scientization of central banking 382–4
and Banca d’Italia 198 and voluntary adoption of 361
and central banks 30–4 instrumental rationality 380
and Federal Reserve System 325 interest rates:
Godeaux, Jean 92 and European Central Bank 87
Goldman Sachs 317 and national loss of control over 39
Gonzalez, Henry 319 see also monetary policy
Goodfriend, Marvin 391 international financial system, and Eurosystem
Goodhart’s Law 358 representation 67–8
Gramm-Leach-Bliley Act (USA, 1999) 315 European Central Bank 79–80
Greece, see Bank of Greece International Monetary Fund (IMF) 17, 37,
Greenspan, Alan 16, 30, 314–15, 316, 319, 224
324, 329, 355, 363, 377, 379, 388, and European Central Bank’s role 79–80
397–8, 399 and inflation targeting 383
Greider, William 397 Issing, Otmar 141, 143
Grimes, Arthur 305 n6 and European Central Bank:
Gronkiewicz-Waltz, Hanna 226, 227, 232 monetary policy 75
Gros, Daniel 85 research capacity 84
Guillen, Pierre 115 scepticism over 1
Gyurcsány, Ferenc 215 Italy, as core insider 55
see also Banca d’Italia
Hammarskjöld, Dag 275 Ittner, Andreas 344
Hampl, Mojmir 235
Hannoun, Hervé 117 Jacobsson, Per 274–5
Hansson, Ardo 210 Járai, Zsigmond 216
Havel, Václav 229, 230, 234 Joint Vienna Institute 224
Heikensten, Lars 382 Jouyer, Jean-Pierre 117
Hoffmeyer, Erik 268 Juncker, Jean-Claude 403
445
Index
Kallas, Siim 209, 211 Marchelli, Paul 115

Kalousek, Miroslav 235 Martin, William McChesney 47, 324
Kauffmann, Henrik 267 Meister, Edgar 135, 147, 149, 150
Keynes, John Maynard 386 Meyer, Lawrence 316
King, Mervyn 244, 355 Mishkin, Frederic 324, 325, 358, 362, 369
Klaus, Václav 228, 229, 234, 235 monetarism 30
Kohl, Helmut 40 and Bundesbank 142
Kohn, Donald 325 and monetary targeting 358–9
Kołodko, Grzegorz 226–7 monetary economics, and central banks 33–4
Kroes, Neelie 194 monetary policy:
and aims of 356–8
Laar, Mart 210, 211–12 and anticipation of change 357–8
Lafontaine, Oskar 134, 144 and asset prices 368–9, 372
Lamfalussy Committee 78 and best practice 361–3
Lamont, Norman 242–3 central bank communication 364–5
Landau, Jean-Pierre 126, 127 commonly accepted ideas 362, 370–1
Larosière, Jacques de 112 form of inflation target 363–4
League of Nations Financial Committee 161 institutional structures 363
legitimacy: ‘state-of-the-art’ approach 362–3
and Banca d’Italia 186 and central bank independence 356, 359, 365
and Bank of France 117 debate over 367–8
and central banks 22, 293, 302, 303 lack of incentives 367
output legitimacy 23–4 and central banks 49–50
and European Central Bank 87, 303 and changing global context of 38–40
and institutional stability 293 and consensus on 370–1
Lehman Brothers 9, 351 and convergence 355, 370–1
Lisbon Treaty: and Ecofin 76, 77
and Europe of concentric circles 59 and Euro Group of Euro Area finance
and external representation 68, 69 ministers 76
Lithuania 217, 223 and European Parliament 76
London, City of: and European System of Central Banks 63–4,
and attitude of Euro Area members 106
towards 258 and evolution of 355, 356
and Economic and Monetary Union: and exchange-rate policy 372
impact of 251 and financial stability 369, 371
preparations for 251–2, 255 and fiscal policy 357, 371
as largest international financial centre 250–1 and forecast-based policies 356–7
influence on Bank of England and increased influence of smaller states 96,
influence 259 106, 108–9
and role of 29, 41–2 and inflation targeting 359, 382–4
Lubbers, Ruud 101 criticism of 367, 371
Luxembourg, and end of Belgian-Luxembourg features of 360–1
monetary association 95–6 form of target 363–4, 371
see also Banque Central du Luxembourg performance of 369–70
as reverse of Bretton Woods elements 361
Maastricht criteria 47 rise of 360
and Central and Eastern Europe 216–18, 231 scepticism over 383
Maastricht Treaty: voluntary adoption of 361
and European Central Bank 73 and monetary targeting 358–9, 366–7
and prudential supervision 77, 339 and power over 356
McCreevy, Charlie 194, 350 and price stability 356, 359–60, 371
Macfarlane, Ian 288 short and long-term properties 359–60
Mack, Connie 321, 399 and refinement of 371
macroeconomic policy: and similarities in 365
and aims of 355 and simple feedback policies 356–7
and central banks 33–4, 49 and structural policies 357
and time inconsistency problem 34 and transparency 364, 371–2
446
Index
and variables affecting 357 and Maastricht criteria 217–18

see also entries for individual national banks and macroeconomic stabilization 205–6
Monnet, Jean 274–5 and monetary policy 205
Monory, René 115 and top-down Europeanization 214–16
Monti, Mario 255 see also Central and Eastern Europe (CEE)
moral hazard, as central banking problem National Bank of Poland (NBP):
37, 50 and convergence 236
Morgan Stanley 317 and criticism of 226–7
and euro entry 237
nation building, and central banks 26–7 conflict with politicians over 232–3
National Bank of Belgium (NBB) 91 and Europeanization 236
and additional functions of 99–100 and independence of:
and Belgian economy (1970s-80s) 93–4 establishment of 225–6
and Belgian franc pegged to D-Mark 94 political conflict over 227
and communication capabilities 99 questioning of 226–7
and Economic and Monetary Union: role of international institutions 226, 227
adjustment to 92 and international training 224
influence on 93 and monetary policy 233
preparation for 94–6 and power of 236
role in creation of 91, 92–3, 108 national central banks, see central banks
and end of Belgian-Luxembourg monetary National Convergence Programs (NCPs) 65
association 95–6 national identity, and central banks 27
and European Monetary System 93, 94 National Stability Programs (NSPs) 64, 65
and Executive Board of 99 Netherlands, see De Nederlandsche Bank (DNB)
as hybrid institution 92, 109 Neves, Pedro Duarte 344
and independence of 108 New Keynesianism 30–1
and introduction of euro 95, 96 New Public Management:
and macroeconomic policy 99 and Banca d’Italia 195–6
and monetary policy, greater influence and Bundesbank 134
over 96 and central banking 17, 44, 378
and partnerships with other central banks 97 and Netherlands 105
and pre-EMU exchange-rate policy 94–5 and Sweden 14, 42
and pre-EMU reforms: and variable adoption of 12
monetary policy 95 New Zealand:
statutes 95 and economic transformation 287
and prudential supervision 97–9 and political system 287
Banking, Finance and Insurance see also Reserve Bank of New Zealand
Commission 98 Nielsen, Svend 267, 268
and reduction in provincial branches 100 Norman, Montagu 16, 47, 355, 379, 386
and research and analytical capacity, Northern Rock 9, 348, 349–50
strengthening of 96–7, 99 Noyer, Christian 119–20
and Research Department of 96 and background of 117
and services to other central banks 97 and criticism of government policy 118
CASH 97 Nyboe-Andersen, Bodil 269–70
ECMS 97
and the Snake 93 Ordo-liberalism, and Bundesbank 140, 141–2
and specialization 42, 43 Organization for Economic Cooperation and
and staffing levels 100 Development (OECD) 17
and statistical functions of 99–100 and European Central Bank’s role 80
and strategic revision 99 output legitimacy:
and strengthened power and influence of 96, and central banks 23–4
108–9 and European Central Bank 30
National Bank of Hungary:
and commercial banking sector 206–7 Padoa-Schioppa, T 342–3
and economic transition 214–16 Papademos, Lucas 85, 161, 173, 347
and independence of 204–5, 208, 214–16 Papandreou, Andreas 172
and industrial relations regime 206 path dependence, and central banks 20–1
447
Index
payment systems: and Federal Reserve System 307, 313, 315–17

and Bank of France 121 and financial crisis (2007–8) 346, 351
and European System of Central Banks 65 epistemic convergence 351–2
impact on insiders/outsiders 65–6 institutional divergence 348–9
Plenderleith, Ian 245, 247 lack of institutional and epistemic
Pöhl, Karl-Otto 139, 141 convergence 350–1
Poland: nature of crisis 347
and central bank independence 221 responses to 348
credibility of 222 structural convergence 348
and credibility of international institutions’ transmission of 348
policies 222 United Kingdom 348–50
and economic transformation 221 and institutional convergence 338, 342–3,
and euro entry: 346
conflict over 232–3 obstacles to 342
inconsistency of international and Maastricht Treaty 77, 339
institutions 231–2 and National Bank of Belgium 97–9
lack of credibility 222–3 and regulatory state 352–3
resistance to 221, 222 and soft power 351
and uncertainty 221–2 and structural convergence 338, 345–6
see also National Bank of Poland (NBP) and transparency 405
Polányi, K 209 and United Kingdom 78
political business cycle 35 public opinion:
power, and central banks 7–11, 15–18 and Banca d’Italia 186
price stability: and Bank of France 118, 128
and European Central Bank 3, 5 and Bundesbank 148, 158
and monetary policy 356, 359–60 and Central and Eastern Europe 218–19
prudential supervision 337 and central banks 50
and Australia 292
and Banca d’Italia 188, 193–4, 197–8 Quaden, Guy 95, 99
and Bank of England 242
removal of responsibility 241, 243 Rameix, Gérard 120
and Bank of France 119–21, 128–9 rationalization, and central banking 375–7, 389
and Bank of Greece 175, 177–9 recruitment processes, and central banks 24,
and Basel Committee on Banking 32–3
Supervision 66, 77, 330 n11, 351 regulatory state, and prudential
and Brown-Eichel plan 78 supervision 352–3
and Bundesbank 78, 141, 149, 150–2, 159 Remsperger, Hermann 147
and central banks 66, 77, 78 Repse, Einars 209
and De Nederlandsche Bank 107 Research Network on Capital Markets and
and democratic control 352–3 Financial Integration in Europe 84
and diversity of institutions 339–40, 343 Reserve Bank of Australia:
and epistemic convergence 338, 343–5, 346, and accountability 291, 300, 301
351–2 and Campbell Committee Inquiry 295
creation of epistemic community 345 and communications policy 297
creation of European Central Bank 344–5 and context of reforms 302
European Union enlargement 345 and credibility deficit 295–6
professionalization 343–4 and decision-making 301
and European Central Bank 66, 151, 269, 339, and exchange-rate policy 298
340 and financial stability 291, 292
lack of control over 77–8 and government’s reserve power over 291
and European System of Central Banks 66, and incremental change 295
339, 342 and inflation targeting 288, 296, 300, 301
Banking Supervision Committee 77, 78, as influential policy actor 287
150 and monetary policy:
impact on insiders/outsiders 66–7 conduct of 296–7
and European Union 194, 338–9 institutional framework for 299–300
and failure of 351, 352 reports on 300
448
Index
and multiple objectives of 288, 290 and international cooperation 266

and organization of 288 and micro-innovation 283
appointments 296 and modernization of 276, 279, 281
and reforms of 289 explanation of 281
and Reserve Bank Act (1959) 289–90, 291, and network strategy:
292 characteristics of 279–80
and Reserve Bank Board’s power 290 diversity of contacts 275–6
and statutes governing 289 Rooth and Jacobsson’s development
bank objectives 290 of 274–5
and transparency 297, 301 and ‘new vision’ for 279
Reserve Bank of New Zealand: and organizational changes 278
and accountability 291, 298, 300, 301 and power of 283
and Board of Directors, role of 290–1 and role of 267
and context of reforms 302 and stability culture 281, 282
and decision-making 301 and staffing levels 278
and exchange-rate policy 298 and structural reform 282
and financial stability 291–2 and transparency 276–7
and government’s reserve power over 291, Rimsevics, Ilmars 217
299 Romania 223
and Governor of: Rooth, Ivar 267, 274, 275, 277
authority of 290–1, 380 Ross, Marten 217
removal of 291 Royal, Ségolène 114
and incremental change 297 Rubin, Robert 398
and independence of 288 Rudd, Kevin 296
and inflation targeting 14, 297, 301, 360, 383, rules:
399 and central banks 31–2
as influential policy actor 287 and Eurosystem 44–5
and monetary policy 288
institutional framework for 299–300 Sachs, Jeffrey 210, 213
political discomfort over 298–9 Sarkozy, Nicolas 6
reports on 300 and European Central Bank 114
and policy dualism 297, 300 Saxton, Jim 399
and Policy Targets Agreement 291, 297, 300 Schilder, Arnold 344
and price stability objective 288, 290, 297 Schlesinger, Helmut 141
and reforms of 289 scientization of central banking 374, 375–8
and Reserve Bank of New Zealand Act and accountability 389
(1989) 288, 290–1, 292 and apoliticization 375–7, 387
establishment of credibility 294–5 and central bank governance 385–9
motives for 294 and civil servant/politician relationship
as paradigmatic shift 293–4 387–8, 390
and statutes governing 289 and cognitive governance 386
bank objectives 290 and committee decision-making 379–81
and technical review of 298 and communication 381–2
and transparency 301 and eclipse of political argumentation 388–9,
Rey, Jean-Jacques 92–3 390
Richards, Paul 254 and epistemic convergence 379
Riksbank: and global governance 389–90
and authority of 282 and growth of civil servant power 387–8
and ‘clash of reform cultures’ 277–8 and imaginary governance 386
and communications policy 365 and impact on research 386–7
and corporate culture 278–9 and inflation targeting 382–4
as euro outsider 264–5 and knowledge communities 385–6
and Europeanization 266 and knowledge governance 386
and exchange-rate policy 266 and move away from political
and financial stability 368 governance 386
and independence of 276 and normative governance 385–6
and inflation targeting 276, 364, 384 and power structures 390
449
Index
scientization of central banking (cont.) Tosovsky, Josef 209, 228, 229, 230, 234
and relationship between science producers Townend, John 245, 251, 252, 253–4
and consumers 390 Trans-European Automated Real-time Gross
and research bias 386 settlement Express Transfer (TARGET)
and role of the state 389 System 43, 65
and transnationalization of governance 385 and Banca d’Italia 196
and transparency 381–2 and Bundesbank 155
Séguin, Phillipe 115 and central banks 78
Sette, Gilbert 127 transparency 25
Simeonov, Rumen 344 and balance of power consideration 391
Simitis, Costas 172 and Banca d’Italia 195
Simor, András 218 and Bank of France 114
Single European Payment Area (SEPA) 65 and central banks 381–2
and Bundesbank 154, 155 and consensus on 391
Skrzypek, Sławomir 233 as contested concept 393
Slovenia, see Bank of Slovenia and Danish Central Bank 271–2
Smets, Jan 95 and De Nederlandsche Bank 105, 108
socialization, and central banker and definition of 392
preferences 24, 32–3 difficulties with 393–4
Société Général 119–20 and economic rationale for 392
sovereignty: and European Central Bank 76, 83, 400–1
and central banks 27 absence of policy debate 404–5
and European integration 41 development of 402
Spain, as core insider 55 impact of bank’s mandate 403–4
Špidla, Vladimı́r 235 role of central bankers 404
Stability and Growth Pact 40 self-interested motivations 402–3
and Bundesbank 155, 157 and Federal Reserve System 318–19, 395–6
and European Central Bank 84 Congressional pressure 398, 400
and fiscal policy 64 development of 396–7
Stark, Jürgen 135, 137, 143, 145, 147, 156, 157, inflation targeting debate 398–400
303 internal pressure for 398
state, the: and monetary policy 364, 371–2
and central banks 25–8, 49 and political rationale for 393
and European integration 41–2 and prudential supervision 405
state building, and central banks 26–7 and Reserve Bank of Australia 297, 301
state capacity, and central banks 22–3 and Reserve Bank of New Zealand 301
Steinbrück, Peer 134, 152, 159 and Riksbank 276–7
strong states, and central banks 23 and sources of variations in:
Strycker, Cecil de 92 executive policy leadership 395
subprime mortgages 316–17, 330 n13, 347 legislative oversight power 395
Surányi, György 216 solidity of central bank independence
Svensson, Lars 298, 361, 372, 380–1 394–5
Sweden: and techniques enhancing 392
and euro entry: Trichet, Jean-Claude 82–3, 231, 302–3, 350, 355
elite support for 263 and background of 117
rejected in referendum 263 and criticism of government policy 117–18
as euro outsider 41 and reform of European Central Bank 85
and European Union: trust, and financial system 8–9
diplomatic activity within 263–4 Tůma, Zdenek 230, 234, 236
relationship with 263
and innovative economy 282 Ukraine 223
and New Public Management 14, 42, 44 Unipol 194
see also Riksbank United Kingdom:
and euro entry, five economic tests for
Tabaksblat, Morris 104 247–50
Tietmeyer, Hans 133, 138, 141, 143, 144 as euro outsider 41
Topolanek, Miroslav 235 and financial crisis (2007–8) 348–50, 352
450
Index
and prudential supervision 78 Weber, Axel 44, 133, 144, 146–7, 150,
see also Bank of England; London, City of 152, 159
United States, and financial and monetary Weber, Max 374, 389
ascendancy 29–30 Wellink, Nout 106, 108
see also Federal Reserve System Welteke, Ernst 133, 144, 145–6, 148
United States Agency for International Werner, Pierre 92
Development (USAID) 224, 226 Werner Committee 138
United States Supreme Court 396–7 Woodward, Bob 397
World Bank 224
Valach, Vladimir 228–9 and Enterprise and Financial Sector
Verplaetse, Alfons 99 Adjustment Loan 226
Vesala, Jukka 344 and Financial Institutions Development
Vocke, Wilhelm 140 Loan 226
Volcker, Paul 30, 309, 382, 383, 396, 397, 399
Yellen, Janet 400
Waigel, Theo 138, 139
Walker, David 242 Zeitler, Franz-Christoph 147, 157–8
weak states, and central banks 23 Zeman, Miloŝ 229
451

Central Banks in The Age of Euro

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Central Banks in the Age of the Euro

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By general consent European monetary union represents an historic event for

1. The Age of the Euro: A Structural Break? Europeanization,

Part I The Changing Context of Central Banking

Part II Eurosystem ‘Insider’ Central Banks

8. The Banca d’Italia: Between Europeanization and Globalization 183

Part III ‘Temporary’ Outsiders: Pace Setters and Laggards

Part IV ‘Semi-Permanent’ Outsiders

Part V Lessons from Non-European Central Banks

Part VI Convergence and Divergence

2.1: Groups of ESCB membership 55

5.1: Appointments to the Bank of France’s Conseil de la politique monétaire

AMLF Asset Backed Commercial Paper Money Market Mutual

EMS European Monetary System

TEU Treaty on European Union

Iain Begg is a Professorial Fellow in the European Institute at the London

Rachel Epstein is an Assistant Professor at the Graduate School of Inter-

2004 to serve as the Robert Schuman Centre’s Transatlantic Research Fellow.

Béla Greskovits is a Professor of International Relations and European Studies

Nicolas Jabko is a research director at the Centre d’Etudes et de Recherches

Lucia Quaglia is a Senior Lecturer in Politics and Contemporary European

Gaby Umbach is a research associate at the Jean-Monnet Chair for Political

John T. Woolley is a Professor of Political Science and Chair of the Political

problematic differentials in output growth; there was high uncertainty about

The Birth of the Euro

national central banks—cloaked behind the principle of decentralization in

Institutional and policy privileging of the ECB in an ‘ECB-centric’ Euro Area

political interference, in a way that further mimics earlier German experience

As an exercise in comparative political economy this volume seeks to avoid

‘stability’ and shifted agenda setting to issues of ‘competitiveness’ and ‘ﬁscal

In a comparative and international context, is what is happening in European

retaining ﬁscal, economic policy, and banking supervision sovereignty—

attitudes. This decoupling became more problematic as the ﬁnancial crisis

Europeanization, Power, and Convergence

Germanic institutional templates that highlight ‘misﬁt’ and need to adapt at

Potential to exercise central bank power, above all to rely on suasion, is

in turn strengthened its agenda-setting role in macro-economic policy. Growth

strategies that target inﬂation, stress on transparency, and ‘knowledge-based’

Historic Commonalities and Variations Amongst Central Banks

Historically speaking too, central banking is two shared stories of transition.

‘Path Dependence’ and State Traditions: Institutional Legitimacy

Domestic Governance Patterns: ‘Strong’ and ‘Weak’ States

‘Output’ Legitimacy; ‘Matching Words to Deeds’

Central Banker Preferences

History-Making: From State Building to Europe Building

empowerment of Eurosystem central banks vis-à-vis states through explicit and

The distinctiveness of the ECB resides in its ‘stateless’, ‘supra-national’ char-

The International Context of the Age of the Euro

Historical Legacy: Core and Periphery Central Banks

Market-Driven Globalization Post-1973: Ideational and Socio-Cultural

and random character of increasingly large, fast-changing, interconnected,

socialization and career inducements—important and that offers an incentive

for central banks in macro-economic policy. Inﬂationary and ﬁnancial crises

Stability and Change in Domestic Political Incentives

Changing International Vulnerabilities: From Exchange

about the adequacy of the rules underpinning banking supervision. In conse-

independence in monetary policy was less credible in ﬁnancial stability pol-

The Changing Global Context of Monetary Policy