by David Herok and Andreas Hoffmann*
Since the financial crisis, trust in the European Central Bank (ECB) has declined substantially among Europeans. We argue that the decline in trust is worrisome and can be both a cause and a consequence of the ECB’s policy failure.
All modern monetary systems are based on trust. Since central banks and governments stopped underpinning their currencies by commodities, trust in the issuing institution to keep stable the value of money is crucial for us to believe that it will continue to serve as a meaningful means of exchange in the future. If trust erodes, the monetary system stands on shaky grounds.
The Eurobarometer regularly asks people in the European Union whether they tend to trust or tend not to trust the ECB. While the question does not specify exactly what is meant by trust, leaving room for various interpretations, a substantial downward trend is observable. Remarkably, net trust (the difference between people who tend to trust and those who tend not to trust) has fallen by more than 40% since 2007. Figure 1 illustrates that when the Euro was introduced in 1999, less than 25% of respondents answered that they tended not to trust the ECB. These numbers remained by and large stable until 2007. Then we see a sharp decline in trust. In 2017, 45% of respondents answered that they tended not to trust the ECB and only roughly 35% tended to have trust in the institution. Why have Europeans lost trust in the ECB?
Source: Eurobarometer 2017.
Empirical research suggests that domestic macroeconomic developments are key in explaining citizens’ trust in the ECB. Rising rates of unemployment during the crisis, specifically in the periphery countries, can explain some of the distrust in the ECB. Such findings are intuitive. But trust in the ECB has also substantially declined in countries that did not experience a rise in unemployment. In early 2007, more than 65% of Germans trusted in central banking Made in Frankfurt. The substantial decline in unemployment rates since the crisis has not prevented the Germans from losing trust in the ECB (see Figure 2).
Figure 2: Net-Trust in ECB in Spain and Germany
Source: Eurobarometer 2017, Net Trust = Tend to trust – Tend not to trust.
It is, of course, conceivable that people do not really distinguish between EU institutions. If so, the data on “trust in the ECB” may not actually measure trust in the ECB alone. To some extent, the decline in trust may reflect a more general increase in Euroscepticism since the crisis. Indeed, trust in all European institutions has deteriorated since the financial crisis.
Nonetheless, the ECB deserves special attention because it is the main policy institution in charge of crisis management. At the wake of the financial and debt crisis, the ECB’s accommodative policies were the (only) means readily available to prevent a shut-down in financial markets and to support crumbling government budgets.
Given Draghi’s openly communicated and often repeated commitment to save the euro area and to do whatever he can to help the recovery, we have reasons to believe that he has been trying hard to stimulate the economy. And ECB policy did, of course, help to provide financial stability by taking pressure off government finances at the height of the debt crisis: When bond prices fell, the ECB started to purchase government bonds in secondary markets, substantially lowering bond yields of the crisis countries. However, these policies were not successful in stimulating bank lending or pushing for a quick recovery of the economy. Although the ECB has been running program after program to stimulate the economy, inflation remained below the announced target rate. The policy ineffectiveness has been accompanied by a decline in trust in the ECB.
Uncertainty about policy intentions
Even the intentions of Draghi’s policy are not all that clear. Does the ECB really pursue price and financial stability, or is it mainly concerned with government financing? On the one hand, Draghi justified expansionary monetary policy with low rates of inflation. On the other hand, he emphasized that the ECB aims to open up a “window of opportunity” for reforms in the member countries. Thus far, bond purchases have merely subsidized unsustainable government budgets and removed incentives for national governments to reform. Despite the obvious failure to induce reform, Draghi has carried on tenaciously, which has led many observers to express serious doubts about the true intentions of his policy.
Trust in the ECB’s ability to solve the crisis may also have declined when it became obvious that there was considerable uncertainty about what monetary policy was allowed to do in times of crisis. Indeed, crisis management was accompanied by a discovery process of the legal constraints of ECB policy. Each new set of unconventional policies raised doubts about its consistency with European law and member state constitutions, as is for example reflected by the numerous lawsuits following Draghi’s OMT program. Institutional uncertainty weakened the ECB’s “power of communication” and the credibility of its announcements.
The need to restore trust
As the consequences of crisis management are troublesome in many ways, the European institution in charge of crisis management has lost trust. But just as policy ineffectiveness deteriorates trust in the ECB, the erosion of trust, as well as the ECB’s failure to deliver on its promises, harms its reputation. Because the effectiveness of monetary policy relies on a central bank’s reputation, Europe’s monetary and financial system will stand on shaky grounds if the ECB does not regain trust among Europeans.