Global Policy Forum

Democracy, Banks, and the Current Euro Crisis

The recent “grand bargain” in the Eurozone, quickening the implementation of austere sanctions against member states should they break fiscal rules, has highlighted the political independence and power of the European Central Bank (ECB). In this article, Sheri Berman from Barnard College debunks the standard neoliberal arguments in favor of central bank independence and points to its illegitimacy. This illegitimacy – favoring technocratic “good outcomes” over inclusive democratic process – characterizes the EU more generally and is untenable, argues Berman. Putting an end to this situation  is democratically necessary and critical for the future of the European project.

By Sheri Berman

January 4, 2012

The recent summit of European leaders in Brussels seems to have produced some agreement among the seventeen members of the Eurozone on a new plan to deal with the EU’s current crisis. This plan, in turn, seems to have been at least partially spurred by Mario Draghi, the head of the European Central Bank (ECB), who has indicated that if the union could enforce more fiscal discipline on its members, the ECB might be willing to do more to help the EU’s beleaguered members. Despite the widely held view that some sort of implicit (or explicit) grand bargain was in the works, Draghi began to back away from his earlier statements almost as soon as the Brussels summit concluded. This episode was, or should be, disturbing. Why, in a time of crisis, should democratic leaders have to make deals with (or even beg) unelected technocrats to come to their aid? Why have central bankers been given such power over the fates of democratic governments and their citizens? Indeed, why are such questions only rarely asked?

Although almost all aspects of the European project are being debated today, few

question the ECB’s independence from politics. Indeed, the ECB’s “apolitical” stance now seems natural; it is, however, anything but. The ECB’s independence is better viewed as the culmination of one of the crucial trends of the neoliberal era: the increasing independence of banks (and other financial actors) from government oversight. During the 1990s, for example, more countries increased the independence of their central banks than in any other decade since the Second World War.

Advocates of this trend tend to justify it with two arguments. The first is technocratic. According to this logic, monetary policy is simply too difficult and complicated for your average politician, much less your average citizen, to understand. On top of this, monetary policy has powerful long-term implications, and politicians and voters are simply unable to think about the long term. For these and other reasons, monetary policy is best left to “experts” who have the knowledge and discipline necessary to make tough decisions.

While there is certainly much truth to these arguments—monetary policy is indeed difficult and complicated and politicians and citizens are indeed often swayed by short-term needs and considerations—it is not at all clear that this is truer of monetary policy than of other policy areas. Who really understands the intricacies of healthcare reform? Who really understood the full implications of the decision to invade Iraq? Aren’t the politics of the Middle East or Far East too important and delicate to be left to the whims of voters and politicians? Ask almost any academic or expert about the issues they study and they will surely complain that decisions about it are constantly screwed up by uninformed voters and politicized politicians. Peter Orzag, for example, recently grumbled about how “politics” was screwing up our nation’s ability to deal with our debt-limit problems. (His solution, surprise, surprise: take key budgetary decisions out of the hands of elected leaders and legislatures and hand them over to “depoliticized” commissions and experts.) Daniel Carpenter made a similar case last month with respect to the Food and Drug Administration, calling on Americans to protect the drug supply from “political meddling” after Kathleen Sibelius disregarded the FDA’s recommended expansion of access to over-the-counter emergency contraceptives.

The second argument often made for central bank independence is that it produces “better” outcomes. But here too the logic and evidence are less than fully convincing. While there is some research that shows that independent central banks are better at fighting inflation than banks under more direct political control, other studies have found that independent central banks are also linked to higher disinflation costs (essentially, what must be paid, in terms of higher unemployment and lower output, in order to purchase lower inflation). More fundamentally, however, these types of arguments don’t deal directly with the question of who decides what “better” economic outcomes are. It is not at all clear why lowering inflation should always or everywhere be the priority. Higher inflation harms some groups more than others (for example, lenders more than borrowers), and so there will always be differences within society about what inflation rate is most “desirable.” (Indeed, it was partially for this reason that the ECB was made independent in the first place: it was a way to signal to markets that the new European currency would be insulated from pressures by groups that did not have a firm commitment to low inflation.)

However, even if we accept that lower inflation is a desirable goal, research has not shown lower inflation to be linked to other desirable goals like lower unemployment or higher growth. Since many citizens probably view the latter two as at least sometimes more important than the former, it is not clear why an organization committed only to lowering inflation (as the ECB is) should have such insulated and preferential status.

In addition to the problems with these standard arguments for bank independence, a more fundamental problem has been highlighted by current events—namely, the lack of legitimacy that comes with insulation from democracy. It has become increasingly commonplace to note that at the heart of the EU’s crisis lays a fundamental disjuncture between its economic and political development. In particular, the EU lacks the type of authoritative political institutions necessary to develop, implement, and enforce solutions to its present problems.

Although the recent Brussels summit is being hailed as a “grand bargain,” it actually reveals how profound this disjuncture is. The “big” decision the summit made was that the EU would now actually enforce promises, particularly on budget deficit limits, that member states agreed to years before. (Whereas previously a breach of the EU’s agreed-upon deficit limits was supposed to bring sanctions, such rules were never really enforced. Under the new rules, sanctions would be more automatic, although still subject to a vote by member states). Despite the rather minimal infringement on sovereignty this would seem to entail, many European leaders and citizens still clearly view it as a step too far. The reason for this, of course, is that they do not believe the union has the legitimacy to make such decisions. What advocates of central bank independence and the designers of the European Union seem to have forgotten, in other words, is need for legitimacy. Or to put it another way: they have neglected the power of democracy.

The essence of and justification for democracy lies not in the outcomes it produces but rather in the process by which those outcomes are reached. Indeed, democrats recognize that democracy may not always produce the best outcomes, but believe it is the best system nonetheless because it allows citizens to participate in determining their own fates. Democratic government, in short, is not just government of and for the people, but also by them. It is this feature of democracy, in turn, that creates legitimacy, which is nothing more than a willingness on the part of citizens to accept authority.

The plans for monetary union and the ECB were drawn up in a relatively placid time when practically no one envisioned the kind of problems Europe is experiencing today. Nonetheless, Europe faces its greatest crisis since the end of the Second World War and is paying the price for forgetting the lesson that war so painfully taught it—that democracy is the only game in town. Despite a growing sense that things are spiraling out of control, Europeans remain extremely wary of handing over authority to European leaders and institutions toward which they feel little kinship and over which they feel they have little control. The solution to these problems lies not in trying to insulate European leaders and institutions further from the demos, but in trying to foster and activate one.

The lack of European demos has become painfully clear over the last months and years. (Europeans have protested austerity policies, but mostly as citizens of their respective countries, and not as a specifically European public.) Although this will take a long time to remedy, it is unlikely to develop without more democracy. Finding ways to give Europe’s citizens a greater voice in EU institutions and decision making will help foster a greater commitment to the EU and a greater sense that it exists to benefit them.

The neoliberal project of the late twentieth century, which diminished and denigrated the power of politics and celebrated the wisdom of markets, has been a failure. Although the European project was born out of a desire to solidify democracy after the Second World War, it too fell prey to the neoliberal dogma of the late twentieth century. The time has come to begin reversing these trends. Now more than ever, Europe needs to find a way to convince its citizens of the value of European project and the need, sometimes, to sacrifice for it. It’s not clear that these goals can or should be reached without more democracy.


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