Christine Lagarde’s nomination to be the next president of the European Central Bank (ECB) to replace Mario Draghi has sparked a divergence of views on how effective she would be and where she might lead the bank. Few doubt her talents or that she will sail into the office easily. Instead, key issues include whether the straitjacket of low-to-negative interest rates prevailing in the European Union could ever offer Lagarde much running room.
Lagarde recently resigned as managing director of the International Monetary Fund (IMF), where she was the first woman to hold the position, in order to advance her ECB nomination, where she is the first woman picked to run it. Europe’s finance ministers have already approved Lagarde’s nomination, making her a virtual shoo-in.
Working against Lagarde: Whoever succeeds Draghi, whose run as president is widely regarded as a big success, “is in a very difficult situation,” notes Ashoka Mody, visiting professor in international economic policy at Princeton’s Woodrow Wilson School of Public and International Affairs. He is also former deputy director in the IMF’s research and European departments and author of Euro Tragedy: A Drama in Nine Acts.
The ECB has “essentially run out of ammunition … [and] is imminently facing if not a recession, then very weak economic conditions,” Mody says. What’s more, there is also a deflationary psychology setting in over the eurozone.
‘Hemmed In’
The ECB is not a single country’s central bank, such as the U.S. Federal Reserve. Instead, it is the overarching central bank for the member nations of the European Union. As a result, it is “hemmed in,” far more than the Fed is, by “the various national interests on the governing council.” It would be difficult for anyone to guide that ship, Mody adds. “I am not sure what Christine Lagarde will bring to this table.”
But Krista Schwarz, a Wharton finance professor, thinks Lagarde’s experience as a negotiator and coordinator of economic policies with multiple countries at the IMF — and her willingness to think outside the box — suggest an openness to leveraging some alternate tools at the ECB’s disposal. Observers should not underestimate what Lagarde may be able to accomplish, Schwarz says. True, she would have “very large shoes to fill” as Draghi’s replacement, and she is not an economist. But as IMF head she was on the frontlines, often working in tandem with the ECB, in setting various policies intended to bail out EU countries, notably Greece, following the financial crisis. “She has seen it from the inside.”
Shoring up that experience, Schwarz points out, Lagarde is also a former finance minister of France, and she is “energetic, decisive and confident.” She is also expected to lean heavily on her technical staff, just as she did at the IMF, Schwarz adds.
Mody and Schwarz made their comments on the Knowledge at Wharton radio show on SiriusXM. (Listen to the podcast at the top of this page.)
Some observers note that Lagarde, like Fed chair Jerome Powell, is a lawyer by training. But Powell had been a Fed board governor. Lagarde “hasn’t explicitly worked at a central bank, but she has interacted with them extensively,” says Schwarz.
Noting there was not much market reaction to her nomination, Schwarz adds that Lagarde seems to be on the same page as the outgoing Draghi, particularly since she has supported Draghi’s efforts to use innovative monetary policies — such as quantitative easing — to help keep financial markets and the economy stable. So markets are expecting Lagarde on balance to favor looser monetary policies. Recent reports note that Draghi is preparing to cut interest rates and introduce more quantitative easing, which adds liquidity to the system via bond-buying programs. The Fed is also expected to reduce interest rates before long, many observers believe.
Four Choices
Mody points out that the U.S. and the EU are in very different places regarding their central banks. The U.S. has managed to raise interest rates, which gives it some room to lower them again should the economy turn soft. Europe was unable to duplicate that. Mody acknowledges the “personal qualities” that Schwarz points out about Lagarde, but sees the ECB as facing one of four choices that would make her stewardship very difficult.
- Reduce interest rates — but rates “are already negative. To make them more negative creates enormous distortion in the market, creates pressure on profitability and is highly undesirable.”
- Quantitative easing “is technically difficult and politically impossible for the ECB. It already owns something of the order of 25% of the bonds of the confederation of nations. To buy more bonds — it will soon start owning some of those countries, which is politically unacceptable.”
- Forward guidance, a promise not to raise interest rates in the future, “is a worthless statement because everybody knows they cannot raise their interest rates in the future.”
- “Minor tinkering” to solve problems, but since these are so deep-rooted, efforts would be ineffective.
Mody adds the ECB, unlike the Fed, is “hamstrung” by the many diverging viewpoints of the various members. The Fed has its version of diverging viewpoints, but eventually it emerges with “a clear consensus view.” The ECB, in contrast, tends to deny that pressures are building and then take “half measures” that are also too late.
Christine Lagarde “hasn’t explicitly worked at a central bank, but she has interacted with them extensively.” –Krista Schwarz.
Perhaps the most fundamental constraint on the ECB, according to Mody, is that members such as Germany in the end say “we will not pay the bills of other countries. That is a foundational principle that just does not go away despite every logical economic reason why it should.” Therefore, a true banking union, which would add needed stability to the European banking system according to many observers, “is a shot in the dark…. Essentially a banking union requires a federal government.”
“I feel almost sorry for Christine Lagarde or whoever else is the incumbent because they are walking into a situation where the degrees of freedom are very limited,” Mody says.
Schwarz agrees that “the outlook isn’t rosy — inflation is low, growth is stagnant.” But she adds that there are ways to be strategic about communication and coordination, and to affect the willingness of large players that could then affect outcomes with regard to growth.
She agrees that the ECB “can’t fix something beyond what the scope of its tools are in a technical sense.” Yet, on a more political and even “personal level I think some of the things that could be tremendously helpful for the European economy, such as fiscal steps, different steps for different countries, some spending more such as Germany, getting rid of the surpluses, and some spending less such as Italy,” might be areas where Lagarde could wield some influence.
Schwarz notes the “fun fact” that Lagarde was on the French national synchronized swimming team, then adds, “she has always had this tendency to be a team player, to be responsive to the environment around her and the other actors in the situation that she is in. I think that is a nice little parallel to draw.”
Christine Lagarde photo by MSC – https://www.securityconference.de/mediathek/munich-security-conference-2018/image/christine-lagarde/filter/image/, CC BY 3.0 de, https://commons.wikimedia.org/w/index.php?curid=71528379
