ECB’s reform plan fails to add up

Date: 22/05/03

By Daniel Gros

IT IS widely accepted that enlargement requires reform of the governing council of the European Central Bank. This body, which takes crucial decisions on interest rates and strategy, is already large (it has 18 members) but could end up having more than 30 as the Union expands.

It is difficult to imagine how a global currency can be effectively managed by a body the size of a mini-parliament.

Moreover, most of the accession states are relatively small countries, which may threaten the 'power balance' with the large countries on the governing council. If all the new members join the eurozone, the central bank governors of the small countries, who would each have one vote in the ECB, would be able to form a majority on the governing council.

The 'small versus large' problem is thus more acute in the ECB than in other EU bodies. Given that the small countries are currently more dynamic than the large ones, many expect that their governors would vote for tighter monetary policies.

So what to do? Recognizing that a 30-plus governing council would be unwieldy, the European Council at Nice in December 2000 agreed on a simplified procedure for the ECB governing bodies - and asked the Bank to make concrete proposals. This set in motion an acrimonious discussion among the national central banks.

In late 2002, the ECB came up with a proposal worked out in secret. This was subsequently endorsed by the Council of Ministers, but vigorously opposed by the European Parliament.

Its essence is that all governors of national central banks in the eurozone may still attend meetings of the council, but not all will have a vote.

For this purpose, eurozone member countries would be divided into three 'classes' measured by economic size, according to gross domestic product (GDP) and "aggregate balance of the monetary and financial institutions".

Each group would have a limited number of votes. In practice, countries would take turns in having the right to exercise that vote. The maximum number of countries voting at any one time would be limited to 15. My calculations, assuming a eurozone of 22 countries, would be:

• Group One. Five largest members: four votes (voting frequency 80). These are, in order of voting weight: Germany, France, Italy, Spain and the Netherlands.
• Group Two. Middle-sized countries: eight votes (voting frequency falls as the eurozone expands; the maximum is 8/11 or 72.27). Belgium, Austria, Ireland, Poland, Portugal, Greece, Luxembourg, Finland, Czech Republic, Hungary and Slovakia.
• Group Three. Small: three votes (the maximum voting frequency is 50). Slovenia, Lithuania, Cyprus, Latvia, Estonia, Malta and Slovenia. (In a eurozone of 28, the UK would slot in behind Germany, Sweden behind Belgium, Denmark behind Austria, Turkey behind Portugal, Romania behind Hungary and Bulgaria behind Slovenia.)

The consent of the smallest member state, Luxembourg, was bought by the fact that it will have a larger weight than Finland (which has roughly ten times the population and six times the GDP). This was made possible due to the weight given to the indicator of financial market size.

Candidate states did not have a voice in this bargain, and that shows as the group with the lowest voting power would consist exclusively of the new members.

Was this the reason for the choice of the weight given to the indicator of financial markets? Why were the shares in the ECB not chosen as the measure of size?

The proposal combines the worst aspects of all approaches one might consider. It gives up the principle of equality of states, potentially undermining the idea that members of the governing council should ignore their national interests and act only in the interest of the entire eurozone.

It does not achieve a significant gain in efficiency: the council is too big. No modern central bank has a decision-making body this size. Moreover, all members of the governing council (with and without voting power) will continue to sit at the table and participate in discussions. The ECB's proposal thus does not solve the problem of the excessive size of the forum and lacks transparency because it is too complicated.

It has arbitrary elements: the weight given to the indicator of the size of financial markets is not justifiable.

It is difficult to understand why such a complicated mechanism was used when a much simpler alternative is available.

This would see the retention of the composition of the governing council, but ensure that it meets less often and delegates authority for short-term decisions on interest rates to the executive board - composed of six people appointed by the European Council.

The tasks of the governing council should be limited to setting the broad direction for monetary policy, deciding on proposals from the executive board, constituting a platform for the exchange of views on the eurozone economy, and monitoring the work of the board.

These tasks can be performed efficiently even by a large body, and the representation of all member countries on the governing council provides the appropriate legitimacy for such a controlling function. By contrast, the six-member executive board is able to take the quick decisions required by fast-moving global financial markets.

Such a division of labour is a model of simplicity that might serve as an example for the broader discussion about the reform of the institutions going on in the Convention on the future of Europe.

• Daniel Gros is a director of the Brussels-based Centre for European Policy Studies.

Analysis of the possible reforms needed at the European Central Bank after the enlargement of the EU in 2004.