The Origin and Effects of Policy Fragmentation Related to Financial Stability in the EMU: The ECB in Perspective

Fragmentation in the policy-making processes related to financial stability has the potential to impede the effective achievement of EMU policy goals. Such fragmentation originated from delegating monetary policies to the European level, while essentially confining fiscal policies and financial supervisory policies to national boundaries. Since monetary policy was first concentrated in the hands of the ECB, which has acquired a high degree of institutional independence from political authorities, coordinating between different policy goals has become even more challenging. In addition, as financial stability policies, including emergency liquidity provisions, require that politically controversial judgments be made, the institutional independence of the ECB, separated from other authorities, may not be appropriate and needs to be reconsidered in the fields of financial stability.

Furthermore, the paper sheds light on the policy environment for the ECB and discusses its impact on policy outcomes. Hall and Franzese (1998) point out the worsening trade-off between unemployment and price stability due to the failure of market actors to take the ECB’s commitment to low inflation into account in their wage setting process. In parallel, investors cannot rely on the ECB’s commitment to financial stability due to a lack of investor of last resort at the European level, escalating their fears associated with sovereign defaults more so than at the national level. The ECB’s price stability and financial stability mandates have not been supported by a complementary policy environment in which the concerns or fears of market actors are placated, thus impacting the effectiveness and efficiency of policy.