Central Banking in Hard Times: Revisiting the Eurozone's Monetary-Fiscal 'divorce'

Much of mainstream monetary theory emphasises the adverse consequences that ensue when inflation-biased governments meddle with the optimal conduct of monetary policy. In the context of European monetary integration, for instance, concerns of this sort have resulted in an ‘unprecedented divorce’ (Goodhart 1998) between monetary and fiscal policy-making and have led to the creation of what many perceive as the world's most independent central bank, the ECB. In striking contrast to this line of reasoning, however, the Eurozone crisis has forced us to consider whether the opposite concern may be equally valid: the ECB, formally the Eurozone's monetary policy-maker, has come to concern itself with national fiscal policy-making in an unprecedented fashion, expressing its views on the appropriate conduct of fiscal policy with ever-increasing intensity. This paper addresses the puzzle of why a singularly independent central bank like the ECB chooses to interfere with fiscal issues, thereby crossing the line in the sand between monetary and fiscal policy that was meant to protect central banks from interference. Drawing on a novel dataset of ECB communication acts and combining techniques of quantitative text analysis (topic modelling) with regression analysis, we show that the ECB's communication on fiscal issues is related to the state of credit risks on its balance sheet – reflecting the central bank's increasing concerns with an appropriate fiscal backing for its monetary policy operations. The implications of our analysis call into question some of the old underpinnings of the Eurozone's monetary-fiscal divorce.