The Political Economy of (European) Central Bank Capital

A decade ago, the outbreak of the global financial crisis and its ensuing repercussions shook conventional wisdom about the institution of independent central banking, i.e. the interplay between elected governments and their politically independent monetary authorities. In hindsight, issues that were 'not foreseen' in mainstream scholarship on central bank independence turned out to be 'fundamental' for effective crisis management, such as the puzzling role played by fiscal backstops in order to insure central banks against alleged losses (Posen 2017). This raises fresh questions, not least for what is often perceived to be the world's most independent monetary authority, the ECB: Why do independent central banks seek to protect their capital bases – i.e. protect themselves against losses and recapitalisation – despite longstanding arguments and empirical evidence suggesting that a central bank's capital should be largely irrelevant for the conduct of monetary policy? I argue that a monetary authority's approach to protecting its capital base depends on the degree of 'financial independence' it is granted (including the chosen accounting rules and the question of who 'owns' the central bank's seigniorage) as well as the existence of arrangements for a hypothetical fiscal backstop for the bank (in the form of explicit or implicit political indemnities). Preliminary evidence suggests that the non-existence of such arrangements proved to be an impediment to ECB action during the crisis, as opposed to the Bank of England, for instance, which received a political indemnity during that time. This yields important implications for the envisaged completion of EMU.