Granting independence to national central banks : Treaty provisions and recent initiatives in Member States

Ernest Gnan

1. Introduction

A number of Member States have recently taken measures to render their central banks more independent. Belgium, Italy and Portugal have adapted their central bank laws, primarily focusing on the prohibition of central bank financing of the public sector. The Banque de France was granted far-reaching independence as from 1994. Spain is in the process of major reforms of its central bank act. In other countries internal discussions on the issue have started within the government/central bank or in the public and academia (e.g. UK).

This is to some extent a reaction to the EMS crisis of 1992 and 1993 and the need for reinforced credibility in the absence of the "safety net" of narrow ERM margins. But it is also part of the process towards Economic and Monetary Union and the establishment of an independent European System of Central Banks as foreseen in the Treaty on European Union.

This article first looks at national central bank legislation in the light of the Treaty on European Union (TEU). Secondly, it summarises the present institutional status of Community central banks, with a special focus on recent initiatives in this field.

2. The timetable for reform required by the Treaty

According to the Treaty on European Union (TEU), the European System of Central Banks (ESCB) consisting of the European Central Bank (ECB) and the national central banks (NCBs) will be responsible for monetary policy from the start of Stage Three of EMU. The Treaty stipulates that the ECB and NCBs will be granted a high degree of independence, while at the same time the system will be democratically accountable (Art. 105-109b, Art. 109e.5, Art. 104; plus a number of Articles in the Statute of the ESCB and of the ECB).

In rendering NCBs independent, the Treaty chooses a gradual approach :

1. On 1.1.1994, Art. 104 TEU as part of the provisions strengthening fiscal discipline in the Union became effective. Art. 104 forbids any overdraft or other credit facilities by central banks in the Union to the public sector as well as the direct purchase of government securities. In parallel with Art. 104, a Council Regulation entered into force, further specifying the prohibition of Art. 104.

2. According to Art.109e.5, during the Second Stage, each Member State shall, as appropriate, start the process leading to the independence of its central bank.

3. At the latest at the date of the establishment of the ESCB (i.e. immediately after 1.7.1998 or earlier, should Stage Three of EMU start ahead of 1.1.1999 - cf. Art. 109l), each Member State shall ensure that the Statutes of its NCB are compatible with the Treaty (cf. Art. 108 and Art. 7 Statute).

Member States have a strong incentive to act earlier before 1996 : by 1996 at the latest, the Commission and the EMI shall report to the Council on the progress made by Member State in the fulfilment of their obligations emanating from the Treaty. These reports include an assessment of national central bank legislation. Furthermore, according to Article 7 of its Statute, the EMI will once a year address a report to the Council on the state of the preparations for the third stage, which will also include the statutory requirements to be fulfilled for national central banks to become an integral part of the European System of Central Banks.

3. Compatibility of national central bank statutes with the Maastricht Treaty

In general terms, the degree of central bank autonomy is influenced by a set of different factors which together account for a central bank's overall independence. These include the following major elements :

A. Does the Bank have a clear unambiguous objective ?

B. "Functional independence"

- B.1. Is there a general provision explicitly mentioning the central bank's independence ?
- B.2. Does the Bank have the authority to decide about the monetary policy strategy, and does it have the necessary choice of monetary policy instruments ?
- B.3. In how far can its monetary policy be counteracted by exchange rate policy ? To what extent is the central bank involved in exchange rate policy ?
- B.4. Is the Bank free from other duties potentially conflicting with its monetary policy task ?
- B.5. Can the central bank be obliged to extend credit to the government ?

C. Do the central bank managers' employment contracts render them immune against political pressure (premature end of contract, salary disincentives in case of "disobedience") ? ("personal independence")

D. Does the legal status of the Bank grant it budgetary autonomy to pursue its tasks ? ("budgetary independence")

E. How is the Bank accountable to the democratic instances ?

For the ESCB as a whole, the Treaty covers all of the above items in a manner such as to ensure a high degree of independence for the system. The requirements on NCB statutes are either directly stipulated in the Treaty or they result from the institutional set up of the ECB and ESCB as a whole, since Art 14.3 Statute states that "the national central banks are an integral part of the ESCB and shall act in accordance with the guidelines and instructions of the ECB". Both Treaty and ESCB Statute in terms of legal rank are European constitutional law directly binding on Governments in Member States and requiring (for the most part) a new Intergovernmental Conference and unanimity among Member States in order to be changed.

A. Objective

Art. 105/Art 2 Statute fixes the primary objective of price stability for the ESCB as a whole, meaning that both the ECB and the NCBs are obliged to pursue this objective. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Community.

The article is directly applicable to each NCB. National central bank laws must not include any provision contradicting it. In order to enhance the credibility of the ESCB's commitment to price stability, it would seem useful to state the primary objective of price stability also explicitly for the NCBs in the national central bank laws.

B. Functional independence

B.1. Explicit statement of independence

Art 107 and Art 7 Statute read that "... neither the ECB, nor the national central banks, nor any members of their decision-making bodies, shall seek or take instructions from Community institutions or bodies, from any government of a Member State or from any other body. Community bodies and the governments of the Member States undertake to respect this principle and not to seek to influence the members of the decision-making bodies of the ECB or of the national central banks in the performance of their tasks".

This general article prohibits influence in two ways : neither must central banks accept instructions nor must Community bodies and governments try to exert influence. This applies both for the ECB and for national central banks. The article is directly applicable at the national level. Obviously, any provision in a national central bank or other law directly violating this article will be incompatible with the Treaty in Stage Three. In addition, it might be considered useful to include an equivalent of Art 107 in NCB Statutes, in order to leave no doubt about national governments' intentions.

B.2. Conduct of monetary policy and choice of monetary policy instruments

The Maastricht Treaty makes clear that the ESCB has the sole responsibility for monetary policy (Art 105. 2/Art 3.1. Statute). It has the note-issuing monopoly in the Community (Art 105a/Art 16 Statute); governments retain the right to issue coins but the volume of coins is subject to approval by the ECB (Art 105a. 2). The ECB is free to decide in which way (technically, institutionally) various monetary policy instruments are used, in particular whether the operations are carried out in a decentralised or centralised manner.

The ESCB has the sole responsibility to hold and manage the official foreign reserves of the Member States (Art 105.2/Art 3.1 ESCB Statute); Member States retain the right to hold foreign exchange working balances but transactions with them are subject to approval by the ECB if they exceed a certain limit to be established by the ECB Council (Art 31 Statute).

As outlined above, Art 14.3 Statute states that the national central banks are an integral part of the ESCB and shall act in accordance with the guidelines and instructions of the ECB. Therefore,

  in the conduct of monetary policy (e.g. setting of intermediate monetary policy targets, interest rate policy, choice of monetary policy instruments) and other policies which the ESCB is in charge of in Stage Three, no interference by governments or any other bodies is permitted;

NCB laws must not contradict the ESCB Statutes as concerns the availability and use of monetary policy instruments.

B.3. Exchange rate policy

Since exchange rates will be irrevocably fixed from the first day of Stage Three, national exchange rate policy by definition will cease to exist. On the European level, Art 109 and Art 105 govern the distribution of power between the Council and the ESCB in exchange rate policy matters.

For Stage Two, and for Member States not yet participating in the common monetary policy in Stage Three, it would seem appropriate that the NCB laws reflect the distribution of power over exchange rate policy between governments and central banks chosen in Art 109. It should be made clear that in Stage III exchange rate policy is conducted at a European level, with national authorities - national governments of NCBs - taking part in the decision shaping process through the Community institutions.

B.4. Other tasks of national central banks

National central banks may perform functions other than specified in the Statute if the ECB Governing Council does not find with a two-thirds majority that these are in conflict with the objectives and tasks of the ESCB (cf. Art 14.4 Statute). In particular, fiscal agent functions (Art 21.2 Statute) and an involvement in the operation of settlement and payment systems are explicitly permitted in the Treaty.

The responsibility of the ESCB in the field of prudential supervision on the European level is limited : "The ESCB shall contribute to the smooth conduct of policies pursued by the competent authorities relating to the prudential supervision of credit institutions and the stability of the financial system" (Art 105.5). Any extension of the scope of such tasks requires a cumbersome procedure (unanimous Council decision, after consulting the Commission and the ECB and after receiving the assent of the European Parliament) and is confined to "specific tasks" (Art 105.6).

This very cautious approach reflects the fear that close central bank involvement in prudential supervision can in the extreme weaken the central bank's monetary policy independence and credibility. It also arises from the principle of subsidiarity and the desire to accommodate as far as appropriate institutional differences in Member States. Apparently, any close involvement of NCBs in prudential supervision is therefore subject to Art 14.4.

Concerning payment systems, the ESCB's involvement is somewhat larger : the issue features among the four basic tasks of the ESCB; but on the other hand, the formulation chosen ("promote the smooth operation of payment systems") is fairly vague and again does not suggest a very close involvement of the ECB. NCBs' involvement in this field should be considered in this light, without, however, affecting the principle of subsidiarity.

B.5. Central bank financing of the public sector

The Treaty prohibits both the ECB and national central banks from granting overdraft facilities or any other form of credit facility to the public sector as well as from purchasing public sector debt instruments directly. Secondary market purchases of debt instruments remain possible.

C. Personal independence

The issue of personal independence is given high priority in the ESCB Statute. The general provision of Art 107/Art 7 Statute prohibits the members of the decision-making bodies of the ECB and NCBs from seeking or taking instructions and protects them from such attempts by other Community institutions and Member States.

Two-thirds of the 18 members of the Governing Council of the ECB will be the governors of the national central banks. The independence of the decision-making process on the NCB level is therefore of central importance to the independence of the ESCB as a whole. Therefore, the personal independence of NCB governors is directly addressed in the Treaty : an NCB Governor's term has to be at least 5 years (Art 14.2 Statute), he may be relieved from office only "if he no longer fulfils the conditions required for the performance of his duties or if he has been guilty of serious misconduct" ( Art 14.3 Statute).

The independence of the other members of the decision-making bodies of NCBs (apart from the Governor) is directly based on Art 107; the Treaty requires no additional "safeguard" provisions (such as minimum term, conditions for being relieved from office, etc.) underpinning this independence.

D. Budgetary autonomy

The Treaty contains no provisions explicitly requiring the budgetary autonomy of national central banks. However, it follows implicitly from Art. 14.3 that the national central banks (forming an integral part of the ESCB and acting in accordance with the guidelines and instructions of the ECB) have to dispose of the necessary budget to perform the tasks allocated to them by the ECB. So, though not stated explicitly in the Treaty, it appears that any provisions in a NCB law giving the government (ministry, any government body) ex ante budgetary power over the national central bank (at least for the tasks related to monetary policy and under the authority of the ESCB), would not be in line with an independent ESCB. This does not, of course, preclude ex post control of the annual accounts of central banks by independent auditors and an examination of the operational efficiency of the management by national courts of audit and the like. Art 27 Statute provides that the accounts of the ECB and NCBs shall be audited by independent external auditors recommended by the ECB Governing Council and approved by the Council. These auditors shall have full power to examine all books and accounts of the ECB and national central banks and obtain full information on their transactions.

E. Democratic accountability

The Treaty (Art 109b and Art 15 Statute) establishes a system of checks and balances between the ECB and other Community institutions (Council, European Parliament, Commission) so that mutual information is guaranteed on a regular basis. This underlines that the ESCB is accountable for the fulfilment of its objectives to the democratic bodies and to the general public; it also reflects the notion that a broad understanding of monetary policy concerns is an important element for the sustainability of price stability and that coordination between different policies is desirable (within the limits given to the ECB in its mandate).

The Treaty does not regulate the issue of democratic accountability on the national level. This is up to national legislation or national practice. It would seem quite natural that the national central bank (respectively its governor) informs the national parliament. But this task might as well be performed by any other member of the ECB Council.

Similarly, other mechanisms of democratic control including the participation, without voting - and, of course, veto - right, by government representatives in the meetings of the decision-making bodies of national central banks would equally appear to be in line with the Treaty, complementing similar mechanisms installed at the European level.

4. Initiatives in Member States towards increased central bank independence

Table 1 summarises some features of Community central banks. Recent years have witnessed quite some change in this area.

The Belgian central bank law was amended in March 1993. In line with Art 104 of the Treaty, it completely abolishes central bank financing of the government; furthermore, the new act abolishes the censor's veto right in the field of monetary policy, foreign exchange operations, the holding and management of official reserves and the promotion of the smooth operation of the payment systems, i.e. in the areas constituting the future tasks of the ESCB.

The Banque de France was granted far-reaching functional and personal independence as from 1994 (for details see the separate article in this issue p.44).

In Italy, the central bank was granted sole responsibility for discount rate changes in February 1992 (Law no. 82 of 7 Feb. 1992). In November 1993, Parliament passed a law abolishing any form of credit line of the government with the central bank.

In Luxembourg, the government is currently in the process of putting before Parliament a major reform of the law relating to the Institut Monétaire Luxembourgeois.

In Portugal a major reform of the Central Bank law took place in October 1990. The Bank of Portugal was granted formally the sole responsibility for the implementation of monetary and exchange rate policy.

In Spain, the government submitted a draft law to Parliament at the end of 1992. Following the June 1993 general election, a new draft has been submitted according to constitutional rules, and the law is envisaged to enter into force by summer 1994. The draft law ensures "far-reaching autonomy" (as opposed to "independence", as the Spanish authorities emphasise) to the Banco de España and grants it sole responsibility for monetary policy. The draft law is interesting insofar as it includes a provision stating that the Banco de España will be subject to the Treaty on European Union in cases where the national law is not consistent with the Treaty.

In the UK, the Treasury and Civil Service Select Committee of Parliament published a report in December 1993 on granting the Bank of England greater independence. In essence, this report recommended a New Zealand type central bank model with Parliament setting an inflation target to be pursued "independently" by the central bank. In February 1994, a Private Members' Bill suggesting broadly the same changes failed to get a second reading in Parliament and in this way was turned down.

Apart from these initiatives, most Member States have recently adjusted national practices and legislation to the requirements of the prohibition of central bank financing of the public sector (Art 104) and to the prohibition of privileged access of the public sector to financial institutions; some are still in the process of doing so.

Current initiatives to render NCBs independent face a fundamental question : How to draft an NCB law both applicable in Stages II and III ? For Stage II, when NCBs are still responsible for monetary policy, provisions safeguarding their - individual - functional independence are necessary. By contrast, in Stage III the ECB will decide about monetary policy; the NCBs, forming an integral part of the ESCB and acting in accordance with the instructions and guidelines of the ECB, are no longer responsible for designing an individual "independent" monetary policy. The question arises as to whether a transfer of monetary policy competence to the ECB from the start of Stage III has explicitly to be mentioned in NCB Statutes. So far no NCB Statute does so, except for the Spanish draft law which includes a general clause stating wherever the law contradicts the Treaty, the Treaty prevails.

On the whole, the changes undertaken so far are encouraging in several respects. Firstly, the convergence in the institutional framework for economic and monetary policy mirrors a growing consensus on the role of monetary policy within the overall framework of economic policies, paving the way for the closer co-ordination of national policies during Stage Two. Secondly, the fact that Member States adopt measures far ahead of the timetable required by the Treaty shows that Member States are not following a "minimalist approach" in the compliance with Treaty provisions. Although not really required at this stage and despite the difficulties involved in designing at the present time a central bank law suitable for the different institutional set-ups of both Stages Two and Three, the changes in many respects already establish a high degree of compatibility with the Treaty.