The European Council’s decision to propose Christine Lagarde and Ursula von der Leyen as the presidential candidates for the European Central Bank (ECB) and European Commission, respectively, sends three subtle but important messages to financial markets:
1) Continuity. Other candidates, particularly to lead the ECB, could potentially have steered policy in a different direction. Lagarde, personally, has called on the ECB to maintain its accommodative stance in the face of low inflation while the International Monetary Fund (IMF) that she leads has advocated for a simpler, symmetric inflation target. Her appointment implies continuity of the monetary policy direction hitherto undertaken by President Mario Draghi.
2) Fiscal policy is the new monetary. Lagarde’s experience as France’s finance minister and IMF chief bring a fiscal perspective to monetary policy, which is particularly timely: In the next recession, the ECB will be challenged by a quasi-depleted tool box, given already low policy interest rates, as well as the efficacy of those tools. Europe’s delayed demographic resemblance to Japan, where monetary policy prioritises avoiding deflation over crushing inflation, suggests that the ECB’s fiscal perspective will most likely result in the central bank continuing to support member states’ government bond issuance through asset purchases.
3) A nod toward completing the eurozone’s unfinished institutional architecture. The eurozone is a unique currency union in that it lacks a central fiscal policy and a democratically elected chamber presiding over common tax revenues and expenditures. This complicates and overburdens the ECB’s task: The central bank is alone in its pan-European monetary scope, while fiscal policies remain fragmented at the member-state level.
The euro celebrated its twentieth anniversary this year, but history teaches us that no large monetary union ever endured without evolving into a federal structure. The Council’s recent decision to initiate a small, centrally financed budget dedicated to the eurozone appears to acknowledge such weakness and sets the foundation for further integration.
Geopolitical changes afoot around the world also suggest Europe could, and some of its important leaders advocate that it should, unify member states’ military forces. This should be an achievable goal under the new Commission and von der Leyen’s federalist credentials raise the likelihood of this happening.
When Europe again faces a critical “whatever it takes” moment, to which President Draghi provided a resolute answer to in 2012, we believe Europe will respond constructively, with both fiscal and monetary policy acting in greater unison. Pending the European Parliament’s ratification, markets should therefore be reassured by a Lagarde - von der Leyen tandem at the helm of two of Europe’s most important institutions.
Interested in Europe’s negatively-yielding rate environment? Read Marc P. Seidner and Andrei Wagner’s “As Negative‑Yielding Bonds Set New Records, Flexible Investing May Offer Benefits”
Should the ECB have the same inflation target as the US’s Federal Reserve? Don’t miss Scott Mather’s “Off‑Target: Central Banks and the Mystique of 2%”