Lagarde poised to take over at the ECB

When the European heads of government nominated Christine Lagarde, currently the Managing Director of the IMF, to take over as President of the European Central Bank (ECB) later this year when current president Mario Draghi’s term expires, it excited less comment than it might have done.

This is partly because, unusually, the presidency of the ECB (equivalent to the more usual central bank terminology of governor) was being decided alongside the other senior posts in the European Union such as the presidents of the Commission and of the European Council.  Whereas all these other posts rotate every five years, their terms of office coinciding with the quinquennial cycle of the European Parliament, the president of the ECB is appointed for a single 8 year term.  It is thus a coincidence that this time round, the end of Draghi’s 8 years in Frankfurt coincided with the ending of all the other senior appointments in Brussels.

For Lagarde, this is perhaps a little unfortunate, because it meant that her nomination became entangled in the usual political horse-trading that Brussels goes through for the other posts, leading commentators to assess her candidacy not just on its own merits, but for how it intermeshed with the other nominations.   It even led to comments from various leaders patting themselves on the back for the gender balance (two women, two men) of the “slate” of senior nominations they had agreed on, which both diminishes the statures of the individual candidates and suggests an agenda other than putting forward the best person for each post.

Furthermore, what comment there was on Lagarde’s nomination tended to concentrate on the fact that she has never worked at a central bank and has no formal economics background.  For some commentators this is seen as a weakness in her candidacy, though in fact it is not that unusual for governments to look outside the ranks of practicing central bankers when appointing senior central bank officials.

We think these criticisms are unjustified, and that Lagarde has what it takes to be a good and successful head of the world’s second most important central bank.  She is hardly unversed in the world of national and international finance, having spent the last eight years in Washington at the head of the IMF – a testing period, especially at the start of her tenure as the global economy was still struggling to recover from the Financial Crisis – and the four years previous to that as finance minister of France, the Eurozone’s second largest and second most important economy.  Many governors of central banks, even if they have spent their full career in central banking, have less practical experience of international finance than that.

On top of this she is a first rate politician, with excellent contacts across the political spectrum, and she is also known to be very good at mastering a brief and leading a team.  Many consider these skills to be at least as important in modern central banking as a formal economics training.  Robin Leigh Pemberton, governor of the Bank of England from 1983-1993, was a lawyer by background and came to the Bank from the chairmanship of a commercial bank;  he never claimed to know the finer details of central banking himself but he was superb at running a team of people who did.  And in his political skills, the crucial ability to work with the central bank’s political masters, he was superior to his predecessor (Gordon Richardson) and both his successors (Eddie George and Mervyn King), all three of whom lost important battles to their respective chancellors and prime ministers.

Nor is Lagarde’s lack of formal or theoretical economics necessarily a handicap.  She will not bring her own biases or preconceptions to the job, as some central bankers have.   That was one of the weaknesses that Mervyn King displayed:  when the real world did not conform to his classical economic theory, he was left uncertain what to do, most famously when the building society Northern Rock ran into trouble in 2007.  The academic theory that a bank failure might be acceptable, even desirable, to avoid moral hazard and to encourage other bankers to be more prudent did not survive pictures on the television news of queues of worried depositors outside Northern Rock branches seeking to withdraw their money before it collapsed.

To a certain extent the same was true of Jean-Claude Trichet, president of the ECB as the Financial Crisis struck, who was also too rigid and had too many prior assumptions.  He never really recovered his reputation from his decision to raise Eurozone interest rates in July 2011 on a technical concern about inflation and the money supply, ignoring the growing debt crisis in the Eurozone and the flashing red lights of failing health in many of the zone’s banking systems.

It took Mario Draghi and his comment that the ECB would do “whatever it takes” – the remark of an arch-pragmatist not a theoretical economist – for the ECB to begin to re-establish control over the Eurozone’s financial health.

If Lagarde has any biases at all, they are to work closely with the elected politicians, and to prefer easy money.  We think the first of these is a definite plus:  the era of the wholly independent central banker who holds himself or herself above the political fray lest they get corrupted by doing something the people actually want (as opposed to what is good for them) has passed, and with central banks now much more intimately integrated into the financial system courtesy of years of Quantitative Easing and expanded balance sheets, their role is inevitably more political and a close working relationship with the political class is of increasing importance.

On her preference for easy money, the assessments will be more nuanced.  Certainly Germany will find her a trial – she will in their minds be Draghi redux, a continuation of what they see as his debasement of the currency through lax monetary policies and over-abundant liquidity.

But then one can argue that it is Germany that is in the wrong here, and that many of Europe’s financial woes would be eased by a more expansive German budgetary stance.  Indeed, defenders of Draghi’s policies observe that it is precisely to counter the obstinate refusal of Europe’s largest economy to relax its very tight fiscal stance and correct its excessive current account surpluses that the ECB maintains its accommodative monetary policy.   It is an argument that Lagarde herself has shown considerable sympathy for, both when she was finance minister of France and (albeit with slightly greater restraint) from her current position in Washington, and there is no reason to suppose that she will change her position if she assumes the presidency of the ECB later this year.

In fact, we think Lagarde’s nomination – and more significantly Germany’s failure for the fourth time to secure the ECB presidency for their candidate – says more about Germany’s weakened position in EU horse-trading and the other states’ ongoing frustration at her economic policies than anything else.  Jens Weidmann, president of the Bundesbank and for much of the last few years the leading candidate to replace Draghi, has been overlooked not for anything he has done (indeed in the last year or two he has conspicuously been softening his hitherto very hawkish stance to increase his appeal), but for what his government in Berlin has not done, viz loosen the purse strings just a little to help the wider Eurozone interest.

So, what will a Lagarde ECB bring?   We would expect continued low or negative interest rates, continued expansionary balance sheet management, continued tacit support for markets, continued forbearance for Italian banks, continued pressure on the politicians to complete the construction of the banking union and single capital market.  In other words, largely more of the same.  For as Lagarde herself will no doubt say, “what is the alternative?”