The Institutional and Cultural Foundations of the Federal Reserve’s and ECB’s Non-Standard Policies

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This is an author version of the contribution:

M. Moschella and D. Lombardi, ‘The Institutional and Cultural Foundations of the Federal Reserve’s and ECB’s Non-Standard Policies’, Stato e Mercato, 2015, Vol. 1

(April), pp. 127-152. ISSN: 0392-9701.

The definitive version is available at:

http://www.rivisteweb.it/doi/10.1425/79495

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The Institutional and Cultural Foundations of the Federal Reserve’s and ECB’s Non-Standard Policies

DOMENICO LOMBARDI Centre for International Governance Innovation

[email protected] +1 519-885-2444 x7227

67 Erb Street West Waterloo, ON, CANADA, N2L 6C2

and

MANUELA MOSCHELLA

Scuola Normale Superiore and Centre for International Governance Innovation [email protected]

+39 055 2673 313 Institute of Humanities and Social Sciences

Palazzo Strozzi, Piazza degli Strozzi 50123 Firenze, Italy

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1. Introduction

For institutions that are so inclined to ‘boring’ policy-making as the Governor of the Bank of

England once put it (King 2000), central banks’ recent adoptions of non-standard policies has been

remarkable. With benchmark rates at or close to zero, a number of central banks in advanced

economies launched innovative programs and facilities and used their balance sheet to mitigate

financial instability and support economic recovery. In spite of having common policy goals,

central banks’ unconventional monetary policies (UMPs) vary considerably in scope and design

across advanced economies. In the words of a central banker, ‘Across central banks, there has been

no standardization of non-standard measures’ (Trichet 2011, 12). Specifically, the mix of

instruments used to achieve the above mentioned goals and the timing of their adoption have been

disparate: among other measures, some central banks largely resorted to open-ended asset purchases

while others granted banks unlimited access to liquidity against a broadened and riskier range of

collateral. Some central banks intervened directly in specific market segments, while others revived

the practice of foreign exchange interventions. Furthermore, whereas some central banks quickly

adopted their UMPs, others lagged behind.

The variation in UMPs is perhaps most vividly illustrated by the policies of the two most

prominent central banks: the European Central Bank (ECB) and the US Federal Reserve (Fed). The

Fed engaged the ‘four-wheel drive’ once it arrived at ‘the end of the road’ (Trichet 2011). That is to

say, once nominal interest rates could not be lowered any further, the Fed expanded its balance

sheet and injected liquidity in order to influence the structure of yields and returns in order to

stimulate aggregate demand. In contrast, the ECB sought to ‘remove the major roadblocks’ in its

way (Trichet 2011). In other words, the ECB’s non-standard liquidity measures intended to

facilitate the effective transmission of its monetary policy stance, rather than to change the ECB’s

policy stance at the time.

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The purpose of this paper is to provide new insights to explanations for why the ECB and

the Fed implemented different UMPs. Using the findings from the comparative case studies, we

argue that variation of UMPs cannot be satisfactorily explained by economic and financial

fundamentals alone. As discussed at greater length below, it is hard to find simple correspondence

between typologies of financial systems and types of UMPs. Explanations that emphasize the

influence of the legal mandates of the two central banks are also insufficient to account for policy

variation. Indeed, these arguments have difficulty explaining how central banks have (re)interpreted

their mandate in the face of new economic challenges,1 as has been the case during the recent

financial crisis. We therefore suggest that institutional and cultural factors help to provide a more

thorough explanation for why the ECB and the Fed implemented different UMPs during the crisis.

Specifically, as will be illustrated at greater length below, the ECB’s more decentralized decision-

making structure relative to the Fed’s has granted the Eurozone opponents of unconventional

policies significant access and voice in its monetary policy decisions. Therefore, opponents have

been able to influence the design of UMPs so as to reduce their ‘unconventionality’. Furthermore,

variations in UMPs also reflect different “accountability cultures”, that is to say, different

organizational understandings of what the central bank is accountable for and to whom. Whereas

the ECB sees itself as the quintessential example of an independent agency responsive almost

exclusively for price stability, the Fed considers itself to be an agent “independent within the

government” that is responsive for the economic needs of American people and their political

representatives. These cultural orientations have influenced the extent to which the central bank

deviated from its standard practices by justifying (for the Fed) or hindering (for the ECB) measures

that have wealth redistributive effects.

We illustrate these arguments by examining the ECB’s and Fed’s unconventional monetary

response from 2008 to 2013. Before proceeding with the analysis, some clarifications are in order

1 Although the mandates of many central banks have remained the same since the bank was established, central banking practices have evolved considerably over time shifting from a role of fiscal agent for domestic governments to guardian of financial stability and, more recently, guardians of price stability (Broz 1998; James 2013).

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concerning the scope of this study, research design and methodology. As for the scope of the

research, it is worth clarifying what is not part of our analysis. This study does not provide an

assessment of the effectiveness of UMPs nor an analysis of the international spillover effects of

these policies. More narrowly, the paper analyzes the factors that shape the design and choice of

UMPs of the two major central banks from 2008 to 2013.

In terms of research design, our analysis relies on the ‘most similar design’ strategy. That is,

we selected two case studies that that are similar under several, important respects with the

exception of the phenomenon to be examined.2 Specifically, the two major central banks that we

selected have both faced largely similar economic circumstances since 2008, including severe

financial instability, persistently sluggish output, growing unemployment and deterioration in

public finances. In the face of these macroeconomic and financial stability challenges, both central

banks resorted to UMPs. However, the reliance on balance sheet measures and non-standard

liquidity supply has varied significantly across the two case studies.

Turning to our methodology, we use process tracing to test the causal weight of the factors

that help explain the differences between the ECB and the Fed’s UMPs (Collier 2011; George and

Bennett 2005, ch. 10). Specifically, the empirical analysis carefully traces the way that the

institutional and cultural factors mentioned above influenced the policy outcomes. In order to

extrapolate empirical support for our arguments, the analysis draws on data from official documents

(publications and public speeches), secondary literature, and semi-structured interviews with

policymaking elites (central banking officials, politicians, and academics).

The rest of the paper is organized as follows. The second section focuses on the dependent

variable by introducing the different types of UMPs that are the objects of our investigation. The

third section engages with the political science literature on central banking and discusses the

institutional factors that, we submit, complement existing explanations for the differences in the

2 This research strategy can be traced back to Lijphart’s (1971)‘Comparative Method’ and stands an alternative to the ‘most different research design’ whose aim is to maximize the number of variables on which the target cases differ (Przeworski and Teune 1970).

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design of UMPs at the two central banks. The fourth section examines the UMPs that the ECB and

the Fed have adopted since the start of the crisis by linking them to the distinctive features of each

central bank’s decision-making system and organizational culture. The final section concludes by

reflecting on the findings and drawing some broad implications for the study of central banking in

the aftermath of the global financial crisis.

2. Unconventional Monetary Policies

Since the start of the global financial crisis in 2007-08, central banks in the major advanced

economies have been at the front lines of fixing financial market dysfunctions and restoring the

foundations necessary for sustained economic growth. In order to achieve these goals, central banks

have displayed both traditional and non-traditional weaponry. In this paper we focus on the non-

traditional tools; we will start by defining what we mean by UMPs.

A good starting point is to define conventional policies. Conventional monetary policy

typically involves influencing short-term interest rates by managing the rate at which banks can

borrow short-term funds from the central bank, often referred to as the key policy rate – which is

the main refinancing rate in the Eurozone and the federal funds rate in the US. That, in turn, affects

interest rates charged on consumer and institutional lending and thus translates to the real economy.

Lowering (or raising) interest rates stimulates (or reduces) demand and stimulates (or cools down)

growth. Modern conventional monetary policy is usually complemented with transparent

communication.

Unconventional monetary policies, on the other hand, refer to a broad set of stimulative

measures that are implemented because the key policy rate has reached or is approaching the zero

lower bound (ZLB) – its lowest effective rate. These additional tools aim to reduce yields or term

spreads and to ease financing conditions. Although there are several ways to classify UMPs, in this

paper we will categorize them by non-standard liquidity facilities and balance sheet policies. These

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policy tools can be placed along a continuum with the most conventional tools on the left to the

most unconventional tools on the right (Table 1).

Table 1 here

Non-standard liquidity facilities consist of extending credit to financial markets by

providing longer-term loans or by relaxing conditions for accessing liquidity (e.g. expanding the list

of eligible collateral or eligible institutions). They aim to restore the proper functioning of financial

markets and intermediation. An example of a non-standard liquidity facility is the ECB’s long-term

refinancing operations (LTROs) through which the ECB issued more than €1 Trillion in cheap

three-year loans between late 2011 and early 2012.3 The Fed also implemented non-standard

liquidity measures by extending loan maturities and the list of eligible collateral under its traditional

discount window. In addition, the Fed created new programs and facilities that granted access to

non-bank financial institutions (i.e. Primary Dealer Credit Facility (PDCF) and Term Asset-Backed

Securities Loan Facility (TALF)). Non-standard liquidity facilities are sometimes regarded as less

unconventional than other UMPs because they can be better assimilated to traditional lender of last

resort (LOLR) measures.4 However, during the crisis, liquidity provisions went far beyond the

traditional LOLR measures in that financial support was extended to a wider set of recipients, at

longer maturities, for unlimited amounts, and against considerably expanded collateral. There

unconventionality may be emphasized by the fact that many of the facilities introduced by the Fed

required it to invoke its emergency authority under section 13(3) of the Federal Reserve Act. The

extensive use of non-standard liquidity facilities has been regarded as the beginning of a new role 3 Although LTRO can be regarded as ‘standard’ liquidity provision by the ECB, the program significantly extended the boundaries of traditional ECB refinancing operations because the maximum maturity of the refinancing operations was temporarily extended as well as the list of eligible collateral. Furthermore, whereas in ‘normal’ refinancing operations the Eurosystem auctions a pre-set amount of central bank liquidity in a variable rate tender procedure, during the crisis, access to central bank liquidity has been unlimited based on a fixed-rate full allotment tender procedure. 4 This role as traditionally conceived was to provide liquidity at a penalty rate and against good collateral to a subset of solvent banks facing temporary constraints on deposit and interbank funding.

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for central banks away from the traditional LOLR towards that of ‘dealer of last resort’ (Mehrling

2011).

Balance sheet policies consist of operations that aim to expand or alter the central bank’s

balance sheet and can be subcategorized by quantitative easing (QE) and credit easing (CE)

policies.5 QE aims to expand the liabilities side of the balance sheet by increasing the supply of

bank reserves, usually through the purchase of government securities. The most clear cut example

of QE is the Bank of Japan’s (BoJ’s) policies in 2001: when its policy rate hit the ZLB, the BoJ

began targeting the size of bank reserves as its monetary policy instrument which they managed by

conducting outright purchases of Japanese Government Bonds (JGBs). The purchases of

government securities by the Fed and the Bank of England may also fall in the category of QE. In

theory and according to empirical evidence, QE supports the recovery by forcing down the private

cost of finance, boosting wealth, and thus increasing nominal spending. In the Eurozone, QE is

highly controversial because buying sovereign bonds would have distributional consequences

across national lines. The ECB has purchased sovereign debt through its Securities Market

Programme (SMP); however, these purchases were sterilized and were intended to restore the

functioning of the sovereign debt markets. Thus the program fits better in the category of CE than

of QE.

CE targets the asset rather than liability side of the central bank’s balance sheet. In other

words, it is concerned with the composition of central bank assets rather than the size of its balance

sheet. Examples include the ECB’s Covered Bond Purchase Program (CBPP) and the Fed’s agency

mortgage-backed securities (MBS) purchase program. These programs aim to stimulate the market

by raising the asset prices and lower yields through the portfolio rebalancing channel; they may also

provide targeted liquidity to dysfunctional market segments.

Although in this paper we solely examine the use of non-standard liquidity facilities and

balance sheet policies, a brief mention of the use of forward guidance is required. Forward guidance 5 Several other classifications of balance sheet policies exists including the IMF (2013a) separation into indirect credit easing, direct credit easing, and quantitative easing.

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is the practice of managing market expectations concerning the future path of monetary policy, and

has become an important UMP tool employed by several central banks. Forward guidance has been

used in more ‘normal’ circumstances to reduce market uncertainty by communicating the projected

path of the key policy rate given current macroeconomic projections. This type of communication is

categorized as ‘Delphic’ forward guidance. During the crisis, however, many central banks adopted

‘Odyssean’ forward guidance which entails a commitment to a specific path of the policy rate

(Campbell, Charles, Fisher, & Justiniano, 2012). Although these commitments are usually

conditional on certain macroeconomic circumstances – such as well-anchored longer-term inflation

expectations – they are more credible for reducing market uncertainty. This type of forward

guidance is an expansionary policy in and of itself and also supports the effectiveness of other

unconventional policies (Woodford, 2012).

3. Central Banks and Unconventional Monetary Policy Decision-making

 There is no shortage of academic texts on central banks in the political science literature.

Scholarly attention has traditionally focused on questions related to the motivations that lead policy

makers to grant independence to central banks (Broz 1998; Grabel 2000; Maxfield 1997;

McNamara 2002), the accountability implications that derive from central bank independence

(Elgie 1998; Roberts 2011), and the diffusion of specific policy strategies such as inflation-targeting

(Gòmez-Mera 2011; Johnson forthcoming). This literature also contains important insights that help

explain central banks’ choice of standard and non-standard monetary policies. In general, it is

possible to distinguish between explanations based on economic and financial fundamentals and

explanations that emphasize political and legal constraints that shape central bankers’ preferences

and behavior.

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3.1. Economic and financial fundamentals

There are at least two sets of economic factors that influence monetary policy decision-making: the

fiscal situation and the characteristics of the domestic financial system. When there are serious

threats to fiscal sustainability, the central bank may be induced to adopt an accommodative

monetary policy to preserve macroeconomic stability – a situation known as fiscal dominance. Part

of the variation in UMPs can thus be explained in light of the fiscal challenges that the economy

confronts; in general, the bigger the challenge, the larger the deviation of monetary policy from

conventional practice.

The characteristics of domestic financial systems also shape the design of UMPs. Indeed,

the structure of the domestic financial system must be taken into consideration if monetary policy is

to be effective. From this perspective, the differences in the ECB’s and the Fed’s UMPs can be

traced back to their domestic models of financial capitalism.6 As a result, ‘more direct intervention

in non-bank credit markets in the USA is consistent with that country’s predominantly market-

based system; the greater focus on supporting banks in the euro area reflects a larger reliance on

bank-based intermediation in the region’ (Borio and Disyatat 2010, 68).

These economic and financial factors have certainly played a key role in the design of UMPs

at the Fed and the ECB; however, as will be demonstrated in the following empirical sections, their

influence should not be over-stated. Indeed, fiscal sustainability concerns were at play on both sides

of the Atlantic, but this circumstance did not prevent the two central banks from adopting different

UMPs (Figures 1 and 2). Furthermore, although the difference between bank-based and capital-

based models is a key determinant of the monetary policies adopted in response to the crisis, the

Fed and the ECB ultimately adopted a mix of unconventional policies (both balance sheet and

liquidity-enhancing policies) that fit both models of financial capitalism. In other words, there is no

linear correspondence between types of UMPs and types of domestic financial systems. Nor is there 6 On the distinction between bank-based and capital-based financial systems Zysman (1983). Also (Allen and Gale 2000).

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a clear distinction between financial systems. Indeed, the definition of bank-based model as it

applies to the EU is the object of scholarly debate. Specifically, Hardie et al. (2013) question

whether the distinguishing features of bank-based models still hold in a financial system where

bank lending is heavily influenced by market forces.

Figure 1 and 2 here

3.2. Legal fundamentals

Another, important factor that helps explain the variation in UMPs can be extrapolated from

the letter of the legal mandate of the two central banks. From this perspective, the differences in

UMPs can be attributed to the fact that the ECB has the primary and overriding objective of

maintaining price stability, while the Fed has a dual mandate of maintaining price stability and full

employment. Different mandates create different constraints and incentives; these have pushed the

two central banks to adopt different policies. The ECB, for instance, has responded to the crisis

while staying in the boundaries of its mandate. Specifically, its non-standard measures were

designed to support the effectiveness of the transmission mechanism of its standard monetary policy

to stabilize prices as mandated by its statute, rather than to directly stimulate the real economy (e.g.

Cour-Thimann and Winkler 2012). In the words of one of the members of the ECB’s governing

council, ‘We have employed non-standard – not un-orthodox – monetary policy instruments

precisely for the reason to achieve our orthodox monetary policy objective of price stability’

(Asmussen 2013). The Fed, in contrast, was more prone to implementing ‘un-orthodox’ policies

which were held as consistent with its multiple and flexible mandate.

The influence exerted by the mandate assigned to the central bank is certainly a crucial

factor in accounting for what a central bank can or cannot do. However, it cannot fully explain why,

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for instance, the ECB has resorted to UMPs in spite of its narrow mandate, or why the Fed is

sometimes inclined to give pride of place to one of its macroeconomic objectives over the others.

Thus, other factors need to be considered in order to provide a more thorough explanation for the

differences in the design of UMPs.

3.3. Institutional and cultural fundamentals

The decision-making structures and accountability cultures of the two central banks, we

submit, are also important for accounting for the types of UMPs adopted over the past five years.

The first factor refers to the structure of representation and to the formal rules of the game that

inform the policy-making process of the monetary policy committee of the central bank, namely the

Governing Council at the ECB and the Federal Open Market Committee (FOMC) at the Fed.

Accountability culture refers to the set of “basic assumptions” that affect how organizational actors

interpret their responsibilities and identify the constituencies to which they are responsive for their

actions. The decision-making systems and organizational cultures of the Fed and the ECB are

different in a number of important respects (Table 2).

Table 2 here

As for the decision-making structure, there are key differences in the degree of

decentralization, that is, in the dominance of federal versus state interests. In the Federal Reserve

System, a majority of the members of the FOMC are appointed by the federal government, while

the other members represent the regional Federal Reserve banks.7 In the Eurosystem, however, only

6 out of 24 members of the Governing Council are appointed by the European Council, while the

rest are representatives of central banks of the 18 members of the Eurozone. This difference 7 By law, the appointments to the Board of Governors must yield a “fair representation of the financial, agricultural, industrial, and commercial interests and geographical divisions of the country”, and no two Governors may come from the same Federal Reserve District. http://www.federalreserve.gov/faqs/about_12591.htm

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indicates that the Eurosystem decision-making system is relatively more decentralized than its US

counterpart, because it grants state interests a stronger role in the decision-making process.

Decentralization is further reinforced by the structure of representation: whereas the regional Fed

banks have jurisdiction over groupings of states, in the Eurozone each national central bank

represents one country. This suggests that ‘the positions taken individually by the regional Fed

presidents are less relevant for the conduct of the US monetary policy than those taken in the

Eurozone by the national central bank governors’ (Smaghi 2013). The fact that national interests

have a strong presence in the ECB’s decision-making system is further reinforced by the role that

national central banks (NCBs) perform in the Eurosystem, from managing the official reserves of

member states to managing the Target system.

As for the accountability culture of the two central banks, a crude representation of the differences

between the ECB and the Fed can be summarized as follows: On the one hand, the ECB conceives

of itself as being fully ‘independent from government’ in that it is not responsive to national or

suprnational governments, but its actions should be solely responsive to what an essentially

inviolable international treaty assigned it to do (Posen 1993). This view can be clearly detected in

the words of the ECB’s long-standing chief economists, Otmar Issing, according to whom the,

“Emu is based on rules enshrined in international treaties. The euro was created as a “depoliticised

currency” – its stability entrusted to an independent central bank with a clear mandate to maintain

price stability” (Issing 2011). On the other hand, as one former top Fed official put it, the Fed

regards itself as being ‘independent within the government’ (Axilrod 2011, 11-12), a definition that

suggests the existence of a much closer relationship between the central bank and domestic political

authorities. Decision-making structures and accountability cultures, we submit, are an important

source of policy variation across central banks’ policies because they perform two basic functions.

First, consistent with the findings of the historical institutionalist scholarship (as developed, among

others, by Pierson 2004; Steinmo, Thelen, and Longstreth 1992; Streeck and Thelen 2005; Thelen

1999; 2004), decision making structures influence who dominates the policy-making process by

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providing access and voice to particular interests. In the cases under investigation, they provided (or

limited) access and voice to those opposed to QE. Second, the understanding of what the central

bank is accountable for and to whom defines the extent to which the central bank may deviate from

its standard practices. In other words, accountability cultures define the elasticity of acceptable

behavior within the outer parameters set by the legal mandate. In what follows, we illustrate the

impact of these factors on the UMPs adopted by the ECB and the Fed.

4. The ECB’s Unconventional Crisis Response

As previously noted, the ECB’s UMP response has primarily relied on non-standard liquidity

facilities and, in particular, on measures to mitigate banks’ funding problems.8 In October 2008, the

Governing Council decided to increase the frequency and size of its LTROs as part of its“Enhanced

Credit Support”, and in May 2009 it further extended the maturity from its initial six months to 1

year. In December 2011, the central bank announced 2 three-year LTROs.

The fact that the ECB primarily relied on liquidity facilities among the weapons in its

unconventional armory certainly reflects the characteristics of the domestic ‘bank-based’ financial

system. In the euro area, around 75% of the real economy’s financing needs originate from the

banking sector and banks are crucial counterparties in the broader system of financial

intermediation. At the same time, an account of the ECB’s UMP response would be incomplete

without explaining the factors that have hindered the ECB’s embrace of more combative types of

unconventional policies, such as QE. Indeed, both the Securities Market Program (SMP) and the

Outright Monetary Transactions (OMT) program – the ECB’s other primary unconventional

monetary policies – have design features that restrict them from being placed on the far right end of

the unconventionality spectrum discussed above.

8 Already in August 2007, the ECB provided liquidity to permit orderly functioning of the money market. In December, the ECB took joint action with the Federal Reserve by offering U.S. dollar funding to Eurosystem counterparties.

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Introduced in mid-2010, the SMP consisted of limited purchases of public and private debt

securities.9 In total, the ECB’s balance sheet policies were modest and amounted to less than fifteen

percent of the Fed’s programs in comparable GDP terms. The SMP, however, was still highly

controversial from the outset because it was difficult to reconcile with the ECB’s accountability

culture. Specifically, the financial market implications of the bond purchases were viewed as a

potential risk to what the ECB is accountable for, price stability. Furthermore, the ECB’s cherished

independence could have been impaired if it was viewed as ‘picking winners’ when purchasing

sovereign bonds. These concerns were exacerbated by the ECB’s decision-making system because

of the opposition voiced by some representatives of the national central banks: The President of the

Deutsche Bundesbank, Axel Weber, withdrew his application to become President of the ECB

Jurgen Stark, as he strongly disagrees with the acquisition of sovereign bonds and his Dutch

counterpart and former ECB’s chief economist, Jürgen Stark, left the ECB for the same reason

(Kübler 2012, 33). A similar and even more dramatic political dynamic occurred in the decision-

making process of the OMT program in the summer of 2012. Under the OMT program, the ECB

pledged to purchase sovereign bonds from countries that were part of an official adjustment

program, conditional on their satisfactory adherence to the conditionalities of the given program.10

Similarly to what had happened for the SMP, the vote on the OMT program was highly divisive for

the members Governing Council. ECB President Draghi did not name the lone dissenter in the press

conference held on 6 September 2012 when the operational details of the OMT program were

announced. There are, however, few doubts that it was Jens Weidmann, president of Germany’s

Bundesbank, which reflects the Bundesbank opposition to the ECB’s intervention to preserve the

singleness of the euro area economy.11

9 The Covered Bond Purchase Programme (CBPP) was the other balance sheet policy implemented by the ECB, however it had less contentious distributional implications because it was intended to support the covered bond market to reduce financing constraints for banks across the EU. 10 The OMT is conditional upon Member States’ activation of an EFSF/ESM program, which, in turn, envisages strict conditionality spanning the fiscal, macroeconomic, and structural spheres 11 In a legal opinion written by the Bundesbank for the German Constitutional Court and leaked to the press, the Bundsbank criticized as subjective the rationale behind the decision of the OMT. The Bundesbank also argued that it is

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The political opposition voiced during decision-making combined with the accountability

culture that characterizes the ECB are reflected in the operational features of the SMP and the OMT

program. These measures were actually included with the explicit intention to differentiate these

programs from Fed-type QE. As the former ECB President described it when commenting on the

adoption of the SMP, ‘What the Federal Reserve and the Bank of England have done was

“quantitative easing”. They were injecting liquidity into the markets and that with the explicit goal

of augmenting the overall liquidity. (Trichet 2010c). By contrast, ‘we [i.e. the ECB] are not

purchasing government bonds in order to inject liquidity into the markets. What we are doing is

fundamentally different.’ (Trichet 2010b).

The fundamental difference Trichet hints at can be detected upon a close examination of the

design of the ECB’s balance sheet policies. These policies were designed with three basic features.

First, both the SMP and the OMT program are temporary measures.12 Second, the scope of

application is limited ex ante in terms of the market where the ECB intervenes (i.e. the secondary

market), in terms of the types of assets that the ECB can purchase (i.e. government bonds with a

maturity between one and three years for the OMT), and in terms of the conditions that determine

activation (i.e. activation of the OMT is not automatic but dependent upon Member States’

activation of an official adjustment program). Finally, these policies are limited ex ante in their

consequences: the liquidity injected by the purchases is absorbed, meaning the money supply is

neutralized through the equivalent sale of assets.

These three conditions were necessary to adhere to the ECB’s organizational culture, so that

the UMPs were adopted for the purpose of and without risk to achieving its primary objective. By

limiting the impact of bond purchases via sterilization and reducing the deviation from standard

practices by setting temporal and access limits, the ECB has been trying to emphasize its

unwavering accountability for maintaining price stability. As Draghi forcefully stated, in deciding

not the role of a central bank to guarantee the irreversibility of the currency (Financial Times, Bundesbank takes aim at Draghi’s ECB rescue plan, 25 April 2013). 12 As for the OMT program, as one of the ECB Governing Council described it, it was designed with ‘a built-in exit strategy’ (Cœuré 2012).

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on the OMT program, ‘we act strictly within our mandate to maintain price stability over the

medium term’ (Draghi 2012). Indeed, ‘OMTs are meant… to restore homogeneous credit

conditions throughout the euro area, but not necessarily to ease credit conditions in the aggregate’,

as is the case for QE (Cœuré 2012). Furthermore, the ECB has designed its balance sheet policies in

a way that clearly signals that it is not accountable to national governments. This reasoning is

highlighted by, among others, Trichet’s forceful rejection as ‘ridiculous’ of the charge that the ECB

leant to governments pressures in its decision to adopt the SMP(Trichet 2010a).

Furthermore, it is plausible to argue that the ECB opted for UMPs that tended towards the

less unconventional end of the spectrum by reflecting on the opposition raised during the decision-

making process. For instance, the limits placed on the ECB’s government bond purchases can be

read as a concession to those political actors, most notably the German central bank, that have

access and influence in the decision-making process. Although it is difficult to reach firm

conclusions in the absence of the minutes of the meetings of the Governing Council,13 it would be

naïve to think that the Bundesbank vocal opposition was not inconsequential in light of its long-

standing role in the creation of the EMU (Dyson and Featherstone 1999).

In short, the ECB adopted the types of UMPs that are as close to ‘conventional’ as possible

given its circumstances to ensure that it remains independent from political interference and

committed to its single purpose as an unelected body. The decision-making system of the

Governing Council, which grants national interests access and influence, is also likely to have

shaped ECB’s decisions by leading the ECB to temper the most unconventional aspects of its

balance sheet policies in the attempt to assuage political opposition. Whether these forces have led

the ECB to adopt policies that have failed to solve the crisis is outside the scope of the paper.14

13 The ECB will start disclosing the minutes of its monetary policy meetings starting in January 2015. 14 For instance, commenting the design of the ECB bond purchase program (e.g. the Securities Market Program SMP), Paul De Grauwe notes that the ECB ‘structured this program in the worst possible way.’ Indeed. ‘By announcing the program would be limited in size and time, the ECB mimicked the fatal problem of an institution that has limited resources’, thus fatally impairing the chances of success (Grauwe 2012).

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These factors contributed to the adoption of policies that are significantly different from the types

adopted by the Fed.

5. The Fed’s unconventional crisis response

The Fed began toying with unconventional monetary policies around the same time as the

ECB when it adopted a number of lending facilities in March 2008 that required the use of its

authority under Section 13(3) of the Federal Reserve Act. After the Lehman bankruptcy the Fed

introduced many other lending and credit facilities that were intended to channel funds to specific

markets and institutions that were facing liquidity constraints and whose collapse would have had

significant systemic effects.

Although non-standard liquidity facilities were critical in the early phase of the Fed’s

response to the financial turmoil, the Fed went well beyond them in providing monetary support

during the crisis. The Fed quickly turned to balance sheet policies to help restore stable

macroeconomic foundations. The first round of its Large Scale Asset Program (LSAP) was

introduced in November 2008 with the primary intent of repairing the mortgage backed securities

(MBS) market to prevent further deterioration in the housing market. The extension of the first

round of LSAP and its subsequent rounds, which included the purchase of both agency MBS and

treasury securities, were intended to improve overall financial conditions and stimulate demand

through the portfolio rebalancing channel. In order to achieve this goal, the Federal Reserve

designed LSAPs to be significantly large enough to impact the financial system and the real

economy. In total, the Fed’s QE program has injected over $3.5 Trillion of liquidity into the

financial system.

The purpose and magnitude of these UMPs reflect the tenets of the Fed’s accountability

culture; specifically, what the Fed perceives to be accountable for and to whom. On the one hand,

the Fed justified its LSAPs as a necessary instrument to meet the Fed’s responsibility for economic

19

growth. In the Fed’s words, the aim of the LSAPs, ‘is to put downward pressure on yields of a wide

range of longer-term securities, support mortgage markets, and promote a stronger economic

recovery.’15 The current Chair of the Federal Reserve, Janet Yellen (2013) also indicated ‘the

Federal Reserve is using its monetary policy tools to promote a more robust recovery’.

On the other hand, the Fed’s interpretation of its accountability to elected policy makers

facilitated the acceptance of QE. Whereas the ECB has tried to signal its independence from

national governments in its crisis responses throughout the past five years, the Fed did not face

similar concerns. For instance, as Ben Bernanke (2010) explained, the Fed reminded itself about its

role as ‘an agent of the government’, that is not solely accountable for its mandated goals, but also

‘responsive to the public and its elected representatives’. Hence, adopting policies with

redistributive implications such as QE was far less controversial in the US than in Europe. In fact

these the Fed was in a sense compelled to adopt such policies: central bankers felt that they must

not to eschew but instead take responsibility for the economic needs of American homeowners..

Indeed, in the case of purchases of MBS, the housing market is at the core of household wealth.

Lower yields on mortgage-backed securities mean lower mortgage rates as well. The purchase of

treasury securities and MBS also benefits the government by lowering its debt servicing costs,

increasing remittances, and stimulating growth and employment.

This does not mean that the US Fed’s balance sheet policies have been uncontroversial

within the Fed. To the contrary, dissenting voices were not uncommon. For instance, Richard

Fisher, president of the Dallas Fed, who is one of the longest-serving members of the FOMC,

forcefully opposed QE (Harding 2013). Similarly, in October 2013, when the Fed decided to

maintain its monthly asset purchases at $85 Billion, the FOMC voted for the decision by a majority

of 9-1. Esther George, the president of the Kansas City Fed, dissented because she was concerned

about the risk of future economic and financial imbalances (Financial Times, Fed stays the course

on bond buying, 30 October 2013). However, in contrast to what happens within the ECB, the 15 Federal Reserve, What are the Federal Reserve's large-scale asset purchases?, Available at http://www.federalreserve.gov/faqs/what-are-the-federal-reserves-large-scale-asset-purchases.htm

20

decision making of the FOMC made opposition much more muted because potential dissenting

voices of the like of Mr. Fischer and Ms. George serve on a short-term, rotating basis.

In short, the decision-making system of the FOMC and the Fed’s accountability culture

accommodated the design of UMPs that are at the far right end of the unconventionality spectrum.

Indeed, although QE was not without controversy within the Fed, opposition was mitigated by the

structure of the decision-making system of the monetary policy setting committee. Furthermore, the

accountability culture of the Fed, which does not perceive its pursuit of economic growth as a risk

to its independence, made the decision of using QE much less controversial than was the case for

the ECB.

6. Conclusions

Unconventional monetary policies have attracted a lot of attention as well as criticisms to

central banks. Some have questioned whether the ultra-loose monetary conditions provided by

UMPs are generating a new credit bubble (Bank for International Settlements 2013) or creating

conditions that discourage fiscal discipline (Issing 2013, 275). Furthermore, despite stressing the

limitations of monetary policy in supporting a self-sustaining recovery, UMPs have perhaps

temporarily expanded central banks’ list of objectives well beyond price stability (El-Erian 2013).

In addition, the distributive consequences of UMPs have created a political and fiscal role for

central banks (c.f. Bank of England 2012; Cecchetti and Schoenholtz 2011, ch. 18; Dobbs, Lund,

Koller, and Shwayder 2013). These consequences have in effect politicized the debate on monetary

policy, placing further risks to central banks’ statutory independence (Orphanides 2013).

This paper has tapped into this debate by furthering and expanding the political economy of

UMPs. Specifically, we shed light on the significant variation that exists across UMPs in spite of

the common goals of restoring financial stability and sustaining economic growth. By comparing

21

the ECB’s and the Fed’s UMPs, the paper also advanced a number of complementary explanations

political-economy explanations for the design and implementation of different policies. In

particular, while recognizing the important of the domestic financial systems and the constraints

enshrined in legal mandates, the paper argued and illustrated that decision-making structures and

organizational cultures also influence the design of UMPs. In particular, the ECB’s decentralized

decision-making structure politicized the decisions on QE by giving significant voice and influence

to those opposed to unconventional monetary policies. In contrast, controversy within the Fed was

much more muted by virtue of a decision-making structure that helped defuse sustained opposition.

Furthermore, the Fed’s accountability culture of an agent ‘independent within the government’

justified its interventions to support economic recovery by way of liquidity injections, whereas the

ECB’s accountability culture was difficult to reconcile with policies that could potentially threaten

price stability and that may favour certain national governments.

Our analysis contributes to the literature on the politics of central banking in a number of

important respects. To start with, the paper has shed light on some understudied – but highly

consequential – political factors that influence central banks’ policies. Furthermore, while the

comparative political literature is rich in comparative insights on government economic policies,16

the comparative study of central banks’ policies is much more limited and is usually included in

analyses that examine domestic economic policy-making in general (for a notable exception

Quaglia 2008). Even in the aftermath of the recent global financial crisis, explanations to account

for cross-country variations in monetary policies have not been fully explored, nor systematically

tested in the political science scholarship.17 This scholarly neglect is particularly puzzling as

compared to the important contributions made to the study of other policy areas in the aftermath of

the crisis, from bank bailouts (Grossman and Woll 2014; Moschella 2011), to fiscal policy

16 For a thorough and updated overview of the main empirical applications in the CPE literature see, for instance, (Clift 2014) 17 For economic analyses of central banks’ UMPs in comparative perspective see, for instance, (den Haan 2013; IMF 2013)

22

(Armingeon 2012; Vail 2012) and financial regulation (Brummer and Loko 2014; Kastner 2014;

Pagliari and Young 2013) among others.

One potential explanation for such scholarly neglect is that most of the relevant political

science literature tends to emphasize the institutional and policy commonalities among central

banks. Indeed, a well-established argument in the central banking scholarship is that central bankers

belong to a transnational epistemic community (c.f. Baker 2006; Johnson forthcoming; McNamara

1998; Verdun 1999) where technicality, international exchanges among peers, and political

isolation favour the formation of common mind-sets and policy orientations. One of the purposes of

this paper has been to show that, despite these important commonalities, key difference exists

among central banks that derive from the institutional environment in which they operate. This is

not to deny the socialization effects of transnational exchanges among experts or the incentives

towards homogeneity exerted by the common, apolitical context in which central bankers operate.

However, central banks are first and foremost domestic institutions that exist in distinctive national

contexts. This means that, even if central bankers are steeped in the same macroeconomic

knowledge and share the views that their peers hold in the international fora, it is ultimately at

home, within the institutional constraints set by policy-makers, where they make their decisions.

23

Tables and Figures

Table 1: Conventional and Unconventional Monetary Policy Tools Key policy rate, liquidity provision

Non-standard liquidity facilities Balance sheet policies

Conventional monetary policy Unconventional monetary policy

Figure 1. Debt-to-GDP Trends

Source: October 2013 IMF World Economic Outlook (WEO)

Figure 2. Deficit-to-GDP Trends

Source: October 2013 IMF World Economic Outlook (WEO)

24

Table 2. Values of decision-making structures and organizational cultures

ECB

Fed

Decision-making structure

Decentralized Centralized

Accountability culture

Independent from the

government

Independent within the

government

25

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