What’s the European Central Bank?

Weird terms like “yield spreads,” “troika,” and “Merkel” have been popping up in the news, often surrounded by acronyms like IMF, ESM, EFSF, and FROB. Our politicians aren't talking about it much, but you can bet your retirement they will once Wall Street underwriters start freaking out about it. Today, the Prospect fills you in on one of the most important acronym in the euro crisis: the ECB, or the European Central Bank.

The European whatsit?

In a nutshell, the ECB is the central bank of the Eurozone—the countries of the European Union that use the euro. Though it only technically became a crucial apparatus of the European Union in 2009, it has a large role in the history of European integration. For now, we'll just leave it at this: The ECB controls the monetary policy of Eurozone countries. It's also one of the newer venues in which France and Germany play chicken over who's the boss of Europe. More on that later.

Monetary policy? So it’s like the Fed?

Sort of. There are definite parallels between the ECB and the Fed: They both try to keep inflation low, they're both governed by politically independent—except not really—councils of governors, and since the ECB sucked the sovereignty-marrow out of the bones of Europe's national banks, those banks function similarly to the 12 regional branches of the Fed.

There are some big differences, though. First, the ECB is a transnational central bank. The Fed only has to keep tabs on one national economy. The ECB, on the other hand, needs to juggle 17 economies.

Second, their missions are different. Since 1913, the Fed has been legally bound to keep inflation and unemployment low; the ECB's only mission is to keep inflation low.

Third, though its mandate is narrower, the ECB has a broader set of responsibilities. Whereas the Fed has to interact with the Treasury—a non-independent department of the executive branch—when it comes to minting currency and buying and selling bonds, the ECB can do all of that in-house.

Depending on how negotiations go among European leaders, the ECB might even start regulating and insuring Europe’s banks, evolving into the European equivalent of the Fed, the FDIC, and the Office of the Comptroller of the Currency all rolled into one.

Who's actually in charge of the ECB?

Like the Fed, the ECB has an independent board of governors. Unlike the Fed, though, politics of nationality matter: By unwritten agreement, Europe's four largest economies more or less control the ECB. They engage in horse-trading for things ranging from the composition of the governing board to debt-payback priorities. Most recently, when the current president of the ECB was named in 2011, France blocked his ascent, insisting that another Italian resign so a French governor could be appointed.

The man the French had blocked, Mario Draghi—sometimes called "Super Mario"—is known for his monetary hawkishness. He was nominated to lead the ECB in early 2011 as Jean-Claude Trichet, whom Germany didn't like very much, was wrapping up his eight-year term. When Germany's top candidate announced that he was calling it quits, Draghi—whom the German tabloid Bild referred to as the “most German” candidate still in the running—was named president.

So what’s the ECB been doing to stanch the tide of bad financial news in Europe?

Depending on whom you ask, not nearly enough—or way too much.

People in the former camp have a lot to lose. These include the Greeks, the Spaniards, the Portuguese, the Italians, the French, and to a lesser extent, the Americans. They'd like to see the ECB cut interest rates again and maybe consider letting inflation go above 3 percent, especially because it's been dropping for the past few months. In general, they'd prefer more liquidity.

In the latter camp we have the Germans, who also have a lot to lose. They've been somewhat allergic to inflation ever since it hit about three million percent in the 1920s, so of course they get antsy whenever it's above 2 percent. They also get suspicious whenever the ECB buys bonds from the Eurozone's struggling governments, as they did until 2011, even though the ECB took steps to ensure that inflation didn't follow those bond purchases.

The people who want the ECB to step up its game aren't completely averse to economic reforms, and Germany has stuck out its neck a lot—like, several-hundred-billion-euros a lot—to save the Eurozone's southern periphery. But when it comes to the ECB, they just can't see eye-to-eye. The result is paralysis. As The New York Times wrote last November, “The European Central Bank seems like a fire department that is letting the house burn down to teach the children not to play with matches.” Not much has changed since then.

What a mess. So what's next?

In a promising development, the ECB announced on Thursday that it would reduce two key interest rates to unprecedented lows to induce borrowing, even though inflation is above 2 percent. Last week, European leaders said they intend to create a banking union, with the ECB overseeing the entire continent’s banks. But that union won’t be forming anytime soon, and it wouldn’t be worth much without a Europe-wide deposit insurance fund (like the FDIC)—a development that the Germans have made clear is not politically possible.

The current trajectory of the Eurozone does not inspire confidence, especially given the crisis brewing in Spain, Europe’s fourth-largest economy. Some have even called on Ben Bernanke to bail out Spain to prevent a global economic collapse. But ultimately, it's not clear how long this crisis will last, how it will end, or what Europe will look like when things get “better.” 

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