Culture shock – Christine Lagarde is taking the ECB out of its comfort zone

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    CHRISTINE LAGARDE has been an outsider before. Speaking to The Economist, she relishes the memory of shaking up bureaucrats—“men in grey suits”—when she took over as France’s finance minister in 2007. She even installed a “psychedelic” carpet in her office, to get them to look up from the floor. Now Ms Lagarde, who then went on to run the IMF, is shaking up the idea of what it is to be a top central banker.

    The main prerequisite used to be a degree of nerdiness: just think of Janet Yellen, a former chairwoman of the Federal Reserve and Joe Biden’s choice for treasury secretary (see article); Ben Bernanke, her predecessor at the Fed; or Mervyn King, a former governor of the Bank of England. All spent decades in academia. By contrast Ms Lagarde, who has been the head of the European Central Bank (ECB) for just over a year, is not an economist but a lawyer and a former executive and politician. She brings a glittering CV and a high public profile to the job, but is probably more comfortable rubbing shoulders with heads of state than participating in a research seminar.

    On the face of it, Ms Lagarde and the ECB have had a decent year. The bank has acted decisively, avoiding the mistakes of the financial crisis of 2007-09 and the sovereign-debt woes of 2010-12. Since the start of the year it has injected stimulus of €2.2trn ($2.6trn) into the economy (see chart 1). In contrast with the austerity of a decade ago, fiscal policy is acting in concert with monetary easing, including at the EU-wide level. The new opportunity to help co-ordinate monetary policy and government spending plays to Ms Lagarde’s strengths. Yet it is precisely her willingness to venture into areas that most central bankers consider political terrain that is causing some controversy among the experts.

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    The ECB’s ammunition was sorely depleted even before covid-19 struck. Its benchmark deposit rate was -0.5%, and it had been buying government and corporate bonds through its quantitative-easing (QE) scheme since 2015. But the bank warded off a credit crunch earlier this year by ripping up self-imposed rules. Instead of buying a country’s assets in rough proportion to the size of its GDP, it has bought more of those of Italy and Spain. The ECB has also expanded the generosity of its long-term loans to banks, paying them up to 1% if they continue to lend. That, together with government guarantees, has kept credit from seizing up, even as a second wave of infections and lockdowns make a double-dip recession seem inevitable. An ECB survey published on November 24th found that access to finance was towards the bottom of small firms’ list of anxieties.

    All this, however, has done little to revive the outlook for inflation. The bank itself expects annual inflation of only 1.3% by 2022. Market participants are even gloomier (see chart 2). It is becoming harder to believe that the ECB can do much more by itself. The Economist spoke to executives from five of the euro area’s biggest banks. None thought the ECB’s cheap funding alone would stir demand for credit, or encourage banks to lend to risky prospects. Ms Lagarde insists stimulus is “not exclusively a fiscal business”, and that the ECB can still do its bit. But in a speech on November 11th she made a forceful case for further fiscal action.

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    There have been two criticisms levelled at Ms Lagarde. One is that communication slip-ups over the past year show that she has only a weak grasp of the technical detail of monetary policy. That may in part reflect economists’ snootiness. But her missteps did indeed move markets. In March her comment that the ECB “was not here to close spreads” sent Italian government-bond yields soaring. In September her seeming indifference to a strengthening euro and its impact on inflation meant the currency only rose further against the dollar. Both were followed the next day by an explanatory blog post from Philip Lane, the bank’s accomplished chief economist—seeming to correct the president’s words.

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    Ms Lagarde is only too aware of the fact that markets hang on her every word, and now carefully watches what she says. In order to stress collective decision-making, blog posts by Mr Lane and others on the bank’s executive board will no longer appear immediately after a press conference. Some wonks reckon she has improved markedly on the job. Still, it is hard to imagine her becoming a conviction rate-setter.

    Where she does have conviction is on matters such as climate change and gender equality, subjects that she promoted while at the IMF, to which grey-suited monetary policymakers generally give a wide berth—and which are the source of the second concern about her approach to central banking. It is instructive to compare Ms Lagarde’s speeches and interviews over the past year with those of Mario Draghi, her predecessor. Though “inflation” has featured 190 times, she is half as likely to mention it as Mr Draghi did in 2018 and 2019. By contrast, Ms Lagarde has mentioned “climate change” 80 times—compared with just seven across Mr Draghi’s entire eight-year term.

    Climate change, according to Ms Lagarde, is an element not just of the ECB’s “secondary” objective—which is to support the EU’s economic policies. More controversially, she sees it as having a bearing on the bank’s primary mandate of price stability. She has said before that the bank will consider the merits of “green” QE, which would tilt bond-buying away from polluters. The idea clashes with the views of many central bankers, including Jens Weidmann, the head of the Bundesbank. At a Bloomberg conference on November 16th, both Ms Yellen and Lord King worried about mission creep at central banks. Few economists think climate change has a big influence on inflation; most would point out that changing polluters’ behaviour is a job for elected officials.

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    Ms Lagarde intends to win over the rest of the ECB’s 25-strong governing council during the bank’s strategy review, due to conclude in mid-2021. It will cover everything from relatively uncontroversial tweaks to the inflation target to more contested areas, the financial-stability effects of low interest rates and, of course, climate change. She says she hopes to convince her colleagues to “appreciate that they should be not only on the right side of history and face their children and grandchildren with a straight face, but be able to focus on the core mandate of price stability”.

    That the euro area has avoided a financial crisis means Ms Lagarde can look back on the past year with some satisfaction. But her term lasts for eight years—far longer than many politicians or executives hang around for. Her push to broaden the ECB’s mission has just begun. And if some countries (eg, Germany) return to economic normality sooner than others (eg, Italy), then the ECB will also face tough choices about when precisely to unwind its emergency measures. The outsider’s next seven years promise to be more controversial than the first one.

    This article appeared in the Finance & economics section of the print edition under the headline "Culture shock"

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