The ECB as a Strategic Actor

The European Central Bank’s relationship to the national governments of the monetary union was modeled as a contest between fiscal and monetary dominance early in the euro crisis (Buiter 2010, drawing on Sargent and Wallace 1981). This paper shows how strategic behavior helped to shape the timing and substance of ECB policy during 2010-2013 as well as the response of governments. While ex ante bargains between the monetary and fiscal authority can in principle preempt the struggle for dominance, political fragmentation of the euro area prevented such bargains during the crisis. Strategic behavior largely explains the differences in the responses of the ECB, the Federal Reserve and Bank of England to their respective crises and continues to play out as the euro area seeks to complete the architecture of the monetary union. Deflation demonstrates that monetary not fiscal dominance prevails in the euro area, decisively. The ECB Governing Council should now prioritize the objective of raising the rate of inflation in light of this victory.