When Lucrezia Reichlin became the first female director-general of research at the European Central Bank in 2005, under former president Jean-Claude Trichet, Europe looked very different.
“Those were the good years. There was rapid financial integration and a lot of hope that other forms of integration would follow,” she says, over espresso in the sun-filled sitting room of her north London house. “To be a central banker was even ‘boring’ because we were in ‘the Great Moderation’ with what looked like a stable economy.”
Reichlin left the ECB in late 2008 to become a professor at the London Business School; today, as chair of the LBS economics department, she admits that European central bankers were lulled into complacency. “Obviously, huge financial imbalances were developing. During those years there were excessive capital flows, which fuelled the credit boom in countries such as Spain and Ireland, and sparked a real estate bubble with no productivity gains … In retrospect, we can see the structural cracks.”
Reichlin found her four-storey Victorian house online. “I was in Frankfurt when I started looking for houses. I wanted to live in north London and I liked this neighbourhood. It’s near Camden High Street in a funky area.” She later learnt that Nobel Prize-winning economist Amartya Sen had been a previous owner.
The house, positioned on a leafy street near Kentish Town, has traditional 19th-century plasterwork and decorative details. “I opened up the kitchen and knocked down two walls. And I put in a lot of bookcases,” says Reichlin. Two antique sofas, reupholstered in a blue-and-white striped pattern, were inherited from her grandmother.
“I basically grew up with my grandmother in a large apartment in Rome,” says Reichlin. “She opened the first real estate agency there. In her generation, it was unheard of that women worked. But she got divorced and needed to support the family. Later, she divided her apartment into two with an adjoining door to take care of us when our mother worked.”
Her parents were colourful leftwing political figures in Italy. “My mother was a member of the Italian parliament and the European parliament.”
Reichlin studied at the University of Modena, “the earthquake city”, and went on to graduate school at New York University. At the Université Libre of Brussels, where she taught for 10 years, she collaborated with statisticians on econometric models that could compute massive amounts of data and created a short-term forecasting model for central banks.
“I went from theory to practice … We call the model ‘nowcasting’. It gives you a quick test of the state of the economy. You usually get data on consumption and GDP with a delay,” she says, explaining that her model reads the constant flow of daily information assessed by the markets – and offers instant snapshots on the state of the economy. She developed the model at the US Federal Reserve in 2002. “Today, most central banks in the world use it,” adds Reichlin, who has also founded a company called Now-Casting Economics, based on the model. “It has a bigger chance than many models to pick up changes reflected in market expectations.”
On the sitting room wall, above a red lacquered Italian table that doubles as a desk, hang family photographs. One black-and-white image of Reichlin as a small girl stands out: she is clutching her father’s hand at a demonstration. “It was a demonstration against landowners, maybe in 1963 or 1964. I remember my grandmother dressed me that day. Those Italians in the photo protesting against agricultural conditions don’t exist today because Italy turned from an agricultural into a big manufacturing economy,” says Reichlin. “Recently, though, the economy has performed badly. Now we need urgent structural reforms.”
So why did the ECB – and her department – fail to predict or identify the banking crisis? “We missed it. I take responsibility. Nobody caught it and even the Americans thought it was a blip … Also, the growing imbalances between banks were just not on the radar, because in Europe the Central Bank was separated from the regulators, so we had this disconnect between national stability surveillance and monetary policy,” says Reichlin. “In retrospect, the banks should have been better regulated; this is a story in which everybody is guilty.”
Reichlin gives the ECB high marks for its moves in the aftermath of the Lehman Brothers collapse in 2008 and more recent tremors but agrees that the threat of looming fiscal and banking meltdowns requires new structures. “The ECB can’t act alone. It’s taken a lot of risk on its balance sheet but can only promote liquidity. It’s not the ECB that can back up the banks or the states. It’s governments that have to clean up their balance sheets and recapitalise the banks,” says Reichlin.
Baby steps towards a European banking union – including a regulatory role for the ECB – are a good start, she says, but there must be tough reforms. “In the short run we need to pool risk at the European level to avoid defaults. In the long run, we need measures to clean up the books.”
On display by a downstairs fireplace is an early 19th-century bronze sculpture of a barefoot boy, a present from her father. “You find these in antique shops in southern Italy,” says Reichlin. “The boy is crab-fishing in Naples. He’s a street kid with no shoes. That’s what southern Italy was like. If poverty comes again to Europe, it will take a different form.”
Today’s leaders, she says, have failed to convince the broader public that Europe owes its prosperity to tighter economic ties. “In our stress, we’ve lost the original motivation of the European project. It was a postwar dream to create a peaceful, democratic society. And an integrated society was also more competitive in the world economy. Everybody would lose in a break-up of the euro.”
So how to avoid it? Reichlin was recently in Brussels for a gathering of economists working on a blueprint for further financial and fiscal integration. “We are trying to come up with proposals that take into account concerns of Germany and the AAA countries.” But will a bunch of technocrats in Brussels succeed in swaying that key constituency that needs to approve any new plan: the European taxpayer?
“It’s true that voters, not just politicians, will have to be on board and accept why some people have to put money on the table and others have to give up sovereignty. We shouldn’t kid ourselves; this will be a hard process with deep changes in our political systems.”
Before I leave, she shows me the neatly planted back garden. “The front garden isn’t done yet,” she says. The sight of stubby shrubbery prompts a parting thought.
“The problem with Europe is it’s unfinished. It’s a crisis of governance. We were too optimistic that we could just use the tools of common money. We thought so because for more than 15 years we had stable conditions. It goes beyond the economics, it’s a system of values. And we need to make clear that going through the pain to preserve an open, integrated, prosperous society is worth it.”
“That was taken a few years ago. My grandmother was almost 100,” says Reichlin, pointing to a framed photograph above her desk. “Then you have my mother, me and my adopted Chinese daughter. This is quite important to me because our family has been a matriarchy.” Reichlin blames the lack of senior women in her profession partly on the absence of mentors. “In economics, women are not good at networking or at supporting each other. So I was fortunate to have my mother and grandmother as role models.”