The victory of socialist François Hollande in the French presidential election has been interpreted, correctly, as a repudiation of the austerity policies imposed on the euro zone by his predecessor, Nicolas Sarkozy, in collaboration with German chancellor Angela Merkel, who endorsed Sarkozy in the election.

Hollande’s win was part of a backlash across Europe, with pro-austerity parties from Britain to Greece taking electoral drubbings. Even in Germany, Merkel’s coalition parties were crushed in a state election in Schleswig-Holstein.

It’s safe to predict that Hollande and Merkel will soon come into conflict over austerity. But Hollande’s real opponents in the struggle over European economic policy are not Merkel and the German government but the European Central Bank and its chairman Mario Draghi.

If Merkel’s intervention in the French election was unusual, Draghi’s was extraordinary. Only a few days before the final vote, he opined that increased taxes were not the right way to solve Europe’s budgetary problems. Draghi did not name any names, but he did not have to. Everyone in his audience knew that Hollande was proposing to raise taxes on the rich while Sarkozy has cut them.

Such a political statement from a central banker in the lead-up to an election is almost unheard of. Draghi’s abandonment of the pretence of neutrality reflects what is at stake in the current struggle over Europe’s response to the global financial crisis. It is not just austerity but the entire system of monetary policy and economic management exemplified by the European Central Bank.

The revolt against austerity will place huge pressure on EU governments to shift from austerity to fiscal expansion. The goal of balancing budgets needs to be achieved through long-term policies, including tax increases, combined with greater discipline over spending. As Hollande and other critics of austerity have argued, policies based on short-term spending cuts are self-defeating.

But a reorientation of fiscal policy will be impossible as long as governments lack control over monetary policy and the ECB maintains its refusal to increase its net holding of government bonds, as done by the U.S. Federal Reserve under its quantitative-easing policies. Under these circumstances, any attempt to issue additional debt will result in a run-up in interest rates and be unsustainable.

The situation facing European governments is now the same as that which arose during the Great Depression. Having restored the pre-1914 gold standard during the 1920s, governments were powerless to respond to the collapse in global demand after 1929. It was only when they abandoned the gold standard and undertook large-scale devaluations (London in 1931, and Washington in 1934) that recovery became possible.

The modern equivalent of the gold standard is the policy of inflation targeting, adopted by central banks throughout the world beginning in about 1990. Inflation targeting was seen as a guide for setting policies intended to maintain both price stability and consistent economic growth.

Inflation targeting contributed to the imbalances that caused the financial crisis and has hobbled the subsequent policy response. As many critics warned, the combination of low inflation and light-handed financial regulation encouraged the development of asset price bubbles, which burst disastrously in 2008 and 2009.

Although the ECB has performed “impeccably,” in the words of former governor Jean-Claude Trichet, in achieving its inflation targets, it has failed in every other way. If the ECB cannot be induced to change course, it seems likely to acquire the dubious distinction of presiding over the collapse of the currency it was created to manage.

Even under the current ECB mandate focusing exclusively on price stability, a shift in focus is justified. After all, price stability is meaningless if the currency in which prices are defined ceases to exist.

In the longer run, what is needed is a shift from an inflation target to a nominal GDP target system in which a target rate of inflation is combined with an estimate of the medium-term rate of real economic growth required to maintain full employment. The aim of nominal GDP targeting is to keep the value of GDP, expressed in current euros, on a growth path consistent with these targets.

Achievement of these goals will require a renegotiation of the treaties that established the euro zone. The ECB must be put under democratic control, with full employment on a par with price stability as a policy goal.

Hollande will have his work cut out for him if he is to achieve such a goal. But in the famous words of Margaret Thatcher, spoken in a very different context, there is no alternative.

John Quiggin is a professor of economics at the University of Queensland, Australia and adjunct professor at the University of Maryland, College Park. He is author of Zombie Economics: How Dead Ideas Still Walk Among Us (Princeton University Press, 2010).

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