Ifo Viewpoint No. 168: Carte Blanche for ECB Gives Cause for Concern
Munich, 19 June 2015
Recent events are even worse than could have been expected after the opinion by the European Advocate General Pedro Cruz Villalón published in January. The European Court of Justice, presided over by Vassilios Skouris, has swept aside the German Constitutional Court’s concerns regarding the OMT (Outright Monetary Transactions) programme for the purchase of government bonds by the European Central Bank (ECB). The European Court of Justice has given the ECB carte blanche to do almost whatever it wants – provided it can be justified from a monetary policy point of view.
In its provisional statement of February 2014, the German Constitutional Court stated that the ECB had exceeded its mandate with the OMT programme, “subject to the European Court of Justice’s interpretation”, because it was conducting economic policy. It even referred to a “usurpation of power”.
The core of the OMT programme announced in 2012 was the statement that the ECB was prepared to make unlimited purchases of a crisis country’s government bonds if necessary, provided that the country in question has received financial sovereign support under the conditions of the ESM (European Stability Mechanism) bailout fund. This was interpreted by the markets as free insurance protection for government bonds and led to a dramatic, rapid fall in the risk premia that the crisis-afflicted countries had to offer their creditors. This insurance protection presumably saved some of those countries from insolvency.
It had a counterproductive effect, however, on budgetary consolidation. In functional federal systems, member states with debt levels that rise excessively quickly are punished by the capital markets with rising interest rates that reflect the higher risk of insolvency. After this brake was neutralised by the OMT, all of the crisis-afflicted countries increased their debt ratios. They did so despite the fact that the fiscal pact proudly announced by Angela Merkel required an annual decrease in the debt ratio of one-twentieth of the differential to the permissible debt ratio of 60 percent of GDP.
In a provisional statement on the ESM made a week before the OMT decision was announced in September 2012, the German Constitutional Court explained that the ECB’s measures contravene the Treaty of Maastricht if they serve to make a state’s financing costs independent of the capital market. And in its statement of February 2014 it asked the European Court of Justice to provide details of how the OMT programme could be constrained to make it compatible with the Treaty of Maastricht.
The European Court of Justice did not comply with this request. Instead it declared the OMT programme as legal without fuss or quibble, arguing that lowering interest rate spreads is a legitimate monetary policy objective, even if this requires the selective acquisition of the government bonds of individual countries. If the ESM bail-out fund purchases such bonds, it goes on, this constitutes economic policy; if the ECB does so, this is monetary policy. The motives for such acquisitions are the determining factor.
The judges repeatedly refer to the uniformity of monetary policy and the need to guarantee monetary policy transmission in all euro countries. Stabilising the Eurosystem is not the ECB’s task (because that is economic policy), but if such stabilisation occurs as a side-effect of monetary policy, then no objection can be made.
From an economic viewpoint this attitude is unconvincing. Interest rate spreads and bankruptcies are key features of functioning capital markets. The fact that interest rates reach exorbitant levels immediately prior to a bankruptcy and accelerate it is just part of the process. Politicians should react by introducing insolvency legislation for states, instead of trying to postpone such bankruptcies for years, as in the case of Greece.
The ECB is using monetary policy jargon to cover its back and bail-out over-indebted countries and their creditors at the expense of third-country taxpayers, who have to make up for the drop in profits distributed by the national central banks to the corresponding treasuries. It is a pity that the European Court of Justice has decided to perpetuate the ECB’s superficial and economically unsustainable semantic ruse.
It remains to be seen how the German Constitutional Court will react to the European Court of Justice’s stance in its forthcoming verdict on the OMT. This judgment is what counts. Only a German court can bindingly decide whether the interpretation of the Maastricht Treaty supported by the European Court of Justice is compatible with the Bundestag’s inalienable right to exercise budgetary control.
Professor of Economics and Public Finance
President of the Ifo Institute
Published in German as “Ein bedenklicher Freibrief für die Europäische Zentralbank”, Wirtschaftswoche, 19 June 2015, p. 39.