A flawed verdict with uncertain consequences

The European Central Bank’s primary goal is to maintain price stability, which is defined as an inflation rate of below, but close to 2%.  It has been set up as one of the most independent central banks in the world to ensure its pursuit of stable prices is shielded from political influence. Both, the sole goal of price stability and the strong emphasis on independence, were unequivocally legally defined in the Treaty of Maastricht at the insistence of the German government. At the time, it was a prerequisite for the German government and the Bundesbank for giving up their monetary independence. 

Yet, in its decision on the ECB’s public sector purchase programme (PSPP), a programme to buy large amounts of government bonds in order to stimulate the economy and to reach the ECB’s inflation target, the German constitutional court has effectively challenged both of these cornerstones of the ECB’s mandate. The court has explicitly asked the governing council of the ECB to weigh its primary monetary policy goal against other economic effects and to provide “documentation demonstrating that such balancing took place.” Furthermore, the court ordered the German government to take steps to ensure that such a “proportionality assessment” takes place. This sounds like a violation of the ECB’s independence.

The court’s insistence on a balancing of monetary goals and other economic effects is based on an arbitrary distinction between monetary policy and economic policy made in the Treaty of Maastricht. According to this distinction monetary policy falls into the ECB’s remit and economic policy is supposed to remain solely in the hands of EU member states. The court has decided that the ECB was crossing the line to economic policy. This claim is substantiated by a list of economic effects it ascribes to the PSPP, that are either non-existent, standard effects of monetary policy, or economic problems that simply cannot be ascribed to the ECB’s programme. It gets more amazing when the court seems to suggest, that the problem can be solved simply by the ECB providing documentation of its proportionality assessment, which it actually has already repeatedly done.

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What are the arguments brought forward? The judges seem to criticize that the PSPP has a wide ranging “economic and social impact on virtually all citizens, who are at least indirectly affected”. That is completely normal for monetary policy and one of the reasons why central banks are such powerful institutions that should be shielded from political pressure. The court also seems to have a problem with the fact that the PSPP improves refinancing condition for governments. This is a standard transmission channel of monetary policy. The ECB buys assets on secondary markets to lower their interest rates, partly in hope that these lower interest rates will be passed on to the rest of the economy. 

A more specific argument is that PSPP induced lower interest rates allow unviable firms to continue doing business. There are four problems with this argument. First of all, changing interest rates is nearly the definition of monetary policy and lowering interest rates is the usual central bank recipe to revive the economy. Second, interest rates were low before and would be low without the programme. Without the PSPP the ECB might have even tried pushing short-term interest rates further into negative territory. Third, this so-called zombie-firm argument is not even a real concern. All firms benefit from lower interest rates and it is far from obvious that unviable firms benefit more than other firms. It could also be the other way around as ECB economists Ulrich Bindseil and Jürgen Schaaf have convincingly argued. Furthermore, there has not been a systematic increase in unprofitable businesses in recent years according to Isabel Schnabel from the ECB. Fourth, it is not the ECB’s task to ensure unviable companies exit the market. This should be done via economic policies like increased competition and an effective insolvency law.

The last of the court’s points that needs to be addressed is the “considerable losses for private savings”. It is not up to the ECB to ensure high positive interest rates for German savers. And they would likely have been worse of in case of less stimulus by the ECB. Up until this year’s coronacrisis unemployment has been falling all over Europe. Germany especially enjoyed record low and decreasing unemployment rates in recent years. The court accuses the ECB of neglecting the negative effects of its measures but forgets itself to mention the benefits of these measures, namely increased economic activity and higher incomes due to lower interest rates, but also avoiding another Eurocrisis. 

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So, what are the implications of all of this for the ECB, the PSPP and the new programme to fight the economic fallout from the coronacrisis? The effects on the PSPP itself seem rather minor for the moment. The ECB has three months to deliver a more detailed discussion of the pros and cons of its programme. If it fails to do so, the Bundesbank (the largest of the national central banks, that form the Eurosystem together with the ECB) won’t be allowed to participate in the PSPP anymore. This would create more legal problems since the Bundesbank is still a part of the Eurosystem and therefore obliged to implement its monetary policy. 

While it should be fairly easy for the ECB to deliver on the demands of the German constitutional court, it may decide to ignore them. Following the court’s orders would acknowledge its jurisdiction over the ECB. That would create a precedence and could open the door for more legal challenges from other national courts. Moreover, given the dubious economic argumentation by the court it remains open to see whether the ECB’s assessment of the costs and benefits of the PSPP would prevail in court. 

Concerning the ECB’s new programme -the Pandemic Emergency Purchase Programme (PEPP)- uncertainty over its legality has increased. The constitutional court has established guidelines to evaluate the legality of ECB purchase programmes. According to previous verdicts that have been asserted on Tuesday, there are limits to the share of securities that the ECB is allowed to buy on secondary markets and the purchases have to be distributed over the Euro Area roughly proportional to the sizes of the member country’s economies. These criteria might put binding limits on new programmes like PEPP and they will make it harder to justify the support of economies particularly hard hit by the crisis, like Italy. Consequentially Italian bond yields have already risen. 

However, as the constitutional court has also stressed the proportionality principle, the ECB’s PEPP might still be deemed legal, since extraordinary circumstances require extraordinary measures. Furthermore, the ECB might comply with the courts demands without acknowledging it. ECB president Christine Lagarde has already pledged to improve the ECB’s communication. If that includes thorough and transparent discussions also of the negative effects –whether they are real or not– of its purchase programmes the court’s demands might be already fulfilled according to Robert Klotz, a legal expert at the University of Freiburg.

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