Germany’s Judges Declare War on the ECB
In a new ruling, Germany's highest court has threatened to throw a wrench into the European Central Bank's efforts to extend liquidity and other forms of assistance to distressed eurozone governments. Coming amid a deep economic crisis, the court's decision could force one or more countries to crash out of the monetary union.
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Germany’s Constitutional Court Goes Rogue
Germany's Federal Constitutional Court, heedless of the political consequences for Europe and Germany, has issued a ruling that risks sacrificing the euro and possibly even the European Union. An institution that, under Germany's Basic Law, no one governs is now out of control.
WASHINGTON, DC – On May 5, Germany’s Federal Constitutional Court ruled that the country’s government and legislature had violated the constitution by failing to monitor properly the European Central Bank, and in particular the bank’s public sector asset-purchase program (PSPP). The ruling was as tortuous as it sounds – a shot from the back through the chest and into the eye, as the German saying goes. And therein lies the problem.
In an angry, self-righteous tone, the court argued that it was not bound by a December 2018 ruling by the Court of Justice of the European Union (CJEU) on the same matter, because that court had grossly violated methods of legal interpretation by failing to apply the EU’s “proportionality principle” properly. As a result, the German court found the CJEU’s ruling to be ultra vires (beyond the CJEU’s powers) and therefore not binding.
In other words, an independent court has attacked the legality of a ruling by another independent (and, with respect to EU law, superior) court, for the latter’s supposed failure to police an independent central bank. The age-old question, “Who governs the governors?” (quis custodiet ipsos custodes?), has never been more relevant.
Within the EU treaty framework, the CJEU has the exclusive power to interpret EU treaty law (under Article 267 of the Treaty on the Functioning of the European Union) and to adjudicate matters concerning the ECB (under Article 35 of Protocol 4 to the TFEU). Having brushed aside the CJEU’s judgment, the German judges embarked on their own analysis of the ECB’s quantitative-easing programs.
Importantly, they did not conclude that the ECB had violated Article 123 of the TFEU, which prohibits the ECB from engaging in monetary financing of member states’ budgets. Instead, they argued that the CJEU had failed to ensure that the ECB applied its own proportionality analysis when assessing the likely impact of its policies on both monetary and broader economic outcomes, keeping in mind that the ECB’s own powers are limited to monetary policies.
Economists were quick to point out the impossibility of clearly distinguishing monetary policies from economic policies, and called the German court’s ruling “economically naive.” But there is a deeper problem: the division of powers within government.
Policing these boundaries is always difficult, but it is especially problematic within the EU’s peculiar multilayered governance regime. The EU is not a federal state; it relies on powers that member states delegate to it, more so in some domains than in others. Viewed in the most favorable light, the German court is arguing that the CJEU’s failure to police the ECB left it with no choice but to ignore the CJEU’s exclusive powers to interpret EU treaty law and instead provide its own interpretation.
It is not impossible to imagine a clear-cut case of illegality that would justify the German court’s position, but failure to apply the proportionality test properly is not it. Although the principle has been incorporated into EU treaty law, the proportionality test is not a bright-line rule, but rather a guide for determining how EU competences can be used in a balanced and reasoned fashion.
Case law has refined the proportionality test into three parts: effectiveness, necessity, and a least-restrictive-means assessment. The CJEU did not ignore the test; at most, it failed to apply the third part fully. According to the German court, this rendered the entire exercise “meaningless.” But one cannot help wondering whether the German judges have pondered the proportionality of their own action.
While the German court accuses the CJEU of unlawful conduct, it has itself pushed the limits by creating a pathway for litigants to initiate these legal actions in the first place. Under Germany’s 1949 Basic Law, only individuals whose constitutional rights are at stake have standing to bring a claim before the Federal Constitutional Court. Such a violation is hardly self-evident when it comes to central-bank policies or the German government’s response to them.
But the court cleared a pathway for such cases by combining the individual right to vote in democratic elections with the principle of democracy enshrined in the Basic Law. On that basis, it argued that any transfer of rights to the EU that is not explicitly endorsed by the German legislature or that might affect its fiscal sovereignty amounts to a violation of the individual right to vote.
This legal construction arguably overstepped the boundaries of judicial competence, as the court’s former justice Gertrude Lübbe-Wolff argued persuasively in her dissenting opinion in the first case concerning the ECB in January 2014. If the court had exercised judicial self-restraint, the power to police the actions of EU institutions in all but the most extreme cases would have remained where it belongs: with the German government and legislature.
With its May 5 ruling, however, the Federal Constitutional Court has fully asserted itself as the ultimate arbiter of ECB policies. For now, the ECB might mitigate the impact of this ruling by adding more detailed proportionality analysis to its policy announcements.
But the problem runs deeper still. The Federal Constitutional Court will police Germany’s relations with the EU, monitor ongoing and future ECB policies, and most likely block any attempt to introduce eurobonds, however powerful the policy case for them might be. And, because the Basic Law, adopted in response to the horrors of the Nazi regime, protects the principle of democracy with an “eternity guarantee,” not even a constitutional amendment can resolve this impasse.
And now that court – heedless of the political consequences for Europe and Germany, contemptuous of the rule of law within the EU, and cavalier about its own limitations – risks sacrificing the euro and possibly even the EU by clamping down on the ECB’s efforts to manage the euro. An institution that, by design, no one governs is out of control.
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Did Germany’s Constitutional Court Inadvertently Strengthen the Eurozone?
Despite the knotty issues raised by the court’s recent ruling on the European Central Bank's program to purchase member states' public-sector bonds, there could be a silver lining. It is now more likely that the European Union will be forced to confront the main institutional weakness of its monetary union head-on.
FRANKFURT – In its recent ruling on the European Central Bank’s program to purchase member states’ public-sector bonds in secondary markets, Germany’s Federal Constitutional Court (GCC) concluded that the ECB failed properly to assess and explain the “proportionality” of its policies. In the process, the Karlsruhe-based court rejected the primacy of European law, a core and constitutive principle of the European Union, by also ruling that the decision by the Court of Justice of the EU (CJEU) to uphold the ECB program was “simply incomprehensible,” unconvincing for “methodological reasons,” and exceeded the court’s remit.
And yet, despite the knotty issues raised by the German court’s decision, there could be a silver lining: It is now more likely that the EU will be forced to confront the main institutional weakness of its monetary union head-on.
Admittedly, the move to limit the ECB’s capacity to respond to a global public-health and economic crisis is extremely untimely. But this is a debate about constitutional issues. Principles either count or they don’t, regardless of circumstances or consequences. As one German commentator argued, the ruling could be understood as a face-saving exercise: Karlsruhe demonstrating to the CJEU who is ultimately in charge. Indeed, this is far from the first time that the GCC can be said to have waged a turf war with the CJEU.
Admittedly, Karlsruhe is, at best, only a reluctant convert to deeper European integration. Still, the GCC has consistently insisted upon democratic legitimacy. Delegating power to higher levels of hierarchy would be acceptable only when aligned with commensurate parliamentary accountability. Thus, the recent ruling throws the eurozone’s main design flaw into sharp relief: although member states have supra-nationalized their monetary policy, they have refrained from federalizing a stabilizing fiscal capacity.
In terms of fiscal policy, the eurozone is a confederation, though one bound by rules. But these rules are often observed only in the breach, and sometimes for good reason. No one would want the Stability and Growth Pact’s deficit strictures to be mechanically enforced in a response to the unprecedented shock of the COVID-19 pandemic.
As a result of this institutional lacuna, the ECB is, by default, first in the firing line when things go awry. And fiscal policymakers at the national level benefit from and seem to appreciate this unequal burden sharing.
Against this backdrop, Karlsruhe is demanding that the ECB Governing Council apply a “proportionality assessment,” and that the German government and Bundestag request such an evaluation. If not conducted (according to an ambiguous, open list of criteria) within three months and explained in a “comprehensible” way to the court, the Bundesbank would be barred from further participation in the ECB’s public-sector bond-purchase program.
Here’s the Catch-22: In acceding to the GCC’s ruling, the Bundesbank would waive its independence, exposing itself to a judicialization of monetary policy. But if it disregards the GCC’s demand, it would incite a constitutional crisis.
To complicate matters further, Karlsruhe also demands that the government and parliament take active steps to monitor monetary-policy decisions. For the ECB, however, there’s no question as to whether it should respond to the request of a national constitutional court. Of course not.
The GCC’s request seems to be based on a fundamental misunderstanding of the arguments for central-bank independence. The delegation of authority to unelected technocrats can be justified when they are given a narrow, binding mandate. In the case of the ECB, the job description boils down to underwriting price stability as the first and foremost priority. Thus, notwithstanding regular allusions in the press to output stabilization, the ECB justifies its policy measures exclusively in terms of their consequences for this objective.
The GCC, however, now calls for the ECB to justify the “proportionality” of its monetary policies in view of their impact on economic and social objectives and agents, including their inevitable side effects. The details of their effects (such as consequences for savers) are analytically rather contentious. For example, only a minority of economists view central banks as the main determiners of real, inflation-corrected interest rates. More important, “proportionality” assessments would cover highly politically charged issues, on which monetary technocrats have no legitimacy to deliberate at all.
It is true that any monetary policy inevitably has distributive consequences. Even in calm economic conditions, monetary and fiscal policy cannot be neatly distinguished and cleanly separated. Both affect the economy through a “common funnel,” as the Nobel laureate economist James Tobin never tired of explaining. In a time of crisis, the supposedly clear-cut boundary inevitably becomes indistinct.
Still, to call upon the ECB to assess its policies’ potential distributive effects is asking it to judge trade-offs which it is simply not entitled – and should not be enabled – to assess. ECB Governing Council members are not Plato’s philosopher kings.
Two decades ago, Tommaso Padoa-Schioppa, then an ECB board member, spoke of the ECB’s “institutional solitude,” owing to the absence of a fiscal counterpart at the eurozone level. After the 2008 financial crisis, ECB President Jean-Claude Trichet called for a European Finance Minister. And former ECB President Mario Draghi continuously criticized national governments for taking the path of least resistance: always shifting the burden to the ECB, instead of fulfilling their responsibility as fiscal policymakers for addressing the eurozone’s lingering vulnerability. Current ECB President Christine Lagarde has, on a number of occasions, already taken a similar position.
At the risk of sounding Panglossian, the recent ruling, viewed from this perspective, might actually prove to be constructive, if inadvertently. True, it could limit the ECB’s room for maneuver in flexibly implementing its current pandemic emergency program. While this is not the best possible solution, it would shift more of the burden on to fiscal policymakers. And the seemingly strong member states would hurt themselves massively if they proved incapable of coordinated and cooperative action.
Is this now Europe’s “Hamiltonian moment,” in which it is forced to adopt a more federal – and of course democratically legitimized – fiscal policy? Given the general inclination to retreat behind national borders and not give up sovereign prerogatives, one is entitled to be skeptical. But the GCC has left it little wiggle room for muddling through. The eurozone’s stateless money needs a constitution to render the ruling moot.
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Taking the German Constitutional Court Seriously
Given the many flaws in the controversial ruling by Germany's Federal Constitutional Court against the European Central Bank, it is tempting to dismiss the decision as yet another instance of German obstructionism. But either through persuasion or reform, Germany's longstanding complaints will have to be addressed.
BERLIN – The German Federal Constitutional Court’s (GCC) ruling against the European Central Bank’s pre-pandemic asset-purchase program has stunned policymakers and other observers outside of Germany. Many will be tempted either to ignore the ruling altogether, or to escalate the legal battle with the GCC. But both approaches would be counterproductive. The situation calls for an earnest debate about the ECB’s mandate and existing European treaties.
Specifically, the GCC has accused the ECB of breaching the Treaty on the Functioning of the European Union by not conducting a proper “proportionality assessment” for its Public Sector Purchase Program. The court regards the PSPP as more than a monetary-policy tool. It is a broader economic policy that has imposed undue costs on small savers, taxpayers, and individual sectors. As such, the GCC believes that the ECB has approached or already crossed the line of extending prohibited monetary financing to member-state governments.
While this is not the first time that the GCC has gone after the ECB, the latest ruling certainly constitutes an intensification of the conflict. In the absence of a proportionality assessment from the ECB, the Bundesbank will be prohibited from participating in the PSPP, with potentially far-reaching implications for Europe’s Economic and Monetary Union (EMU).
There is much to criticize about the ruling, not least its failure to understand the economics of monetary policy. The ECB does, in fact, conduct a regular, broad assessment of the implications of its policies each time it publishes quarterly projections. Moreover, price stability is not attainable in an economy where savers have been disowned, zombie firms are flourishing, and the banking system has collapsed. By demanding that the ECB offer the kind of assessments that it requires, the GCC is provoking a dangerous clash between European and German law. It is not surprising that many economists and legal scholars have described the GCC’s arguments as utter nonsense.
Nonetheless, European institutions must take the GCC’s challenge seriously, or catastrophic consequences could follow. Given that the GCC has long been on a mission to challenge the ECB’s policies, there is no reason to assume that it will stop with this latest ruling. More important, one cannot ignore the fact that the court’s arguments resonate with many German economists, politicians, and voters. Across the German mainstream, there is a deep conviction that the ECB does not act in Germany’s best interest. Especially since the 2008 global financial crisis, a growing chorus has criticized not just the ECB’s bond-purchase programs, but also its interest-rate and collateral policies, and even its TARGET2 payment system.
This intensifying public sentiment has steadily eroded the ECB’s credibility in Germany. That is not a problem that can be brushed aside. Trust and credibility are a central bank’s most important assets, without which it cannot fulfill its mandate. The EU and other member-state governments therefore can no longer ignore the GCC and the constituency it speaks for.
As a first step, the ECB needs to understand what the GCC (and the German public) expects from it. The court’s complaint that existing monetary policies impose costs on specific groups implies that it doesn’t think price stability should be the ECB’s primary objective. The GCC is essentially demanding that the ECB pursue a different mandate.
To be sure, the GCC has no authority to demand such a change. But, to avert a deeper crisis, the ECB needs to convince the German public that price stability is its primary objective for a reason, and that it cannot simply decide to discipline certain governments or favor policies that would benefit German savers and banks. This issue will not be resolved through the ECB’s standard strategy review process.
The GCC also objects to the risk-sharing element that is inherent in all ECB policy decisions. Monetary policy always will have distributional consequences within societies, and, in the eurozone, across countries. But the German mainstream view is that ECB policies since 2008 have been designed to benefit weaker southern European countries at Germany’s expense. Again, it may be tempting to dismiss this argument as nonsense (which it is), and to point out that Germany has benefited as much as others from ECB policies over the past decade. But that will not resolve the conflict.
After all, the ECB has assumed an extraordinary degree of responsibility for maintaining economic and financial stability – first during the 2008 crisis, then during the subsequent European debt crisis, and now in response to COVID-19. With a proper fiscal and capital-market union to strengthen risk sharing, divergences within the eurozone could be reduced, allowing the ECB to step back from sovereign bond purchases and other interventions. But this probably won’t happen any time soon, which means that the ECB would do well to adjust its strategy.
The ECB should revise its definition of price stability and its method of analyzing the implications of monetary policy, not to please the German court, but to enhance transparency. For now, at least, that could help protect its operational, institutional, and legal independence. But in the long term, the EU and member-state governments cannot ignore the German position. Despite several serious weaknesses and contradictions in its reasoning, the GCC raises legitimate and important issues concerning the ECB’s monetary-policy mandate and its role within the EMU.
In the best-case scenario, the EU will take the GCC’s ruling as a wake-up call to work toward a viable fiscal and capital-market union, and to clarify the ECB’s role therein. That will require a maddeningly difficult EU treaty change. But the alternative would be far worse.
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Germany’s Constitution and European Sovereignty
The recent controversial ruling against the European Central Bank by Germany's Federal Constitutional Court could not have come at a worse time. But it was a necessary reminder that the EU is a community based on the rule of law, and that only its sovereign member states can develop it further.
MUNICH – In addition to the euro crisis, Brexit, and COVID-19, Europe now faces a constitutional crisis, as the Court of Justice of the European Union (CJEU) and Germany’s Federal Constitutional Court (GCC) fight over the policies of the European Central Bank. Although this latest crisis has erupted at an inopportune moment, it had been presaged by a series of earlier rulings and opinions on the ECB’s policies and thus should not have surprised anyone.
In its latest ruling, the GCC accused the CJEU of exceeding its mandate and employing arbitrary reasoning in a December 2018 judgment in favor of the ECB. But the widespread outcry over the GCC’s decision points to a disconnect between what many commentators might wish and legal reality.
Although a hierarchy of authority between the two courts clearly exists on matters of monetary policy, it does not in other policy areas, especially when it comes to the comprehensive and unconventional fiscal rescue policies that the ECB has pursued in recent years with money from the printing press. The ECB should have been specifically authorized to carry out such measures under Article 5 of the EU Treaty. But this authorization was not granted.
Furthermore, the EU and its institutions do not have the status of an absolute sovereign, as some observers seem to believe. Under its current treaties, Europe is far removed from the perhaps desirable statehood that would grant the ECB and the CJEU powers comparable to those of similar institutions in nation-states or confederations. For now, Europe’s nation-states are the masters of the EU treaties, and under these treaties, the highest courts in Denmark and the Czech Republic have been able, in other cases, to pronounce and enforce ultra vires judgments against the CJEU’s rulings.
Regarding the dispute over the ECB’s purchases of government securities, consider this: even in the United States, the Federal Reserve has not bought the public debt of individual states, a matter that has become a bone of contention in Europe. When California, Minnesota, and Illinois were on the brink of bankruptcy, the Fed did not come to these states’ rescue by buying their bonds.
In the eurozone, however, the ECB has already allowed eurozone members’ central banks to buy a third of member states’ outstanding government securities (issuer limit). These purchases have protected bondholders from losses and kept interest rates low despite high levels of public debt, thus encouraging governments to borrow even more. In so doing, the ECB has not supported economic policy, as it is allowed to do, but has directly countered it by undermining the various EU fiscal and debt compacts that aim to prevent national debt from escalating.
Even with a two-thirds majority in favor, the German Bundestag could not approve EU treaty provisions that would allow the ECB to pursue a policy of state bailouts entailing major foreseeable risks for eurozone taxpayers. Instead, the Federal Republic would first have to be refounded and a new constitution adopted by referendum.
Moreover, the EU and the CJEU do not have the legal means to enforce such a policy. True, the EU could initiate infringement proceedings against Germany. But that would not help, because the German government would not be permitted to pay an EU fine for disobeying a CJEU ruling that the GCC has deemed illegal. The CJEU could not rule on the issue itself, because it is the object of the infringement procedure (nemo judex in causa sua). The resulting conflict over competencies would have devastating consequences for the EU.
The GCC’s ruling was a necessary reminder that the EU is a community based on the rule of law, and that only its sovereign member states can develop it further. It cannot be developed arbitrarily by expanding the CJEU’s jurisdiction or through the decisions of a technocratic body such as the ECB Governing Council.
To be sure, the EU’s sovereign states should stand together and help those hit hardest by the crisis – above all Italy, which was the first European country to be affected by the pandemic and has suffered 31,000 COVID-19 deaths, the highest number in the EU. In addition to unilateral transfers, which each national government can freely decide on, member states should increase the EU budget to provide special aid for Italy’s people and hospitals.
If that is not enough, then a debt moratorium for Italy could be introduced under the rules of the Paris Club of creditor countries. This would have to be combined, as in the case of Greece, with capital controls to stop the huge capital flight from Italy to Germany and the United States that has been occurring since March.
Notwithstanding all this, EU member states should come together to form a political union that will in fact enable the bloc to achieve its desired sovereignty. Such a union should not primarily involve the communitization of the purse. A political union’s claim to sovereignty depends first and foremost on the establishment of a European army, with everything that this entails. A mere fiscal union would, in fact, block the road to political union, because some member states would provide the money while others would hold the military trump cards.
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The EU’s Nullification Crisis
By challenging the right of an EU court to rule on the European Central Bank's monetary-policy decisions, Germany's Federal Constitutional Court most likely has picked a fight it cannot win. Like South Carolina in 1832, Germany's judges may soon find that they have less political support than they think they do.
BERKELEY – A recent ruling by Germany’s Federal Constitutional Court (GCC) has opened a deep rift in the eurozone. In three months, the Bundesbank will be prohibited from participating in the European Central Bank’s Public Sector Purchase Program (PSPP) unless the GCC receives a satisfactory explanation that the ECB’s bond buying constitutes a “proportionate” measure for maintaining price stability.
Never mind that the ECB has already explained itself in countless publications, speeches by its Governing Council’s members, and in academic publications by its staff. That apparently is not enough for the German justices, who have long wrung their hands over the arcane question of whether central-bank bond buying constitutes a form of fiscal policy. As any economist knows, all monetary policies have fiscal implications; and insofar as central banks have deployed “unconventional” instruments, they may indeed be operating in a gray zone between monetary and fiscal policy.
The problem is that lawyers abhor gray zones. The Treaty on the Functioning of the European Union stipulates that while the ECB has sole authority over EU monetary policy, fiscal policy is the exclusive preserve of member states. This division of labor implies that the Court of Justice of the European Union (CJEU) should decide on any legal issue concerning monetary policy, whereas national courts should rule on matters of fiscal and other economic policies. The question, of course, is who should judge whether the ECB has exceeded its legal monetary-policy remit.
In its latest ruling, the GCC accepts (with some reservations) a previous CJEU ruling that determined the PSPP to be legal. But it also claims the authority to challenge CJEU decisions “where an interpretation of the Treaties is not comprehensible and must thus be considered arbitrary from an objective perspective.” On that basis, the GCC argues that the ECB failed to conduct a proper “proportionality test.”
Such “competency” (jurisdictional) disputes are common in all federations. The United States experienced a similar debate in the 1830s, when its federal system was still younger than the EU is today. How that crisis came about, and how it was resolved, offers interesting clues about the EU’s future. Then as now, the key issue was whether a policy instrument that was intended for a specific purpose could be used to favor particular states or sectors at the expense of others.
In antebellum America, the federal government’s primary economic competence was limited to trade policy, because tariffs in that period were the federal government’s main source of revenue. After the War of 1812, additional revenue was sorely needed to service the national debt, so Congress, in the late 1820s, decided to increase tariffs substantially. But raising revenues was not the sole aim. The ulterior motive was to protect northern manufacturers of textiles and other products from the industrial superpower of the day, Great Britain.
In the event, the southern states, which exported cotton but had no local textile industries, objected, arguing that US trade policy was being misused as a de facto industrial policy to serve select constituencies. The case against the policy was made most forcefully in the South Carolina Exposition and Protest, a pamphlet later attributed to then-Vice President John C. Calhoun, which rejected the Tariff of 1828 as unconstitutional. Calhoun’s reasoning was very similar to that of the GCC today:
“In fact, to divide power, and to give to one of the parties the exclusive right of judging of the portion allotted to each, is, in reality, not to divide it at all; and to reserve such exclusive right to the General Government (it matters not by what department to be exercised), is to convert it, in fact, into a great consolidated government, with unlimited powers, and to divest the States, in reality, of all their rights.”
Likewise, the GCC contends that Germany’s Basic Law is vulnerable to being undermined if an EU institution (like the CJEU) can judge whether another EU institution (the ECB) is adhering to EU treaties. The German justices are channeling the doctrine of nullification: the ultimate right of a state to reject federal decisions it considers unconstitutional.
This idea became so dominant in South Carolina during the tariff debate that, in 1832, the state legislature ordered state officials not to enforce the measure, and later declared the US tariff schedule null and void in the state. The GCC’s threat to bar the Bundesbank from participating in the ECB’s bond-buying program reflects a similar evolution.
In the American case, the nullification crisis was resolved with a political compromise, because both sides realized that they had much to lose from open conflict (as would become abundantly clear when the Civil War erupted 30 years later). The tariff schedule was reduced slightly, allowing South Carolina to declare victory while avoiding a conflict that it could not win (no other state shared its extreme position). Recognizing that the South had a legitimate grievance, the federal government (and the northern states) worried that opposition to the tariff would increase unless they did something to relieve the pressure.
A compromise to defuse Germany and the EU’s legal conflict over monetary policy is already on the table: a simple explanation by the ECB should be sufficient for the GCC. Still, some commentators worry that meeting the GCC’s demand would threaten the ECB’s own independence. In any case, the ECB will have to walk a fine line.
In Albert O. Hirschman’s famous taxonomy of political strategies – exit, voice, and loyalty – the GCC’s latest move should be seen as a demonstration of “voice,” carrying an implicit threat of “exit.” But as Hirschman was always quick to point out, the choice between exit and voice cannot be understood without the third element.
In the coming months, the German political system’s loyalty to the European project will be tested. Fortunately, most German leaders place far more value on the EU than they would on a minor victory in the GCC’s quibble with the ECB. Much like South Carolina in the 1830s, the GCC might have scored an “own goal” by picking a fight that it cannot win.
NEW YORK – Germany’s Federal Constitutional Court has just set in motion a process that could culminate in the unraveling of the European Economic and Monetary Union. The court has ruled that, following a transitional period of no more than three months, the Bundesbank may no longer participate in the eurozone’s Public Sector Purchase Program (PSPP), unless the European Central Bank demonstrates that the policy’s objectives are “not disproportionate to the economic and fiscal policy effects resulting from [it].”
The court’s decision covers the period between the PSPP’s first asset purchases on March 9, 2015, and the reinvestments phase that began on January 1, 2019, thus effectively stopping the clock on November 8, 2019, when cumulative PSPP purchases amounted to nearly €2.1 trillion ($2.3 trillion). Primarily at issue is a ruling in December 2018 by the Court of Justice of the European Union (CJEU), which itself contained two key elements.
First, the CJEU ruled that the PSPP did not circumvent Article 123 of the Treaty on the Functioning of the European Union (TFEU), which prohibits the monetary financing of member states’ budgets. Second, it decided that the program also did not violate the “principle of proportionality,” under which “the content and form of Union action shall not exceed what is necessary to achieve the objectives of the Treaties.”
The German court does not dispute the first point, nor does it address more recent measures taken to address the COVID-19 pandemic, such as the expansion of the PSPP to include a €750 billion Pandemic Emergency Purchase Program, or the ECB’s most recent targeted bank-lending operations. But it does reject (rather contemptuously) the CJEU’s conclusion about the principle of proportionality. In the German court’s view, the CJEU’s ruling on this point went far beyond its legal authority as stipulated in the Treaty on European Union.
Indeed, the German court openly questions the CJEU’s legal competence, explaining that it will respect CJEU decisions, “as long as the CJEU applies recognized methodological principles and the decision it renders is not arbitrary from an objective perspective.”The implication, of course, is that the CJEU has not satisfied this basic criterion.
Citing Articles 5.1, 5.2, and 5.4 of the TEU, the German court then rubs the point in further. “The CJEU held that the Decision of the ECB Governing Council on the PSPP and its subsequent amendments were still within the ambit of the ECB’s competences,” the judges state. “This view manifestly fails to give consideration to the importance and scope of the principle of proportionality … and is simply untenable from a methodological perspective given that it completely disregards the actual economic policy effects of the program.”
To my mind, it is remarkable that the German court has gone so far as to dispute the PSPP’s wider economic-policy effects, above and beyond what it may have achieved (and continues to achieve) in terms of keeping eurozone inflation “below, but close to 2%.” Did the German court summon a panel of expert witnesses comprising Old and New Keynesians, Monetarists, behaviorists, and Marxists to provide evidence of these supposed effects?
This is not to jest, because the situation is very serious. It is highly unlikely that the ECB Governing Council will offer a narrative that will convince the German court that “the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the program.” After all, the PSPP clearly has a significant effect on the terms on which some member states can access sovereign-debt markets. Italy is an obvious example. So, too, is Greece, following the ECB’s decision to include sub-investment-grade public debt in the PSPP.
Looking ahead, as public-sector deficits expand as a result of the pandemic response, PSPP purchases of sovereign debt may become important drivers of sovereign borrowing costs and even of sovereigns’ market access. If Germany were suddenly to say “nein” to the PSPP, one or more eurozone countries could be forced to crash out of the monetary union.
Worse, the German court’s ruling touches on much more than the PSPP/sovereign-debt nexus. For example, the judges also express concerns about the effects of ECB asset purchases not just on banks’ balance sheets and interest rates, but also on zombie companies, and thus on potentially every saver, lender, real-estate owner, and insurance-policy holder in the eurozone.
Yes, portfolio-balance considerations imply that quantitative easing and qualitative easing affect asset yields and prices, and thus real economic activity and the economic wellbeing of domestic and foreign residents. These are legitimate issues for the ECB, the European Parliament, and the European Council to consider. But they are no business of the German court.