Who is exceeding their powers?

THE turning-point in the euro crisis came when the European Central Bank (ECB) pledged in September 2012 to make if necessary unlimited purchases of government bonds) for countries under siege in the markets, a doctrine it christened “Outright Monetary Transactions” (OMT). The policy gave teeth to Mario Draghi’s earlier “do-whatever-it-takes” vow to save the euro. The bond-purchase pledge proved so successful in routing the bond vigilantes that it has remained on the shelf as a deterrent rather than being fired in anger.

But for over a year the German constitutional court, based in Karlsruhe, has been considering whether the ECB took a step too far in adopting OMT. Today it issued its long awaited judgment, which is hostile yet provisional. It is hostile because the court says that the ECB has exceeded its powers in adopting OMT and that the doctrine violates the ban on monetary financing of government budgets in the European treaty. It is provisional because in an unprecedented move the court has referred crucial questions to the European Court of Justice (ECJ) for a preliminary ruling.

At hearings last June the ECB argued that OMT fell squarely within its mandate, which is to use monetary policy in order to secure price stability. Jörg Asmussen, who was then on the bank’s executive board (he resigned late last year to take up a ministerial post in the new German coalition government), said that it was “the necessary and appropriate step to eliminate the disruption in the transmission of monetary policy caused by concerns that there would be an unwanted break-up of the euro”. Such worries meant that in some parts of the currency union “the steering of monetary policy was not functioning fully, or was in part not functioning at all”. Spelling out what was going wrong, Mr Asmussen said: “The key interest rate had lost its key function, with considerable disruption of the transmission of monetary policy on account of the implicit exchange-rate risk.”

However, the court dismisses this argument. It claims that OMT is an act of economic rather than monetary policy and therefore exceeds the ECB’s powers since under European law the ECB cannot pursue its own independent economic policy. This overreach follows, it says, from the fact that the immediate objective of OMT is to ”neutralise” bond spreads of selected member states. These spreads between bond yields on the troubled periphery of the euro zone and those in the core, such as Germany, had widened alarmingly during the crisis. The court notes the ECB's break-up risk explanation but points out that the markets were also worried about budgetary indiscipline and possible state insolvency. It also takes exception to the fact that the purchases would favour only some states (a condition for OMT eligibility is that a country is complying with strict economic and fiscal terms as part of a bail-out programme from the euro zone’s rescue fund) whereas the ECB’s monetary policy generally does not differentiate between the various members of the currency union.

Moreover, the court finds that OMT violates the prohibition of monetary financing in the European treaty. If bond purchases were acceptable every time the transmission mechanism were disrupted, it says, this would amount to giving the ECB the power to remedy any deterioration in countries’ credit ratings. “This would largely suspend the prohibition of monetary financing of the budget.”

But, in its zeal to stop the ECB exceeding its powers, is the German court itself exceeding its own? Two of the eight judges dissented from the ruling on the grounds that the case was inadmissible. One said that monetary and economic policies related to each other and could not be strictly separated, and argued that the ECB’s insistence that OMT was intended first and foremost to restore the monetary transmission mechanism could not brushed aside so unequivocally.

Now attention turns to the European Court of Justice. The German court in effect sets out a compromise proposal setting out how it believes OMT might be made to conform to European law. It makes three demands. One is that the ECB should not accept haircuts (“debt cuts”) on bonds it has bought. That might be tricky since the bank’s readiness to be on an equal standing (pari passu) with other creditors was designed to avoid the undesirable effect of its purchases scaring remaining private bondholders by shrinking the amount of debt that might be subject to a restructuring, which in turn would require higher haircuts.  A second stipulation—that “interferences with price formation on the market are to be avoided wherever possible”—is more fudgeable. But the third demand, that bond purchases should not be in unlimited amounts, appears to castrate OMT, which has cowed the vigilantes by threatening to make potentially unlimited purchases. On the other hand, a way out might be found through the fact that any purchases would in practice be limited (as Mr Asmussen pointed out in June) since the ECB would confine them to bonds with a remaining maturity of between one and three years.

It seems rather unlikely that the notoriously integrationist ECJ in Luxembourg will fully back the German court’s suggested compromise, not least given the dissent among the judges at Karlsruhe. If the European court instead essentially supports the central bank’s defence of OMT, then it will demonstrate that it is the German court rather than the ECB that has overstepped the mark.

And we will all have learned the meaning of ultra vires.

The economist