Finance: Research, Policy and Anecdotes

Last week’s ruling of Germany’s Constitutional Court in Karlsruhe that the ECB’s asset purchase programme might not be proportional and thus possibly unconstitutional has sent shock waves through the euro area. I will not comment on the legal arguments of the Court’s ruling and its implication for the legal order within the EU and rather focus on its implication for economic policy going forward.

The ECB Executive Board has already made it clear that it does not see this ruling as any impediment for its monetary policy decisions going forward and that it regards this as a purely intra-German matter.  It will thus have to be the Bundesbank and/or the German government that answer to the German Constitutional Court.  In the worst case scenario that the Bundesbank will no longer be allowed to participate in asset purchase programmes of the ECB, even that would not be a major problem, as the ECB can simply ask other national central banks to buy German bonds.

The problem is more a political one. The Constitutional Court of the euro core country has sent a strong negative signal against ECB’s independence, giving a boost to opponents of the euro and the current move towards a more integrated policy framework not just in Germany but across the euro area. It has also opened the door to legal challenges across the euro area against future monetary policy decisions and tools of the ECB.  

Most importantly, this decision might affect the space that the ECB will have in the next few years in how to deal with the increasing sovereign debt if not fragility of several euro area member countries. Future “whatever it takes” announcements might not necessarily be taken at face value anymore by markets. It sheds doubts on the idea that a rising sovereign debt burden can be dealt with a combination of ESM loans and ECB bond purchases.

On the upside, this court ruling puts the pressure back on governments across the EU and the euro area to finally rise up to the challenge of taking forward-looking decisions on how to deal with the large deficits and rapidly rising sovereign debt burdens across the euro area. As I have written earlier, such a decision should be taken by democratically elected and directly accountable governments rather than independent and indirectly accountable central banks. There is a strong case for loss sharing within the EU and/or the euro area, on economic, political and moral grounds. There are certainly different structures and mechanisms that one can think of, but burdening again the ECB with the main responsibility to deal with the fallout from the COVID-19 crisis should be avoided, even more so with this court ruling.

This ruling has also made clear that the current institutional and governance structure of the euro area is not fit for purpose, especially during crisis times. There have been important reforms in the banking area in the form of the banking union; it is also clear that it is not complete and does not provide for sufficient risk sharing yet. More risk sharing through capital markets will continue to be a high policy priority. But what the current crisis has shown us is that in these extreme tail events, it can only be the government that can provide the necessary degree of certainty. This in turn puts a stronger premium on delegating a larger share of fiscal policy responsibilities to the euro area level. Suggestions have been made: a crisis-specific recovery initiative, a reconstruction fund and unemployment reinsurance.

In summary, one can see the glass as half empty, with this decision undermining the ECB’s ability to respond to this and future crises; one can also see this as a glass half full as the ruling has again shown the deficiencies in the euro area governance and should be interpreted by governments across the euro area as a call for action.

13. May, 2020