“Whatever it takes.”
With those three words, former European Central Bank President Mario Draghi burnished his legacy during the tumult of the euro crisis in 2012 and opened an unreconcilable wedge between the euro zone’s fiscal hawks in the prosperous North and the debt-laden South.
Fast-forward to this year’s coronavirus crisis, and Draghi’s successor Christine Lagarde tried to avoid following suit—until her refusal to have the ECB buy more Italian bonds battered the markets. Days later, the Eurozone’s central bank relented. With Europe scrambling to keep its economies afloat, “whatever it takes” was back.
But is it really?
On Tuesday, the ECB’s ability to keep credit flowing (and, indirectly, the markets happy) was dealt a potentially devastating blow by Germany’s highest court. In a 7-1 decision, the federal constitutional court ruled that the ECB had overstepped its mandate back in 2015 when it began a bond-buying purchase program that’s pumped the equivalent of €2.7 trillion into Europe’s struggling economy. Since the start of the coronavirus pandemic the ECB has doubled down on its quantitative easing-styled asset-buying; for now, those more recent moves are safe, and can continue.
But longer terms, there are fresh doubts.
In essence, today’s German court ruling calls the ECB out on the scope of a favored piece of ammunition that it loads into its bazooka whenever a fresh crisis threatens to pull the union apart.
The result could be a further weakening of the European Union, which is already struggling to demonstrate economic solidarity in the face of the COVID-19 onslaught—broadly speaking, the bloc’s richer north is likely to weather the storm more easily than its poorer, harder-hit south.
What’s on the line
The court was not directly dealing with the ECB’s new coronavirus response package—a 750 billion euro ($813 billion) asset-purchase scheme called the Pandemic Emergency Purchase Programme (PEPP). Instead, it’s asking the ECB to justify the five-year-old Public Sector Purchase Programme (PSPP) scheme which was being challenged by German critics who are unhappy with how the QE-style stimulus in essence shifts the balance of power from national capitals to the European stage. It’s a particularly hot political issue in fiscally conservative Germany, which runs a tight ship; in debt-strapped Italy, Spain and Greece, the bond-purchasing program has been a godsend for its weak banks.
But although pandemic bailouts were not the subject at hand on Tuesday, the central questions are the same: is a big ECB bond-buying program compatible with Germany’s constitution, and is quantitative easing even part of the ECB’s mandate to begin with?
Pure QE, which involves the purchase of all kinds of sovereign and corporate assets from mortgage-backed securities to country-issued debt, has become monetary policy de rigueur around much of the world. Its scope, though, in Europe has always been under question, particularly during the Draghi years. The Italian central banker right up to the end of his term said the central bank had the power to open up its check book and buy, buy, buy to stimulate growth, and therefore meet that part of its mandate by… yes, “whatever it takes.”
In recent years “whatever it takes” took the form of PSPP.
“What a big bang!”
On Tuesday, The German court ruled that the PSPP program was possibly illegal in Germany because the German government and parliament had not tried to ensure that it was proportionate. The upshot is that, unless the ECB explains how PSPP is proportionate within the next three months, Germany’s central bank—the Bundesbank—will have to opt out of the coordinated scheme, and stop buying government bonds.
Here’s where the potential impact on the newer PEPP scheme—this one to bailout Europe’s coronavirus stricken economies and businesses— becomes clear. When the ECB launched PEPP in mid-March, it did so while saying: “We are fully prepared to increase the size of our asset purchase programs and adjust their composition, by as much as necessary and for as long as needed. We will explore all options and all contingencies to support the economy through this shock.”
To the markets, that sounded a lot like “whatever it takes,” the sequel. Europe’s bourses have since soared as the borrowing costs of the bloc’s shakiest economies came down.
But the question remains: can the central bank’s move to open up its balance sheet in such a generous fashion be squared with the proportionality demands of German judges who argue for clearly defined limits to the “the amount of purchases” from the start.
Good news, bad news
Economists stepped in on Tuesday, trying to predict how this will play out.
“The good news is that the ruling does not seem to apply to the PEPP, but there is a bigger concern that it limits the ability of the ECB to ‘do whatever it takes’,” Standard Chartered chief Europe economist Sarah Hewin told Reuters.
“What a big bang!” wrote ING’s chief economist for the Eurozone, Carsten Brzeski, in an emailed note. “An optimistic interpretation could be this is lots of barking without biting and that everything is fine as long as the ECB demonstrates that it has thought through the economic consequences of its decisions, but a pessimistic interpretation could be no amount of additional ECB analysis will convince German judges and could, therefore spell the end of QE.
“Today’s decision could become a real problem for the ECB in the next phase of the crisis when the recovery starts.”
Some argued that, should the ECB’s spending powers ultimately be clipped, it would be time to rethink the central bank’s role and function.
“How is Europe supposed to deliver an appropriate economic response to the COVID-19 crisis when the ECB cannot act like a normal central bank, but must engage in legal tightrope walks all the time?” tweeted Jens Suedekum, an adviser to Germany’s economy ministry. “Maybe it’s time to reconsider the rules of the game themselves.”
Clash of the courts
Tuesday’s ruling was also notable for another reason: it set up a major conflict between Germany’s highest court and Europe’s highest court, the Court of Justice of the European Union or CJEU.
Again, this could have major implications for the European Union.
During the five-year case that led to this week, Germany’s constitutional court asked the CJEU for its view. The European court delivered its preliminary ruling at the end of 2018, saying the PSPP scheme was entirely kosher—and on Tuesday, the German court partially tossed that ruling aside. In the world of European law, this was a seismic event, because the CJEU is a higher authority even than Germany’s top court.
The German court’s reasoning was that the CJEU had not examined the actual economic-policy effects of PSPP, making it impossible to judge whether the ECB was sticking to its monetary-policy mandate or not. This decision, the German court said Tuesday, “contradicts the methodological approach taken by the CJEU in virtually all other areas of EU law.” The result, it warned, was that the ECB could gradually expand its own mandate.
So, the court argued, it was “not bound by the CJEU’s decision.”
“That the German court rejects a key plank of a decision by the European court is a legal bombshell which will make significant legal waves across Europe,” said Berenberg chief economist Holger Schmieding in a note. And, Axiom Alternative Investments research chief Jerome Legras told Reuters he had “never seen such a legal slap in the face in my entire life.”
If Europe’s member states get to decide when they do or don’t listen to the CJEU, that could have implications that extend far beyond the quantitative-easing debate. But for now, the key question is what the implications will be for the stability of the euro—and perhaps for its ultimate survival as an economic and political project.
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