Following the PDU’s response to the Karlsruhe ruling on monetary policy, Dr Wolfgang P. Warth gives an alternative view.
The transfer of the decision on certain aspects of monetary policy within the ESCB from the German constitutional court BVerfG (Bundesverfassungsgericht) to the European Court of Justice (ECJ) is a promising step – it has the power to clarify some flaws in the ECB statute which will strengthen the monetary union. The decision will make necessary changes to the agenda of the EU Commission as it decides on the future of the euro. This must be seen as good news for all those who would appreciate further integration of the EU.
It is asked whether the OMT program is in line with the ECB statute. The OMT program is designed as a tool of monetary policy and not, as often said, a tool to help ailing European governments. If it were, it would clearly be banned.
The BVerfG stated that the OMT program could lead to a massive transfer of assets between EU member-states if state bonds, acquired by the ECB, are held until maturity. If there are capital gains, these will be distributed among the member-states and the corresponding losses will be incurred by private investors from different states. Capital will flow from the periphery to the core of the EU. In the case of capital losses, these will reduce the equity capital of the ECB and will probably force the states to raise new equity capital – then capital will flow from the core to the periphery of the EU. It is difficult to predict which case will occur. The risk, however, is limited, since the ECB has decided to buy bonds with a short term maturity.
What matters is at what price a bond will be acquired by the ECB. In the case of a speculative attack on the euro, OMT provides the ECB with a tool to limit further losses. An intervention of the ECB buying bonds on the secondary market of member-states that have come under pressure will limit the fall of prices and stop the devaluation of assets, which the ECB uses as collateral for refinancing banks within the eurozone. An attack without intervention would reduce the value of these collaterals and result in a destabilization of the ECB balance sheet.
But there remains uncertainty, and the question arises as to whether the ECB is competent enough to estimate the future value of state bonds offered on the secondary market. But this (basic) hypothesis must be assumed, if a monetary system is set up and founded on the stability of state bonds. Otherwise the refinancing of banks would be a hazardous game, reliant upon the political framework of the EU.
If the ECB buys undervalued bonds of member-states then this could be a tool of monetary policy. In this case, the ECB stabilizes the market value of acquired state bonds and prevents simultaneously a devaluation of its own assets, at least those which have been accepted as collateral. Furthermore if an undervaluation can be assumed, the action can be justified. As long as the ECB sticks to this principle, secondary-market activities must be accepted. In the case when the hypothesis of undervaluation must be rejected, then the intervention on secondary markets must be seen as an illegitimate action of monetary financing a state’s budget, since there is no reason to buy these assets. Consequently the only question is, whether the evaluation of state bonds by the ECB can be assumed as correct or not. And the answer is yes, for without this basic hypothesis the monetary system cannot exist and the ECB cannot accept states’ bonds as collateral.
According to article 267 of the Treaty on the Functioning of the European Union, the ECJ is responsible for the ruling of the European treaties: “the interpretation of the treaties and the validity and interpretation of acts of the institutions, bodies, offices or agencies of the Union. Where such a question is raised before any court or tribunal of a EU member-state, that court or tribunal may, if it considers that a decision on the question is necessary to enable it to give judgment, request the court to give a ruling thereon”. So it is not at all surprising that the BVerfG transferred the complex question on the conformity of the OMT program with European law early last month to the ECJ.
The transfer is accompanied by indications that give an idea of how the OMT program could be seen in line with the EU treaties. Some commentators stated that the BVerfG had strongly criticized this programme. In contrast, the BVerfG statement can be seen as a necessary clarification of restrictions under those the ECB has the right to act and this is good news. If the ECJ adopts these restrictions then the European treaties would have to be changed correspondingly and ECB activities on secondary markets will be consistent with the treaties. So the BVerfG decision puts the monetary union rules on the EU agenda, and the ECJ will consequently have to clarify the scope of action which can be used by ECB.
The basic task of the ECB is to define and implement the monetary policy of the EU and this must be done independently from other EU policy. In that respect, the ECB is an undemocratic institution. But this is a well-conceived structure to support price stability and to separate fiscal policy from monetary policy. To do this, and to be additionally in line with European treaties, monetary policy within the eurozone however must be subordinate to decisions on the EU level and for instance those taken by the ESM. And if the ESM adopts the perspective that a member-state will overcome temporary financial stress and thus offer financial aid, then the ECB will have the right to buy (and sell) government bonds of that state, eventually respecting certain restrictions as stated by the BVerfG.
If the ECB acts on secondary markets, the primary intention is to protect the bank’s balance sheet. This is the result when there is an evidence of undervaluation which is corrected by the bank’s intervention. If the ECB would be banned from acting in this way, it would be necessary to invest additional equity capital by the member-states. And this requires an evaluation of the economic potential of the states in order to estimate the financial assets of the bank, for otherwise the needed equity capital could not be calculated. Either the ECB has the competency to do so (this is the basic hypothesis) or not. And if not, the states would have to do the calculation consensually. It remains an open possibility as to whether such an evaluation could be assigned to a democratically-controlled institution and could be done in a reasonably short period. Democratic control would command a decision of EU citizens on the evaluation of the economic potential of member-states and which quotation of state bonds is justified. When we observe that markets are not able to solve the evaluation problem, why could this done better by a different democratic procedure? Thus to assign the decision to the ECB seems to be the most favourable against all alternatives.
One could assume the ECB will act if and only if there are excesses to be observed on the secondary markets triggered by animal instincts. These excesses could lead to an undervaluation of state bonds and destabilize the monetary system. In such a case the action is justified from a behavioural economics perspective, which often is not looked at in traditional economics. And this is why there are different views in the world of economists. But irrational actions have to be considered, since they are often observed on markets.
The BVerfG stated that under certain restrictions the OMT program is in line with the European treaties. This is the case when the conditionality of ESM programs is respected and the OMT program is not more than a supporting initiative to the EU policy. In the light of the Treaty on the Functioning of the European Union, three conditions must be considered:
- No cut of state bonds must be expected
- The limitation of interventions concerning state bonds in secondary markets
- No intervention in secondary markets to influence the pricing of state bonds
The first condition is fulfilled if the ailing state is confronted with a temporary financial crisis. The second condition is an incentive for states to reduce debt and to prevent banks from supporting states building up new debt. The third condition is a ban on secondary markets activities that are not executed on the assumption of undervalued state bonds.
As a consequence, an ECB action can be implemented only after decisions have been made by the ESM to offer assistance to an ailing state. In such a situation the ECB would support democratically-legitimated decisions of the ESM with a monetary tool. So a first assessment of the economic potential of an ailing state has to be done by the ESM and this assessment would be used by the ECB to evaluate bonds of this state and to eventually intervene in secondary markets.
If the ECJ adopts the restrictions stated by the BVerfG, then it will be clear that the risk-bearing capacity of the ESM will be relevant, and not just the ability of the ECB to print money if and when the euro has to be saved. That means that the ESM becomes the decisive watchdog of member-states’ fiscal and monetary policy.
It is to be hoped that the decision of the BVerfG will influence the EU agenda and the discussions over the European monetary system will gain momentum. Forming a fiscal union and a banking union will not be sufficient to strengthen the euro if discussions continue to revolve around whether or not the ECB acts within its mandate. There is a need to clarify this mandate and to change some articles, mainly Article 18 of Protocol 4 of the Lisbon Treaty concerning the refinancing of banks, accepting state bonds as collateral and corresponding transactions in state bonds on secondary markets. Furthermore it would be helpful to support a strong euro, if low indebted member-states had a stronger weight concerning decisions on the monetary strategy of the ECB, still respecting the independence of that institution. This could be implemented by changes in Article 10 of the same Protocol.
It must be made clear in the public debate that the stability of money is equivalent to nothing less than stability of the state (or a confederation of states) issuing this money. Money is the outstanding product of markets with the highest value and if it is covered by state bonds, instead of other goods such as gold or silver, these state bonds must be beyond dispute. Consequently the higher the debt obligations of a state, the higher will be the loss of credibility and the degree of instability of money. This is true today and was in times past, when money was a commodity and gold or silver coins circulated. At that time too states had the right to issue money, and when they fell into debt the states coined gold in a different way and used the seigniorage to finance the debt and to expropriate the people. This resulted in a loss of credibility of the state – we cannot afford that again.
Image: “Richterroben am Bundesverfassungsgericht” by “Evilboy”. Published under Creative Commons 3.0 license.