Posted by: Dirk | May 5, 2020

The German constitutional court’s judgment on the ECB’s bond purchase – a brief commentary

In today’s ruling, the Federal Constitutional Court upheld several constitutional complaints against the Public Sector Purchase Programme (PSPP), stating that the ECB’s decisions on the Public Sector Purchase Programme were incompetent, as the proportionality had not been assessed:

A public sector purchase programme such as the PSPP, which has significant economic policy implications, requires in particular that the monetary policy objective and the economic policy implications are identified, weighted and balanced against each other. Therefore, the unconditional pursuit of the monetary policy objective of the PSPP to achieve an inflation rate below but close to 2 %, while ignoring the economic policy implications of the programme, appears to disregard the principle of proportionality.

The necessary balancing of the monetary policy objective with the economic policy implications of the means used does not follow from the decisions which are the subject of this procedure. They therefore infringe the second sentence of Article 5 (1) and (4) TEU and are not covered by the ECB’s competence in the field of monetary policy.

In my opinion, this assessment is adventurous. A central bank has a big hammer – interest rates – and almost as big – the rules on what collateral is accepted for central bank loans. To be able to influence interest rates in the long term, a central bank buys and sells government bonds. In the euro area, this is done through resale transactions (so-called repos = repurchase agreements). This is fundamental – without trading in government bonds, the central bank cannot influence interest rates and yields. (Technically, it would be possible to set interest rates in such a way that the interbank market rate is set without the central bank buying and selling government bonds, but this requires that, in case of doubt, government bonds can be bought in large quantities by the central bank. This is not permanently fulfilled in the euro zone).

A central bank sets the short-term interest rate directly via the deposit rate, main refinancing rate (maturity: 1 week) and marginal lending rate (overnight). The economy adapts to this. I am not aware of a single example of a central bank where a trade-off takes place in the sense that side effects are explicitly discussed and weighed. Of course, monetary policy has an influence on distribution, public finances and wealth. But the Federal Constitutional Court misjudges the way a central bank functions. It sets an interest rate, which is difficult enough. There is the theory of the inflation target, according to which the interest rate of the central bank is aligned with the inflation rate, but this does not work. Inflation is too low. Since its inception, the ECB has only been able to influence the inflation rate – it does not control it. (More detailed information on these issues can be found in my book “Money and Credit: A € European Perspective”, 3rd edition, February 2020).

The side effects, which the Federal Constitutional Court sees, are sometimes hair-raising:

For example, there are significant risks of loss for savings. Companies which are no longer economically viable per se remain in the market because of the general interest rate level, which has also been reduced by PSPP. Finally, as the duration of the programme and the overall volume increase, the Eurosystem is becoming increasingly dependent on the policies of the member states, as it is becoming increasingly difficult to terminate and unwind the PSPP without jeopardising the stability of the monetary union.

Could the SNB please explain to the Central Bank at what exact interest rate ‘non-viable companies’ have disappeared? That is outrageous. Such an “equilibrium interest rate” may be haunting the minds of some errant economists, but that is not something that can be seriously advocated! What comes next? A lawsuit against government spending because it keeps “businesses that are no longer viable” alive? This approach presupposes that there is a balance in the economy and that it can be observed. I do not consider both of these conditions to be fulfilled. This argument should therefore be rejected.

Similarly nonsensical is the argument about the “significant risks of loss” of savings. Have the judges perhaps ever considered what happens to asset prices when the central bank buys assets worth several hundred billion euros from asset owners? Will stock prices and property prices rise or fall? Asked the other way round, does the Constitutional Court believe that an interest rate increase to 5% by the ECB will raise asset prices? To be honest, I see more than “significant risks of loss”.

Under the same condition, the Bundesbank is obliged to ensure a coordinated – also long-term – reduction of the holdings of government bonds within the Eurosystem.

As long as other national central banks of the Eurosystem then buy these government bonds or others, this is unproblematic for the continued existence of the euro. However, it is possible that the ECB’s PEPP will then make all eurozone government bonds risk-free and accordingly in demand – except for German government bonds. This would raise their interest rates, and Germany could even become the new Greece if the other central banks refuse to buy up German government bonds. But we are nowhere near that point.

Conclusion: economic ignorance has led the BVG to make a hair-raising judgement. If the ECB’s PEPP also becomes the target of a lawsuit, this could mean the end of the Eurozone.

Translated with (free version)

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