More courtroom drama

As central banks and governments around the world battle to put in place measures to mitigate the worst of the Covid-19 economic fallout, the euro zone once again finds itself in an extremely difficult position. Whilst EU governments have done much to provide a range of packages to support workers who would otherwise lose their jobs, the only pan-Emu institution capable of looking at the regional picture is the ECB which is, to use the English cricketing parlance, batting on a sticky wicket.

Yesterday’s ruling by the German Constitutional Court (GCC) ordering the German government to ensure the ECB carries out a “proportionality assessment” of its debt purchases threatens to open a new front in the dispute between northern and southern members of Emu. The GCC is concerned that the “economic and fiscal policy effects” of the bond purchases should not impinge upon the ECB’s policy objectives and it has threatened to block Bundesbank purchases unless the ECB completes a review within three months. Having watched the UK Supreme Court intervene in Brexit-related issues, rightly in my view, it is difficult for me to say that the GCC is wrong. It is, after all, merely acting in what it perceives to be Germany’s national interest according to domestic law.

But this is not the first time that the GCC has become embroiled in the euro zone debate, having generally taken a dim view of Mario Draghi’s “whatever it takes” policy to keep the euro zone together. A case was first brought to the GCC in 2015 when a group of concerned citizens claimed that the ECB was engaged in monetary deficit financing which runs contrary to the Maastricht Treaty. This was subsequently referred to the European Court of Justice in 2018 which ruled in favour of the ECB. However, the GCC has now ruled that the ECJ’s earlier ruling is “untenable from a methodological perspective” which is a much stronger tone than anything it has delivered previously.

Had the ECB not recently ramped up asset purchases, the GCC would not have had to reopen the debate. But it did, and we could now be looking at a major constitutional problem. In effect the GCC has questioned the primacy of EU law, which takes precedence over national law and was such a bone of contention for Brexit supporters in the UK. Panos Koutrakos, professor of European law at City University in London is quoted in the FT as suggesting this represents “the first case where a German court says the European court has no jurisdiction.” One does not have to be a lawyer to realise that if the court has no jurisdiction, the legal basis of the single currency is under threat. It could get a lot worse for the EU if this encourages other governments to ignore ECJ rulings. For example, it has raised fears that the Polish government, which is engaged in a dispute with Brussels over the independence of the judiciary, could continue to defy the ECJ which would undermine the basis of the EU itself.

The GCC’s actions serve further to underscore the notion that there is one law for the prosperous north and another for the highly indebted southern Emu economies. If Germany is going to chafe at the actions of the ECB, the likes of Italy are less likely to accept lectures from other Emu members regarding fiscal policy. German politicians are likely to argue that both the actions of the ECB and the Italian government are in breach of the legal foundations of the euro zone. They may even be right. But that is not how the episode will be seen in Rome which is already disgruntled by the apparent lack of solidarity regarding support for those economies hardest hit by Covid-19.

As it happens, I find it hard to believe that the GCC really wants to cause the single currency project to unravel. Consequently I expect that the ECB will come back with a justification for its actions which satisfies all parties and the single currency will remain intact. But this is perhaps the most serious illustration yet of the flaws of the project. There are no instances of a single currency project holding together in the long run without some form of fiscal union. It is precisely because no such fiscal body exists within Emu that the ECB has to act as it does. History records that the Gold Standard lasted for almost a century whilst the Latin Monetary Union endured for 50 years. But the Bretton Woods System fell apart after 26 years. The common factor in the demise of each of these systems were the strains inherent in maintaining fixed exchange rate parities without any instruments other than monetary policy. Moreover, Bretton Woods fell apart because the US, as the biggest economy, was no longer prepared to subordinate its domestic policy to maintain the international order. The lesson from history is that the longer term future of the European single currency remains in doubt unless reforms are made to the institutional architecture.

But are the German critics right in their view that the buying of assets represents monetary deficit financing? The ECB has always been careful to emphasise that its balance sheet expansion has been driven by the need to raise inflation to meet the 2% target. If we accept this as true, then it is acting in accordance with its monetary mandate and not out of any fiscal concerns. Furthermore, the ECB buys in accordance with the capital key which means that it has bought more German Bunds than corresponding securities from other Emu members.

However, the lingering suspicion remains that there is a gulf between what the central bank says in public and the underlying motivation for its actions. But as Gertjan Vlieghe of the Bank of England pointed out recently, looking merely at the balance sheet transactions is not a good guide as to what a central bank is doing because “when a central bank issues reserves, the main counterpart asset on the central bank balance sheet is generally some form of government financing … in a strict sense some part of government spending is always financed with central bank money.”  The crucial determinant of the action is “who makes the decision and with what objective.” Given the separation of powers between Emu governments and the central bank, it is hard to make the case that the ECB is directly engaged in monetary financing. However much the judges sitting on the GCC may know about the law and however much they may suspect the actions of the ECB, they cannot prove anything beyond reasonable doubt. This may be an instance where the court has bitten off more than it can chew.