ECB Court Probe Focuses on Limits to Monetary Policy

Germany’s top judges examining the European Central Bank’s plan to buy bonds of crisis-torn countries asked whether the operation crosses the line from legitimate monetary policy to illicit state financing.

Witnesses at the second day of hearings before the Federal Constitutional Court in Karlsruhe faced queries from the panel on whether the central bank’s Outright Monetary Transactions program oversteps the mark beyond the ECB’s mandate to conduct monetary policy. Judges also asked whether the rules underpinning that mandate should be revamped.

“We have heard that it’s very difficult to demarcate the line between state financing and monetary policy” when analyzing the OMT, Chief Justice Andreas Vosskuhle said. The question is whether “the OMT’s caveats could be a good middle course.”

The line of questioning followed comments yesterday from ECB Executive Board member Joerg Asmussen that the central bank’s OMT plan has safeguards that prevent it from turning into a government financing program, including a waiting period before an emitted bond can be bought on the secondary market. European Union rules ban government financing by the ECB. The as-yet unused OMT, which ECB President Mario Draghi has said is the “most successful” central bank tool, foresees bond purchases if countries sign up to economic reforms.

Tighter Leash

Bundesbank President Jens Weidmann said today that while officials could put the OMT on a tighter leash, it would no longer be the same instrument. Asked whether the markets believed that the ECB would use “unlimited firepower,” he said the spread reduction after the OMT announcement indicate that the markets took the central bank at its word.

“Of course it’s possible that the ECB uses its unlimited firepower, but the question then is if this firepower is consistent with our mandate,” said Weidmann.

Asmussen said in a closing statement today that “the rule that you don’t fight the U.S. Fed now applies to the ECB.” The ECB has established that it is the strongest player in the market “through the announcement of the OMT,” he said.

Germany’s top court is reviewing suits by political groups, professors and lawmakers who argue the ECB’s OMT program and the European Stability Mechanism violate European laws and the constitutional principle of democracy.

Clemens Fuest, president of the ZEW Center for European Economic Research in Mannheim, Germany, told the judges there’s no clear boundary between monetary and fiscal effects of such a policy. Every purchase of government bonds has the effect that it becomes easier for the country to refinance itself, he said.

‘Gray Area’

“It’s a gray area,” said Fuest. “But I think the main effect of the ECB’s policies is to ease access of these countries to the financial markets. That doesn’t mean, however, that the bank didn’t have any monetary considerations” for the OMT.

Fuest backed claims that German lawmakers can’t control how big the liabilities will be under the rescue policies. While they have a say on the debt Germany assumes under the ESM, they cannot steer how much the OMT may cost in the end.

“As a lawmaker, I would have to ask how much taxpayer money I would put at risk when voting on an ESM rescue program,” said Fuest. “Well, I couldn’t answer that question.”

Ulrich Haede, a lawyer for the government, argued that Germany wouldn’t automatically have to pay for any losses the ECB incurs, since central banks usually carry losses forward. The issue would only arise if at some point the euro member states needed to recapitalize the ECB, he said.

Troubled States

Vosskuhle said that all the experts asked to speak yesterday and today -- including those backing the ECB’s strategy -- acknowledged that the OMT has effects that help troubled states to refinance, and that this is somehow also intended.

Fuest and Hans-Werner Sinn, president of the Ifo research institute, told the court a waiting period for buying bonds -- one of the caveats under the OMT cited by Asmussen yesterday -- wouldn’t avoid risking government financing via the OMT.

“It doesn’t matter that the ECB says it will wait a period of time before buying bonds,” said Sinn. “It only matters to the markets that the ECB is there in the end to buy the bonds.”

On whether it would be a viable option to refine the rules on what the ECB may do under its mandate, Vosskuhle asked if there was potential room for maneuver.

Possible ‘Leeway’

“Maybe there is a way to fence in the leeway somehow,” said Vosskuhle. “We have to think about how to empower the guarantees of our constitution, that’s why that question is important.”

Asmussen replied that it is a very German approach to think of additional rules to restrict the ECB under EU law. He warned that any new discussion over the ECB’s rules could also take a direction Germany wouldn’t want.

If the court comes to the conclusion that there is a violation of EU rules, everything points toward sending the case to the European Court of Justice to seek its guidance, Vosskuhle said, replying to a plaintiff lawyer who argued against that step because the EU’s top judges would clear the ECB action in any case.

“The fact that you expect a ruling you don’t like isn’t an argument for us not to send the case” to the ECJ, said Vosskuhle.

A ruling is expected later this year.

The cases are BVerfG, 2 BvR 1390/12 et al.

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