buiter14_Sebastian Gollnowpicture alliance via Getty Images_ECBbondsGermanycourt Sebastian Gollnow/picture alliance via Getty Images

Germany’s Judges Declare War on the ECB

In a new ruling, Germany's highest court has threatened to throw a wrench into the European Central Bank's efforts to extend liquidity and other forms of assistance to distressed eurozone governments. Coming amid a deep economic crisis, the court's decision could force one or more countries to crash out of the monetary union.

NEW YORK – Germany’s Federal Constitutional Court has just set in motion a process that could culminate in the unraveling of the European Economic and Monetary Union. The court has ruled that, following a transitional period of no more than three months, the Bundesbank may no longer participate in the eurozone’s Public Sector Purchase Program (PSPP), unless the European Central Bank demonstrates that the policy’s objectives are “not disproportionate to the economic and fiscal policy effects resulting from [it].”

The court’s decision covers the period between the PSPP’s first asset purchases on March 9, 2015, and the reinvestments phase that began on January 1, 2019, thus effectively stopping the clock on November 8, 2019, when cumulative PSPP purchases amounted to nearly €2.1 trillion ($2.3 trillion). Primarily at issue is a ruling in December 2018 by the Court of Justice of the European Union (CJEU), which itself contained two key elements.

First, the CJEU ruled that the PSPP did not circumvent Article 123 of the Treaty on the Functioning of the European Union (TFEU), which prohibits the monetary financing of member states’ budgets. Second, it decided that the program also did not violate the “principle of proportionality,” under which “the content and form of Union action shall not exceed what is necessary to achieve the objectives of the Treaties.”

The German court does not dispute the first point, nor does it address more recent measures taken to address the COVID-19 pandemic, such as the expansion of the PSPP to include a €750 billion Pandemic Emergency Purchase Program, or the ECB’s most recent targeted bank-lending operations. But it does reject (rather contemptuously) the CJEU’s conclusion about the principle of proportionality. In the German court’s view, the CJEU’s ruling on this point went far beyond its legal authority as stipulated in the Treaty on European Union.

Indeed, the German court openly questions the CJEU’s legal competence, explaining that it will respect CJEU decisions, “as long as the CJEU applies recognized methodological principles and the decision it renders is not arbitrary from an objective perspective.”The implication, of course, is that the CJEU has not satisfied this basic criterion.

Citing Articles 5.1, 5.2, and 5.4 of the TEU, the German court then rubs the point in further. “The CJEU held that the Decision of the ECB Governing Council on the PSPP and its subsequent amendments were still within the ambit of the ECB’s competences,” the judges state. “This view manifestly fails to give consideration to the importance and scope of the principle of proportionality … and is simply untenable from a methodological perspective given that it completely disregards the actual economic policy effects of the program.”

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To my mind, it is remarkable that the German court has gone so far as to dispute the PSPP’s wider economic-policy effects, above and beyond what it may have achieved (and continues to achieve) in terms of keeping eurozone inflation “below, but close to 2%.” Did the German court summon a panel of expert witnesses comprising Old and New Keynesians, Monetarists, behaviorists, and Marxists to provide evidence of these supposed effects?

This is not to jest, because the situation is very serious. It is highly unlikely that the ECB Governing Council will offer a narrative that will convince the German court that “the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the program.” After all, the PSPP clearly has a significant effect on the terms on which some member states can access sovereign-debt markets. Italy is an obvious example. So, too, is Greece, following the ECB’s decision to include sub-investment-grade public debt in the PSPP.

Looking ahead, as public-sector deficits expand as a result of the pandemic response, PSPP purchases of sovereign debt may become important drivers of sovereign borrowing costs and even of sovereigns’ market access. If Germany were suddenly to say “nein” to the PSPP, one or more eurozone countries could be forced to crash out of the monetary union.

Worse, the German court’s ruling touches on much more than the PSPP/sovereign-debt nexus. For example, the judges also express concerns about the effects of ECB asset purchases not just on banks’ balance sheets and interest rates, but also on zombie companies, and thus on potentially every saver, lender, real-estate owner, and insurance-policy holder in the eurozone.

Yes, portfolio-balance considerations imply that quantitative easing and qualitative easing affect asset yields and prices, and thus real economic activity and the economic wellbeing of domestic and foreign residents. These are legitimate issues for the ECB, the European Parliament, and the European Council to consider. But they are no business of the German court.