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Germany’s Pyrrhic Victory

BERLIN – The German Constitutional Court has ruled against the European Central Bank’s pledge to buy potentially unlimited quantities of distressed eurozone countries’ government bonds, and has called on the European Court of Justice (ECJ) to confirm its decision. Until that happens, the “outright monetary transactions” (OMT) scheme is effectively dead, weakening the ECB’s ability to act as an effective and credible financial-market backstop at a time when European governments remain unwilling to fill the void.

The German court considers OMT a violation of the ban on monetary financing of governments. According to the court, the scheme can be legal only if it is limited in size ex ante, rules out losses on sovereign debt, and avoids “interferences with price formation on the market.” The problem is that almost all ECB policies would violate these principles, which is why the ruling represents a severe setback for Europe.

To be sure, the ECB could, in principle, still use OMT, at least until the ECJ rules on the case. In practice, however, rising opposition in Germany to OMT and other ECB policies will make it impossible to use the program as intended – that is, to intervene effectively in sovereign-bond markets to stem a panic.

Limiting the ECB’s purchases of government bonds ex ante, as the German court requires, would be nonsensical, because it could easily invite market speculation. As a result, the ECB will have to use alternative policy tools to deal with dysfunctional financial markets. That means focusing once again on supporting banks, as well as deploying new instruments that have a more direct effect on crisis countries’ firms and households.