The ECB Grows Up

BERKELEY – August 2 marked the first anniversary of the European Central Bank’s “outright monetary transactions” program, under which it stands ready to purchase government bonds on the secondary market. The ECB announced OMT in response to last summer’s panicked sales of southern European sovereign debt, which threatened to blow apart the eurozone.

At one level, the anniversary was a happy one. Yields on Spanish and Italian bonds, which had risen to unsustainable heights over fears of a eurozone breakup, fell sharply after the announcement. They have remained at lower levels ever since, despite little visible improvement in the European economy. Perhaps best of all, the ECB has never had to activate the facility. It has not actually bought any bonds under the program. Its promise to act was enough to calm markets.

But the OMT scheme is also condemned for exceeding the ECB’s mandate. Critics view it as a devious attempt to circumvent the prohibition on the ECB’s direct purchases of eurozone governments’ bonds. It is thus a source of moral hazard, for it relieves pressure on spendthrift politicians to balance budgets and push ahead with reforms. In addition, it is seen as exposing the ECB’s principal shareholders, notably Germany, to the risk of losses on their holdings of southern European bonds.

Earlier this summer, these issues were the subject of two days of hearings before Germany’s Constitutional Court, which will issue its ruling shortly. If it finds that the OMT program is inconsistent with the German Constitution, it could force the Bundesbank to withhold its participation. It might even force the ECB to abandon OMT.