The German Constitutional Court Decision and the ECB

What it means

Jim Stewart25/06/2020

Ireland and other EU countries face many uncertainties relating to outcomes from Covid  19  and  Brexit.  To these must be added fallout from the German Constitutional Court (GCC)  decision in relation to the ECB bond  purchasing programme) .

The GCC decision followed an appeal of a ruling by the European Court of Justice (ECJ) to the GCC. The ECJ had ruled that the bond purchasing by the European Central Bank (ECB) was lawful under European Treaties. The judgement has been very controversial because rather than recognising the primacy of the European Court of Justice, the GCC decided that (1) it has the powers  to examine the ECJ December 2018 decision in terms of German law and (2) to overturn the ECJ decision.

An editorial in the Financial Times stated that  the ruling was of  monumental significance for the integrity of the EU.  This point is repeated by other commentators (Martin Wolf F.T. May 14; Willhelm Buiter, Project Syndicate May 6th 2020) .

 

The German Constitutional Court Decision.

The issue of what is an exclusive competency of EU institutions and Member States is central to the GCC judgement.  Monetary policy, within the Eurozone  is an exclusive competence of EU institutions ).  However Member State's fiscal policy is not an exclusive competence of EU institutions. The GCC argue that to safeguard the principle of democracy “the division of competences in the European Union be respected”, and the ECB bond-buying programme did not respect this division (GCC, par. 5 p. 2). 

 

The court ruled that following a transitional period of no more than three months:

the Budesbank may no longer participate in the  ‘further purchases of bonds’ or ‘an increase in the monthly purchase volume” (par. 235, GCC).

These findings are followed by an important caveat:-

 “unless the EC Governing Council adopts a new decision that demonstrates in a comprehensible and substantiated manner that the monetary policy objectives pursued by the ECB are not disproportionate to the economic and fiscal policy effects resulting from the programme”.

 

This caveat may provide a possible solution to the continued existence of the Bundesbank in the ECB bond-buying programme, but the continued participation of the ECJ as the court of last appeal in relation to EU treaties is now in doubt.

Not surprisingly, countries in dispute with the European Union and facing adverse decisions from the ECJ have applauded this decision.  For example, the deputy justice Minister of Poland stated:-

This judgment shows that in the dispute over the ability to reform the Polish judiciary, the Polish government is in the right. We’ll defend this position, and now we have another argument in hand,” (Politico, 13th May 2020).

 

The ECB Bond-Buying Programme

The ECB Government  bond-buying programme is regarded as a key  response to the financial crash of 2008-2012.  The ECB bond-buying programme has ensured financial stability and enabled Government borrowing to be financed at  historically low interest rates.

The ECB initiated a further €750 billion bond buying programme on March 18th, 2020 in response to the Coviv-19 economic and social crisis. This programme was extended to include non-financial commercial paper, as well as relaxing rules relating to the risk of assets accepted in exchange for refinancing.  The ECB also statedThe Governing Council will do everything necessary within its mandate”.  

The problem is the ECB  has a very large bond-buying programme, but then in three months, a key member, Germany is prohibited from participating.

 

The Court Decision Makes some valid Points

Although extensively criticised, the GCC judgement has valid points.  It  poses difficult questions about the relationship between monetary and fiscal policy.  This is  important because the GCC consider European Treaties as giving   “an absolute prohibition on monetary financing.  It does not leave room for interferences on the grounds that the relevant measures are necessary and justifiable” (par. 196).

Article 123 (1) of the  Treaty on the Functioning of the European Union (TFEU) states that the ECB may not provide “overdraft facilities” or “any other type of credit facility to EU institutions or national governments” or purchase debt instruments from them. This means that the ECB may not directly finance Governments, EU institutions and other public bodies.  This is referred to several times in the GCC judgement as a “prohibition on monetary financing”. However purchases of already issued government debt (subject to certain restrictions) are not regarded as monetary financing (par. 70 of CCG judgement).

In practice there is  a considerable overlap between monetary and fiscal policy. Government deficits and their financing are a key part of fiscal policy. Government debt/GDP ratios expanded rapidly in the  Great Financial Crash and will exceed these levels in the current crisis.

This overlap is acknowledged by the ECB. The judgement states (par 50) That the TFEU “contains no precise definition of monetary policy but defines both the objectives of monetary policy and the instruments available” and in par (6)  “the authors of the Treaties did not intend to make an absolute separation between economic and monetary policy”.

 

Economic Policy and Democratic decision Making

The de facto mixing of monetary and fiscal policy raises issues relating to the democratic control of economic policy. Within the parameters of EU law, all member states have considerable discretion in relation to fiscal policy.  This is underwritten by Union treaties. The TFEU, (Article 192) states that decisions by the EU of a fiscal nature can only be made if agreed unanimously by Member States at the European Council.  This gives rise to the famous ‘veto’ of Member States in relation to tax changes.

The GCC ruled that ECB decisions lacked “the minimum of democratic legitimacy’” to be compatible with EU treaties, although they did not “violate the [EU Treaty] prohibition of monetary financing” (par. 116).  The court argued that because of the absence of democratic legitimacy the principle of “proportionality” in EU decision making is vital.  That is acts of EU institutions must “be appropriate for attaining the legitimate objectives pursued by the legislation at issue and do not exceed the limits of what is appropriate and necessary in order to achieve those objectives” (par. 126).

Member States do not have democratic control of the ECB.  Article 130, TFEU, specifically prohibits national Central Banks and the ECB from taking instructions from “any government of a  Member State or from any other body”.  The independence of  National Central Banks in modern central banking theory has been incorporated in national law of individual states for many years, with consequent issues of democratic accountability.

There is democratic accountability for other functions performed by Central Banks, which are specified and may change via legislation, with implications for monetary policy, such as prudential regulation of banks and Central Banks are accountable to national Parliaments for these functions.  For example, the Irish Central Bank regularly appears before the Joint Committee on Finance, Public Expenditure and Reform.  Likewise, the ECB reports to the European Parliament to “explain the ECB’s reasoning and decisions on specific topics” so that they may  “form a judgement on the ECB’s performance against its objectives, which are specified in the Treaty on the Functioning of the European Union”.

 

Possible Solutions

The solution to increased democratic accountability of the ECB is to provide additional documentation and reporting by the ECB to the European Parliament and to its specialised committees.

The solution to the GCC decision – that the ECB should conduct a proportionality assessment of the bond buying programme is simple and most likely easily done. The problem is who should tell the ECB ?  Under the TFEU, the ECB is sovereign and independent and subject only to the ECJ.  A secondary problem is why would the ECB respond to such a request? The ECB has already decided that it will ignore the judgement. A further bond-buying programme has already been initiated.

One suggested solution is that  Bundesbank provides that assessment on behalf of the ECB. This is the option suggested by an expert group from the Bundestag (Reuters June 15th 2020), and the Bundesbank is to begin providing quarterly reports to the Bundestag (Derek Scally, Irish Times 19th June, 2020).  In addition the ECB will publish in full an official accounts of its last monetary policy meeting and provide some unpublished documents to the Bundesbank (Financial Times 22 June 2020).

The German Chancellor, Ms Merkel has been quoted as stating “the issue is solvable, but also stated that the issue had become more complicated" because of comments by the Polish Prime Minister who had described the judgement as  “one of the most important rulings in the history of the European Union” (Guardian 11th May 2020).

Unease at support from Poland and other countries had also been expressed by one of the key judges (Judge Huber) involved in drafting the judgement. In an newspaper interview  (Sueddeutsche Zeitung), he stated simply: “We got a lot of applause from the wrong side”,  (Bloomberg, May 13th 2020). 

This ‘unease’ may reflect the danger of unintended consequences from the GCC ruling.  The President of the General Court of the EU has stated that  the judgement could lead  to the “dismantling of the rule of law in certain member  states” with the implication "If the rule of European law no longer applies in these countries, they will be outside the EU’s legal order and will de facto withdraw from the common project".  Effectively, they exit from the EU.

The division of competencies between EU institutions and Member States creates numerous ambiguities and scope for litigation following the GCC precedent. A former advocate General at the European Court of Justice considers that the GCC judgement is “likely to lead, not only to increased tensions between national constitutional courts and the ECJ, but between those national constitutional courts themselves”. 

Some may approve of the GCC judgement that the competences of the EU and the  “insatiable ambition for aggrandisement” of the ECJ must be limited (M. McDowell, Irish Times 20th May 2020) and that “our own [Ireland] interests may lie in keeping a limited role for the CJEU as a treaty tribunal”.

This thinking may be reflected in the recent Programme for Government, which states  the 12.5 % tax rate is recognised as a “national competence”. This defence is very different from the recent Fianna Fail and Fianna Gael 2020 election  manifestos.  The Fine Gael manifesto (2020, p. 51 ) repeated a commitment to the 12.5% Corporation Tax Rate and the “retention of national sovereignty over taxation policy”. The Fianna Fail Manifesto stated the 12.5% rate is the “cornerstone of our Foreign Direct investment strategy” and FG is“committed to defending it”.

 

Conclusion: Appropriate Economic Policy and Existing EU Treaties

The GCC has made some valid  points in relation to the rule of law and economic decision making within the EU. The problem is that while the bond-buying programme may violate aspects of German basic law, in a political and economic context, it has been a success. It has prevented EU disintegration. It has helped member states with large deficits  to finance their deficit, though supporting the market in Government debt to the great advantage of EU citizens. Many other non-EU countries have undertaken these policies. 

The issues on how economic policy should be pursued within EU Treaties -written for a very different world - is difficult.  Determining what the  words used by “authors” of the Treaties mean (as referred to in GCC judgement), if they could have foreseen the future, is not a rational way to determine policy. 

 

 

Posted in: Banking and financeEconomicsEurope

Tagged with: bondmarketcentralbankECBeuEurobondsmonetary policy

Prof Jim Stewart

James Stewart

Dr Jim Stewart is Adjunct Associate Professor at Trinity College Dublin. His research interests include Corporate Finance and Taxation, Pension Funds and financial products, Financial Systems and Economic Development.

He is widely published and his titles include Mutuals and Alternative Banking: A Solution to the Financial and Economic Crisis in Ireland (2013), Choosing Your Future: How to Reform Ireland's Pension System (co-author, 2007) and For Richer, For Poorer: An Investigation of the Irish pension system (2005).


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