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Law Meets Economics in the German Federal Constitutional Court: Outright Monetary Transactions on Trial

Published online by Cambridge University Press:  06 March 2019

Carsten Gerner-Beuerle ,
Esin Küçük  and
Edmund Schuster

Extract

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The Eurozone banking and sovereign debt crisis has brought the fragility of the European monetary union into sharp focus and exposed the lack of effective instruments at the European level to maintain financial stability. As a response to the crisis, the Member States and the institutions of the Union adopted in short succession several financial assistance measures that have given rise to much political and legal controversy. The European Central Bank (ECB) played an active role in the institutions' efforts to contain the crisis and prevent the disintegration of the Eurozone by deploying a number of so-called non-standard or unconventional monetary policy measures, namely its Securities Markets Programme, Long-Term Refinancing Operations, and in September 2012 the Outright Monetary Transactions Programme (OMT Programme). The OMT Decision envisages unlimited purchases by the ECB of specific types of sovereign bonds issued by Member States participating in an EFSF/ESM macroeconomic adjustment or precautionary program in the secondary market. Without the program having been activated, i.e. without the ECB actually implementing the decision and without any purchases of government bonds, yields on bonds of the affected Eurozone countries decreased markedly after the announcement of the OMT Decision. The OMT Programme has accordingly been credited with having been instrumental in restoring financial stability and preventing a breakup of the Euro area and with being one of the most effective announcements any central bank has ever made.

Type
Research Article
Information
German Law Journal , Volume 15 , Issue 2: Special issue - The OMT Decision of the German Federal Constitutional Court , 01 March 2014 , pp. 281 - 320
Copyright
Copyright © 2014 by German Law Journal GbR 

References

1 The most important rescue measures were: Council Regulation 407/2010, 2010 O.J. (L 118/1) (EC) (establishing a European Financial Stabilisation Mechanism (EFSM)); European Financial Stability Facility (EFSF), EFSF Framework Agreement (2010) (establishing the EFSF on the basis of an intergovernmental agreement of the Eurozone Member States on May 9, 2010); Treaty Establishing the European Stability Mechanism (ESM), Feb. 2, 2012, 2011 O.J. (L 91) 1 - The rescue measures have been the subject of a number of legal challenges, see, e.g., Case C-370/12 Thomas Pringle v Government of Ireland, Ireland and The Attorney General, Judgment of 27 November 2012, n.y.r.; and the decisions of the German Federal Constitutional Court: Bundesverfassungsgericht [BVerfG - Federal Constitutional Court] Case No. 2 BvR 1099/10, 126 Entscheidungen des Bundesverfassungsgerichts [BVerfGE] 158 (June 9, 2010), http://www.bundesverfassungsgericht.de/en/index.html; 129 BVerfGe 124 (ESF); 130 BVerfGe 318 (StabMechG); BVerfG, Case No. 2 BvR 1390/12 (Sep. 12, 2012), http://www.bundesverfassungsgericht.de/en/index.html (ESM Judgment).Google Scholar

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40 See OMT Ruling at para. 98.Google Scholar

41 The Constitutional Court continues by stating that bond spreads are therefore “regardless of their rationality, essential for market-based pricing.” OMT Ruling at para. 98. It is hard to see content in this statement—bond spreads (i.e. here the difference between the bond yields of different Member States) are not “essential” for market-based pricing, they are the result of pricing, whether rational or irrational, and whether market-based or not.Google Scholar

42 In the current context, it is best to view the yields in German sovereign bonds as representing this “risk-free” interest rate. See, e.g., Grauwe, Paul De, The European Central Bank as Lender of Last Resort in the Government Bond Markets, 59 CESifo Econ. Studies 520, 529 (2013).Google Scholar

43 This is a (highly) simplified version of the currency crisis model described in Romer, David, Advanced Macroeconomics 632 (4th ed. 2012).Google Scholar

44 Creditors will have certain expectations as to the extent to which revenue can be increased or public expenditures reduced without rendering the option of defaulting relatively more attractive.Google Scholar

45 In essence, the term structure of a country's indebtedness determines the proportion of a country's debt that falls due and thus must be refinanced every year.Google Scholar

46 See the literature cited supra at note 39 and accompanying text.Google Scholar

47 We will ignore the fact that countries indebted in a currency they control themselves cannot (at least under normal circumstances) “default” in the traditional sense, given that they can always print enough money to satisfy any creditors’ claims (albeit at the cost of creating inflation).Google Scholar

48 See, for example, Romer, supra note43, for a formal model of this process.Google Scholar

49 Let us assume that a country has a probability of default of 5%, if it were to pay the risk-free interest rate. Since 5% is too high a risk for only receiving the risk-free rate, investors demand a higher return. The country doubles the interest rate, but as a result its default probability rises to, say, 15%. Investors may say that a default probability of 15% is too high, even at the higher interest rate. Further increases of the interest rate always lead to the same result —investors are not interested in an investment. There thus exists no equilibrium in which the country avoids default, unless the country receives a wealth transfer that, for instance, reduces the amount of its outstanding debt and thus the probability of default.Google Scholar

50 TFEU arts. 119(2), 127; Protocol on the Statute of the European System of Central Banks and of the European Central Bank, art. 2, 2012 O.J. (C 326) 230. The main principles defining the role and institutional structure of the European System of Central Banks and the ECB, including an emphasis on price stability, were already laid down in the Delors report. See Committee for the Study of Economic and Monetary Union, Report on economic and monetary union in the European Community 21–23 (1989).Google Scholar

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52 See the original version of the German Bundesbank law establishing the central bank: Gesetz über die Deutsche Bundesbank [Law on the German Bundesbank], Bundesgesetz Blatt I [BGBl. I – Federal Law Gesetz] §§ 3, 12 (1957). Research indicates that the ECB's independence is even more pronounced than that of the Bundesbank. For a review of these findings and a critical discussion, see Lorenzo Bini Smaghi & Daniel Gros, Open Issues in European Central Banking 125–132 (2000).Google Scholar

53 Thygesen, Niels, The Delors Report and European Economic and Monetary Union, 65 Int'l Aff. 637, 646–647 (1989). Price stability continues to be of central concern to the Bundesbank. For this reason, the German Central Bank was critical of the ECB's actions during the financial crisis, see for example: Weidmann, Jens, Eingangserklärung anlässlich der mündlichen Verhandlung im Hauptsacheverfahren ESM/EZB [Opening Statement at the hearing in the proceedings for ESM/ECB] (June 11, 2013), available at http://www.bundesbank.de/Redaktion/DE/Kurzmeldungen/Stellungnahmen/2013_06_11_esm_ezb.html, and the Bundesbank's submission in these proceedings, pp. 12–13, available at http://www.bundesbank.de/Navigation/DE/Presse/Stellungnahmen/stellungnahmen.html.Google Scholar

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55 This view goes back to Friedman, Milton, The Role of Monetary Policy, 58 Am. Econ. Rev. 1 (1968). For this reason, standard economic theory speaks of the “long-run neutrality” of money. For a non-technical overview, see ECB, The Monetary Policy of the ECB 55 (3rd ed. 2011), available at http://www.ecb.europa.eu/pub/pdf/other/monetarypolicy2011en.pdf.Google Scholar

56 Id. at 10.Google Scholar

57 There is some disagreement about the intermediate target the central bank should choose in order to achieve the policy goal of price stability. Friedman, id. at 15, favored a monetary total, while several central banks now target inflation. See De Grauwe, supra note 26, at 197. The ECB follows a two-pillar approach, consisting of economic and monetary analysis. As far as economic analysis is concerned, the ECB reviews a broad range of real variables, cost and price indicators, and fiscal policy in order to assess the likely development of prices and identify potential threats to price stability. Monetary analysis seeks to identify the growth rate of the money stock, which is associated with inflation in the medium to long run. On the basis of the information from both pillars, the ECB's Governing Council then takes its monetary policy decision. See ECB, supra note 55, at 69–82, for an explanation of both pillars in detail.Google Scholar

58 A notable exception is the Federal Reserve System of the United States, which pursues price stability as one of several policy goals on an equal footing. See Apel, Emmanuel, Central Banking Systems Compared: The ECB, the preeuro Bundesbank, and the Federal Reserve System 31–32 (2003).Google Scholar

59 See, e.g., Grauwe, De, supra note 26, at 190; Issing, Otmar, A New Paradigm for Monetary Policy, 16 Int'l Fin. 273, 279 (2013).Google Scholar

60 ECB, supra note 55, at 83.Google Scholar

61 Id. at 84–85. See id. at 64, for a formal definition of “price stability.”Google Scholar

62 See supra note 57 and accompanying text.Google Scholar

63 ECB, supra note 55, at 85. The ECB does not see the task of monetary policy as having to prevent asset bubbles from occurring or “pricking” such bubbles. The bank therefore emphasizes that it is important to adopt a carefully calibrated response that does not affect economic growth and takes into account that policy makers may have difficulties in assessing whether a speculative bubble is in the process of forming. See id. at 84–85.Google Scholar

64 In the German language version of the decision the Court uses the word “konterkarieren.”Google Scholar

65 OMT Ruling at para. 70.Google Scholar

66 Id. Google Scholar

67 Id. at para. 69.Google Scholar

68 Id. at para. 72.Google Scholar

69 Id. Google Scholar

70 See id. at paras. 95–97, in particular para. 96: “The fact that the purchase of government bonds can, under certain conditions, help to support the monetary policy objectives of the European System of Central Banks [here the correction of a disruption to the transmission mechanism] does not turn the OMT Decision itself into an act of monetary policy.”Google Scholar

71 Id. at para. 69.Google Scholar

72 In order to substantiate that this is the aim of the decision, the Constitutional Court makes references to ECB, Monthly Bulletin 7 (Sep. 2012); ECB, Monthly Bulletin 7–8 (Oct. 2012). See OMT Ruling at para. 70. However, the ECB's explanation in these documents shows clearly that the intended economic effect of OMTs is not simply to neutralize spreads (see also the discussion in the text immediately following this footnote). On p. 7 of the Monthly Bulletin September 2012, the ECB states:Google Scholar

OMTs aim at safeguarding the transmission mechanism in all euro area countries and the singleness of the monetary policy. OMTs will enable the Eurosystem to address severe distortions in government bond markets which originate, in particular, from unfounded fears on the part of investors of the reversibility of the euro, as reflected, inter alia, in widening differences in the pricing of short-term sovereign debt up to July 2012. … In such an environment, OMTs will provide a fully effective backstop to avoid destructive scenarios with potentially severe challenges for price stability in the euro area.

ECB, Monthly Bulletin 7 (Sep. 2012). On p. 8 of the Monthly Bulletin October 2012, the ECB states:

[S]pecific operational modalities have been set up to ensure that OMTs do not interfere with the three objectives of the monetary financing prohibition, namely safeguarding (i) the primary objective of price stability, (ii) central bank independence, and (iii) fiscal discipline. A major concern has been the need to ensure that this monetary policy instrument could not ultimately weaken fiscal discipline. … The current situation is characterised by severe distortions in government bond markets which originate, in particular, from unfounded fears on the part of investors of the reversibility of the euro. This translates into severe cases of malfunctioning in the price formation process in the government bond markets, which undermines the functioning of the monetary policy transmission mechanism.

ECB, Monthly Bulletin 8 (Oct. 2012).

73 For a discussion of the moral hazard problem and its implications for the role of the central bank see, for example, Bini Smaghi & Gros, supra note 52, at 45–49.Google Scholar

74 See supra Part C.Google Scholar

75 See supra Part C.II. For a model specifically dealing with members of a monetary union, see De Grauwe & Ji, supra note 28, at 33–35. It is important to note that this problem is particularly pronounced in a monetary union, because member countries cannot provide for potentially unlimited liquidity, see id. at 35.Google Scholar

76 See ECB, Monthly Bulletin 7 (Sep. 2012), supra note 72; ECB, Monthly Bulletin 7–8 (Oct. 2012), supra note 72; and Introductory statement to the press conference with Q&A (Sep. 6, 2012), available at http://www.ecb.europa.eu/press/pressconf/2012/html/is120906.en.html (explanations of Mario Draghi after the OMT Decision was taken). In the Q&A session, Draghi is very clear:Google Scholar

[T]he assessment of the Governing Council is that we are in a situation now where you have large parts of the euro area in what we call a “bad equilibrium”, namely an equilibrium where you may have self-fulfilling expectations that feed upon themselves and generate very adverse scenarios. So, there is a case for intervening, in a sense, to “break” these expectations, which, by the way, do not concern only the specific countries, but the euro area as a whole. And this would justify the intervention of the central bank. But then, we should not forget why countries have found themselves in a bad equilibrium to start with. And this is because of policy mistakes. That is why we need both legs to fix this situation and move from a bad equilibrium to a good equilibrium. If the central bank were to intervene without any actions on the part of governments, without any conditionality, the intervention would not be effective and the Bank would lose its independence. At the same time, we see that we are in a bad equilibrium and, therefore, policy action, though convincing, does not seem to produce – at least not in the relatively medium term – the results for which it is geared. So that is why we need both legs for this action.

77 ECB, Monthly Bulletin 7 (Sep. 2012).Google Scholar

78 OMT Ruling at para. 71; para. 98 (“[T]he distinction between rational and irrational is meaningless”).Google Scholar

79 See De Grauwe & Ji, supra note 28 (calculating the part of the surge in spreads of peripheral Eurozone countries that was disconnected from underlying increases in the debt to GDP ratios and fiscal space variables and arguing that this part was associated with negative self-fulfilling market sentiments); Poghosyan, Tigran, Long-Run and Short-Run Determinants of Sovereign Bond Yields in Advanced Economies, IMF Working Paper 12/271 (2012) (arguing that “that spreads against Germany in some European periphery countries exceeded the level determined by fundamentals in the aftermath of the crisis, while some North European countries have benefited from ‘safe haven’ flows”).Google Scholar

80 See, e.g., Shleifer, Andrei, Inefficient Markets: An Introduction to Behavioral Finance (2000).Google Scholar

81 See Herrmann, Christoph, EZB-Programm für die Kapitalmärkte verstößt nicht gegen die Verträge, 21 Europäische Zeitschrift für Wirtschaftsrecht (EuZW) 645, 646 (2010); Herrmann, Christoph, Die Bewältigung der Euro-Staatsschulden-Krise an den Grenzen des deutschen und europäischen Währungsverfassungsrechts, 23 Europäische Zeitschrift für Wirtschaftsrecht (EuZW) 805, 811 (2012).Google Scholar

82 OMT Ruling at para. 100.Google Scholar

83 The Constitutional Court seems to believe that the allocation of competences in Articles 139 and 140 TFEU apply generally to any question concerning the “composition of the euro currency area.” OMT Ruling at para. 72. The Court also refers to a press release of the ECB in which it allegedly claimed that the OMT Decision served to safeguard the current composition of the Eurozone. This press release—ECB Press Release of 26 July 2012—could not be retrieved by the authors. Possibly the Court means the speech by Mario Draghi given in London on 26 July 2012, in which he famously said that “the ECB is ready to do whatever it takes to preserve the euro,” but where he did not mention the composition of the euro area. Mario Draghi, President, European Cent. Bank, Global Inv. Conference in London (July 26, 2012), available at http://www.ecb.europa.eu/press/key/date/2012/html/sp120726.en.html (last visited Feb. 21, 2014). He also said on this and other occasions that it was the aim of the ECB to make the euro “irreversible.” Id. These statements were aimed at reassuring investors that the common currency would not disintegrate. They are, therefore, better understood as comments regarding financial stability concerns than the composition of the Eurozone.Google Scholar

84 See, for example, the original version of the German Bundesbank law establishing the central bank, supra note 52. “The German Bundesbank shall regulate, by exercising the powers in the field of monetary policy conferred on it by this law, the circulation of money and the supply of credit to the economy with the aim of protecting the currency. …” Id. Google Scholar

85 See supra text accompanying notes 59–63.Google Scholar

86 See supra note 50.Google Scholar

87 Id. art. 18.1.Google Scholar

88 Id. Google Scholar

89 Id. art. 19.Google Scholar

90 Pursuant to Article 18.1 of the Statute, the ECB and the national central banks may “operate in the financial markets by buying and selling outright (spot and forward) or under repurchase agreement and by lending or borrowing claims and marketable instruments. …” ESCB Statute, supra note 50, art 18.1.Google Scholar

91 The same arguments are used to substantiate a violation of Article 123 TFEU. See OMT Ruling at para. 87 and our analysis infra part D.II.Google Scholar

92 Id. Google Scholar

93 In fact, the ECB's inability to target its monetary policy, combined with a lack of fiscal coordination, can create moral hazard among Member States, as fiscal responsibility may be a sub-optimal strategy depending on the behavior of other Member States; see Bob Hancké, The Political Economy of Fiscal Policy in EMU, 1 Eur. Pol. Econ. Rev. 1 (2003) (analyzing the adoption of low inflation policies as a collective action problem for Member States).Google Scholar

94 See OMT Ruling at para. 87.Google Scholar

95 See ESM Treaty art. 18(2).Google Scholar

96 See Pringle, supra note 1.Google Scholar

97 See OMT Ruling at para. 76.Google Scholar

98 Id. Google Scholar

99 See supra Part C.II.Google Scholar

100 See the literature cited supra note 39.Google Scholar

101 See supra note 76 and accompanying text.Google Scholar

102 See OMT Ruling at para. 98.Google Scholar

103 See e.g. Spiegel, Mark M., Solvency Runs, Sunspot Runs, and International Bailouts, 65 J. of Int'l Econ. 203 (2005).Google Scholar

104 ESM Treaty art. 20.Google Scholar

105 See European Stability Mechanism, ESM Pricing Policy (2012), available at http://esm.europa.eu/pdf/Pricing%20guideline.pdf.Google Scholar

106 ESM Treaty art. 20.Google Scholar

107 See European Stability Mechanism, supra note 105, at 7.Google Scholar

108 See Press Release, European Stability Mechanism, ESM Issues Inaugural Long-Term Bond (Oct. 8, 2013), available at http://www.esm.europa.eu/press/releases/esm-issues-inaugural-long-term-bond.htm.Google Scholar

109 See Mnyanda, Lukanyo, Italian Bonds Rise as Five-Year Borrowing Costs Fall at Auction, Bloomberg (Dec. 30, 2013), http://www.bloomberg.com/news/2013–12–30/italian-bonds-advance-after-borrowing-costs-fall-at-debt-auction.html.Google Scholar

110 See Wise, Peter, Portugal Enjoys Strong Demand in Debt Sale, Financial Times (Jan. 9, 2014), http://www.ft.com/intl/cms/s/0/9b47af68–791a-11e3-b381–00144feabdc0.html#axzz2v17AUrMP.Google Scholar

111 TFEU art. 127(1); ESCB Statute, supra note 50, art. 2.Google Scholar

112 See Häde, Ulrich, in EUV/AEUV Article 127 TFEU, para. 5 (Christian Calliess and Matthias Ruffert eds., 4th ed. 2011).Google Scholar

113 OMT Ruling at para. 81.Google Scholar

114 The decision states that the “Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate.” Id. Google Scholar

115 See OMT Ruling at para. 82.Google Scholar

116 Id. Google Scholar

117 See supra text to notes 73–76 and 97–102.Google Scholar

118 On this standard of review see OMT Ruling at paras. 24, 37–38 and Part A above.Google Scholar

119 Id. at para 84 (translating from “dürfte … ebenfalls verstoßen”).Google Scholar

120 See OMT Ruling at paras. 84–94.Google Scholar

121 See also ESCB Statute, supra note 50, art. 21(1).Google Scholar

122 i.e. purchases directly from the issuer, and thus transactions where the price paid for the purchase of the debt instrument directly flows to the issuer (i.e. the sovereign debtor). This prohibition is explicitly made in Article 123 TFEU, although primary market purchases are clearly caught by the general prohibition of any “credit facility.”Google Scholar

123 i.e. purchases of such securities from bond holders after the issuance by the sovereign. Obviously, in such secondary market transactions, any purchase price paid by the ECB—or any other purchaser—flows to the seller of the bond, with no immediate impact on the credit position of the initial issuer.Google Scholar

124 The notion that secondary market purchases are in principle permissible has not been seriously questioned. See also ESCB Statute, supra note 50, art. 18 (providing explicitly for these transactions).Google Scholar

125 See also Council Regulation 3603/93, pmbl., 1993 O.J. (L 332) (EC) (“In particular, purchases made on the secondary market must not be used to circumvent the objective of that Article.”).Google Scholar

126 See ECB submission, http://www.handelsblatt.com/downloads/8135244/3/EZB%20Gutachten, 16–17.Google Scholar

127 Minus the negligible discount for overnight deposits.Google Scholar

128 See supra Part D.I.Google Scholar

129 OMT Ruling at para. 87.Google Scholar

130 Id. The Constitutional Court treats this aspect as two distinct points, but clearly they are inseparable.Google Scholar

131 The latter two points are also best treated together. See infra Part D.II.4.Google Scholar

132 See supra Part D.I.2.2Google Scholar

133 See, e.g., OMT Ruling at para. 100.Google Scholar

134 See OMT Ruling at para 71.Google Scholar

135 See supra notes 65–79 and accompanying text.Google Scholar

136 Or, at least, as long as no other mutualization of debts are expected by the market.Google Scholar

137 See the references supra note 4.Google Scholar

138 See supra Part D.I.2.2.Google Scholar

139 See e.g., Gärtner & Griesbach, supra note 39; De Grauwe & Ji, supra note 28.Google Scholar

140 See supra note 76.Google Scholar

141 See OMT Ruling at para 88.Google Scholar

142 See supra Part D.II.1.Google Scholar

143 OMT Ruling at para. 90.Google Scholar

144 Id. Google Scholar

145 Id. at para. 98.Google Scholar

146 See id. at paras. 92–94.Google Scholar

147 See supra Part D.II.1.Google Scholar

148 See OMT Ruling at para. 60; Case C-11/00 Commission v. ECB [2003] ECR I-7147.Google Scholar

149 In a way this would be akin to a “presumption of illegality”: whenever an EU law instrument gives discretion to an institution or an official, this discretion could in theory be used in an illegal way. It would hardly be practicable to have the Court—whether national or European—limit the discretion before it is exercised in order to ensure legality. Were that possible, competent legislators would rarely decide that vesting discretion is necessary in the first place.Google Scholar

150 See OMT Ruling at para. 100.Google Scholar

151 Id. at para. 27.Google Scholar

152 Bundesverfassungsgericht [BVerfG – Federal Constitutional Court], Case No. 2 BvR 2134/92, 2159/92, 89 Entscheidungen des Bundesverfassungsgerichts [BVerfGE] 155 (Oct. 12 1993), http://dejure.org/dienste/vernetzung/rechtsprechung?Gericht=BVerfG&Datum=12.10.1993&Aktenzeichen=2%20BvR%202134/92.Google Scholar

153 Id. at para. 92.Google Scholar