On 5 May, the German Constitutional Court’s ruling questioned the legality of the European Central Bank (ECB)’s purchases of sovereign bonds, which play a key role in preventing an implosion of the Eurozone. Where is this judgement coming from and what are its political, legal and macroeconomic potential consequences?
The German Constitutional Court's ruling of the 5th of May is a turning point in the judicial history of the European Union (EU) and the Eurozone. The Bundesverfassungsgericht (BVerfG)'s Second Senate ruled by seven votes to one that the legality of the European Central Bank (ECB)'s main asset purchasing programme was questionable. This decision is unprecedented as it contradicts a previous ruling of the Court of Justice of the European Union (CJEU) that declared the ECB's Quantitative Easing (QE) programme legal and in line with the European Treaties. In addition, the German court ruling oblige the Bundesbank (Germany's central bank) to end its participation in the ECB's asset purchase within three months, unless the ECB justifies adequately its bond purchases. The Bundesbank would also have to sold the German government's bonds it bought under this asset purchase programmes, thus threatening Eurozone's macroeconomic stability in the midst of its worst economic crisis since its creation. This contribution aims at explaining the context surrounding the 5th of May ruling, describes its main aspects and analyses both its political and economic consequences for the euro area.
The origin of the 5th of May ruling is the gap between the unconventional measures implemented by the ECB in response to the 2008 financial crisis (and its deepening into a sovereign debt crisis since 2010) and the initial ordoliberal model of the ECB. Indeed, at its foundation, the ECB was designed on the model of the Bundesbank, as an independent central bank whose main objective would be to maintain price stability. The very high degree of independence of the central bank from political institutions is legally enshrined in the EU Treaties, as well as the priority given in its mandate to the struggle against inflation. Furthermore, the Maastricht treaty forbid monetary financing that is the direct financing of governments' expenses by the central bank. These features illustrate the embeddedness of the ordoliberal paradigm in the ECB original design.
Since 2010, in order to avoid a collapse of the financial system, the ECB developed three asset purchases programmes that consist in buying bonds (including governments bonds, i.e. sovereign debt of Eurozone member States) in the financial markets. These purchases aimed at avoiding deflation in the euro area, as well as preventing its implosion in the context of rising borrowing costs in the financial markets for peripheral countries (Greece, Italy, Spain, Portugal). These purchases of sovereign bonds met with strong opposition from German ordoliberal elites who perceived them as deviation from the original model of the central bank thus paving the way for risk-sharing and fiscal transfers between euro area countries. According to these critics, the repurchasing of governments bonds on the secondary market by the central bank would give a free ride to highly indebted peripheral states on the back of German savers. A group of German ordoliberal activists with strong connections with the Alternative für Deutschland (AfD) systematically challenged in court the legality of these three asset purchases programmes, both before the German Constitutional Court and the CJEU. They claimed these purchases violate the EU Treaties as they overstep the ECB's mandate and consist of debt monetization.
These judicial procedures followed a similar sequence, with the German Constitutional Court referring questions on the legality of the purchases to the CJEU, which then rules on these questions and, based on the CJEU's judgment, the German judges make their final decision. This sequencing stems from the EU legal order established by the Treaties since the beginning of European integration that is based upon the principle of primacy of EU law over the national legal systems. Hence, the CJEU has an exclusive competence to interpret the EU Treaties as well as controlling the compatibility of actions of EU institutions with the law of the EU. Therefore, the ECB's actions fall under the exclusive jurisdiction of the CJEU, thus compelling the German Court to request the opinion of the CJEU. In the case of the two first asset purchase programmes, the CJEU validated their legality and the German Constitutional Court accepted and followed these decisions in its final judgments, despite voicing concerns in accordance with the plaintiffs' arguments. The 5th of May ruling is a turning point as, for the first time, the German Constitutional Court rejected the CJEU's assessment about the legality of the third ECB purchase programme and stated that it is not bound by the CJEU's decision.
Launched in March 2015, this programme (the Public Sector Purchase Programme - PSPP) is still ongoing and is so far the largest ECB asset purchase programme by its size: more than 2.150 billion euros worth of sovereign bonds were repurchased on the secondary market under this programme. As soon as the ECB launched the PSPP, the German ordoliberal moral entrepreneurs lodged a complaint before the German Constitutional Court, whose 2017 preliminary ruling stated that the PSPP violated the EU Treaties but referred to the CJEU for its opinion. The German judges notably declared that sovereign debt purchases resemble monetary financing and also characterise as fiscal policy, thus exceeding the ECB's mandate that is strictly confined to monetary policy by the Treaties. In its December 2018 ruling, the European Court of Justice's deemed the PSPP as legal with regard to EU law and rejected the complaints. The next step and currently latest is the controversial 5th of May ruling that in effect cast aside the 2018 CJEU decision.
The BVerfG judgement indeed dismissed the CJEU assessment of the PSPP as "meaningless" and "incomprehensible" and pointed out that the European Court of Justice did not conduct a substantial judicial review of the legality of the PSPP. More precisely, the Karlsruhe-based Constitutional Court stated that the Luxembourg-based CJEU's ruling failed to apply properly the EU law principle of proportionality, hence making the ruling non-binding. The proportionality principle stipulates that the actions of an EU institution shall not exceed what is necessary for achieving the objectives assigned by the Treaties to this institution. In other words, the German judges assessed that the CJEU failed to ensure that the ECB did not overstep its mandate (which is restricted to monetary policy and whose primary goal is price stability). According to the German judges, the CJEU did not correctly assess the economic impact and consequences of the ECB's asset purchases with regard to its mandate. Therefore, the Karlsruhe Court decided to conduct its own review of the legality of the ECB's Quantitative Easing programme, thus stepping into the shoes of the Luxembourg Court.
Paradoxically, the BVerfG' conclud that it could not ascertain that the PSPP breaches the prohibition of monetary financing specified in the EU Treaties, thus coming to the same conclusion than the CJEU. However, the Karlsruhe Court deems that the ECB decisions on the adoption and implementation of the PSPP lack sufficient proportionality considerations and thus go beyond the competences of the ECB. The German judges state that the PSPP seems to better qualified as an economic policy rather than a monetary one, thus exceeding the ECB's mandate. Their characterisation is strongly anchored in ordoliberal dogmas as shows their description of the negative economic consequences of the asset purchases and the resulting low interest rates. Accordingly, the artificially low interest rates would create losses for private savings (hence negatively affecting estate owners, pension funds, savers and insurance policy holders) as well as keeping afloat companies that otherwise would not be viable (so called "zombie firms"). Moreover, the PSPP would allow Member States to escape market discipline thus disincentivizing fiscal consolidation. The underlying narrative is that the ECB asset purchases benefit highly indebted Southern European States and firms at the expenses of the German savers and taxpayers, hence the traditional German ordoliberal point of view. Furthermore, the strict distinction between monetary and fiscal policies (that is central in the ordoliberal paradigm) does not make sense anymore in the current financial context: the development of repo markets relying on safe assets as collateral gives a central role to sovereign debt in the transmission of monetary policy. All in all, the BVerfG's reasoning concurs with several arguments of the plaintiffs stemming from the ordoliberal paradigm.
The Constitutional Court therefore command to the Bundestag (the German Parliament) and the Bundesbank to take action for ensuring that the ECB conducts a thorough proportionality assessment. In the three months following the ruling, the Bundesbank need to ensure that the ECB demonstrates that "the monetary policy objectives pursued by the PSPP are not disproportionate to the economic and fiscal policy effects resulting from the programme". If the ECB fails to do so, the Bundesbank is obliged to withdraw from the PSPP (hence stopping its purchases of German sovereign bonds) and initiate the selling of the bonds already purchased.
This ruling is historical as it is the first time that the German Constitutional Court judgment overrules a CJEU decision. Nevertheless, the repercussions of this ruling go far beyond the power struggle between these two institutions and affect three main domains: the EU legal order, the separation of powers within the Eurozone governance and the future of the monetary union.
The 5th of May judgment set a precedent as it is the first time that a national Court declares a decision from the European Court of Justice as invalid, hence possibly undermining the uniform application of EU law and paving way for further contestations of the primacy of EU law by national courts. Indeed, it opens the door to legal challenges against the EU legal order from Member States opposed to other aspects of EU law, notably Hungary and Poland (whose authoritarian governments are already at odds with the CJEU on the rule of law and democratic standards enshrined in the EU Treaties). The Karlsruhe's decision could actually provide these governments with a precedent for justifying their non-enforcement of EU law and CJEU's rulings. The several ruling of the CJEU against the reform of the Polish judiciary have often been deemed by the Polish government as exceeding the Court's competences. Warsaw actually refuses to enforce theses judgments and reverse its destruction of judicial independence. Even though the primacy of European law is not progressive in itself, it is currently one of the main tools for containing the growing authoritarianism of the Hungarian and Polish governments. Unsurprisingly, both governments have praised the Karlsruhe's ruling and may probably be encouraged by this ruling to further defy European judgments against their autocratic and undemocratic reforms.
In the case of the PSPP ruling, several key EU actors have reaffirmed the importance of compliance with the primacy of EU law and have rejected the German Constitutional Court dismissing of the CJEU verdict (to the surprise of the German judges.
The second area impacted by the BVerfG's ruling is the institutional architecture of the euro area and its governance, as the judgment raises the issue of the control of ECB's activities. Juvenal's famous question is as topical as ever: "who governs the governors?", which could be actualised into "Which institution shall control the decisions of the ECB's Governing Council?". It shall be acknowledged that the German Court was right in its denunciation of the lack of substantive legal review of ECB's actions by the European Court of Justice.
Indeed, the ECB is often and rightly so described as "the most independent central bank in the world", due to its very high degree of autonomy from political institutions (at both the national and the European levels) and its very poor accountability framework. First of all, the restriction of its mandate to a sole objective not precisely defined in the Treaties (price stability) gives the ECB a large discretionary power the interpretation of its mandate and in the design of its policies. In addition, a modification of the ECB's mandate requires a Treaty change and hence unanimity among the 27 Member States. Moreover, the only institution the ECB is accountable to is the European Parliament, but the quarterly hearings of the President of the ECB in front of the European Parliament are non-binding and serve solely an informative purpose. In comparison with other central banks (the Federal Reserve, the Bank of England), the ECB's parliamentary oversight is particularly loose while the modification of its goals is extremely complicated (and almost impractical given the very divergent views on monetary policy of Member States' governments). However, from a progressive point of view, a substantive judicial review of the legality of the central bank's activities is not the right solution to this lack of accountability and democratic control brought to light by the 5th of May ruling. Such a judicial review would actually consist in an independent countermajoritarian institution whose legitimacy is based on expertise in judicial matters (a Court) controlling another independent countermajoritarian institution whose legitimacy is based on expertise in economics and monetary policy (the central bank). As such, it falls short to meet expectations in terms of satisfying oversight, which shall fall to an institution with democratic legitimacy, i.e. made of elected representatives. The only progressive answer to the issue raised by the BVerfG lies in a strengthening of the controlling powers of the European Parliament over the ECB's activities, as well as an increased transparency.
The Karlsruhe's ruling give rise to two main macroeconomic potential consequences for the euro area monetary policy: the first one relates to the eventual termination of the Bundesbank's involvement in the PSPP while the second concerns the ECB's measures implemented in response to the economic crisis caused by the Covid-19 crisis. In both situations, the risk would be of a severe weakening of the ECB's bond-buying programmes. Yet these programmes were vital for keeping the European single currency afloat and prevent an implosion of the Eurozone during the sovereign debt crisis; and are now essential to avoid a repetition of such dramatic economic cataclysm.
The first consequence of the ruling is the (not very likely) risk of a termination of the Bundesbank participation in the PSPP. If the German Constitutional Court is not satisfied by the proportionality assessment (that will in all likelihood be presented in the 90 days delay), the ruling forces the Bundesbank to stop its purchases of German sovereign bonds and sold the bonds already purchased. Under the PSPP programme, the central banks of the Eurosystem are currently buying 20 billion of bonds per months, and sovereign bonds accounts by far for the largest component of these purchases (around 90%). Moreover, the ECB decided last March to add 120 billion of extra purchases for the year 2020 to the QE programme, as a measure to fight the Covid-19 crisis. As a reminder, the current total amount of securities purchased under the PSPP is worth 2 159 billion euros, while the selling of around a fifth of the sovereign bonds hold by the ECB would massively disturb the financial markets. As a result, it would probably cause an unstainable rise in borrowing costs for the highly indebted States of the Eurozone, thus in effect jeopardising the survival of the monetary union (through the doom loop between banks and national governments). Even though the withdrawal of the Bundesbank from the PSPP seems very unlikely, the 5th of May ruling revives the worst-case scenario of an unprepared dislocation of the euro area.
Secondly, the Karlsruhe ruling may constrain the ECB's response to the Covid-19 crisis and the ensuing economic crisis. One of the key instruments of the ECB for facing this crisis is a new temporary asset purchase programme, launched in March and named the Pandemic Emergency Purchase Programme (PEPP). In its current shape, the PEPP's overall envelope amounts to 750 billion euros and the purchases are supposed to end at the earliest in December 2020. Although the German judges specifically indicate that their ruling do not concern the measures taken by the ECB for facing the coronavirus crisis, it seems very likely that the German ordoliberal moral entrepreneurs will continue their judicial guerrilla war. Indeed, they systematically challenged in Court every asset purchase programme created by the ECB, and their victory in the PSPP case will only strengthen their determination to fight the latest bond-buying programme of the ECB. Furthermore, the features of the PEPP makes it an ideal target for the ordoliberal legal activists as, in the case of the PEPP, the ECB relaxed the limits it self-imposed on the PSPP. In designing the PSPP, the ECB self-imposed some limits precisely for making sure that the PSPP does not infringe the prohibition of monetary financing enshrined in the EU Treaties. The 5th of May BVerfG ruling clearly specifies that the German Constitutional Court cannot ascertain that the PSPP circumvent the prohibition of monetary financing because of the existence and enforcement of these self-imposed limits. Therefore, this ruling pave the way for a potentially successful judicial contestation of the PEPP, building on the emphasis of the Karlsruhe judgement on the self-imposed limits.
However, the relaxation of these self-imposed limits is central for giving the ECB the room of manoeuvre necessary for preventing a second sovereign debt crisis in the context of the Eurozone worst recession. The design of the PSPP included three main self-imposed limits:
The first two limits seriously hampered the action of the ECB in the previous years: several Eurozone countries were either decreasing their deficit or generating fiscal surplus, hence reducing the volume of available bonds to be purchased and complexifying the respect of the capital keys in the purchases. Dropping these limits allows the ECB to include Greece in the PEPP purchases and make sure that no Eurozone country could be excluded from the PEPP if its credit rating is downgraded to "junk grade" (Italy may get in this situation in the coming months). It also gives the ECB the necessary flexibility for concentrating most of its purchases (instead of strictly following the capital keys) on the sovereign bonds of the countries most hit by the pandemic that are also the most indebted, namely Italy and Spain. Given the German Court's emphasis on the self-imposed limits, the 5th of May ruling generates a direct risk for the PEPP, i.e. a successful judicial contestation based on the prohibition of monetary financing. Nevertheless, it also creates a second and more insidious risk: in order to preserve the PEPP, the ECB could interiorise the legal risks and thus restrain its purchases from now on (either by progressively restoring a strict respect of the capital keys or by not passing the 33% threshold). In this case, the ruling would impact the ECB by restraining and limiting its policy options (notably the modalities of its securities purchases) for the upcoming years. In addition, the Karlsruhe's ruling could also invigorate the more "hawkish" members of the ECB's Governing Council and encourage them to obstinately fight any attempt to increase the size of the PEPP (such an increasing is under consideration at the ECB). In short, this ruling set legal boundaries on ECB's asset purchase programmes for not violating the prohibition of monetary financing, and thus set a precedent for limiting the scale of any ECB future sovereign bond purchase programmes, on the basis of the EU Treaties.
In their ruling, the German judges rightly (but implicitly) point out the huge and widening gap between the ECB's mandate and initial design and its current role in the euro area. At its creation, the ECB was only supposed to achieve inflation "close but below 2%" by adjusting its interest rates. Nowadays, the ECB is in effect the lender of last resort of both the Eurozone's financial sector and Member States: it provides massive amounts of liquidity to the banking sector and concretely prevents the implosion of the Eurozone with its sovereign bonds purchases. In the absence of large-scale debt mutualisation and massive fiscal transfers between Eurozone countries, the only things preventing the resumption of increasing borrowing costs for highly indebted countries (and the ensuing vicious circle of austerity & economic depression) are the ECB's asset purchases (the PSPP & the PEPP and its flexibility). In other words, unless the Eurozone turns into a transfer union with a common safe asset, the ECB's asset purchases will remain the only game in town and the last defence for avoiding a rise in the yields of the sovereign bonds of the countries most hit by the pandemic. Consequently, the Eurosystem balance sheet will probably reached 6 trillion euros by the end of the year while it stood at 1.5 trillion in 2007. Since the 2008 financial crisis, the ECB's role and instruments radically changed, while its mandate has not been modified. Likewise, leaving aside the banking union, the accountability framework of the ECB has almost not been changed since its creation, while the distributional consequences of its actions multiplied.
The ECB's design follows closely a paradigm that is now obsolete: the highly independent central bank focused solely on price stability. Crisis after crisis, the central bank has been developing new instruments for facing the new challenges (high unemployment and diverging trend in a dysfunctional monetary union, the haunting spectre of deflation, structural financial instability). Nonetheless, the ECB continues to release convoluted justifications of the adequation between its policies and its mandate. However, the gap between the ECB's action and its original mandate is widening and, in a way, the German Constitutional Court's ruling signals the necessity to close this gap, hence to change the mandate. The Karlsruhe judgment shines a light on the increasing incompatibility between the old and dated legal framework of the euro area and the instruments required for conducting modern central banking. In light of the current pandemic crisis and the under-way climate catastrophe, the need for radical changes to the EU Treaties' provisions about monetary policy is more acute than ever. The bare minimal required changes would encompass a much stronger parliamentary oversight and a real democratic control over the central bank's activities, a modification of the mandate for adding a full employment goal, a loosening of the prohibition of monetary financing, and a primacy of environmental targets over the market neutrality principle. For that matter, a Treaty change could also be a good opportunity to fix the dysfunctional features of the monetary union, namely the lack of debt mutualisation and fiscal transfers; and thereby "all would be for the best in the best of all possible monetary union" …