Guntram Wolff has been the director of Bruegel – a European think tank specialising in economics – since June 2013. A member of the French prime minister's Conseil d'Analyse Economique, he previously worked for the European Commission on the macroeconomics of the euro area and the reform of its governance, and as an adviser to the International Monetary Fund.
The German constitutional court, based in Karlsruhe, is currently deliberating on the legality of the European Stability Mechanism (ESM) and the ECB’s Outright Monetary Transaction programme (OMT). After the court had preliminarily approved the ESM in September last year, Karlsruhe had a hearing on the scope and boundaries of the ECB’s monetary policy mandate and the OMT programme and its consequences on the budget right of the Bundestag (the German parliament) in June and it is expected to announce its decision later this autumn.
Ultimately the court could force the German government to bring the ECB to the European Court of Justice or, even more dramatically, request Germany to leave the eurozone as the former constitutional court judge Udo di Fabio argued.
So is the ECB acting beyond its mandate? The answer is clearly no. The situation in the eurozone was dramatic before the announcement of the OMT programme. Nominal interest rates had hugely diverged, banks’ access to finance was severely hampered, and the eurozone’s financial system was deeply fragmented. Changes in the monetary policy stance of the ECB were not transmitted and the ECB was therefore not able to fulfil its mandate of ensuring the proper conduct of monetary policy in the euro area. It was also not able to contribute to financial stability.
To fix this untenable situation for the ECB, bold action was required. The ECB’s governing council decided on the OMT programme, which consists of the option to buy unlimited quantities of sovereign debt with a maturity of less than three years in the secondary markets, if the necessary but not sufficient condition of an agreement on an ESM programme is fulfilled.
The decision has led to a dramatic improvement in the monetary policy transmission. Sovereign bond yields in Spain and Italy fell by 100 and 50 basis points in the first month after Draghi’s ‘whatever it takes’-speech in July 2012, and are currently around 300 basis points lower. Financial fragmentation was reversed and the so-called Target2 net liabilities fell by €134 billion in Spain and €38 billion in Italy between July 2012 and April 2013. Contrary to the possibility of a pure ESM programme, the OMT programme was thus successful in re-establishing the monetary policy transmission, even though the transmission mechanism is not fully restored yet.
Why was the OMT programme so successful? It was so successful primarily because it addressed a fundamental problem of the monetary union: a monetary union with decentralised fiscal policies is inherently unstable. Countries in the eurozone do not have direct influence on monetary policy, but issue debt in euros. This constellation resembles a situation where governments issue debt in a foreign currency – and the breeding ground for a self-fulfilling crisis is established. Once investors start losing trust in the government’s fiscal sustainability, they will start selling bonds and push up interest rates. Yet, it is only raising interest rates that eventually renders government debt unsustainable and thereby the initial doubt is self-fulfilling.
Only the ECB has the capacity to address this problem and to credibly prevent a self-fulfilling crisis. An ESM programme alone could not achieve this. It is impossible for a pure ESM programme to address the sovereign as well as the resulting private sector fragilities due to the large size of capital withdrawals in case of a crisis. The credibly flexible scope of the OMT programme was thus necessary in order to fix the monetary policy transmission,
So, has the ECB with its OMT programme taken on board excessive budgetary risks? Has this undermined the budgetary sovereignty of the German Bundestag? The answer is again a clear no. Arguably, before the OMT announcement, the budgetary risks for Germany were higher due to its exposure in the standard liquidity operations by the ECB. Only the OMT programme managed to bring down financial fragmentation and thereby helped the ECB to reduce its current role as a financial intermediary between banks in the fragmented financial system.
Overall the ECB clearly acted within its mandate of ensuring the proper conduct of monetary policy. The pure announcement of a potential OMT programme helped to reduce fiscal risks and to coordinate markets in a good equilibrium. Going forward, it is desirable for the euro area to move ahead with further fiscal integration in order to complement centralised monetary policy and to deal with unsustainable fiscal situations, for which the OMT programme is not designed.