Is a Second Euro Crisis Possible?

Philip Arestis and Malcolm Sawyer

The announcement by the European Central Bank (ECB) of its Outright Monetary Transactions (OMT) programme in July 2012, along with the prior statement by the ECB’s president that the bank would do “whatever it takes” to save the euro, restored the confidence of the markets. The interest rates on Italian and Spanish sovereign debt, for example, fell to more tolerable levels.

Further details of the OMT programme have emerged since September 2012, when it was announced that relevant candidate countries would receive help and be allowed access to OMT if they only had complete market access—that is, the ability to get credit from private sources. (The ECB, instead of publishing OMT’s legal documentation “soon” after September 2012, shifted its stance to “only publish when a country applies.”) The ECB shifted to the stricter condition of complete market access from the one of July 2012, under which the programme might help those countries that were simply regaining market access.

The German central bank, the Bundesbank, though, opposes OMT on the grounds that it is close to the monetary financing of budget deficits. In other words, OMT implies clear and direct borrowing by governments from their own central banks, which, it is stressed, is banned by the Maastricht Treaty. It is clear, though, that the treaty permits the ECB to buy public debt in the secondary markets.

However, a serious problem has arisen, closely to the case of the Bundesbank, which has never warmed to the OMT. On 7 February 2014, the OMT matter was referred to the German constitutional court, which in its turn referred the ECB’s OMT scheme to the European Court of Justice (ECJ), the highest legal court in the EU. The view of the German constitutional court vehemently opposes the OMT programme as being outside the mandate of the ECB; it is, therefore, “incompatible with primary law” and violates the German constitution. It would deprive the German government of its fiscal sovereignty since it would force it to accept any generated losses (see the Financial Times, 8 February 2014). The court considers OMT to be “monetary financing” or “debt monetisation,” whereby a central bank prints money to finance sovereign debt; such practice is outlawed under European treaties, in this view.

All of this raises questions over the OMT’s legality and provides ammunition to the ECB’s critics on the programme, thereby prolonging legal uncertainty over the OMT. The German constitutional court has obviously decided that only the ECJ could decide on the matter. But whatever the outcome of the ECJ’s decision, serious problems seem to be inevitable. Assume that the ECJ’s decision is to uphold the ECB’s defence of bond buying. This would clearly and squarely suggest that the OMT is consistent with the ECB’s monetary policy mandate, putting the EMU in the awkward position of having the EU’s highest court disagree with a decision of the highest constitutional court of one of the most powerful EMU countries, namely Germany. If the ECJ does not uphold the ECB’s defence of bond buying, the ECB then will be in its own very awkward position, having been refused one of its most promising programmes. It is clear, though, that both the Bundesbank and Germany’s constitutional court have registered their strong objection to monetary policies underpinning the euro.

Winkler (2014) argues that if the OMT violates the ECB’s mandate, then the ECB is in court defending its function as a lender of last resort rather than the monetary financing of government deficits. Consequently, an ECJ decision against the OMT would imply that it would endorse a reduction of the ECB’s economic mandate that goes against the long history of modern banking since the time of Walter Bagehot’s Lombard Street contribution in 1873. Without the OMT programme, Winkler (op. cit.) concludes, there is a risk for another euro crisis, and such a monetary union “is neither sustainable nor desirable” (p. 44).

This awkward problem, coupled with the possibility of a serious deflation in the euro area, cannot be encouraging news for the euro. The ECB has not been successful in terms of securing price stability—its main policy objective (see, also, Arestis and Sawyer, 2013). In the year ending February 2014, the inflation rate in the euro area was 0.8%, well below its target inflation rate of “below but close to 2 per cent over the medium term.” Deflation is a real possibility in view of the additional factor that demand in the euro area is weak—in the fourth quarter of 2013, 5% below its level in the first quarter of 2008. We may also add to all these occurrences the unexpected and relentless appreciation of the euro. Clearly, the higher the appreciation the greater the downward pressure on domestic prices. It is therefore the case that the economic situation in the euro area is very fragile. This poses a really worrying question of whether a further crisis is in the offing with this degree of fragility.

References

Arestis, P. and Sawyer, M.C. (2013), Economic and Monetary Union Macroeconomic Policies, Current Practices and Alternatives, Basingstoke: Palgrave Macmillan.

Winkler, A. (2014), “The Lender of Last Resort in Court”, Working Paper Series No. 207, Frankfurt: Frankfurt School of Finance and Management.