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Analysis
Merkel’s tough love on EMU

Merkel’s tough love on EMU

OMT inoperability neatly timed to make Berlusconi behave
Weidmann can have best of both worlds on likely ECB rate cut

by David Marsh

Mon 29 Apr 2013

Less than five months before the German elections, Chancellor Angela Merkel’s policies on the future of the euro area are becoming clearer. With her constant references to Europe needing to remain competitive in a world where 90% of growth takes place outside the Old Continent, Merkel is showing ‘tough love’ to members of economic and monetary union (EMU).

Merkel’s EMU line spells reluctant acquiescence in a probable imminent cut in European Central Bank interest rates – which leading European central bankers are lining up to say will do little good economically. It heralds a watchful Berlin eye on the new Italian government to ensure that one of its prime backers, Merkel’s arch-adversary Silvio Berlusconi, demonstrates good behaviour. And it portends further deep-seated tension with France, singled out by Berlin as the prime country in Europe that has still not adapted to 21st century Europe.

Here are the main contours of Merkel’s euro policies now gradually emerging.

European interest rates

Merkel’s statement last week that Germany’s own economic circumstances made higher rather than lower interest rates preferable was a gesture of understanding for the ECB’s ‘difficult position’ ahead of a probable 0.25 percentage point cut in the ECB’s headline interest rates to 0.50% on Thursday. The heavily-flagged cut, labelled as largely psychological by key central bankers, will be similar to past gestures by the pre-EMU Bundesbank in reducing its symbolic discount rate to show foreign politicians it was not totally lacking in empathy. In a world full of credit easing – look at what’s happening in Japan, the US, the UK – the ECB cannot remain totally abstemious.

Play-acting with the Bundesbank

Sporadic comments over the past year that Merkel has fallen out with her former adviser, Bundesbank president Jens Weidmann, are wide of the mark. The two understand each other’s roles in euro play-acting. Weidmann probably won’t need to vote against the interest rate cut when the 23-man ECB council meets in the Slovakian capital of Bratislava.

The Bundesbank chief can have the best of both worlds. On a matter that he will dismiss as largely technical, he can show a certain solidarity with council colleagues, saving ammunition for more important future battles. And, through the Bundesbank’s relentless press machine, he can let the media know that he takes a pretty dim view of easy money and understands in statesmanlike fashion those who worry about higher German inflation and world-wide asset bubbles.

Austerity policies – a bit of flexibility

Merkel is worried more about the overall direction of policy than precise on-the-nail efforts to hit the 3% public deficit target everywhere simultaneously. The European Commission already has the authority to operate flexibly the celebrated ‘stability and growth’ targets for public deficits. That’s why regular complaints about the limits of austerity by José Manuel Barroso, the European Commission bleater-in-chief, provoke irritation in Berlin.


ECB support for peripheral bonds: not for now

The well-publicised leak of the Bundesbank’s 29-page evidence to the Karlsruhe-based German constitutional court damning the ECB’s not-yet-used Outright Monetary Transactions (OMT) programme for purchasing weaker countries’ bonds renders the OMT effectively inoperable. The Bundesbank paper, released ahead of a formal court hearing on 11 and 12 June, attacks the OMT on almost all conceivable grounds as infringing the prohibition on monetary financing, undermining central bank independence, creating moral hazard, taking pressure off errant governments, damaging operation of credit markets and harming the Bundesbank’s balance sheet. Like the Holy Roman Empire was neither holy nor Roman nor an empire, the OMT is not outright, not mainly monetary and will probably never lead to any transactions.

Constitutional court judgement

Karlsruhe will take months, until after the German election, to come to a decision. The court may rule in the end that the issue has to go to the European Court of Justice. No matter. While this hangs in the air, no European government can start the lengthy process of applying for OMT help. Expect ECB president Mario Draghi to repeat in coming days that his famous ‘whatever it takes’ statement last July emphasised that the ECB could only work ‘within our mandate’, i.e. any ECB action has to be legal. As ECB people like to point out to sceptical German audiences, these latter three words form an integral part of the July statement, something we shouldn’t forget.

New Italian government

The Bundesbank shot across Rome’s bows is neatly-timed. OMT uncertainties make it even more crucial that Enrico Letta’s Grand Coalition government sticks to policies laid down by former prime minister Mario Monti. Memo to Berlusconi: Everyone now agrees (note: ‘everyone’ in this context means Merkel, Draghi and Weidmann) that, if it doesn’t, there is no safety net in Frankfurt. The man charged with adhering to the fiscal straight-and-narrow is new economy minister Fabrizio Saccomanni, a 70-year-old Bank of Italy veteran and friend/accomplice of Draghi who has helped guide Italy across every stone of 30 years of rocky European financial paths. Saccomanni’s task, like other venerable Bank of Italy staffers before him, will be to tell excitable or wily Italian politicians that there really is no alternative. Berlusconi, for the time being, has no choice but to listen to him. Until some point in the future when Berlusconi decides this is no longer in his best interest, that will remain the case.


France: not much love to lose

This is the big one. Nothing in last week’s leaked French Socialist party document denouncing Merkel’s ‘selfish intransigence’ over austerity will have surprised the Berlin government. The description of Merkel – ‘who thinks of nothing but the deposits of German savers, the trade balance recorded by Berlin and her electoral future’– was a precise depiction that could have been written by a Berlin insider. Not much love to lose between the chancellor and president François Hollande. Don’t forget that Merkel, believing her previous ally-of-convenience Nicolas Sarkozy would win the April-May 2012 French election (or maybe not caring who did), despatched her own party general secretary Hermann Gröhe to France in January 2012 to flash Rottweiler teeth at Sarkozy’s rival. Gröhe’s attacks on Hollande for proposing ‘outdated concepts and left-wing dreams from the ragbag of politics’, though not designed to win friends from what turned out to be the new government party, formed a pretty accurate prediction of Parisian policy.

Treaty change in the European Union

Merkel is sticking with EMU. The Germans are not going to leave, and the euro (probably in less ambitious form) will remain in place. But the influence of the new anti-euro party in Germany will harden the debate. Merkel will announce that Germany is sticking to the European rules. Allowing for a year or so of missed targets, everyone else will have to as well. Otherwise, they may be free to get off the bus before it gets to its final destination. The Germans are making increasingly clear that, to encompass the more politically unified Europe they want, and to meet increased legal and constitutional objections, changes to the European treaties will be required, maybe in the next 2013-17 legislature period. This could even require a European referendum in Germany in 2016 – a constitutionally and politically complex idea, a year before the French presidential elections. If the Germans go down this route, France will have to ratify a new treaty too, probably with its own referendum, a nightmare for Hollande. In the last two decades, the French have not been good at winning popular votes on refashioning Europe. They had better get ready for one. France is being asked to accept a German-style Europe. That may be better than no Europe at all.

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