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Analysis
Central banking tussle at constitutional court

Central banking tussle at constitutional court

OMT programme up for defence

Weidmann vs Asmussen in Karlsruhe

by David Marsh

Mon 10 Jun 2013

A tussle of gladiatorial severity is in store this week between Germany’s Bundesbank and the European Central Bank (ECB) at the German constitutional court – a High Noon episode in long-running European psychological warfare over monetary union.

The eagerly-awaited public hearing centres on the legitimacy of the ECB’s (so far unused) Outright Monetary Transactions (OMT) proposition to buy weaker countries’ government bonds to heal the risk of euro break-up.

As Mario Draghi, the ECB president, put it in understandably but perhaps unnecessarily bombastic tones last week, the OMT ‘has been probably the most successful monetary policy measure undertaken in [the] recent time.’ The OMT’s problem has also been its triumph, namely that the threat (or hope) that the ECB could undertake ‘unlimited’ support purchases of Italian or Spanish bonds, has not been turned into practice. Probably it never will be.

Like the nuclear deterrent during the Cold War, the OMT depends for its credibility on the ever-present assumption that it could actually be used. During the hearings on Tuesday and Wednesday at the Karlsruhe German constitutional court, that assumption seems likely to be stretched to close to breaking point. The ECB has already gone to great lengths to limit the judicial vulnerability of its defence case, confirming weekend German press reports that the OMT programme is not ‘unlimited’ after all but would be capped at €524bn.

In another sign of political positioning ahead of the court hearing, the German government, in the form of an unnamed ‘representative’ speaking to the Handelsblatt business daily, ruled out any new money for Greece in the case of a further debt restructuring for the Greek state – a step advocated recently by the International Monetary Fund.

The Karlsruhe hearings pit together two people who know each other well. They will speak in separate sessions but listeners will be making direct comparisons and drawing instant conclusions.

One of them, Jens Weidmann, the mild-mannered but combative Bundesbank president, appears to be relishing the encounter. The other, Jörg Asmussen, the German representative on the ECB’s six-man board, wishes he were somewhere else, knowing that, in a war of words with his former fellow economics student Weidmann, he can hardly win.

Asmussen has burnished his hawkish credentials by voting against the ECB’s 0.25 percentage point interest rate cut at the beginning of May. But otherwise he is widely regarded as far more prone to compromises than the steely Weidmann, who has taken over much of the approach and bearing of Helmut Schlesinger, Bundesbank president during upheavals in the European Monetary System in 1992-93.

The case for the OMT programme has been widely spelled out by Draghi in recent days: it has brought down bond yields in the problem countries but not at the expense of a softening of overall criteria on debts and deficits. Draghi underlined in Shanghai on 3 June that the ECB’s requirement of effective conditionality discouraged governments and parliaments from requesting a programme unless strictly necessary. ‘They can either reform without OMTs and retain economic sovereignty or they can reform with OMTs but give up some of their economic sovereignty. Either way, they have to persevere in their reform efforts. So it is quite misleading to compare OMTs to historical episodes in which governments relied on central bank support to replace fiscal consolidation.’

Significantly, Draghi said the aim of the OMT programme was not to compress European yield spreads back to levels before the financial crisis. In a statement that might be interpreted as effectively putting a floor on Spanish and Italian yields, Draghi said: ‘OMTs are designed to keep government bond yields just below ‘panic’ levels, as previously defined, not to bring them down to levels that would somehow help government solvency’.

The Bundesbank’s 29-page evidence to the court, leaked to the German press six weeks ago, damned the OMT plan 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. Some of this may be outrageous and overdone, but the OMT has effectively been rendered inoperable. This week’s Karlsruhe sessions, which will not lead to any kind of decision until after the elections, will not change that.

No one really disagrees with Lord (Meghnad) Desai of the London School of Economics, and chairman of the OMFIF Advisory Board, who in January called the OMT ‘a brilliant confidence trick.’ Desai summed up the position thus: ‘No country would be likely to ask for such help as it would indicate to the markets that bankruptcy was imminent. Markets would act faster than ECB and hence no country, not even Spain, has made an application. Yet the expectation that they may do so has buoyed markets. The ECB is a “class act” and knows a trick or two. But how long can the conjuring trick last?’ In Karlsruhe this week, we may find out.

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