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Analysis
Governments, not the ECB, are in charge of euro area destiny

Governments, not the ECB, are in charge of euro area destiny

Constitutional court upholds Voltaire verdict 

by David Marsh

Mon 10 Feb 2014

After the European Central Bank (ECB) unveiled its celebrated Outright Monetary Transactions (OMT) programme to shore up weaker euro bloc members’ debt in September 2012, I recalled 18th century French philosopher Voltaire’s quip that the Holy Roman Empire was ‘neither holy, nor Roman, nor an empire’. My view was that future historians might say that the OMT was neither outright, nor monetary nor a transaction.

The complex OMT device masterminded by Mario Draghi, the ECB president, has been remarkably successful in engineering lower euro bloc yield spreads. Yet it remains non-operational. That looks likely to remain the case after the German constitutional court on Friday ruled that the OMT contravened Germany’s basic law in several fundamental instances, even though it deferred judgement on the lawsuit by handing it to the European Court of Justice.

The OMT has been confirmed as the best form of conjuring trick: one that achieves its purpose of bamboozling observers without the secrets of its internal mechanics ever being unveiled.

The judgement was much as expected. It confirmed the constitutional court’s long-practised custom both of upholding German parliamentary scrutiny over bail-out actions and also of refusing to hand down direct verdicts that could wreak havoc on financial markets. Both plaintiffs and defendants in the bond-buying stand-off have something to celebrate.

The psychological effect, though, is clear. The OMT cannot be used while the legal uncertainty remains. The German government and parliament, which would have a big say in unleashing the OMT by approving an economic programme to be carried out by applicant countries, will make sure that this nuclear missile remains immobilised in its launch silo.

The message is important for clarifying the responsibilities behind euro area governance. Markets and governments know that the onus for shoring up the euro is on politicians, not central bankers. This is a message with which both Draghi and Jens Weidmann, the Bundesbank president, who argued fiercely against key aspects of the bond-buying scheme at the Karlsruhe court hearing last summer, will agree.

The court decision will have a secondary effect by making even less likely that the ECB will move to across-the-board quantitative easing (QE) of the sort carried out in the US, UK and Japan in recent years. Draghi had already distanced himself from speculation about such action in recent weeks.

The ECB council’s refusal to cut interest rates at its monetary policy meeting last Thursday, citing the need for further data on inflation and growth in the 18-country area, confirms that the ECB is unspooked by worries of incipient deflation in parts of the euro bloc.

Public opinion in the crisis countries remains volatile, with a strong anti-euro protest vote expected in the May elections to the European parliament. Bank of Greece governor, George Provopoulos, speaking at an OMFIF lecture in London on Friday 7 February, underlined the economic and political risks facing his country, in spite of his strong message that ‘Grecovery’ and not ‘Grexit’ (a Greek exit from the euro) was on the way.

Throughout the euro area, decision-makers are lined up firmly in the direction of maintaining fiscal and monetary discipline and supply-side reforms, witnessed by French president François Hollande’s swing (much praised, not surprisingly, in Berlin) in the direction of German-style austerity. All this could come unstuck. But for the time being, orthodoxy is in place – and the German constitutional court’s double-edged judgement confirms that.

ECB officials have been at pains in recent weeks to deliver a Bundesbank-style message that even talk of across-the-board central bank bond-buying could cause governments in crisis countries to backtrack on reforms needed to accelerate the euro area recovery.

Indeed, disagreements between the Bundesbank and the ECB on key aspects of European monetary are now rarely on display. Draghi’s words and actions have placed him far more in the Weidmannesque camp than was previously realised. The Bundesbank itself has been conspicuously supporting the Draghi line against constantly sceptical German public opinion.

Many arguments mitigate against any further across-the-board European easing. These range from the incipient, though modest, recovery in the euro area and the awkward juxtaposition of the ECB’s comprehensive assessment of banks’ balance sheets, which could be easily compromised by large-scale action to ease credit or raise prices on government bonds. The anti-QE arguments include, too, the start of Federal Reserve tapering of its own QE programme, and the inconclusive, if not negative, results of the Bank of Japan’s massive bond purchases.

The Bundesbank and the ECB agree that any future asset purchase schemes need to be geared to private sector assets such as bundles of bank loans that could be developed for securitisation purposes. The ECB is still some way from finalising technical preparations for such measures – and no doubt hopes that, like the OMT, they will become increasingly unnecessary as time goes on.

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