If Germany Won’t Help Bail Out Italy, Who Will?
It would be an understatement to say that the European Central Bank (ECB) and the German Constitutional Court are not getting along.
Last month, the court ruled that the ECB might have exceeded its authority by pursuing an aggressive government bond-buying program. The ECB’s response has been to pretend that the ruling didn’t exist. As the conflict between these two powerful European institutions escalates, it is not only Italy’s economic future that is threatened, but the whole of Europe’s.
In its recent review of the ECB’s past quantitative easing policy, the German Constitutional Court took to task the German government and the German central bank, the Deutsche Bundesbank, for not having challenged the ECB’s unorthodox monetary policy. The court found that the ECB likely exceeded its authority by not respecting the Eurozone’s principle of “proportionality.” The court is now threatening to preclude the Bundesbank, the ECB’s largest member bank, from participating in the ECB’s bond-buying program unless the Bundesbank provides a convincing legal defense of the ECB’s actions.
The ECB’s immediate reaction was to declare that it was subject to the jurisdiction of the European Court of Justice and not to that of the German Constitutional Court. Since the European Court of Justice had already ruled that the ECB’s bond-buying program was within its mandate, the ECB saw no need to respond to the German court.
Now, as if to thumb its nose at the German court, the ECB has expanded the program under dispute. It enlarged its Pandemic Emergency Purchase Program (PEPP) from €750 billion to €1,350 billion. Along the way, it disregarded its former policy of buying government bonds of individual member countries only in strict proportion to those countries’ ECB capital contribution. Now, the ECB is choosing to exercise complete discretion as to which countries’ government bonds it will buy and in what proportion.
It is unlikely that the disproportionate amount of Italian government debt that the ECB has bought over the last two months will have escaped the German court’s notice. Neither will the court be likely to dismiss as coincidence that in April and May, the ECB purchased €50 billion in Italian government bonds—almost exactly equal to the Italian government’s gross financing needs over those two months.
All of this could put the ECB on a serious collision course with the German court later this summer.
If the German court had a problem with the ECB’s past quantitative easing program, how much more will it object to an expanded ECB bond-buying program? Moreover, even if the German court were to accept the ECB’s likely explanation that expanded bond-buying was needed for the ECB to meet its inflation objective in the wake of the coronavirus pandemic, how will the ECB convince the German court that buying a disproportionate amount of Italian bonds does not constitute monetary financing of a member country’s government deficit—exactly the practice that sticks in the German court’s craw?
Twenty years ago, when Germany gave up the Deutsche Mark for the Euro, its worst fear was that the newly created ECB would engage in the monetary financing of a wayward member country’s budget deficit. To guard against such an eventuality, Germany insisted that the Treaty of Lisbon include Article 123, which explicitly prohibits the ECB from doing so. One can be sure that the German court will now raise the fundamental question of how the ECB’s secondary market purchase of the equivalent of the Italian government’s entire gross financing needs does not constitute monetary financing of a member country’s budget deficit.
The outcome of this dispute matters the most for Italy, whose economy is among those in Europe hardest hit by the coronavirus pandemic, and whose public finances are on an unsustainable path. The only thing that will allow Italy to avoid defaulting on its government debt will be for the ECB to continue buying large quantities of Italian government bonds. However, if the German court rules that the Bundesbank may not participate in an ECB bond-buying program that exceeds the ECB’s mandate, a hobbled ECB will not be up to the task of bailing out Italy. The third-largest economy in the Eurozone could face a second sovereign debt crisis.
Hopefully, German Chancellor Angela Merkel will succeed in using some form of political magic to get the German Constitutional Court to back down from its confrontation with the ECB. Just as hope is not a strategy, magic is not a policy. But having come this far, it’s unlikely the German court will retreat of its own accord.