06 March 2014

Paul De Grauwe: Why the ECJ should reject the German Constitutional Court's ruling on OMT

The main argument used by the German judges, which was very much influenced by the Bundesbank advice on OMT, can be summarised as follows. When the ECB buys government bonds it mixes monetary and fiscal policies. The fiscal component of OMT arises from the fact that the government bonds bought by the ECB can lose value if the governments whose bonds are bought default. If that happens the ECB will incur a loss that can wipe out its equity. As a result, governments of the member countries will have to use taxpayers’ money to recapitalise the ECB. Thus, by buying government bonds the ECB puts future taxpayers at risk. The latter may be forced to pay taxes, without due democratic process. Indeed decisions to tax can only be taken by national parliaments, and not by a politically irresponsible bureaucracy like the ECB.

This sounds like a very weighty argument. If true, there is not much one can put in the way of the judges and one has to conclude that the OMT programme undermines the basic democratic principle of “no taxation without representation”. The problem with this argument is that it is wrong.

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There are of course risks involved in the use of the OMT programme. These risks have to do with potential inflation and with moral hazard. But none of these risks have anything to do with taxpayers that are being forced to pay a tax without a democratic vote in national parliaments. The inflation risk arises from the fact that a government bond purchase leads to a creation of money base. Elsewhere De Grauwe has argued that this risk is small as the ECB will be called upon to activate the OMT programme during moments of financial crisis when economic agents scramble for liquidity. During such moments the greater risk is deflation, not inflation.

The risk of moral hazard is a real one. It arises because the OMT could give incentives to governments to be more relaxed about debts and deficits. In order to deal with this risk a separation principle should be applied. The responsibility of the central bank is to provide liquidity in times of crisis. The European Commission is responsible for containing the moral hazard risk. It has a legal mandate to do so through the Stability and Growth Pact that has been strengthened since the outburst of the sovereign debt crisis.

One can conclude that an important argument used by the judges of Karlsruhe to declare the OMT illegal testifies to an appalling lack of understanding of the basics of central banking. The OMT programme does not create a risk that eurozone citizens will have to pay taxes arising from losses of the ECB. It is quite terrifying that such an important judgement that could destroy the ECB’s necessary responsibility of lender of last resort is based on ignorance. One can only hope that the judges of Luxembourg will not show the same degree of ignorance.

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