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The ruling of the German Federal Constitutional Court (GFCC) of May 5 on the ECB’s monetary policy affects not only the relation of Germany to the European Central Bank (ECB) and the Court of Justice of the European Union (ECJ) but also the constitutional foundations of monetary policy. The court departs from the German tradition of entrusting monetary policy to an independent central bank that is only given the task of pursuing price stability. According to the the court’s reasoning, much of what the German Bundesbank used to do would not be permissible under the German Basic Law.
We consider this to be problematic. This criticism should not be interpreted as an approval of the ECB’s monetary policy. Some of us are also critical of certain aspects of this policy. However, we are all concerned that the judgment of the Constitutional Court undermines the constitutional basis of the independence of the central bank and its price stability mandate.
The GFCC believes that the ECB’s purchases of sovereign debt under the Public Sector Purchase Programme (PSPP) of 2015 violate the boundaries that the European Treaties set to the ECB’s activities. According to the court, such ultra vires actions, actions that go beyond the competences that national legislators have provided to EU institutions through the Treaties, must not be tolerated; otherwise the basic rights of German citizens would be violated. The court does not in principle dispute the ECB’s right to implement such a programme. After all, Article 18 of the Statute of the European System of Central Banks (ESCB) and of the ECB explicitly allows central banks to purchase marketable securities, including government bonds, without any restrictions. However, the GFCC complains that the ECB did not demonstrate the proportionality of the programme satisfactorily. The court therefore mandates the German government and the Bundestag to obtain a satisfactory proportionality assessment from the Governing Council of the ECB. If such an assessment is not obtained, the court mandates the Bundesbank to withdraw from the PSPP and similar programmes; in other words, the Bundesbank should stop to fulfil its Treaty obligation of implementing ECB policy as decided by the Governing Council.
The GFCC writes: “A programme for the purchase of government bonds only satisfies the principle of proportionality if it constitutes a suitable and necessary means for achieving the aim pursued; the principle of proportionality requires that the programme’s monetary policy objective and the economic policy effects be identified, weighed and balanced against one another.“ Specifically, it calls for “the effects of a programme for the purchase of government bonds on, for example, public debt, personal savings, pension and retirement schemes, real estate prices and the keeping afloat of economically unviable companies … (to be) taken into account in the proportionality assessment … and – in an overall assessment and appraisal – weighed against the monetary policy objective that the programme aims to achieve and is capable of achieving.”[1]
The core of the court’s argument can be sketched as follows: (1) The ECB is entrusted with monetary policy; in contrast economic policy is reserved for the Member States. (2) The PSPP has side effects that belong to the area of economic policy, i.e., the domain that is reserved for the Member States. (3) Since the PSPP’s side-effects fall within the domain of economic policy, in which the ECB has no role, the ECB should have explained why the pursuit of its monetary-policy mandate justified undertaking the PSPP despite these side-effects; this would have required a proportionality assessment. (4) The ECJ should also have carried out such a proportionality assessment when it commented on the PSPP’s compatibility with the Treaty at an earlier stage of the procedure. Because the ECJ failed to do so, its “interpretation of the Treaties is not comprehensible and must thus be considered arbitrary from an objective perspective”[2] and its judgment itself was an ultra vires act.
The terminology used by the court is oddly imprecise. It uses the term “economic policy effects”,[3] but when it fills this term with substance, it does not refer to the effects of the PSPP on economic policy but to the effects on public debt, savings, pension provisions, property prices and the survival of companies. The term “economic policy effects” refers to the court’s opinion that the effects listed belong to the domain of economic policy, rather than to the substance of the effects as such. Since the Treaties reserve economic policy for the Member States, the court presumes ultra vires behaviour and asks for a proportionality assessment.
This analysis has two major weaknesses. First, the court’s view of how to separate economic policy and monetary policy is problematic. Second, the court does not indicate what standards should be used for the “overall assessment and appraisal”[4] that it is asking for. The court’s request is in fact incompatible with the Treaty and with its own 1993 ruling on the Maastricht Treaty. It is also incompatible with the tradition of central bank independence with an exclusive commitment to price stability that has been central to the position of the Bundesbank in Germany for decades.
The court’s attempt to introduce a categorical separation between economic policy and monetary policy cannot succeed. Monetary policy measures always have “economic policy effects”. Changes in interest and exchange rates are a normal part of any monetary policy. Changes in interest rates affect the attractiveness of real estate and other capital goods, as well as aggregate demand for goods and services and the level of employment. It is precisely these effects that make for a link between monetary policy and price stability.
To be sure, the distinction between monetary policy and economic policy is enshrined in the European Treaties, with a separation of responsibilities between the ECB and the Member States. But the Treaties do not say that this separation hinges on the effects of measures taken, as the GFCC claims. They leave open the possibility of basing the separation on the kinds of measures taken, the instruments used and the objectives pursued; this is the interpretation of the ECJ, which the German Federal Constitutional Court has declared to be “arbitrary from an objective perspective”. Under the ECJ’s approach, government funding by debt issues would be a matter of economic policy belonging to the domain of Member States even though these debt issues have side-effects on the monetary system and inflation; at the same time, increases in the money supply through purchases of government bonds by the ECB would be a matter of monetary policy belonging to the domain of the ECB even though they have side-effects in areas of concern for Member State economic policy, for example, effects on the conditions under which Member State governments can issue public debt.
The Statute of the ESCB and of the ECB, which is an integral part of the Treaty, specifies the instruments available to the central banks in the ESCB without mentioning the possible side effects of these instruments in areas of concern to general economic policy. The statute provides no support for the notion that such side-effects might pose a problem of ultra vires behaviour, which must be addressed by a proportionality assessment.
In fact, the GFCC’s discussion of this assessment is less concerned with the alleged ultra vires behaviour as such, than with the economic effects of the PSPP. In terms of content, the court does not talk about the presumed transgression of limits set to the ECB’s competence but about the assessment of the economic effects as such. The court pays particular attention to the effects on the environment for government debt funding. It follows the ECJ in its assessment that the PSPP cannot be classified as (prohibited) monetary government funding, but argues that the reduction of the overall level of interest rates, to which the PSPP has contributed, reduces the costs of debt funding for Member States, an effect that it sees critically.
However, such criticism of the effects of a measure does not by itself justify the conclusion that the measure involves a transgression of competence limits. If the effect of monetary policy on the interest rate level and thus on the national budgets of the Member States – which is unavoidable – is to be regarded as an indication of ultra vires action, the criticism must be applied to interest rate increases, which presumably the GFCC likes, just as to interest rate decreases. The assessment whether competence limits have been violated or not must be independent whether one likes the measure or not.
The standards for such an assessment are unclear, and on this point the judgment does not help. How should the ECB or the ECJ evaluate the alleged transgression of competence limits and how should it compare them to the objective of price stability that is set by the Treaty itself? Can they do so at all, and what legitimizes them to make the requisite value judgments? The court evades these questions by making economic effects, rather than “economic policy effects” the subject of the proportionality assessment.
But an examination and evaluation of the economic effects of the PSPP is also problematic. Such an examination requires (i) a comprehensive account of these effects, with an assignment of weights to all, and (ii) a comparative evaluation relative to the objective of price stability. The “overall assessment and appraisal” that the GFCC is asking for in the proportionality assessment would in principle have to allow for a conclusion such that, on the one hand, the PSPP is deemed to be suitable and necessary for the pursuit of price stability but, on the other hand, the side effects of the programme, for example, the harm to savers, who no longer receive much interest income, are so significant that one should refrain from implementing the programme. There are no standards whatsoever for how to weight these different considerations.
The indicated conclusion would also be incompatible with the European Treaties. The Treaties call for a “single monetary policy and exchange rate policy the primary objective of both of which shall be to maintain price stability and, without prejudice to this objective, to support the general economic policies in the Union, in accordance with the principle of an open market economy with free competition”[5] (Article 119 TFEU; Article 127 TFEU states the objectives of the ESCB with almost the same wording). The Treaties give priority to the objective of price stability over all other considerations (unlike in the USA, where the law also makes employment an objective of monetary policy). Other economic effects of monetary policy measures may only be taken into account to the extent that this can be done without damaging the objective of price stability. In relation to the PSPP, the ECB has specified its price stability objective as “below, but close to 2 percent”.[6] Both the ECJ and the GFCC have accepted this clarification, they have also accepted the ECB’s explanation of why the monetary policy pursued since 2015 was appropriate and necessary to pursue this objective. The Federal Constitutional Court’s additional demand for a proportionality assessment that evaluates the side effects of this policy is not compatible with the Treaties. Nor could this demand be fulfilled without violating the principle of democratic legitimacy that is invoked by the court. In its Maastricht judgment of 1993, the court stated that responsibility for monetary and exchange rate policy was an essential part of national sovereignty which in principle should not be transferred to a supranational institution. It nevertheless deemed the transfer of this responsibility to the ECB under the Maastricht Treaty to be permissible, because the ECB would be independent, governed by a body of experts, and only committed to the objective of price stability, an objective about whose appropriateness the GFCC had no doubt. At that time the court was aware that taking account of several objectives together would require an assignment of weights to them, that such weighting would require value judgments and that such value judgements would require political legitimation by the democratically elected bodies. Today it is asking that the ECB – or the ECJ – make precisely such assessments requiring value judgments.
In this context, it is worth looking back at the decades before the Maastricht Treaty. In 1973/74, 1980/82 and 1991/92 the Bundesbank raised interest rates significantly in order to fight inflation. The subsequent transition to a recession was faster and more radical than in other countries where central banks were less tough. Unemployment rose dramatically, on the order of 500000 to 1 million. The trade unions criticised the Bundesbank for not taking the effects of its policies on unemployment into account. On each occasion, the Bundesbank stressed that, by law, it only had a mandate for price stability and that a consideration of other objectives would violate its mandate.
In those decades, the combination of a price stability mandate and independence of the Bundesbank insulated monetary policy from political pressures, including the influence of trade unions, industry associations, and their allies in politics – quite in line with what the argument in the GFCC’s 1993 Maastricht ruling. The affected parties, trade unions, industry associations, the Federal Government, and the Bundestag, had to accept the Bundesbank’s policies as a given for their own actions. According to the logic of the current ruling, however, the Bundesbank would have had to examine whether the monetary policy measures it took to fight inflation did not interfere excessively with, e.g., the fundamental rights of workers and trade unions, as it restricted the scope of what they could achieve in collective bargaining.
The Bundesbank’s policies at the time were devoted to fighting inflation, the ECB’s policies today are devoted to fighting deflation, but this difference can hardly justify the dilution of the ECB’s price stability mandate that is inherent in the GFCC’s ruling. The mandate for “price stability” encompasses both, fighting inflation and fighting deflation, and the experiences of inflation in 1923 and deflation in 1931 show that both are needed. Workers and employment, trade unions and collective bargaining rights are not mentioned in the current ruling, which only lists concerns of German critics of the ECB. However, if the ECB is asked to take account of concerns other than price stability, it will also have to consider the impact of its policies on workers. Moreover, it will have to take account of the concerns of people in other Member States, not just in Germany. After all, we are talking about a single monetary policy for the entire monetary union. The more concerns are taken into account, however, the more problematic the necessary weightings and value judgements become. The authors of the Bundesbank Law and the Maastricht Treaty avoided this quandary by limiting the central bank’s mandate to the pursuit of price stability.
To be sure, monetary policy has distributional effects. But it always does, and the exclusion of these effects was and is an essential aspect of the transfer of monetary policy to an independent institution that only has a mandate for price stability. Distribution conflicts must be addressed elsewhere in the polity. Central banks lack the political legitimacy to evaluate distributional effects, and, if they were mandated to do so, the objective of price stability would suffer. Even the courts do not have the political legitimacy required to make the necessary value judgments.
The GFCC’s judgments have shown little concern for the reasons for central bank independence. In its Maastricht judgement, the court stated that it would be good to have monetary policy ”taken out of the domain of influence of lobby groups and office holders wanting to be re-elected.” This formulation suggests that the court was more interested in protecting democratic elections against corruption than in protecting the public’s trust in the stability of the value of money.
We need central bank independence to ensure that monetary policy does not become a pawn of the politics of the day, with measures that harm those who hold money and other nominal assets and who have no legal claims that might protect the value of their holdings. For this same reason, we also need the central bank’s mandate to give priority to the price stability mandate. The GFCC’s demands undermine both the central bank’s exclusive commitment to price stability and the central bank’s independence, with harmful effects not only for the ECB but also for the Deutsche Bundesbank and the stability of our currency.