ECB operations are like the wild west and beyond democratic legitimacy

I read a very interesting study by two Dutch academics last week – The ECB, the courts and the issue of democratic legitimacy after Weiss – which will be published in the Common Market Law Review (Vol 57, No 6, 2020). It examines the way in which the ECB operations and policy interventions have gone way beyond their original conception in the Maastricht Treaty and now conflict with democratic accountability. While the authors propose ways to address the democratic deficit, I am sceptical. Essentially, there needs to be a fundamental change in the Treaty and the establishment of a federal fiscal capacity embedded into a genuine European government. But then pigs might fly!

The Background

The paper by Nik de Boer and Jens van ‘t Klooster reflects on the recent court cases pertaining to challenges to the ECB’s – Public Sector Purchase Programme (PSPP) – which according to the – latest data – (October 2020) has seen the ECB accumulate €39.7 billion worth of government bonds.

The PSPP is a component of the overall Asset Purchase Programme (APP) conducted by the ECB.

Note, this is a separate program from the – Pandemic Emergency Purchase Programme (PEPP) – which just amplifies the massive holdings of government bonds by the ECB.

By November 20, 2020, the ECB had bought €680,894 million under the PEPP.

The PSPP was challenged by several groups in the Bundesverfassungsgericht (Federal Constitutional Court, Germany) on the grounds that it was violating the terms of the Treaties (bailout rules) and that the German government had failed to oversee the participation of the Deutsche Bundesbank in the ECB’s programs.

The challenges essentially claimed that the ECB was moving outside of its legal mandate and engaging in “monetary financing”.

This conduct infringed the basic democratic principles embedded in the German constitution (Basic Law) and thus undermined the German constitutional status.

The Bundesverfassungsgericht determined in 2018 that (Source):

… if the PSPP programme exceeds the mandate of the ECB or infringes the prohibition of monetary financing, it must uphold those various actions. The same applies if the rules on the sharing of losses arising under that programme affect the budgetary responsibility of the Federal Parliament.

As a result, it pushed the matter to the European Court of Justice (ECJ) to interpret the “validity of the PSPP programme in the light of EU law”. The ECJ is the court that upholds the legal structure of the EU.

On December 11, 2018, the ECJ found that the PSPP:

… does not infringe EU law … It does not exceed the ECB’s mandate and does not contravene the prohibition of monetary financing

It claimed that the PSPP fell “within the area of monetary policy … and observes the principle of proportionality”.

They found that the PSPP was intended to push inflation up to the 2 per cent ECB definition of price stability.

Regular readers will know that the inference that purchasing government bonds with bank reserves would drive up inflation is a reflection of the belief in flawed mainstream quantity theory of money and the money multiplier.

It was never going to drive up inflation and the ECB has systematically failed to maintain price stability according to its own definition.

But that is an aside to today’s blog post.

I considered the ECB’s continuing failure in this regard in these blog posts (most recently):

1. Eurozone inflation heading negative as the PEPP buys up big – don’t ask the mainstream to explain (June 4, 2020).

2. ECB confirms monetary policy has run its course – Part 1 (September 17, 2019).

3. ECB confirms monetary policy has run its course – Part 2 (September 18, 2019).

You can read the ECJs judgement in full – HERE.

So then the matter went back to the Bundesverfassungsgericht, which determined in its – May 5, 2020 Ruling – that the Court of Justice of the European Union had “exceeded its judicial mandate” in determining that the ECBs asset purchase program (PSPP) was within the legal limits of the Treaties.

The ruling said that:

… the Federal Government and the German Bundestag violated the complainants’ rights under Art. 38(1) first sentence in conjunction with Art. 20(1) and (2), and Art. 79(3) of the Basic Law (Grundgesetz – GG) by failing to take steps challenging that the ECB, in its decisions on the adoption and implementation of the PSPP, neither assessed nor substantiated that the measures provided for in these decisions satisfy the principle of proportionality.

Proportionality is a ‘principle’ built into the TEU (Articles 5(1) and 5(4)) which relate to the “division of competencies between the European Union and the Member States”.

In this case, the intent of the ruling was to question whether the ECB’s behaviour was commensurate with its stated monetary policy objectives.

It is clear that the Treaties never considered the ECB would play a major fiscal policy role, which in the climate of austerity imposed by the Commission on Member States, became essential if the common currency was to survive.

On the one hand, it has made it impossible for Member States to maintain high levels of prosperity. Member States move between various degrees of crisis as they try to stay within the ‘unworkable’ fiscal rules.

On the other hand, the ECB, which was entrusted with monetary policy, has been forced by the austerity bias to become a sort of de facto fiscal agent, which the Treaties claim (via subsidiarity etc) is the sole domain of the Member States.

This is what the BVerfG is ruling against.

I considered that decision in this blog post – BVerfG decision once again exposes the sham of the Euro system (May 6, 2020) – and the title indicates what I thought about it.

There have been all sorts of compromises proposed to deal with the fall out of the decision, particularly in relation to the conduct of the Bundesbank. But that is not the topic today.

The issue of democratic legitimacy

The Dutch academic paper asked the question:

Why did both courts come to such different answers?

They argued that “the fundamental issue of legitimacy at stake is of a kind that courts by their nature are ill-equipped to address.”

Their conjecture is that:

1. The ECB was mandated by the Maastricht Treaty to maintain price stability at a time when the “monetarist paradigm” dictated that a narrow, rules-based approach to a single policy goal could still be considered legitimate in a democratic sense.

2. The central bank would be entrusted to use interest rate variations to pursue these narrow goals, which was tantamount to “democratic authorization”.

3. The judicial process can only assess whether the ECB has acted “within the confines of its democratically authorised mandate.”

4. The Treaty “was imbued by ideas and concerns that were prevalent in Europe at the time” – which means that monetarist ideas were dominant and the broader neoliberal consensus imposed tight restrictions on what governments and the central bank could do.

Hence we had – Article 125 – the so-called ‘no bailout clause’ as a centrepiece of the creation of the EMU.

The Dutch paper reflects that:

… it is not surprising that the ECB’s mandate reflects assumptions that have become highly contentious since then or even turned out to be false.

The problem was that the politicians and the bureaucrats were warned by several economists (including myself – in my earlier days) that the system they were creating would have no chance of sustaining prosperity.

But the ideological hold of the monetarists pushed Europe into a dysfunctional setup that would falter when the first test came along.

That was the 2003 recession which saw Germany and France push their fiscal positions outside the legal limits of the Treaty.

But as the Dutch authors note:

The dramatic events of the 2007-2008 Global Financial Crisis, the 2010-2012 Eurozone Crisis and the Covid-19 Pandemic have confronted the ECB with new challenges, which were not anticipated in the mandate.

The point is that these crises created this confrontation for the ECB because the Stability and Growth Pact rules meant that the Member States were heavily constrained from using the fiscal tools that had been left intact at the national level by the Treaty design.

So to save the Eurozone from meltdown, particularly in 2010 and again in 2012, the ECB, as the currency-issuer in the flawed system, had to move outside – and by a lot – the mandate that it was given in the Treaty process.

And that is why there are all these legal challenges to the legality of the ECB operations.

As I have said many times, the ECB saved the EMU from collapse by effectively operating illegally, even though the ECJ found otherwise.

See my book – Eurozone Dystopia: Groupthink and Denial on a Grand Scale (published May 2015) – for a very detailed analysis of all these issues.

The Dutch paper observes that central bankers are being forced to recognise “that monetary policy impacts new economic policy objectives such as financial stability and environmental sustainability.”

So the concept of a narrow price stability target would seem to be somewhat outdated given the challenges that the monetarist paradigm assumed away – large-scale crises, etc.

This environment is thus:

In the existing institutional set-up, in sum, the ECB will continue to face what we term “authorization gaps”: the central bank has to make choices for which its mandate provides almost no guidance, but which have far-reaching consequences.

In other words, for a monetary system that professes virtue because it is so rule-driven, the day-to-day reality is a sort of ad hoc adventure where there are no rules.

It is like the wild west! Anything seems to go.

The Dutch authors examine how this ‘wild west’ behaviour by the ECB fits with the original democratic legitimacy that its narrow functions defined.

The “authorization gap” refers to the fact that “there is currently no clear democratic answer for many choices the ECB faces.”

The ECJ decision was a whitewash – it believed the official ECB line that all this bond buying was just part of its liquidity management function, which any reasonable economist knows is totally implausible – given the scale required and the scale executed.

Everyone knows that it was to keep the bond spreads low so that Member State governments could continue to access funds from primary debt investors.

They all looked the other way, when the debt was hoovered up ‘next day’ after the primary issuance by the ECB.

The ECJ just allowed the widest definition of the monetary policy mandate to be considered legal – which amounts to anything the ECB does! – and did not juxtapose the original concerns about democratic legitimacy.

That is why the BVerfG decision was so interesting. It was concerned about the latter – in particular whether the German public via its democratic voice (the German Parliament) – was involved in the radically broadened mandate being pursued by the ECB.

But as the Dutch paper notes this:

… puts the German judges themselves in a position of making decisions with immense consequences … If it is democratically illegitimate for the central bankers to make significant policy decisions, the same holds for the courts.

That was the interesting angle taken by the paper.

One of the things I am working on at the moment, which will be fully developed in in my next book, is the way in which political legitimacy is bestowed through public authority.

The current design of the Eurozone determines that the Member State governments are not ‘sovereign’ in the sense that they are forced to use a foreign currency and must issue debt to private bond markets in that foreign currency to fund any fiscal deficits.

Their fiscal positions must then take the full brunt of any economic downturn because there is no ‘federal’ counter stabilisation function.

The EMU is a federation without the most important component.

The decision by the Delors Committee in 1989 to ignore these recommendations reflected two realities:

1. The neoliberal ideology had become dominant and they didn’t want a major fiscal role for government in the new system.

2. But, relevant here, the decision to leave fiscal policy responsibilities at the Member State level reflected the diverse cultural, historical and language differences across the 19 Member States.

In particular, Germany’s dominant position in the European economy allowed it to dictate terms and there was never going to be a system established where permanent fiscal transfers could be made between states, which in the European context would have meant transfers from Germany to the South (mainly).

There was simply no European ‘demos’, which could force the creation of a truly federal Europe.

Which led me to conclude in – Eurozone Dystopia: Groupthink and Denial on a Grand Scale – that the option for Europe to create an effective federal system was not viable.

That led me to recommend various orders of exit starting from the politically impossible orderly dissolution of the currency sharing to different forms of unilateral exit.

But the point was that currency sovereignty is only legitimised if there is a demos that accepts that sovereignty and all that it implies (permanent asymmetric spatial transfers and the like).

Importantly, while MMT places currency sovereignty at the centre of the macroeconomic analysis, and I consider that to be a necessary condition for underpinning an effective progressive agenda, there needs to be more work done on outlining what determines the political legitimacy of the currency sovereign government.

Why are some currency arrangements unworkable (such as the EMU) and others effective (Australia)?

The Dutch paper is about some of these issues.

Monetarism promoted the view that:

… democratic institutions are myopic and that their direct accountability to citizens precludes effectively implementing a long-term oriented monetary policy.

In other words, we just have to trust the technicians that determine monetary policy.

The reality is that this approach has not delivered on its promise.

So from an outcomes perspective – that democracy is intact if mandated entities actually deliver – the ECB fails.

Even within the bounds of its original narrow mandate, the ECB is failing.

Earlier German Constitutional Court decisions ruled that the Bundestag had to retain the powers (which reflected its legitimisation from the people) to control German institutions like the central bank.

And, while some transfer of powers to the EU was consistent with this, the Court clearly ruled that behaviour by European institutions that were “no longer covered by the Treaty would lack democratic legitimation from the Bundestag and could not be given effect in the German legal order.”

The problem will compound when the climate change challenges are introduced.

The Dutch paper concludes that:

… it is unlikely that the ECB will be able to incorporate the EU’s climate-related and environmental objectives into its operations without more formal backing, setting it up for new legal challenges. By not providing the ECB with adequate democratic guidance, the EU’s political institutions weaken it as an institution …

So by pretending that there was no need for bailouts, and screwing fiscal policy at the Member State level down tightly, the EU political elites have not only created a dysfunctional monetary system, but, have also reduced the quality and scope of democracy in Europe.

To reform that gap, treaty changes are required to broaden the scope of the ECB beyond narrow price stability targets.

That is unlikely to happen any time soon.

Conclusion

The current practice of ignoring the fiscal rule limitations and the bond-buying free-for-all from the ECB really highlight how dysfunctional the architecture of the EMU is as specified in the Treaty.

It survives, in part, because its principle monetary institution operates illegally.

What happens if a vaccine is found that ends the health crisis is anyone’s guess.

My view is that Europe cannot go back to the Stability and Growth Pact and the Excessive Deficit Mechanism any time soon.

How long the politics will delay a return to austerity is the issue.

That is enough for today!

(c) Copyright 2020 William Mitchell. All Rights Reserved.