Opinion

Pulling the eurozone back from the brink

In the coming months, the ECJ will assess the German Constitutional Court’s ruling that the European Central Bank’s “outright monetary transactions” (OMT) scheme – which allows the ECB to purchase weaker eurozone countries’ government bonds, in exchange for compliance with the rules of the European Stability Mechanism (ESM) – is illegal.

By: Date: November 2, 2014 Topic: European Macroeconomics & Governance

On October 14, as yet another financial storm gathered over Europe, the European Court of Justice convened in Luxembourg. In the coming months, the ECJ will assess the German Constitutional Court’s ruling that the European Central Bank’s “outright monetary transactions” (OMT) scheme – which allows the ECB to purchase weaker eurozone countries’ government bonds, in exchange for compliance with the rules of the European Stability Mechanism (ESM) – is illegal.

The mere announcement of OMT – the eurozone’s most potent crisis-management tool – immediately calmed panicked markets in the summer of 2012, prompting ECB President Mario Draghi to describe it as “the most successful monetary-policy measure undertaken in recent time[s].” That is why the German court’s ruling earlier this year that OMT oversteps the ECB’s authority under the Lisbon Treaty was met with consternation.

The German court did, however, pause to ask the “Europe-friendly” ECJ – the ultimate arbiter of European law – for its opinion. And, once the 2012 financial-market panic subsided, it seemed possible that OMT may have served its purpose, without ever having to be called to duty.

Europe may be facing another moment of reckoning, and the scenarios are bleak. Suddenly, the ECJ’s deliberations have become much more important

Then, earlier this month, amid slowing global growth, German economic indicators swooned, the risk premium on Greek sovereign bonds spiked, and ECB statistics showed that investors were pulling out of Italy. Europe may be facing another moment of reckoning, and the scenarios are bleak. Suddenly, the ECJ’s deliberations have become much more important.

Of course, this storm may blow over. But others will undoubtedly arise. The eurozone economy faces a grimmer outlook than at any time since the start of the global financial crisis in 2008. Growth prospects have been steadily downgraded; public debt/GDP ratios have risen dramatically, despite – or, some might argue, because of – unrelenting fiscal austerity; household debt burdens are not falling; and Italy’s vicious circle of rising debt and falling prices will soon be the fate of other stressed eurozone economies.

Moreover, all feasible policy options to jump-start growth – including a bold, eurozone-wide (not just German) fiscal stimulus and substantial, internationally coordinated euro depreciation – have been ruled out. Simply put, the eurozone is fragile, and it lacks a reliable safety net.

The OMT scheme could provide that safety net. But the German court’s case against it is strong. Indeed, it is based on the ECB’s own judgment validating the ESM (the eurozone’s existing effort to create a firewall against financial crises).

The German Constitutional Court and the ECJ agree that the Lisbon Treaty prohibits the ECB from taking action to support a sovereign on the verge of insolvency; that is a fiscal and political issue. Central-bank best practice follows the same view. The ECB’s argument that the OMT program’s primary purpose is to prevent a eurozone breakup is unconvincing to the German court, for only a nearly insolvent sovereign would risk breaking up the union.

The ECJ may ask the ECB to dilute its OMT promise

The ECJ may ask the ECB to dilute its OMT promise. Even Jörg Asmussen, former member of the ECB Governing Council, conceded to the German court that the “unlimited” purchases pledge contravened the treaty and would thus have to be limited. After all, once such purchases are initiated, the market will likely test the ECB to find out where it will draw the line.

Worse, the ECB has made an ambiguous promise to share losses with private creditors if a distressed sovereign does not eventually repay its debts. If the ECJ reverses this provision, OMT is unlikely to survive.

If, instead, the ECJ finds a legal argument to validate the scheme – and the German court, sensitive to current financial uncertainties, acquiesces – the ambiguities will be pushed aside, to be addressed later. A loss incurred by the ECB on an OMT operation would create a fiscal liability for Germany (and others), with far-reaching political consequences. (The recently leaked minutes of the ECB’s Governing Council meetings highlight the differences between Draghi and Bundesbank President Jens Weidmann’s views, adding to operational concerns about OMT.)

The problem is that none of these discussions addresses the fundamental flaw in the eurozone’s structure: It is an incomplete monetary union. Eurozone countries surrendered monetary sovereignty, but remain loath to pay for one another’s fiscal mistakes.

Unwilling to confront that issue, the eurozone authorities are consumed with tweaking trivialities like the degree of “flexibility” in the fiscal rules and the ECB’s dubious plan to purchase asset-backed securities. All the while, they are relying on Scarlett O’Hara’s credo: “Tomorrow is another day.”

A financial guarantee like OMT can work wonders to dampen market fears and ease pressure, but only if it is credible. If it is not, it is likely to fail spectacularly.

The authorities have pulled the eurozone back from the brink before. Is it too late to do so again?

To avoid such an outcome, Europe’s leaders should agree to share, with full transparency, whatever losses the ECB incurs from its OMT operations, thereby giving OMT the political legitimacy it needs to serve as an effective safeguard for the eurozone. Such an agreement could, however, prompt a public referendum in Germany, at which point all bets would be off.

Whatever its flaws, OMT is the closest thing to a safety net the eurozone has. The authorities have pulled the eurozone back from the brink before. Is it too late to do so again?

Republished with permission from project Syndicate.

Read more on OMT

The OMT programme was justified but the fiscal union question remains

Did the German court do Europe a favour?


Republishing and referencing

Bruegel considers itself a public good and takes no institutional standpoint.

Due to copyright agreements we ask that you kindly email request to republish opinions that have appeared in print to communication@bruegel.org.


Warning: Invalid argument supplied for foreach() in /home/bruegelo/public_html/wp-content/themes/bruegel/content.php on line 449
View comments
Read article More on this topic More by this author

Blog Post

Revision of the Posted Workers Directive misses the point

The Commission’s proposed revision of the Posted Workers Directive has been approved by the European Parliament’s Employment Committee, which welcomes the arrival of “equal pay for equal work”. But the revision will have little impact, and was largely unnecessary. Instead we should focus on the fight against bogus self-employment, social security fraud and undeclared work.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: October 18, 2017
Read article Download PDF More on this topic

Policy Contribution

Spotting excessive regional house price growth and what to do about it

Rapidly rising house prices are a well-known source of financial instability. This Policy Contribution examines whether there are regional differences in house price growth within European countries and, if so, whether this warrants more targeted measures to address vulnerabilities.

By: Grégory Claeys, Konstantinos Efstathiou and Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: October 18, 2017
Read about event More on this topic

Upcoming Event

Oct
26
14:30

Growth, productivity and social progress in Europe

On 26 October, Bruegel is organizing an interactive brainstorming seminar on Growth, Productivity and Social Progress in Europe. This is a closed-door, high-level workshop for a selected number of experts in the field.

Speakers: André Sapir Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read about event More on this topic

Upcoming Event

Nov
6
12:30

An independent assessment of the EU's fiscal framework: presentation of the first annual report of the European Fiscal Board

This event will feature a presentation of the first Annual Report of the European Fiscal Board.

Speakers: Mateusz Szczurek, Niels Thygesen and Further speakers to be confirmed Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article

Blog Post

An update: sovereign bond holdings in the euro area – the impact of quantitative easing

Since the European Central Bank’s announcement in January 2015 of its quantitative easing programme, national central banks have been buying government and national agency bonds. In this post we look at the effect of QE on sectoral holdings of government bonds, updating calculations that we published initially in May 2016.

By: Pia Hüttl and David Pichler Topic: European Macroeconomics & Governance Date: October 10, 2017
Read article

Blog Post

India’s trade ties with the UK and EU

As EU and Indian leaders meet in Delhi, we look at the figures on trade. The UK’s place in the relationship warrants special attention. EU-India trade has more than tripled since 2000, but UK-India trade is largely static. The shift is especially noticeable for EU exports to India, where the UK share has dropped from 29% to 10%.

By: Maria Demertzis and Alexander Roth Topic: European Macroeconomics & Governance, Global Economics & Governance Date: October 6, 2017
Read article More on this topic More by this author

Blog Post

Catalonia and the Spanish banking system

As tensions rise around Catalonia's independence movement, there are worries about the impact on the Spanish banking sector. Banks based in Catalonia account for around 14% of total assets. Some major institutions are already moving their headquarters to other parts of Spain. However, most Spanish banks have significant exposure to the Catalan market, and all could be caught up in the turmoil.

By: Yana Myachenkova Topic: European Macroeconomics & Governance Date: October 6, 2017
Read article More on this topic

Blog Post

What has driven the votes for Germany’s right-wing Alternative für Deutschland?

The AfD vote in East Germany was consistently stronger than in the West, even after controlling for income, age, education, religion and the overall rural nature of the new Bundesländer.

By: Alexander Roth and Guntram B. Wolff Topic: European Macroeconomics & Governance Date: October 5, 2017
Read about event

Upcoming Event

Nov
28
12:30

Sustainable growth in transition countries

This event will feature a presentation of the EBRD Transition Report 2017-18.

Speakers: Jonathan Charles, Zsolt Darvas, Jean Pisani-Ferry, Sergei Guriev and Debora Revoltella Topic: European Macroeconomics & Governance, Finance & Financial Regulation Location: Bruegel, Rue de la Charité 33, 1210 Brussels
Read article Download PDF

External Publication

European Parliament

The single monetary policy and its decentralised implementation: An assessment

This paper assesses the decentralised implementation of monetary policy by the Eurosystem in terms of its transparency, efficiency and simplicity. Compared to the Fed, the Eurosystem seems to have higher staff numbers and operational costs for similar tasks.

By: Francesco Papadia and Alexander Roth Topic: European Macroeconomics & Governance, European Parliament, Testimonies Date: October 4, 2017
Read article More on this topic More by this author

Blog Post

Ukraine’s oligarchs are bad for democracy and economic reform

Ukraine’s late and incomplete economic reform created a class of super-wealthy oligarchs who now stand in the way of further liberalisation. The oligarchs’ oversized influence only deepens public distrust in a structurally weak political system. Nevertheless, Ukraine is making some attempts to uproot corruption and the next steps are clear.

By: Marek Dabrowski Topic: European Macroeconomics & Governance Date: October 3, 2017
Read article Download PDF More by this author

External Publication

An innovation deficit behind Europe’s overall productivity slowdown?

Reinhilde Veugelers' chapter in "Investment and Growth in Advanced Economies", conference volume of the European Central Bank’s Forum on central banking in Sintra.

By: Reinhilde Veugelers Topic: European Macroeconomics & Governance, Innovation & Competition Policy Date: October 2, 2017
Load more posts