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 European Macroeconomics & Governance Tags & Topics

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.

View comments
Read article More by this author

Blog Post

Zsolt Darvas

Single market access from outside the EU: three key prerequisites

In relative terms, Norway’s current net financial contribution to the EU is similar to the UK’s. Switzerland and Liechtenstein pay surprisingly little, while Iceland is a net beneficiary. Relative to their population, Switzerland, Norway, Iceland and Liechtenstein received about twice as large an inflow of EU immigrants as the UK. These countries also have to adopt the vast majority of EU regulation to gain access to the single market.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: July 19, 2016
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

The difficulties of defining EU-UK economic relations

Negotiations on the UK's exit from the EU have not yet begun, but the UK leadership needs to find a balance between single market access and free movement. There are also tensions between the demands of voters and what EU partners can plausibly agree. Guntram Wolff doubts the likelihood of a Norway- or Switzerland-style deals, and urges caution on all sides.

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: July 19, 2016
Read article More on this topic More by this author

Blog Post

Marek Dabrowski

Iran: from isolation to economic cooperation

With some sanctions temporarily lifted, now is the chance for Iran to reintegrate into the global economy and political system. But comprehensive economic and political reforms are needed.

By: Marek Dabrowski Topic: European Macroeconomics & Governance Date: July 15, 2016
Read article More on this topic More by this author

Blog Post

Zsolt Darvas

Brexit vote boosts case for inclusive growth

In the United Kingdom’s Brexit referendum, income inequality and poverty boosted ‘leave’ votes, in addition to geographical differences and larger shares of uneducated and older people in UK regions, according to my regression analysis. The actual presence of immigrants did not have a significant effect on the results. Disadvantaged people voted in smaller proportions. Turnout was also low among the young and residents of Scotland, Northern Ireland and London, who were more likely to vote ‘remain’.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: July 13, 2016
Read about event More on this topic

Past Event

Past Event

Does the euro area need a sovereign insolvency mechanism?

The sovereign debt crisis shook the Euro to its foundations. It soon became clear that there was no mechanism to allow a tidy insolvency of a state wishing to remain inside the euro area. To face future crises, does the EU need a sovereign insolvency mechanism?

Speakers: Jochen Andritzky, Lars Feld, Zsolt Darvas and Guntram B. Wolff Topic: European Macroeconomics & Governance Location: Bruegel, Rue de la Charité 33, 1210 Brussels Date: July 12, 2016
Read article More on this topic More by this author

Blog Post

Jérémie Cohen-Setton

The great risk shift and populism

What’s at stake: For many commentators, Brexit was the signal of a broad populist backlash and illustrated the need to articulate policies that address the grievances of those citizens who have been left behind by recent economic changes.

By: Jérémie Cohen-Setton Topic: European Macroeconomics & Governance Date: July 11, 2016
Read article Download PDF More on this topic More by this author

Policy Contribution

Cover

An Italian job: the need for collective wage bargaining reform

Italy’s current system of centralised wage bargaining needs to be reformed. The system was designed without regard for the underlying industrial structure and geographical heterogeneity of the Italian economy. This has fostered perverse incentives and imbalances within Italy.

By: Alessio Terzi Topic: European Macroeconomics & Governance Date: July 6, 2016
Read article More on this topic More by this author

Opinion

Guntram B. Wolff

市场与公投承诺不可兼得

未来几个月市场的动荡还将持续,直到英国与欧盟关系的条款最终敲定。英国与欧盟保持密切关联的政治可能性越高,市场反应将会越积极。相反,如果英国采取孤立主义,以及欧洲大陆的惩罚性情绪越高,那么英国和欧盟的股市下跌将会越严重。

By: Guntram B. Wolff Topic: European Macroeconomics & Governance Date: July 6, 2016
Read article More on this topic More by this author

Opinion

Schoenmaker pic

登录 注册 丢了“欧盟护照”伦敦金融城伤不起

 作为全球金融中心,伦敦一部分的吸引力来自于其窗口作用——在伦敦扎根可以直接打入泛欧洲经济区(EEA)的内部市场。这么说来,金融企业有一个英国经营牌照就如同有一本“欧盟护照”,境外机构可以在整个欧洲经济区提供金融服务,畅通无阻。

By: Dirk Schoenmaker Topic: European Macroeconomics & Governance Date: July 5, 2016
Read article More on this topic More by this author

Blog Post

Dalia Marin

Inequality in Germany – how it differs from the US

The pay gap between workers and CEOs in Germany is driven by a lack of managers. Income inequality could fall if there were more managers available for companies to hire. Firms should start hiring more CEOs who are women or from abroad.

By: Dalia Marin Topic: European Macroeconomics & Governance Date: July 5, 2016
Read article More on this topic

Blog Post

Alvaro Leandro
jaume

Spanish unemployment and the effects of the 2012 labour market reform

What’s at stake: Spain is currently the EU country with the second highest level of unemployment, after Greece. The high and persistent level of unemployment and the appropriate labour market reforms are a major topic of discussion in Spain. We review arguments made in the blogosphere and by international organisations on the reasons for Spain’s stubbornly high unemployment, and various assessments of the labour market reforms of 2012.

By: Alvaro Leandro and Jaume Martí Romero Topic: European Macroeconomics & Governance Date: July 4, 2016
Read article More on this topic More by this author

Blog Post

Zsolt Darvas

No Lehman moment on currency markets after Brexit vote

While the pound sterling has lost a lot of its value right after the Brexit vote, from a historical perspective neither the fall of the exchange rate, nor its current level, is unprecedented. The situation is not as severe as it was in the aftermath the collapse of Lehman Brothers.

By: Zsolt Darvas Topic: European Macroeconomics & Governance Date: June 30, 2016
Load more posts