The independence of the central bank at risk

The independence of the central bank at risk

The authors of the blog are worried that the recent judgement of the German Federal Constitutional Court on the ECB’s monetary policy undermines the constitutional basis of the independence of the central bank and its own price stability mandate.

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The ruling of the German Federal Constitutional Court (GFCC) of May 5 on the ECB’s monetary policy affects not merely the relation of Germany to the ECB and the Court of Justice of europe (ECJ) but also the constitutional foundations of monetary policy. The court departs from the German tradition of entrusting monetary policy to an unbiased central bank that’s only given the duty of pursuing price stability. Based on the court’s reasoning, a lot of what the German Bundesbank i did so wouldn’t normally be permissible beneath the German Basic Law.

We think about this to be problematic. This criticism shouldn’t be interpreted as an approval of the ECB’s monetary policy. Some people are also critical of certain areas of this policy. However, we all have been concerned that the judgement of the Constitutional Court undermines the constitutional basis of the independence of the central bank and its own price stability mandate.

The GFCC believes that the ECB’s purchases of sovereign debt beneath the Public Sector Purchase Programme (PSPP) of 2015 violate the boundaries that the European Treaties set to the ECB’s activities. Based on the court, such ultra vires actions, actions that exceed the competences that national legislators have provided to EU institutions through the Treaties, should not be tolerated; otherwise the essential rights of German citizens will be violated. The court will not in principle dispute the ECB’s to implement such a programme. In the end, Article 18 of the Statute of the European System of Central Banks (ESCB) and of the ECB explicitly allows central banks to get marketable securities, including government bonds, without the restrictions. However, the GFCC complains that the ECB didn’t demonstrate the proportionality of the programme satisfactorily. The court therefore mandates the German government and the Bundestag to secure a satisfactory proportionality assessment from the Governing Council of the ECB. If this assessment isn’t obtained, the court mandates the Bundesbank to withdraw from the PSPP and similar programmes; quite simply, 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 takes its suitable and necessary opportinity for reaching 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 each other.“ Specifically, it demands "the consequences of a programme for the purchase of government bonds on, for instance, public debt, personal savings, pension and retirement schemes, property prices and the keeping afloat of economically unviable companies … (to be) considered in the proportionality assessment … and – within an overall assessment and appraisal – weighed against the monetary policy objective that the programme aims to accomplish and is with the capacity of achieving." 1

The core of the court’s argument could be sketched the following:

(1) The ECB is entrusted with monetary policy; on the other hand economic policy is reserved for the Member States.

(2) The PSPP has unwanted effects that belong to the region of economic policy, i.e., the domain that’s reserved for the Member States.

(3) Because the PSPP’s side-effects fall within the domain of economic policy, where the ECB does not have any role, the ECB must have explained why the quest for its monetary-policy mandate justified undertaking the PSPP despite these side-effects; this might have required a proportionality assessment.

(4) The ECJ also needs to have completed such a proportionality assessment when it commented on the PSPP’s compatibility with the Treaty at a youthful stage of the task. Because the ECJ didn’t do so, its "interpretation of the Treaties isn’t comprehensible and must thus be looked at arbitrary from a target perspective" 2 and its own judgment itself was an ultra vires act.

The terminology utilized by the court is oddly imprecise. It uses the word "economic policy effects", 3 however when it fills this term with substance, it generally does not refer to the consequences of the PSPP on economic policy but to the consequences on public debt, savings, pension provisions, property prices and the survival of companies. The word "economic policy effects" identifies the court’s opinion that the consequences listed participate in the domain of economic policy, instead of to the substance of the consequences as such. Because the Treaties reserve economic policy for the Member States, the court presumes ultra vires behaviour and requests a proportionality assessment.

This analysis has two major weaknesses. First, the court’s view of how exactly to separate economic policy and monetary policy is problematic. Second, the court will not indicate what standards ought to be used for the "overall assessment and appraisal" 4 that it’s requesting. The court’s request is actually incompatible with the Treaty and using its own 1993 ruling on the Maastricht Treaty. Additionally it is incompatible with the tradition of central bank independence with a special commitment to price stability that is central to the positioning of the Bundesbank in Germany for many years.

The court’s try to introduce a categorical separation between economic policy and monetary policy cannot succeed. Monetary policy measures will have "economic policy effects". Changes in interest and exchange rates certainly are a normal part of any monetary policy. Changes in interest levels affect the attractiveness of property and other capital goods, along with aggregate demand for goods and services and the amount of employment. It really is precisely these effects that produce for a connection between monetary policy and price stability.

To be certain, the distinction between monetary policy and economic policy is enshrined in the European Treaties, with a separation of responsibilities between your ECB and the Member States. However the Treaties usually do not say that separation hinges on the consequences of measures taken, as the GFCC claims. They leave open the chance of basing the separation on the kinds of measures taken, the instruments used and the objectives pursued; here is the interpretation of the ECJ, that your German Federal Constitutional Court has declared to be "arbitrary from a target perspective". Beneath the ECJ’s approach, government funding by debt issues will be a matter of economic policy owned by the domain of Member States despite the fact that these debt issues have side-effects on the monetary system and inflation; as well, increases in the amount of money supply through purchases of government bonds by the ECB will be a matter of monetary policy owned by the domain of the ECB despite the fact that they have side-effects in regions of concern for Member State economic policy, for instance, effects on the conditions under which Member State governments can issue public debt.

The Statute of the ESCB and of the ECB, which can be an integral area of the Treaty, specifies the instruments open to the central banks in the ESCB without mentioning the possible unwanted effects of the instruments in regions of concern to general economic policy. The statute provides no support for the idea that such side-effects might pose a issue of ultra vires behaviour, which should be addressed by a proportionality assessment.

Actually, the GFCC’s discussion of the assessment is less worried about the alleged ultra vires behaviour as such, than with the economic ramifications of the PSPP. With regards to content, the court will not discuss 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 focus on the effects on the surroundings for government debt funding. It follows the ECJ in its assessment that the PSPP can’t be classified as (prohibited) monetary government funding, but argues that the reduced amount of the overall degree of interest rates, to that your PSPP has contributed, reduces the expenses of debt funding for Member States, an impact that it sees critically.

However, such criticism of the consequences of a measure will not by itself justify the final outcome that the measure involves a transgression of competence limits. If the result of monetary policy on the interest level and therefore on the national budgets of the Member States – which is unavoidable – is usually to be regarded as a sign of ultra vires action, the criticism should be applied to interest increases, which presumably the GFCC likes, just concerning interest decreases. The assessment whether competence limits have already been violated or not should be independent whether one likes the measure or not.

The standards for this assessment are unclear, and upon this point the judgment will not help. How if the ECB or the ECJ measure the alleged transgression of competence limits and how should it compare them to the aim of price stability that’s set by the Treaty itself? Can they do so at all, and what legitimises them to help make the requisite value judgments? The court evades these questions by making economic effects, instead of "economic policy effects” the main topic of the proportionality assessment.

But an examination and evaluation of the economic ramifications of the PSPP can be problematic. This examination requires (i) a thorough account of the effects, with an assignment of weights to all or any; and (ii) a comparative evaluation in accordance with the aim of price stability. The “overall assessment and appraisal” that the GFCC is requesting in the proportionality assessment would in principle need to enable a conclusion in a way that, on the main one hand, the PSPP is regarded as to be suitable and essential for the quest for price stability but, alternatively, the side ramifications of the programme, for instance, the injury to savers, who no more receive much interest income, are so significant that you need to avoid implementing the programme. There are no standards whatsoever for how exactly to weight these different considerations.

The indicated conclusion would also be incompatible with the European Treaties. The Treaties require a “single monetary policy and exchange rate policy the principal objective of both which shall be to keep up price stability and, without prejudice to the objective, to support the overall economic policies in the Union, relative to 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 aim of price stability total other considerations (unlike in america, where in fact the law also makes employment a target of monetary policy). Other economic ramifications of monetary policy measures may only be studied into consideration to the extent that can be carried out without damaging the aim of price stability. With regards to the PSPP, the ECB has specified its price stability objective as "below, but near 2 percent". 6 Both ECJ and the GFCC have accepted this clarification, they also have accepted the ECB’s explanation of why the monetary policy pursued since 2015 was appropriate and essential to pursue this objective. The Federal Constitutional Court’s additional demand for a proportionality assessment that evaluates the medial side ramifications of this policy isn’t appropriate for the Treaties. Nor could this demand be fulfilled without violating the principle of democratic legitimacy that’s invoked by the court. In its Maastricht judgment of 1993, the court stated that responsibility for monetary and exchange rate policy was an important part of national sovereignty which in principle shouldn’t be used in a supranational institution. It nevertheless deemed the transfer of the responsibility to the ECB beneath the Maastricht Treaty to be permissible, as the ECB will be independent, governed by a body of experts, and only focused on the aim of price stability, a target about whose appropriateness the GFCC had without doubt. In those days 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 really is asking that the ECB – or the ECJ – make precisely such assessments requiring value judgments.

In this context, it really is worth looking back at the decades prior to the Maastricht Treaty. In 1973/74, 1980/82 and 1991/92 the Bundesbank raised interest levels significantly to be able to fight inflation. The next transition to a recession was faster and more radical than far away where central banks were less tough. Unemployment rose dramatically, in the region of 500,000 to at least one 1 million. The trade unions criticised the Bundesbank for not taking the consequences of its policies on unemployment into consideration. On each occasion, the Bundesbank stressed that, for legal reasons, it only had a mandate for price stability and a consideration of other objectives would violate its mandate.

In those decades, the mix of a cost stability mandate and independence of the Bundesbank insulated monetary policy from political pressures, like the influence of trade unions, industry associations, and their allies in politics – quite consistent with what the argument in the GFCC’s 1993 Maastricht ruling. The affected parties, trade unions, industry associations, the government, and the Bundestag, had to simply accept the Bundesbank’s policies as confirmed for his or her own actions. Based on the logic of the existing ruling, however, the Bundesbank could have had to examine if the monetary policy measures it took to fight inflation didn’t interfere excessively with, e.g. the essential rights of workers and trade unions, since it restricted the scope of what they could achieve in collective bargaining.

The Bundesbank’s policies at that time were specialized in fighting inflation, the ECB’s policies today are specialized in fighting deflation, but this difference can hardly justify the dilution of the ECB’s price stability mandate that’s 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 aren’t mentioned in today’s ruling, which only lists concerns of German critics of the ECB. However, if the ECB is asked to take account of concerns apart from price stability, it will need to consider the impact of its policies on workers. Moreover, it has to take account of the concerns of individuals in other Member States, not only in Germany. In the end, we are discussing an individual monetary policy for the whole monetary union. The more concerns are considered, however, the more problematic the required 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 quest for price stability.

To be certain, monetary policy has distributional effects. Nonetheless it always does, and the exclusion of the effects was and can be an important aspect of the transfer of monetary policy to an unbiased institution that only includes a mandate for price stability. Distribution conflicts should be addressed elsewhere in the polity. Central banks lack the political legitimacy to judge distributional effects, and, if indeed they were mandated to take action, the aim of price stability would suffer. Even the courts don’t have the political legitimacy necessary to make the required value judgments.

The GFCC’s judgements show little concern for the reason why for central bank independence. In its Maastricht judgement, the court stated that it might be good to have monetary policy “removed from the domain of influence of lobby groups and office holders attempting to be re-elected." This formulation shows that the court was interested in protecting democratic elections against corruption than in protecting the public’s rely upon the stability of the worthiness of money.

We are in need of central bank independence to ensure monetary policy will not turn into a pawn of the politics of your day, with measures that harm those that hold money and other nominal assets and who’ve no legal claims that may protect the worthiness of their holdings. Because of this same reason, we also need the central bank’s mandate to provide priority to the purchase price stability mandate. The GFCC’s demands undermine both central bank’s exclusive commitment to price stability and the central bank’s independence, with harmful effects not merely for the ECB also for the Deutsche Bundesbank and the stability of our currency.

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