Eurozone Crisis & The ECB

Going back to the famous Maastricht Treaty.It connected a subset of EU states through a common monetary policy (EMU) and made no imagestreaty provision for fiscal coordination.Well It was prepared the Stability and Growth pact (, which took its legal authority from the Treaty on the Functioning of the European Union (TFEU).

So when Last July Mario Draghi, president of the European Central Bank, spoke of the ECB’s intent to do “whatever it takes” to hold the euro area together. In the months after his comment, the ECB unveiled its Outright Monetary Transactions programme, in which it pledged to make unlimited purchases of troubled government bonds under certain conditions. No policy has been as important in bringing down government borrowing costs around the periphery.

So what I am gonna argue today well the decision of ECB OMT now faces scrutiny in Germany’s constitutional court.

In the wake of the post-Lehman recession, the Federal Reserve and the Bank of England have bought bonds worth 19% and 25% of their country’s GDP, respectively. Asset purchases by the European Central Bank stand at a mere 3% of GDP. If the ECB had intervened as eagerly as the BoE, it would have acquired sovereign debt worth the entire outstanding amount of Italian and Spanish public bonds. A more activist ECB approach would have almost certainly prevented a nasty Greek problem from turning into a life-threatening crisis for the euro zone.

In August 2012 the ECB finally announced that it would do what it takes to preserve the euro and potentially buy bonds of countries that meet tough conditions. The German constitutional court is now probing whether the ECB overstepped its mandate with this decision.

The EU Treaty has entrusted the ECB with running the monetary policy for the euro zone with the “primary objective…to maintain price stability”. As a consequence, the bank must pursue a policy that reaches the real economy. Otherwise, it would have no control over trends in price levels and would be unable to meet its mandate and prevent inflation and deflation. Simply letting some banknotes rain down from the Eurotower in Frankfurt would not be good enough.

Bond purchases are a standard instrument of monetary policy. Even the German court admits that the ECB can buy bonds on the open market for monetary policy purposes. But the ECB is not allowed to finance governments. The question is thus whether the ECB’s “Outright Monetary Transactions” are part of monetary policy or a way to finance governments.

The Greek debt crisis erupted at the end of 2009. Until mid-2011, the problem was well contained, affecting only Greece, Ireland and Portugal (jointly 6% of euro-zone GDP). The euro zone as a whole enjoyed trend growth of 2% throughout this time. But in July 2011, Europe heeded advice from the IMF, to restructure Greek debt. From that very moment, contagion spread like wildfire. Sudden massive capital flight out of Italy and Spain caused havoc in bond and equity markets, plunging the entire euro zone into recession just two months later.

The ECB tried many things to contain the damage. It cut rates to a record low and swamped the banking system with liquidity through three-year refinancing operations. The effects evaporated shortly. Turmoil in financial markets and the banking system prevented the transmission of monetary stimulus to the real economy. The ECB had lost control.

Critics claim that the OMT redistributes risks within the euro zone and that the ECB has no mandate to do so. That is disingenuous.

Two legal considerations suggest that the German court should exercise utmost restraint.

First, the court has no jurisdiction over the ECB, which is an EU institution subject to the European Court of Justice. The court can only judge whether the ECB has usurped powers which Germany never ceded to the bank. But the German parliament, which is the body which actually ceded the power to run monetary policy to the ECB, has brought no complaint against the OMT to the court and seems to back the ECB with a considerable majority.

Second, Germany is only one of 17 euro members. If the Supreme Courts in all 17 countries were to claim for themselves the right to judge whether ECB actions conform to their understanding of monetary policy, the result could be utter chaos. Almost anything the ECB might do or not do could be shrouded in legal uncertainty. That would not be a way to run a monetary policy that can deliver price stability, as the ECB has done for 14 years already.

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