ECB: Monetary policy needs limits

The German Constitutional Court has rightly expressed doubts about the monetary policy of the European Central Bank (ECB) and has asked the European Court of Justice for a legal review of it. This time, the case is about the Public Sector Purchase Program (PSPP), within which the ECB has already purchased bonds worth 1.6 trillion euros. The limits on the asset purchases have to be clarified.

In June 2016, the German Constitutional Court had already ruled against two other complaints on the ECB’s asset purchase programs – the Securities Markets Program (SMP) and the Outright Monetary Transactions (OMT). As in the previous case, the complainants insinuate that the ECB is conducting economic policy beyond its mandate and imposing too high liability risks on the German public budget through the scale of the asset purchases.

In the former case, the Constitutional Court had basically confirmed the ECB's monetary policy, albeit with restrictions. Among other things, the volume of purchases should be limited in order to minimize the liability risks for the public budget. There should also be a sufficiently long period between the emission of the bonds on the primary market and the subsequent purchase by the central bank so as not to distort the rates of the bonds too much. Otherwise, the ECB's program would be close to government financing. In the current case, the constitutional judges have to clarify whether the volume of the PSPP is too high and whether sufficient time has passed between initial sale and purchase of the bonds.

The ECB has justified the bond purchases with the risks of deflation in the euro area. In the period from December 2014 to February 2016, the inflation rate was negative. Inflation is still below the inflation target of close to two per cent. But there is no longer a risk of deflation: growth in the euro area is robust and unemployment is declining. It would be time for the ECB to end the accommodative monetary policy. However, the president of the ECB, Mario Draghi, has repeatedly emphasized the possibility of extending the program. As of today, the ECB is still buying bonds worth 60 billion euros per month until the end of the year.

However, even if the PSPP program expires, a clarification from the Constitutional Court is justified. When the next recession comes, the ECB will be forced to resume its buying program. Because of the low market interest rates, there are hardly any opportunities for a conventional reduction of the ECB’s policy rates. The Constitutional Court, which has now submitted the case to the European Court of Justice for consideration, should, in its final judgement, specify the basic guidelines for the purchase of the ECB's loans from the previous OMT decision. A capping of the monthly purchases to 60 billion euro and a time limit of the program to up to two years would be realistic limits, in order to keep the liability risks for the public budget low. In addition, in order to avoid the possibility of monetary government financing, the Constitutional Court should set the period between issuance and purchase by the ECB for at least two weeks.