World Economy

Is ECB Allowed to Prevent Eurozone Bond Market Panics?

Is ECB Allowed to Prevent Eurozone Bond Market Panics?Is ECB Allowed to Prevent Eurozone Bond Market Panics?

The European Court of Justice is set to rule on the legality of the European Central Bank’s “Outright Monetary Transactions” program. What is that, and why does it matter? A story of bond markets, panics and laws.

This week, the European Court of Justice will decide whether a European Central Bank bond-buying program called OMT, or Outright Monetary Transactions, is legal in light of European Union treaty law, DW reported.

The ECJ’s decision has major implications for the future of the euro–the common currency used by 19 European Union member nations–and for the ability of several governments to fund themselves.

“OMT made it possible for the ECB to provide emergency liquidity assistance to individual eurozone member governments like Portugal, Spain and Greece that, in 2011-12, were having trouble raising money on bond markets at affordable interest rates,” said Phillip Konig, a macro-economist at the German Institute for Economic Research in Berlin.

“It’s analogous to central bank support of a bank which is illiquid–having trouble raising money on private capital markets–but not insolvent, i.e. its balance sheet is basically okay. The central bank acts as a “lender of last resort” to banks in that situation. Similarly, under OMT, the central bank would act as a lender of last resort to illiquid national governments.”

 Germans Hate OMT

The ECB’s new OMT policy was very controversial, particularly in Germany. The German central bank’s (Bundesbank’s) representative at the ECB, Jens Weidmann, voted against adopting OMT at the central bank’s governing council meeting in mid-2012. He argued that OMT would reduce the pressure on eurozone member states to implement needed economic reforms aimed at increasing their economic competitiveness and improving budget discipline. But Weidmann was outvoted by the majority on the governing council, and OMT was approved.

It wasn’t long before OMT was challenged in the courts. Several members of the German parliament–including members of Chancellor Angela Merkel’s own party, as well as members of the Left party–brought a legal action to the German Federal Constitutional Court, arguing that OMT was in conflict with a key European Union framework law, the Treaty on European Union. They said it effectively amounted to the ECB making fiscal policy–which is not its area of responsibility.

 ECB Restricted

In February 2014, the German court, strongly influenced by arguments made by the Bundesbank, issued a preliminary ruling saying OMT was illegal under EU treaty law.

But the supreme court didn’t simply prohibit OMT–instead, it referred the case to the European Court of Justice in Luxembourg, asking the judges there to evaluate the German court’s ruling. The ECJ will issue its own ruling on OMT this week in response to the German court’s referral.