Law, politics and the ECB road to quantitative easing

The European Central Bank The European Central Bank: Legal obstacles to quantitative easing seem to have been removed

It now looks like the European Court of Justice (ECJ) won't stand in the way of the European Central Bank in deploying unconventional monetary instruments - although a formal decision will be given at a later date.

The ECJ examined one such instrument, the Outright Monetary Transactions (OMT) programme, at the request of the German Constitutional Court.

Back at the height of the euro crisis, the OMT was the instrument that ECB president Mario Draghi chose to fulfil his pledge to do "whatever it takes" to save the euro.

Under the OMT, the ECB could have bought up government bonds, subject to a number of conditions involving the eurozone rescue mechanisms.

That is why today's ruling is viewed as a gauge of whether the ECB can carry out quantitative easing or QE, which many expect this year or as soon as next week.

But, today's opinion from one of the Advocate Generals also makes clear that the OMT has not actually been used, although its very existence has been enough to calm bond market jitters.

So the final judgement depends on how the OMT is now deployed by the ECB.

The question of whether OMT is a way of financing government spending is what worries the Germans, and that is the sticking point.

Market distortion

For some who view all QE as simply central banks buying up government debt, this seems to be what is happening, particularly as some banks buy so many bonds that they are in danger of distorting the market.

But, for others - particularly central bankers - who don't view QE as anything new, but just a way of controlling the quantity of money rather than its price (ie the interest rate), that argument doesn't hold water, because they always used to control monetary supply in the past.

In the UK, for instance, the Thatcher government attempted to control M1 and various monetary aggregates before eventually using interest rates instead.

Today's announcement from the Advocate General means the ECB has overcome these issues.

The next question is which government bonds to buy.

The options being floated are either buying bonds in each country in the eurozone in proportion to their respective GDPs, or purchasing only AAA or investment-grade ones.

The latter would be "safer" and in theory, push investors toward more risky bonds.

"Safe haven" bonds, such as those issued by Germany, already have negative yields, so investors are actually paying to lend to Germany. Perhaps this way they can be nudged to buy peripheral debt instead.

The other decision to be faced is whether it should be the national central banks that constitute the ECB, eg the Bundesbank, who buy the bonds, so the risk sits more on their balance sheets instead.

The legal challenge is one thing to have overcome, but it'll be the political debate that determines the shape of what the ECB does next.

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  • rate this

    Comment number 2.

    The ECB may deliberately defer buying Greek government bonds contemporaneously to other €uro countries under QE.

    Perhaps the ECB, other Troika members & German government are awaiting the Greek election's outcome to negotiate a single package hellenic debt & monetary solution.

    Herr Schaeuble & Frau Merkel should actively apply the lessons of The London Debt Agreement 1953 to Greece now.

  • rate this

    Comment number 1.

    The politics behind these decisions is as you rightly point out the key.

    Draghi & the ECB's Board seem committed to do whatever it takes. German politicians appear much more cautious, being respectful of their national neurosis on inflation, dating back to Weimar's monetary travails.

    Der Spiegel has reported that the bonds will be purchased through national central banks. Berlin yet to deny.



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