Consultation on the impact of the judgment of the German Constitutional Court of May 5th 2020

A couple of financial market participants asked to consult me on the impact of the recent judgment by the German Constitutional Court (GCC). The notes I had prepared for these two consultations follow here.

• In practice and over the short term not much changes because of the judgment
  • Strong answer by Lagarde, who declared the ECB “undeterred”. In the Oxford dictionary, the meaning of this word is “not frightened”. So, a strong word. She must have had the agreement of the Governing Council for such a strong statement, notwithstanding the earlier statement by Weidmann that hinted at compromising with the request of the GCC.
  • Also strong was the statement by the Commission President, Von der Leyen, that even talked about the possibility of an infringement procedure against Germany.
  • The European Court of Justice (ECJ) statement that followed the judgment of the GCC did not have the strident, heavy and very unusual words used by the GCC, but was also strong in reaffirming its exclusive competence on matters of EU law.
  • The German Member of the ECB, Ms. Schnabel, defended the ECB actions and argued that it should do more if needed. This is breaking a pattern of uncooperative German Members of the ECB Board.
  • Will there be, notwithstanding these factors, a residual negative effect on ECB decision making? I don’t think so, they will continue doing what they judge is needed.
• In principle and over the medium/long-term the impact of the GCC judgment is very serious.
  • This is a controversy between two “Supreme” courts, no superior arbitrator
  • Opens the way to each national constitutional court establishing its limits to EU action (e.g. Poland, Hungary) and thus
  • Jeopardizing the unity of the legal framework within the ECB can act
  • The GCC practically said that it is not bound, also on EU issues, by the judgments of the ECJ and that it can give orders, through the Bundesbank and the German government, to the ECB. Establishing a form of tutelage on it, which will encourage plaintiffs to put  new cases, e.g. on the PEPP, to the GCC
  • On the proportionality issue raised by the GCC, is it not obvious that what the ECB did and is doing is justified by the pursuit of its inflation objective? If anything, the ECB could be considered failing at achieving its dominant objective, notwithstanding the extraordinary measures it took. Has the GCC the power and competence to judge whether the actions of the ECB effectively pursue the inflation objective? The ECB recently published a book about the effects of unconventional measures on inflation (modest but positive), can the GCC criticize the hundreds of pages as insufficient?
  • Given the lexicographic ordering of the inflation objective, how could the ECB establish trade-offs between it and other objectives, as the GCC is asking (expropriation of savers, financial instability, moral hazard, zombie firms)? By the way it is meaningful that the GCC did not mention the most obvious other possible objective (look at the FED) for a central bank, unemployment. This tells a lot about the economic policy views of the GCC, where the viability of German insurance companies is more important than unemployment.
  • The ECB is independent (art. 130 of the TFEU) as regards the tools to pursue its objectives, while being obliged as far as the objective is concerned, and therefore it cannot be instructed, through the Bundesbank and the Bundestag, to justify its action.
• Will a soft or a hard approach be pursued from the parties concerned?
  • Soft approach
    • The ECB does not answer.
    • The Bundesbank, possibly using specific material from the ECB, argues that what the ECB is doing is proportionate and legal (this would be consistent with statements of Merkel and Schaüble).
      • There are, however, two difficulties here
        • The Bundesbank should make the subtle point that QE is undesirable but legal.
        • Which position to take on the parameters (capital key, 33%) substantially weakened by the ECB in PEPP? (necessary, according to the GCC or sufficient, according to the ECJ?)
      • The German government agrees with the Bundesbank
      • The GCC does not, possibly in a new case, object to the conclusion of the Bundesbank and the German government.
    • Alternatively, it is the German government that takes on itself the responsibility of providing the proportionality proof.
  • Hard approach, possibly leading to a constitutional crisis.
    • The ECB does not answer
    • The Bundesbank is torn between two contrasting allegiances
    • The Bundesbank either
      • Does not take the responsibility on itself
      • Or does not conclude that QE is legal even if undesirable
      • Confirms that only if the parameters are respected is QE proportional
      • Formally asks the ECB to answer the criticism
      • The German government does not take the responsibility on itself either
      • The Bundesbank stop participating in the purchases and is substituted by the ECB or other NCBs
    • The GCC in a subsequent case on the PEPP does not agree with the Bundesbank conclusion on legality and proportionality (if there was one)
    • The Commission starts an infringement case against
      • The Bundesbank
      • The German Government
      • The German Constitutional Court
    • The European Court of Justice issues a judgment against the relevant German body
    • Difficult to find a solution is the hard approach is followed, even if one thinks of changes in Treaty and/or German constitution, there are inalienable parts (democracy) in German constitution which are interpreted by GCC as strictly limiting fiscal solidarity and central bank action.