Christine Lagarde, then-director of the International
Monetary Fund, speaks with Jerome Powell, the chair of the U.S. Federal
Reserve, during the family picture of the G-20 meeting of finance
ministers and central bank governors in Buenos Aires on July 21, 2018.
EITAN ABRAMOVICH/AFP via Getty Images
In Europe, a ruling by the German Constitutional Court that the
European Central Bank (ECB) failed to adequately justify a program of
asset purchases it began in 2015 is convulsing the political and
financial scene. Some suggest it could lead to the unraveling of the
euro. It may be difficult at first glance to understand why. Yes, the
purchases were huge—more than 2 trillion euros of government debt. But
they were made years ago. And the points made by the court are arcane.
So how could a matter like this assume such importance?
The legal clash in Europe matters not only because the ECB is the
second-most important central bank in the world and not only because
global financial stability hinges on the stability of the eurozone. It
also brings to the surface what ought to be a basic question of modern
government: What is the proper role of central banks? What is the
political basis for their actions? Who, if anyone, should oversee
central banks?
As the COVID-19 financial shock has reaffirmed, central banks are the
first responders of economic policy. They hold the reins of the global
economy. But unlike national Treasuries that act from above by way of
taxing and government spending, the central banks are in the market.
Whereas the Treasuries have budgets limited by parliamentary or
congressional vote, the firepower of the central bank is essentially
limitless. Money created by central banks only shows up on their balance
sheets, not in the debt of the state. Central banks don’t need to raise
taxes or find buyers of their debt. This gives them huge power.
How this power is wielded and under what regime of justification
defines the limits of economic policy. The paradigm of modern central
banking that is being debated in the spartan court room in the German
town of Karlsruhe was set half a century ago amid the turbulence of
inflation and political instability of the 1970s. In recent years, it
has come under increasing stress. The role of central banks has
massively expanded.
In much of the world, notably in the United States, this has
engendered remarkably little public debate. Though the litigation in
Germany is in many ways obscure, it has the merit of putting a spotlight
on this fundamental question of modern governance. Faced with the
hubris of the German court, it may be tempting to retreat into a defense
of the status quo. That would be a mistake. Though it is flawed in many
ways, the court’s judgment does expose a real gap between the reality
of 21st-century central banking and the conventional understanding of
its mission inherited from the 20th century. What we need is a new
monetary constitution.
Central
bankers gather for a G-7 meeting in Washington in April 2004, including
(from left) David Dodge of the Bank of Canada; Christian Noyer of the
Bank of France; Jürgen Stark of the Bundesbank; Jean-Claude Trichet of
the European Central Bank; Alan Greenspan of the U.S. Federal Reserve;
Toshihiko Fukui of the Bank of Japan; Mervyn King of the Bank of
England; and Antonio Fazio of the Bank of Italy. Stephen J. Boitano/LightRocket via Getty Images
The proud badge worn by modern central bankers is that of
independence. But what does that mean? As the idea emerged in the 20th
century, central bank independence meant above all freedom from
direction by the short-term concerns of politicians. Instead, central
bankers would be allowed to set monetary policy as they saw fit, usually
with a view not only to bringing down inflation but to permanently
installing a regime of confidence in monetary stability—what economists
call anchoring price expectations.
The analogy, ironically, was to judges who, in performing the
difficult duty of dispensing justice, were given independence from the
executive and legislative branches in the classic tripartite division.
With money’s value unhooked from gold after the collapse of the Bretton
Woods system in the early 1970s, independent central banks became the
guardians of the collective good of price stability.
The basic idea was that there was a trade-off between inflation and
unemployment. Left to their own devices, voters and politicians would
opt for low unemployment at the price of higher inflation. But, as the
experience of the 1970s showed, that choice was shortsighted. Inflation
would not remain steady. It would progressively accelerate so that what
at first looked like a reasonable trade-off would soon deteriorate into
dangerous instability and increasing economic dislocation. Financial
markets would react by dumping assets. The foreign value of the currency
would plunge leading to a spiral of crisis.
Under the looming shadow of this disaster scenario, the idea of
central bank independence emerged. The bank was to act as a counter-majoritarian institution. It was charged with doing whatever it
took to achieve just one objective: hold inflation low. Giving the
central bank a quasi-constitutional position would deter reckless
politicians from attempting expansive policies. Politicians would know
in advance that the central bank would be duty bound to respond with
draconian interest rates. At the same time as deterring politicians,
this would send a reassuring signal to financial markets. Establishing
credibility with that constituency might be painful, but the payoff in
due course would be that interest rates could be lower. Price stability
could thus be achieved with a less painful level of unemployment. You
couldn’t escape the trade-off, but you could improve the terms by
reassuring the most powerful investors that their interest in low
inflation would be prioritized.
It was a model that rested on a series of assumptions about the
economy (there was a trade-off between inflation and unemployment),
global financial markets (they had the power to punish), politics
(overspending was the preferred vote-getting strategy), and society at
large (there were substantial social forces pushing for high employment
regardless of inflation). The model was also based on a jaundiced vision
of modern history and more or less explicitly at odds with democratic
politics: first in the sense that it made cynical assumptions about the
motivations of voters and politicians but also in the more general sense
that in the place of debate, collective agreement, and choice, it
favored technocratic calculation, institutional independence, and
nondiscretionary rules.
Bundesbank
President Karl Blessing lays the cornerstone for the new Bundesbank
building in Frankfurt, Germany, in November 1967. Roland Witschel/picture alliance via Getty Images
This conservative vision legitimated itself by reference to moments
of historical trauma. The German Bundesbank founded after World War II
in the wake of two bouts of hyperinflation—during the Weimar Republic
and the aftermath of Germany’s catastrophic defeat in 1945—was the
progenitor. The U.S. Federal Reserve made its conversion to
anti-inflationary orthodoxy in 1979 under Paul Volcker’s stewardship.
The mood music was provided by President Jimmy Carter’s famous speech on
the American malaise compounded by global anxiety about the weakness of
the dollar after repeated attempts by the Nixon, Ford, and Carter
administrations to stabilize prices through government-ordered price
regulations and bargains with trade unions and businesses. Democratic
politics had failed. It was time for the central bankers to act using
sky-high interest rates. That ending inflation in this way would mean
abandoning any commitment to full employment, plunging America’s
industrial heartland into crisis, and permanently weakening organized
labor was not lost on Volcker. There was, in that famous phrase of the
era, no alternative.
By the 1990s, an inflation-fighting, independent central bank had
become a global model rolled out in post-communist Eastern Europe and
what were now dubbed the “emerging markets.” Along with independent
constitutional courts and adherence to global human rights law,
independent central banks were part of the armature that constrained
popular sovereignty in Samuel Huntington’s “third wave of democracy.” If
the freedom of capital movement was the belt, then central bank
independence was the buckle on the free-market Washington Consensus of
the 1990s.
For the community of independent central bankers, those were the
golden days. But as in so many other respects, that golden age is long
gone. In recent decades, central banks have become more powerful than
ever. But with the expansion of their role (and their balance sheets)
has gone a loss of clarity of purpose. The giant increase in power and
responsibility that has accrued to the Fed and its counterparts around
the world in reaction to COVID-19 merely confirms this development.
Formal mandates have rarely been adjusted, but there has clearly been a
huge expansion in reach. In the American case, where the extension has
been most dramatic, it amounts to a hidden transformation of the state,
indeed of the U.S. Constitution, that has taken place in an ad-hoc way
under the pressure of crisis with precious little opportunity for
serious debate or argument.
Conservative economists watch in horror as the paradigm of the 1990s
has come apart. Won’t a central bank that intervenes as deeply as modern
central banks now do distort prices and twist economic incentives? Does
it not pursue social redistribution by the back door? Will it not
undermine the competitive discipline of credit markets? Will a central
bank whose balance sheet is loaded with emergency bond purchases not
fall into a vicious circle of dependence on the stressed borrowers whose
debts it buys?
These concerns are at the root of the drama in Germany’s
constitutional court. But to know how to respond to them, we need to
start by doing what neither the German court nor the ECB’s defenders
have so far done, namely to account for how the familiar model of
central bank independence has come apart since the 1990s.
The
eurodollar options pit at the Chicago Mercantile Exchange erupts on Dec.
19, 2000, after a Fed announcement that it saw economic risk tilted
toward a downturn rather than toward inflation. SCOTT OLSON/AFP via Getty Images
The assumptions about politics and economics that anchored the model
of the independent central bank in 1980s and 1990s were never more than a
partial interpretation of the reality of late 20th-century political
economy. In truth, the alarmist vision they conjured was not so much a
description of reality as a means to advance the push for market
discipline, away from both elected politicians and organized labor. In
the third decade of the 21st century, however, the underlying political
and economic assumptions have become entirely obsolete—as much because
of the success of the market vision as its failures.
First and foremost, the fight against inflation was won. Indeed, it
was won so decisively that economists now ask themselves whether the
basic organizing idea of a trade-off between inflation and unemployment
any longer obtains. For 30 years, the advanced economies have now been
living in a regime of low inflation. Central banks that once steeled
themselves for the fight against inflation now struggle to avoid
deflation. By convention, the safe minimal level of inflation is 2
percent. The Bank of Japan, the Fed, and the ECB have all systematically
failed to hold inflation up to that target. It was the desperate
efforts of the ECB to ensure that the eurozone did not slide into
deflation in 2015 that led to the drama in the German courtroom last
week. The ECB’s giant bond purchases were designed to flush the credit
system with liquidity in the hope of stimulating demand.
Long before the lawyers starting arguing, the economics profession
has been scratching its head over this situation. The most obvious
drivers of so-called lowflation are the spectacular efficiency gains
achieved through globalization, the vast reservoir of new workers who
were attached to the world economy through the integration of China and
other Asian export economies, and the dramatic weakening of trade
unions, to which the anti-inflation campaigns, deindustrialization, and
high unemployment of the 1970s and 1980s powerfully contributed. The
breaking of organized labor has undercut the ability of workers to
demand wage increases. This lack of inflationary pressure has left
modern central banks unconcerned about even the most gigantic monetary
expansion. However much you increase the stock of money, it never seems
to show up in price increases.
Nor is it just the economics that are haywire. Whereas the classic
model assumed that politicians were fiscally irresponsible and thus
needed independent central banks to bring them into line, it turns out
that a critical mass of elected officials drank the 1990s Kool-Aid. In
recent decades, we have seen not a relentless increase in debt but
repeated efforts to balance the books, most notably in the eurozone
under German leadership. Contrary to its reputation, Italy has been a
devoted follower of austerity, leading the way in fiscal discipline. But
so has the United States, at least under Democratic administrations.
Politicians campaigned for fiscal consolidation and debt reduction
instead of promises of investment and employment. In the agonizingly
slow recovery from the 2008 crisis, the problem for the central bankers
was not overspending but the failure of governments to provide adequate
fiscal stimulus.
Rather than obstreperous trade unions and feckless politicians, what
central bankers have found themselves preoccupied with is financial
instability. Again and again, the financial markets that were assumed to
be the disciplinarians have demonstrated their irresponsibility
(“irrational exuberance”), their tendency to panic, and their
inclination to profound instability. They are prone to bubbles, booms,
and busts. But rather than seeking to tame those gyrations, central
banks, with the Fed leading the way, have taken it on themselves to act
as a comprehensive backstop to the financial system—first in 1987
following the global stock market crash, then after the dot-com crash of
the 1990s, even more dramatically in 2008, and now on a truly
unprecedented scale in response to COVID-19. Liquidity provision is the
slogan under which central banks now backstop the entire financial
system on a near-permanent basis.
To the horror of conservatives everywhere, the arena in which central
banks perform this balancing act is the market for government debt.
Government IOUs are not just obligations of the tax payer. For the
government’s creditors, they are the safe assets on which pyramids of
private credit are built. This Janus-faced quality of debt creates a
basic tension. Whereas conservative economists anathematize central
banks swapping swap government debt for cash as the slippery slope to
hyperinflation, the reality of modern market-based finance is that it is
based precisely on this transaction—the exchange of bonds for cash,
mediated if necessary by the central bank.
One of the side effects of massive central bank intervention in bond
markets is that interest rates are very low, in many cases close to
zero, and at times even negative. When central banks take assets off
private balance sheets, they drive prices up and yields down. As a
result, far from being the fearsome monster it once was, the bond market
has become a lap dog. In Japan, once one of the engines of financial
speculation, the control of the Bank of Japan is now so absolute that
trading of bonds takes place only sporadically at prices effectively set
by the central bank. Rather than fearing bond vigilantes, the mantra
among bond traders is “Don’t fight the Fed.”
Central bank intervention helps to tame the risks of the financial
system, but it does not stem its growth, nor does it create a level
playing field. While high-powered fund managers and their favored
clients hunt for better returns in stock markets and exotic and
exclusive investment channels like private equity and hedge funds, thus
taking on more risk, more cautious investors find themselves on the
losing side. Low interest rates hurt savers, they hurt pension funds,
and they hurt life insurance funds that need to lock in safe long-term
returns on their portfolios. It was precisely that constituency that was
the mainstay of the litigation in front of the German constitutional
court.
A
woman jumps on a table, throwing papers and confetti and calling for an
“end to the ECB dictatorship,” as she disrupts a news conference in
Frankfurt on April 15, 2015. DANIEL ROLAND/AFP via Getty Images
The plaintiffs and their lawyers blame the central bank for pushing
interest rates down, benefiting feckless borrowers at the expense of
thrifty savers. What they ignore are the deeper economic pressures to
which the central bank itself is responding. If there is a glut of
savings, if rates of investment are low, if governments, notably the
German government, are not taking up new loans but repaying debt, this
is bound to depress interest rates.
The result of this combination of economic, political, and financial
forces is an economic landscape that, by the standards of the late 20th
century, can only seem topsy-turvy. Central bank balance sheets are
grotesquely inflated, yet prices (except for financial assets) slide
toward deflation. Before the COVID-19 lockdown, record low unemployment
no longer translated into wage increases. With long-term interest rates
near zero, politicians nonetheless refused to borrow money for public
investments. The response of central bankers, desperate to prevent a
slide into self-sustaining deflation, is to reach again and again for
stimulus.
In the United States, at least in this respect, the election of
Donald Trump as president helped restore a degree of normality, if with a
perverse edge. Egged on by Republicans in Congress, his administration
has shown no inhibition about huge deficits to finance regressive tax
cuts. Apart from anti-immigrant rhetoric, Trump’s winning card in 2020
would be an economy running hot. In 2019, the Fed seemed to be headed
into the familiar territory of weighing when to raise interest rates to
avoid overheating. Chair Jerome Powell certainly did not appreciate the
president’s bullying against rate hikes, but at least the Fed was not
lost in the crazy house of low growth, low inflation, low interest
rates, and low government spending that the Bank of Japan and the ECB
had to contend with.
Since the 1990s, the Bank of Japan has engaged in one monetary policy
experiment after another. And driven by the profound crisis in the
eurozone under the leadership of Mario Draghi, the ECB embarked on its
own experiments. These efforts proved effective in delivering a measure
of financial stability. They made central bankers into heroes. But they
also fundamentally altered the meaning of independence. In the paradigm
that emerged from the crises of the 1970s, independence meant restraint
and respect for the boundaries of delegated authority. In the new era,
it had more to do with independence of action and initiative. More often
than not, it meant the central bank single-handedly saving the day.
Whereas in most of the world this was accepted in a pragmatic
spirit—it was reassuring to think that someone, at least, was in
charge—in the eurozone it was never going to be so easy. The way that
Chancellor Helmut Kohl’s government sold German voters on the
abandonment of the Deutsche mark was the promise that the ECB would
resemble the Bundesbank as closely as possible. It was barred from
directly financing deficits, and, in the hope of limiting undue national
influence, it had limited political accountability. Its narrow mandate
was simply to ensure price stability.
This was always a gamble, which depended on the willingness of the
Italians and French, who also had a voice in the euro system, to go
along. Their financial elites pushed for a common currency in part
because they were looking for a restraint on their own undisciplined
political class—but also because they were gambling that as members of
the eurozone they would have a better chance of bending European
monetary policy in their direction than they would if their national
central banks were forced to follow the Bundesbank by the pressure of
bond markets. In the early years of the euro, the compromise worked to
mutual satisfaction. But it was always fragile. Once the financial
crisis of 2008 forced a dramatic expansion of the ECB’s activity, buying
both government and corporate bonds, intervening to cap the interest
rates paid by the weakest eurozone member states, pushing bank lending
by complex manipulation of interest rates, conflict was predictable.
This tension exploded in the German Constitutional Court last week.
People
wearing face masks walk in front of a big euro sign in front of the
European Central Bank headquarters in Frankfurt on April 24. YANN SCHREIBER/AFP via Getty Images
For the majority of financial opinion, the ECB’s growing activism is
broadly to be welcomed. It is the one part of the complex European
constitution that actually functions with real authority and clout as a
federal institution. Though grudging in her public support, Chancellor
Angela Merkel has rested her European policy on a tacit agreement to let
the ECB do what was necessary. Allowing the ECB to manage spreads—the
interest rate margin paid by weaker borrowers—was easier than addressing
the question of how to make Italy’s debt-level manageable. But a
recalcitrant body of opinion in Germany has never reconciled itself to
this reality. For them, the ECB serves as a lightning rod for their
grievances about the changing political economy of the last decade. They
blame it for victimizing savers with its low interest policy. They
blame it for encouraging the debts of their Southern European neighbors.
Exponents of the old religion of German free market economics regard
cheap credit as subversive of market discipline. All in all, they
suspect the ECB of engaging in a policy of redistributive Keynesianism
in monetary disguise, everything that Germany’s national model of the
social market economy was supposed to have ruled out. For these Germans,
the ECB is an opaque technocratic agency arrogating to itself powers
that properly belong to national parliaments, barreling down the
slippery slope to a European superstate. And, for them, it is anything
but accidental of course that it is all the creation of a Machiavellian
Italian with trans-Atlantic business connections, Mario Draghi.
For the body of opinion that had always been suspicious of the euro,
Draghi’s commitment to do “whatever it takes” in 2012 was the final
straw. The Alternative for Germany (AfD) emerged in 2013 not originally
as an anti-immigrant party but as a right-wing economic alternative to
Berlin’s connivance with the antics of the ECB. As the AfD has
consolidated its position as the anti-establishment party of right-wing
protest above all in eastern Germany, its agenda has shifted. But Bernd
Lucke, one of the founders of the AfD who has since left the party, was
among the plaintiffs whose case the German constitutional court decided
last week.
Meanwhile, Germany’s influential tabloid Bild pursued a
campaign amounting to a vendetta against Draghi, picturing him last
September as a vampire sucking the blood of German savers. And even the
Bundesbank leadership, both current and emeritus figures, has not been
shy about associating itself with public opposition to the expansive
course of the ECB. Defending the strength of the euro against the
spendthrift, inflationary ways of Southern Europe played well with the
patriotic gallery. But so long as Merkel preferred to cooperate with the
ECB’s leadership, that opposition remained marginalized. What has
thrown a spanner in the works are the well-developed checks and balance
of the German Constitution guarded by the Constitutional Court.
The German Constitutional Court, based in modest digs in the sleepy
town of Karlsruhe, has an activist understanding of its role within the
German polity, presenting itself as “the citizens’ court” unafraid of
upending the political agenda on issues from the provision of child care
or means-tested welfare benefits to the future development of the
European project. Since the 1990s, the court has been a vigilant check
on unfettered expansion of European power. It makes the argument on the
basis of defending democratic national sovereignty, insisting on its
right to constantly review European institutions for their conformity to
the basic norms of the German Constitution.
Each progressive expansion of ECB activism has thus stirred a new
round of legal activism. Announced in 2012, Draghi’s instrument of
Outright Monetary Transactions, an unlimited bond-buying backstop for
troubled eurozone sovereign debtors, was challenged by a coalition of
both left-wing and right-wing German plaintiffs. It was not until the
summer of 2015 that the court finally and grudgingly ruled it
acceptable.
When Draghi finally launched the ECB into large-scale bond buying in
2015, of the type that both the Fed and Bank of Japan had embarked on
years before, it too immediately triggered a new round of litigation. In
2017, the court gave a preliminary ruling but referred the case to the
European Court of Justice (ECJ). In December 2018, the ECJ declared the
program to be in conformity of the European treaties. But the German
constitutional judges were not satisfied with the reasoning of the ECJ
and held hearings in 2019. After months of deliberation, Karlsruhe was
supposed to issue its judgment on March 24, but that was postponed a
week beforehand due to the coronavirus pandemic.
That turned out to be opportune because financial markets in March
were in crisis. Between March 12 and 18, as the ECB failed to calm the
waters, the interest paid by Italy for state borrowing surged. Thanks to
massive intervention by the ECB, they have since cooled. Christine
Lagarde’s ECB has promised to make an additional round of purchases in
excess of 700 billion euros, with more to come if necessary. To calm the
markets, what was needed was discretion and largesse—precisely what the
German critics of the ECB feared most and had criticized so incessantly
in the 2015 bond-buying program.
The
judges of the German Constitutional Court in Karlsruhe arrive to give
their ruling on the European Central Bank bond-buying program on May 5. SEBASTIAN GOLLNOW/dpa/AFP via Getty Images
This made the judgment from Karlsruhe on the 2015 program even more
significant. What might the ruling on Draghi’s quantitative easing (QE)
signal for possible action against Lagarde’s crisis program? How might
the court influence the course of debate in Germany? The initial
hearings in 2019 had not sounded favorable to the ECB. The selection of
expert testimony by the court was conservative and biased. The court had
given full vent to the protests of smaller German banks about the low
interest rates that ECB policy permitted them to offer savers. It was as
though the court had summoned oil companies, and oil companies only, to
give evidence on the question of carbon taxes.
For all the anticipation, the judgment has come as a shock. The
question that has ultimately proved decisive is a seemingly conceptual
one concerning the distinction between monetary policy and economic
policy. The German Constitutional Court declared that the ECB, in
pursuing its efforts to push inflation up to 2 percent, had overstepped
the bounds of its proper domain—monetary policy—and strayed into the
area of economic policy, which the European treaties reserve for
national governments.
This is by no means an obvious distinction. It was originally built
into the treaties both to protect national prerogatives and to ensure
that the ECB’s focus on price stability was shielded against any
improper meddling by parties that might prioritize concerns like
unemployment or growth. Making this distinction is one of the central
dogmas of the German school of economics known as ordoliberalism. But
once monetary policy reaches any substantial scale, it in fact becomes
meaningless.
The ECJ in Luxembourg reasonably took the view that the ECB has
fulfilled its obligation to respect the boundary by justifying its
policy with regard to the price objective and following a policy mix
typical of modern central banks. It is this casual approach on the part
of the ECJ to which Karlsruhe objects. The ECJ waived the case through
without assessing the proportionality of the underlying trade-off, the
German Constitutional Court thundered. In doing so, it had failed in its
duty and acted ultra vires—beyond its authority. It was thus
up to the German court to adjudicate the issue, and it duly found that
the ECB had not to its satisfaction answered the economic concerns
raised by the court’s witnesses. The ECB too was therefore found to have
overstepped its mandate.
Since the German court does not actually have jurisdiction over the
ECB, the ruling was delivered against the German government, which was
found to have failed in its duty to protect the plaintiffs against the
overreaching policy of the ECB. As Karlsruhe emphasized, its judgment
would not come into immediate effect. The ECB would have a three-month
grace period in which to provide satisfactory evidence that it had
indeed balanced the broader economic impact of its policies against
their intended effects. Barring that, the Bundesbank would be required
to cease any cooperation with asset purchasing under the 2015 scheme.
The judgment was delivered to a court room observing strict social
distancing, though the judges did not wear face masks. Chief Justice
Andreas Voßkuhle, whose 12-year term at the court ends this month, noted
that the ruling might be interpreted as a challenge to the solidarity
necessary to meet the COVID-19 crisis. So he added by way of reassurance
that the ruling applied only to the 2015 scheme. There is no need,
therefore, for any immediate change of policy. The markets have so far
taken the intervention in stride. But the Karlsruhe decision is,
nevertheless, shocking.
It is a spectacular challenge to European court hierarchy. Instead of
merely assessing the conformity of the ECB’s policies with the German
Constitution, the German court arrogated to itself the right to evaluate
the conformity of the ECB actions with European treaty law, an area
explicitly left to the ECJ. This will surely play into the hands of
those in Poland and Hungary who are determined to challenge the common
norms of the European Union. It did not take long for Poland’s deputy
justice minister to signal his enthusiastic support for the Karlsruhe decision. This may end up being the case’s most lasting effect.
But it is spectacular also for another reason. In challenging the ECB
to justify its QE policy, the German court has put in question not just
a specific policy but the entire rationale for central bank
independence. What is more, it has done so not only formally but
substantively. It has exposed the political and material basis that lies
behind the norm of independence.
The claim that the ECB overstepped the bound between monetary and
economic policy is, as an abstract proposition, not so much a scandal as
a tautology. Only in an ordoliberal fantasy world could one imagine
monetary policy working purely by way of signaling without it having an
impact on the real economy. Indeed, to affect real economic activity by
lowering the cost of borrowing is precisely the point of monetary
policy. Far from failing to consider the economic impact of its monetary
policies, this is precisely what the ECB spends its entire time doing.
Nevertheless, by harping on this seemingly absurd distinction the
court has in fact registered a significant historic shift. The shift is
not from monetary to economic policy but from a central bank whose job
is to restrain inflation to one whose job is to prevent deflation—and
from a central bank with a delegated narrow policy objective to one
acting as a dealer of last resort to provide a backstop to the entire
financial system. The German court is right to detect a sleight of hand
when the ECB justifies an entirely new set of policies with regard to
the same old mandate of the pursuit of price stability. But what the
German court fails to register is that this is not a matter of choice on
the part of the ECB but forced on it by historical circumstances.
Cutting through the legalese and abstruse arguments, the complaint
brought to the court by the plaintiffs is that the world has changed.
Europe’s central bank was supposed to be their friend in upholding an
order in which excessive government spending was curbed, wage demands
and inflation were disciplined, and thrifty savers were rewarded with
solid returns. The reality they have confronted for the last 10 years is
very different. They suspect foul play, and they blame the newfangled
policies of the ECB and its Italian leadership. Rather than taking the
high ground, recognizing the historical significance of this crisis and
calling for a general reevaluation of the role of central banks in
relation to a radically different economic situation, the German
Constitutional Court has made itself into the mouthpiece of the
plaintiffs’ specific grievances, linked those to an expression of
fundamental democratic rights, and mounted a challenge to the foundation
of the European legal order.
Its willingness to assume this role no doubt reflects its resentment
at the usurpation of its supremacy by the ECJ. The decision reflects in
this sense a concern to defend German national sovereignty. But it also
reflects the cognitive shock of failing to come to terms with the role
of central banks in a radically changed world. What this starkly reveals
is the limits of existing modes of central bank legitimacy—including
the narrative of central bank independence—at the precise moment at
which we have become more dependent than ever on the decisive actions of
central banks.
To see the head-turning effect of this ruling, imagine an alternative
history. Imagine a citizen’s court like that in Karlsruhe convening
sometime in the mid-1980s in the United States to evaluate whether or
not Volcker’s Fed had adequately weighed the economic impact of its
savage interest rate hikes on the steelworkers of the Rust Belt. Or,
only slightly more plausibly, imagine a hearing in the Spanish or the
Italian constitutional court on the question of whether or not their
governments were remiss in not demanding to see the reasoning that
justified the ECB’s decision in 2008 or 2011 to raise interest rates
just as the European economy was sliding into first one and then a
second recession. Were German concerns about inflation at those critical
moments weighed against the damage that would be done to the employment
opportunities of millions of their fellow citizens in the eurozone?
Would Karlsruhe have heard a case brought on those grounds by an
unfortunate German citizen who lost his or her job as a result of those
disastrously misjudged monetary policy moves?
Of course those decisions were criticized at the time. But that kind
of criticism was not considered worthy of constitutional consideration.
That was merely politics, and it was the duty of the central bank, and a
measure of its independence, to override and ignore such objections.
Flags
of the European Union and Germany hang in front of the court in
Frankfurt on May 5, the day the German Constitutional Court pronounced
its judgment on billion-euro purchases of government bonds by the
European Central Bank. Sebastian Gollnow/picture alliance via Getty Images
The political impact of the court ruling has been revealing. On the
German side, the business council of Merkel’s Christian Democratic Union
immediately expressed its support for the court. So too did a
spokesperson for the AfD. Friedrich Merz, a possible right-wing
successor to Merkel, let it be known that he now considers the German
government bound to exercise a precautionary check on any further
expansion of the ECB’s range of action.
The reaction of the European Commission and the ECB was no less
immediate. They closed ranks around the ECJ. The clear message they sent
was that they are bound by Europe’s common law and institutions. After a
few days of deliberation, the ECB declared with supreme understatement
that it takes note of the judgment from Karlsruhe but intends to ignore
it since the ECB answers to the European Parliament and the European
court, not the German Constitutional Court. The ECJ ruled in December
2018 on the asset purchase program at the request of the German court.
There are no do-overs. The case is closed.
This leaves the German government and the Bundesbank in a tight spot.
The German government, for its part, often goes for years without fully
implementing the Constitutional Court’s most ambitious judgments. The
Social Democrat-led Finance Ministry in Berlin, which cultivates its
image as an advocate of pro-European policies, has played down the
decision. The neuralgic point will be the Bundesbank. It is both a
German agency, answerable to the Constitutional Court, and a member of
the euro system—and thus bound by the statutes of the ECB.
An open and irresolvable conflict between the Bundesbank and the
Constitutional Court on the one side and the ECB on the other would
compound the tensions already being felt within the eurozone over the
issue of the funding of the emergency response to the COVID-19 crisis.
Resentment in Italy and Spain toward Germany is already at a high pitch.
One might take the German court’s call to limit and balance the ECB’s
expansion as a call to, instead, expand the reach of European fiscal
policy. The ECB has made precisely that argument itself. But
unfortunately the same political forces in Germany that brought the case
to the Constitutional Court also stand in the way of a major move
toward fiscal federalism.
Given the economic conservatism and hubris of the German court and
the prospect of a string of challenges from across the EU by even more
unfriendly forces, a strong stance from the European side is to be
welcomed. But it would be regrettable if the ECB responded to the
quixotic German onslaught against the realities of 21st-century central
banking by itself retreating into a defensive bunker.
A placard with “capitalism is more dangerous than the coronavirus” is seen at a demonstration in Cologne, Germany, on May 1. Ying Tang/NurPhoto via Getty Images
If it was not already evident, the COVID-19 shock has made clear
beyond a shadow of a doubt that both the political and economic
circumstances out of which the original model of central bank
independence emerged have changed, not just in Germany or Europe but
around the world. This renders the classic paradigm of
inflation-fighting independence obsolete and has thrown into doubt
models of narrow delegation. To address the new circumstances in which
the real problems are the threat of deflation, the stability of the
financial system, and the passivity of fiscal policy, the ECB, like all
its counterparts, has indeed been pursuing a policy that goes well
beyond price stability conventionally understood. In fact, in Europe the
ECB is the only agency engaged in economic policy worthy of the name.
Given the limitations of its mandate, this does indeed involve a degree
of obfuscation. Despite itself groping in the dark, the Karlsruhe
decision has helpfully put a spotlight on the ECB charade.
To respond by doubling down on a defense of independence may be
inevitable in the short run. But this too will run its course. The more
constructive response would be to advocate for a wider mandate to ensure
that the central bank does indeed balance price stability with other
concerns; the bank’s second objective should surely be employment and
not the interests of German savers. But an open debate about the range
of the ECB’s mandate would be a step forward for European politics. The
politics of treaty adjustment are not easy, of course. It will take
political courage. But the demand itself should not be presented and
dismissed as outlandish. After all the Fed has a dual mandate. Alongside
price stability, it is enjoined by the Humphrey-Hawkins Act to aim for
the maximum rate of employment possible. As the history of the Fed
attests, this is far from being a binding commitment. But since 2008 it
has provided the Fed with the latitude necessary to expand its range of
activities.
That expansion of activity has in large part been a matter of
technocratic discretion. The point of pushing for a discussion of a
widening of the ECB’s mandate should be the opposite. The aim should be
to encourage a wide-ranging discussion about the wider purpose of
central banks. Again, the U.S. example may be an inspiration. The Fed’s
dual mandate is, somewhat surprisingly, a legacy of progressive
struggles fought in the 1960s and 1970s—specifically, by the civil
rights movement under Coretta Scott King’s leadership—to force social
equity to the top of the macroeconomic policy agenda. This may seem
far-fetched, but progressives cannot shrink from the challenge. They
should not allow themselves to be held prisoner to the 1990s mystique of
central bank independence.
Two new issues make this pivotal in the current moment. One is the
financial legacy of the COVID-19 crisis, which will burden us with
gigantic debts. The balance sheet of the central bank is a pivotal
mechanism for managing those debts. The other issue is the green energy
transition and the need to make our societies resilient to environmental
shocks to come. That will require government spending but also a
reorientation of private credit toward sustainable investments. In that
process, the central bank also has a key role. The current mandates
require those concerns to be shoehorned in by way of arguments about
financial stability. It is time for a more direct and openly political
approach.
The independence model emerged from the collapse of the Bretton Woods
system and the need to anchor inflation during the Great Inflation of
the 1970s. The huge range of interventions currently being pursued by
global central banks have emerged out of the crises of a globally
integrated financial system. They have been enabled by the absence of
inflationary risk. They have succeeded in staving off catastrophe for
now. But they lack a positive purpose and updated democratic grounding.
We value price stability, but for better and for worse the forces
that once made it an urgent problem are no longer pressing. That
objective alone is no longer sufficient to define the mandate of the
most important economic policymaking agency. Financial stability is
essential, but the current incestuous relationship between central banks
and the financial system tends, if anything, to underwrite and
encourage dangerous speculation by a self-enriching elite. Meanwhile,
slow growth, inequality, and unemployment are at the root both of many
of our social ills and by the same token the problem of the debt
burden—how we manage government debt depends crucially on how rapidly
the economy is growing. Finally, we can no longer deny that we confront
fundamental environmental issues that pose a dramatic generational
challenge for investment.
These are the policy challenges of the third decade of the 21st
century. Money and finance must play a key role in addressing all of
them. And central banks must therefore be at the heart of policymaking.
To pretend otherwise is to deny both the logic of economics and the
actual developments in central banking of recent decades. We should also
acknowledge however that this expansion stands in tension with the
current political construction of central banks and particularly the
ECB. Defining their position in terms of independence, strictly
delimited mandates, and rules limits their democratic accountability.
That was the explicit intention of the conservative reaction to the
turmoil of the 1970s.
If Europe wants to escape the impasse created by the German court
ruling, in which one countermajoritarian institution checks another at
the behest of a resentful and self-interested minority, we need to step
out from this historical shadow. Doing so is no doubt hedged with risks.
But so too is attempting to patch and mend our anachronistic status
quo. Half a century on from the collapse of Bretton Woods and the
emergence of a fiat money world, 20 years since the beginning of the
euro, it is time to give our financial and monetary system a new
constitutional purpose. In so doing, Europe would not only be laying to
rest its own inner demons. It would offer a model for the rest of the
world.
Adam Tooze is a history professor and director of the European Institute at Columbia University. His latest book is Crashed: How a Decade of Financial Crises Changed the World, and he is currently working on a history of the climate crisis. Twitter: @adam_tooze
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