There was a time, before the existence of the euro, when the financial markets hung on every syllable uttered by the president of the Bundesbank. Not only was the German central bank the most respected institution in global finance, it was a founder member of the awkward squad, and was frequently willing to stare down politicians, no matter what the temporary costs in market turbulence. Macro traders, who were routinely dismissive of public officials throughout the world, never found that it paid to be dismissive of the Bundesbank.
Since monetary union, the Bundesbank has lost some of its lustre, which is inevitable given that its president now has only a single vote on the ECB’s 23-member governing council, the same as the head of the central bank of Cyprus. However, this week it has been just like old times, with Jens Weidmann, president of the Bundesbank, setting the entire agenda for the financial markets with his FT interview on November 13, in which he appeared to torpedo hopes that ECB bond buying would soon become open ended in order to support the new government in Italy. Mr Weidmann not only argued that such buying would be inadvisable, he went as far as to claim that an unlimited extension of the SMP to hold down bond yields would be illegal, which is another matter entirely.
A large part of his opposition to bond purchases under the Securities Market Programme (SMP) is now fairly familiar, and has been analysed in earlier blog posts. He says that the SMP cannot overcome longer term fundamentals like the path for debt and deficits. Furthermore, by reducing bond yields, the SMP can reduce the incentives on governments to undertake necessary economic reforms. The programme also involves disguised transfers of resources between member states, transfers which the members are reluctant to sanction in a more open manner.
Many present and past central bankers have a lot of sympathy for Mr Weidmann on these questions. Today, for example, Mervyn King basically supported his point of view. But these qualms, which are also undoubtedly shared by other members of the ECB governing council (including by Mr Draghi himself) have not been enough to prevent a significant increase in the pace of bond purchases since August. Since then, the ECB has extended its bond purchases by €113bn, to make a current total of €187bn. Mr Weidmann is reported to have voted against this acceleration of bond purchases, but he has not been able to block it.
He has therefore decided to step up his public opposition to any large extension of the SMP, and to emphasise a new argument, based on legality. In a recent speech, he says that the lines between fiscal and monetary policy are becoming blurred, and adds:
One of the severest forms of monetary policy being roped in for fiscal purposes is monetary financing, in colloquial terms also known as the financing of public debt via the printing press. In conjunction with central banks’ independence, the prohibition of monetary financing, which is set forth in Article 123 of the EU Treaty, is one of the most important achievements in central banking … The Eurosystem’s mandate to ensure price stability rightly involves the prohibition of any kind of monetary financing.
He is of course right about this. But the question is whether the SMP, as currently practised, is in breach of the specific wording of Article 123. This says very clearly that any ECB bond purchases direct from a member government are prohibited, but it certainly does not prohibit the purchases of government bonds in the secondary market. In fact, such purchases are clearly permitted under Protocol No. 4, Article 18, which allows the ECB to “operate in the financial markets by buying and selling outright … claims and marketable instruments”. Importantly there is no upper limit on these purchases.
Furthermore, under Protocol No 4, Article 20, “the governing council may, by a majority of two thirds of the votes cast, decide upon the use of such other operational methods of monetary control as it sees fit”, as long as this does not imperil price stability.
Mr Weidmann does not actually say that the SMP, as it has been conducted so far, violates the treaty. But in his FT interview, he does say that it would do so if it became unlimited in size (in order to set a limit on the Italian bond yield, for example), or if it were part of a “lender of last resort” facility. In either case, he argues that this would amount to monetary financing of budget deficits, and contrary to the over-arching treaty objective handed to the ECB, which is the maintenance of price stability. He therefore suggests that this would be illegal, despite the language of Articles 18 and 20 of Protocol 4, which seem to point clearly in the opposite direction.
Where does this leave the future of the SMP, which is crucial for the behaviour of the markets and possibly to the resolution of the entire debt crisis? It seems that Mr Weidmann is saying that he already opposes the current SMP, but he does not yet claim it is illegal. However, he is drawing a clear line in the sand, and is warning that open-ended bond purchases would be deemed illegal by the Bundesbank.
It is not clear how large the SMP would need to be before Mr Weidmann would deem it to be monetary financing, a threat to price stability and therefore illegal. Nor does he say what he would do about it if he did come to that view. But he is clearly already very uncomfortable about the size of the programme. And Mrs Merkel said today that the ECB “doesn’t have the possibility of solving the euro problem” under the present treaties.
I do not agree with the German reading of the treaties. But it represents a powerful roadblock to those who believe that large scale ECB bond purchases are needed to solve the crisis.