What #ChristineLagarde #ECB presidency means for the #LisbonTreaty

| October 30, 2019

On 1 November, Christine Lagarde assumed the Presidency of the European Central Bank (ECB) from the outgoing Mario Draghi. In addition to marking the end of Draghi’s historic term at the ECB, the transition completes a functional amendment of some of the Treaty of Lisbon’s restrictions to the ECB’s powers, writes Yale Law School Professor Yair Listokin.

The ECB now enjoys legal and political ratification for large-scale purchases of the sovereign debt of Eurozone members, despite the Treaty of Lisbon’s restrictions against such purchases. With this question resolved, the ECB needs to articulate a revised understanding of the Treaty’s limits that preserves its power over monetary policy while respecting the rule of law.

 Yair Listokin is the Shibley Family Fund Professor of Law at Yale Law School. He is the author of Law and Macroeconomics: Legal Remedies to Recessions.

Yair Listokin is the Shibley Family Fund Professor of Law at Yale Law School. He is the author of Law and Macroeconomics: Legal Remedies to Recessions.

The macroeconomic turmoil that characterized Draghi’s tenure spawned several programs that pushed the boundaries of the ECB’s mandate. I will focus on only one of these programs—known as quantitative easing (QE). In response to a deep recession in the Eurozone in the wake of the Euro crisis, Draghi’s ECB bought roughly €2 trillion in Eurozone sovereign bonds in an attempt to lower interest rates (below 0% in many cases) and stimulate spending. After a brief pause in QE in late 2018, the ECB responded to a recent slowdown in Eurozone growth by announcing a new round of QE bond buying in September.

The Treaty of Lisbon, which governs central banking in the Eurozone, instructs the ECB to pursue “stable prices”, a term now defined to mean inflation slightly below 2%. QE helps prevent deflation in the Eurozone, in accord with the ECB’s mandate.

While QE helps the ECB comply with its stable price mandate, QE contravenes another component of the ECB’s legal framework. The Treaty of Lisbon forbids the ECB or its affiliates in national Eurozone central banks from providing “credit” to finance the debt and deficits of Eurozone member nations. QE functionally provides credit to Eurozone member states by holding their debt in large quantities. Before QE, the ECB and its affiliates owned approximately 4% of Eurozone public debt—the minimum necessary to conduct monetary policy. Today, that figure exceeds 15%. The ECB and its affiliates have become important creditors of the Eurozone governments.[1]

The ECB’s QE program limited the importance of central banks as Eurozone creditors by promising to hold less than 33% of any nation’s debt. This provision nods to the Treaty of Lisbon prohibition of central bank credit—even if central banks become important creditors of Eurozone governments, they will not become the dominant creditor.

Not surprisingly, QE provoked litigation. In 2016, the German Constitutional Court opined that QE “may not be covered by the ECB’s mandate” because it violated the Treaty of Lisbon’s restriction against the provision of credit to Eurozone governments.[2] Instead of striking down QE, however, the German Court referred the legal question to the European Court of Justice (ECJ). The ECJ upheld QE late last year. While I would quibble with the technical merits of the ECJ’s decision, the outcome is plausible. In order to comply with one element of its mandate (stable prices), the ECB might reasonably push the boundaries of another element—the limitation on long term credit provision.

Most observers and politicians expect Lagarde’s ECB to continue with the QE policies initiated by Draghi. Because Lagarde’s appointment was a political decision taken by the leaders of the EU’s member nations, Lagarde’s appointment by the represents a political ratification of QE, complementing the ECJ’s legal stamp of approval.

While the legality and political legitimacy of QE at current levels is now secure, the Treaty of Lisbon’s restrictions on credit provision to national governments are likely to remain a headline issue for the ECB. If QE continues, the ECB and its affiliates will soon own 33% of the outstanding public debt of several member nations. Once this ceiling is hit, the ECB must either stop QE or raise the self-imposed 33% limitation.

Both options are fraught. Ending QE risks a prolonged Eurozone slump and opens the risk of deflation. But raising the ownership limits above 33% reignites the legal controversy associated with QE. It raises the spectre of ECB lawlessness. The 33% limit was introduced to respect the Treaty of Lisbon’s limitations on ECB credit provision to national governments. Raising this limit as soon as it becomes inconvenient suggests a lack of respect for this provision that may do even more harm to the ECB than the original legal controversy surrounding QE.

Lagarde’s ECB needs to end the practice of announcing legally controversial programs such as QE without addressing their legal weakpoints until hauled into court. Instead, the change in leadership presents an ideal opportunity to explicitly articulate the ECB’s understanding of the tradeoff between its mandate to pursue price stability and the now weakened prohibition of credit provision to national governments. By providing such a statement and adhering to it even when it is inconvenient, Lagarde’s ECB can put the legal controversies associated with Draghi’s otherwise successful tenure permanently to rest.

[1] https://ftalphaville.ft.com/2019/05/07/1557223379000/The-legacy-of-the-ECB-s-bond-buying-program/

[2] https://www.bundesverfassungsgericht.de/SharedDocs/Pressemitteilungen/EN/2017/bvg17-070.html

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