Is the Asset Purchase Program legal?


Four professors’ challenge to the ECB’s APP program reveals its failings.


From 2015 to 2018, the European Central Bank bought billions of bonds under the mandate of attaining 2% inflation, a new strategic direction that lies under the umbrella of their revamped expansionary monetary policy. This move, while basely aiming to address the risks of prolonged periods of low inflation, has also drawn criticism from smaller EU members, accusing the ECB of merely injecting their economies with supersized liquidity. Others are taking aim at the legality of the policy, claiming that it rings strikingly similar to monetary financing, which is currently subject to an ECJ ban. To properly address both claims, we must take a magnifying glass to ECB’s take on quantitative easing, particularly its Asset Purchase Program, while also jogging our own memories on the ECB’s macro monetary policy in the modern era.  

Monetary policy of the ECB 

The monetary policy of the ECB includes measures to shock aggregate demand (AD) into fulfilling the bank’s primary objective: maintaining 2% inflation.[1] Inflation occurs at many different speeds: creeping, walking, galloping, and hyperinflation, but mostly it only comes in two forms: demand-pull or cost-push inflation. When an economy overheats because aggregate demand outpaces aggregate supply in an economy, we see too much money chasing too few goods, causing a rise in the general price level and a fall in purchasing power of the euro in a chain of causation economists call demand-pull inflation. Cost-push inflation, on the other hand, occurs when there is a general increase in the cost of production (be it wages or raw materials) of firms who, in turn, transfer that cost onto consumers by means of a price increase. When the ECB observes that inflation, be it cost-push or demand-pull, is at risk of increasing above the 2% target, the central bank employs its inflation-fighting arsenal, namely standard and non-standard monetary policies. 


  tradingeconomics.com/euro-area/interest-rate.

The ECB’s standard monetary policy is controlled through open market operations (OMO) and is devised as to control interest rates and influence liquidity situations in markets via Main Refinancing Operations (MROs) and Longer-Term Refinancing Operations (LTROs). The former aims to steer short-term interest rates in a desired direction, manage liquidity, and effectively communicate a centralized outlook on the Eurozone’s economy and monetary policy to members and investors, while the latter concerns itself with refinancing directed at the financial sector. The APP, unlike the two aforementioned programs, generates liquidity on a first-degree basis. In essence, whereas under MROs and LTROs, liquidity is either expanded or constricted through policies that either encourage or discourage borrowing, the APP tethers liquidity to its bond buy-back volume, thus enabling a dynamic control that is foregone when the consumer is included in the cycle. This control is especially important in today’s EU monetary environment. Considering that interest rate cuts, the ECB’s lean-to for years past, is increasingly uncorrelated with higher inflation, and with inflation remaining worryingly low and stagnant, the bank has been forced to introduce ulterior methods that move the inflationary gauge. The APP presents the opportunity to do just this, and for the ECB to, in a way, commandeer its economic brigade for the time being. Let’s get to know it.

The Technicalities of the Asset Purchase Program (APP)

The APP is comprised of programmes under which private sector securities and public-sector securities are purchased by National Central Banks (NCBs) and the ECB. [2] We The ECB controls the purchase of the securities through decentralised implementation, meaning that it is the NCBs who ultimately pull the trigger on security and bond purchases. However, in practice, it is the ECB maintains the final call over what is and is not purchased. This coordination allows the ECB to both meticulously track inflation levels and act as a unilaterally responsible economic planner for Europe. 


The figure demonstrates the amounts and composition of purchases in through the APP program.

The asset purchasing programmes put in place include the covered bond purchase programme (CBPP3), asset-backed securities purchase programme (ABSPP), public sector purchase programme (PSPP), and the corporate sector purchase programme (CSPP). About 85%[3] of the acquisitions have been made through PSPP, which include purchasing regional and local government bonds across the continent. The NCB in question, under ECB directives, buys these securities, thus taking direct responsibility for the cross-border flows. Asset purchases under the APP have led to a doubling of the Eurosystem’s balance sheet from €2,150 billion at the end of 2014 to €4,620 billion in September 2018. At the same time, total outstanding general government debt in all 19 euro-area countries increased by €392 billion between the end of 2014 and January 2018. As a result of the ECB’s PSPP, the share of government bonds held by NCBs surged in the last three years from around 5% to 15-20% of total outstanding government bonds.

Is the APP legal? 

On Tuesday July 10, 2018, four German professors mounted a challenge towards the ECB’s APP publicly in a German constitutional court. Prof. Dr. Christoph Beck, Degenhart, Murswiek, and Prof. Dr. Hans Detlef-Horn claimed the participation of the German Bundesbank in the PSPP program is unconstitutional as participation was not democratically legalised by the Bundestag, hence the participation violates the fundamental principles of democracy. Additionally, they argued that Germans’ common welfare was heavily infringed upon, as liability risks for the federal budget increase with participation in the programme. 

The professors argued that in launching the programme for the purchase of public sector securities, the European System of Central Banks (ESCB) actively violates the prohibition of monetary financing (Art. 123 of the Treaty on the Functioning of the European Union – TFEU). The purchase of debt securities issued by European institutions is permitted if the bonds are brought on the secondary market. However, the actions of the ECB work against the principle of refinancing for the following reasons: There is a de facto certainty that, on the markets, issued government bonds will, indeed, be purchased by the Euro system. Additionally, the verification process to confirm that the minimum periods between the issuing of the securities on the “primary market and the purchase of the relevant securities on the secondary market” is questionable.  

Through these claims, it remains ambiguous whether or not the APP program resembles a system that allows the ECB to simply inject liquidity into failing economies such as the Greek, Spanish, Italian and Portuguese ones. However, if refinancing were the ECB’s goal the TARGET2, imbalances show refinancing failing, as claims accumulate in Germany and other core countries. This, in essence, implies that the money that flows into the poor economies is then reinvested into secure EU markets such as the German one. While the ECB has since rolled back on APP rather significantly, noting public alarm and private sector pressure, we must continue to hold a watchful eye to the ECB’s movings and shakings – low inflation is still endemic to the EU and interest rate cuts still don’t seem to have their desired effects. Odds are, we’ll see many other non-standard monetary policy measures going forward with similar objectives in mind.  

The German Constitutional Court will reopen a challenge to the ECB’s bond-buying at the end of July. Once again the program will be challenged.


References

[1] Bank, European Central. “Monetary Policy.” European Central Bank. N.p., n.d. Web. 08 Sept. 2017. <https://www.ecb.europa.eu/mopo/html/index.en.html>.

[2] Bank, European Central. “Asset Purchase Programmes.” European Central Bank, www.ecb.europa.eu/mopo/implement/omt/html/index.en.html.

[3]N.p., n.d. Web. 10 Aug. 2017. <https://www.bundesbank.de/Redaktion/EN/Downloads/Publications/Monthly_Report/2016/2016_03_monthly_report.pdf?__blob=publicationFile>

Illustration: Getty Images

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