[This is an invited guest post by Jens van 't Klooster, who is a FWO Postdoctoral Fellow in philosophy at KU Leuven and a member of the research group A New Normative Framework for Financial Debt at the University of Amsterdam.--ES]
Wednesday night’s ECB announcement of a Pandemic Emergency Purchase Programme (PEPP) is a radical break in the institution’s existence. It will see the ECB issue €750 billion in new money, which is by now sort of business as usual. What is really new is the ECB’s overt willingness to fund fiscal measures that the member states take in response to the pandemic.
The rationale for PEPP is not immediately clear, since the economy does not exactly need a stimulus. The pandemic measures will have cataclysmic economic impact, likely worse than that of the Global Financial Crisis. But, the damage comes from people being at home, rather than consuming and producing. The emergency is that without government intervention, people can’t pay rent and firms will collapse this month. ECB president Christine Lagarde explicitly acknowledges that she is not in any position to counter those effects, since the economic damage is itself integral to the virus-fighting program: “Essentially, for a temporary period, a large part of the economy is being switched off.” Mitigating these effects, meanwhile, requires targeted measures. The pandemic has a devastating impact on some sectors. It has much less impact on others, where employees should just work from home, wait and not go out and shop. Better access to credit can help those who are struck in the short term, but the ECB has better tools for that. More lending, moreover, will ultimately only add to already historically unprecedent levels of debt, which may ultimately end up on the governments plate in any case.[1] PEPP, therefore, should not be understood as monetary policy aimed at easing private sector credit. Its primary role is to support EU member states who then decide on their own targeted policies. The ECB has even opened the door to favouring those member states struck hardest.
The key passage in the ECB’s announcement of PEPP is not in the list of measures, but comes at the end:
"To the extent that some self-imposed limits might hamper action that the ECB is required to take in order to fulfil its mandate, the Governing Council will consider revising them to the extent necessary to make its action proportionate to the risks that we face."[2]
What does the ECB say here? The first thing to note is the term that does not appear anywhere in the press release: Price stability. This may be unsurprising to outsiders but I can’t remember ever seeing an ECB document that does not contain these words. Instead, the release uses the more generic term “mandate”, which here refers to the ECB’s objectives. This is important because although the ECB’s primary objective is price stability, it is also tasked with supporting “the general economic policies in the Union”.[3] So, in contrast to earlier crisis-fighting measures, the ECB has not attempted to shoehorn what it does under price stability. The second thing to note is the admission that most limits hitherto applied to ECB tools were self-imposed.[4] Therefore, the ECB asserts, they can be revised in light of the objectives. This is relevant with regard to three types of restrictions that the ECB until now adhered to. First, the ECB took various measures to ensure that markets continue to shape interest rates paid by individual member states. It may now give up some or all of these restrictions. Second, earlier government bond purchases were subject to a minimum investment grade rating but now Greece, despite lacking such a rating, is explicitly part of the programme.
Most consequential, however, is what the ECB could now do in relation to its previously strict allocation of purchases in accordance with its capital key. The ECB capital key is determined by the population and GDP of individual member state. Giving up on this restriction allows the ECB to target purchases on member states that need funding most. This intention is clear from Lagarde’s statement that the PEPP “is tailored to manage the staggered progression of the virus and the uncertainty about when and where the fallout will be worst.” Divergence from the capital key, Lagarde suggests, may not just happened in response to what bonds are available in the market, but also in response to the severity of the crisis in individual member states. That would not be in line with the legal constraints that the ECB previously imposed on itself, and hence open it to new legal challenges.
If implemented, targeted bond purchases would be a huge deal. 92% of the interest that governments pay on bonds currently purchased goes straight to their national central bank, rather than to the ECB, and is paid back as central bank profits at the end of the year.[5] In theory, the ECB could sell the bonds that it purchases. In practice, it is highly unlikely to do this with the over three trillion euros in bonds currently parked on its balance sheet. The ECB will most likely not only keep the bonds but also replace them when they mature. But, if that is true, then states do not actually need to repay their debt and targeted purchases provide them with free cash. In envisaging targeted purchases, the ECB acknowledges that adequate financing for government expenditures is itself a necessary condition for achieving the objectives spelled out in its mandate.
If operations no longer have a clear price stability objective, we should probably even be hesitant to describe them as quantitative easing. Instead, the economic term would be monetary financing transactions.
It is possible that the ECB’s dramatic announcement will motivate the member states to come up with something better. Is that Lagarde’s strategic aim in opening the door to radical central bank activism? It’s too soon to say. The Dutch and German member of the ECB Governing Council are already said to have voiced their misgivings. In any case, the ECB’s current approach breaks with its role in the Eurozone crisis, when it waited until the member states created the European Stability Mechanism before announcing its bond buying programme. This time, the ECB has acted first and thereby put pressure on EU governments to propose a more adequate burden sharing mechanism (Eurobonds, helicopter money, anything really is on the table). But, as Daniela Gabor points out, it is unlikely that all crisis measures can be funded through debt, so that at some point the member states will also need to think about taxes.
For now, it is clear that even the suggestion that the ECB may target government bond purchases makes PEPP a big deal, which has the potential to radically change the Eurozone. For better or worse, it has finally endorsed its status as, to put it in the words of Nicolas Jabko’s unduly neglected article on this topic, “the boldest expression of a nascent federal power at the EU level”. I will write a second blog later this week that draws more on my current historical research on ECB risk management. There I will focus on the PEPP’s significance in light of the ECB’s decades long struggle with its monetary financing prohibition.
Update (30.3.2020): The ECB has now published the legal framework for the PEPP programme, which retain the capital key but give up another self-imposed restriction: The requirement that the ECB does not buy more than 33% of debt from any issuer individuals, which makes the PEPP potentially unlimited in size. I say more on this in a German blog based on this one at the Dezernat Zukunft.
[1] It is a sign of how extreme the crisis is that almost no attention has gone to the ECB’s lowering of bank capital requirements to enable €1.8 trillion in additional bank loans. Of course, bank bailouts will still be paid by individual member states, since there is still no EU deposit insurance scheme.
[2] It is so important that it is also literally in the blog that Christine Lagarde published the same day to explain PEPP.
[3] The whole formulation is “The primary objective of the European System of Central Banks (hereinafter referred to as ‘the ESCB’) shall be to maintain price stability. Without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in Article 3 of the Treaty on European Union.” Article 3 TEU contains a long list of benign but generic and difficult to interpret ends.
[4] Not withstanding the European Court of Justice’s ruling that when purchasing government bonds “sufficient safeguards must be built into its intervention to ensure that [the ECB] does not fall foul of the prohibition of monetary financing”.
[5] The Bundesbank pushed for this initially but since yields on other bonds are higher, it is already costly for Germany. If targeted purchases would happen it will clearly have been a tactical mistake.
Comments