In September 2012, the European Central Bank announced its new Outright Monetary Transactions (OMT). The programme – very successful in easing tensions on sovereign bond markets – foresees the possibility to purchase government securities on the secondary market. It is virtually unlimited, although de facto limited by the existing outstanding stock of eligible bonds with maturities that make them eligible. Differently from a previous bond-buying programme (the SMP), the OMT specifies that the ECB will not have preferential creditor status in the occurrence of a credit event (i.e. it will be pari passu).
What is more important is that a necessary condition for OMT is explicit “strict and effective conditionality” attached to an appropriate EFSF/ESM programme
The ECB intervention will not be automatic, but the Governing Council will decide on a case-by-case basis when and to what extent it will intervene. In particular: “the Governing Council will consider Outright Monetary Transactions to the extent that they are warranted from a monetary policy perspective as long as programme conditionality is fully respected, and terminate them once their objectives are achieved or when there is non-compliance with the macroeconomic adjustment or precautionary programme. Following a thorough assessment, the Governing Council will decide on the start, continuation and suspension of Outright Monetary Transactions in full discretion and acting in accordance with its monetary policy mandate”.
This conditionality is controversial. The OMT framework introduces explicit conditionality for the bond buying and it links the decision of the Governing Council to continue or suspend the OMT to the assessment of whether such conditionality is fulfilled.
As Zsolt Darvas and I pointed out earlier, this setting puts the ECB in an extremely delicate position. The objective of the OMT is to “safeguard the monetary policy transmission mechanism in all countries of the euro area. […] to preserve the singleness of […] monetary policy and to ensure the proper transmission”. At the same time the OMT is a monetary policy instrument, the activation and use of which is made subject to considerations that would not strictly pertain to a central bank in the exercise of its monetary policy competences. The ECB in fact explicitly commits to terminate the OMT not only – as it would be logical – in case the latter is no longer warranted from a monetary policy perspective, but also in case the beneficiary country fails to comply with the required conditionality..
And the implications of such conditionality requirement have been central to the advocate general’s opinion on whether the OMT falls within the statutory mandate of the ECB to conduct monetary policy (and thus is legitimate) or whether it actually amounts to economic policy of the kind that would fall outside the ECB’s mandate.
In his opinion, the European Court of Justice’s Advocate General observes that the framing and implementation of monetary policy are the exclusive competence of the ECB, which “must have a broad discretion” when framing and implementing it. The question is therefore to establish what is monetary policy in the euro area, and then whether the OMT can be legitimately considered part of it.
The architecture of euro area monetary policy is essentially based on three articles of the Treaty. Article 119 states that the “primary objective” of monetary policy shall be to “maintain price stability and, without prejudice to this objective, to support the general economic policies in the Union, in accordance with the principle of an open market economy with free competition”. Article 127 translates this general principle into an objective for the institution that deals with monetary policy, stating that the primary objective of the European System of Central Banks (ESCB) shall be to maintain price stability and that – 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 123 draws the boundary, by prohibiting the ESCB to engage in operations that amount to monetary financing.
From this, the advocate general states that, “for a measure of the ECB actually to form part of monetary policy, it must specifically serve the primary objective of maintaining price stability and it must also take the form of one of the monetary policy instruments expressly provided for in the Treaties and not be contrary to the requirement for fiscal discipline and the principle that there is no shared financial liability”. If there were to be “isolated economic-policy aspects to the measure at issue”, the latter will be compatible with the ECB’s mandate only “as long as it serves to ‘support’ economic policy measures but remains subordinate to the ECB’s primary inflation objective”.
Whether the OMT is legitimate therefore depends on where the line between its monetary and economic policy component lies. In the opinion of the ECJ’s advocate general, linking the OMT to compliance with financial assistance programmes blurs this line considerably, because of the role that the ECB itself is assigned in the context of financial assistance.
The ESM Treaty confers multiple responsibilities on the ECB in the course of a financial assistance programme, including participation in negotiations and monitoring. The ECB’s hybrid role in the Troika raises concerns about possible conflicts of interest that the ECB could experience in relation to the conduct of its other functions. The potential conflict of interest with the ECB’s bond-purchase programmes is especially strong. By buying bonds of vulnerable countries in the context of OMT, the ECB would become formally a creditor of the governments receiving financial assistance, and this may influence its position in the negotiations and its assessment of conditionality.
The advocate seems to recognise this risk when he points out that “the ECB, in creating and announcing the OMT programme, did not properly weigh up the impact of its involvement in those financial assistance programmes on the monetary nature of the OMT programme”.
The problem is that “the ECB is involved in the elaboration of the conditionality imposed on the State requesting assistance whilst, subsequently, it also takes part in the task of monitoring compliance with conditionality”. The ECJ’s Advocate general points out that “unilaterally making the purchase of government bonds subject to compliance with conditions when those conditions have been set by a third party is not the same as doing so when the ‘third party’ is not really a third party”.
If the ECB is at the same time participating in the negotiation and monitoring of financial assistance programmes and deciding on the activation of the OMT, which requires the fulfilment of those programmes’ conditionality, then “the purchase of debt securities subject to conditions may become another instrument for enforcing the conditions of the financial assistance programmes”. And if the OMT purchases can be perceived as an “instrument which serves macroeconomic conditionality” then their monetary policy nature is in doubt.
The conclusion is therefore that the ECB does not necessarily need be prevented from regularly participating in financial assistance programmes, because the fact that a financial assistance programme is adopted does not mean that an OMT programme will be activate for sure in the future. However, if the OMT were to be activated, it would be “essential for the ECB to detach itself henceforth from all direct involvement in the monitoring of the financial assistance programme applied to the State concerned”. Otherwise, in the view of the advocate general, the OMT programme could no longer be considered a pure monetary policy measure.
This conclusion has potentially interesting consequences. A first question, if the ECJ were to follow the opinion of the advocate general, is what changes would be needed to the legal texts that establish the ECB’s participation in the Troika, i.e. the ESM Treaty and Regulation 472/2013. According to these documents, the negotiation and monitoring of programme conditionality should be done by the Commission “in liaison” with the ECB, a wording that is blurry. The question therefore is whether the ECB’s acting “in liaison” with the European Commission in the Troika qualifies as “direct involvement” in the sense suggested by the ECJ’s advocate general. If it were, and if the ECJ were to follow the opinion of the Advocate General, then the question is whether amendments should be made to these legal text to ensure remove the “liaison”.
A second question is whether the conditionality attached to the OMT programme would still make any sense. In a view to limit the moral hazard that could be induced by ECB’s purchases, the ECB Governing Council can decide to terminate the programme – even if it were still warranted from a monetary policy perspective – if the conditionality is not met. In order for the ECB to act independently in the pursuit of its monetary policy, the OMT technical rules state that such assessment is a prerogative of the Governing Council. At present, by directly taking part in the Troika, the ECB can form its judgement on the fulfilment of programme conditionality. But if it were no longer involved in the monitoring – as the advocate general seems to require – then the ECB’s assessment of conditionality fulfilment would need to be based on information obtained from a third party, i.e. the other institutions involved in the Troika.
The question then is whether this would still qualify as an independent decision. The definition of ECB independence is given in Article 130 TFEU, which states that “when exercising the powers and carrying out the tasks and duties conferred upon them […] neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body.”
While being true that the ECB would not be formally “instructed” by a third party to terminate OMT, the fulfilment of conditionality is a necessary requirement for the continuation of the purchases and that assessment would necessarily be outside of the ECB’s control, possibly exposing it to political capture. At that point, it would be more reasonable for the ECB to scrap the link to conditionality completely, making the OMT decision dependent only on the assessment of whether the programme is warranted from monetary policy purpose to safeguard the monetary policy transmission mechanism and to preserve the singleness of monetary policy.
monetary policy with conditionality presents significant theoretical and practical problems
In conclusion, in his opinion the ECJ advocate general pointed out the problematic multifaceted role of the ECB in the macroeconomic adjustment programmes,. This is welcome, as the ECB’s role in the Troika was ill designed since the start, and put the ECB in an uncomfortable position. On top of that, the analysis supports the claim that monetary policy with conditionality presents significant theoretical and practical problems and the logical consequence of requiring the ECB not to have any direct involvement in the programmes, if OMT is activated, makes the OMT conditionality even less meaningful and possibly tricky for the central bank’s independence. At that point, the least risky option would be to scrap the OMT’s link to conditionality completely. After all, it made little sense to put it there in the first place.
This article was originally posted at Bruegel