The European Central Bank and the European

Macroeconomic Constitution

The book is about money, central banking and constitutions. It

explains how the European Central Bank was established to
ensure stability and prosperity for the euro area. The ECB was
guided and controlled by a coherent European Macroeconomic
Constitution. However, this model has failed during recurring
crises, and the ECB has started to act as the euro area fire
brigade. Consequently, it is pushing the boundaries of
monetary policy, and with that challenging the accountability
mechanisms and fundamentally also the democratic
legitimacy of the EMU. The book sheds light on this complex
economic-constitutional setting with a view on the future. The
imbalance between various new operations and a single price
stability objective is difficult to remedy. New objectives of
financial stability, economic adjustment and environmental
sustainability can cause fundamental ruptures between the
ECB’s formal role and its actions, and they also dangerously
overburden monetary policy moving forward with
substantial risks.

Klaus Tuori is a research fellow at the University of

Luxembourg. He is one of the leading scholars of the EU
economic-constitutional model, whose multidisciplinary
approach and understanding stems from his work as a central
bank economist at the European Central Bank and financial
markets. He is the co-author of The Eurozone Crisis:
A Constitutional Analysis (Cambridge, 2014).

Published online by Cambridge University Press

 Cambridge Studies in European Law and Policy

The focus of this series is European law broadly understood. It

aims to publish original monographs in all fields of European
law, from work focusing on the institutions of the EU and the
Council of Europe to books examining substantive fields of
European law as well as examining the relationship between
European law and domestic, regional and international legal
orders. The series publishes works adopting a wide variety of
methods: comparative, doctrinal, theoretical and inter-
disciplinary approaches to European law are equally welcome,
as are works looking at the historical and political facets of the
development of European law and policy. The main criterion is
excellence i.e. the publication of innovative work, which will
help to shape the legal, political and scholarly debate on the
future of European law.

Joint Editors

Professor Mark Dawson

Hertie School of Governance, Berlin
Professor Dr Laurence Gormley
University of Groningen
Professor Jo Shaw
University of Edinburgh

Editorial Advisory Board

Professor Kenneth Armstrong, University of Cambridge
Professor Catherine Barnard, University of Cambridge
Professor Richard Bellamy, University College London
Professor Marise Cremona, European University Institute, Florence
Professor Michael Dougan, University of Liverpool
Professor Dr Jacqueline Dutheil de la Rochère, University of Paris
II Pantheon-Assas,
Director of the Centre for European Law, Paris
Professor Daniel Halberstam, University of Michigan
Professor Dora Kostakopoulou, University of Warwick
Professor Dr Ingolf Pernice, Director of the Walter Hallstein
Institute, Humboldt University of Berlin
Judge Sinisa Rodin, Court of Justice of the European Union
Professor Eleanor Spaventa, Università Bocconi
Professor Neil Walker, University of Edinburgh
Professor Stephen Weatherill, University of Oxford

Published online by Cambridge University Press

 Books in the Series

The European Central Bank and the European Macroeconomic Constitution

Klaus Tuori
Digital Constitutionalism in Europe: Reframing Rights and Powers in the Algorithmic
Society
Giovanni De Gregorio
Can the European Court of Human Rights Shape European Public Order?
Kanstantsin Dzehtsiarou
The Constitutional Boundaries of European Fiscal Federalism
Brady Gordon
Private Selves: Legal Personhood in European Privacy Protection
Susanna Lindroos-Hovinheimo

Fissures in EU Citizenship: The Deconstruction and Reconstruction of the Legal Evolution of

EU Citizenship
Martin Steinfeld

The Boundaries of the EU Internal Market: Participation without Membership

Marja-Liisa Öberg
The Currency of Solidarity: Constitutional Transformation during the Euro Crisis
Vestert Borger
Empire of Law: Nazi Germany, Exile Scholars and the Battle for the Future of Europe
Kaius Tuori
In the Court We Trust: Cooperation, Coordination and Collaboration between the ECJ and
Supreme Administrative Courts
Rob van Gestel and Jurgen de Poorter
Beyond Minimum Harmonisation: Gold-Plating and Green-Plating of European
Environmental Law
Lorenzo Squintani
The Court of Justice of the European Union as an Institutional Actor: Judicial Lawmaking
and its Limits
Thomas Horsley
The Politics of Justice in European Private Law: Social Justice, Access Justice, Societal Justice
Hans-W Micklitz

The Transformation of EU Treaty Making: The Rise of Parliaments, Referendums and

Courts Since 1950
Dermot Hodson and Imelda Maher

Redefining European Economic Integration

Dariusz Adamski

Published online by Cambridge University Press

 Human Rights in the Council of Europe and the European Union: Achievements, Trends and
Challenges
Steven Greer, Janneke Gerards and Rosie Slowe
Core Socio-Economic Rights and the European Court of Human Rights
Ingrid Leijten

Green Trade and Fair Trade in and with the EU: Process-based Measures within the EU
Legal Order
Laurens Ankersmit

New Labour Laws in Old Member States: Trade Union Responses to European Enlargement
Rebecca Zahn
The Governance of EU Fundamental Rights
Mark Dawson
The International Responsibility of the European Union: From Competence to Normative
Control
Andrés Delgado Casteleiro
Frontex and Non-Refoulement: The International Responsibility of the EU
Roberta Mungianu
Gendering European Working Time Regimes: The Working Time Directive and the Case of
Poland
Ania Zbyszewska
EU Renewable Electricity Law and Policy: From National Targets to a Common Market
Tim Maxian Rusche

European Constitutionalism
Kaarlo Tuori

Brokering Europe: Euro-Lawyers and the Making of a Transnational Polity

Antoine Vauchez
Services Liberalization in the EU and the WTO: Concepts, Standards and Regulatory
Approaches
Marcus Klamert
Referendums and the European Union: A Comparative Enquiry
Fernando Mendez, Mario Mendez and Vasiliki Triga
The Allocation of Regulatory Competence in the EU Emissions Trading Scheme
Jospehine van Zeben
The Eurozone Crisis: A Constitutional Analysis
Kaarlo Tuori and Klaus Tuori

International Trade Disputes and EU Liability

Anne Thies

Published online by Cambridge University Press

 The Limits of Legal Reasoning and the European Court of Justice
Gerard Conway
New Governance and the Transformation of European Law: Coordinating EU Social Law
and Policy
Mark Dawson

The Lisbon Treaty: A Legal and Political Analysis

Jean-Claude Piris

The European Union’s Fight Against Corruption: The Evolving Policy Towards Member
States and Candidate Countries
Patrycja Szarek-Mason
The Ethos of Europe: Values, Law and Justice in the EU
Andrew Williams
State and Market in European Union Law: The Public and Private Spheres of the Internal
Market before the EU Courts
Wolf Sauter and Harm Schepel
The European Civil Code: The Way Forward
Hugh Collins
Ethical Dimensions of the Foreign Policy of the European Union:
A Legal Appraisal
Urfan Khaliq
Implementing EU Pollution Control: Law and Integration
Bettina Lange

European Broadcasting Law and Policy

Jackie Harrison and Lorna Woods

The Transformation of Citizenship in the European Union: Electoral Rights and the
Restructuring of Political Space
Jo Shaw

The Constitution for Europe: A Legal Analysis

Jean-Claude Piris
The European Convention on Human Rights: Achievements, Problems and Prospects
Steven Greer
Social Rights and Market Freedom in the European Constitution: A Labour
Law Perspective
Stefano Giubboni
EU Enlargement and the Constitutions of Central and Eastern Europe
Anneli Albi

Published online by Cambridge University Press

Published online by Cambridge University Press
 The European Central Bank and
the European Macroeconomic
Constitution
From Ensuring Stability to Fighting Crises

Klaus Tuori
University of Luxembourg

Published online by Cambridge University Press

 Shaftesbury Road, Cambridge CB2 8EA, United Kingdom
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Cambridge University Press is part of Cambridge University Press & Assessment,

a department of the University of Cambridge.
We share the University’s mission to contribute to society through the pursuit of
education, learning and research at the highest international levels of excellence.

www.cambridge.org
Information on this title: www.cambridge.org/9781108488747
DOI: 10.1017/9781108771757
© Klaus Tuori 2022
This publication is in copyright. Subject to statutory exception and to the provisions
of relevant collective licensing agreements, no reproduction of any part may take
place without the written permission of Cambridge University Press & Assessment.
First published 2022
A catalogue record for this publication is available from the British Library.
ISBN 978-1-108-48874-7 Hardback
Cambridge University Press & Assessment has no responsibility for the persistence
or accuracy of URLs for external or third-party internet websites referred to in this
publication and does not guarantee that any content on such websites is, or will
remain, accurate or appropriate.

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 Contents

List of Figures page xi

Series Editors’ Preface xiii
Preface and Acknowledgements xv
List of Abbreviations xvii

1 Introduction: A Supranational Central Bank

as a Subject 1

Part I The ECB as the Central Bank of the European

Macroeconomic Constitution
2 The Three Foundations of the EMU 15
3 The Principles of the European
Macroeconomic Constitution 69
4 ECB Organisation, Monetary Policy Strategy and
Operational Framework 92

Part II Crises, ECB Measures and the

Macroeconomic Constitution
5 ECB Monetary Policy during the Financial Crisis 129
6 The Prelude to the Sovereign Debt Crisis:
Events, ECB Verbal Interventions and EU
Rescue Programmes 150
7 Selective Government Bond Purchases 162
8 The ECB’s Quantitative Easing 193

ix

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 x contents

9 The Banking Union: The ECB Takes over

Banking Supervision 215
10 ECB Measures during the Covid-19 Pandemic 239

Part III The ECB from a Central Bank of Stability

to a Central Bank of Crisis
11 The Fate of the European
Macroeconomic Constitution 261
12 The Objectives for the ECB and the
Macroeconomic Constitution Going Forward 274
Epilogue: Where Do We Go from Here? 296

Bibliography 302
Index 329

Published online by Cambridge University Press

 Figures

4.1 The monetary policy transmission mechanism page 101

4.2 ECB main refinancing operations (bn euros) 109
4.3 ECB eligible collateral (bn euros) 112
4.4 Use of collateral (bn euros) 113
5.1 Use of the ECB’s marginal deposit facility (bn euros) 135
5.2 ECB longer-term refinancing operations (bn euros) 138
7.1 Euro area bond yields 166
13.1 ECB total assets (bn euros) 300

xi

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Published online by Cambridge University Press
 Series Editors’ Preface

The European Central Bank (ECB) has played a major role in the develop-
ment of European law and policy since its inception; it is characterised
by its independence, the eight-year, non-renewable term of membership
of its Executive Board and by the primary objective of the European
System of Central Banks (ESCB), of which it is the core central actor,
the maintenance of price stability (Article 127(1) TFEU). The importance
of price stability is further emphasised in the tasks of the European
Union set out in Article 3(3) TEU. Unsurprisingly, issues of accountability
and independence have been discussed since before the structure of the
ESCB and the ECB was agreed. Independence and accountability can be
unruly bedfellows; in the name of the latter, politicians desire to keep a
finger on the pulse of monetary policy; in the cause of the former,
central bankers seek to ensure that they do not become pawns in the
prospects of re-election of sitting politicians. Particularly in times of
crisis, the co-ordination of economic and monetary policy can become
something of a battleground. In this book, Klaus Tuori casts a sceptical
eye on the system which the European Treaties have established in a
stimulating and challenging discussion.
Tuori first sets out to construct the key constitutional principles of the
euro area macroeconomic framework, the European Macroeconomic
Constitution, based on its foundations. He then uses these principles as
normative premises for assessing the ECB’s actions before, during and
after a series of crises. He then looks at the overall impact of these events
and measures on the European Macroeconomic Constitution to assess
how it has changed, and what that implies for the future. Tuori argues
that the relevant Treaty provisions and EU legal principles form a rela-
tively coherent and internally consistent economic-constitutional whole

xiii

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 xiv series editors’ preface

that can be divided into two layers: one microeconomic, consisting of

the four economic freedoms and competition law; the other macro-
economic which contains the single monetary policy, the euro currency
and the framework for other macroeconomic policy-making in the
Member States.
The book is, like Ancient Gaul, divided into three parts. Part I deals
with the key constitutional principles of the European Macroeconomic
Constitution that set the normative premises for the assessment of
common monetary policy and the ECB, ending with a description of
those constitutional principles and of the ECB as it was established
accordingly. Part II examines the impact of the financial, economic,
sovereign debt and pandemic crises on the ECB and the constitutionality
of its measures in the light of the European Macroeconomic
Constitution. Finally, Part III embraces a broader perspective on the
overall implications for the European Macroeconomic Constitution,
ECB accountability, and even the rule of law.
Tuori argues that the change in the importance of objectives from
price stability to financial stability demonstrates that the ECB has
mutated from a central bank of stability to a central bank of crisis. He
argues that the financial stability of the euro area has become the main
objective and rationale for most new elements introduced in the broad
field of EU macroeconomic governance over the last decade. Hence, it
could be a prime candidate to become a new constitutional objective for
the European Macroeconomic Constitution that could restore its ability
to provide future stability and prosperity. However, he observes that the
problem with adopting financial stability as a legal objective is that it is
based on an elusive economic concept that lies at the intersections
between macroeconomics, public finances, financial markets, and finan-
cial institutions; it is a crisis concept which is difficult to transform into
a constitutional one. Tuori sees structural economic adjustment and
environmental sustainability appearing to penetrate the European eco-
nomic constitution. He concludes by sketching three paths for the
future, each with different legitimacy implications. It will be intriguing
to see how events unfold, as we live in interesting times.
It is with great pleasure indeed that we welcome this challenging and
closely-argued addition to Cambridge Studies in European Law and Policy.

Jo Shaw
Laurence Gormley
Mark Dawson

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 Preface and Acknowledgements

This book is built on a need to understand how a supranational money,

the euro, and the European Central Bank (ECB) as its guardian could and
should function. I thought I had an idea, when I was among the people
preparing and starting the new currency more than two decades ago.
However, the events of the last decade have changed this perception.
Both the economic and the constitutional aspects of the ECB have
become increasingly confusing, and it seems that fewer people than ever
have a structured idea where we are heading. Given the importance of
money for our liberal and hopefully humane societies, this is not a
comfortable situation even for the ECB.
Two personal confessions might help the reader. First, I have some
trust issues with public sector actors, including central banks. Central
banks can make positive contributions, as they attract clever people that
have the best of intentions. However, the positive contributions are more
likely to happen if they remember that they are technocrats that only
facilitate others to create actual prosperity. History warns against central
banks that become omnipotent and start solving broader problems by
their main instrument, issuance of currency, that has small initial costs
but potentially devastating longer-term consequences. And worse, the
more the public trusts the central bank, the smaller is the initial cost,
and larger the potential for devastation. Second, I have an ambivalent
view on the EU. Many things are to like: the freedoms, people, peace and
even the very idea of Europe as our common destiny. However, the EU as
a problem-solving mechanism has some caveats alongside its many
positive features. The EU politicians and civil servants sometimes form
their own reality that is insulated by slogans, statements and claims of
success from the realities of other people. These two notes underlie my

xv

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 xvi preface and acknowledgements

research: for my small part, I wish to help the ECB to keep its focus on
the longer term; and I aim to look beyond slogans and claims of success,
at actual facts for a firmer foundation for the future.
I have been fortunate to be supported by many enthusiastic and intelli-
gent people that have commented on the work at different stages:
Fernando Losada, Diane Fromage, Kaarlo Tuori, Agustín Menéndez,
Giandomenico Majone, Adrienne Heritier, Otmar Issing, Fritz
W. Scharpf, Marise Cremona, Claire Kilpatrick, Kaius Tuori, Christian
Joerges, Tuomas Ojanen, Fabian Amtenbrink, Hans-W. Micklitz, Phedon
Nicolaides, Juha Raitio, Thomas Beukers, Paul Dermine, Vesa Vihriälä,
Sixten Korkman, Peter Nyberg, Álvaro de Elera, Tuomas Saarenheimo,
John Erik Fossum, Päivi Leino-Sandberg and Jukka Snell. My important
research environments include the University of Helsinki as my intellec-
tual origin, the University of Luxembourgas my new intellectual home,
and the locations of my excellent research visits, the EUI (Firenze) and
the Sciences Po (Paris).
In addition to the academic community, I want to thank my ex-
colleagues and friends from the financial markets, at the ECB and
Suomen Pankki for the many interesting discussions.
Last but not least, I want to thank my family.

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 Abbreviations

ABSs asset-backed securities

BIS Bank for International Settlements
BoE Bank of England
BoJ Bank of Japan
CEBS Committee of European Banking Supervisors
CDS credit default swap
CJEU Court of Justice of the European Union
CoG Committee of Governors
D-Mark Deutsche Mark, German currency before EMU
EBA European Banking Authority
ECB European Central Bank
ECJ European Court of Justice (also the CJEU)
ECOFIN Economic and Financial Affairs Council
ECSC European Coal and Steel Community
ECU European Currency Unit
EEC European Economic Community, can also refer to the
Treaty of Rome
EFSF European Financial Stability Facility
EIOPA European Insurance and Occupational Pensions Authority
EMI European Monetary Institute
EMS European Monetary System
EMU Economic and Monetary Union (refers principally to the
Third Stage of the EMU)
ERM exchange rate mechanism
ESAs European supervisory authorities
ESCB European System of Central Banks
ESFS European System of Financial Supervision

xvii

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 xviii list of abbreviations

ESM European Stability Mechanism

ESMA European Securities and Markets Authority
FCC (German) Federal Constitutional Court,
Bundesverfassungsgericht
Fed US Federal Reserve System
FOMC Federal Open Market Committee
FSA Financial Supervision Authority
GDP gross domestic product (the size of the economy)
IMF International Monetary Fund
LTROs longer-term refinancing operations
M1 measure of money supply, a narrow monetary aggregate
with most liquid form of money
M3 measure of money supply, a broad monetary aggregate
with less liquid forms
MPC Monetary Policy Committee
MRO main refinancing operations, ECB’s main policy
interest rate
NAIRU non-accelerating inflation rate of unemployment
NCB National Central Bank
NY Fed Federal Reserve Bank of New York
OMOs Open market operations
OMT Outright Monetary Transactions Programme
PEPP Pandemic Emergency Purchase Programme
PSPP Public Sector Purchase Programme, ECB’s QE programme
QE Quantitative Easing, in practice central bank measure of
buying vast amounts of assets
RBC Real Business Cycles approach
SGP Stability and Growth Pact
SMP Securities Market Programme
SNB Swiss National Bank
SRB Single Resolution Board
SRF Single Resolution Fund
SRM Single Resolution Mechanism
SSM Single Supervisory Mechanism
TARGET ECB (Eurosystem) payments system, Trans-European
Automated Real-time Gross Settlement Express Transfer
System
TARGET2 The revised payments system from 2007
TEU Consolidated version of the Treaty on the European Union

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 l ist of abbreviations xix

TFEU Consolidated version of the Treaty on the Functioning of

the European Union
Tier1 ECB (Eurosystem) list of eligible collateral
WWI The First World War
WWII The Second World War
ZIRP Zero interest rate policy

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https://doi.org/10.1017/9781108771757.003 Published online by Cambridge University Press
 1 Introduction: A Supranational
Central Bank as a Subject

In 1999, eleven EU Member States started a historic experiment. This

consisted of introducing a common currency, the euro, safeguarded by a
newly-founded central banking system with the European Central Bank
(the ECB) at its centre. The new euro area monetary system was
to provide a stable currency and an enhanced framework for further
economic integration, stability and prosperity. The framework and
objectives for common macroeconomic policy were elevated to a consti-
tutional level in the Maastricht Treaty. The underlying economic, polit-
ical and even constitutional assumptions and constraints were agreed
upon by the Member States, but from different perspectives. Some
Member States saw them as preconditions, some as a price to be paid
for a common currency, while others largely ignored them. Nevertheless,
the first decade showed mostly the positive sides of the Economic and
Monetary Union (EMU) with an internally stable currency and a benign
economic environment.
In 2008, the global economy was hit by the worst economic and
financial crisis since the Great Depression. Many economies recovered
relatively quickly once the negative shocks evaporated. However – and
mainly in the richest countries – the crisis questioned their very eco-
nomic model of the preceding decades. Trust in economic policy actors,
first and foremost central banks, in smoothing economic fluctuations
came to an abrupt end and the idea that private and public debt could
increase without upper boundaries was at least temporarily questioned.
No economy system was hit as fundamentally and from as many sides as
the euro area, where the financial crisis was followed by economic and
sovereign debt crises. In 2020, the euro area was, again, among the worst
hit by the pandemic crisis.

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 2 1 introduction

This series of crises has questioned the whole EMU economic and
constitutional model. The historic experiment with a common currency
turned out to be poorly equipped to deal with crises that its constitu-
tional model was assumed to prevent in the first place. Consequently, the
carefully designed economic-constitutional model has been replaced by a
constant flow of ad hoc measures that were largely responses to the
economic and political realities of the moment and specific interests of
individual Member States and their financial sectors. The ECB has found
itself at the heart of this economic, political and also constitutional
experimentalism with its measures pushing the boundaries of the trad-
itional conduct of monetary policy.
The ECB measures have not been dramatically different from
those taken by other major central banks that also deemed their well-
tested policy responses insufficient. However, in practice and especially
in constitutional terms the ECB differs from other central banks. As
a supranational system it lacks a nation state’s economic and political
will-formation as its counterpart and as its ultimate control. Its
main counterpart is the constitutional framework, called here the
European Macroeconomic Constitution, based on specific assumptions
concerning economic policy competences, accountability mechanisms
and fundamentally also the democratic legitimacy of euro area economic
governance. The ECB is a highly independent central bank insulated
from the democratic process and not equipped to make value-based
decisions. This in turn should have implications as to how it can
expand its role.
Constitutions protect the most important values of their respective
societies, and they should have a high level of suspicion concerning
demands arising from urgency. At the same time, particularly economic
constitutions can be too inflexible. Central banks need some discretion
in implementing policies in the ever-changing economic circumstances
and realities of financial markets. For the ECB this tension between
innovative responses to new situations and its rigid legal mandate is
more profound than with other central banks, because of its distance
from the general executives and legislatures. Central banks that enjoy
access to governments or parliaments can make the case for exceptional
measures and even find a sensitive ear. In the EU, the mandates are
anchored at the level of the Founding Treaties that are even more diffi-
cult to change than individual national constitutions.
How should the ECB be assessed? As an economic policy actor it needs
to be assessed on the grounds of how it achieves its objectives and how it

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 1.1 eu economic constitutional law as framework 3

performs its tasks.1 However, as an EU institution with considerable

independence, it needs to be assessed on the basis of how it operates in
this complex economic-political setting, and how it respects and
advances the values it is supposed to protect and serve. This constitu-
tional perspective ensures that the ECB does not lose sight of the
common objectives and values that the EU is based on. Both the eco-
nomic and constitutional perspectives are important, but they differ in
the period of assessment; economic assessment seems to focus more on
short-term problems, while the economic constitution by nature has a
longer perspective.
This book aims to shed light on this complex economic-constitutional
setting to understand how and with what constraints the ECB and the
European Macroeconomic Constitution should function. How and with
what implications has the ECB’s role changed during and after the crises
when the constitutional model no longer ensured stability and prosper-
ity? After all that has happened, where are we now and where can go
from here?

1.1 EU Economic Constitutional Law as the Framework

Constitutional questions related to the ECB acquire some extra flavour
from the EU law perspective. The research needs to be anchored on an
understanding of its object, the concepts of law, legal systems and legal
competence. The starting point is to define the legal system as an insti-
tutional normative order, which is not only the case with state law with
its coercive elements, but also with ‘the law of the organised associations
of states such as the EC/EU’.2
There is, however, a conceptual problem stemming from the self-
referential nature of legal systems. In the institutional order, institutions
with power to decide upon legal competences are themselves part of the
institutional order, as is well demonstrated by the Court of Justice of the
European Union’s (CJEU) role in defining the content and reach of EU
law. The self-referential problem can be alleviated by claiming that the
existence of institutions is only partially defined by their own norms. An
additional element is efficacy through demonstrated power over the
addressees of norms and some legitimacy by those who are governed.3

1
It could still take at least a decade to become conclusive as it was with the Great
Depression of the 1930s.
2
MacCormick (1995), ‘The Maastricht-Urteil’, 261. 3
Ibid., 261–262.

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 4 1 introduction

The efficacy argument gains support from traditional legal theories.4

Law requires as a pre-condition that some legal sovereign can be
assumed and be based on efficacy arguments.5 This existence of a legal
sovereign is a reflection or even proof of the existence of a political entity
(or polity).
In EU constitutional law, different interpretations exist on the con-
struction of the legal system. In general terms, discussion on EU consti-
tutional law and its relationship with national constitutional laws can
take place under the concept of constitutional pluralism.6 It sees the
relationship between the EU legal order and Member State legal orders as
interactive and intertwined rather than hierarchical.7 For the ECB, its
exclusive EU competence in monetary policy sets it clearly in the domain
of the EU constitutional order, but only to the extent that its actual
measures are legitimately included in competences conferred by
Member States to the EU. Hence, whether a specific competence question
falls under EU law or national law is not a precondition for research but
rather a result of research. The German constitutional court’s (the FCC)
Maastricht judgment held that it (the Court) would continue to uphold
the fundamental values of German constitutional law and it could in the
future question any undue expansion of EU competences.8 Accordingly,
Kompetenz-Kompetenz to define the limits of conferred monetary policy
competences would have remained with the Member States.
However, this ultimate Kompetenz-Kompetenz problem is complicated by
the fact that both the CJEU and the national constitutional courts can
legitimately claim to define the borders of their authority. The CJEU
insists that it is competent to decide where EU authority based on the
Founding Treaties ends, but Member State courts have also maintained
the right to review EU Treaty changes and transfers of power to the EU to
ensure that EU law is compatible with national legal orders.9 Hence, it is
the specific cases that define the limits of conferral, where the starting

4
Kant (1797), ‘Die Metaphysischen Anfangsgründe der Rechtslehre’, 311. Kant sees
sovereignty as an a priori condition for a legal system that facilitates the institutional
framework for the common will.
5
Schmitt (2005), Political Theology, 5.
6
Walker (2002), ‘The Idea of Constitutional Pluralism’, 317; Davies (2012), ‘Constitutional
Disagreement’; Barber (2006), ‘Legal Pluralism’, 306–329.
7
MacCormick (1995), ‘The Maastricht-Urteil’, 264. 8
FCC 2 BvR 2134/92.
9
Subsequently, in the Lisbon Judgment, the FCC urged the limitation of the transfer of
national powers to the EU to ensure that ‘sufficient space is left to the Member States for
the political formation of economic, cultural and social living conditions’. FCC 2 BvE 2/08.

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 1.1 eu economic constitutional law as framework 5

point can be either Member State courts or the CJEU. The recent Weiss
judgment by the FCC elaborated the subject by insisting that the CJEU
review of the ECB has to fulfil some qualitative criteria to be
acceptable.10
A fully pluralistic approach would claim that no ex ante supremacy to
decide on the subject needs to be found.11 In cases of persistent conflicts,
political solutions would need to be found, resulting ultimately in
amending either the national constitutions or the Treaties.12
Furthermore, accepting some pluralistic foundations for the EU consti-
tutional model does not exclude that many universal themes or prin-
ciples can be derived from the normative status of free and equal
individuals of the EU. These universal constitutional principles include
legality, subsidiarity, democracy and some basic rights and freedoms.13
In conclusion, for the purpose of this book, the constitutional law
framework for the assessment of the ECB is essentially a pluralistic,
interactive and intertwined institutional normative order located at the
intersection of the EU legal order and Member State legal orders. Actual
analyses of the interaction – and particularly the criteria concerning the
validity of specific issues – need to consider both sides of the interaction.
Even the highest political decision-maker, the EU Council, is a product of
both the EU constitutional order and of Member State national consti-
tutional orders. The EU constitutional order defines the role and compe-
tences of the Council, while national constitutional orders define the
composition of the Council and give it legitimacy through the link
to electorates.
The subject of EU constitutional law and the ECB touches upon
another fundamental issue concerning the nature of law and legal sci-
ence, the dual citizenship of legal science.14 The questions are first and
foremost scientific, and should be answered by the methods accepted by
the scientific community. However, it would be scientific dishonesty to
neglect that the questions are also an integral part of legal-economic-
political reality and practice. Answers and even the formulation of

10
FCC 2 BvR 859/15.
11
Walker (2002), ‘The Idea of Constitutional Pluralism’, 317; Kumm (1999), ‘Who Is the
Final Arbiter of Constitutionality in Europe?’, 351–386.
12
Walker (2016), ‘Constitutional Pluralism Revisited’, 333–355 and Baquero Cruz,
‘Another Look at Constitutional Pluralism’.
13
See, Kumm (2007), ‘Constitutionalism and the Moral Point of Constitutional Pluralism’,
and Kumm (2007), ‘Institutionalising Socratic Contestation’, 19.
14
Tuori (2002), Critical Legal Positivism, 285.

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 6 1 introduction

questions can intervene in ongoing legal-economic-political debates with

implications far beyond scientific interest in the issue. This, in turn,
affects the value of some judgments, if they are perceived to be influ-
enced by short-term political considerations.15

1.2 Three Roads Crossing: An Economic-Constitutional

Methodology
The search for a methodology for scientifically solid answers to consti-
tutional questions about the ECB results in something that could be
called an economic-constitutional approach. The methodology incorpor-
ates the necessary information sources and theoretical considerations
to a broadly based legal constitutional assessment. First, the key
constitutional principles of the new euro area macroeconomic frame-
work, the European Macroeconomic Constitution, will be constructed on
the basis of its foundations. Second, these constitutional principles are
used as normative premises for assessing the ECB’s actions before,
during and after a series of crises. Third, the overall impact of these
events and measures are reflected on the European Macroeconomic
Constitution to assess how it has changed and what that implies for
the future.
The concept of the European Macroeconomic Constitution is a theor-
etical framework for collecting and systematising relevant information.
Additionally, it is a theoretical reconstruction on the basis of that infor-
mation that can be used as a normative premise to analyse the interrela-
tions between various Treaty provisions but also the underlying
economic and societal aims and assumptions. I will claim that the
relevant Treaty provisions and EU legal principles, form a relatively
coherent and internally consistent economic-constitutional whole that
can be divided into two layers: a microeconomic layer consisting of the
four economic freedoms and competition law, plus a macroeconomic
layer that contains the single monetary policy, the euro currency and the
framework for other macroeconomic policy-making in the Member
States.16
The first part of the methodology is to discover the content of the
European Macroeconomic Constitution to find out what kind of central

15
Hydén (2011), ‘Looking at the World through Lenses of Norms’, 126–128.
16
The two layers of the European economic constitution were first described in Tuori and
Tuori (2014), The Eurozone crisis.

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 1.2 an economic-constitutional methodology 7

bank and monetary policy it implies. The legal framework for the
EMU macroeconomic order, including the role of the ECB, was designed
in a short period from 1989 to 1991, whereas the monetary policy
framework had deeper origins that help us to understand its nature.
Arguably, the EMU was possible because three different roads that
could be described as its foundations happened to cross at the same
time. These three roads, or foundations, are economic-constitutional
thinking as the philosophical foundation, the institutional and theoretical
evolution in central bank economics as the economic foundation, and
the economic, political and legal developments in European economic
integration as the institutional foundation. By the end of the 1980s these
three foundations guided consensus on the specific model to introduce
more macroeconomic elements in European economic integration. In
order to understand the content and assumptions of the key constitu-
tional principles, it is necessary to know how the three foundations
shaped them.
The paradigms of legal science, particularly legal dogmatism, legal
realism as well as law and economics, provide a broad but inconclusive
list of methods that could be used as part of the methodology to discover
the principles of the European Macroeconomic Constitution. However,
the three foundations each have their own theoretical and empirical
premises that need to be respected without superimposing one overrid-
ing approach. Most key concepts need to be analysed using the methods
and traditions of economics as well as those of law and other social
sciences. The connective methodology is the search for the substance of
the concepts and Treaty provisions from the three foundations respect-
ing the methods of each of these fields of science. These are incorporated
into a broad constitutional analysis to bring coherence and structure to
the overwhelming, inconclusive and even occasionally incompatible
information and also validity claims.
The second part of the methodology focuses on the constitutional
assessment of specific ECB measures, in which the legal dogmatic
approach plays a larger role in finding the content of individual provi-
sions in specific circumstances. The Treaty provisions are the basis for a
legal assessment of actual policy measures, but they are complemented
by the principles of the European Macroeconomic Constitution as nor-
mative premises for the EMU. This provided more substantive and less
formalistic interpretations of the Treaty provisions.
The main body of legal assessment is then to analyse and interpret the
relevant legal provisions to find out their legal meaning through

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 8 1 introduction

utilisation of legal sources and rules of interpretation.17 However, this

needs argumentative support from other areas of social science, in par-
ticular economics. It is evident that an EU-level monetary policy aimed at
social and political effects that cannot be derived from strictly legal
sources, and these aims can be necessary inputs for the constitutional
assessment of actual monetary policy.18
In conclusion, the overall methodology to be applied is a collection of
methodological tools that are held together by an overall narrative of EU
monetary policy as a key element of the European Macroeconomic
Constitution and of its philosophical, economic, and institutional foun-
dations. It could be defined as a law in context approach, because it is
based on analysing the underlying context in which the phenomena
should be seen, taking into account the interdependencies. The lack of
scientific rigour imposed by a well-tested single scientific approach
demands that the chosen approach remains aware of and sensitive to
the broader scientific requirements as well as keeps the argumentation
as open as possible.
Additional items that need to be addressed include legal sources and
sources of information on the content of legal norms covering the
common monetary policy. Treaty articles are the starting point. The
most important provisions – introduced in the Maastricht Treaty – have
remained more or less intact. However, many important elements were
already introduced in the Treaty of Rome (1957), including the four
economic freedoms. In addition, relevant legal provisions appear in
secondary EU law and even in national law concerning macroeconomic
management. Furthermore, the legal form of an ECB measure does not
dictate its constitutional importance, as many ECB critical measures do
not get an explicit legal form. Hence, all material and practices by the
ECB and other authorities can feature as sources of law. Measures are
assessed on the basis of their substance, not merely their legal form. In
addition, other strictly legal material includes decisions by the highest
(constitutional) courts. The book followed developments until the end
of 2021.
Classic EU doctrine already recognises a number of secondary sources
of law, such as legal practice and foreign law, as well as some more
general legal concepts. In addition, an extensive list of so-called source

17
Aarnio (1989), Laintulkinnan teoria, 194.
18
Elderson (2005), ‘Legal Interpretation within the European System of Central Banks’,
93–114.

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 1.2 an economic-constitutional methodology 9

factors that have influenced relevant legal decisions might need to be

included.19 Hence, apart from traditional legal sources, other types of
information sources are used, including the theoretical and historical
background of the European Macroeconomic Constitution. For example,
the ordoliberal school of thought and its concept of economic
constitution can be relevant information in reconstructing the economic
constitution at the European level, even if it is hardly a substantive legal
source as such. Similarly, theoretical and empirical information on eco-
nomic policy concepts is relevant. From the methodological perspective
the inclusion of empirical information for the purpose of inductive
theory-building as well as for its validation can be difficult, although it
could be essential for legal interpretation, when ‘causal factors convert
into sources of law’.20
Economic and monetary policy concepts introduced in the Maastricht
Treaty were based on the economic thinking of the time they were
introduced. However, this does not mean that the economic paradigms
have validity claims beyond their influence on the formulation of the
Treaty provisions. It could instead be assumed that concepts and terms
on macroeconomic management were intentionally left open to keep the
economic constitution flexible to developments in the economy. Against
this background, it is preferable to consider the impact of economic
theory more substantively on specific issues. For the actual ECB meas-
ures to combat crisis, the relevant theoretical and empirical information
needs to include developments in economics up to that point. Economics
as a science has an ongoing dialogue with actual economic policy, and
the results of this dialogue influence subsequent policy measures.
Indeed, central bank measures during the crises have also paved the
way for new economic theoretical considerations that need to be
included in the assessments, even if the scientific conclusions are tenta-
tive at best.
Institutional information on central banks can be relevant from two
perspectives. Information concerning the predecessor institutions could
help to fill some information gaps. A particularly useful informative
source is the Deutsche Bundesbank that can be seen as a template for
the ECB, though the practices of other national central banks could also
be included. In addition, comparisons with other major central banks
help to analyse the economic and operational concepts related to

19
See Evald (2000), Law, Method and Values, and Eckhoff (1993), Rettskildelære.
20
Pattaro (2007), A Treatise of Legal Philosophy and General Jurisprudence, 15.

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 10 1 introduction

monetary policy. This information could be particularly useful with

regard to the unconventional monetary policy measures during
the crises.
Finally, the rules for legal interpretation need to be explicated. First,
literary interpretation of the Treaty provisions is the starting point even
if the provisions might be too ambiguous for definitive literary interpret-
ations. Second, systematic interpretation plays an important role.
Provisions on monetary policy are part of the more general macroeco-
nomic governance model that contains elements both at the EU level and
at the Member State level. A broad list of provisions, general principles
and rules needs to be incorporated in a systematic framework. Third, the
teleological interpretation of Treaty provisions and other EU legislation
is important, as the aims of European integration have been given a
prominent role in the case law of the CJEU from the very outset. The
teleological needs of integration are turned into systemic requirements
for the EU legal order. This is close to a value-based interpretation
incorporating the values inherent in EU law and interpreted by the
CJEU such as the rule of law, fundamental and human rights, as well
as values related to democracy.21 Fourth, the role of preparatory works
in interpreting and applying EU law is much more limited than in most
national legal orders. The same applies to legal research on the ECB.
Finally, comparative analysis and interpretations may help to find the
underlying motivations and assist in defining concepts and measures in
legal terms. In particular, it can be illuminating if unconventional ECB
measures are differently termed or given different justifications than is
the case with other major central banks that have different mandates.

1.3 Structure of the Book

The book is divided into three parts. Part I forms the key constitutional
principles of the European Macroeconomic Constitution that set the
normative premises for the assessment of common monetary policy
and the ECB. This part ends with a description of these constitutional
principles and of the ECB as it was built accordingly. Part II examines the
impact of the financial, economic, sovereign debt and pandemic crises on
the ECB and the constitutionality of its measures in the light of the
European Macroeconomic Constitution. Part III takes a broader

21
Tridimas (2006), The General Principles of EU Law.

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 1.3 structure of the book 11

perspective on the overall implications for the European Macroeconomic

Constitution, ECB accountability and even the rule of law. The change in
the importance of objectives from price stability to financial stability is
seen to demonstrate a mutation of the ECB from a central bank of
stability to a central bank of crisis.

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 Part I
The ECB as the Central Bank of the
European Macroeconomic Constitution

The birth of the euro and the ECB marked a new era both for the EU
Member States and for the global monetary system. For Member States,
their monetary policy was transferred to a new, fundamentally
unknown, institution and their economic policy was assigned a frame-
work of objectives and controls. For the global monetary system, the
playing field was changed with a new key actor arriving and mostly
taking the place of the earlier important actors, in particular the
German Bundesbank, Banque de France and Banca d’Italia.
In order to understand, what kind of a currency the EU Member States
launched and what kind of a central bank they established to guardian
this currency, we need to study its main intellectual building blocks. As a
first step, we will analyse the foundations of the new EU framework for
macroeconomic governance that I have labelled here as the European
Macroeconomic Constitution to stress both its constitutional legal basis
in mainly EU primary law and its distinctive nature stemming from its
macroeconomic substance. These foundations help to form the key prin-
ciples of the new constitutional model and of the new constitutional
central bank, the ECB. Apart from the general and more theoretical con-
siderations related to the constitutional model as it was introduced in the
Maastricht Treaty, it is necessary to analyse the actual design of the ECB: its
strategy, operations, communications and also constitutional control.
Part I will thus explain the main element of the European
Macroeconomic Constitution, as a constitutionally enshrined model that
was assumed to guarantee stability and prosperity for the euro area. It is
still formally valid, but as Part II and III will analyse, the model has faced
enormous pressure for change when the euro area has been witnessing a
series of recurring crises for more than a decade already.

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 2 The Three Foundations of the EMU

2.1 Philosophical Foundation: The (Ordoliberal)

Economic-Constitutional Thinking
Economic-constitutional thinking can be considered as the philosophical
foundation of the EMU. The very idea of an economic constitution has its
origins in German ordoliberal thinking, which guided the Bundesbank,
the template for the European Central Bank. The following aims to shed
light on the approach of elevating key elements of the economic frame-
work to the constitutional level, beyond the reach of daily policy-making.
The main takeaway is to understand how the various elements of the
economic constitution can be interlinked, and the type of economic,
political and institutional implications that this economic-constitutional
approach entails. Nevertheless, ordoliberal thinking should not be seen
as a substantive model for the European economic constitution.

2.1.1 The Origin of Ordoliberalism

The concept of the economic constitution was created by a group of
German economic and legal scholars called the ordoliberals. The original
core is also called the Freiburg School (Freiburger Schule), which consisted
of Walter Eucken, Franz Böhm and Hans Grossmann-Doerth.1 They
sketched an ordoliberal approach from the early 1930s onwards,2 as a
response to recurrent societal crises in Germany that called for a more
sustainable economic and political framework.3 The ordoliberals

1
Vanberg (2004), ‘The Freiburg School’, 1–2.
2
The Ordo manifesto of 1936 laid down the main elements of the school. Böhm et al. (1936
[1989]), ‘The Ordo Manifesto of 1936’.
3
Including war reparations after WWI, hyperinflation, the chaotic Weimar Republic, the
Great Depression including mass unemployment, Hitler’s rise to power, the oppressive

15

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 16 2 the three foundations of the emu

included mainly economists and legal scholars, but also sociologists,

political scientists, politicians and civil servants.4
Walter Eucken was the most important economist among the early
ordoliberals, and his research was in opposition to the economic
research and policy-making in Germany of the time.5 His major works
Die Grundlagen der Nationalökonomie (1939) and Grundsätze der
Wirtschaftspolitik (1952) included the main elements of a framework-
based economic policy.6 Another important economist was Leonhard
Miksch, who also worked after World War II (WWII) in the German
economic administration under the minister of economic affairs, Ludwig
Erhard with a major influence on both 1948 currency reform and com-
petition policy.7 Wilhelm Röpke was associated with the ordoliberals,
and his main areas were macroeconomics and international trade, where
he also argued for an economically open Germany to ensure that it
would not cause problems for its neighbours again.8
The most notable legal scholar among the original ordoliberals was
Franz Böhm. His work concentrated on monopolies and the means of
preventing concentration of private power.9 His main work, Wettbewerb
und Monopolkampf (1933), contained the idea that the basic laws of a
competitive economy should be defined and established as a legal consti-
tution for economic life. After WWII, Böhm helped the Allied forces to
draft legislation in the areas of economic and industrial policy.10 Ernst-
Joachim Mestmäcker (1926–) also deserves to be mentioned, particularly
for his work in establishing a common competition policy as a special
adviser to the Commission. He has also published extensively in the field

Nazi regime, WWII and finally the military, economic and moral collapse of the nation.
Bonefeld (2012), ‘Freedom, Crisis and the Strong State’, 636–638.
4
Different groupings are used by Vanberg (2004), ‘The Freiburg School’; Ptak (2009),
‘Neoliberalism in Germany’, 98–138; Oliver (1960), ‘German Neoliberalism’, 117–149;
Gerber (1994), ‘Constitutionalizing the Economy’, 24–84; Kolev (2010), ‘F. A. Hayek as
an Ordoliberal’.
5
His background included the German historical school of economics, Neo-Kantianism and
phenomenology. See also, Eucken (1932), ‘Staatliche Strukturwandlungen’, 297–323.
6
Eucken (1939), Die Grundlagen der Nationalökonomie. Eucken (1952), Grundsätze der
Wirtschaftspolitik.
7
Miksch (1937), Wettbewerb als Aufgabe, and Goldschmidt and Berndt, ‘Leonhard Miksch
(1901–1950)’, 975–976.
8
Röpke (1946), The German Question (originally Die Deutsche Frage in 1945).
9
He gained first-hand knowledge by working in the German Cartel office before turning
to academia. Lenel (1996), ‘The Life and Work of Franz Böhm’, 301. See, Böhm (1928),
‘Das Problem der Privaten Macht’, 324–345.
10
Böhm (1933), Wettbewerb und Monopolkampf.

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 2.1 philosophical f oundation 17

of European competition law and policy as well as on the European

economic constitution.11
Alexander Rüstow was a sociologist who brought to discussion the
failures caused by totally free and unchecked market forces and market
power.12 For the actual political impact of ordoliberalism, Ludwig Erhard
deserves a special place. As a key figure in German economic policy after
WWII, he relied on much by way of ordoliberal thinking,13 although he
also embraced other influences, including that of Franz Oppenheimer.14
(West) Germany’s social market economy model (Soziale Marktwirtschaft)
and its initiator, Alfred Müller-Armack, shared many ordoliberal ideas,
though many important differences existed as well.15
Of the other liberal scholars, Friedrich Hayek shared common ground
with Eucken and Röpke, particularly in the 1930s.16 The Road to Serfdom
could be seen as the peak of this common ground:
The functioning of competition not only requires adequate organization of cer-
tain institutions like money, markets, and channels of information – some of
which can never be adequately provided by private enterprise – but it depends,
above all, on the existence of an appropriate legal system, a legal system designed
both to preserve competition and to make it operate as beneficially as possible.17

Later, the evolution of Hayek’s thinking led to areas of difference rather

than to common themes18 and he neglected rational planning of the
economic framework,19 although Hayek’s importance increased within
the ordoliberal school from the 1960s onwards with a ‘shift of emphasis
from private to public distortions of competition’.20

11
See, Mestmäcker and Bartodziej (2008), Verfassung und Politik; Mestmäcker (2011), Die
Wirtschaftsverfassung der EU im globalen Systemwettbewerb; and Mestmäcker (2003),
Wirtschaft und Verfassung in der Europäischen Union.
12
Rüstow (1950), Das Versagen des Wirtschaftsliberalismus and Rüstow (1950–1957),
Ortsbestimmung der Gegenwart.
13
Mierzejewski (2006), ‘Water in the Desert?’, 275–287.
14
Goldschmidt (2004), ‘Alfred Müller-Armack and Ludwig Erhard’, 7–9.
15
Ibid., 3–5 and 17–21.
16
He even held Eucken’s old chair at Freiburg University in the 1960s. Kolev (2010),
‘F. A. Hayek as an Ordoliberal’, 7–10.
17
Hayek (1944 [1994]), The Road to Serfdom, 43, and also in Kolev (2010), ‘F. A. Hayek as an
Ordoliberal’, 14.
18
Streit and Wohlgemuth (1997), ‘The Market Economy and the State’.
19
Hayek (1939), Freedom and the Economic System, 189–210 and Kolev (2010), ‘F. A. Hayek as
an Ordoliberal’, 12–13.
20
Joerges (2005), ‘What is Left of the European Economic Constitution?’, 461–489.

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 18 2 the three foundations of the emu

2.1.2 The Ordoliberal Economic Constitution: What Kind of Order Is

Required for a Humane and Economically Successful Life?
The term ‘economic constitution’ (Wirtschafsverfassung) is at the heart of
ordoliberal constitutional discourse.21 The economic constitution is a
comprehensive decision or a systemic decision (Systementscheidung)
anchoring the key elements of the economic model at the level of
the constitution with the ultimate aim of guaranteeing the sphere of
individual freedoms and humanism. Only a market economy relying on
performance-based competition (Leistungswettbewerb) was seen as compat-
ible with the aims of ‘a humane and economically successful life’,22
and its key elements need to be outside both short-term democratic
decision-making and administrative discretion. By excluding discretion-
ary economic activity from the political system ‒ such as interventionist
economic policies ‒ the economic constitution also protects the
political system from undue influence from interest groups and
large corporations.

The Role of the State

The main explicit difference between ordoliberalism and other forms of
liberalism is the role of the state. This is the ‘ordo’ in ordoliberalism. The
state functions primarily as a rule-setter. It creates a proper framework
for the economy that guarantees its functioning and ultimately the
sphere of individual freedoms.23 The state should be strong but
limited,24 where the term ‘strong’ refers to the state’s ability to resist
undue pressure from various interest groups to maintain strict adher-
ence to the rule of law. Böhm also used the concept of bescheidenen staat,
which could be translated as a ‘humble state’, pointing to a preference

21
The term Wirtschafsverfassung (economic constitution) was introduced by Böhm in article
Das Problem der privaten Macht (1928). In, Wettbewerb und Monopolkampf (1933, 107), he saw
the economic constitution as a comprehensive decision (Gesamtentscheidung). Eucken’s
main question was how to give the modern industrialised economy a functioning and
decent order, repeated in Grundsätze der Wirtschaftspolitik (1952, 14). See also Freytag
(2002), ‘Die ordnende Potenz des Staates’, 113–127 and Sauerland (2002), ‘Ziele, Mittel
und Träger’, 113–135.
22
Eucken and Böhm (1948), ‘Vorwort – Die Aufgabe des Jahrbuches’.
23
The first elaboration of the need to have a substantial role for the state was in Eucken
(1932), ‘Staatliche Strukturwandlungen’, 297–321.This was echoed by Rüstow and Röpke
from the economics aspect and by Böhm from the legal aspect. Gerken (2000), Walter
Eucken und sein Werk, 75.
24
Reference to a strong state was first made by Alexander Rüstow in 1932, as pointed out
by Wörsdörfer (2010), ‘On the Economic Ethics of Walter Eucken’, 40, footnote 13.

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 2.1 philosophical f oundation 19

for self-restraint in expanding the state’s role.25 The state needs to resist
temptations to expand its role beyond maintaining the basic framework
for the economy. The ultimately negative outcome is a state-controlled
society that would contradict the ideals of humanity, where the fascist
and communistic regimes provide the sad examples.
The ordoliberal state can be compared to both the other liberal ideolo-
gies and also the German social market economy model. For most liberal
ideologies, the state is the ultimate threat to freedom and liberty.
Ordoliberals balance this threat with others arising from private and
interest group power. The state maintains the framework for the econ-
omy against the risks stemming from intrusion by cartels, monopolies
and diverse social interest groups.26 Ordoliberals also see social policy as
a means to maintain the acceptability of the liberal economic consti-
tution.27 Hayek, in contrast, became increasingly suspicious of the
rational planning of the economic framework due to lack of know-
ledge.28 The spontaneous order of economic action, namely ‘catallaxy’,
allows competition to function as a discovery procedure.29
On the other side, the negative perception of governmental involve-
ment in the economy is one demarcation line between the ordoliberals
and other proponents of the (German) social market economy.
Ordoliberals stress that the state should limit its actions to regulatory
policies specified in the economic constitution, and it should remain
outside short-term majoritarian policies and discretionary administra-
tive actions.30 Moreover, social policy needs to be analysed as part of the
economic framework, taking into account interdependencies. In con-
trast, Müller-Armack valued social policy in its own right as a compen-
sating factor for the ills of the market economy.31

25
Zieschang (2003), Das Staatsbild Franz Böhms, 203–204. See also, Jayasuriya (2001),
‘Globalization, Sovereignty, and the Rule of Law’, 453. However, Schmitt’s concept of
‘totalen Staates’ is totally different from the ‘starken Staates’ used by Eucken, Rüstow
and Röpke, who also strongly criticised Schmitt’s concept. See, Eucken (1948), ‘Das
ordnungspolitische Problem’, 73, 76.
26
Zieschang (2003), Das Staatsbild Franz Böhms, 163–170.
27
For example, Eucken (1952), Grundsätze der Wirtschaftspolitik, 304–325, devotes a full
chapter to the issue of social policy.
28
This is visible in Hayek (2006 [1960]), The Constitution of Liberty.
29
Ibid., 193–194. The only ‘framework’ needed is the rule of law.
30
During the heyday of Keynesian economics in the 1960s, the ordoliberal view was seen as
old-fashioned and even regressive. Rittershausen (2007), ‘The Postwar West German
Economic Transition’.
31
Ptak (2003), Vom Ordoliberalismus zur sozialen Marktwirtschaft.

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 20 2 the three foundations of the emu

Competition as Constitutional Principle

In the ordoliberal economic constitution, free and unhampered compe-
tition based on performance (Leistungs-wettbewerb) guarantees economic
prosperity and limits the concentration of private power. Cartels and
monopolies also threaten individual freedoms through their coercive use
of private power.32 Thus, a well-functioning market economy produces
the best economic performance and also safeguards other freedoms
in society.33
The concept of performance-based competition requires that competi-
tion takes place by means of efficiency, rather than concentration of
economic or political power.34 The ordoliberal economic constitution
also assigns tasks to the public sector to restore the conditions for
performance-based competition, for example by breaking up cartels or
monopolies or by using other means to control the use of private power
in the case of natural monopolies.35 Furthermore, a properly functioning
price mechanism is a necessary condition for performance-based compe-
tition to fulfil its role in the economic constitution.36

The Rule of Law

The rule of law is essential for the economic constitution and for build-
ing a state based on law (Rechtsstaat).37 It could be seen as the opposite
concept to the administrative discretion inherent in state intervention in
economic life. Functionally, the rule of law safeguards the framework
under which individuals and companies have the freedom to act and
realise their individual autonomy in the form of non-coercive decisions
and actions.38 As with other liberal approaches, the rule of law is needed
to prevent the arbitrary use of power and to maintain the sphere of
freedoms against the state. Ordoliberals even use the term
Privatrechtsgesellschaft to emphasise the private law perspective on the
economic constitution.39 Thus the ordoliberal economic constitution
contains not only constitutionally elevated substantive law elements

32
Gerber (1998), Law and Competition in Twentieth Century Europe.
33
Bonefeld (2012), ‘Freedom, Crisis and the Strong State’, 1–2.
34
Böhm even saw competition as a synonym for a situation where coercive power does not
exist. Böhm (1956), ‘VerstöÔt ein gesetzliches Kartellverbot gegen das Grundgesetz?’,
173–187.
35
Möschel (1989), ‘Competition Policy from an Ordo Point of View’, 142–159.
36 37
Zieschang (2003), Das Staatsbild Franz Böhms, 42–53. Ibid., 187–189.
38
Eucken (1952), Grundsätze der Wirtschaftspolitik, 250.
39
Böhm (1966), ‘Privatrechtsgesellschaft und Marktwirtschaft’, 75–151.

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 2.1 philosophical f oundation 21

but also a well-functioning private law system, which together encom-

pass all the legal rules that are constitutive of the economic system.40

Public Power and Private Power

Power is a key concept in understanding the ordoliberal economic consti-
tution, and the mechanisms and interdependencies within the econ-
omy.41 However, power also raises fundamental questions beyond
economic ones, as demonstrated by fascist and communistic rule.42
This stresses the importance of preventing any concentration of power.
The concentration of private power takes the shape of monopolies and
cartels that hamper the functioning of the economy and is detrimental
to a free society by creating coercive power. The concentration of public
power manifests itself in discretional and arbitrary public power.43

The Interdependence of Orders

One ordoliberal specialty is an understanding of the links between dif-
ferent parts of society, which was coined as thinking in orders (Denken in
Ordnungen). This draws on the methodology to find the underlying forms
of economic and societal systems to see how economic, legal, political
and other orders are interconnected.44 The economic order produces
different results depending on the other orders. For example, a market-
based economic order functions properly only if the other orders are
compatible with it.45 The interdependence of orders has some ramifica-
tions. The economic constitution needs to be seen as a coherent whole: a
change in one area involves repercussions in other areas. As a conse-
quence, transplanting a specific economic constitution to new economic,
political and social realities is difficult. In the EU, the interplay between
the various areas of multi-level European constitutional order makes
simplistic transplantations of previous national constitutional solutions
unfeasible. Furthermore, the interdependencies highlight the risks of ad
hoc changes to the economic constitution

40
Streit and Mussler (1994), ‘The Economic Constitution of the European
Community’, 320.
41
Böhm (1928), ‘Das Problem der privaten Macht’, 324–345.
42
Rüstow (1980), Freedom and Domination, and Mann (1984), ‘The Autonomous Power of the
State’, 185–213.
43
Eucken (1952), Grundsätze der Wirtschaftpolitik.
44
Zweig (1980), The Origins of the German Social Market Economy, 20.
45
Here the methodological apparatus resembles the Husserlian or phenomenological one.

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 22 2 the three foundations of the emu

Box 2.1 Walter Eucken economic-constitutional model

Eucken’s framework for the economic constitution, described in Grundsätze
der Wirtschaftpolitik (pp. 254–303) is built upon seven constitutive principles
supported by regulating principles. The constitutive principles of the economic
order are: 1. a well-functioning price system without government or private
intervention; 2. primacy of monetary policy (stabilising the value of money). ‘All
efforts to make a competitive order a reality are pointless unless a certain level
of monetary stability can be ensured. Monetary policy thus has primacy for the
competitive order’; 3. open markets without entry barriers through government
and private measures; 4. private ownership of the means of production,
excluding the property rights of monopolies and cartels; 5. freedom of contract
without freedom to limit the freedom of contract; 6. full liability of owners,
including bearing the risk in totality in negative outcomes; 7. permanence and
stability of economic policy in order not to increase economic uncertainty.
These constitutive principles are complemented with regulatory principles,
to prevent too large an amount of social power in single hands, either private
or public: 1. the state should prevent the creation of monopolies, and existing
monopolies should be broken up or at least regulated by an independent body;
2. market-based income distribution may need to be complemented by some
state-induced redistribution of income to guarantee social justice without
causing too large implications for investment and growth; 3. regulatory needs
may arise from the difference between the private and total social costs of
actions. Environmental issues are good examples.

2.1.3 Economic and Monetary Policy

The economic-constitutional approach emphasises frameworks, as was
explained, for example, in Eucken’s version in Box 2.1. It assumes that
active economic policy does not outperform decentralised private deci-
sions on consumption and investment because of the limited quality of
knowledge, and hence excludes short-term attempts to fine-tune eco-
nomic activity. ‘The detailed problems of economic policy, trade policy,
credit, monopoly, or tax policy, or of company or bankruptcy law, are
part of the great problem of how the whole economy, national and
international, and its rules, are to be shaped.’46 The policy tools are thus
structural. Cyclical programmes and industrial policies fail due to inter-
est groups pressures and they lack information.47

46
Eucken (1950), The Foundations of Economics, 314.
47
Eucken (1952), Grundsätze der Wirtschaftpolitik and Miksch (1949), ‘Die Wirtschaftspolitik
des Als-Ob’, 310–338.

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 2.1 philosophical f oundation 23

Monetary issues and the importance of a monetary policy framework

started with hyperinflation experience.48 Price stability was a precondi-
tion for economic growth.49 However, the link between price stability,
economic systemic choice and ‒ even more fundamentally ‒ general
economic and other freedoms became clearer after analyses of centrally
organised economic regimes.50 Price stability is linked to functioning
markets,51 where prices of goods, services and labour guide the
efficient allocation of resources. A functioning price mechanism
directs the decentralised economy towards economic growth and
enhanced welfare.
The 1930s Great Depression raised questions concerning the causes of
economic fluctuations. Although monetary policy should in normal
times aim at neutrality, it was realised that destabilising economic
fluctuations might have monetary origins. Even some aspects of cyclical
economic policy could be accepted in such exceptional times,52 but
generally central banks were to prevent harmful expansion in money,
credit and prices. One suggestion was a rule to keep the quantity of
money constant, and the central bank could stabilise cyclicality by using
interest rates,53 although cyclical policy always risked undermining the
functioning of the capitalist economic system.54
The ordoliberals viewed free international trade positively. Concerning
the international monetary system, some ordoliberals favoured the gold
standard as an anchor for the global economy instead of the Bretton
Woods system.55 The main problem was basically Mundell’s impossible
trinity,56 namely the incompatibility of the free convertibility of curren-
cies, the stability of exchange rates and differences in monetary

48
Milène Wegmann provides an elaborated discussion on the development of the
ordoliberals in Früher Neoliberalismus (2002).
49
Eucken (1923), Kritische Betrachtungen zum deutschen Geldproblem, 70–83.
50
See, for example, Eucken (1948), ‘On the Theory of the Centrally
Administered Economy’.
51
Eucken (1952), Grundsätze der Wirtschaftpolitik, 254–291.
52
Röpke (1936), Crises and Cycles, 149–150; chapter 3 in Röpke (1960), A Humane Economy and
also Hayek (1960), The Constitution of Liberty, 199 and the whole of chapter 15.
53
Röpke (1936), Crises and Cycles, 76, 111–113, 118, 151.
54
Röpke (1931 [1969]), ‘The Intellectuals and “Capitalism”’, 30–35.
55
Röpke (1969), ‘World without Monetary System’, 221–228.
56
Also coined as the unholy trinity, the irreconcilable trinity, the inconsistent trinity and
the Mundell–Fleming trilemma. See Mundell (1963), ‘Capital mobility and stabilization
policy’, 475–485 and Fleming (1962), ‘Domestic financial policies’, 369–379.

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 24 2 the three foundations of the emu

discipline. A uniform monetary discipline could be achieved via the gold

standard, if countries abided to its rules.57
A policy framework that is compatible with other elements of the
ordoliberal economic constitution includes the primacy of price stability,
independent conduct of monetary policy, and stability of economic
policy. The objective of price stability stems from the functioning of
the decentralised economic model that needs the information provided
by prices. Protecting the price mechanism from undue influences makes
the price stability objective a systemic choice. All the other parts of the
economic constitution depend on the price mechanism, whose malfunc-
tion would make it unsustainable.58
Various proposals to safeguard the price mechanism have been sug-
gested. The gold standard and other commodity-based monetary systems
maintain price stability over the longer term, although limits in the
production of gold can lead to deflationary periods that are also prob-
lematic. The most suspect regime is a pure fiat money regime at the
disposal of the political system, in which central bank money creation
can be used to support other policies, opening the door for intervention-
ist aims and undue interest-group influence. The independence of the
central bank was not explicitly discussed among the original ordolib-
erals, but the public administration of money was to exclude discretion-
ary, politically driven issuance of currency.59 A rule-based monetary
policy with limited discretion could guide expectations concerning the
future path of monetary policy.60
Indeed, stability of economic policy can also include monetary policy.
Cyclical activism fails due to lack of information and invites undue
attempts to influence policy-makers. Cyclicality is an inherent part of a
competition-based and decentralised economy. Monetary policy main-
tains price stability as a means to safeguard the price system, rejecting
the idea that the central bank should seek to fine-tune the economy with

57
Röpke (1969), ‘World without Monetary System’, 229–230. He saw attempts to control
the balance of payments crisis through the creation of fiat money as unsustainable.
Transfers between countries could not solve competitiveness problems.
58
Eucken (1952), Grundsätze der Wirtschaftspolitik, 255–257. The German experience of
hyperinflation in 1923 was an example of the ultimate failure of the monetary regime.
Fergusson (2010), ‘When Money Dies’, 10–11.
59
Some hoped for an automatic central banking function akin rule-based monetary
policies, such as Friedman’s k – per cent rule introduced later. See Friedman (1959),
A Program for Monetary Stability.
60
Oliver (1960), ‘German Neoliberalism’, 145–146 and Miksch (1949), ‘Die Geldordnung
der Zukunft’, 155–158 and Miksch (1949), ‘Die künftige Bundes-Bank’, 517–519.

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 2.1 philosophical f oundation 25

an activist interest rate policy. Moreover, leaving the price stability task
solely to central banks is not enough.61 Other economic policy areas, such
as tax policy, are also important to maintain the price mechanism.62
The ordoliberals also discussed instruments of monetary policy and
the interaction between the central bank and the banking sector from
the perspective of money creation and credit expansion. Although public
influence on interest rates can be seen as interventionist policy,63 it was
accepted that some influence on market interest rates and quantities is a
necessary part of central banking. However, central bank discretion
concerning the amounts or interest rates for individual banks could be
problematic. As with any conduct of public administration, the monet-
ary policy framework should be based on general rules rather than on
discretionary decisions by the central bank. The principle of the rule of
law should apply, and the central bank should interfere with the func-
tioning of the markets only for well-articulated reasons.

2.1.4 The Influence of Ordoliberalism: The Bundesbank as the Central

Bank of an Economic Constitution
Ordoliberals had no impact on German economic life before or during
the Nazi regime, when economic reality was characterised by continu-
ously expanding state intervention and state-induced cartelisation.64
Their time came after WWII, when ordoliberal ideas guided many eco-
nomic decisions. The key routes for ordoliberal ideas were Minister
Erhard and the important academic advisory board for economic legisla-
tion, the Beirat.65 A critical moment was currency reform and price
liberalisation in June 1948. Major chaos and social misery were feared,
but the outcome exceeded most expectations and the economic situation
rapidly improved.66 Indeed, the currency reform is considered as a

61
See Röpke (1964), Welfare, Freedom, and Inflation.
62
Eucken (1952), Grundsätze der Wirtschaftspolitik, 264; and Röpke (1987), 2 Essays by Wilhel
Röpke, 83.
63
Bibow (2012), ‘At the Crossroads’. 64
Eley (1986), From Unification to Nazism.
65
In a speech given in 1961, Erhard famously declared himself to be one of the
ordoliberals. Wegmann (2002), Früher Neoliberalismus, 105. Later on, Böhm continued
counselling Erhard’s Ministry of Economics. Gerber (1994), ‘Constitutionalizing the
Economy’, 59–62. Nicholls (2000), Freedom with Responsibility, 183–184.
66
Böhm strongly supported Miksch’s views against the more cautious views, for example,
by Schiller. See Nicholls (2000), Freedom with Responsibility, 192–195.

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 26 2 the three foundations of the emu

starting point for the German Wirstshaftswunder67 and a proof of the

pivotal role of price mechanism.
After WWII, German economic policy was a mixture of various views.
The economic-constitutional perspective gave German economic policy
some original characteristics, but it did not dominate the overall agenda.
Similarly, in the legal arena, the ordoliberal reading of the economic
constitution as a systemic choice was never broadly accepted or con-
firmed by the FCC.68 However, in the German monetary model and the
Deutsche Bundesbank, the ordoliberal influence and economic-
constitutional perspective was substantial and also informative for the
ECB, which was created using the Bundesbank as a template.69

The Ordoliberal Influence on the Bundesbank Act

The drafting of the Bundesbank Act was preceded by two decades of
monetary turmoil and various versions of the German mark.70 The
Bundesbank actually found its shape and started operating well before
the Act was finalised in 1957. The starting point was the aforementioned
currency reform, which replaced the old Reichsmarks with the new
Deutsche Mark.71 The drafting of the Bundesbank Act showed the ordo-
liberal influence that stressed the role of price mechanism and the need
for a stable currency, favouring an independent but not an isolated
central bank.72 A Report on Monetary Order and Economic Control in
194973 stated: ‘[t]he unity of economic and monetary order requires a
timely coordination between all authorities involved. This also includes
the central bank, since the aspired economic order cannot be realised
without a corresponding monetary constitution and monetary policy.
Within this framework of cooperation the central bank needs to be
independent to the extent that it bears responsibility for the currency.

67
Rapid growth of the West German economy in 1948–57 despite receiving less Marshall
aid than, for example, France or the UK. White (2010), The Clash of Economic Ideas and
Eichengreen and Ritschl (2008), Understanding West German economic growth.
68
In particular, the FCC judgment Investitionshilfegesetz stated that the Grundgesetz had not
adopted some economic model nor did it require neutrality from economic
policy. 20.7.1954, BVerfGE 4, 7, 17/18. A. This view was repeated in the
Mitbestimmungsgesetz judgment. 1.3.1979, BVerfGE 59, 290, 337/38.
69
Dyson (2005), ‘Economic Policy Management’; De Haan (2000), The History of the
Bundesbank; Posen (1997), ‘Lessons from the Bundesbank’.
70
James (1998), ‘Die Reichsbank 1876 bis 1945’, 29–90.
71
White (2010), The Clash of Economic Ideas, 231–245 and 317–319.
72
Bernholz (1989), ‘Ordo-liberals and the Control of the Money Supply’.
73
By the Wissenschaflicher Beirat.

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 2.1 philosophical f oundation 27

This independence is to be protected by law.’74 An independent central

bank needed to cooperate with other economic policies to avoid conflict-
ing policies.75 The alternative was to replace the existing Allied control
with full subordination of the Bundesbank to the Federal Government.
This was supported by Chancellor Adenauer, who criticised the bank
later by stating: ‘[w]hat we have here is a body that answers to no-one,
not even a parliament, not even a government.’76
The independent central bank view gained the upper hand. The
Bundesbank managed to navigate between the central government and
the states by stressing its own federal structure. During the debates, it
also sought media and public support for its independence.77
Exceptionally at the time, the Act made the Bundesbank independent
from the Federal Government when fulfilling its tasks78and gave it the
primary task of safeguarding the currency.

The Bundesbank Framework and Conduct of Monetary Policy

The Bundesbank monetary policy was long hailed as a success among
central banks with its distinctive focus on price stability.79 The legal
objective was to safeguard the currency, which was interpreted as a
constitutional price stability objective. Even when the Bretton Woods
system imposed a formal external objective of the exchange rate against
the US Dollar, the Bundesbank read this external target through the
internal price stability objective.80 When the Bretton Woods system
collapsed, the Bundesbank simply continued its focus on price stabil-
ity.81 As the first major central bank, the Bundesbank started to publish
its price stability-oriented monetary policy strategy to guide the public in

74
Translation from Bibow (2004), ‘Investigating the Intellectual Origin’, 21.
75
Röpke (1969), ‘The Fight against Inflationism’, 181–185.
76
See, www.bundesbank.de/Redaktion/EN/Topics/2016/2016_02_09_130_birthday_vocke
.html and also Bibow (2004), ‘Investigating the Intellectual Origins’, 6–7.
77
Responsibility was shifted to Erhard’s ministry that supported ordoliberal ideas and the
Bundesbank’s independence. In 1949 he stated that: ‘the legal autonomy or
independence of the central bank must not be touched. This principle has always proved
prosperous.’ See Bibow (2004), ‘Investigating the Intellectual Origins’, 8–9, 23
78
Article 12 of the Bundesbank Act.
79
Clarida and Gertler (1997), ‘How the Bundesbank Conducts Monetary Policy’, 363–412;
König (1996), ‘The Bundesbank’s Experience in Monetary Targeting’; Deutsche
Bundesbank (1995), The Monetary Policy of the Bundesbank.
80
Neumann (1998), Geldwertstabilität, 309–346.
81
Initially coined as unavoidable inflation, and since 1985 as a medium-term inflation
assumption of 2 per cent when defining monetary targets. Posen (1997), ‘Lessons from
the Bundesbank’.

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 28 2 the three foundations of the emu

their expectations of future monetary conditions. The strategy relied on

monetary targets, which stressed the monetary nature of inflation.82
The Bundesbank’s independence limited the tasks that could be allo-
cated to it in fields other than monetary policy. Political and otherwise
far-reaching issues beyond the monetary policy sphere such as exchange
rate arrangements were ultimately in the hands of the government.83
Issues such as financial stability and particularly banking supervision
were also excluded from its mandate. This guaranteed a clear mandate
and focus on price stability without conflicts of interest between price
stability and financial stability objectives. The single mandate was also in
line with the rule of law in the central banking context and ordoliberal
resistance towards concentration of power.
As a counterpart to its independence, the Bundesbank made efforts to
maintain accountability. One part was transparency in the form of
extensive publications also explaining past monetary policy.84 The inde-
pendence of the Bundesbank relied on the support it sought and gained
from the German public.85 The market conformity of the Bundesbank’s
monetary policy measures was less clear. Over the years, monetary
policy was implemented through a large variety of measures, such as
the open market operation, official interest rates and currency market
intervention that were mainly market-based.86 However, the Bundesbank
also used official (administrative) interest rates to affect its target vari-
ables, monetary aggregates, economic activity and inflation.

2.1.5 The Take-Aways from the Philosophical Foundation of the EMU

Arguably, the economic-constitutional model introduced by the ordolib-
erals can be seen as the philosophical foundation of the EMU, starting
from the very idea that some key elements of the economic system are
elevated above daily democratic decision-making. Additionally, many
institutional and substantive features of the ordoliberal model can be
used as points of reference when analysing the European economic

82
Neumann (1998), Geldwertstabilität, 309–346, and Posen (1997), ‘Lessons from
the Bundesbank’.
83
The Bundesbank did express its opinion, for example, on the EMS and the currency
reform during the German unification. Berger (1997), ‘The Bundesbank’s path to
independence’, 427–453; Kaltenthaler (1996), ‘The Restructuring of the German
Bundesbank’, 23–48.
84
Posen (1997), ‘Lessons from the Bundesbank’.
85
Deutsche Bundesbank (2013), The road to Central Bank Independence.
86
Walter (1995), German Financial Markets.

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 2.2 the economic foundation 29

constitution, but it needs to be stressed that ordoliberal views do not

have any substantive superiority claims.
For the EMU and the European Macroeconomic Constitution, the
original economic-constitutional thinking can provide further insights,
because the German Bundesbank was a template for the ECB, both
institutionally and also with regard to the conduct of monetary policy.
One assumed benefit of the EMU was to employ the Bundesbank’s
credibility and reputation,87 and hence the ordoliberal premises of the
Bundesbank found their way to inform the ECB.88 Although it cannot be
concluded that the Bundesbank followed solely the economic-
constitutional model, many features of the ordoliberal economic consti-
tution did penetrate its institutional and policy choices, most promin-
ently the role of price stability. Moreover, the assignment of monetary
policy to an independent organisation was exceptional and resulted
largely from ordoliberal influence.

2.2 The Economic Foundation: Institutional and Theoretical

Evolution in Central Banking
The EMU was designed to bring economic prosperity and stability to the
EU through its objectives, constraints and institutional choices that were
based on underlying economic theories and assumptions. These assump-
tions could be labelled as the economic foundation of the EMU. For the
monetary policy part, they are based on ideas of what is a central bank
and what functions should be attributed to it. Historically, central bank
models have ranged from non-existent to very powerful, as ‘central
banking doctrine and practice are never static’.89 The central banks also
have a close relationship with economic theory. They are advised by new
developments in economic theory, but they also push the boundaries of
existing theories.
The section starts by describing the evolution of central banking
function and continues with developments in economic and institutional
theories on monetary policy. These developments question the ideas of
permanent macroeconomic theory or central banking functions, but
they also pave the way for economic and institutional consensus on

87
Majone (2011), ‘Monetary Union and the Politicization of Europe’, 16.
88
The link between ordoliberalism and the ECB through the Bundesbank was also in Dyson
(2005), ‘Economic Policy Management’, 127–128.
89
Bernanke (2013), ‘A Century of US Central Banking’, 13.

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 30 2 the three foundations of the emu

central banking at the time the Maastricht Treaty was agreed upon. The
section concludes by listing the main features of the 1990s consensus
model and also its limits.

2.2.1 Early Central Banking and the Gold Standard

The first central bank was established more than two millennia after the
first organised forms of money existed.90 Early monetary systems were
based on precious metals,91 which did not require a central bank, only
simply official validation for the coinage.92 The central banks were
initially established in response to three needs: providing a framework
for the currency, functioning as a centre for the banking sector and
financing the state. Industrialisation and increased trade created
demand for a better means of exchange, which was met by state-
guaranteed banknotes representing precious metal value. However,
state-guaranteed notes could also be used to finance governments, and
governments occasionally used this discretion to issue notes well in
excess of the amount of precious metal held.93
The leading country of industrialisation also led the way for a more
formalised central bank. The Bank of England (the BoE) was established
in 1694 to act as the Government’s bank and debt-manager that could
issue notes that were convertible to gold. However, it issued too many
notes to finance the Napoleonic Wars, which caused massive inflation,
followed by destructive deflation when convertibility to gold was
restored.94 A key step was the Bank Charter Act of 1844 that gave legal
form to the BoE monetary system and its formal monopoly to issue notes
against gold reserves.95
Towards the end of the nineteenth century other countries followed
the UK to the gold standard, although by different paths. The USA

90
Money was documented over 2,600 years ago in Lydia and Ionia and in China. Bernholz
(2006), Monetary Regimes and Inflation, 1. Sveriges Riksbank is considered as the first
central bank, when it became a state-owned note issuance bank in 1688.
91
Roberds and Welde (2016), ‘The Descent of Central Banks’, 18–61.
92
In Jevons (1875), Money and the Mechanism of Exchange. See also Jobst and Ugolini (2016),
‘The Coevolution of Money Markets and Monetary Policy’, 145–194.
93
Described by Jevons (1875), Money and the Mechanism of Exchange.
94
www.bankofengland.co.uk/about/Pages/history/timeline.aspx#3.
95
The BoE was nationalised only in 1946 by the Labour government ‘to bring the bank
under public control’.

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 2.2 the economic foundation 31

experimented with various forms of money,96 before the Congress

inserted a clause in the US constitution that the US dollar was based on
gold in 1900.97 Similar developments towards a more centralised and
institutionalised monetary system took place in most major European
countries,98 where the currency was often related to a state-building
exercise.99 The major Asian economies also turned to the gold standard
by the end of the nineteenth century.100

2.2.2 The Gold Standard and Its Problems

The world economy turned to the gold standard without any master
plan or even substantial international coordination. The gold standard
monetary system had a few key features. In its simplest form, central
banks mainly guaranteed the convertibility of their banknotes to gold.
This link ensured price stability by anchoring inflation expectations in
the long-term, but not without steep and even long inflationary and
deflationary periods. In particular, wars led to exceptional state finan-
cing needs with excessive issuance of notes, and paper (fiduciary) money
became associated with economic disturbances, high inflation and even
subsequent misery.
Central banks had small or even non-existent roles, as the gold stand-
ard allowed very limited policy discretion. This created some problems:
interest rates saw large cyclical fluctuations and even seasonal pat-
terns101 and the system was prone to banking panics and shocks. The
root causes of instability included wars, government finances, and

96
The Revolutionary War in 1775–1791 was funded by public note issuance, leading to a
phrase ‘not worth a continental’, when the notes lost their value. Newman (1990), The
Early Paper Money of America, 17, 49.
97
Friedman and Schwartz (1963), A Monetary History of the United States, 113–119.
98
The French Revolution rebuilt the monetary system but the excessive issuance of
assignats led to hyperinflation and the collapse of the First Republic. In 1800 the Banque
de France was established by the Consulate. The German Reichsbank was established as
the central bank of Prussia in 1876. Holdsworth (1914), Money and Banking and Bernholz
(2006), Monetary Regimes and Inflation, 66–69.
99
A counter-development was the Latin Monetary Union in 1866, initially with France,
Belgium, Italy and Switzerland, with Spain and Greece joining in 1868, followed by
Romania, Bulgaria, Venezuela, Serbia and San Marino in 1889. However, stability was
not sustained. Some countries issued notes to finance expenditure, and finally, Greece
disregarded the rules of the union. Baea and Bailey (2011), ‘The Latin Monetary Union’,
131–149.
100
India adopted the gold standard in 1893 and Japan in 1897. Mitchener et al. (2009),
‘Why Did Countries Adopt the Gold Standard?’, 4–5.
101
Broaddus, Jr. (1993), ‘Central Banking’, 5.

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 32 2 the three foundations of the emu

speculative bubbles, but some blame was always put on the monetary
system and its rigid institutional set-up.102The function of maintaining
financial stability was initially taken over by the BoE in the form of
liquidity provision to banks. This redefined the role of a central bank, not
only as the holder of gold reserves but also as the supplier of liquidity in
cases of banking emergencies.103 Indeed, the BoE was the central bank in
the nineteenth century that shaped the architecture of the global financial
system, and made London the international financial centre. This was
enhanced by the legalised basic principles of monetary order: the monopoly
of issuance of notes, limiting issuance in relation to the amount of gold
reserves and the requirement of transparent balance sheets.104
A major turning point in central banking was WWI. Most countries
had to finance the war through note issuance exceeding gold reserves,
which in turn led to high inflation and the suspension of convertibility of
notes to gold. After the war, most countries settled for a gradual stabil-
isation of the price level. However, the UK deemed it necessary to return
to pre-war gold parity for the prestige of the Empire. A devaluation of the
currency was deemed detrimental for the credibility of the pound and
London as the financial centre.105

2.2.3 The Federal Reserve Is Established in 1913 to Tackle

the Problems of the Gold Standard
The US Federal Reserve (the Fed) was established to mitigate the prob-
lems of frequent liquidity crises and unnecessary fluctuations in interest

102
Kindleberger and Aliber (2005), Manias, Panics, and Crashes.
103
In England alone, major financial crises were reported in at least 1825, 1847, 1866 and
1890. See Friedman and Schwartz (1963), A Monetary History of the United States, 395. By
1825, the BoE acted as a provider of emergency liquidity to banks. An oft-quoted
statement defines the Bagehot rule. Bagehot (1873), ‘Lombard Street’, 51–52.’ “We lent
it,” said Mr. Harman, on behalf of the Bank of England, “by every possible means and in
modes we had never adopted before; we took in stock on security, we purchased
Exchequer bills, we made advances on Exchequer bills, we not only discounted outright,
but we made advances on the deposit of bills of exchange to an immense amount, in
short, by every possible means consistent with the safety of the Bank, and we were not
on some occasions over-nice. Seeing the dreadful state in which the public were, we
rendered every assistance in our power.”’ and www.bankofengland.co.uk/about/Pages/
history/timeline.aspx#4.
104
The Federal Reserve Act was adopted in December 1913 after a seventy-five-year period
without a central bank.
105
The BoE carried out its stabilisation policy regardless of an adverse economic
environment with rising unemployment and gold parity was restored by 1925. Bordo
and Hautcoeur (2003), ‘Why didn’t France Follow the British Stabilization’.

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 2.2 the economic foundation 33

rates.106 It was authorised to issue an ‘elastic currency’ only controlled

by a minimum of 40 per cent gold reserves against notes issued.107 The
initial Federal Reserve Act balanced between a strong public sector role
and mainly private model. In particular, the banking community opposed
the Federal Reserve Act, calling it ‘socialistic, confiscatory, unjust, un-
American, and generally wretched’.108 In practice, the public sector elem-
ent became dominant, as banknotes were the liability of the US Treasury.
The Fed was to ‘furnish an elastic currency, to afford means of rediscount-
ing paper, to establish a more effective supervision of banking in the
United States, and for other purposes.’109 The objective was to avoid
banking panics, while the gold standard ensured price stability.110

2.2.4 The Great Depression Changed Central Banking

A period of strong economic growth and an asset price boom in the 1920s
was followed by a long and steep recession called the Great Depression. In
the USA, this lasted from the latter half of 1929 to the first half of 1933,
and halved industrial production, increased unemployment to 20 per cent
and saw a virtual collapse of the financial sector.111 For central banking,
the Great Depression became a point of fierce debates and reassessments
that also caused fundamental institutional changes.112
The gravity of the Great Depression has been assigned various explan-
ations. The early explanations stressed the speculative bubble in the
stock market fuelled by reckless bank lending. The stock market specu-
lation explanation also involved the Fed, because it had hesitated in
providing banks with liquidity when markets crashed in October
1929.113 As households were dependent on consumer credit, they had
to cut spending.114 Another, the so-called tariff war explanation claimed

106
Broaddus, Jr. (1993), ‘Central Banking’, 5–6 and www.federalreserveeducation.org/
about-the-fed/history/.
107
Bernanke (2013), ‘A Century of US Central Banking’, 4.
108
American Bankers Association annual convention resolutions in 1913. Johnson (2010),
‘Historical Beginnings’, 18–26 and 30.
109
Apel (1993), Central Bank Systems Compared, 20–21.
110
Johnson (2010), ‘Historical Beginnings’.
111
In the USA, output and prices both dropped by 30 per cent, and unemployment peaked
at 25 per cent. Equity prices dropped 86 per cent from the peak of 1929 to the trough of
June 1932, and the number of bank suspensions exceeded 9,000. Cecchetti (1997),
‘Understanding the Great Depression’, 1–2.
112 113
Ibid. 1. Meltzer (2010), A History of the Federal Reserve, Vol. 1, 271–415.
114
Dominguez et al. (1988), ‘Forecasting the Depression’, 595–612 and Mishkin (1978),
‘The Household Balance Sheet’, 918–937 and Romer (1990), ‘The Great Crash’, 597–624.

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 34 2 the three foundations of the emu

that the adverse international environment transmitted the crisis from

one country to another, worsening the decline.115
The early explanations failed to explain why the normal economic
downturn turned into an economic and social disaster. It took some time
to understand how the combination of the gold standard and restrictive
monetary policy combined with the central banks’ inability to function
as the ultimate liquidity providers to banks turned an ordinary recession
into a debt-deflation spiral in which ‘[c]entral bankers continued to kick
the world economy while it was down until it lost consciousness.’116 The
commitment to the gold standard had lost credibility because of the
events of WWI, and this invited speculative gold outflows from countries
in trouble. Fighting these outflows by increasing interest rates only made
economic problems worse.117 The system lacked a responsible leader, a
benevolent hegemon, as the BoE no longer had the strength and the Fed
was unwilling to take its place.118 The series of destructive events started
in Austria with the collapse of Creditanstal bank, spread to Germany,
which had to abandon the gold standard, and continued to the UK, which
was forced out of the gold standard in September 1931. US dollar gold
parity was defended with high interest rates, again with negative results
for the declining economy for two more years.119
The Fed’s monetary policy-related mistakes had actually started
already when acting against the ‘speculative lending’ that it thought
was crowding out normal business lending.120 At the time, nominal
interest rates were the main indicator of the monetary policy stance
and in 1930 the Fed was worried about having too expansionary a
monetary policy that might cause inflation,121 although real interest
rates were increasing and peaked in 1932 at more than 20 per cent!122

115
Crucini (1994), ‘Sources of Variation’, 732–743.
116
Eichengreen and Temin (1997), ‘The Gold Standard and the Great Depression’, 1–2.
117
Bernanke (2004), ‘Money, Gold and the Great Depression’, 6. The adjustment
mechanism was claimed to have become dysfunctional through less flexible prices and
wages after WWI, related to the greater political importance of workers. Eichengreen
and Temin (1997), ‘The Gold Standard and the Great Depression’, 3.
118
Bernanke (2004), ‘Money, Gold and the Great Depression’, 7–8.
119
The Congress passed the Gold Reserve Act on 30 January 1934 devaluing the US dollar
by a 40 per cent. Bernanke (2004), ‘Money, Gold and the Great Depression’, 3–4.
120
Cecchetti (1997), ‘Understanding the Great Depression’, 4–6. 121
Ibid., 14–15.
122
This was supported by Fed’s minutes and external communication. Meltzer (2010),
A History of the Federal Reserve, Vol. 1, 271–415; Meltzer (1976), ‘Monetary and Other
Explanations’, 458 and Cecchetti (1997), ‘Understanding the Great Depression’, 14–15.

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 2.2 the economic foundation 35

These misperceptions of the monetary policy stance related to other

policy failures, particularly concerning the banking sector. Deflation
increased the real value of debt; a development called the debt-deflation
spiral. Banks became unable to function properly due to their liquidity
problems, which led to a negative spiral of deposit runs and fire sales of
assets. Although the Fed was founded to avoid panics ‒ which happened
three times during the Great Depression ‒ its123 failure to function as a
lender of last resort turned the liquidity crisis of the banking sector into
a solvency crisis.124 Larger scale open market purchases started only in
April 1932, after two banking crises and following heavy pressure from
Congress.125
These critical assessments of the central banks during the Great
Depression changed the role of central banking126 with many institu-
tional changes and a factual abandonment of the gold standard. It also
questioned the banking sector’s ability to manage itself, which led to
three types of institutional change: deposit insurance, financial regula-
tion, and changes in the framework of central bank liquidity provi-
sion.127 The Glass–Steagall Act imposed new financial regulation,
including the separation of deposit banking from investment banking
activities.128
A fundamental consideration in terms of central banking was a real-
isation of the influence that central banks can exert on the economy and
how unwilling they are to acknowledge their mistakes. Most changes

123
Until the bank holiday in March 1933.
124
Its strict collateral policy did not follow the Bagehot rule to lend freely to solvent banks
at a penalty rate. The Fed’s failures have been thoroughly analysed, for example, in
Bernanke (2000), Essays on the Great Depression; Chandler (1971), American Monetary Policy;
Eichengreen (1992), ‘The Origins and Nature of the Great Slump Revisited’, 213–239;
Kindleberger (1986), The World in Depression; Meltzer (2010), A History of the Federal
Reserve, Vol. 1 and Romer (1993), ‘The Nation in Depression’, 19–39.
125
Friedman and Schwartz (1963), A Monetary History of the United States, 322.
126
Already during the Great Depression Irving Fisher described the debt-deflation spiral.
Fisher (1933), ‘The Debt-Deflation Theory’, 337–357. See also, Bernanke (2004), ‘Money,
Gold and the Great Depression’, 1 and Eichengreen and Temin (1997), ‘The Gold
Standard and the Great Depression’, 1.
127
‘Federal insurance of bank deposits was the most important structural change in the
banking system to result from the 1933 panic and, indeed in our view, the structural
change most conducive to monetary stability since state bank note issues were taxed
out of existence immediately after the Civil War.’ Friedman and Schwartz (1963),
A Monetary History of the United States, 434.
128
Financial markets were also subjected to more regulation when the Securities and
Exchange Commission was established with the Securities Act of 1933 and the
Securities Exchange Act of 1934.

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 36 2 the three foundations of the emu

emanated from the political side: the US Congress put pressure on the
Fed to buy bonds to increase money supply, while the UK’s abolition of
the gold standard also came from political parties.129 Consequently, the
central banks’ ability to independently manage monetary matters was
questioned. Paradoxically, the powers of central banks also increased
after the Great Depression. Without the gold standard, central banks
gained policy discretion. In the Fed, this was facilitated by the creation of
the Federal Open Market Committee (FOMC) and centralisation of
decision-making powers.130

2.2.5 The Bretton Woods System after WWII

The next major change in central banking took effect after WWII,
although the design of the new international monetary system had
started already during the war. This included a system of rules, insti-
tutions, and procedures to regulate the international monetary
system.131 The new monetary model, the Bretton Woods system, was
based on the US dollar that in turn had a fixed price in gold.132 Other
currencies were valued in relation to the US dollar, and the member
countries had to adjust their monetary policy accordingly and avoid
competitive devaluations.133 The International Monetary Fund (IMF)
was established to provide temporary loans to cover international pay-
ment imbalances. The aim was to combine exchange rate stability of the
gold standard with ability to pursue national policies. The system was
consciously designed with a clear hegemon and an international agree-
ment with rules preventing destabilising national decisions.
The Bretton Woods system existed from 1945 until 1973, but in full
only from 1958 to 1971.134 In the 1960s, the steady inflow of dollars
made US monetary policy excessively loose and inflation difficult to
control. The US authorities resorted to various regulatory measures
and capital controls, which led to many unintended results, such as

129
Eichengreen and Temin (1997), ‘The Gold Standard and the Great Depression’, 24–25.
130
The FOMC consisted of the seven members of the Board of Governors of the Federal
Reserve System and five from the Federal Reserve Banks, meaning a major
centralisation of the monetary policy decision-making.
131
Steil (2013), The Battle of Bretton Woods.
132
It was not a pure gold standard as the US dollar could not be redeemed with gold by the
public. The Fed was only obligated to exchange dollars for gold in central bank
transactions to maintain the link between the US dollar and gold.
133
Bordo (1993), ‘The Bretton Woods International Monetary System’, 5.
134
Japan joined in 1964. See Bordo (1993), ‘The Bretton Woods International Monetary
System’, 4.

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 2.2 the economic foundation 37

giving birth to offshore Eurodollar markets.135 The final blow was pres-
sure by Germany and France to convert their dollar reserves to gold,
which led President Nixon to end US dollar gold convertibility in August
1971 and to devalue the US dollar.
At the heart of the problems was the so-called impossible trinity
hypothesis: countries cannot simultaneously maintain fixed exchange
rates, free capital movements, and independent monetary policies.136
National monetary autonomy became impossible without increasing
capital controls. The system was run by central banks that held US dollar
reserves and ensured currency convertibility at fixed rates. At the same
time, monetary policy was often subordinated to the needs of domestic
economic policy, which caused very different inflations that capital
controls could not repair.137 In addition to divergent economic policies
and growing imbalances between countries, the collapse of the Bretton
Woods system also related to discontent with the USA. The Vietnam War
impacted the US economy but also its moral standing, weakening its
position as the leader of the system.138

2.2.6 A New Model Emerges with Monetary Targeting

as a Preliminary Solution
Without the Bretton Woods system, national monetary regimes did not
have clear objectives,139 and the first years of floating exchange rates
were economically difficult for most countries. Inflation became a desta-
bilising economic factor with the loss of a formal anchor. Germany was
best equipped to deal with the new situation because the Bundesbank’s
internal price stability objective was well suited to a floating exchange
rate regime, unlike the case with the UK, France and Italy.140
At the same time, the first oil price shock in 1973–1974 added difficul-
ties for economic policy-makers. High and variable inflation made nom-
inal short-term interest rates inaccurate tools with unintended real
interest rates. One solution was monetary targeting that relied on the
information conveyed by monetary aggregates and made the central
bank accountable for achieving monetary growth targets. Germany led

135
Eurodollar markets refer to dollar-denominated markets outside US
banking regulation.
136
Mundell (1963), ‘Capital Mobility and Stabilization Policy’, 475–485 and Fleming (1962),
‘Domestic Financial Policies’, 369–379.
137
Bordo (1993), ‘The Bretton Woods International Monetary System’, 9–10.
138 139
Ibid., 80. Triffin (1960), Gold and the Dollar Crisis.
140
Bordo (1993), ‘The Bretton Woods International Monetary System’, 77–79.

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 38 2 the three foundations of the emu

the way by introducing monetary targets in 1974. The Bundesbank’s

official monetary target replaced the exchange rate as the formal target
of monetary policy, but the underlying main objective was still price
stability.141 ‘Monetary targeting in Germany and Switzerland was pri-
marily a method of communicating the strategy of monetary policy that
focused on long-run considerations and the control of inflation.’142
Germany was followed by the USA, Switzerland, the UK, France and
Italy. Monetary targets were mainly intended as internal anchors to
stabilise the economic environment,143 and also as a way to convince
politicians of the link between large fiscal deficits and high inflation.
Unfortunately, most central banks soon realised that monetary targets
as anchors for monetary systems were not easy to operationalise. Targets
were very often missed even when defined as broad target ranges
because the supply of money was not easy to control. Monetary targets
perhaps helped to get inflation under control after the 1970s but could
not find a clear role in conducting monetary policy.144 From the early
1980s onwards, countries began to abandon monetary targeting, first in
practice and later formally.145 In the USA, monetary aggregates were
used during the disinflationary period, but they proved to be unreliable.
In the course of the 1980s, the bias shifted to inflation, seemingly
without dramatic changes or statements,146as the monetary policy
objective ‘to promote effectively the goals of maximum employment,
stable prices, and moderate long-term interest rates’ allowed different
policy frameworks.147

2.2.7 Inflation Targeting as the New Consensus

Inflation targeting began as the last available option after formal
exchange rate targets and monetary targets had failed. Inflation

141
Clarida and Gertler (1997), ‘How the Bundesbank Conducts Monetary Policy’, 363–412.
142
Mishkin (2000), ‘From Monetary Targeting to Inflation Targeting’, 5. 143
Ibid., 1–6.
144
Ibid., 7–9.
145
In a telling episode in 1982, when Canada abandoned monetary targets due to
unreliable signals, the central bank governor concluded: ‘[w]e didn’t abandon monetary
aggregates, they abandoned us.’ Mishkin (2000), ‘From Monetary Targeting to Inflation
Targeting’, 3–4.
146
The Fed’s monetary policy objective was added with a reference to stable prices in the
Federal Reserve Reform Act of 1977: ‘to promote effectively the goals of maximum
employment, stable prices, and moderate long-term interest rates.’ However, only in
1993, the Fed officially abandoned monetary aggregates as targets for monetary policy.
Mishkin (2000), ‘From Monetary Targeting to Inflation Targeting’, 2.
147
www.federalreserve.gov/aboutthefed/section2a.htm.

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 2.2 the economic foundation 39

targeting refers to a monetary policy model in which the main objective

is a low level of inflation. Other features often include an information-
based strategy to steer monetary policy instruments and accountability
of the central bank concerning its inflation objective.148 A key benefit of
inflation targeting is that monetary policy aims directly at its objective
rather than through some intermediate targets. Central banks are also
seen to have tools for controlling inflation through interest rates,
although with temporary effects on economic growth and employment.
Explicit inflation targeting started with experiments by smaller coun-
tries,149 although the central banking models of Germany and
Switzerland already had many of its features.150 Towards the end of
the 1990s, most central banks had adopted some forms of inflation
targeting. The Fed adopted a formal inflation target by merely announ-
cing a new interpretation of its mandate.151 The spread of inflation
targeting also demonstrated the close contacts within the central
banking community.152 The focus of monetary policy transformed from
mainly external constraints to domestic considerations, as floating
exchange rate regimes replaced fixed exchange rates. Institutionally,
the roles of the IMF and the US authorities declined, and the importance
of national central banks increased. The new requirements included
central bank independence, transparency, accountability, and also eco-
nomic expertise.153 Inflation targeting thus changed central banking
profoundly. However, before discussing the consensus central banking
model, we turn to parallel developments in economic theory.

2.2.8 Economic Theory Shapes Central Banking

The economic theory of the gold standard related mainly to the stability
of the monetary system. The fundamental background for price stability
relied on the quantity theory of money stating that if the amount of
money in circulation grows more than economic activity the result is

148
Bernanke and Mishkin (1997), ‘Inflation Targeting’, 97–116.
149
New Zealand was the first in 1989–1990, followed by Canada and Israel in 1991, and
Australia in 1993. Many European countries adopted it after the ERM collapse in 1992
(the UK, Sweden, Finland and later Spain).
150
Bernanke and Mishkin (1997), ‘Inflation Targeting’, 98.
151
January 2002, the Fed issued a statement stating that it judges that inflation at the rate
of 2 per cent is most consistent with its statutory mandate. Goodfriend (2003), ‘Inflation
Targeting in the United States?’.
152
Bernanke and Mishkin (1997), ‘Inflation Targeting’, 97–98.
153
Rose (2007), ‘A Stable International Monetary System Emerges’, 672.

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 40 2 the three foundations of the emu

inflation. The early theory154 was developed further by Irving Fisher to

explicate inflation in monetary terms.155 In addition, classic economics
focused mainly on supply-side questions. Public economic policy was not
a major theme. Central banks maintained a monetary framework with
some responsibility to prevent economic shocks stemming from finan-
cial instability. WWI changed the situation as it increased the role of the
public sector.

The Great Depression Caused the Keynesian Revolution

in Economics
The Great Depression marked a major turning point in economic theory.
The gold standard theory could not explain the depth of social destruc-
tion, but its critiques could. J. M. Keynes was a central figure searching
for alternative approaches that started macroeconomic theory.156 His
claim was that deep recessions could be avoided if government sup-
ported aggregate demand through a combination of lower interest rates
and increased government spending. This increased the role of central
banks in economic management but also incorporated monetary policy
in the broader economic policy framework.157
In monetary theory, Keynes introduced the important concept of
liquidity preference for money to explain how people’s preferences for
holding wealth in liquid and illiquid forms can depend on the economic
situation. This in turn implies that central banks should be concerned
with the liquidity situation and cut interest rates when liquidity prefer-
ences drive up the demand for money. For example, economic uncer-
tainty makes households hoard cash, which reduces the money supply
unless it is counterbalanced by central bank measures. These Keynesian
views were not immediately accepted by central banks. The economic
policy change from stabilising the external (gold) value of currency to
ending domestic deflation was driven by governments. For example, the

154
Hume (1748), ‘Of Interest’.
155
Fisher (1911), The Purchasing Power of Money defined the basic form of the quantity theory
of money as MV = PT, where M is the stock of money, V is the velocity of money
circulation, P equals the price level and T is the total volume of transactions. In later
forms transactions were mostly replaced by real income (Y) and hence the most used
simple version reads MV = PY.
156
Keynes published A Treatise on Money in 1930 in the middle of the Great Depression and
The General Theory of Employment, Interest and Money in 1936.
157
Keynes saw himself primarily as a monetary economist, although his name is more
often related only to active fiscal policy. Tily (2006), ‘Keynes’s Theory of Liquidity
Preference’, 659.

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 2.2 the economic foundation 41

Fed was downgraded to a technical operator of political decisions made

by the President and the Treasury.158
The era of Keynesianism, in academia and also in economic
policy, extended from WWII to the 1970s. A key tool was the IS-LM
framework, which described the relationship between interest rates
and real output in the goods (and services) market and also in money
markets.159 The model showed how a general equilibrium in the econ-
omy was achieved and what its main determinants were.160 It formed
the basis for macroeconomic modelling that guided the choices available
for economic policy.161
At its peak, the Keynesian approach limited the discretionary role of
monetary policy. A case in point was the importance of the so-called
Phillips curve162 that describes an inverse relationship between
unemployment and inflation, suggesting that there was a trade-off
between the two. Lowering inflation would lead to higher unemploy-
ment and, as importantly, lower unemployment could be achieved
through allowing higher inflation.163 Consequently, low inflation
was deemed a lesser objective, and disinflationary monetary policies
were blamed for having considerable negative effects.164 Income pol-
icies or even rationing were perceived better means for fighting
inflation.165
In the 1970s, this theoretical consensus on Keynesian economics and
economic policy was becoming questioned by economic reality. High
inflation and rising unemployment, stagflation, followed the oil price
shock in 1973–1974, and the Keynesian economic policy model needed
alternatives.166

158
Bordo et al. (2006), ‘The Historical Origins of US Exchange Market Intervention Policy’,
15–18.
159
Investment Saving–Liquidity Preference Money Supply model.
160
Developed first by economists Roy Harrod, John R. Hicks, and James Meade. Hicks
(1937), ‘Mr. Keynes and the Classics’, 147–159 and Modigliani (1944), ‘Liquidity
Preference’, 45–88.
161
Mankiw (2006), ‘The Macroeconomist as Scientist and Engineer’, 3–4.
162
Originally Phillips (1958), ‘The Relationship between Unemployment and the Rate of
Change of Money Wages’, 283–299.
163
Samuelson and Solow (1960), ‘Analytical Aspects of Anti-Inflation Policy’, 177–194.
164
Every 1 percentage point permanent reduction in inflation was claimed to cause even
10 per cent annual reduction in output and employment. See Okun (1978), ‘Efficient
Disinflationary Policies’, 348–352.
165
Tobin (1980), ‘Stabilization Policy’, 64.
166
Goodfriend and King (1997), ‘The New Neoclassical Synthesis’, 231–296.

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 42 2 the three foundations of the emu

Monetarism Strikes Back

The main critique of the Keynesian approach came from monetarism.
The monetarists saw themselves as intellectual descendants of the clas-
sical school and the quantity theory of money and they claimed that
inflation was fundamentally a monetary phenomenon with no lasting
impact on the real economy. This demanded different monetary policy to
Keynesians,167 one that agreed with monetary nature of inflation in the
long run.,168 While Keynes had argued that the supply of money was
determined by aggregate demand, and thus demand policies (and even
higher inflation) could have lasting effects on growth, Monetarists169
questioned the direction of this effect and insisted that money supply
could affect prices directly.170
It was agreed that during the Great Depression, the decline in money
supply had worsened recession.171 However, the monetarists claimed
that in more normal times increased money supply can increase the
velocity of money, which leads to high inflation, economic instability,
and higher unemployment. These findings became largely accepted in
academia. However, some further development was needed before a
more fruitful synthesis could be achieved.172 For monetary policy, the
key monetarist contribution was to claim that central banks can use
monetary policy to effectively control inflation. First, there was evidence
that sustained inflation was related to the growth in money supply
substantially exceeding the economic growth rate. Government deficits,
income policies, or raw material prices have a short-term influence on
inflation, but a lasting effect comes through money supply. Second,
monetarist theory of money demand was supported by econometric
evidence that showed that control of money was possible. Third, monet-
arists explained how central banks can use their monopoly issuance of

167
Ibid. 239.
168
Keynes fundamentally ascribed to it but only in the long run. Even Marx (1887) accepted
the basic formula in his Capital.
169
The key monetarists included Milton Friedman, Karl Brunner, and Allan Meltzer.
Goodfriend (2007), ‘How the World Achieved Consensus’, 6.
170
Friedman agreed that the velocity of money is not constant, but insisted that it could
change to the opposite direction. Friedman (1956), ‘The Quantity Theory of Money’,
51–67. He also suggested that economic policy should be limited to a rule of a constant
increase in money supply, which did not become generally accepted.
171
Friedman and Schwartz (1963), A Monetary History of the United States.
172
Friedman (1974), ‘A Theoretical Framework for Monetary Analysis’ and (1968), ‘The
Role of Monetary Policy’, 1–17.

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 2.2 the economic foundation 43

money to gain sufficient, if not perfect, control over money supply and
eventually also over inflation.

Rational Expectations Open the Way for a New Consensus

Economics saw rapid developments from the late 1970s onwards that
laid foundations for a relatively broad consensus that emerged towards
the early 1990s. The Keynesian consensus had failed the test of reality,
but early monetarism was not fully convincing either. A few more
innovations from both sides helped to find a common ground. This
new consensus has been labelled the New Neoclassical Synthesis and also
the New Keynesian model of monetary policy.
The understanding of rational expectations was the main new theor-
etical element. At first, rational expectations questioned Keynesian
macro-models by claiming that the models did not take into account
that economic agents, households and companies anticipate the deci-
sions made by policy-makers. The model parameters change when
people learn about the most likely policy reactions, referred to as the
Lucas critique.173 For monetary policy, rational expectations helped to
understand the formation and importance of inflation expectations,
which changed the perspective on the trade-off between unemployment
and inflation. If households had fully rational expectations, any expected
increase in inflation would not have any impact on the real economy.
The Phillips curve would lose relevance. Only unanticipated inflation
could affect the real economy. Rational expectations could also explain
the self-fulfilling inflation dynamics of fiscal deficits and excessive
money creation.174 The rational expectations model proposed that infla-
tion expectations could be influenced by the central bank that credibly
committed to slow money growth and low inflation. Such disinflation
policy could lead to a reduction in inflation without major social costs.175
The credibility of disinflationary policy became a key issue.
The conclusion that the central bank could only affect the real econ-
omy through surprises created the time-inconsistency problem in the
conduct of monetary policy. A central bank has incentives to promise
low inflation, but when it became anticipated by the public (in wage

173
Presented by Lucas (1976), ‘Econometric Policy Evaluation’, 19–46 and by Sargent and
Wallace (1975), ‘“Rational” Expectations’, 241–254. A more coherent description
followed in Lucas and Sargent (1981), Rational Expectations and Econometric Practice.
174
Sargent (1986), Rational Expectations and Inflation.
175
Goodfriend (2007), ‘How the World Achieved Consensus’, 6–7.

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 44 2 the three foundations of the emu

negotiations), the central bank would have incentives to surprise with

higher inflation to achieve better growth. However, as this behaviour by
the central bank was also expected, the public would behave as if infla-
tion would be high anyway. If the central bank now kept its low inflation
promise, it would be a negative shock for the economy. The central bank
could not achieve the best outcome through surprise inflation, but it
could not even achieve expected low inflation without an economy
shock. At best, it could achieve high inflation without a positive surprise.
The time-inconsistency problem means that a fully discretionary monet-
ary policy leads to suboptimal outcomes.176
Similar issues arose with active fiscal policy, as rational inter-temporal
expectations limit its effectiveness. Activist government spending
financed by public debt might not affect total demand if the public
anticipated that this would lead to higher taxes in the future. They
would simply save more, and public consumption would only replace ‒
rather than add to ‒ private consumption.177 This assumption of fully
rational households is unrealistic178 but it shows how household expect-
ations determine fiscal policy effectiveness. This became labelled as the
fiscal policy multiplier.179
One of the main attempts to combine macroeconomic and microeco-
nomic thinking is the Real Business Cycles approach (RBC) that aims to
understand business cycles caused mainly by the timing of consumption
and investment decisions. The starting assumption is the neutrality of
money.180 In RBC models, cycles are initiated by temporary changes in
productivity. Increases in productivity encourage households to work
more and consume less, and the opposite happens with temporary nega-
tive shocks to productivity.181 The RBC view on fiscal policy is blunt.

176
Kydland and Prescott (1977), ‘Rules Rather than Discretion’, 473–492 and Barro and
Gordon (1983), ‘Rules, Discretion and Reputation’, 101–121. Friedman’s externally set
rule for the central bank would have solved the time inconsistency problem.
177
For example, the Ricardian equivalence proposition assumes that people value the
consumption of their children and grandchildren the same way as their own. See, for
example, Barro (1979), ‘On the Determination of the Public Debt’, 940–971.
178
Ricardian equivalence would make it irrelevant whether government spending is
financed through debt or new taxes. See Barro (1974), ‘Are Government Bonds Net
Wealth?’, 1095–1117 and Barro (1979), ‘On the Determination of the Public Debt’,
940–971.
179
Blinder (2004), ‘The Case Against’, 2–3 and Mankiw (2007), ‘The Macroeconomist as
Scientist and Engineer’, 29–46.
180
Goodfriend and King (1997), ‘The New Neoclassical Synthesis’, 242.
181
Prescott (1986), ‘Theory ahead of business cycle measurement’, 9–22.

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 2.2 the economic foundation 45

Taxes are basically negative productivity shocks, and active fiscal policy
to reduce economic fluctuations actually explains most economic
fluctuations.182
The New Keynesian Economics also used rational expectations to
understand the inflation dynamics. Inflation was seen to relate to supply
shocks such as oil price increases that persisted due to institutional
factors.183 The microeconomics of wage formation included rational
expectations and assumed unemployment persistence.184 Instead of per-
fect markets and perfect competition, monopolistic competition pre-
vailed in many important markets. Companies could adjust prices to
maximise profits and were often slow in their price adjustments. This
had a large impact on the role of monetary policy. Rather than only
adjusting monetary policy to impulses from the rest of the economy, the
central bank had a temptation to increase output by positive demand
shocks. Accordingly, the New Keynesian approach also faces the time-
inconsistency problem.185 If monetary policy can affect the real econ-
omy, the design of its framework becomes critical.

Macroeconomics Finds a Consensus

Towards the early 1990s, a consensus of some sort emerged within
public administration and academia on the main elements of macroeco-
nomic policy. The new assumptions involved inter-temporal optimisa-
tion, rational expectations, imperfect competition and costly price
adjustments. When these were incorporated in macroeconomic theory,
the separation between monetarists and Keynesians became blurred.186
Economic growth results mostly from structural factors, at least in the
longer run. When the economy grows at this structural (potential) rate,
unemployment is at its natural level (NAIRU).187 From this level, it
cannot be sustainably reduced by activist monetary or fiscal policies,
because higher growth would only lead to higher inflation and not

182
McGrattan (1994), ‘The Macroeconomic Effects’, 573–601 and Goodfriend and King
(1997), ‘The New Neoclassical Synthesis’, 231–296.
183
Gordon (1982), ‘Price Inertia and Policy Ineffectiveness’, 1087–1117.
184
Taylor (1980), ‘Aggregate Dynamics and Staggered Contracts’, 1–23.
185
Barro and Gordon (1983), ‘Rules, Discretion, and Reputation’, 101–121.
186
The former under the title of the New Neoclassical Synthesis and the latter as the New
Keynesian Approach. Mankiw (2007), ‘The Macroeconomist as Scientist and
Engineer’, 37.
187
The non-accelerating inflation rate of unemployment.

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 46 2 the three foundations of the emu

sustained better employment.188 The importance of productivity shocks

in causing economic fluctuations was understood,189 but the policy
implications ‒ not fully. Inflation targeting as the preferable monetary
policy model was more easily accepted than the idea that fiscal policy
was mainly a real economy shock.190
In the new consensus, the formation of prices became more nuanced.
It was accepted that companies often have some market power (monop-
olistic competition) stemming from, for example, substantial fixed costs
such as R&D or brand value. This implies that companies do not adjust
their prices immediately as they would in perfect markets.191 The setting
of price or wage demands is guided by expectations of future prices; and
thus current inflation patterns depend on expectations of future
inflation.192
The new understanding of the functioning of the economy affects the
way economic policy operates. For short-term economic fluctuations
above or below potential, the new consensus stresses monetary policy
tools that affect the economy through the so-called transmission
mechanism.193 Monetary policy is defined in terms of short-term interest
rates that are changed in response to both the output gap and inflation
compared to the target. This so-called Taylor rule states that real rates
are increased when the economy grows above its potential and inflation
is above its target.194 Short-term interest rates could also be used against
sudden increases in inflation expectation.195

2.2.9 Academic and Central Banking Consensus as the

Economic Foundation
Periods of stable international monetary systems and domestic monetary
policy frameworks have been temporary. However, the easing up of the
rivalries between Keynesian and monetarist views paved the way

188
Economists refer to the output gap, as the difference between potential output and
actual output. It can be positive or negative.
189
King et al. (1988), ‘Production, Growth and Business Cycles’, 2–3.
190
As an example, a permanent increase in public spending causes a negative real economy
shock due to increased taxation, which should be counteracted by a restrictive
monetary policy to adjust the economy to a lower level of potential output.
191
Blanchard and Kiyotaki (1987), ‘Monopolistic Competition’, 647–666.
192
Clarida, Galí, and Gertler (2000), ‘Monetary Policy Rules’, 147–180.
193
Goodfriend and King (1997), ‘The New Neoclassical Synthesis’, 256 and McCallum
(1981), ‘Price Level Determinacy’, 319–329.
194
Originally in Taylor (1993), ‘Discretion versus Policy Rules in Practice’, 195–214.
195
Goodfriend (1993), ‘Interest Rate Policy’.

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 2.2 the economic foundation 47

towards a consensus concerning monetary policy and central banking in

the course of the 1980s, which also formed the basis for the central
banking part of the Maastricht Treaty. The consensus can be described
under the headings of the effectiveness of monetary policy, low inflation
target, the importance of independence and credibility, and finally a
communicated monetary policy strategy.

The Effectiveness of Monetary Policy

The view of monetary policy effectiveness changed fundamentally from
the early 1970s. The Keynesian view of subordinated and ineffective
monetary policy was turned around to the perception that monetary
policy is the most effective tool for economic stabilisation.196 At the
same time, the perception that inflation is primarily a monetary phe-
nomenon gained importance, with money demand equations showing
the link between controllable instruments and the amount of money.
However, it was the actual evidence from central bank practice that was
the most convincing. Germany, Switzerland and Japan showed that
inflation could be kept under control with monetary policy. The view
was further tested with the Volcker Shock in the USA,197 when high
policy interest rates reduced inflation with only a temporary shock for
the economy.198 The central banks were seen to have instruments ‒
mainly the short-term interest rates ‒ to reach their objective without
relying on fiscal or incomes policies. This re-established monetary policy
as a self-standing part of economic policy.

Low Inflation as the Optimal Monetary Policy Target

Acceptance of a low inflation objective is based on an understanding of
the costs of inflation and the benefits of price stability. In particular, the
Keynesian trade-off between employment and inflation was questioned,
first by the stagflation of the 1970s and later also theoretically.199 A low
inflation target for central banks is even considered optimal for achiev-
ing economic stabilisation. By maintaining low inflation, the central

196
Blinder (2004), ‘The Case Against’, 1–3.
197
Paul Volcker, a proponent for using monetary policy to fight high inflation, was
nominated as the Fed’s governor in August 1979. Under his leadership, the FOMC raised
policy rate from 11 per cent to 19 per cent by 1981. This increased unemployment
temporarily but reduced inflation from 15 per cent to 4 per cent by the end of 1982.
Meltzer (2009), A History of the Federal Reserve, Vol. 2.
198
Goodfriend (2007), ‘How the World achieved Consensus’, 8–12.
199
Broaddus (1993), ‘Central Banking’, 4.

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 48 2 the three foundations of the emu

bank makes the best contribution to the stabilisation of output and

employment and allows the economy to operate at its potential.
Monetary policy should react to employment or output only if they
signal inflationary or deflationary pressures.200
If monetary policy reacted only to output or employment, it could
paradoxically increase their volatility. The reason is that the optimal
reaction ‒ for example, to increased output growth ‒ depends on its
causes. If the reason is increased productivity, monetary policy should
not react to it because that would simply hamper the economy’s adjust-
ment to a higher level of potential production. However, if the reason is
excess demand that pushes the economy above its potential, monetary
policy should react before inflation picks up. The same holds with the
permanent negative supply shocks that reduce potential output and
thereby create excess demand. If monetary policy reacts to increased
unemployment by supporting demand, it simply adds inflation to the
list of problems.
The direct benefits of price stability are related to its very definition as
a lack of uncertainty concerning future price levels. This lengthens the
planning horizon for the economy and removes the lottery-element from
long-term contracts. Additional benefits are related to the reduced dis-
turbances caused by inflation.201 The benefits and costs of price stability
can vary between price stability definitions, namely zero or low, core or
headline, and present or expected inflation. Zero inflation makes nom-
inal interest rates less effective as monetary policy instruments. In
addition, zero inflation contains a higher risk of deflation, particularly
assuming product quality improvements (measurement bias).202 Core
consumer price inflation excludes items such as energy and food that
have even large temporary fluctuations unrelated to broader economic
developments. Targeting overall inflation in the case of temporary
shocks to food or energy prices can increase real economy fluctu-
ations.203 However, most central banks still target headline inflation
because non-core price components can have long trends, and the risk
of reacting to wrong signals, such as transitory or even false increases in
inflation, can be mitigated by medium-term orientation. The key target
should be expected rather than actual inflation, because expected

200
Goodfriend (2007), ‘How the World achieved Consensus’, 25–26.
201
Feldstein (1997), ‘The Costs and Benefits’, 123–156.
202
Kieler (2003), ‘The ECB’S Inflation Objective’, 17–18.
203
Mishkin (2007), ‘Headline versus Core Inflation’.

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 2.2 the economic foundation 49

inflation directs the forward-looking decisions of economic agents and

also because monetary policy actions take time to pass through to the
real economy and prices.204

Credibility of Monetary Policy Argues for Independent

Central Banks
The importance of central bank credibility is part of the consensus based
on both theoretical and practical arguments. Economic theory explained
the time-inconsistency problem inherent in discretionary monetary
policy. Central banks have to be credible in their commitment to low
inflation policy.205 If a credible central bank promises low inflation,
people with rational expectations will expect low inflation and act
accordingly. As a result, maintaining low inflation does not cause
unemployment and other costs.206 Subordinating the central bank to
the government can cause the time-inconsistency problem because gov-
ernments have a short-term perspective due to the electoral cycle. One
proposal was a simple monetary growth rule in binding legislation.207
However, the most common solution is the model of an independent
central bank guided by a clear policy objective, much like the
Bundesbank.208 An independent central bank with a single objective is
credible in achieving price stability, which reduces the social cost of
achieving it. The model solves the time-inconsistency problem and its
inflationary bias.209 Other objectives such as employment or financial
stability complicate the task, and if central bank’s credibility is tested
through increased inflation expectations in interest rates, it would need
to demonstrate its commitment to price stability at the cost of other
objectives.210

204
Issinget al. (2001), Monetary Policy in the Euro Area and Svensson and Woodford (2003),
‘Indicator Variables’, 1177–1188.
205
Barro and Gordon (1983), ‘Rules, Discretion, and Reputation’.
206
Blinder (1999), ‘Central Bank Credibility’.
207
Cukierman, Webb, and Neyapti (1992), ‘Measuring the Independence of Central Banks’,
353–398.
208
Rogoff (1985), ‘The Optimal Degree’, 1169–1189. Also referred to as a conservative
central banker mode, in which monetary policy be delegated to a governor who is more
averse to inflation than the general public.
209
Okun (1978), ‘Efficient Disinflationary Policies’.
210
As further evidence, when the Fed chose to prioritise financial stability considerations
over inflation scares in 1987, inflation expectations became more persistent.
Goodfriend (2007), ‘How the World Achieved Consensus’, 12.

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 50 2 the three foundations of the emu

Institutional solutions to ensure central bank independence encom-

pass many complementary features: independent and transparent
boards, giving governors long-term contracts or selecting only very
senior and conservative people as governors. Personal independence
can also be advanced by extensive personal transparency concerning
interests and connections.211 At the institutional level, various forms of
monitoring and disciplining have been implemented. Federal models,
such as the Fed or the Bundesbank, might have improved the independ-
ence of the central bank by reducing the risk of subordination to the
central government. In contrast, proposals of constitutional monetary
policy rules have not been successful, and even central bank independ-
ence has rarely enjoyed explicit constitutional protection. In Germany,
the credibility of maintaining low inflation was achieved over a consider-
able period and through communication efforts by the Bundesbank.212
When price stability was internalised by the public, the legal form was
less important. In contrast, countries aiming to break away from a high-
inflation and low-credibility past, such as Italy or the UK, relied on more
explicit legal solutions.213

Communicated Strategy
Transparency has turned from a swearword into a policy tool for central
banks. For a long time, central banks were hesitant to explain their
actions, and secrecy was a means to maintain public confidence. The
Bundesbank changed the landscape through its monetary targeting
strategy.214 The Fed also communicated its disinflationary strategy of
the early 1980s, but its overall communication remained uninformative
well into the 1990s.215

211
For example, the Fed makes available the financial disclosure forms of their President.
See www.frbsf.org/our-district/governance/financial-disclosures/. The ECB has not
followed a similar practice.
212
Blinder et al. (2001), ‘How Do Central Banks Talk?’, 72.
213
In Italy, substantial powers over monetary policy were assigned to the central bank
governor alone in order to facilitate disinflation. See, Goodman (1992), Monetary
Sovereignty, 55–56. In the UK, the model of explicit inflation targeting was introduced in
1997. www.bankofengland.co.uk/monetarypolicy/Documents/pdf/
chancellorletter970506.pdf.
214
Blinder et al. (2001), ‘How Do Central Banks Talk?’.
215
Ibid., 65–66. A long-time Fed governor, Alan Greenspan, described his own
communication as ‘mumbling with great incoherence’ in his statement to the Senate
Sub-Committee in 1987.

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 2.2 the economic foundation 51

In the new consensus, an announced strategy and transparency go

hand in hand with inflation targeting. The aim is to convince the public
that the central bank is able to control inflation, which guides inflation
expectations towards the target. A well-designed strategy is the founda-
tion for communication with the public, and an open strategy and
forecasting process can engage its stakeholders in a process of continu-
ous learning.216 An announced strategy and transparency also serve
central bank accountability. By being accountable for its inflation object-
ive, a central bank gains credibility and overcomes the time-inconsistency
problem. This does not contradict the deeper reasoning for accountabil-
ity, namely the legitimacy of the central bank.217 It could even be argued
that the consensus model has facilitated the overall accountability and
even legitimacy of the central banks,218 although central bank practice
still sees considerable variation in accountability models due to various
constitutional and democratic traditions.

The Limits of Consensus

The features of central banking consensus should be read with some
caution. Each element remained still subject to both theoretical and
practical disputes. Furthermore, central bank consensus probably
reached its peak in the 1990s, only to be questioned by the economic
and financial crisis.
The relationship between monetary policy and asset prices remained
an important topic without clear agreement. In the run-up to the finan-
cial crisis, the main policy was to exclude asset prices from monetary
policy strategy, or at least to avoid direct monetary policy reactions to
asset price fluctuations. However, many central banks claimed that they
took asset prices into account when assessing inflation expectations and
economic development more generally. A common approach to asset
prices, called the Jackson Hole consensus,219 contained three elements.
First, central banks should not target asset prices as part of their strat-
egy. Second, central banks should not try to burst asset price bubbles,
because they do not hold superior information to the market. Third,
central banks react to the bursting of the bubble, the so-called mod-up

216
Geraats (2007), ‘The Mystique of Central Bank Speak’, 37–80.
217
Blinder et al (2001), ‘How Do Central Banks Talk?’, 58–60.
218
Greenspan (1996), ‘The Challenge of Central Banking’.
219
See www.economist.com/node/14303627.

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 52 2 the three foundations of the emu

strategy, in order to limit its effects on the real economy.220 The third
part raised criticism even before the financial crisis, as it suggested that
central banks react asymmetrically to asset prices, thus creating moral
hazard.221 Market participants see this as central bank protection
against steep declines in asset prices, a ‘Greenspan put’, that actually
encourages risk-taking and asset price booms.222
A related criticism of pure inflation-targeting relates to the longer
cycles that can be called financial cycles. By focusing on shorter-term
inflation-related cycles, central banks could actually increase long-term
cycles that are related to simultaneous increases in property prices and
credit.223 Hence, inflation targeting could paradoxically fail by being too
successful. The ability to reduce short-term economic fluctuations can
lead to longer and steeper cycles.
There was never a consensus on the role that central banks should
have in ensuring financial stability or in banking supervision.
Traditionally, many central banks had supervisory tasks, but in the
1980s and 1990s, the trend was towards a separation of monetary policy
and banking supervision responsibilities, which culminated with the
establishment of the FSA in the UK. As the focus shifted to inflation
targeting, differences, even conflicts, between the monetary policy and
supervisory tasks became more apparent and risked hampering the
credibility of inflation targeting and also central bank accountability.
With the financial crisis the tide turned towards combining the tasks,
initially due to crisis management reasons.

2.3 The Institutional Foundation: Economic, Political and

Legal Evolution in the Community
Economic-constitutional thinking as the philosophical foundation in
conjunction with practical and theoretical developments in central
banking as the economic foundation provide theoretical backgrounds
for the EMU. However, the picture is not complete without a third ‒
institutional ‒ foundation that includes developments in the economic,

220
Smets (2009), ‘Financial Stability and Monetary Policy’.
221
Most prominently by reacting to stock market disturbances in 1987 and 2000–2001.
222
The ‘put’ refers to put options that give the holder a right to sell at a given price. Put
options can be used to provide protection against asset price declines. See, for example,
Hellwig (2014), ‘Financial Stability, Monetary Policy’.
223
Borio and White (2004), ‘Whither Monetary and Financial Stability?’, 131–211.

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 2.3 the institutional f oundation 53

political and legal spheres. This process can be called European economic
constitutionalisation, in which the CJEU and the Commission have util-
ised the Treaty to enhance European integration.
The aim of this section is to explain the key developments in European
economic integration that paved the way for the EMU. It was an evolu-
tion from the preliminary microeconomic approach in the Treaty of
Rome to the macroeconomic perspective of the Maastricht Treaty that
resulted in a fundamental change in the constitutional model towards a
European Macroeconomic Constitution.224

2.3.1 The Treaty of Rome as the Basis for a European

Microeconomic Constitution
The Treaty of Rome (1957)225 started the process of elevating the key
elements of the economic framework to the European level and giving
them legal protection. European integration that took place in the eco-
nomic sphere was motivated by economic theories supporting integra-
tion ‒ theories which were also applied in the legal reasoning of the
CJEU. Indeed, the first decades laid foundations for the EU legal order
and legal principles that, together with reliance on expert organisations,
formed the cornerstones of the economic-constitutional approach. In
this operationalisation of the Treaty, in particular the ordoliberals pre-
sented it as a basis for a European economic constitution.226 Indeed,
ordoliberal influences are visible in free movement and competition
policy part of the Treaty of Rome, as they strongly advocated this new
European economic framework to be based on a market-liberal
approach.227 However, the ordoliberal influences were balanced by
mainly French views that demonstrated more trust in governmental

224
The two layers of the European economic constitution was introduced in Tuori and
Tuori (2014), The Eurozone Crisis.
225
The Treaty establishing the European Economic Community (EEC) was signed on
25 March 1957 in Rome by Belgium, France, Italy, Luxembourg, the Netherlands and
West Germany.
226
McGowan and Wilks (1995), ‘The First Supranational Policy of the European Union’.
227
Many ordoliberals were sceptical about European integration due to its political
dimension. See Röpke (1959), International Order and Economic Integration (particularly
Part 4 on ‘Towards a New World Economy’) and Petzina et al. (1981), ‘The Origin of the
European Coal and Steel Community’ and Baquero Cruz (2002), Between Competition and
Free Movement, 35.

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 54 2 the three foundations of the emu

intervention, dirigisme,228 for example, in the areas of agriculture, trans-

port and economic policy coordination.229

The Economic Substance of the Treaty of Rome

The Treaty of Rome introduced the four economic freedoms and compe-
tition rules that constitutionalised some elements of the economic
framework. The freedoms and competition law had the behaviour of
households and companies, the subjects of microeconomic theory, as
their main objects. Particularly the free movement of goods was the
cornerstone of the common market from the start.230 The other three
freedoms were subject to restrictions and transition periods. The free
movement of workers was complicated by its links to Member State
national social security systems.231 Freedom to provide services had
some areas such as transportation and banking that were given special
treatment.232 Finally, the free movement of capital faced most restric-
tions due to the needs of national monetary and exchange rate policies.
In addition, the competition rules were constitutive of a market econ-
omy model.233 As important as substantive articles, the Treaty assigned
to the Commission powers to ensure the application of rules.

228
These influences can be read in the area of the common agricultural policy of the EEC.
Ackrill (2000), Common Agricultural Policy.
229
Article 3 EEC.
230
Based on Article 9(1) TEEC ‘The Community shall be based upon a customs union which
shall cover all trade in goods and which shall involve the prohibition between Member
States of customs duties on imports and exports and of all charges having equivalent
effect, and the adoption of a common customs tariff in their relations with third
countries.’
231
It was related to the right of establishment (Arts. 52–58 EEC) including both self-
employed people and companies.
232
Articles 59–65 EEC.
233
In Articles 85–89 EEC. Article 85(1) EEC: ‘The following shall be prohibited as
incompatible with the common market: all agreements between undertakings, decision
by associations of undertakings and concerted practices which may affect trade
between Member States and which have as their object or effect the prevention,
restriction or distortion of competition within the common market, and in particular
those which:
(a) directly or indirectly fix purchase or selling prices or any other trading conditions;
(b) limit or control production, markets, technical development, or investment;
(c) share markets or sources of supply;
(d) apply dissimilar conditions to equivalent transactions with other trading parties,
thereby placing them at a competitive disadvantage;
(e) make the conclusion of contracts subject to acceptance by the other parties of
supplementary obligations which, by their nature or according to commercial usage,
have no connection with the subject of such contracts.’

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 2.3 the institutional f oundation 55

All in all, the economic provisions of the Treaty of Rome constituted a

framework that protected economic freedoms and performance-based
competition, although with the aim of promoting integration. European
integration and the creation of the common market were to be achieved
primarily through daily economic decisions by individual economic
agents, who were protected from the negative influence of national laws
and regulations that could create barriers to trade. Integration was
achieved through a process, which relied on microeconomics.
Macroeconomic policy with aggregate level policy tools such as demand
or interest rate policy remained at the national level.234

Integration through the Rule of Law: Constitutionalising the

Economic Framework
The legal nature of European integration is inherent in the chosen
approach, namely that the economic framework (constitution) provides
individual actors with rights and also protection against the undue use of
power by others. As these rights were guaranteed at the European level,
they required legal procedures, the rule of law, to ensure legal remedies
at the same level.235 The provisions gained their effective economic-
constitutional role through effective legal safeguards that made the
EEC a community based on (the rule of ) law.236 The Commission pointed
to three different dimensions of European law: the community was
created by law, it had become a source of law, and it was a legal order
in itself. All of these were linked to the perception of the EEC as a
community that provides effective safeguards against arbitrary use of
power.237

234
Kingreen (2011), ‘Fundamental Freedoms’, 515–516.
235
Although the procedural autonomy of the Member States was mostly maintained. Van
Gend en Loos v Nederlandse Administratie der Belastingen Case (26/62); [1963] ECR 1; [1970]
CMLR 1established that the Treaty provisions were capable of creating legal rights that
could be enforced by both natural and legal persons before the courts, namely the
principle of direct effect. See Lonbay and Biondi (1997), Remedies for Breach of EC Law,
26–34 and Oosterom-Staples (2009), ‘Effective Rights’, 65–92.
236
Herdegen (2008), ‘General Principles of EU Law’, 344.
237
For more elaborate discussion, see chapter 11 of Tuori and Tuori (2014), The Eurozone
Crisis, with reference to the first President of the Commission Walter Hallstein. See also
Pernice (2001), ‘Der Beitrag Walter Hallsteins’. The rule of law became a community
constitutional principle through the CJEU‘s the Les Verts case. Case 294/83 Les Verts
v. Parliament [1986] ECR 1339, para. 23. The CJEU stated that the EEC ‘is a Community
based on the rule of law, inasmuch as neither its Member States nor its institutions can
avoid a review of the question whether the measures adopted by them are in
conformity with the basic constitutional charter, the Treaty’ and continued ‘[n]atural

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 56 2 the three foundations of the emu

The importance of law and courts, particularly the CJEU, for the
creation of the common market can hardly be exaggerated. The granting
of rights to individuals on the basis of Treaty provisions with the possi-
bility of seeking protection gave birth to the European (micro)economic
constitution. This developed the CJEU towards a constitutional court that
actively defined the content of EU law in its landmark cases and was the
engine for integration through law.238 The process through which the
Treaty of Rome became the European economic constitution can be
labelled economic constitutionalisation, also through the creation of
EU legal principles by the CJEU. In addition to the rule of law, the EU
legal order relies on the principles of direct effect, the primacy of EU law, as
well as the principles of conferral, proportionality, and subsidiarity.239
The principles of direct effect and primacy of EU law were needed to
ensure economic freedoms. Protection of Treaty-based rights have to be
similarly effective across the Member States, and therefore the Treaty
provisions are capable of creating individual rights which can be invoked
by both natural and legal persons before national courts.240 Later, the
scope was extended to most forms of EU law, such as regulations and
even directives under certain conditions.241 The primacy of Community
law applies to conflict situations between EU law and Member State law,
in which EU law takes precedence over national law, even national
constitutional law.242

and legal persons are thus protected against the application to them of general
measures which they cannot contest directly before the Court by reason of the special
conditions of admissibility’.
238
For example, Van Gend en Loos, Costa v ENEL, Dassonville or the Cassis de Dijon judgment of
the Court of 11 July 1974. Procureur du Roi v Benoît and Gustave Dassonville. ECLI:EU:
C:1974:82 and Judgment of the Court of 20 February 1979. Rewe-Zentral AG v
Bundesmonopolverwaltung für Branntwein, ECLI:EU:C:1979:42.
239
Weiler (1991), ‘The Transformation of Europe’, 2413–2423.
240
With the qualifications that the provision has to be clear and precise and must also be
unconditional so that no further Member State action is required to give it legal effect.
It also needs to be capable of conferring rights on individuals. de Witte, ‘Direct Effect,
Supremacy and the Nature of the Legal Order’, 177–213.
241
See Weiler (1991), ‘The Transformation of Europe’, 2403–2483 and Craig and De Burca
(2015), EU Law, 275.
242
According to CJEU case law, EU law prevails and conflicting national norms have to be
set aside. In particular, ‘the law stemming from the treaty, an independent source of
law, could not, because of its special and original nature, be overridden by domestic
legal provisions, however framed, without being deprived of its character as
community law and without the legal basis of the community itself being called into
question.’ Case 6/64, Flaminio Costa v. ENEL [1964] ECR 585, 593 and Craig and De Burca
(2015), EU Law, 266.

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 2.3 the institutional f oundation 57

The principle of conferral was developed in legal practice to clarify the

relationship between the Member States and the Community.243 This
principle protects Member State competences against Community com-
petences: ‘competences not conferred upon the Union in the Treaties
remain with the Member States’.244 The principles of subsidiarity and
proportionality are related to the principle of conferral, further qualifying
how the Community should exercise its competences. According to
proportionality, the Community cannot go beyond what is necessary to
meet the Treaty objectives. Subsidiarity maintains that decisions should
be taken close to the people concerned. In addition, the elevation of
economic integration to a main legal objective allowed the CJEU to use
these economic provisions extensively.
For the CJEU’s case law to become the motor of European integration
instead of politics, an important element was the preliminary ruling
procedure. Domestic courts may request preliminary rulings from the
CJEU on the interpretation of EU law or the validity of acts of EU insti-
tutions, such as regulations, directives and decisions. This ensures legal
certainty by uniform application of EU law,245 and it importantly
engages the national courts in the application of EU law.

Competition Rules as an Example of Constitutionalisation

Competition rules became constitutionalised with the help of the
objective of advancing economic integration. The key provisions were
not predominantly designed to aim at free competition but rather to
facilitate creation of the common market by reducing obstacles arising

243
Case C- 376/98, Germany v Parliament and Council (tobacco advertising), [2000] ECR I-8419.
It was explicitly stated only in the Lisbon Treaty.
244
Article 5(2) TEU: ‘[u]nder the principle of conferral, the Union shall act only within the
limits of the competences conferred upon it by the Member States in the Treaties to
attain the objectives set out therein. Competences not conferred upon the Union in the
Treaties remain with the Member States.’ Article 4(1) TEU and for the EU institutions
further specifications are in Article 13(2) TEU): ‘Each institution shall act within the
limits of the powers conferred on it in the Treaties, and in conformity with the
procedures, conditions and objectives set out in them. The institutions shall practice
mutual sincere cooperation.’
245
The procedure in Article 267 TFEU requires national courts that act as a final resort to
refer to the CJEU for a preliminary ruling. Only if the CJEU has already ruled on the
matter (acte éclairé) or the interpretation of the EU law is obvious (acte clair) can national
courts bypass the preliminary ruling procedure. Anderson and Demetriou (2002),
References to the European Court.

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 58 2 the three foundations of the emu

from national practices.246 It was the objective of economic integration

that made the competition rules an effectively enforced part of the
economic framework without even discussing the merits of free
competition.247
Indeed, the nature of competition rules as either politically driven
cooperation between the Member States or as legally oriented fields with
independent institutions in charge became an early contest. The Treaty
allowed for both options.248 It was the roles of the Commission and the
CJEU that turned competition rules into an effective part of EU legal
order. The Commission prepared an enforcement mechanism that was
finally agreed as a regulation.249 This paved the way for the
Commission’s intellectual ownership of the competition field, and the
early contest was won by judicial competition procedure.250
The CJEU was equally important in legitimising the Commission-led
process and made the link between the objective of the common market
and effective implementation of the economic framework. Competition
rules acquired a de facto constitutional status through being essential for
the Community’s main objectives.251 The CJEU empowered economic
actors by providing them legal protection ‒ even against their own
governments ‒ through EU law. This legal innovation covered for the
political inability to advance the European economic integration252 that
left the ground for law, the courts, and independent institutions.253 The
role of the Commission as the competition authority is a typical expert
function of the economic constitution. A non-political body that was

246
This aim is already clear in the report by Spaak (1956), ‘Intergovernmental Committee
on European Integration’.
247
Economic benefits stemming from the market-based allocation were later mentioned in
CJEU case law in Joint Cases 56 and 58/64, Establissements Consten SA & Grundig-Verkaufs-
GmbH v. Commission [1966] ECR 299, 339–40, [1966] CMLR 418 — 64, 65, 166.
248
Goyder (1988), EEC Competition Law, 65; Owen (2012), ‘Industrial Policy in Europe’;
Guillaume (1986), ‘Implications of the New Indicative Planning’, 119, 125–127and
Gerber (1994), ‘Constitutionalizing the Economy’, 103–104.
249
Council Regulation No 17 (EEC): First Regulation implementing Articles 85 and 86 of the
Treaty (at present Articles 81 and 82) [Official Journal No. 013, 21.02.1962].
250
Gerber (1994), ‘The Transformation of European Community’, 106–107. The political
advisory committee could only consult the Commission according to Article 10(3) of
Regulation 17/62.
251
Everling (1990), ‘Zur Wettbewerbskonzeption’, 995, 1000.
252
Gerber (1994), ‘The Transformation of European Community’, 108. The political
obstacles of the early years found their peak in the French ‘empty chair’ policy and
negotiations over the common agricultural policy.
253
Weiler (1991), ‘The Transformation of Europe’, 2403–2483.

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 2.3 the institutional f oundation 59

elevated – jointly with competition rules – at the level of the European

economic constitution.
In conclusion, the actions of the Commission and the CJEU were
essential in European economic constitutionalisation. The creation of
EU legal principles by the CJEU ensured the efficacy of EU law, but also
highlighted the constitutional status of the economic framework. The
law and the courts (and the rule of law) were utilised by giving rights to
individuals that could turn to courts to make their rights effective.254
The CJEU justified and empowered competition rules for the broader
objectives of the Community.255

Macroeconomic Policy in the Treaty of Rome

The macroeconomic provisions of the Treaty of Rome gained limited
legal status. The Member States were to ‘regard their conjunctural pol-
icies as a matter of common concern’. The vague provisions and the
demand for unanimous decisions reflected fundamental economic policy
differences particularly between France and Germany. Economic policy
remained a national responsibility and discretion.256 Balance of pay-
ments was a more concrete issue and Article 104 EEC could have
imposed clear constraints and objectives for national macroeconomic
policy-making.257 However, balance of payments already had the
broader Bretton Woods framework.258 Similarly, the institutional innov-
ation, the Monetary Committee,259 became a mere discussion forum
between finance ministries. The EEC central banks had a cooperation
body of their own called the Committee of Governors of the Central

254
Pech (2010), ‘A Union Founded on the Rule of Law’.
255
Meade (1996), ‘Modelling a European Competition Authority’, 159–162.
256
Article 103(1) EEC and Maes (2004), ‘Macroeconomic and Monetary Policy-Making’, 2–3.
257
Article 104 EEC imposed a clear objective or even an obligation on Member States:
‘[e]ach Member State shall pursue the economic policy needed to ensure the
equilibrium of its overall balance of payments and to maintain confidence in its
currency, while taking care to ensure a high level of employment and a stable level of
prices.’ For example, the Bundesbank urged countries to take the responsibility
seriously in their economic policy. Emminger (1958), ‘Les aspects monétaires’, 93.
258
Kaplan and Schleiminger (1989), European Payments Union. The Treaty provisions were
factually based on the founding articles of the IMF without explicitly acknowledging
their origin. James (2012), Making the European Monetary Union, 40–41.
259
It was based on a French initiative and even on the anticipation that it could facilitate
the mutual assistance of Member States in the future. Maes (2004), ‘Macroeconomic and
Monetary Policy-Making’, 5.

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 60 2 the three foundations of the emu

Banks (the CoG).260 The Treaty of Rome thus contained a broad set of
macroeconomic issues, and the objectives of price stability and equilib-
rium in the balance of payments, but these were left to national eco-
nomic policy or to the broader international cooperation within the
Bretton Woods system.

2.3.2 The First Attempt at a Common Currency: The Werner Report

In December 1969, economic and monetary union was discussed in the
Hague.261 WestGermany had its first Social Democratic government. This
converged economic policy views between Germany and France262 and
made it possible to commission a plan to create an economic and monetary
union from a committee led by Luxembourg Prime Minister Werner.263 The
resulting Werner Report set out a three-stage process to achieve economic
and monetary union with ‘the total and irreversible convertibility of cur-
rencies’. The Report also saw a substantial transfer of fiscal and economic
policy competences from Member States to the Community, which would
need to be acknowledged in the Community political framework.
The Report did not receive broadly based support either from France or
Germany.264 The Council still adopted the resolution on the economic
and monetary union in stages265 and decided to deepen cooperation
between central banks’ policies.266 However, the short period of

260
64/300/EEC: Council Decision of 8 May 1964 on cooperation between the Central Banks
of the Member States of the European Economic Community (SE I V1963–1964, 141).
Giovannini (1995), The Debate on Money in Europe, 162.
261
‘The Hague conference of Heads of State or Government, with a view to examining the
problems arising for the Community, principally in the matter of its completion, its
consolidation and its enlargement.’ See ‘The Hague Summit’ (1970), 7–18. http://aei.pitt
.edu/58651/1/BUL154.pdf.
262
Allen (2005), ‘“Ordo-Liberalism” Trumps Keynesianism’, 199–221.
263
Final communiqué of the conference of heads of state or government at the Hague
(2 December 1969).
264
Achard (2002), ‘Le Plan Werner et la Monnaie Européenne’, 139–148 and Maes (2004),
‘Macroeconomic and Monetary Policy-Making’, 22–23. Frowen and Pringle (1998), Inside
the Bundesbank, 175–180.
265
Resolution of the Council and the Representatives of the Governments of the Member
States on the attainment by stages of economic and monetary union in the Community
and also Resolution of the Council and of the Representatives of the Governments of the
Member States of 21 March 1972 on the application of the Resolution of 22 March 1971
on the attainment by stages of economic and monetary union in the Community. OJ
C 038, 18/04/1972 pp. 0003–0004.
266
71/142/EEC: Council Decision of 22 March 1971 on the strengthening of co-operation
between the central banks of the Member States of the European
Economic Community.

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 2.3 the institutional f oundation 61

common views on economic policy between France and Germany ended

with the resignation of economics minister Schiller and the disappear-
ance of his Keynesian politics in Germany.267 The decisive blow to the
Werner Plan came from the economy. The international monetary crisis
pushed aside the brief cooperative mood and more nationalistic views on
how to solve problems took over. The Werner Plan was placed in the
Community archives of failed proposals,268 having made clear that fun-
damental disagreements on economic policies and on the theories under-
lying these policies needed to be resolved before moving forward.

2.3.3 The Path to Maastricht: The EMS, the Single European Act,
and the Delors Report
After the collapse of the Bretton Woods system, exchange rate fluctu-
ations between Community currencies, balance of payments problems
and rising inflation continued to cause problems for the Member States
and particularly their central banks. One attempt for a solution was the
so-called ‘snake in the tunnel’ arrangement in which currencies floated
jointly within a narrow range, like a snake, while the broader tunnel was
defined in relation to the US dollar.269 The ‘snake’ began in 1972, but the
situation of the Bretton Woods collapse and the oil price shock was too
difficult.270 The second attempt to improve stability between European
currencies was the European Monetary System (EMS) that was launched
in March 1979 to include all the Community currencies except the UK
pound.271 Exchange rates could only be adjusted in the case of funda-
mental needs. The system included the Exchange Rate Mechanism (ERM),
which specified rules for interventions and also for necessary interest
rates and fiscal policy adjustments. The EMS also created a new insti-
tution, the European Monetary Cooperation Fund, alongside the new
currency unit: the ECU. However, the D-Mark was the real anchor
with the (German) internal price stability objective and monetary
policy stance.

267
Johnson (1998), The Government of Money, 77–78.
268
Schulz-Forberg and Stråth (2010), The Political History of European Integration, 44–46 and
Hendriks and Morgan (2001), The Franco-German Axis, 59–61.
269
http://ec.europa.eu/economy_finance/euro/emu/road/ems_en.htm.
270
Mundell (1994), ‘The European Monetary System’.
271
The Bundesbank was not enthusiastic, but Chancellor Schmidt threatened to amend the
Bundesbank Act if it did not agree. See, Marsh (1992), The Bundesbank, 194; Crawford
(2007), Power and German Foreign Policy, 118 and Lohmann (1994), ‘Designing a Central
Bank in a Federal System’, 247–277.

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 62 2 the three foundations of the emu

Until 1983, the EMS was relatively unstable, because Germany and
France had very different economic policies.272 However, after its eco-
nomic policy U-turn, France assigned itself a German type of monetary
policy labelled the ‘fort franc’ policy. The general economic environment
also became more favourable in the latter part of the 1980s. GDP growth
was fairly solid and unemployment declined.273 As the credibility of the
system increased, it became easier to maintain without frequent
exchange rate adjustments. Fundamentally, the EMS made German price
stability the model for most Community central banks regardless of
their formal monetary regimes. At the same time, the first major change
in the Treaty of Rome in the form of the Single European Act (the SEA
1986), stressed the objective of completing the common market by the
end of 1992. The efficiency of the EU political process was improved by
broadening the scope of issues with qualified majority voting, and the
European Parliament’s role was increased to give democratic legitimacy
to European decision-making.274
In this spirit of optimism, the SEA also started a new round of discus-
sion on economic and monetary union. The opportunity presented itself
through the success of ‒ and also pressures on ‒ the EMS. Free movement
of capital was important for the single market, but further economic
integration and liberalised capital movements constrained national mon-
etary policy from both the economic and the political side.275 This caused
pressures but also provided opportunities, as the political environment
was more optimistic partly due to mutual trust between Kohl,
Mitterrand and Delors.276 The later collapse of the EMS in 1992–1993
even confirmed that EMS was an unstable middle-ground. The ultimate
shock that caused the collapse was German unification and its expan-
sionary fiscal policy that forced the Bundesbank to prioritise its domestic

272
Cobham (2012), ‘From Bretton Woods to Inflation Targeting’, 732.
273
Sachs and Wyplosz (1986), ‘The Economic Consequences of President Mitterrand’,
261–306.
274
See, for example, http://eur-lex.europa.eu/legal-content/EN/TXT/?uri=uriserv:xy0027.
275
The so-called Basel-Nyborg agreement between participating central banks formalised
procedures for inter-marginal interventions in the currency markets. Story and Walter
(1997), Political Economy of Financial Integration in Europe, 50–65.
276
For France, even the successful period of the EMS had involved a surrender of national
economic policies to the German model imposed ultimately by the Bundesbank. For
Kohl, the larger historical view on European cooperation was probably more important
than economic issues that were not his expertise. James (2012), Making the European
Monetary Union, 233–235.

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 2.3 the institutional f oundation 63

price stability objective by increasing interest rates. This did not suit
other EMS countries, but a revaluation of the D-mark was not an option
due to the poor competitiveness of ex-communist East Germany. The
shock emanating from the anchor of the system was something that the
EMS could not handle.277 In addition, small but persistent differences in
inflation rates without compensating productivity gains had led to the
deterioration in competitiveness of some countries and to an intolerable
situation for pegged exchange rates.278

The Delors Report

The positive environment allowed the European Council in 1988 to set
up a Committee for the Study of Economic and Monetary Union with an
unusual composition. Chaired by the President of the Commission,
Jacques Delors, the Committee included all the central bank governors,
along with three independent experts. Given a mandate to propose a
timetable with clear, practical and realistic steps for creating an eco-
nomic and monetary union,279 the Committee managed to find unani-
mous agreement in the form of the Delors Report. The report first
concluded that the EMS was structurally vulnerable as ‘the lack of suffi-
cient convergence of fiscal policies as reflected in large and persistent
budget deficits in certain countries has remained a source of tensions
and has put a disproportionate burden on monetary policy’.280
Institutional guarantees against budget deficits were thus essential
going forward.
The Report saw that irrevocably fixing exchange rates and, finally, a
single currency required a common monetary policy that was to be
vested in a new institution, the European System of Central Banks.
Policy coordination would be needed, in particular, in fiscal policy that
fundamentally affected the common monetary policy’s operating envir-
onment. The SEA was envisaged to increase interdependences between
the Member States, but the Werner Plan’s solution of increasing
the fiscal powers of the Community was not considered plausible.281

277
Buiter, Corsetti, and Pesenti (1998), ‘Interpreting the ERM crisis’, 24–26 and Issing
(2008), The Birth of the Euro.
278
Mundell (1994), ‘The European Monetary System’. 279
Ibid., 233–235.
280
Committee for the Study of Economic and Monetary Union (Delors Committee), ‘Report
on an Economic and Monetary Union in the European Community’ (17 April 1989).
281
France was keen to maintain its economic sovereignty. The German position was more
complex. It saw the need to harmonise fiscal and even social policies to make a common
currency sustainable, but it had doubts about the willingness of other countries to abide

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 64 2 the three foundations of the emu

‘The permanent fixing of exchange rates would deprive individual coun-

tries of an important instrument for the correction of economic
imbalances and for independent action in the pursuit of national object-
ives, especially price stability’.282 A common monetary policy would
necessitate ‘a high degree of compatibility of economic policies and
consistency in a number of other policy areas, particularly in the fiscal
field’. An important element was to exclude any access to central bank
monetary financing.283
The Report insisted that economic policies ‘should be geared to price
stability, balanced growth, converging standards of living, high employ-
ment and external equilibrium’.284 Most decisions would remain
national, but fiscal policies would need to be placed in an agreed macro-
economic framework and subjected to binding rules. Fiscal policy thus
needed institutional safeguards, as the single currency provided incen-
tives for deficit-driven fiscal policies. The Report stressed market discip-
line on government spending but acknowledged its limits. Reliance on
pure market discipline could lead to unnecessary fluctuations, as market
forces were seen to be initially slow and weak and later too sudden and
disruptive.285 Institutional constraints were difficult for most Member
States and the rules on budget deficits demanded some flexibility.
The Delors Committee explicitly refrained from commenting on
political union.286

Turning the Delors Report into the Maastricht Treaty

The Delors Report and the drafting of the Maastricht Treaty did not
follow the model of European economic constitutionalism.287 It was a
political process, a revolution rather than evolution. The French and
German views demonstrate the situation. The French advocated monet-
ary integration as a means to facilitate other economic and political
integration, while the Germans saw economic integration as a

to the economic discipline. Failing that, Germany was afraid of becoming the
designated support mechanism, either directly or through the value of common
currency. James (2012), Making the European Monetary Union, 235–260.
282
Committee for the Study of Economic and Monetary Union (Delors Committee), ‘Report
on an Economic and Monetary Union in the European Community’ (17 April 1989), 16.
283 284
Ibid., 13–15. Ibid., 12–13.
285
Ibid., 20, ‘[M]arket perceptions do not necessarily provide strong and compelling signals
and that access to a large capital market may for some time even facilitate the financing
of economic imbalances.’
286
James (2012), Making the European Monetary Union, 232.
287
Eichengreen (1990), ‘Is Europe an Optimum Currency Area?’.

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 2.3 the institutional f oundation 65

precondition for monetary integration.288 The controversy between

these views is one of the longer traits in European monetary integration.
Another dimension is the controversy related to the role of the state. The
German view stressed the state as a provider of a framework for the
liberal market economy. In contrast, the French held trust in state
intervention and rational planning. These long controversies cooled
down in the late 1980s, as French economic policy moved closer to the
German model, including an independent central bank with a price
stability objective.289 For Germany, this convergence of economic pol-
icies and economic integration alleviated some of their fears. At the same
time, German reunification was tied to deepening integration at the
European level.290
As the longer-term disputes lost steam, economic, political and even
geopolitical developments supported the negotiations on a common
macroeconomic constitution. The Delors Report listed the steps includ-
ing complete liberalisation of capital movements, full integration of
financial markets, irreversible convertibility of currencies, irrevocable
fixing of exchange rates, and the replacement of national currencies
with a single currency.291 The ECOFIN Council led the drafting of the
EMU Articles, although the actual drafting was assigned to the
technocrats, namely the Monetary Committee (ministries of finance)
and the CoG (central banks).292 The CoG provided a draft statute for
the ECB with the primary objective of price stability, the independence
of the central bank and the indivisibility of monetary policy. The struc-
ture for a single monetary policy was mostly based on the template of the

288
Robert Triffin: ‘Monetary unification would not require, in any manner, a full
unification of national levels of prices, costs, wages, productivity, or living standards. . . .
Neither does monetary unification require a uniformization of the budgetary economic,
or social policies of the member countries. . . . The problem of monetary unification is
therefore a political rather than an economic problem’ in Maes (2004), ‘Macroeconomic
and Monetary Policy-Making’, 9 and the original in Triffin (1957), Europe and the Money
Muddle, 228–229.
289
This was even agreed to by President Mitterrand. Maes (2004), ‘On the Origins of the
Franco-German EMU Controversies’, 31.
290
Loth (2013), ‘Negotiating the Maastricht Treaty’, 71.
291
The Madrid European Council of June 1989 decided to proceed to the first stage of the
EMU in July 1990. In December 1989 Strasbourg European Council called for an
intergovernmental conference to determine the Treaty revisions needed for the second
and third stages of the EMU.
292
James (2012), Making the European Monetary Union, 269 and James (2013), ‘Designing a
Central Bank’, 111.

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 66 2 the three foundations of the emu

Bundesbank,293 but the CoG could not agree on the central banks’ role
in financial supervision.294
In December 1991, the heads of state and government of the European
Council at Maastricht approved the Treaty on European Union. The
outcome was a compromise. German views arguably dominated on the
monetary policy side, while French perceptions on economic coordin-
ation prevailed, although with elements of fiscal discipline to calm
German fears. The fundamental French victory was that the EMU would
begin by the end of the century even without the economic convergence
of most countries. A combination of centralised monetary policy and
national economy policies was agreed against the push for more central-
isation of fiscal and economy policy. Paradoxically, the EMU was subor-
dinated to political objectives but its implications for political union
were modest.295

The Last Mile to the EMU: Entry Criteria and Their Interpretation
The EMU was a legal Treaty obligation but not automatic: it required
some economic convergence between the Member States, soundness of
public finances and compatible central bank legislation as entry cri-
teria.296 The economic convergence criteria were: price stability meas-
ured by an inflation rate close to the best performing Member States; the
sustainability of the government financial position (deficit at most 3 per
cent and ‒ for debt ‒ 60 per cent of GDP); currency in the ERM for two
years; and the long-term interest rate close to the best inflation rate
countries.297 With the Maastricht Treaty ratified, preparations for a
common currency continued with the establishment of the European
Monetary Institute (EMI) in 1994. The EMI and the Commission were to

293
When the CoG was assigned the task of drafting the monetary policy part of the EMU,
the chairmanship was taken over by the Bundesbank President Pöhl. His influence was
most likely decisive. James (2012), Making the European Monetary Union, 282–283.
294
Ibid., 288–293 and Kaltenthaler (1998), Germany and the Politics of Europe’s Money, 80–85.
295
For a thorough description, see Dyson and Featherstone (2000), The Road To Maastricht.
296
The criteria are in Article 140 TFEU with a reference to the Protocols of the Treaty to
provide numerical specifications.
297
Protocol 13 on the convergence criteria specified the criteria as an inflation rate of
maximum 1.5 percentage points above the three best Member States and a long-term
interest rate maximum of 2.0 percentage points above the average rates of those
countries. Consolidated version of the Treaty on European Union - PROTOCOLS -
Protocol (No 13) on the convergence criteria OJ C 115, 9.5.2008, 281–282.

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 2.3 the institutional f oundation 67

draft reports on the convergence of the Member States for the EU

Council to decide which Member States fulfil the entry criteria.
The criteria reflected the German view that the EMU could be success-
ful only if countries were economically and institutionally sufficiently
similar. However, in economic terms, the convergence criteria set only
two major preconditions for entry: some sustainability in public finances
and short-term monetary stability. During the Maastricht Treaty negoti-
ations, inflation differentials among Member States were still substan-
tial.298 Following the negotiations, a substantial decline in inflation rates
occurred mostly due to a disinflationary global economic environ-
ment.299 In 1998, when the initial countries were selected, all Member
States with the exception of Greece met the inflation criterion,300 and
even Greece met that criterion two years later.301
Internal monetary stability was complemented by the exchange rate
criterion that measured external monetary stability. Keeping ERM par-
ities was difficult for countries that deviated substantially from the
German monetary stability. However, the required two-year period was
very short for testing real economic convergence. Similarly, the long-
term interest rate criterion became self-fulfilling once the prospect of
EMU membership increased.302 In other words, capital markets priced in
the likelihood of a given political decision rather than constrained it.
The criteria for public finances and the constitutional principle of
Member State responsibility to maintain sound public finances were
measured by general government deficit and debt without any reference
to the substance of public sector activities or convergence between public
sector functions. There was no criterion on convergence, for example, in
social security functions or in tax structures.303 Member States retained
full discretion over public finances as long as their public sector expend-
itures did not exceed revenues by more than 3 per cent of GDP. The
deficit criterion was the key, because it continued to be applicable
through the excessive deficit procedure in the EMU. If it was applied
consistently, the relative level of public debt would diminish over time.

298
For example, in 1990 German and Dutch inflation rates were below 3 per cent, those of
Spain and Italy exceeded 6 per cent, and in Greece inflation stood above 20 per cent.
299
SE Asia and particularly China provided a structural disinflationary effect together with
lower oil prices.
300 301
EMI Convergence Report (March 1998), 6. ECB Convergence Report (2000), 16.
302 303
Ibid., 24, 38. James (2012), Making the European Monetary Union.

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 68 2 the three foundations of the emu

However, the 1998 figures contained some bending of the rules in almost
all the Member States, and the interpretation of the debt criteria was
political rather than juridical.304 Even Greece managed to fulfil the
deficit criterion in 2000 by pushing the bending of rules to the
extreme.305

304
A strict interpretation would have excluded not only Italy and Belgium but also
Germany, Spain, Netherlands and Austria. Hence, the EU Council, in effect, did not
apply debt criteria.
305
See report by Eurostat on the revision of the Greek Government Deficit and debt figures
(22 November 2004).

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 3 The Principles of the European
Macroeconomic Constitution

The Maastricht Treaty introduced a new macroeconomic layer to the

European economic framework with its provisions on EMU. This chapter
reconstructs the content of this new economic framework as the
European Macroeconomic Constitution. The aim is to form a coherent
if incomplete economic constitutional order characterised by a set of
principles. These constitutional principles are derived from the Treaty
provisions1 with the help of the three foundations analysed in Chapter 2.
The principles are either objectives or institutional choices and
safeguards that together form the normative premises for the EMU.

3.1 The European Macroeconomic Constitution

The EU macroeconomic framework was introduced in the Maastricht
Treaty. It also became part of the larger European economic-
constitutional framework that already included an earlier microeco-
nomic framework based on the Treaty of Rome and subsequent develop-
ments in the EU, as discussed previously. The resulting European

1
The constitutional law relevant for the assessment includes the consolidated versions of
the Treaties on the European Union and on the Functioning of the European Union,
including the protocol on the Statute of the European System of Central Banks and the
European Central Bank. In addition, the relevant secondary law is included. For example,
setting up the EMU involved a number of regulations and resolutions, such as those
forming the Stability and Growth Pact, Resolution on the Stability and Growth Pact of
Amsterdam, [1997] OJ C236/1; Council Regulation (EC) 1466/97 on the strengthening of
the surveillance of budgetary positions and the surveillance and coordination of
economic policies and Council Regulation (EC) 1467/97 on speeding up and clarifying the
implementation of the excessive deficit procedure, [1997] OJ L209/1. On the negotiations
leading to the Pact see Heipertz and Verdun, Ruling Europe. The Politics of the Stability and
Growth Pact (Cambridge: Cambridge University Press, 2010) 19–41.

69

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 70 3 principles of the european macroeconomic constitution

economic constitution with its two layers should be understood as a

normative reconstruction, not a traditional constitution as such,
although most provisions appear in EU primary law that holds suprem-
acy over national law, even constitutions.

3.1.1 Objectives of the European Macroeconomic Constitution

The EU works on the basis that Member States confer competences on
the EU in order to achieve common objectives of promoting peace, the
well-being of its peoples, and the values of the EU consisting of respect
for human dignity, freedom, democracy, equality, the rule of law and
respect for human rights (TEU).2 These ultimate aims and objectives
mostly manifest themselves in the application of the more concrete
objectives and functions of the EU, including those related to the
European economic constitution. In the Maastricht Treaty, the main
microeconomic objective of an internal market was accompanied with
the main macroeconomic objective of price stability. Further macroeco-
nomic objectives included balanced economic growth and a ‘highly
competitive social market economy’, which in turn should aim at full
employment and social progress.3

The Objective of Creating an Internal Market

The main explicitly economic objective of the EU was inherited from the
EEC, namely to establish an internal market. The euro was to support
achieving the internal market that was still to be achieved through
abolition of barriers to trade by conferring enforceable rights on individ-
ual economic actors. The constitutional approach of the microeconomic
constitution, based on a teleological interpretation of the objective of
economic integration by the Commission and the CJEU, remained intact.
In the European Macroeconomic Constitution, the internal market
objective is less directly applicable, because the causal link between
macroeconomic policy measures and the internal market objective is
less obvious. However, internal market objective can be an interpret-
ational tool for assessing the constitutionality of the EU or Member State
measures or even a meta-objective for using measures to resist the
disintegration of internal markets such as the EMU break-up.

2
Articles 1, 2 and 3(1) TEU.
3
Article 3(3) TEU. The Treaty of Lisbon collected the macroeconomic objectives under the
heading of Economic Policy, including Article 4. Consolidated version of the Treaty on the
Functioning of the European.

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 3.1 the european macroeconomic constitution 71

The Maastricht Treaty adhered to the principle of the unity of the EU,
where exclusive EU competence over monetary policy was to comple-
ment and support the microeconomic constitution for the whole EU.4
The indivisible monetary policy became an exclusive EU competence.
The Member States were assigned the objective of introducing a single
currency and were committed to work for the required economic and
legal convergence. The assumption was that all Member States would
join as soon as they fulfilled the convergence criteria. The euro was not
only a political but also a legal obligation, with the exception of the UK
and Denmark.5

Objective of Price Stability

The Maastricht Treaty introduced price stability as the main new object-
ive that guides the EU and the Member States in their economic and
monetary policy.6 This elevated position of a price stability objective is
exceptional in international comparison, giving it a more protected and
independent position than is the case with other central banks or eco-
nomic policy frameworks.7 Most inflation-targeting economic frame-
works assign an important instrumental role for price stability, but the
European Macroeconomic Constitution goes beyond that. Price stability
could even be perceived a systemic choice with stand-alone value in
facilitating social stability and progress without being conditioned on
its ability to facilitate short-term economic and social progress.8

4
The macroeconomic provisions are mainly applicable to the euro area countries,
including Article 3(1)(c) TFEU, which states that the Union has exclusive competence in
the area of monetary policy for Member States whose currency is the euro.
5
Article 119 TFEU. See Indruchová, ‘European Union Member States Outside the Euro
Area’ [2013] Lawyer Quarterly 3(3), 229.
6
The TEU refers to the price stability objective: ‘the Union shall . . . work for the
sustainable development of Europe based on balanced economic growth and price
stability’ (Art. 3(3) TEU). Article 3a(3) TEU on Principles states that the economic policy
activities of the Member States and the Community shall entail compliance with the
guiding principles of stable prices, sound public finances and monetary conditions and a
sustainable balance of payments.
7
The statutes of the US Federal Reserve System or the Bank of England provide a less
fundamental role for price stability. Perhaps only in Switzerland are some of the key
elements of the monetary policy framework stipulated in the constitution. Article 99 of
the Federal Constitution. www.snb.ch/en/mmr/reference/Bundesverfassung_Art_99/
source/Art_99_Geld_und_Waehrung_en.pdf.
8
The FCC: ‘the monetary union is designed as a community based on stability
[Stabilitatsgemeinschaft], the primary objective of which is to maintain price stability.’ ‘This
concept of the monetary union as a community of stability is the basis and object of the
German Act of Consent.’ BVerfGE 89, 155.

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 72 3 principles of the european macroeconomic constitution

For monetary policy, Article 127(1) TFEU made clear that the ‘primary
objective of the European System of Central Banks . . . shall be to main-
tain price stability. Without prejudice to the objective of price stability,
the ESCB shall support the general economic policies in the Union’.9 The
Treaty left open as to how price stability is defined: constant prices, small
changes in prices, low inflation, or something else, but it assigned the
ECB the task of defining price stability as part of defining monetary
policy. This brought some flexibility to the constitutional architecture.10
Clearly, the price stability objective was not to be defined politically by
either the ECOFIN Council or the EU Parliament. Price stability is also the
primary objective of the common exchange rate policy,11 as the formal
agreements on exchange-rate systems for the euro concluded by the
ECOFIN Council12 also need to be in line with the objective of price
stability.13 This ensured that exchange rate policy and monetary policy
would be synchronised, and also reduced the risk that the ECOFIN
Council could use exchange rate policy to put pressure on the ECB.
The primacy of price stability has an economic, institutional and
political background. The economic consensus in the early 1990s saw
that, by focusing on price stability, the central bank would make the best
contribution to overall economic developments, which was a major
break from the perceived trade-off between inflation and employment.
Theoretically, an unconditional price stability objective is more credible
and thus less costly to achieve. A clear and unconditional price stability
objective is part of the institutional model to prevent the time-
inconsistency problem. In EMU, such a constitutional ‘overkill’ could
also compensate for the lack of broader societal internalisation of a price
stability culture by policy-makers, social partners, and the general

9
The ESCB is commonly termed the Eurosystem when it refers to the ESCB in its euro
area composition.
10
See Gali, ‘Monetary Policy in the Early Years of EMU’.
11
Article 119(3) TFEU states: ‘the definition and conduct of a single monetary policy and
exchange-rate policy the primary objective of both of which shall be to maintain price
stability’
12
And also to formulate general orientations for exchange-rate policy in relation to other
currencies (Arts 219(1) and 219(2) TFEU).
13
The term ‘general orientation’ replaced the term ‘guidelines’ in the Maastricht
negotiations on German request. See Loth (2013), ‘Negotiating the Maastricht Treaty’, 82.
It can be recalled that the conflict between exchange rate arrangements and the
Bundesbank’s internal price stability objective was an area of conflict in the German
coordination of various economic policy areas.

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 3.1 the european macroeconomic constitution 73

public.14 Consequently, price stability became a precondition in the

Delors Report for the process towards European monetary integration,15
when the change in central banks’ orientations had already aligned EU
central banks with the model of the Bundesbank. Furthermore, the price
stability objective is supported by other elements of the economic consti-
tution, including the independence of the central bank, the prohibition
of public financing by central banks, and sound public finances.

The Principle of an Open Market Economy and Free Competition

The objective of the internal market is linked to the Treaty provision on
the principle of an open market economy and free competition. The open
market economy is the key means of achieving the internal market that
has its origins in the microeconomic constitution, stating that competi-
tion in the common market should not be distorted.16 The terms ‘open
market economy’ and ‘free competition’ were introduced only in the
Maastricht Treaty. In the European Macroeconomic Constitution, achiev-
ing an open economy included assigning obligations to economic policy-
makers instead of giving rights to private actors. The principle of an open
market economy and free competition became a general principle that
required balancing argumentation in the national legislature.17 Whether
it obliges EU institutions directly or whether it requires a similar balan-
cing act in the EU institutions divides opinion.18 The objective received
some attention in subsequent Treaty reforms, demonstrating a politicisa-
tion of the principle, and even calling into question whether it should be
seen as an independent objective.19 According to the CJEU, the Member

14
This argument could underlie the Maastricht decision of the FCC. BVerfGE 89,155. See
Majone (2012), ‘Rethinking European Integration after the Debt Crisis’.
15
In a letter to Chancellor Kohl, Bundesbank governor Pöhl suggested that the currency
union should be based on central bank independence and a commitment to price
stability. James (2012), Making the European Monetary Union, 233–234; Delors Report,
13 and Loth (2013), ‘Negotiating the Maastricht Treaty’, 67–68.
16
Article 3 (f ) EEC.
17
Case 229/83 Leclerc v Au blé vert [1985] ECLI:EU:C:1985:1 and Case C-9/99 – Échirolles
Distribution [2000], ECLI:EU:C:2000:532.
18
Townley (1999), Article 81 EC and Public Policy, 56–57.
19
The proposed formal EU constitution included the objective of ‘an internal market
where competition is free and undistorted’ in Article I–3 (2). After its rejection, French
President Sarkozy insisted that undistorted competition was relocated to the Economic
Policy part of TFEU. The question remains, whether it had any substantive significance
when the Lisbon Treaty transferred the objective from the title ‘Principles’ to the title
‘Economic Policy’. Article 120 TFEU still states: ‘Member States and the Union shall act
in accordance with the principle of an open market economy with free competition,

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 74 3 principles of the european macroeconomic constitution

State obligation to comply with the principle of an open market economy

and free competition in its economic policy ‘do not impose on the
Member States clear and unconditional obligations which may be relied
on by individuals before the national courts’.20
For the ECB and EU monetary policy, the principle is clear: ‘the
activities of the Member States and the Union shall include . . . the
adoption of an economic policy which is . . . conducted in accordance
with the principle of an open market economy with free competition’.21
The ECB should also be ‘favouring an efficient allocation of resources’
and following a ‘market economy-based’ rationale in its monetary policy
and supporting tasks.22 This is important for the operational framework
of the ECB, which should have a limited effect on the functioning of the
free market economy.23

3.1.2 Institutional Choices and Safeguards

The objectives and tasks of the European Macroeconomic Constitution
assigned the ECB a unique role to conduct common monetary policy
aimed at price stability and to advance European integration. However,
the overall architecture of the European Macroeconomic Constitution
cannot be understood solely on the basis of its objectives and tasks. It
included many essential institutional choices and safeguards.

Independence of the Central Bank

Central bank independence had become part of the consensus in eco-
nomics in the 1980s, when achieving and maintaining price stability
became the central bank’s main contribution. European monetary
cooperation within the EMS, and with an anti-inflation stance, also
supported central banks in their quest for greater independence from

favouring an efficient allocation of resources, and in compliance with the principles set
out in Article 119’. Parker et al. (2007), ‘EU scraps free competition goal’.
20
Case C-9/99 Échirolles Distribution SA v Association du Dauphiné and Others Echirolles,
para 25.
21
Article 119(1) TFEU.
22
Smits (1997) reaches the same conclusion in The European Central Bank, 190–191.
23
This is also stressed by the ECB in The Monetary Policy of the ECB (2004), 72 and Issing (2008)
The Birth of the Euro, 122–130, which contains a good description of the decisions and
early evolution of the ECB operational framework. The same could hold also for the
actual monetary policy operations and the operationalisation of the minimum
reserve system.

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 3.1 the european macroeconomic constitution 75

governments.24 The Bundesbank was the template25 and constitutionally

enshrined central bank independence was a non-negotiable precondition
for German participation in the EMU. This detachment of monetary
policy from other national economic policies facilitated the EMU as
monetary policy was – for the national political systems – largely a lost
territory even before it was transferred to the EU.
The independence of the ECB became a cornerstone of the whole
European Macroeconomic Constitution alongside the price stability
objective. Article 130 TFEU states that neither the ECB nor NCBs ‘shall
seek or take instructions from Union institutions, bodies, offices or
agencies, from any government of a Member State or from any other
body’. Similarly, EU institutions and Member States should ‘respect this
principle and not to seek to influence the members of the decision-
making bodies of the European Central Bank or of the national central
banks in the performance of their tasks’. Several other provisions sup-
ported the disentangling of common monetary policy from external
influences (the terms of office of the Executive Board and Governing
Council members and a special audit procedure). The independence was
accompanied by a list of tasks assigned to the ECB in the Treaty and
Statute that specified the fields to be protected by independence. The ECB
is only bound by the primary objective of price stability – and even that is
defined by the ECB Governing Council. In addition, financial independ-
ence requires that the ECB and NCBs possess sufficient means to fund
their operations, stemming mainly from the monetary income.
Independence faced some legal boundaries. For example, the ECB’s
claim that it was not bound by rules related to the EU institutions was
rejected by the CJEU.26 Thus the independence of the ECB is a key
constitutional principle of the European Macroeconomic Constitution
that is mostly of a functional nature.27 It does not elevate the ECB above
the legal framework nor isolate it from the demands of accountability.28

24
James (2012), Making the European Monetary Union, 44, 266; Reinalda and Verbeek (1998),
Autonomous Policy Making by International Organizations, 184 and Sachs and Wyplosz (1986),
‘The Economic Consequences of President Mitterrand’.
25
Section 12 of the Bundesbank Act 1957. Article 88 of the German Basic Law only
envisaged a central bank, not its independence.
26
Case C-11/00 Commission of the European Communities v. the European Central Bank.
27
See Goebel (2005), ‘Court of Justice Oversight Over the European Central Bank’.
28
Articles 127(2) TFEU and 3.1 Statute. See, Fabian Amtenbrink and de Haan (2002), ‘The
European Central Bank’, 69–70.

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 76 3 principles of the european macroeconomic constitution

Narrow Mandate of the ECB Excluding Value Judgments

The boundary between the ECB’s tasks ‒ principally monetary policy ‒
and other economic policies received limited attention in the Maastricht
negotiations, even though it became the borderline between national
and EU competences. The independence of the ECB had the counterpart
that the Treaty enumerated its tasks in Article 127 TFEU: defining and
implementing the monetary policy of the Union; conducting foreign-
exchange operations; holding and managing the official foreign reserves
of the Member States; and promoting smooth operation of payment
systems. The ECB was given limited leeway to expand its tasks alone or
even through EU secondary legislation.
The model could be called a narrow central banking model that
includes only tasks that have a direct link to monetary policy.29 The
model protects national economic policy competences, and hence
embodies the principle of conferral. Some discussion on the borderline
took place with regard to financial stability30 with a decision to maintain
it mainly as a national responsibility. Banking supervision continued to
be based on the principles of home-country supervision and a European
passport.31 The ECB was only to ‘contribute to the smooth conduct of
policies pursued’ by mainly national authorities, although the ECB could
be given some special tasks in the prudential supervision of credit
institutions.32
Theoretically, giving tasks to an independent expert requires that
these tasks can be controlled mainly by judicial means. If this independ-
ence is constitutionally protected, the requirements are stronger. A key
EMU assumption is that monetary policy is a function that can be
assigned to an independent expert with a condition that the ECB’s strict
mandate excludes political value judgments and explicit distributional
functions. As the ECB has acknowledged itself, it is not equipped to make
legitimate political value-based decisions.33

29
Broader central banking models contain a variety of legacy tasks, for example, related to
banking supervision or management of government debt.
30
de Haan et al. (2009), European Financial Markets and Institutions, 355.
31
‘European passport’ refers to the model where a bank supervised in one EU country is, in
principle, allowed to provide financial services in other Member States.
32
Articles 127(5) and 127(6) TFEU.
33
‘Financial support measures potentially involving the significant transfer of credit risk
from financial institutions to the taxpayer clearly fall within the realm of fiscal policy.’
in Trichet (2009), ‘The ECB’s Enhanced Credit Support’.

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 3.1 the european macroeconomic constitution 77

Defined Monetary Policy Strategy

The defining and implementing common monetary policy is left to the
ECB with some guidance for implementation.34 The ambiguity of the
Treaty framework is balanced by the ECB’s obligations to make public its
monetary policy strategy, operational targets and the operational frame-
work. The published strategy facilitates the accountability of the ECB by
providing points of reference to assess how the ECB aims to achieve its
primary objective. Its Statute gives indications about the possible elem-
ents: setting up central bank accounts, open market and credit
operations based on adequate collateral, imposing minimum reserve
requirements on credit institutions, and, importantly, other monetary
policy instruments the Governing Council deems necessary. This open-
ended list contains the idea that the ECB is obligated to announce its
monetary policy strategy, operational targets and operational frame-
work. Even the Statute points to an obligation to ‘establish general
principles for open market and credit operations’.35
The defined monetary policy strategy is a constitutional requirement
stemming from the ECB’s unique independence. The strategy also facili-
tates the accountability of the ECB by explaining how the ECB achieves
its primary objective and by setting a point of reference to assess
whether the ECB operates according to its objectives and tasks or not.
Otherwise, the monetary dialogue in the EU Parliament could become an
empty formality. The strategy is thus an intellectual framework under
which the ECB ex ante informs the public of its policy choices, and ex post
explains how policy measures contributed to achieving objectives.

Prohibition of Public Financing

The Maastricht Treaty made it clear that monetising public sector debt
should never be an option in the EMU.36 Central bank-financed public

34
The ECB can decide by a qualified majority on new instruments, but needs approval from
the ECOFIN if the instruments impose obligations on third parties (Art. 20 Statute).
35
Articles 127(2) TFEU and 18.2 Statute.
36
Article 123 TFEU: ‘[o]verdraft facilities or any other type of credit facility with the
European Central Bank or with the central banks of the Member States in favour of
Union institutions, bodies, offices or agencies, central governments, regional, local or
other public authorities, other bodies governed by public law, or public undertakings of
Member States shall be prohibited, as shall the purchases directly from them by the
European Central Bank or national central banks of debt instruments’. NCBs can still
function as fiscal agents (Art. 21 Statute). A Council regulation clarified Article 123
TFEU, pointing out that ‘purchases made on the secondary market must not be used to
circumvent the objective of that Article’. Council Regulation (EC) No 3603/93 specifying

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 78 3 principles of the european macroeconomic constitution

debt and inflation are linked both historically and theoretically. Hence,
the prohibition of central bank financing protects price stability by
maintaining the central bank in control of money supply, which also
reduces incentives to create surprise inflation to reduce the real value of
accumulated government debt.37 In the EU, the prohibition also protects
fiscal prudence alongside the no-bailout clause. Allowing the ECB or the
NCBs to finance governments could ultimately lead to the ECB assuming
liability for those debts.38 Hence, the provision supports market discip-
line on Member State public finances, as Member States cannot rely on
privileged access to NCB or other bank financing.39 The application of
Article 123 TFEU was clarified by a Council regulation that pointed out in
its preamble that ‘purchases made on the secondary market must not be
used to circumvent the objective of that Article’.40
The prohibition is based on a similar provision in the Bundesbank
Act41 that also was meant to protect price stability.42 The initial
German position was to prohibit all dealings with government bonds,
but most EU countries had insufficiently developed private bond
markets for the purpose of monetary policy operations. The balance
struck in the Treaty contains a strict prohibition on purchasing bonds
directly from governments, affirming that the ECB should not play a
creditor role towards governments. The prohibition of public financing
is hence a constitutional principle that excludes central bank financing
of governments and facilitates market discipline, and thereby supports
Member State fiscal soundness. Importantly, it also protects the ECB’s
independence by removing the incentives to make it assume liability for
Member State debt.

definitions for the application of the prohibitions referred to in Articles 104 and 104b (1)
of the Treaty [1993] OJ L 332, 31/12/1993, 1–3.
37
Clarida and Gertler (1997), ‘How the Bundesbank Conducts Monetary Policy’ and
Committee of Governors (CoG) Document 1669/1670.
38
Also Article 125 TFEU. The ECB has been explicit on the prohibition, pointing that the
prohibition must be interpreted extensively in order to ensure its strict application,
Legal Opinion CON/2008/46.
39
Article 124 TFEU.
40
Council Regulation (EC) No 3603/93 of 13 December 1993 specifying definitions for the
application of the prohibitions referred to in Articles 104 and 104b (1) of the Treaty. OJ
L 332, 31/12/1993, 1–3.
41
Article 20. Clarida and Gertler (1997), ‘How the Bundesbank Conducts Monetary
Policy’, 366.
42
CoG Document 1669/1670, 25, according to Smits (1997), The European Central Bank, 289.

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 3.1 the european macroeconomic constitution 79

National Responsibility for Economic Policy and Safeguards

against Unsound Policies
The EMU did not abolish Member State sovereignty in economic policy,
but that sovereignty was imposed EU-level guidelines and restrictions
to ‘conduct their economic policies with a view to contributing to the
achievement of the objectives of the Union’.43 The Member States and
the EU, including the ECB, were to support the general economic policies
in the Community without compromising the price stability objective.44
National discretion over economic policy involved a risk that a
Member State could cause negative repercussions for other Member
States and for the conduct of common monetary policy. Consequently,
provisions on public finances in the EMU were stricter than the earlier
provisions on economic policy coordination. The aim was to guarantee
that Member States took the objective of sound public finances seriously.
The focal point was general government deficit; the Treaty imposes an
obligation to avoid excessive government deficits and provides means to
correct them should they occur.45 Continuous monitoring was comple-
mented with a corrective arm that relies on the excessive deficit proced-
ure.46 However, the decision on the existence of an excessive deficit, on
remedies and on potential sanctions was given to the EU Council.47
The perceived need for safeguards against reckless fiscal policy
resulted also from differences between Member State economic models
concerning fiscal, social and industrial policies that had not converged
significantly.48 Some Member States were seen to lack fiscal discipline, at
least historically, and Germany feared that the need for support inter-
ventions, a common theme in the EMS, would become a structural

43
Articles 120 and 121(1) TFEU.
44
And taking place ‘in accordance with the principle of an open market economy with free
competition’ Article 119(2) TFEU. The formulation was changed during the Maastricht
negotiations to stress that the economic policy counterparts for the ECB were the
economic policies of the Member States. James (2013), ‘Designing a Central Bank’.
45
Article 119(3) TFEU. The multilateral surveillance procedure set out in Article 121 TFEU
and further specified by Regulation 1466/97.
46
Articles 121 and 126 TFEU were complemented by the Stability and Growth Pact,
including the Resolution of the European Council, which emphasised prevalence of the
price stability objective over national fiscal policies.
47
Council Regulation (EC) 1467/97 on speeding up and clarifying the implementation of
the excessive deficit procedure [1997] OJ L209/6. The SGP complemented Treaty
provisions with timetables and procedures for sanctions that could be imposed on
Member States failing to correct excessive deficit.
48
Thiemeyer (2013), ‘Economic Models in France and Germany’.

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 80 3 principles of the european macroeconomic constitution

feature in the EMU. Markets provided insufficient incentives for sound

public finances at first, but once a default was possible, Member States
were expected to lose market access altogether.49
Maastricht Treaty guarantees against unsound fiscal policies include a
no-bailout clause prohibiting shared liability for government debt by
Member States and the EU. It addresses the moral hazard problem:
reckless borrowing by Member States and reckless lending by credit
markets. An expected bailout by the EU or by other Member States would
reduce market incentives to undertake a proper credit assessment and
continuous monitoring. The no-bailout clause gave an expression to
Member States’ exclusive liability for national fiscal commitments.
A fundamental and largely unresolved problem was that, in effect,
national fiscal policy became more important due to loss of national
monetary policy. For example, reacting to country-specific economic
shocks relied on national fiscal policy. At the same time, constraints
were imposed on Member State sovereignty in economic policy. The
importance of fiscal policy increased, requiring sufficient leeway for
Member State decision-makers, and at the same time, potential spill-
overs, especially to common monetary policy, required strict
European constraints.

3.2 Assumptions of the European Macroeconomic

Constitution
The European Macroeconomic Constitution was based on a set of
constitutional principles discussed above:
• the internal market objective;
• the price stability objective;
• indivisible and exclusive monetary policy competence for
the EU;
• national responsibility for fiscal and other economic policies;
• the principle of an open market economy and free competition;
• the independence of the Eurosystem, the ECB and NCBs;
• a narrow ECB mandate, excluding areas in need of political value
judgments;
• a defined strategy for the ECB;

49
The colourful history of interventions in James (2012), Making the European Monetary
Union, 181–209 and Delors Report, 20.

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 3.2 und erlying assumptions 81

• prohibition on central bank financing of the public sector;

• safeguards against unsound national economic policies.
These principles should be seen as a constitutional whole and as a part of
the larger European economic constitution that also includes microeco-
nomic components. The macroeconomic constitution was even built on
the success of the microeconomic constitution, although there are fun-
damental underlying differences between the two that could be attrib-
uted to their different economic backgrounds.

3.2.1 Microeconomic and Macroeconomic Constitutions

Represent the Same Whole
The European economic constitution forms a unified constitutional
whole in which the micro- and macroeconomic constitutions are closely
interrelated both through common constitutional themes and values as
well as through assumed causalities. A critical feature is that the eco-
nomic constitution includes elements that do not need frequent demo-
cratic inputs, which can explain why it first developed in the area of the
microeconomics, while macroeconomic parts continued as national
responsibilities that required democratic inputs.50 The Maastricht
Treaty formed the link between the two constitutions by maintaining
the primacy of microeconomic objectives. The economic policies of the
Member States and the EU, including monetary policy, needed to support
the internal market and be conducted in accordance with the principle
of an open market economy with free competition.51 It could be argued
that this reflected the original economic constitutional thinking that
aimed to protect a decentralised economic model with individual choices
by households and companies at the core.
Differences in Member State economic stability had hampered the
functioning of the microeconomic constitution. Both the Werner
Group and the Delors Committee saw the EMU as a natural further step
in economic integration. The interdependencies between Member State
economies had already increased, and strengthening the single market

50
This is linked to the view that the EU relies almost exclusively on liberal legitimation
discourses, while republican or democratic legitimation discourses occur at national
level. Scharpf (2009), ‘Legitimacy in the Multilevel European Polity’, 176.
51
Articles 119(1), 119(2) and 127(1) TFEU.

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 82 3 principles of the european macroeconomic constitution

further required integration at the macroeconomic level,52 as diverging

trends in macroeconomics became a hindrance to the objectives of
the Community.
The interdependence between the microeconomic and macroeconomic
constitutions goes both ways. The macroeconomic constitution relied on
the premise of the microeconomic constitution being fully implemented.
Issues such as euro area labour mobility and even wage flexibility are
often considered necessary for a well-functioning currency area. The
euro was hoped to yield rewards from the attainment of market free-
doms and performance-based competition, but there was also a fear that
it would punish Member States with inflexible and malfunctioning prod-
uct and labour markets.
The early benefit that the microeconomic constitution did not need
democratic inputs was becoming a caveat as well. Constitutional evolu-
tion driven by the actions of the CJEU and the Commission did not build
institutional capacity for the Community as a political power on a global
scale. Community macroeconomic competences could become a plaus-
ible way to gain political influence and potentially achieve broader aims
and objectives, including beyond EU borders.
Furthermore, the microeconomic constitution and its institutional
experiences and implementation acted as a procedural model for a
macroeconomic constitution. Consequently, the economic provisions in
primary law were given effective judicial protection similar to the micro-
economic constitution. The Treaty also assigned independent experts to
safeguard the principles. In the microeconomic constitution these
experts were the Commission and the CJEU, and in the macroeconomic
constitution the main expert role was played by the ECB with the CJEU
acting as a safety valve.

3.2.2 Differences between the Two Economic Constitutions

Differences between the microeconomic and macroeconomic constitu-
tions were most likely overlooked. They are based on the approaches and
rationales of two different fields of economics, in which the robustness
of the underlying economic paradigms are fundamentally different.
Microeconomics is the area of economics that focuses on the behaviour
of consumers, companies and industries. It aims to understand the

52
In effect, the price stability part of the economic constitution was at least formally
stipulated in the Bretton Woods system through the currency peg to the US dollar and
hence indirectly to gold.

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 3.2 und erlying assumptions 83

decision-making process of firms and households and the distribution of

production and income among them. Individuals are assessed as sup-
pliers of labour and capital, but also as consumers. Similarly, companies
are users of labour and capital as well as suppliers of products. Particular
emphasis is placed on the interaction between the various parties in
different markets that determine prices and output on the basis of
supply and demand.53 The basic paradigms of microeconomics have
remained stable for a long time, and continuous development and even
new elements in the analytical framework (such as game theory) could
be described as evolutionary rather than revolutionary.54 In addition, the
data used in microeconomic analyses is mostly reliable and directly
observable. The prices, quantities and other reflections of individual
decisions can generally be derived from reliable sources.55
Macroeconomics focuses on the aggregate level of the economy. The
separation of macroeconomics occurred when Keynesian thinking was
adopted not only theoretically but more importantly in economic policy.
Rather than focusing on the actions of individuals or the functioning of
specific markets, macroeconomics is concerned with mainly economy-
wide phenomena such as changes in unemployment, aggregate national
income, GDP growth, the price level, public expenditure and revenues,
savings, investments and purchasing power. Macroeconomics is often
based on empirical generalisations that are facilitated by theoretical
considerations. Moreover, aggregate-level data based on statistics can
be surprisingly unreliable.56 In contrast to microeconomic theory, very
few macroeconomic theories have remained unchanged or uncontested
for long periods of time. Furthermore, while theoretical development in
microeconomics is mostly incremental and evolutionary, macroeconom-
ics has witnessed revolutions, leading to very different policy
conclusions.
The underlying fundamental differences between microeconomic and
macroeconomic theories have affected their relationship with law. The
most elementary part of microeconomics has been governed by private
law, which is the main legal framework for economic life in liberal

53
www.britannica.com/EBchecked/topic/380357/microeconomics.
54
Many classic economics books are still mostly in line with contemporary thinking on
microeconomics: such as Menger (1976 [1871]), Principles of Economics; Walras (1954),
Elements of Pure Economics; and Marshall (1890), Principles of Economics.
55
Faust et al. (2005), ‘News and Noise’, 403–419.
56
www.britannica.com/EBchecked/topic/178548/economics/38847/Definition.

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 84 3 principles of the european macroeconomic constitution

societies. Even when the legal elements in societies have increased,

microeconomic issues are still largely based on frameworks, be it com-
petition law or consumer protection, rather than on administrative or
political discretion. By contrast, the macroeconomic influence on the
economy is often based on active economic policies. Although the bulk
of public expenditure is defined in structural policies in the form of laws,
these fundamentally rely on value judgments and thus on the political
process and democratic inputs.

3.3 Constitutional Implications of Links and Differences

The discussion on economic theories revealed some fundamental differ-
ences that are likely to have constitutional implications, for example, for
the roles of law and courts, the role of expert bodies, and finally, the
constitutional control mechanism.

3.3.1 National and International

Compared to national constitutions, the reach of EU primary (consti-
tutional) law in both micro- and macroeconomic issues is exceptional. At
the national level, economic models are generally subject to political
battles.57 The microeconomic provisions on economic freedoms and
competition law have been interpreted by the CJEU in a way that argu-
ably constitutionalised an economic model based on free trade and
undistorted (intra-EU) competition, which has conceivably given
European economic integration a broader liberalist orientation.58
However, this was not explicit, as EU integration from the start
(Schuman declaration) and continuing to Article 345 TFEU did in ‘no
way prejudice the rules in Member States governing the system of
property ownership’ nor assume any economic model.
The European Macroeconomic Constitution continued along the same
path of constitutionalising elements of the economy that are rarely
contained at least explicitly in national constitutions such as economic
objectives and constraints.59 National constitutions generally maintain

57
Some key elements can be constitutionally protected, such as the right to property,
freedom of contract and freedom of trade.
58
Scharpf (2009), ‘Legitimacy in the Multilevel European Polity’, 173–204.
59
Some federal constitutions may coordinate the responsibilities and liabilities of the
various levels, as in the US and Germany.

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 3.3 constitutional links and differences 85

economic policy neutrality; indeed, constitutional constraints on public

deficit and debt were criticised from this perspective. This neutrality
stems from the premise that economic policy involves value choices,
which in turn cannot be derived from generally accepted, objective
economic facts. Paradoxically, as many elements of the European
Macroeconomic Constitution were not constitutional at the national
level, this facilitated their development at the EU level by reducing the
likelihood of conflicts between constitutions. Community economic con-
stitutionalisation could develop in parallel with diverse national
constitutional developments.

3.3.2 The Role of Courts and the Rule of Law

Micro- and macroeconomic constitutions demonstrate differences that
are important for the role of law and courts. These include their address-
ees, the type of regulation, and also the organs assigned the task of filling
the gaps and leading experimentalism when unforeseen situations arise.
The four freedoms as well as competition and state aid rules are typical
rule-based economic regulations with relatively clear addressees and
objectives. Rules and regulations obligate and empower addressees, and
their application requires straightforward legal (and economic)
techniques.
The role of courts and also the rule of law with the respective eco-
nomic constitutions is affected by the subject matter. With the micro-
economic constitution the facts of the case are known, including the
actions and omissions of the parties. A straightforward legal interpret-
ation can define the outcome. In the macroeconomic constitution,
objectives and aggregate values can be defined in seemingly exact terms,
such as an upper limit for government deficit or debt, but their attain-
ment depends on many policy decisions and external factors that cannot
be exhaustively regulated by law. Furthermore, even precisely defined
objectives and values need to leave room for exceptions to allow reac-
tions to surprising events. This puts the rule of law in doubt.
Another major difference between the microeconomic and macroeco-
nomic constitutions is the number and nature of legal cases. The evolu-
tionary development of the microeconomic constitution took place
through numerous cases brought to the CJEU by domestic courts
through the preliminary ruling procedure. The CJEU was able to intro-
duce new legal elements gradually to the European economic constitu-
tion. Landmark cases did not generally hold enormous economic
importance in themselves. Their significance came through their impact

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 86 3 principles of the european macroeconomic constitution

on legal principles and the content of the microeconomic constitution.60

In contrast, even before the crisis, the few cases in the area of the
macroeconomics were politically loaded, putting the CJEU in situations
where it struggled to apply standard legal reasoning or methodology
without considering the outcome.
The CJEU and the Commission took the main roles of defining the
content of the microeconomic constitution on the basis of their man-
dates to create and maintain an effective legal order for the commu-
nity.61 The CJEU was responsible for the necessary experimentalism with
regard to unforeseen situations, ‘integration through law’,62 also
engaging national courts through the preliminary ruling procedure.
The fact that the microeconomic constitution mainly dealt with the
behaviour of individual economic actors, even if the addressees were
Member States, facilitated the role that law and courts played in imple-
menting and further elaborating the microeconomic constitution.
However, this was not a straightforward application of law in new
situations, but a more nuanced development in which the Court kept
one eye on the majoritarian acceptability of its more far-reaching inter-
pretations. In the area of macroeconomics, the contribution of the law
and the courts has been less prominent.
The EMU did not give new rights to individuals, nor did it impose new
restrictions on Member-State relationships with private parties.63 It
assigned new economic objectives, tasks and responsibilities to public
authorities. However, although the ECB was given the responsibility for
the common monetary policy with the objective of price stability, the
actual content of monetary policy was not thoroughly defined. Even
price stability is not an unambiguous concept, and the ECB’s numerical
definition is a statistical aggregate figure that could be composed in
many ways. Furthermore, the ECB does not have direct means to control
price stability. Similarly, national governments have the responsibility to
maintain their public deficits below a predetermined limit, but this is a
combination of many factors over which governments have varying

60
Maduro explains the process thoroughly with regard to the previous Article 30 on the
free movement of goods in Maduro (1998), We The Court. See also Alter (2001), Establishing
the Supremacy of European Law and Sweet (2000), Governing with Judges.
61
de Búrca and Weiler (2001), The European Court of Justice.
62
Probably for the first time used by Cappelletti, Seccombe, and Weiler (1985), Integration
Through Law.
63
During the crisis, some cases could add a new perspective on the issues such as Case C-8/
15P Ledra Advertising Ltd and Others v European Commission and European Central Bank (ECB).

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 3.3 constitutional links and differences 87

degrees of control. Hence, the links between measures and outcomes are
vague. This in turn makes juridical control difficult, even before con-
sidering that many issues lie at the heart of the Member States’
democratic processes.
Consequently, legal regulation of macroeconomic issues became
focused on procedures rather than substantive policies. However, the
effectiveness of procedural regulation, giving expression to the open
method of coordination, has proved many pessimistic expectations cor-
rect. The outcomes of constitutionally regulated procedures have been of
a ‘soft’ law nature. Correspondingly, the courts – both the CJEU and
national courts – have played a limited role in implementing the
European Macroeconomic Constitution. Before the crises, the only judg-
ments of the Court explicitly addressing the macroeconomic constitu-
tion were Commission v. Council in 2004, which dealt with the sanctions
regime of the excessive deficit procedure,64 and the OLAF case.
Commission v. Council exemplifies the problem with juridical control
and contested macroeconomic policy choices. In November 2003 the
ECOFIN Council declined to endorse the Commission’s recommenda-
tions to take further steps in the excessive deficit procedure against
France and Germany. Consequently, the Commission filed a case against
the Council. Although the CJEU agreed with the Commission on formal
issues, it declared the action inadmissible for the main substantive part.
The judgment gave the Council a wide discretion: ‘It can on the basis of a
different assessment of the relevant economic data, of the measures to
be taken . . . modify the measure recommended by the Commission.’65
The CJEU showed that the excessive deficit procedure contained a polit-
ical judgment that was allocated to the ECOFIN Council. An automatic
disciplinary mechanism had been available for the Treaty drafters, but
they opted for a flexible model. When the Council used that discretion, it
was acting within its powers.66 The judgment is defendable on the basis
of EU law, but it largely ended the excessive deficit procedure and the

64
Case C-27/04 Commission v Council [2004] ECR I-6649.
65
Case C-27/04 Commission of the European Communities v Council of the European Union. ECLI:
EU:C:2004:436.
66
This was considered an unfortunate judgment according to many including the ECB.
ECB press release (25 November 2003), ‘Statement of the Governing Council on the
ECOFIN Council conclusions regarding the correction of excessive deficits in France and
Germany’, www.ecb.europa.eu/press/pr/date/2003/html/pr031125.en.html; Gros et al.
(2004), ‘The Nine Lives’.

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 88 3 principles of the european macroeconomic constitution

Stability and Growth Pact as fiscal disciplinary measures, and showed the
difficulty of legally reinforcing macroeconomic provisions.67
Arguably the problems concerning the limited role for law and courts
in terms of the macroeconomic constitution were acknowledged. As
explained, the excessive deficit procedure contains political judgments.
Similarly, no specific liability was included for failing to achieve the price
stability objective. Failure to maintain price stability is not a legal ground
for dismissal of the ECB President or even for activating a mechanism to
ensure proper action.

3.3.3 The Role of Expert Bodies

The general preconditions for an independent expert function are, first, a
conviction that expert knowledge is critical for performing a task. This
means applying expert tools and cumulative information to specific
cases. A further precondition is that these tasks are best performed
independently, outside – particularly – political influences. The formal
independence of an expert relates to the risks of harmful interventions.
A formally and intentionally independent organisation is an exception
that requires specific justification.68
The main examples of independent expert functions include courts
and competition authorities that were also supranationalised in the EU.
Assigning competition authorities an independent expert role started to
gain support only during the first half of the twentieth century to avoid
the economic interests involved taking over the political system, with
harmful consequences.69 The formal independence of central banks is an
even more recent innovation and also the first example of macroeco-
nomic management being assigned to an independent expert. As could
be recalled from Chapter 2, the idea was based on both empirical and

67
This was visible in media and market reaction to the ECOFIN decision in headlines such
as ‘France and Germany smash Euro pact’, www.telegraph.co.uk/finance/2870055/
France-and-Germany-smash-Euro-pact.html, ‘France and Germany evade deficit fines’,
www.theguardian.com/business/2003/nov/25/theeuro.politics; ‘Le gel du pacte de
stabilité divise l’Europe’. www.lemonde.fr/archives/article/2003/11/25/le-gel-du-pacte-de-
stabilite-divise-l-europe_343383_1819218.html?xtmc=commission&xtcr=5.
68
Habermas labels this type of decision-making as a technocratic model, in which there is
no longer room for political decision-making, as scientific rationalisation reduces the
available options to one. It assumes that there is a continuum of objective rationality
that can and must be applied. Habermas, (1971), ‘Toward a Rational Society’, 63–64.
69
This is the ordoliberal nightmare of an interest group society, for example, in Eucken
(1952), Grundsätze der Wirtschaftpolitik.

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 3.3 constitutional links and differences 89

theoretical considerations to institutionally solve the time-inconsistency

problems.
Both the micro- and macroeconomic constitutions consider some
underlying economic issues as scientifically and objectively determined
choices that do not benefit from continuous democratic inputs.
Consequently, these can be left to non-political specialists whose expert-
ise guarantees the optimal outcome. Within the microeconomic consti-
tution, the key players are the courts – mainly the CJEU – and the
Commission as the competition authority. In the macroeconomic consti-
tution, the position of the courts is more limited, and the main guardian
of the macroeconomic constitution is the ECB as an expert body insu-
lated from political influence. The Commission coordinates and moni-
tors Member States’ economic and fiscal policies.70

3.3.4 Constitutional Control

The European economic constitution can also be seen in the light of its
underlying legitimation discourses.71 The legitimation discourse also
advises on the most suitable constitutional control mechanisms, because
the legitimacy of the constitutional model rests on the justifying narra-
tives and discourses that contribute to compliance even with undesired
decisions and gives them justification. The main discourses to be con-
sidered are the republican and liberal ones.72
The republican discourse stresses the idea of the common good. The
actual form of governance is less critical than the process of ensuring
that the most appropriate leaders serve the interests of the political
community. In the democratic model, the republican discourse sees
elected representatives as holders of the common interest that are
accountable for their actions through ongoing discussion in the
public space and ultimately through elections.73 Liberal discourse places
the individual above the political community, although individual

70
Eucken (1952), Grundsätze der Wirtschaftpolitik states that monetary stability is the first
constituent principle of economic order.
71
Scharpf (2009), ‘Legitimacy in the Multilevel European Polity’, 174–175.
72
See, for example, Beetham (1991), The Legitimation of Power; Easton (1965), A Systems
Analysis of Political Life and Scharpf (1999), Governing in Europe.
73
See Scharpf (2012), ‘Legitimacy Intermediation in the Multilevel European Polity’ and
Habermas (2001), ‘Constitutional Democracy’, 766–781.

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 90 3 principles of the european macroeconomic constitution

self-interest can rationalise many forms of government, for example, to

achieve security, basic freedoms and property rights.74
In most Western countries, the republican and liberal discourses have
co-existed, and they have used both input and output-based legitima-
tions. In republican discourse, output can be measured via the common
good, in whatever way derived. Liberal discourse emphasises protection
of security and liberties against various threats. With regard to input-
based legitimacy, the republican discourse allows more inroads into the
lives of individuals as long as these are based on processes that guarantee
the assumed common good. Liberal discourse sees less room for input-
based legitimation to reduce private autonomy, such as substituting free
markets for active public sector interference. In the EU, the republican
discourse takes place mainly at the national level, while part of the
liberal discourse has become European.75
The liberal discourse as a key legitimation mechanism involves impli-
cations for the constitutional control of the European Macroeconomic
Constitution and in particular of the ECB as an independent apolitical
expert. First, the tasks assigned to the ECB need to be such that they can
be controlled by the dual means of juridical control and accountability,
facilitated by transparency, where the threshold for judicial review
should be low. Second, functions and decisions that contain value judg-
ments are excluded. Third, delegated functions have to be defined ex ante
relatively precisely, including their possible outcomes. These three con-
ditions must be part of the initial (democratic) decision on the assigned
function and its objectives.
Arguably the functions delegated to the ECB largely fulfilled the cri-
teria with some assumptions. The most essential assumption was that
the role of monetary policy followed the consensus model of the early
1990s with the addition of some economic constitutional thinking. As a
result, the EMU monetary system holds features that are closer to an
enhanced gold standard than a field of activist monetary policy,
although most Member States hardly subscribed to this.76
Furthermore, it could be argued that the ECB’s constitutional control
mechanisms met the minimum criteria for a narrow central banking

74
The main philosophers include John Locke, Adam Smith, Jeremy Bentham and even
Friedrich A. Hayek.
75
Falkner (2011), The EU’s Decision Traps; Scharpf (1999), Governing in Europe and Scharpf
(2012), ‘Legitimacy Intermediation in the Multilevel European Polity’.
76
See the quite different aims and perceptions in Dyson and Featherstone (2000), The Road
To Maastricht.

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 3.3 constitutional links and differences 91

model. However, much was left to the ECB to meet the requirements of
transparency and accountability and also to exercise considerable self-
restraint in the borderlines of its mandate. If accountability through
transparency failed or the ECB lost its self-restraint, the safety valve
would be judicial control, which left the CJEU with an enormous
responsibility.
The failure of constitutional control mechanisms, whether account-
ability or judicial review, would lead to democratic legitimacy problems
that are particularly difficult for an independent expert at the supra-
national level, let alone with the potentially extensive economic powers
of the ECB. The democratic legitimacy of the ECB was a topic from the
Delors Committee onwards, as the principle of independence excluded
democratic inputs to the common monetary policy. However, to con-
clude that the ECB is not democratically legitimate is not correct. The
most important democratic legitimatisation took place when the
common central banking system was decided upon. The ECB’s compe-
tences are defined in the Maastricht Treaty that was agreed upon
through the democratic processes of each Member State. An additional
and more problematic form of legitimacy is the so-called output legitim-
acy. The system is legitimate as long as it provides people in the euro area
with prosperity and economic stability.
In conclusion, the EMU can be presented as a legitimate choice to give
some elements of the macroeconomic framework constitutional protec-
tion, to the extent that its key actors are controlled by a combination of
accountability and extensive transparency, and failing that, through
judicial means. The preconditions and assumptions for a systemic choice
need to be met, or they lose their legitimacy-providing properties.
Importantly, the model left excessive discretion to independent experts –
mainly the ECB – considering that the underlying economic paradigms
are prone to changes. If the ECB needs to head into unchartered seas, it
finds difficulty in getting the democratic navigation it needs. The final
safety valve is the possibility to change the Treaty.

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 4 ECB Organisation, Monetary Policy
Strategy and Operational Framework

An economic constitutional assessment of the ECB needs to be based

on an understanding of how its monetary policy operates. Although
the monetary policy practices have converged, many instruments and
concepts still differ. Additionally, the ECB has its own peculiarities not
least because the uncertainties related to ECB monetary policy exceeded
those of the older central banks. Three different but interlinked concepts
are important to understand: monetary policy strategy, the monetary
policy transmission mechanism, and the operational framework.
Monetary policy strategy describes the ECB’s role in the economy
and how it achieves its objectives. The monetary policy transmission
mechanism is embedded in monetary policy strategy and seeks to
explain how monetary policy measures are transmitted to the economy,
and how monetary policy decisions affect the primary objective of price
stability. The operational framework makes monetary policy decisions
operational by proving the link from monetary policy decisions to money
market interest rates and ultimately to the economy at large. These are
discussed in turn after a brief description of the ECB’s organisation and
decision-making bodies. A broad constitutional assessment concludes
the chapter.

4.1 Institutional Structure

The EU central banking model contains three types of institutions that
have been assigned tasks and objectives. These are the ECB, the national
central banks of euro area countries (NCBs), and the national central
banks of countries that have not adopted the euro (non-euro NCBs). The
ECB and the euro area NCBs form the Eurosystem, the central banking

92

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 4.1 institutional structure 93

system of the euro area.1 In this book, the term ECB is used instead of the
Eurosystem unless there is a specific need to differentiate between
the two.
The key decision-making bodies of the ECB are the Governing Council
and the Executive Board. The Governing Council consists of the six
members of the Executive Board located at the ECB headquarters in
Frankfurt and the governors of the NCBs.2 The Governing Council makes
the formal decisions of the ECB and hence also of the Eurosystem.3 The
Governing Council has to meet at least ten times a year and keep
approved minutes. In practice, the Governing Council meets twice a
month, of with the first is the actual monetary policy meeting followed
by a formal statement and a press conference.4 The meetings are closed
and the Statute even requires confidentiality, although the Governing
Council has gradually increased the information it provides.5 However, it
still does not publish transcripts or personal voting records.6
The ECB Executive Board comprises the President and Vice-President
of the ECB and four members. The Board takes care of the daily
operations of the ECB in accordance with the guidelines specified and
decisions taken by the Governing Council. The most important part is
the implementation of monetary policy with the necessary coordination

1
The ECB and all the EU national central banks form the European System of Central
Banks (ESCB).
2
Articles 129 and 283(1) TFEU. When the euro area countries reached nineteen in 2015,
rotation of voting rights among the governors started. Governors of the five largest
countries share four voting rights between them and the rest share eleven voting rights.
All the Executive Board members have a vote, raising the total number of votes to twenty-
one. This aimed to avoid a major decentralisation of votes (Art. 10.2 Statute). See, www
.ecb.europa.eu/explainers/tell-me-more/html/voting-rotation.en.html. For example, in the
Fed’s FOMC, the Board of Governors have seven votes, the New York Fed one vote and the
rest share four rotating votes.
3
Its functions are summarised in Article 12 Statute: ‘[t]he Governing Council shall adopt
the guidelines and take the decisions necessary to ensure the performance of the tasks
entrusted to the ESCB under these Treaties and this Statute. The Governing Council shall
formulate the monetary policy of the Union including, as appropriate, decisions relating
to intermediate monetary objectives, key interest rates and the supply of reserves in the
ESCB, and shall establish the necessary guidelines for their implementation.’ The specific
rules are in the Rules of Procedure of the ECB. Decision of the ECB of 19 February 2004
adopting the Rules of Procedure of the ECB (ECB/2004/2) (2004/257/EC).
4
www.ecb.europa.eu/ecb/orga/decisions/govc/html/index.en.html. The second meeting,
called Non-monetary policy meeting, tackles more practical and administrative issues.
5
From 2015 onwards, a narrative of the meetings is published after four weeks labelled
Account of the monetary policy meeting of the Governing Council of the European Central Bank.
6
See www.bundesbank.de/Redaktion/EN/Topics/2015/2015_02_19_ecb_accounts.html.

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 94 4 organisation, strategy & f ramework

and instructions to NCBs. The Executive Board also organises the meet-
ings of the Governing Council, which are chaired by the ECB President.7
The ECB General Council – that consists of the President and Vice-
President of the ECB and all the EU central bank governors – is a transi-
tional body with preparatory tasks that are carried until all EU Member
States adopt the euro.8
The selection processes for both Executive Board members and also
NCB governors are critical for the personal independence component of
the ECB’s independence. The President, the Vice-President and the other
members of the Executive Board are appointed by the European Council,
acting by qualified majority. They must be of recognised standing and
have professional experience in monetary or banking matters. They
serve a non-renewable term of office of eight years.9 The other
Governing Council members are NCB governors and their requirements
are in national legislation, but as Governing Council Members they are in
personal capacity, not as representatives of their country or central
bank. Therefore, some EU law guarantees are needed to ensure govern-
ors personal independence including a minimum term of office of five
years and protection against removal of office.10 This borderline between
EU law and national law gave rise to an interesting legal case when the
Latvian anti-corruption office relieved local governor Rimšēvičs from his
duties during a pending criminal case. This decision was annulled by the
CJEU at the request of the ECB to protect the independence of its
decision-making body.11
The basic rule for the publication of ECB documents is that the pro-
ceedings of the decision-making bodies are confidential unless the
Governing Council authorises the President to make the outcome of

7
Articles 12.1 and 12.2 Statute list the duties of the Executive Board. Further rules are
stipulated in the Decision of the ECB of 12 October 1999 concerning the Rules of
Procedure of the Executive Board of the ECB (ECB/1999/7) and (1999/811/EC). The Board
member responsible for the Economics gives the economic briefing prepared by the
ECB staff.
8
The General Council addresses the ECB tasks that are equally relevant for the euro and
non-euro Member States, including some advisory and statistical functions (Art. 47
Statute). Decision of the ECB of 17 June 2004 adopting the Rules of Procedure of the
General Council of the ECB (ECB/2004/12), OJ L 230, 30.6.2004, 61.
9
Selection procedure of the Executive Board is in Article 283(2) TFEU and Article 11.2
Statute. Nomination requires a recommendation from the Council after consultation
with the European Parliament and the Governing Council.
10
Articles 131 TFEU and 14 Statute.
11
Cases C-202/18 and C-238/18 Rimšēvičs and ECB v Republic of Latvia.

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 4.2 monetary policy strategy 95

deliberations public. All documents are freely accessible only after a

period of thirty years.12
On budgetary matters, the Governing Council has a Budget Committee
that serves as an ex ante control of the ECB budget by its owners, the
NCBs.13 The Directorate Internal Audit of the ECB is a tool for
the Executive Board to supervise internal operations mainly from the
financial-prudential point of view. These internal procedures, while
undoubtedly necessary as such, have other aims than to increase the
control and the accountability of the ECB concerning its monetary
policy.
The decision-making bodies and the staff of the ECB follow the Codes
of Conduct to secure a level of professional standards and ethics. For the
Governing Council members, the codes protect both their integrity and
their independence, although the codes are more based on requiring
information on affiliations than actually prohibiting them. The codes
are also based on a memorandum agreed upon by the Governing Council.
A similar Code for the ECB staff was issued by the Executive Board.14

4.2 Monetary Policy Strategy

One of the first tasks of the freshly established ECB was to decide upon
its monetary policy strategy, which specified how its own measures
contribute to its objectives. The strategy describes the way the economy
is expected to function and how the central bank contributes to it. The
first ECB strategy, published under the title A stability-oriented monetary
policy strategy for the ESCB in October 1998, just before the euro was
launched, explained the general principles of conducting monetary
policy including the intellectual framework for making decisions on
official interest rates. It contained a quantitative definition of the pri-
mary objective of price stability; a prominent role for money with a
reference value for the growth of a monetary aggregate (M3); and a

12
Article 23 on the Decision of the ECB of 19 February 2004 adopting the Rules of
Procedure of the ECB (ECB/2004/2), (2004/257/EC).
13
Based on Article 15 of the ECB’s Rules of Procedure. Arguably, the budgetary pressure
from the NCBs also aims to control the growth of the ECB at the expense of the NCBs.
14
Code of Conduct for the Members of the Governing Council OJ (2002/C 123/06). More
specific rules govern issues such as insider trading, see Code of Conduct of the ECB in
accordance with Article 11.3 of the Rules of Procedure of the ECB. OJ 2001/C 76/11. Part
1.2 of the ECB Staff Rules containing the rules on professional conduct and professional
secrecy, OJ 2001/C 236/08.

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 96 4 organisation, strategy & f ramework

broadly based assessment of the outlook for future price developments.15

Since, this original and long-prepared strategy, the ECB has made two
reviews. The first, called the revised strategy, took place after four years
in 2003 and could be considered a brief first maintenance, in which the
real-life experiences were incorporated and some ambiguities clarified.
The second review was initiated by the current ECB governor Lagarde in
early 2020 after she took office and it was published in July 2021.16 By
that time, the recurring crises had had their effect on the ECB, its actual
strategy and its operations. The review process was long and thorough
with the aim of engaging the wider society and enhancing the ECB’s
credibility and reputation. The initial strategy remains the basis on
which adjustments are made, as was also the case in 2021 strategy review.
Some still unclear elements such as the ECB’s participation in fighting
climate change are discussed in Part III.
The starting point is that as the monopoly issuer of central bank
money the ECB can affect the economy. The strategy still largely follows
the model of the broad economics consensus of the 1990s with two
critical assumptions. First, inflation is fundamentally a monetary phe-
nomenon. After an adjustment period, monetary policy only affects the
price level, not the real economy. Longer-term income and employment
are based on structural features of the economy, not on issues that
monetary policy could influence. Second, the ECB is assumed to have
appropriate tools to influence the price level, its ultimate objective. The
specific routes through which it affects the economy are described in the
monetary policy transmission mechanism. Third, the longer-term neu-
trality of money needs to be accompanied with some assumed benefits of
price stability that the ECB sees stemming from economic and social
grounds. It improves the efficiency of the economy (including relative
prices and lower inflation risk premia) and helps the economy to reach
its full potential. Furthermore, surprise inflation causes arbitrary wealth
redistribution, even with devastating social consequences.17 In the
2021 review, the ECB barely discussed the negative effects of inflation
apart from pointing out their non-linear nature. In contrast to earlier

15
ECB press release (13 October 1998), ‘A stability-oriented monetary policy strategy for
the ESCB’, www.ecb.europa.eu/press/pr/date/1998/html/pr981013_1.en.html.
16
www.ecb.europa.eu/home/search/review/html/ecb.strategyreview_monpol_strategy_
statement.en.html.
17
The Monetary Policy of the ECB (2004), 41–43.

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 4.2 monetary policy strategy 97

strategies, the ECB stressed that it takes the price stability objective as
given, which could signal a reduced conviction.18
The ECB has actively communicated its monetary policy strategy but
also the uncertainties surrounding it. Initially, the experimental nature
of the euro and the risks of major structural discontinuities was a key
theme.19 The 2021 review and its background documents stressed the
changing and uncertain economic fundamentals, particularly the
declined natural real interest rate. The EMU monetary policy remains a
discovery process. The strategy review 2021 was accompanied by five in-
house reports on key topics and twelve reports by specific workstreams,
which mainly followed the approach of the original strategy.20
One key element of monetary policy strategy is the quantitative defin-
ition of price stability. It is expressed as a year-on-year increase in
consumer prices (HICP) for the euro area. Initially the numeric value
was below 2 per cent,21 the 2003 revision increased it to below but close
to 2 per cent, and finally in the 2021 review the ECB decided to aim at
2 per cent inflation over the medium term.22 In practical terms, while
the main figure has remained 2 per cent, the operative target has grad-
ually increased from 1 to 2 per cent to 2 per cent. The ECB has constantly
aimed to a buffer above zero to give monetary policy sufficient operating
space. As real interest rates have presumably declined, the zero bound on
nominal interest rates is a more frequent constraint. The ECB also wants
to have sufficient safety margin both against the risks of deflation and
also some level of cross-country inflation differentials.23 Furthermore,
wages are assumed to be nominally rigid downwards, and a measure-
ment bias could still overstate observed inflation. Apart from the more
strictly economic reason, the 2 per cent consumer price inflation has

18
www.ecb.europa.eu/home/search/review/html/ecb.strategyreview_monpol_strategy_
overview.en.html.
19
Issing et al. (2006), Imperfect Knowledge and Monetary Policy.
20
The Monetary Policy of the ECB (first published in 2001, a revised edition published in
2004 and the latest in 2011); Issing et al. (2001), Monetary Policy in the Euro Area.
21
ECB press release (13 October 1998), ‘A Stability-Oriented Monetary Policy Strategy for
the ESCB’, www.ecb.europa.eu/press/pr/date/1998/html/pr981013_1.en.html.
22
ECB Press Release (22 July 2021), ‘Monetary Policy Decisions’ and Consolo et al. (2021),
‘The Need for an Inflation Buffer in the ECB’s Price Stability Objective’.
23
ECB press release (8 May 2003), ‘The ECB’s Monetary Policy Strategy’, www.ecb.europa
.eu/press/pr/date/2003/html/pr030508_2.en.html and www.ecb.europa.eu/home/search/
review/html/ecb.strategyreview_monpol_strategy_statement.en.html

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 98 4 organisation, strategy & f ramework

become a norm among developed economies’ central banks since it was

first introduced by the Bundesbank in 1985.24
However, in the specific euro area context, this definition of price
stability is not obvious. Even the numerical definition of price stability
can be questioned, as a behavioural definition has clear intuitive advan-
tages. The ECB has chosen to use a numerical definition mostly to anchor
inflation expectations and also to enhance the accountability of monet-
ary policy.25 By selecting the same inflation rate as the Bundesbank had
done previously, the ECB perhaps hoped to convince people that the
orientation would not change from the Bundesbank’s stability-oriented
monetary policy. In the 2021 review, the ECB started a process to include
the costs of owner-occupied housing in its inflation definition, but the
process is expected to take some time. The aim is to recognise the impact
of even substantial increases in house prices on household consumption
expenditure, not least as this increase is largely caused by the ECB’s
measures.
The ECB took it upon itself to define the price stability it was aiming
at. The issue was not explicitly addressed in the Treaty,26 but it was
addressed in the ECB strategy explanations. The Governing Council sees
the numeric inflation target (if any) as part of defining and implement-
ing the common monetary policy. The position can be defended as no
other body was assigned a role in defining price stability, and the
exchange rate-related tasks of the ECOFIN Council were conditioned on
the price stability objective. The Treaty clearly did not allow the ECB to
be controlled through the definition of price stability objective, as is the
case in some inflation-targeting regimes, where the inflation target is set
by the government rather than the central bank.27
The price stability definition involved some further issues. It referred
to consumer prices, not to all prices such as asset prices. This reflected an
economic consensus view that asset prices or financial stability concerns
affect the conduct of monetary policy predominantly through their
influence on the outlook for price stability and economic activity.28

24
Defined as the maximum tolerable rise in consumer prices. Gerberding et al. (2005),
‘How the Bundesbank Really Conducted Monetary Policy’, 277–292.
25
The Monetary Policy of the ECB (2004), 50–52.
26
de Grauwe (1998), ‘The Design of the European Central Bank’, 10.
27
Most notably, the Bank of England changed to a system where the inflation target was
set by the Minister of Finance in 1997.
28
Also referred to as the Jackson Hole consensus. Smets (2009), ‘Financial Stability and
Monetary Policy’, 135.

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 4.2 monetary policy strategy 99

In the earlier strategies, the prominent role assigned to monetary factors

in the ECB strategy included asset market developments, if they were
driven by credit expansion.29 In the 2021 strategy review, the monetary
factors were replaced by the broader monetary and financial analysis.
The focus was shifted to the operation of the monetary transmission
mechanism and the possible risks to medium-term price stability from
financial imbalances and monetary factors. The broader causes and
implications of this change are discussed in Part III and here it suffices
to note that financial stability, and with that also asset prices, were given
a more elaborated role even as a precondition for price stability.
Price stability is presented as a medium-term target, reflecting the fact
that monetary policy affects prices only with uncertain time lags. Trying
to influence short-term changes in inflation can create unnecessary real
economy fluctuations. The medium-term orientation made it explicit
that the ECB would not, as a rule, react to temporary swings in inflation.
For example, consumer price changes stemming from oil prices should
not invite monetary policy reactions.30
A major worry in the euro area relates to inflation differentials. The
numerical definition of price stability for the euro area is the weighted
average of euro area consumer prices.31 The ECB explained that inflation
differentials are normal features in monetary unions and even within a
nation state. In the euro area, they are likely to be relatively large
because of the catching-up of the poorer euro area countries. In concrete
terms, it is assumed that the euro area countries with the lowest income
levels would close the gap over the years and that their average inflation
rate during that period could be higher. If this is a transitory phenom-
enon, it should not cause problems. However, the ECB cannot react to
differentials even if they are non-transitory and potentially destabilising.
The ECB objective is only the euro area average inflation,32 and non-
transitory national inflation differentials and other macroeconomic
adjustments need to be addressed at the national level.

29
A direct reference was made to the developments in Japan in the ECB background
documents for the strategy revision. See Masuch et al. (2003), ‘The Role of Money in
Monetary Policy Making’, 187–228.
30
The Monetary Policy of the ECB (2004), 53–55. See also Castelnuovo et al. (2003), ‘Definition
of Price Stability, Range and Point Inflation Targets’, 43–90 and Consolo et al. (2021),
‘The Need for an Inflation Buffer in the ECB’s Price Stability Objective’.
31
See Camba-Mendez (2003), ‘The Definition of Price Stability’, 32–42.
32
The Monetary Policy of the ECB (2004), 53–54.

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 100 4 organisation, strategy & f ramework

The numerical price stability objective is complemented with an ana-

lytical framework for the conduct of monetary policy. The explicit for-
mulation of the analytical framework served the ECB’s aim of developing
analytical tools to understand economic developments in the euro area.
Economic analyses contain assessments of financial markets, exchange
rates, and other forecasts and indicators. The ECB tries to convince
citizens and financial markets that it is capable of assessing euro area
economic developments correctly. For example, ECB economic forecasts
are published as ECB staff macroeconomic projections.33 Critically, the
ECB has to convince the public that it had sufficient tools to detect risks
to price stability and the means to mitigate those risks. Economic analy-
sis is the most essential part of the analytical framework, which is
manifested by the enormous analytical effort of the 2021 strategy review
and its background documents.
The ECB stresses transparency as its basic approach over the strategy
and economic analysis. Communication aims at explaining monetary
policy decisions to the public in a transparent manner, which should
help the ECB to carry out its mandate more effectively. Transparency
includes providing the public with information on ECB strategy, assess-
ments and policy decisions as well as on its procedures – and doing so in
a timely manner. Transparency helps the effective conduct of monetary
policy. Inflation expectations become more firmly anchored if the ECB is
perceived as able and willing to fulfil its primary objective. Public scru-
tiny of the conduct of monetary policy also provides incentives for
decision-making bodies to fulfil their mandates in addition to facilitating
accountability. The 2021 strategy review might have complicated the
picture and thus reduced transparency, as the ECB is more readily
including secondary objectives in its analysis and decision-making, but
not as clear and separate objectives but rather additional elements to be
incorporated into achieving the price stability objective.

4.3 Monetary Policy Transmission Mechanism

The monetary policy transmission mechanism is a core concept in cen-
tral banking: it describes the process by which monetary policy decisions
are assumed to affect the economy and particularly prices. It contains

33
www.ecb.europa.eu/pub/projections/html/index.en.html.

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 4.3 monetary policy transmission mechanism 101

Figure 4.1 The monetary policy transmission mechanism. Source: www.ecb

.europa.eu/mopo/intro/transmission/html/index.en.html

uncertainty with regard to the importance of the various elements and

time lags involved – uncertainties that are particularly large in the euro
area.34 A sketch of the transmission mechanism is provided by the ECB
in Figure 4.1. The top of the flow chart is monetary policy action and the
bottom is the objective.
The routes through which monetary policy affects prices are called
transmission channels. The starting point is a change in official interest
rates directly or through the amount of funds provided to the banking
sector. The ECB as the monopoly issuer of central bank money can
determine the interest rates for its own operations and consequently
short-term interest rates more generally. Changes in current and
expected official interest rates affect other interest rates in the economy.

34
Issing at al (2006), Imperfect Knowledge and Monetary Policy and Angeloni et al. (2003),
‘Monetary Policy Transmission in the Euro Area’ and Altavilla et al (2021), ‘Assessing the
Efficacy, Efficiency and Potential Side Effects of the ECB’s Monetary Policy Instruments
since 2014’.

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 102 4 organisation, strategy & f ramework

Generally, the influence is most direct on short-term interest rates on the

least risky assets. As the maturity or the risk level increases, other
factors play an increasing role. Official interest rates and expectations
concerning future official rates also affect asset prices, including the
exchange rate. Finally, current and expected money market interest
rates affect bank interest rates as well as supply and demand for loans
and deposits. Together these form the financial market layer of the
monetary policy transmission mechanism.35 The new unconventional
measures largely by-pass the first layer, and affect liquidity and asset
prices directly, but these are still defined as non-standard measures
in the 2021 strategy review and will be discussed more thoroughly in
Parts II and III.
Changes in various interest rates, asset prices (including the exchange
rate) and also the amount of liquidity created by the asset purchases
affect diverse supply and demand decisions by economic actors. Two
areas are often separated due to their different implications on inflation.
In product markets, changes in interest rates affect the timing of con-
sumption and investment decisions. Higher interest rates tend to post-
pone consumption decisions and make funding of investments more
expensive. The role that social partners play in the labour markets also
differs across euro area countries. In a nation state setting, the relation-
ship between the social partners and monetary policy can be interactive
as wage demands are affected by assumed monetary policy reactions.
This was a source of a major structural break in the EMU that continues
to complicate monetary policy. In the euro area, the disciplinary mech-
anism of anticipated monetary policy action is less important, as none
of the social partners is large enough to influence monetary policy
decisions.36
Finally, the transmission mechanism indicates how changes in prod-
uct and labour markets affect overall price developments. Monetary
policy transmission from official interest rates (and asset purchases) to
price developments thus necessarily affects product and labour markets.
Monetary policy first affects demand and employment, and only later the
level of prices.37 Thus if monetary policy reacts only to actual inflation, it
can cause significant fluctuations in output and employment. Hence,
monetary policy tries to be forward-looking even if this causes further
uncertainties and forces the central bank to decide on the risks it wants

35 36 37
The Monetary Policy of the ECB (2004), 44–46. Ibid., 45–46. Ibid., 48.

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 4.4 operational framework 103

to accept. Furthermore, an uncertain monetary policy transmission

mechanism makes the exact formulation of monetary policy and its
intermediate targets difficult, which is factor that can also have implica-
tions for accountability mechanisms. The 2021 strategy review did not
improve the situation as the uncertainties concerning the transmission
mechanism are as large as ever, and are added with a more multifaceted
objective for the monetary policy operations.
The monetary policy transmission mechanism shows that the chan-
nels through which monetary policy affects the economy are numerous
and may vary in importance. However, it should not be excessively
mystified either. Analysis of monetary policy transmission is not an
exact science, nor is it a field where the central banks possess exclusive
knowledge. Some monetary policy measures can also have different
short-term and medium-term effects. This is the expert knowledge the
ECB should convey to the people, and if successful, that in turn enhances
the efficiency of monetary policy.

4.4 Operational Framework

Monetary policy strategy needs to be accompanied with a set of monetary
policy instruments and procedures, called the operational framework, to
make monetary policy operational. The ECB operational framework is
built on its position as the sole issuer of central bank money, the monet-
ary base, in the euro area. Through this monopoly, the ECB can manage
the liquidity situation in the money markets and influence money
market and other interest rates. The analysis starts with the function
of issuing money, turns to the main operational framework, and con-
cludes with the payment system function.

4.4.1 Issuance of Banknotes

The issuance of notes and coins was at the heart of traditional central
banking. However, the concept of ‘printing money’ no longer refers
mainly to the issuance of notes, because nowadays this is a purely
demand-driven function.38 A concern that the ECB would start to print
physical money does not, in the strict sense, constitute a realistic threat.
The main economic question concerning banknote issuance is the

38
Ibid., 87.

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 104 4 organisation, strategy & f ramework

possibility to invest the proceeds and earn interest, which is called

seigniorage income or monetary income.39
Issuance of banknotes by the ECB is based on the Treaty,40 according to
which the Governing Council has the exclusive right to authorise the
issue of euro banknotes within the Union.41 The issuance of banknotes is
an ECB liability that can be invested in the financial markets.42 The
outstanding stock of bank notes in the euro area reached 1.5 trillion
euros by the end of 2021.43 This generates monetary income that is then
allocated to NCBs according to the capital key and not according to the
banknotes held by the public in each Member State. This constituted a
substantial income transfer from countries where the general public
holds large cash balances to countries where people use debit and credit
cards instead of cash.44 However, as the short-term interest rates have
been zero since 2014, the risk-free monetary income has diminished.
A specific issue is that increasing money in circulation in a Member State
can signal worries over its breakaway from the euro area.45

39
Seigniorage is the ‘right of the lord (seigneur) to mint money’, namely the income
arising from the monopoly issuance of money. Rolnick et al (1997), ‘The
Debasement Puzzle’.
40
Articles 128(1) TFEU and 16 Statute.
41
Formally, the liability of the total value of euro banknotes in circulation is allocated to
the NCBs in accordance with their share of the paid-up capital of the ECB based on
Article 29.1 Statute. See Decision ECB/2003/4 of 20 March 2003 on the denominations,
specifications, reproduction, exchange and withdrawal of euro banknotes.
42
On the basis of Article 32.2 Statute, the NCB’s monetary income is the annual income
derived from the assets it held against notes in circulation and bank deposits in central
bank accounts. Decision ECB/2010/23 of 25 November 2010 on the allocation of
monetary income of the national central banks of Member States whose currency is
the euro.
43
ECB website ‘Banknotes and Coins Circulation’. www.ecb.europa.eu/stats/money/euro/
circulation/html/index.en.html.
44
Preamble (2) and (3) and Article 3 of the Decision of The ECB of 25 November 2010 on the
allocation of monetary income of the national central banks of Member States whose
currency is the euro.
45
In Greece, the increase in banknotes could have indicated lower perceived safety of bank
deposits. The banknotes in circulation amounted to less than 7 billion euros in 2001,
when Greece joined the EMU. Since then, the amount has increased to 27 billion euros,
almost 15 per cent of the GDP, which is sevenfold the share in the least cash-prone euro
area countries. See www.bankofgreece.gr/Pages/en/Statistics/monetary/monetary.aspx.
Large monthly increases were recorded in October 2008, January 2009, December
2014 and July 2015. See also Seitz and Bindseil (2001), ‘Currency in Circulation’,
531–548.

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 4.4 operational framework 105

4.4.2 The Monetary Policy Operational Framework

The purpose of the operational framework is to implement monetary
policy decisions made by the Governing Council.46 The main elements of
the operational framework are the minimum reserve system, which
affects the monetary base directly, and official interest rates and related
credit operations, particularly the main refinancing rate (MRO) and
interest rates on standing facilities. The amounts allocated and interest
rates applied in MROs and other operations affect the interest rates and
liquidity situation in the money markets. However, since the crisis began
in 2008, the operational framework has been supplemented by many
non-standard measures that will be discussed mostly in Part II.
The ECB has announced its guiding principles for the operational
framework based on the principle of an open market economy with free
competition. These include operational efficiency that means the frame-
work’s ability to implement monetary policy decisions rapidly and cor-
rectly, mostly to short-term money market interest rates. Cost efficiency
is another guiding principle. The ECB relies on decentralised implemen-
tation of monetary policy, where direct links to banks and actual trans-
actions are carried out by the NCBs. All credit institutions are also
treated equally regardless of their size or nationality. Additionally, the
ECB follows the principles of simplicity, transparency and continuity
that guided the design of a simple and explainable monetary policy
framework that is not changed unnecessarily. Finally, the principle of
safety ensures that the ECB’s financial and operational risks are kept to a
minimum.47
Most euro area credit institutions can become eligible for monetary
policy operations if they are subject to the ECB’s minimum reserve
system, are financially sound and properly supervised. In practice, more
than 2,000 banks have been eligible for open market operations and even
more banks have access to standing facilities. This is an ECB speciality, as
other main central banks operate directly with only a limited number of
large banks that in turn facilitate liquidity provision to the broader
banking sector.48 In the euro area, with initially limited cross-border ties
between banks and with many existing national arrangements, a

46
The legal basis for the operation framework is Article 127(2) TFEU andArticles 3.1, 9.2,
12.1, 14.3, 18.2 and 20 Statute.
47
The ECB has its operational framework, for example, in The Implementation of Monetary
Policy in the Euro Area (2011).
48
A primary dealer-based system.

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 106 4 organisation, strategy & f ramework

relatively closed operational framework was not feasible to ensure suffi-

cient liquidity across the euro area. The more closed systems can use the
access of banks to become preferred counterparties as a persuasion tool
for the central bank to ‘guide’ major banks.49 With an open and broad
list of counterparties, the ECB has a more distant relationship with
banks and hence assumes a smaller role in maintaining financial stabil-
ity from this perspective. This is enforced by the decentralised oper-
ational model, where direct contacts with banks are under the
responsibility of the NCBs based on ECB Guidelines.50 In contrast to some
other major central banks, the ECB operational framework also uses the
official interest rate for the actual funds it lends to banks.

4.4.3 Minimum Reserves

A minimum reserve system is a traditional central bank tool, and also
the ECB requires credit institutions to hold minimum reserves on
accounts with the ECB that relate to the conduct of monetary policy.51
The ECB issues regulations52 on determining minimum reserves, but the
basis for minimum reserves and the maximum permissible ratios and
sanctions are decided by the ECOFIN Council.53 The ECB cannot impose
minimum reserve requirements independently, because the

49
For example, the NY Fed handling of the LTCM crisis in 1998. Fleming and Liu (1998),
‘Near Failure of TCM’.
50
Guidelines include: Guideline (EU) 2015/510 of the ECB of 19 December 2014 on the
implementation of the Eurosystem monetary policy framework (ECB/2014/60), OJ L 91,
2.4.2015, 3 with amendments; Guideline (EU) 2016/65 of the ECB of 18 November
2015 on the valuation haircuts applied in the implementation of the Eurosystem
monetary policy framework (ECB/2015/35), OJ L 14, 21.1.2016, 30; Guideline of the ECB
of 20 February 2014 on domestic asset and liability management operations by the
national central banks (ECB/2014/9), OJ L 159, 28.5.2014, 56; Decision of the ECB of
5 June 2014 on the remuneration of deposits, balances and holdings of excess reserves
(ECB/2014/23), OJ L 168, 5.6.2014, 115; Decision of the ECB of 29 July 2014 on measures
relating to targeted longer-term refinancing operations (ECB/2014/34), OJ L 258,
29.8.2014, 1; Decision (EU) 2015/509 of the ECB of 18 February 2015 repealing Decision
ECB/2013/6 on the rules concerning the use as collateral for Eurosystem monetary policy
operations of own-use uncovered government-guaranteed bank bonds; Decision ECB/
2013/35 on additional measures relating to Eurosystem refinancing operations and
eligibility of collateral and Decision ECB/2014/23 on the remuneration of deposits,
balances and holdings of excess reserves (ECB/2015/9), OJ L 91, 2.4.2015, 1.
51
The legal basis for minimum reserves is Article 19.1 Statute.
52
Regulation (EC) No 1745/2003 of the ECB of 12 September 2003 on the application of
minimum reserves (ECB/2003/9).
53
In accordance with Article 129(4) TFEU.

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 4.4 operational framework 107

requirements have individual credit institutions as direct addressees.54

This indicates a correct division of labour in EU macroeconomic man-
agement. Specific policy decisions are taken by the independent expert,
the ECB, but the democratically legitimised bodies set the limitations on
requirements and costs on individual addressees. Unfortunately, the
initial regulation by the ECOFIN Council before the euro was excessively
broad, effectively limiting its protective role.55
The minimum reserve requirements are based on a broad set of liabil-
ities,56 also compared to the other major central banks,57 but they are
remunerated, and not a cost for banks. Equally importantly, in normal
times minimum reserve requirements ensure that banks have a liquidity
shortage and need to draw on the ECB liquidity provision through open
market operations. Therefore the ECB minimum reserve system aims to
ensure constant liquidity needs that are fulfilled by the ECB’s open
market operations and the averaging procedure also stabilises interbank
markets. However, this has played a minor role since the crisis. Other
potential uses for minimum reserves – prudential use to reduce the risk
of bank runs and monetary control to restrict bank lending – are not
relevant for the ECB.58

4.4.4 Open Market Operations and Standing Facilities

Implementation of ECB monetary policy aims to reach a level of short-
term interest rates that is in line with the monetary policy stance
deemed appropriate by the Governing Council. Additionally, it contrib-
utes to the proper functioning of money markets through provision of
liquidity.59 The most important part of monetary policy implementation
is open market operations. These are used to steer interest rates, manage
the liquidity situation in the money markets and signal monetary policy
stance. Open market operations are mostly conducted through reverse

54
Article 4.1 of the Regulation set a range of 0–10 per cent reserve ratio even though at the
time the ECB was contemplating a reserve ratio of 2 per cent.
55
Council Regulation (EC) No 2531/98 of 23 November 1998 concerning the application of
minimum reserves by the ECB. OJ L 318, 27.11.1998, 1.
56
Article 4 of Regulation (EC) No 1745/2003 of the ECB of 12 September 2003 on the
application of minimum reserves (ECB/2003/9).
57
Many central banks do use minimum reserves and the Fed applies them only for
transaction accounts. See Gray (2011), ‘Central Bank Balances and
Reserve Requirements’.
58
Ibid.
59
Eser et al. (2012), ‘The Use of the Eurosystem’s Monetary Policy Instruments’.

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 108 4 organisation, strategy & f ramework

transactions, so called repos.60 In addition, the ECB can also make out-
right transactions, issue debt certificates, conduct foreign exchange
swaps, and collect fixed-term deposits.61
Four types of ECB open market operations are listed according to their
aim, regularity and procedure:62
1. Main refinancing operations (MROs) are weekly liquidity-
providing reverse transactions with a frequency and maturity
of one week. They use standard tenders. In normal times, MROs
fulfil the bulk of refinancing to the banks created by the min-
imum reserve requirements.
2. Longer-term refinancing operations (LTROs) are similar to MROs,
but have a longer maturity. They are regularly conducted with a
monthly frequency and with a maturity of three months.
Irregular longer-term operations can be conducted at times and
with other maturities. These operations aim at providing add-
itional longer-term refinancing to the banking sector rather than
signalling monetary policy stance. The LTROs were also used as
non-standard monetary policy with longer maturity and more
complexity conditions as will be discussed in Part II.
3. Fine-tuning operations can be executed on an ad hoc basis to
manage the liquidity situation in the money markets and to steer
interest rates.
4. Structural operations can be executed whenever the ECB wishes
to adjust its structural position with the financial sector.
MROs were designed as the main monetary policy tool, the official
interest rate. Figure 4.2 shows the monthly outstanding amounts of
the MROs. After 2008, the amounts became more erratic due to other,
non-conventional measures, even before the excess liquidity of asset
purchases rendered MROs irrelevant for the time being. However, they
remained the backbone of the operational framework also in the 2021
strategy review.

60
The process of borrowing money by combining the sale of an asset (usually a fixed
income security) with the subsequent repurchase of that same asset for a slightly higher
price (which reflects the borrowing interest rate). www.ecb.europa.eu/home/glossary/
html/glossr.en.html#100.
61
Article 18 Statute.
62
Article 4 of Guideline (EU) 2015/510 of the ECB of 19 December 2014 on the
implementation of the Eurosystem monetary policy framework (ECB/2014/60) for an
illustrative table.

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 4.4 operational framework 109

350,000 350,000
325,000 325,000
300,000 300,000
275,000 275,000
250,000 250,000
225,000 225,000
200,000 200,000
175,000 175,000
150,000 150,000
125,000 125,000
100,000 100,000
75,000 75,000
50,000 50,000
25,000 25,000
0 0
2000 2005 2010 2015 2020

Figure 4.2 ECB main refinancing operations (bn euros)

Source and copyright: ECB Statistical Data Warehouse.

The aim of MROs is to signal monetary policy stance, to ensure proper

functioning of the money market and to help credit institutions meet
their liquidity needs in a smooth manner. High frequency and short
maturity MROs are used to actively steer the liquidity of the banking
sector. By contrast, the infrequent LTROs have fixed amounts in normal
times and are mainly conducted as variable rate tenders and the ECB as
price-taker. They provide banks with additional longer-term refinancing
unrelated to short-term liquidity fluctuations.63 The special LTROs and
Targeted-LTROs are crisis and non-standard measures and discussed in
Part II.
The ECB approach to open market operation differs from other major
central banks. The ECB’s open market operations are generally open to
most banks across the euro area, although only a part of all the eligible
banks have participated in auctions. Roughly 700 banks took part in the
first MRO, but the number soon declined to more or less half of that. In
LTROs the initial number was around 300 and declined to 150 by 2003.64
In contrast, the US Federal Reserve has relied on roughly twenty-five

63
Linzert et al. (2004), ‘The Longer Term Refinancing Operations of the ECB’.
64
Ibid. and Nyborg et al. (2002), ‘Bidder Behavior and Performance’.

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 110 4 organisation, strategy & f ramework

primary dealers and the Bank of Japan typically has thirty to fifty
counterparties.65 However, non-standard monetary policy has rendered
both MROs and standard LTROs marginal for the time being.
The MROs started in 1999 with a fixed interest rate, which led to
structural over-bidding by banks. The ECB had to ration the liquidity it
provided on the basis of its pre-determined assessment of the liquidity
shortage. However, as soon as the euro area banking sector was deemed
accustomed to the new money market framework, the MROs were
changed to variable rate auctions, where the need for rationing was
taken care of by the price mechanism.66 During the crises this was again
reversed, and the MROs were conducted with fixed interest rates
(although soon to be rendered insignificant by other operations).
In addition to open market operations, the ECB also has standing
facilities to ensure stable liquidity in all situations. Banks can use the
Marginal lending facility to lend overnight liquidity from the ECB. The
deposit facility can be used to deposit excess cash with the ECB. As a rule,
the deposit rate is below, and the loan rate is above, the MRO rate.
Standing facilities are a last resort for banks to access or deposit extra
liquidity, and their use was exceptional before the crises.67 Crises and
particularly excess liquidity created by the ECB have increased demand
for the deposit facility.

4.4.5 Collateral Policy and Practices

A very important element of the operational framework is the ECB
collateral policy. Collateral consists of assets that are pledged to the
ECB as security for credit operations. Central banks operate directly in
securities markets without the need for collateral, but most central
banks and particularly the ECB operates through temporary open
market operations (credit auctions and standing lending facility), by
lending money to banks. This lending demands collateral to be safe.
The main transaction type is the repurchase agreement, where the
central bank becomes a temporary owner of the eligible asset for a fixed
period of time and at a fixed selling price.68

65
Blenck et al. (2002), ‘The Main Features of the Monetary Policy Frameworks’.
66
Mercier and Papadia (2011), The Concrete Euro, 323.
67
The Monetary Policy of the ECB (2004), 86.
68
That equals the amount loaned and the interest paid. Cheun et al. (2009), ‘The Collateral
Frameworks of the Eurosystem’, 7–9.

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 4.4 operational framework 111

The use of collateral aims to prevent financial losses and ultimately

loss of public trust. Central bank statutes can contain general safety
provisions, for example, that exclude some counterparts, instruments
or collateral,69 but most often it is left to the central bank to decide on
the appropriate safety features. For the ECB, specific safety issues arose
from its institutional independence and distance from taxpayers, and
perhaps also from the risk that it can become a transfer mechanism
between the Member States.
In the ECB’s vocabulary, an asset can be ‘eligible’ collateral if it fulfils
certain criteria. These criteria, ECB collateral policy, are communicated
in a regularly updated document.70 The specific features of ECB
collateral policy are the large number of counterparties (banks), a broad
list of eligible collateral, and de-centralised procedures through the
NCBs. The ECB started off with a diversified collateral policy, taking into
account national practices in the run-up to the single currency.
Moreover, the need for collateral was deemed to be high, as the ECB
wanted to have a strong hold on the money markets by creating a
substantial liquidity shortage. Collateral included both public and pri-
vate assets.71
The euro area financial market structure is different from the USA or
the UK. Traditional bank lending has a larger role in financial intermedi-
ation and both mortgage and SME lending is mostly provided by banks.
Subsequently, many national peculiarities were deemed necessary to be
included into the original ECB framework. The solution was a temporary
two-tier structure, where Tier1 collateral consisted of marketable debt
instruments fulfilling uniform and harmonised euro area-wide criteria.
The Tier2 collateral list consisted of marketable and nonmarketable
assets that were deemed important for the national banking systems.72
Tier2 was gradually abolished by expanding the Tier1 list to include bank
loans. In 2007, the ECB moved to a single and uniform collateral frame-
work. Compared to other central banks, the collateral list was still broad,
particularly with regard to non-marketable assets (bank loans): ‘By
accepting bank loans as eligible assets, the ECB is allowing credit

69
Ibid., 9–10.
70
The implementation of monetary policy in the euro area: General Documentation on
Eurosystem monetary policy instruments and procedures. (ECB/2011/14) OJ L 331.
71
Cheun et al (2009), ‘The Collateral Frameworks of the Eurosystem’, 9–12.
72
Tier2 eligibility criteria were set by the NCBs but subject to the minimum criteria
established by the ECB.

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 112 4 organisation, strategy & f ramework

18,000
Other marketable
16,000 assets

14,000 Asset-backed
securities
12,000
Corporate bonds

10,000
Covered bank
8,000 bonds

Unsecured bank
6,000 bonds

4,000 Regional
government
securities
2,000

0
2004 2010 2016

Figure 4.3 ECB eligible collateral (bn euros)

Source and copyright: ECB Statistical Data Warehouse.

institutions to reserve their marketable securities for use in private

payment and securities settlement systems.’73
The ECB’s collateral policy aims at neutrality, while not preventing
further developments in the financial markets. Hence, it is open to new
requests from banks and other actors and has balanced acceptance
criteria. Two elements are important. The safety criteria are defined
with reference to credit ratings and also to default probabilities.74 In
addition, variable haircuts in collateral values take into account other
risk features, such as credit default and liquidity risk.
Figure 4.3 shows how the amount of eligible assets increased from
2004 onwards for the harmonised Tier1. The amount is also very large in
comparison to GDP and bank lending as well as in relation to ECB
lending to banks.
The actual use of collateral in Figure 4.4 shows the amount of assets
that banks have pledged to the ECB for intra-day payments and for ECB
funding. The use of government bonds declined even in absolute terms
until 2008, and the use of uncovered bank bonds increased substantially

73 74
Ibid., 33. Ibid., 33–34.

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 4.4 operational framework 113

3,000 Fixed term and

cash deposits*
2,500
Credit Claims*
2,000
Non-marketable
1,500

1,000 Other marketable

assets
500
Asset-backed
0 securities
2004 2010 2016

Figure 4.4 Use of collateral (bn euros)

Source and copyright: ECB Statistical Data Warehouse.

as was deemed appropriate. During the crises, the increase in the use of
collateral related particularly to the special LTROs.
Collateral policy utilises the legal basis for implementation of monet-
ary policy and to a lesser extent promotion of the smooth operation of
payment systems. The Treaty also prohibites the ECB from financing
public entities and requires that public and private banks are treated
equally with regard to ECB operations. The Statute requires that lending
be based on adequate collateral, and only for monetary policy.75
The main criticism of collateral policy was the initial inclusion of all
government bonds in the highest safety category with the lowest haircut
regardless of the risk. The reason was not economic but national sensi-
tivity. It can even be seen as a subsidy to the lowest credit quality euro
area governments, particularly Greece.

4.4.6 Payment Systems

Central banks have close links to payment systems, and even banknotes
are still primarily used for payment purposes. In the euro changeover,
the issuance and logistics of huge amounts of euro notes was also a
payment system project, in which the euro area retail payment system
was transformed in a matter of months.76
The central bank perspective on payment systems includes both their
actual role in operating payment systems and also their oversight

75
Articles 123 and 124 TFEU. For payment systems, there is no similar provision in Article
22 Statute as in Article 18.1.
76
Bank for International Settlements (2003), CPSS – Red Book, 75–76.

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 114 4 organisation, strategy & f ramework

function of other payment systems. The ECB has both these functions: it
operates its own TARGET payment system77 and oversees payment
systems within the euro area. These are based on the basic tasks of the
ECB, namely to promote the smooth operation of payment systems and
to implement monetary policy78 by facilitating safe transfers of large
monetary policy-related payments. Indeed, the TARGET payment system
and the operational framework are closely linked, and use the same
collateral for the intra-day transactions.
When the EU central banks were preparing for EMU, they needed to
design a payment system for common monetary policy operations in the
decentralised structure of the ECB that settle euro payments across
national borders.79 The first version of TARGET commenced operations
in 1999 together with the euro80 and it simply linked the existing RTGS
systems with only a minimum set of harmonised features.81 The new
system settled payments in real time and on a non-netting basis, thus
preventing the piling-up of liabilities and reducing domino risks. This
increased costs, as the number of transactions increased and more
liquidity was tied up.82
The long-term solution was to replace national payment systems with
TARGET2.83 This uniform and more centralised payment system was
finally launched in 2007.84 The euro area NCBs joined TARGET2, but
formally they remained the counterparts for their banks and provided
the intra-day credit needed.85 The decision was not controversial and
until mid-2007 outstanding balances within the system were negligible.

77
Trans-European Automated Real-time Gross Settlement Express Transfer System.
78
Article 127(2) TFEU. See also Lamandini (2006), ‘The ECB and Target 2 – Securities’.
79
The basic principles were stated in EMI (1994), ‘The EMI’s intentions with regard to
cross-border payments in Stage Three’.
80
The ECB Guideline on TARGET described the operational elements for the euro area
NCBs and the ECB, and an Agreement on TARGET by the ECB and the NCBs to tackle the
relations between euro area NCBs and the ECB on the one hand and non-euro area NCBs
on the other. See also ECB TARGET Annual Report (May 2001), 35–37.
81
EMI Report (May 1995), ‘The TARGET system’ – Trans-European Automated Real-time
Gross Settlement Express Transfer System, a payment system arrangement for Stage III.
82
For example, if payments are netted at the end of the day and they cancel each other out,
no transactions take place that would need liquidity balances at the central bank. The
same payments settled on a gross basis require even large intra-day balances.
83
Based on a Single Shared Platform by the largest euro area NCBs, the Banque de France,
the Banca d’Italia and the Bundesbank.
84
ECB press release (19 November 2007), ‘TARGET2 Successfully Launched’, www.ecb
.europa.eu/press/pr/date/2007/html/pr071119_1.en.html.
85
ECB TARGET Annual Report (2006), 29.

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 4.5 communication and accountability 115

During the crises, TARGET2 has received considerable attention as will

be discussed in Section 5.4.
The central bank functions of operating and supervising payment
systems can overlap, which requires measures to separate the functions
and reduce conflicts of interest. The oversight function mainly focuses
on systems rather than on the individual institutions involved.86
Furthermore, the ECB’s own, non-market-based provision of payment
system needs justifications, as requested also by the BIS,87 such as to
promote stability and perhaps even European integration.88 In addition,
the ECB needs to ensure that it does not use oversight information to its
own competitive advantage.89

4.5 Communication and Accountability

The central banks’ communication practices and also the perceived need
for accountability have varied through time. Central bank communica-
tion started from minimum disclosure of measures. However, this
secrecy became considered a shield from accountability or political over-
sight.90 In the 1990s, some central banks began to endorse communi-
cation even as their main policy instrument.91
The link between communication and accountability is not straight-
forward. Communication is not the only or even the most effective way
of becoming accountable. However, it has become an important account-
ability mechanism over the last few decades, when some of the
earlier accountability mechanisms became less applicable with the inde-
pendence of central banks. Direct political accountability weakened and
was replaced by more transparency and communication. Arguably,

86
See BIS Committee on Payment and Settlement Systems (May 2005), ‘Central Bank
Oversight of Payment and Settlement Systems’. www.bis.org/cpmi/publ/d68.pdf.
87
BIS Committee on Payment and Settlement Systems (August 2003), ‘The Role of Central
Bank Money in Payment Systems’, 23.
88
Bank for International Settlements (2012), CPSS – Red Book, 93–97.
89
ECB TARGET Annual Report (2006), 25–26.
90
Mishkin (2004), ‘Can Central Bank Transparency Go Too Far?’, 48–65.
91
Famously, in 1928 the Bank of England deputy governor pointed out in his testimony in
front of the Parliamentary Committee that ‘to defend ourselves is somewhat akin to a
lady starting to defend her virtue’, Macmillan Committee (Committee on Finance and
Industry (1931), 27–31), quoted in Issing (2005), ‘Communication, Transparency,
Accountability’, 65–83. The Fed declined to disclose its Federal Funds rate until February
1994. Ehrmann and Fratzscher (2007), ‘Transparency, Disclosure, and the Federal
Reserve’, 179–225. Another extreme is the New Zealand’s central bank, which published
inflation targeting and its own forecasts on policy rates at the same time.

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 116 4 organisation, strategy & f ramework

accountability towards elected politicians was replaced by direct

accountability towards the people.
The ECB has divided accountability into three aspects: legal, institu-
tional, and practical. It is acknowledged that the framework for ECB
accountability differs substantially from the nation-state setting.
National central banks have counterparts in the Executives (govern-
ments), through relationships that have oscillated between subordin-
ation, close cooperation, and independence. Furthermore, national
parliaments often have close relations with central banks, particularly
if the central bank is relatively independent from the Executive. In the
case of the ECB, the Executive does not exist in the traditional sense.
Although the ECOFIN Council (the Eurogroup) is the closest replacement,
it is not a proper counterpart. It is not the main economic policy-maker
of the euro area nor does it hold strong formal means to interact with the
ECB, as these were explicitly excluded for the sake of independence. The
European Parliament also has a role through the monetary dialogue, but
this has so far gained limited public attention.
The basic elements of ECB communication have remained the same.
Communication is less based on legal requirements than on the needs of
the effectiveness of monetary policy and also of the acceptability and
accountability of the ECB.92 The requirements of the Maastricht Treaty
represented a relatively modest level of formal communication require-
ments that left considerable discretion to the new ECB to decide on the
most appropriate forms of communication. Furthermore, national prac-
tices had differed considerably, and were largely inapplicable to the new
situation.93
Under the Maastricht Treaty, the ECB is obliged to publish reports on
its activities at least quarterly and a consolidated financial statement has
to be published each week.94 However, the main formal publication tool
is the Annual Report on the activities of the Eurosystem (ESCB) and
particularly on monetary policy.95 The Annual Report is usually pub-
lished in April of the following year and is presented by an ECB Executive
Board member to the European Parliament. However, the main formal

92
Issing (2005), ‘Communication, Transparency, Accountability’, 65–83.
93
EU central banks that formed EMS had to follow the Bundesbank interest rate policy
with limited national discretion, and thus any policy communication contained limited
relevance. Goodman (1992), Monetary Sovereignty.
94
Articles 15.1 and. 15.2 Statute.
95
It also has special addressees, namely the European Parliament, the Council, and the
Commission, which elevate its importance, Articles 284(3) TFEU and 15.3 Statute.

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 4.6 constitutional assessment of pre-crisis 117

hearing at the European Parliament is with the Economic and Monetary

Affairs Committee. The idea is – similar to the USA – that the members
of the Committee gain expertise in the monetary field and the
Committee becomes a serious counterpart to the ECB President.
Furthermore, it was hoped that the hearings would attract media atten-
tion, thereby also enhancing the role of the European Parliament.
However, this has not yet materialised.
In practice, the most important communication is the monthly
Governing Council statement and the following press conference with
the President and Vice President. This is complemented by publication of
the Economic Bulletin one week after the meeting, which presents the
ECB view on economic and monetary development. In comparison to
other major central banks, the ECB communication is probably on the
active side due to the monthly press conference, numerous speeches and
also active participation in academic seminars. However, communica-
tion has also depended on the personal qualities and preferences of the
Presidents and other Board members.96

4.6 Constitutional Assessment of the Pre-crisis ECB

The description of various elements of the ECB covers mainly its initial
period that lasted until the economic and financial crisis. It paints a
picture of the Maastricht Treaty-based or ‘standard’ ECB, before external
and internal shocks started their reshaping process, and arguably the
ECB that should reappear once the destabilising forces of the crises
evaporate. From the constitutional perspective, it is the template against
which later practical and constitutional changes could be reflected. The
primary question is to what extent this template corresponds to the
principles of the European Macroeconomic Constitution.
The objective of internal markets can be found throughout the ECB
design – even the euro itself was largely motivated by it. The operational
framework and the payment system were influenced by the internal
market objective as shown by the push towards uniform structures
and only temporary national peculiarities.
The principle of the unity of the EU and an indivisible monetary policy
is more problematic. The Member State obligation to join was not

96
For example, the explaining of monetary policy and strategy has been done by either the
President as with Draghi or by the Executive Board Member responsible for economics
and research as with Issing or Lane.

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 118 4 organisation, strategy & f ramework

consistently pursued. For example, Sweden fulfilled most of the eco-

nomic entry criteria, but decided not to join the ERM or change its
legislation in order not to fully comply with the Treaty requirements.97
It even held a referendum that rejected the EMU without any reaction
from the Commission to search for legal remedies. This, de facto, made
EMU membership a political decision. Whether this would apply analo-
gously so that the existing EMU members could also consider their
membership as a political choice has not been formally addressed, but
most commentators have pointed to Article 50 TEU and a full with-
drawal from the EU as the only option.98
An indivisible monetary policy for the euro area seemed to hold, at least
up to the crisis. Implementation of monetary policy did not allow for
substantial national discretion. At the same time, the borderlines of mon-
etary policy competence became initially defined through the abolition of
all national measures perceived as monetary policy. ECB monetary policy
strategy and its operational framework embodied the monetary policy
function. The main element was steering short-term interest rates through
weekly auctions, supported by minimum reverse requirements. In the
setting of short-term interest rates and the provision of liquidity, national
discretion was minimal. The ECB functioned as a unified whole.99
The price stability objective guides the European Macroeconomic
Constitution. For the ECB, price stability is an overriding objective for
the common monetary policy,100 and the ECB monetary policy strategy
clearly echoes this priority. Although price stability could have been
left undefined, the choice to define price stability in numerical terms
by the ECB is arguably the most compatible with the European
Macroeconomic Constitution. The numerical definition increased the
ECB’s accountability and even its independence by not giving the
ECOFIN Council any role.101
The numerical value chosen by the ECB of a less than 2 per cent annual
rate of harmonised consumer prices (and the later on average 2 per cent)

97
Following Article 131 TFEU.
98
A positive answer based on a symmetric approach could be contrasted with the potential
negative repercussions for the other euro Member States. The ECB President Mario
Draghi stated that a euro Member State cannot exit at will because of the negative
repercussions for other countries and the euro. Draghi (2014), ‘Stability and Prosperity
in Monetary Union’.
99
Smits (1997), The European Central Bank, 94.
100
And also to the exchange-rate policy (Arts. 3a(2) EC and 127 TFEU).
101
In contrast to the provision on exchange rate arrangements (Art. 219 TFEU).

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 4.6 constitutional assessment of pre-crisis 119

could be assessed by asking whether it is incompatible with price stabil-

ity. The aim is that price changes indicate relative changes and also that
households and companies can make longer-term plans relying on the
ECB’s promise that overall price levels will not change substantially.
Negative risks related to price level objectives argued against price stabil-
ity being defined as constant prices. Also, the medium-term orientation
is convincingly based on consensus economic thinking. The aggregate
euro area level is more difficult to judge as the Treaty seems to require
price stability everywhere in the euro area. High inflation in some
Member States and deflation in others would not qualify as price stabil-
ity. However, uniform monetary policy makes a euro area-wide defin-
ition the only realistic option. National differences are for national
economic policy makers and social partners to take care of. However,
the ECB has been unwilling to engage in domestic economic policy
discussions, and more worryingly, the NCBs have often failed to voice
concerns in cases where deviations were becoming destabilising.
The actual conduct of monetary policy indicates how the ECB reacted
to changes in inflation during its first decade. Was price stability the
primary objective for the ECB in reality? The launch of the euro in
1999 took place in a moderate inflationary environment; the inflation
rate was close to 1 per cent and many politicians voiced deflation
fears.102 However, the inflation rate soon surpassed the target of below
2 per cent, initially through an increase in oil prices, but in 2001 core
inflation also rose, and remained somewhat above the target for most
years until 2009, which could have multiple interpretations. Arguably,
the ECB failed to achieve its own numerical target for price stability. At
the same time, the stability of the inflation rate confirmed that the ECB
maintained inflation expectations in check. It did not react to small
deviations from the target, but followed the medium-term orientation
of its strategy. There is thus limited evidence that the ECB disregarded
price stability either in its monetary policy strategy or in its actual
conduct of monetary policy. The main question is the divergent inflation
paths that were disregarded by the ECB monetary policy strategy. It is
possible that allowing an inflation rate of above 2 per cent was related to
deflation fears in some euro area countries, which could indicate that

102
For example, German Minister of Finance Lafontaine put considerable pressure on the
ECB to lower the inflation rate amid fears about deflation in 1999. See, for example,
Dedman (2009), The Origins and Development of the European Union, 154.

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 120 4 organisation, strategy & f ramework

the ECB weighted the risks of inflation and deflation at country levels
as well.
The principle of an open market economy and free competition can be
assessed in three areas: monetary policy strategy, the operational frame-
work, and payment systems. The more the ECB works through direct
influence on private actors’ plans, the less it follows market economy
principles. By and large, the ECB strategy was based on reacting to
economic developments through very short-term and low risk interest
rates. Monetary policy impulses fed through the market process by
letting private economic agents take care of consumption, investment
and capital allocation decisions. Against this background, the oper-
ational framework with weekly allocations and the ECB’s fully collateral-
ised lending to banks with variable interest rate was, even explicitly,
designed to have limited effects on market mechanisms. The minimum
reserve requirement is an administrative measure that is remunerated
and based on a very broad set of liabilities, which reduces its allocative
impact. Nevertheless, minimum reserve system could be seen as prob-
lematic for the principle of an open market economy, although the
explicit Treaty provision makes it in any case a permitted deviation from
the principle.
Monetary policy operations during the first decade provided liquidity
and did not target the pricing of risks, as provision of liquidity through
the ECB’s operations was at low risk and based on adequate collateral.
The ECB’s collateral policy in 2007 underlined the principle of promoting
an open market economy. The broad list of collateral ensured that
government bonds did not acquire a privileged position. At the same
time, though, treating all government bonds similarly can be questioned.
The inclusion of bank loans is a borderline case with regard to safety.
Using illiquid bank assets as collateral in the operational framework
potentially enlarged the role of the ECB beyond the needs of the effect-
iveness of monetary policy. Most precisely, if banks can rely on illiquid
assets to gain ECB funding, this can increase moral hazard in bank
lending, although accepting these assets as collateral well below their
full value (large haircuts) reduces that risk.
The final question is whether the ECB’s own provision of payment
services violated the free market principle. The guiding principles for the
TARGET system showed that the ECB was aware of the problem. Its
payment system benefited from monopoly power to issue central bank
money and the ECB oversaw its competitors. Two arguments could be
proposed for the constitutional acceptability of provision of payment

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 4.6 constitutional assessment of pre-crisis 121

services: first, the need for a central bank payment system for monetary
policy operations, as is also evidenced by most central banks having
similar systems; second, the task of promoting smooth conduct of pay-
ment systems is a Treaty-based obligation and TARGET could be a pro-
portionate way to fulfil that task. That being said, the ECB has the
obligation to guarantee that it is not using its position in an anti-
competitive manner.
The independence of the ECB is a cornerstone of the European
Macroeconomic Constitution. The Treaty provides clear institutional
means for safeguarding the principle by disentangling the ECB’s
decision-making from any political or interest group influence. The
actual design of the ECB and the conduct of monetary policy during its
first decade raised some constitutional concerns. For personal independ-
ence, a long and non-renewable term of office is important. However, the
issue arose with the first President Duisenberg, who came under some
pressure to resign due to his alleged role in financial market uncertainty
and decline in the external value of the euro in 2000.103 This pressure
was appropriately coped with, similarly to Minister Lafontaine’s political
pressure earlier.104 However, the drama of forcing President Duisenberg
to hand the Presidency to the French candidate Trichet related directly to
central bank independence. When Duisenberg was nominated in 1998,
he refused to promise to resign at half-term, but agreed to state that he
was unlikely to serve the full term due to his age.105 Duisenberg finally
resigned in November 2003 after political pressure from France
reminding him of his commitment.106 Legally, this was compatible with
Treaty provisions, but not with its spirit.
Some issues have been raised on the personal independence and other
qualities of the NCB governors as members of the Governing Council.
The fear is that national discretion on selection modalities leads to
questionable nominations of NCB governors.107 The Rimšēvičs case dis-
cussed showed that the ECB was willing to push the boundaries of the
governor’s independence, by getting the decision by the national

103
See, for example, www.independent.co.uk/news/business/news/defiant-duisenberg-
declares-he-is-doing-a-good-job-and-will-not-resign-635545.html and Kaltenthaler
(2006), Policymaking in the European Central Bank, 63.
104
See also Guttman (2001), Europe in the New Century, 146.
105
Liddle (2014), The Europe Dilemma, 83 and Beaumont and Walker (1999), Legal Framework
of the Single European Currency, 183.
106
Rothacher (2005), Uniting Europe, 64.
107
Zilioli (2016), ‘The Independence of the European Central bank’, 151.

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 122 4 organisation, strategy & f ramework

corruption office to be annulled by the CJEU. However, that case

addressed the political influence on the governor in office, which is
mostly indicative that similar considerations also take place when gov-
ernors are elected. Without minutes of the Governing Council meetings,
it is unclear whether the NCB governors have pushed nationalistic views
on euro area monetary policy.108 An indication of a political element is
that the background in politics has probably gained value in the selection
of NCB governors, which is counterintuitive from a substantive
perspective.
The Treaty-protected independence saw some limits in the OLAF
case.109 The CJEU recalled that well-based grounds for independence do
not provide for total autonomy. It was not demonstrated that common
rules promoting the enhanced financial accountability of the
Community would hamper the monetary policy independence of the
ECB. Nevertheless, the CJEU confirmed the functional independence of
the ECB, and as such OLAF did not question the ECB’s independence.
The independence of the ECB thus has the counterpart that it should
remain within the boundaries of its objectives and tasks as stipulated by
the Treaty. During the first decade, this was explicitly followed by the
ECB, as was evident from the description of the strategy and monetary
policy operations: the ECB remained within the borders defined in the
European Macroeconomic Constitution. At the same time, the ECB has
defined the line between a single monetary policy and other, national,
economic policies. The core of ECB monetary policy consisted of setting
short-term interest rates and maintaining sufficient liquidity in the
money markets. There were no major redistributive elements in its
policy, as even the potential subsidy element in the operational frame-
work was kept at bay. Monetary income – tax on money from the
issuance of notes – was largely distributed to the NCBs and from thereon
to governments. However, as we will discuss in Parts II and III, the
borderline between common monetary policy and national economic
policies was not set in stone.
Arguably, the numerical definition of price stability enhanced the
accountability of the ECB. In the same vein, the explicit description of
the monetary policy strategy and operational framework was in line

108
Bini Smaghi and Gros (2000), Open Issues in European Central Banking, 13–14.
109
Case C-11/00 Commission of the European Communities v. the European Central Bank,
where the Commission challenged the validity of the ECB Decision 1999/726/EC of
7 October 1999 on fraud prevention (ECB/1999/5).

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 4.6 constitutional assessment of pre-crisis 123

with constitutional principles. In particular, the transparency and open-

ness of the operational framework, including the collateral policy,
helped to draw the lines of ECB involvement in the economy. The
framework clearly fulfilled the obligation to ‘establish general principles
for open market and credit operations including for the announcement
of conditions under which the ECB stands ready to enter into
such transactions’.
The ECB’s monetary policy strategy shows the assumed path towards
maintaining price stability, although the credibility of the strategy
lacked empirical evidence and institutional history. The announced
strategy and operational targets serve the needs of accountability, as
they provide means of assessing whether the ECB performed according
to its objectives and tasks. The ECB acknowledges that its independence
from politics needs to be balanced with accountability. Accordingly, it
accepts an obligation to explain and justify its decisions to the people of
the euro area and their elected representatives. As the Treaty require-
ments for accountability are relatively modest, the ECB has gone beyond
the legal requirement. Some criticism could be directed towards the lack
of transparency concerning personal voting records and the transcripts
of the Governing Council.110 For example, the US Federal Reserve, the
Bank of Japan and the Bank of England are generally more transparent in
this regard.111
In the European Macroeconomic Constitution, government deficit and
debt receive special treatment, as they can cause problems for both the
common monetary policy and national fiscal policies alike. In its own
conduct the ECB was to reduce rather than increase incentives for debt-
financed government expenditure. With a single monetary policy and
multiple fiscal policies, the risk of moral hazard was aggravated. The
special treatment for public sector debt by central banks was abolished
on the way to EMU.112 The initial operational framework did not pro-
hibit all dealings with government bonds, but considered them as one
instrument of many, and the amount of private sector collateral was

110
Amtenbrink (1999), ‘The European Central Bank: Democratically Accountable or
Unrestrained?’ and Amtenbrink et al (2004), ‘The Transparency and Credibility of the
European Central Bank’.
111
See www.ft.com/cms/s/0/75fe8686-7983-11e4-9e81-00144feabdc0.html#axzz3xtf77Uhg.
112
Following Article 123 TFEU and the related Council regulation, ensuring that
‘purchases made on the secondary market must not be used to circumvent the objective
of that Article’.

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 124 4 organisation, strategy & f ramework

increased substantially. In fact, before 2008, private collateral was

crowding out government bonds in the ECB framework.
The ECB was also wary of the no-bailout clause and resisted assuming
any liability for government debt. The borderline between a possible
monetary policy operation in the secondary market and a prohibited
assumption of liability was not tested, as the ECB avoided outright
purchases of government bonds. Cooperation between – or at least the
coexistence of – national economic policies with common monetary
policy is among the most difficult issues in EMU architecture. The
common monetary policy needs safeguards against unsound national
fiscal policies. The ECB supported keeping public deficit under control
through the Stability and Growth Pact,113 but its role was limited to
stressing the strict interpretation and also the need to gain sufficient
room for manoeuvre for national economic policy to tackle asymmetric
shocks. The practical fate of the SGP was outside the ECB’s control.
One critical area where the ECB (and the EMI) had a more pronounced
role with regard to fiscal policy was entry to the EMU. The Convergence
Reports assess EU countries on their readiness to join the EMU with
detailed descriptions of Member State fiscal policy sustainability with
assessments of whether countries fulfil the entry criteria. The early
Reports were criticised for failing to address fiscal sustainability,
although the EMI Convergence Report of 1998 rejected Greece on the
grounds of its public finances.114 However, with hindsight the politicised
decision-making on the entry criteria was an early sign that political
judgment can overrule economic-constitutional provisions also in the
EMU. This was evidenced in the cases of Italy and Belgium that had twice
the public debt allowed in the Treaty. The main concrete issue the ECB
neglected with regard to fiscal policies and avoiding moral hazard in
public finances related to its operational framework, where the ECB
rules on eligibility of government bonds as collateral deviated from
fiscal prudence.
In conclusion, the ECB monetary policy strategy and its operational
framework were compatible with the principles of the European
Macroeconomic Constitution during the first decade. The same holds,

113
The multilateral surveillance procedure of Article 121 TFEU was further specified by
Regulation 1466/97, constituting the preventive arm of the SGP. The corrective arm was
based on the excessive deficit procedure.
114
EMI Convergence Report (March 1998), ‘Report Required by Article 109 j of the Treaty
Establishing the European Community’.

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 4.6 constitutional assessment of pre-crisis 125

by and large, for ECB monetary policy. The ECB functioned as an eco-
nomic-constitutional central bank that was aware of its unique insti-
tutional and legal position. This could also be seen as confirmation of
economic-constitutional principles as the normative premises for the
EMU. The ECB was designed and operated as a central bank of stability,
introducing the framework and practical conduct of monetary policy
that was to guarantee stability and prosperity going forward. However,
very little was to remain unchanged.

4.6.1 Annex: The Monetary Policy Framework in the US

The US monetary policy framework can be seen as the closest compari-
son to the ECB. It consists of the main objectives of maximum sustain-
able employment and price stability as well as of the Federal Funds rate
as the main policy target.115 The Fed is independent from the govern-
ment in its conduct of monetary policy, but ultimately accountable to
Congress. Independence is based on a long fourteen-year term for Board
members and a prohibition on having elected officials or members of the
administration on the Board. Furthermore, the Fed enjoys financial
independence. However, most critically the Fed’s independence relies
on the practices of US presidents since the late 1970s.116
The main monetary policy decision-making body is the Federal Open
Market Committee (FOMC), in which the voting rights are allocated to
seven members of the Federal Reserve Board in Washington and five of
the twelve Federal Reserve Bank presidents.117 US monetary policy has
followed the same procedures since 1994–1995, when the FOMC decided
to publish its monetary policy stance (Fed Funds rate). Before each
meeting it publishes a Beige Book with economic analyses and after each
meeting, the FOMC issues a press release summarising the main eco-
nomic assessment and the Federal Funds target required to achieve its
objectives. The minutes of meetings are released after three weeks with
individual voting records.118

115
www.federalreserve.gov/monetarypolicy/fomc.htm.
116
Bernanke (2010), ‘Central Bank Independence’.
117
The structure has been the same since the amendment of the Act in 1942, giving the
New York Federal Reserve a permanent voting right. Section 12A, Federal Reserve Act
Amendment of 1942 (56 Stat. 647).
118
The transcripts of the meeting, containing everything that was said with minor editing
and deletion of confidential business information, are published after five years. www
.federalreserve.gov/monetarypolicy/fomc_historical.htm.

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 126 4 organisation, strategy & f ramework

The Fed Funds rate119 is operationalised through open market oper-

ations. One special feature of the US system is that the NY Fed makes
permanent transactions in US government bonds with twenty-four
primary dealers that include mostly large banks and securities broker-
dealers that have to participate consistently as counterparties to open
market operations and in all auctions of US government debt.120 The
other main monetary policy instruments include the discount rate and
reserve requirements121 that provide funding to solvent banks with
difficulties in short-term market funding. Reserve requirements impose
an obligation on banks to hold some part of their most liquid liabilities in
cash or deposits at Federal Reserve Banks.

119
See, for example, Greenspan (1996), ‘The Challenge of Central Banking’, 11–12.
120
‘Domestic Open Market Operations During 2013’. A report to the FOMC by the NY
Fed, 39.
121
In the Depository Institutions Deregulation and Monetary Control Act (1980).

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 Part II
Crises, ECB Measures and the
Macroeconomic Constitution

The European Macroeconomic Constitution and the ECB as its central

actor stressed the maintenance of stability. The constitutional frame-
work acted as a guarantee for stable growth in income and employment,
and threats to stability were to be tackled at their origin. The reality
turned out to be very different. The EMU was hit by a sequence of shocks
that questioned the ability of the constitutional model to provide stabil-
ity, but importantly also questioned the institutional and constitutional
structures involved. The passage started with the financial crisis that
increased ECB involvement in financial markets through excessive
liquidity provision and an expanded collateral pool. The ECB crisis meas-
ures continued with the sovereign debt crisis from spring 2010 onwards.
The ECB was involved in implementing rescue packages as well as pur-
chasing government bonds. In addition, the ECB’s banking supervision
mandate was primarily a crisis measure. A brief moment of calm was
interrupted by the Covid-19 pandemic that, again, saw the ECB taking a
central role. In Part II, the series of crises and the ECB’s measures are
assessed from the perspective of the European Macroeconomic
Constitution in order to gain an understanding of the EMU central bank
function and its limits.

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 5 ECB Monetary Policy during
the Financial Crisis

5.1 The Financial Crisis: First Phase in 2007

The first indications of an approaching financial crisis showed them-
selves in the latter half of 2007,1 but the problems did not dominate the
policy agenda. For example, the ECB raised interest rates twice during
the first half of 2007,2 and even once more in July 2008. The ECB
Financial Stability Review concluded that: ‘with the euro area financial
system in a generally healthy condition and the economic outlook
remaining favourable, the most likely prospect is that financial system
stability will be maintained in the period ahead’.3 The initial stages of
the financial crisis hence did not raise any major alarms a the ECB.
The ECB responded to financial market problems with a series of
measures to ease the liquidity situation in the banking sector and to
ensure short-term market funding for (solvent) banks. Ad hoc measures
and an unusual use of standard measures started in August 2007, when
the ECB indicated that it would provide all the liquidity needed for
markets.4 This began a long series of announcements on liquidity policy
that were accompanied by fine-tuning operations to address short-term
nervousness in the money markets. The ECB convinced the markets that

1
A key event was the failure of the Bear Stearns bank on losses from two hedge funds
investing in sub-prime loans, which started a series of negative surprises concerning the
US real estate markets, and a realisation that many risks were underestimated. Banks’
ability to trust one another eroded and led to malfunctions in the interbank market.
2
ECB press release (8 March 2007), ‘Monetary Policy Decisions’, www.ecb.europa.eu/press/
pr/date/2007/html/pr070308.en.html and ECB press release (6 June 2007), ‘Monetary
Policy Decisions’, www.ecb.europa.eu/press/pr/date/2007/html/pr070606.en.html.
3
ECB Financial Stability Review (June 2007), 9.
4
This was followed by a full allotment in the following weekly tender, i.e. banks received
all the financing they asked for.

129

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 130 5 ecb monetary policy during the financial crisis

it would provide more than the necessary liquidity and that the still
variable interest rate of weekly tenders would be close to the MRO.
However, short-term liquidity measures were insufficient as the
liquidity shortage persisted, and the ECB engaged in a series of longer-
term financing measures in order to normalise money market condi-
tions. Relying only on very short-term ECB funding had kept banks
unnecessarily alert with regard to the availability of funding. Tenders
were all variable rate, mainly for three months,5 and reached 150 billion
euros. The ECB concluded that the major banks were solvent, and the
liquidity shortage resulted from some deleveraging and US-induced
uncertainties.6 Another ad hoc measure was the provision of US dollar
liquidity in connection with the Fed.7 This provided non-US banks with
US dollar liquidity by using collateral domiciled elsewhere.
Overall, ECB measures before the escalation of the crisis were motiv-
ated by bank liquidity needs stemming mainly from the US subprime
markets rather than by fear of a banking crisis. The poor financial health
of the euro area banks was not yet apparent as was shown by the
takeover of ABN AMRO in October 2007.8 Additionally, credit default
swaps for the European banks increased by only fifty basis points in July
2007, to less than half of US investment banks.9 Hence, the liquidity
shortage was only a signal of increased risk awareness and apprehension
about unexpected risk exposures by some bank counterparts.
ECB measures contained a few key features. First, the ECB operated
mostly through its normal operational framework. Exceptional liquidity
was provided by weekly MROs and ad hoc measures were part of the
operational framework. The normal operational mode of monetary
policy was maintained and the only truly exceptional measure was to

5
On 27 August, a supplementary liquidity-providing LTRO with a maturity of three
months allocated 40 billion euros to banks. This was followed on 6 September by a similar
LTRO with a maturity of three months, but this time with a variable rate tender and with
no pre-set allotment amount (75 billion euros). On 8 November, a decision took place to
renew the supplementary LTROs with variable rate tenders, each with a pre-set amount of
60 billion euros. Similar renewals took place on 7 February, 28 March and 31 July 2008.
6
ECB Financial Stability Review (December 2007), 18.
7
On 12 December 2007, the ECB joined the Fed, the Bank of Canada, the Bank of England
and the Swiss National Bank to offer US dollar funding to banks globally with US dollars
provided by the Fed.
8
A consortium of large EU banks ‒ Royal Bank of Scotland, Fortis, and Banco Santander ‒
bought the Dutch bank for 71 billion euros, which was the largest sum ever paid in a
European bank acquisition. See, http://news.bbc.co.uk/2/hi/business/7033176.stm.
9
ECB Financial stability report (December 2007), 81.

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 5.2 escalation in 2008 and 2009 131

act as an agent for the Fed. Second, the ECB convincingly maintained the
market conformity of its operations. Refinancing operations were con-
ducted as variable rate tenders without a guarantee of full allotment,
although with some reassuring communication. Longer-term operations
were carried out with truly variable interest rates and with fixed
allotments. Overall, ECB influence on financial market pricing increased
with market uncertainty, but apart from very short-term interest rates
the ECB remained a price-taker in the market place.
Third, although ECB lending to euro area banks increased, even sub-
stantially, there was no doubt that the reason was anything other than
liquidity provision to maintain the functioning of the interbank market.
The ECB explicitly remained outside discussions over banking sector
solvency support.10 Liquidity support was not mixed with indirect solv-
ency support or indirect public financing. Against this background, the
ECB’s focus on its price stability objective was not questioned, nor was
its independence.
Finally, ECB communication presented a thorough picture of its meas-
ures, and of motivations behind the measures. Indeed, a novelty was the
distinction between normal monetary policy and unconventional mon-
etary policy measures: the former was dedicated to the price stability
objective whereas the latter was used more broadly, for example, against
banking sector liquidity concerns. Later, with the normalisation of the
crisis mode, the unconventional measures were labelled non-standard
monetary policy.

5.2 The Financial Crisis: Escalation in 2008 and 2009

Financial turmoil continued in 2008 and liquidity measures were unable
to improve the situation. This raised ‘more fundamental concerns about
creditworthiness and the capital positions of several key financial

10
When a German bank failed over US subprime liabilities, Trichet stated in a press
briefing on 2 August 2007: ‘I will not add anything to what has been said by the German
entities concerned themselves, by the authorities and by Axel Weber.’ This made it clear
that the ECB had nothing to do with euro area bank failures. At a press conference on
2 October 2008, Trichet was explicit on the responsibility concerning Fortis Bank: ‘[a]nd
in a period when it appears that the situation calls for government responsibility,
I confirm that we judge it appropriate that governments take up their responsibilities.
I think they did well in the case you mentioned, they did well in other cases, including in
this country: I confirm that I think the government did well in Germany.’

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 132 5 ecb monetary policy during the financial crisis

firms’,11 which placed further tensions on mutual trust between banks.

Interbank liquidity problems began to affect the financing conditions of
non-financial companies, households, and even some governments.12
Indicators of bank risks reached new heights. A picture emerged
whereby the amount and complexity of risks had reached unforeseen
levels, making it impossible to predict which bank could face serious
problems. Many banks had concealed their risks from regulators and
also relied on short-term funding for their longer-term investments.13
A turn for the worse came on 15 September 2008 with the collapse of
Lehman Brothers, the fourth largest US investment bank active in most
financial market sectors. The collapse was preceded by last-minute
attempts to rescue it.14 The fact that a bank of Lehman’s size was allowed
to fail was a shock to market confidence in general and to interbank
markets in particular.15 Lehman’s large exposures to most markets and
counterparties made it likely that other banks could face major losses
once Lehman failed to make good its liabilities. The banks’ ability to
trust each other was eroded to an extent not previously seen in modern
banking. The European banking sector was in the middle of the crisis.
For example, two large Benelux banks, Fortis and Dexia, had to be
rescued by governments, joined by Hypo Real Estate in Germany in
September 2008 and Anglo-Irish Bank.16
For central banks, the main concern was still the interbank market.
Without mutual trust, banks could not borrow or lend in the interbank
market. Lack of interbank funding would lead to large-scale reductions
in lending, fire-sales of assets, and other reactions that were transform-
ing a liquidity crisis into a banking and economic crisis. Along with other
central banks, the ECB had to react. Official interest rates were lowered
after the Lehman collapse. The first decision was a joint action on
8 October 2008 by many central banks, including the Fed, the Bank of

11 12
ECB Financial Stability Review (June 2008), 11. Ibid., 77–78.
13
Hüfner (2010), ‘The German Banking System’, 17–19 and Buder et al. (2011), ‘The Rescue
and Restructuring of Hypo Real Estate’.
14
The Fed, the US Treasury and the Federal Deposit Insurance Corporation (FDIC) were
involved in attempts to sell Lehman Brothers first to the Korean Development Bank and
during the last day to British Barclays and Bank of America, but US officials refused to
guarantee the deal. Wiggins et al. (2014), ‘The Lehman Brothers Bankruptcy’.
15
This surprise was probably made bigger by the fact that Bear Stearns had been rescued
only six months earlier through a sale to JPMorgan Chase that was facilitated by
financial assistance from the NY Fed.
16
And many locally important banks. See http://ec.europa.eu/competition/publications/
cpn/2011_3_9_en.pdf.

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 5.2 escalation in 2008 and 2009 133

Canada, the BoE, the ECB, Sveriges Riksbank and the Swiss National
Bank.17 The ECB continued aggressive cuts until the MRO rate reached
1 per cent in May 2009.18 Monetary policy decisions were mostly argued
on the basis of inflation expectations that declined with the collapsing
economy.19

5.2.1 Measures within the Operational Framework

The ECB was also active with other standard and ad hoc measures of the
operational framework.20 After the Lehman collapse, weekly MROs were
carried out as fixed rate tenders with full allotment and the corridor of
standing facilities was halved to 100 basis points. These measures were
deemed temporary, but no expiry date was announced.21 The ad hoc
measures from the first phase of the financial crisis were continued,
including the provision of US dollar liquidity.22 Special longer-term refi-
nancing operations (LTROs) also became regular and their maturity was
increased. They were carried out through fixed rate tender procedures
with full allotment that marked a major shift from the initial stage of
the financial crisis.23 The banks were given all the funding they needed,
as long as they had collateral.
A covered bond programme was introduced in May 200924 that con-
tained 60 billion euros of direct purchases of high-quality bonds in both

17
ECB press release (8 October 2008), ‘Monetary Policy Decisionswww.ecb.europa.eu/press/
pr/date/2008/html/pr081008.en.html.
18
ECB press release (7 May 2009), ‘Monetary Policy Decisions’, www.ecb.europa.eu/press/
pr/date/2009/html/pr090507.en.html.
19
ECB Annual Report (2008), 16–21.
20
ECB press release (8 October 2008), ‘Changes in tender procedure and in the standing
facilities corridor’, www.ecb.europa.eu/press/pr/date/2008/html/pr081008_2.en.html.
21
Communication of the changes was peculiar: first the ECB announced a decline in the
policy rate and standing facilities. Later the same day, it announced a narrowing of the
corridor. Hence, for the standing facility interest rates, two subsequent changes were
introduced on the same day. See ECB press release (8 October 2008), ‘Monetary policy
decisions’, and ECB press release (8 October 2008), ‘Changes in tender procedure and in
the standing facilities corridor’, www.ecb.europa.eu/press/pr/date/2008/html/pr081008_2
.en.html.
22
The first in a series of decisions was taken on 26 September 2008 and was a coordinated
measure with other central banks.
23
For example, on 7 May 2009 the ECB announced for the first time a schedule of one-year
auctions with fixed rate and full allotment, representing a considerable lengthening
of maturity.
24
The formal decision was made on 2 July 2009 on implementation of the covered bond
purchase programme (ECB/2009/16).

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 134 5 ecb monetary policy during the financial crisis

the primary and the secondary markets.25 The aim was to support an
important market segment for bank funding that was heavily affected by
the crisis. In some euro area countries, bank funding relied on covered
bonds, and thus the purchases were symmetrical to the LTROs in other
countries. The programme was used in full in 2009 and the bonds were
to be kept until maturity,26 making the ECB effectively a longer-term
financier of the market segment.27
The use of the ECB standard operations increased to new heights after
the Lehman collapse. The MROs increased from slightly more than
220 billion euros to more than 300 billion euros and longer-term refi-
nancing operations rose even more (Figure 5.2).28 Hence, the role played
by the ECB in providing financing to euro area banks increased substan-
tially, and the balance shifted to longer-term operations.
The use of standing facilities provides additional information on the
situation. The marginal deposit facility is a good indicator of banking
stress, as the deposit rate is lower than money market rates. When banks
nevertheless deposit money at the ECB, either they do not trust other
banks or they see a need for excess cash in an excessively risky situation.
Accordingly, the use of a deposit facility is generally limited, but
coloured with stints of uncertainty (Figure 5.1). The marginal lending
facility saw small amounts, apart from single days. With weekly tenders
and full allotments, only completely unforeseen events imposed on
banks the need to draw on their marginal lending facility. However,
with the structural excessive liquidity from 2015 onwards, the deposit
facility became a sign of banks’ problems with excess deposits.
The ECB’s practice of using many counterparts facilitated liquidity
provision during the financial crisis. During the worst weeks the number
of participants in weekly tenders exceeded 700 banks, which signalled a
serious dysfunction of the interbank markets. However, as ECB liquidity
provisions became a persistent feature with full allotments, banks also
adjusted their funding procedures in line with the central banking

25
ECB Guideline ECB/2007/10, amending Guideline ECB/2000/7 on monetary policy
instruments and procedures of the Eurosystem. Amendments to Annex I (General
Documentation) and Annex II (Additional Minimum Common Features) to Guideline
ECB/2000/7 on monetary policy instruments and procedures, 30 October 2007.
26
Another covered bond programme was later announced but not fully implemented.
27
ECB Monthly Bulletin (August 2010), 32–34 and Beirne et al. (2011), ‘The Impact of the
Eurosystem’s Covered Bond Purchase Programme’.
28
See ECB Datafiles from www.ecb.europa.eu/mopo/implement/omo/html/top_history.en
.html.

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 5.2 escalation in 2008 and 2009 135

800,000 800,000

700,000 700,000

600,000 600,000

500,000 500,000

400,000 400,000

300,000 300,000

200,000 200,000

100,000 100,000

0 0
2000 2005 2010 2015 2020

Figure 5.1 Use of the ECB’s marginal deposit facility (bn euros)
Source and copyright: ECB Statistical Data Warehouse.

system rather than market financing.29 The convenience of ECB funding

replaced interbank funding and potentially increased the segmentation
of the euro area banking markets.
As the financial markets calmed down towards early 2010, the ECB
decided to continue a gradual phasing out of its non-standard oper-
ational mode and announced that MROs as fixed rate tender procedures
with full allotment would end in the latter half of 2010. As part of the
normalisation, the ECB also decided to return to variable rate tender
procedures in LTROs. However, these decisions were never fully oper-
ationalised, as the second phase of crisis emerged with Greek problems
and the subsequent sovereign debt crisis.

5.2.2 ECB Measures on Collateral Policy

Paradoxically, just days before the Lehman collapse, the ECB had made
its collateral policy tighter, fearing lower collateral quality.30 However,

29
ECB Data warehouse.
30
A uniform haircut of 12 per cent was set for the ABSs and 5 per cent for bank bonds. ECB
press conference (4 September 2008), ‘Introductory Statement’, www.ecb.europa.eu/
press/pressconf/2008/html/is080904.en.html.

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 136 5 ecb monetary policy during the financial crisis

already on 15 October 200831 the ECB broadened its collateral frame-

work considerably and quickly until the end of 2009.32 The euro area
banks had excessive funding needs that rendered available collateral a
potential constraint. The ECB also lowered the credit threshold for mar-
ketable and non-marketable assets,33which turned out to be a substantial
change. The new threshold did not leave any buffer between eligible
collateral and the speculative credit rating, which made credit down-
grades more dramatic from the collateral perspective. Figure 4.3 shows
how the amount of potential collateral increased in 2008–2009. The main
increase was in uncovered bank bonds and asset-backed securities.34
In April 2010, as a sign of normalisation, the ECB announced that the
temporary collateral expansion would cease by the end of 2010 and that
it would introduce graduated valuation haircuts for lower-rated assets,
while keeping the minimum credit threshold at the lowest investment-
grade level.35 Haircuts were based on maturities, liquidity categories and
credit quality that replaced the uniform haircut of 5 per cent. The
smallest haircuts applied to most liquid assets with the shortest matur-
ities. This intended to reduce the ECB’s exposure to low quality collateral
and also to increase the market conformity of collateral policy. Lower
credit quality would immediately be reflected in collateral value, not
only when it reached the level of non-eligibility. No changes were intro-
duced to the haircut schedule for government debt instruments, and the
ECB was criticised for bending its rules for Greece.36

31
The ECB Regulation (ECB/2008/11) amended, albeit temporarily, the ECB Guideline ECB/
2000/7, followed by the respective ECB Guideline on temporary changes to the rules
relating to the eligibility of collateral (ECB/2008/18).
32
The new collateral included marketable debt instruments in other currencies, UK law
syndicated euro loans, debt issued by credit institutions traded on accepted non-
regulated markets (CDs), and subordinated debt instruments.
33
S&P, similar to other rating agencies, defines that ‘BBB exhibits adequate protection
parameters. However, adverse economic conditions or changing circumstances are more
likely to lead to a weakened capacity of the obligor to meet its financial commitment on
the obligation.’ Compared to A-rating ‘the obligor’s capacity to meet its financial
commitment on the obligation is still strong’. www.standardandpoors.com/en_US/web/
guest/article/-/view/sourceId/504352.
34
A smaller change was implemented a year later for the ABSs. At least two ratings were
required and the ‘second-best’ rule would apply. ECB press release (20 November 2009),
‘ECB amends rating requirements for asset-backed securities in Eurosystem credit
operations’, www.ecb.europa.eu/press/pr/date/2009/html/pr091120.en.html.
35
The actual new haircut schedule was published on 28 July 2010.
36
See, for example, the heated discussion at a press conference on 8 April 2010 www.ecb
.europa.eu/press/pressconf/2010/html/is100408.en.html. The issue will be discussed
also later.

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 5.2 escalation in 2008 and 2009 137

Overall, the available collateral pool for ECB liquidity operations (and
payment systems) increased substantially during the financial crisis. The
share of government bonds declined when uncovered bank bonds and
asset-backed securities gained in importance. By 2010, the collateral was
no longer a critical issue.

5.2.3 Longer-Term Funding to Banks as Sovereign Debt Problems

Add to Financial Market Worries
ECB measures focused on the money market as long as the root cause of
problems stemmed from the financial sector. The ECB tried to restore
the functioning of the financial markets by providing liquidity in the
short and safe part of euro area financial markets through weekly MROs
with a fixed rate and full allotment, standing facilities and also LTROs of
up to twelve months. In the first half of 2011, the situation had
recovered to the extent that MRO rates were even increased on two
occasions in April and July.37 However, towards the end of 2011, con-
cerns in euro area financial markets increased again. For example,
longer-term Italian government bond yield increased from less than
5 per cent to more than 7 per cent,38 in Ireland to more than 14 per
cent,39 and in Portugal interest rates exceeded 13 per cent towards the
end of 2011.40 In a low inflation environment, these yields constituted
intolerable real interest rates if sustained for a prolonged period of time.
In this situation, the ECB Governing Council decided on two unpreced-
ented longer-term refinancing operations (LTROs) with three-year matur-
ity as ‘additional enhanced credit support measures to support bank
lending and liquidity in the euro area money market’. Both auctions
were conducted at fixed rate and full allotment. The decision was accom-
panied with a relaxation in collateral policy and increasing NCBs’ discre-
tion in accepting bank claims as collateral.41 The first three-year LTRO in
December 2011 provided 489.2 billion euros to banks, with the second in
February 2012 adding another 529.5 billion euros (Figure 5.2).42
The three-year LTROs can be discussed both as supporting the func-
tioning of the financial markets or as the ECB’s engagement in the

37 38
ECB Annual Report (2011), 14. www.bloomberg.com/quote/GBTPGR10:IND.
39
www.investing.com/rates-bonds/ireland-10-year-bond-yield-advanced-chart.
40
www.bloomberg.com/quote/GSPT10YR:IND.
41
ECB press release (8 December 2011), ‘ECB announces measures to support bank lending
and money market activity’, www.ecb.europa.eu/press/pr/date/2011/html/pr111208_1.en
.html.
42
ECB Annual Report (2011), 16.

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 138 5 ecb monetary policy during the financial crisis

2,250,000 2,250,000

2,000,000 2,000,000

1,750,000 1,750,000

1,500,000 1,500,000

1,250,000 1,250,000

1,000,000 1,000,000

750,000 750,000

500,000 500,000

250,000 250,000

0 0
2000 2005 2010 2015 2020

Figure 5.2 ECB longer-term refinancing operations (bn euros)

Source and copyright: ECB Statistical Data Warehouse.

sovereign debt crisis. Even the ECB communication contained both

elements. The pressing issue in the interbank market was the drying-
up of cross-border interbank lending mainly due to the lack of credit-
worthiness of banks in troubled countries, which was compensated by
ECB lending. The pattern was most pronounced in Greece, where lending
from the ECB increased to over 15 per cent of bank liabilities in 2010.43
The link to the sovereign debt crisis will be discussed in the next chapter.

5.3 The Financial Crisis: A Constitutional Assessment

of the ECB’s Approach
A constitutional analysis of ECB measures during the financial crisis is
complicated by the gradual nature of events and ECB measures. Did the
measures lie within the realm of monetary policy? Was the independ-
ence of the ECB jeopardised? Did the measures respect the principle of
the European Macroeconomic Constitution, including free competition?

43
Similar developments took place in Ireland and from 2010 onwards in Portugal. This was
followed by Italian and Spanish banks in late 2011 and early 2012 when they used the
ECB 3-year LTRO lending extensively.

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 5.3 constitutional assessment of approach 139

The assessment is based on the economic content of the ECB measures

that primarily aimed at maintaining the functioning of the euro area
interbank market amidst the rapidly evolving events. The Lehman’s
collapse and the losses that the euro area banks faced in various markets
and instruments seriously hampered the banks’ trust of each other that
in turn reflected distrust in financial supervision.44 When providing
banks with liquidity amid dysfunctional interbank markets, the ECB
increasingly replaced the money markets. In particular, the ECB ensured
unlimited funding to banks as long as they had collateral, the list of
which was expanded. The ECB also purchased covered bonds directly.
The overall increased role of the ECB is visible in its loans to euro area
residents, which tripled from 560 billion in July 2007 to 1,780 billion
euros by March 2012.
Analysis of the ECB collateral policy can be static or dynamic. In static
terms, the main issue is whether the relaxation of collateral policy
questioned the applicability of the term ‘adequate collateral’,45 although
no unambiguous definition of adequate collateral exists. It should be
recalled, however, that ECB lending does not allow proper pricing of
risks. Indeed, the safety requirement should be stricter than with private
banks due to the lack of compensation for risks. In dynamic terms, the
question is whether the ECB’s collateral policy reduced market discipline
and even increased systemic risks. For example, the use of debt instru-
ments issued by credit institutions traded in non-regulated market
places as collateral was against the ECB’s own decision only one and half
months earlier, just before the Lehman collapse. The aim was to reduce
using bank-created assets as collateral, because they could lead to a loss
of market discipline and to lower collateral quality. Thus, the expanded
use of bank-created assets as collateral was a conscious decision to
increase risks.
Against this background, the expansion of collateral in the direction of
bank-created assets led to moral hazard or even a potential gamble for
resurrection. When banks knew that the ECB had incentives to rescue
them or to demand that Member States rescue them, banks could even
increase their risk-taking (moral hazard). If banks were facing probable

44
Without going into too much detail, it was clear that some supervisory solutions, such as
the transition of potentially problematic assets including some government bonds from
application of the mark-to-market accounting principle to hold to the maturity principle
of the banking book, effectively increased distrust in the system.
45
Article 18.1 Statute.

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 140 5 ecb monetary policy during the financial crisis

bankruptcy, they could increase risk-taking in order to gamble their way

out. In theory, this could lead to increased risks, even to the level of
systemic risk. Whether this was a real threat remains unclear, but it
shows the difficult dynamics involved with the banking sector.
The liquidity provision via standard and special auctions that replaced
the market mechanism by ECB measures could be against the principle
of an open market economy. The ECB operational framework effectively
replaced the market mechanism in bank funding, which was also dem-
onstrated by the increase in the number of banks that relied on the ECB
for their funding. However, liquidity provision is a traditional central
bank function that always interferes to some extent with the market
mechanism. Arguably, the ECB’s creation of liquidity reached levels that
were not compatible with the principle of an open market economy and
could even have functioned against European integration, but it can also
be considered proportionate in the face of the destabilising forces arising
from the financial markets. Relying mainly on market mechanisms
could have been too great a risk for the euro area economy. The
disintegration of euro area financial markets was caused by forces out-
side the control of the ECB, and measures to reduce recourse to ECB
facilities could have been destabilising.46
The three-year LTROs could be assessed somewhat differently. Such
long-term funding is rarely part of monetary policy. Similar operations
were not conducted by other central banks, at least directed to the
banking sector as a whole, with a broad list of collateral and in unlimited
amounts. Additionally, ECB communication of the operations and the
actual outcome were unsynchronised: the ECB argued that three-year
LTROs facilitated bank lending to companies and households,47 but they
were used for these purposes only moderately. On a more negative
assessment, the three-year funding to banks even hampered the very
bank lending it claimed to support. Banks used the funding to buy
government bonds, which could have reduced their ability to lend for

46
ECB Euro money market survey (September 2011), www.ecb.europa.eu/pub/pdf/other/
euromoneymarketsurvey201109en.pdf and Euro money market Study (December 2012),
www.ecb.europa.eu/pub/pdf/other/euromoneymarketstudy201212en.pdf.
47
ECB press release (8 December 2011), ‘ECB Announces Measures to Support Bank
Lending and Money Market Activity’, www.ecb.europa.eu/press/pr/date/2011/html/
pr111208_1.en.html. See also ECB press conference (8 December 2011), ‘Introductory
Statement’ and admission that the decision on the measures was not unanimous (www
.ecb.europa.eu/press/pressconf/2011/html/is111208.en.html).

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 5.3 constitutional assessment of approach 141

real economy purposes. The discussion on three-year LTROs continues

with ECB measures during the sovereign debt crisis.
The ECB standard and LTRO lending are linked to ECB independence
through the risk exposure to the euro area banks. When market funding
was replaced with central bank money in troubled countries, this
exposed the ECB to potentially unsound banks and even made it depend-
ent on them. Indeed, as the ECB’s balance sheet exceeded 3 trillion
euros in 2012, a major part of its assets comprised liabilities of euro area
banks. The solvency of many banks was further dependent on national
governments and their direct or indirect guarantees. The ECB could thus
have become exposed to banks and to some governments in a manner
that risked its independence and ability to focus on its price
stability objective.
ECB purchases of covered bonds (CBPP) are different. The market
conformity of the operation is a paradoxical question, as it explicitly
aimed to affect the functioning of the markets. However, there is a
difference between calming down excessive market uncertainty and
having a permanent influence on the market mechanism. Covered bond
purchases affected solid areas of the bond markets in a positive way,
although it could also be claimed that these fundamentally solid markets
would have recovered without any interference. Nevertheless, it is also
evident that ECB purchases had only a limited impact in the pricing of
the markets beyond the short-term effect stemming from announce-
ment of the programme.48
More broadly, ECB measures during the financial crisis can be assessed
in terms of whether they can be classified as monetary policy. Using the
CJEU argumentation would lead to peculiar outcomes.49 The CJEU chose
a restrictive interpretation of monetary policy in the Pringle case by
excluding from it all the activities foreseen for the European Stability
Mechanism (ESM). One key element was ‘the objective pursued by that
mechanism, which is to safeguard the stability of the euro area as a
whole, that is clearly distinct from the objective of maintaining price
stability, which is the primary objective of the Union’s monetary
policy’.50 However, an important objective of ECB measures during the

48
Beirne et al. (2011), ‘The Impact of the Eurosystem’s Covered Bond
Purchase Programme’.
49
The FCC used the legal logic of the Pringle case to exclude bond purchases from the
monetary policy function. FCC 2 BvR 2728/13 loc. cit., n. 64.
50
CJEU, Judgment of 27 November 2012, Case C-370/12, 56 and also 93–97.

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 142 5 ecb monetary policy during the financial crisis

financial crisis was stability and sufficient liquidity in the euro area
financial markets. Even the ECB distinguished between standard monet-
ary policy that aimed at price stability, on the one hand, and unconven-
tional monetary policy measures that also had other aims, on the other.
Hence I would disagree with the CJEU’s excessively narrow definition of
monetary policy that requires a direct link to the price stability objective.
Clearly, central banking history supports the idea that, regardless of any
direct link to price stability, liquidity provision to banks is part of
monetary policy that stems from central banks’ ability to create money.
However, Pringle also had a more agreeable conclusion from the per-
spective of the European Macroeconomic Constitution, namely that ‘[t]he
grant of financial assistance to a Member State, however, clearly does not
fall within monetary policy’. Could some of the measures by the ECB
during the financial crisis have constituted direct or indirect financial
assistance to Member States or their banks? The measures did not con-
tain intentional financial support elements, except perhaps the excessive
relaxation of collateral requirements. With short-term lending, the
financial assistance element is small, but as the time period increases
the assistance element strengthens. In this regard, three-year LTROs
could be the most suspicious on the grounds of providing financial
assistance to Member States or to their banks.

5.4 Specific Topic: TARGET2 during the Crisis

Banking sector problems had unforeseen repercussions also for the
ECB’s TARGET2 payment system. When the euro area interbank market
became dysfunctional due to lack of trust, it caused a partial denational-
isation of the money market. Banks in troubled countries could not fund
themselves from the interbank market, forcing the ECB to provide
liquidity to banks. This is a traditional central banking function to
provide short-term funding to solvent banks, basically in unlimited
amounts, which ensured vital payment flows in the economy and pre-
vented fire sales of assets and reduced bank lending.51
However, the ECB differs from national central banks. Replacement of
the interbank market led to large cross-country imbalances. German
(and some other) banks with surplus liquidity deposited extra liquidity
at their NCBs (e.g., the Bundesbank) instead of lending it to banks in now

51
Jobst et al. (2012), ‘Reference to Understanding TARGET 2’ and Neumann (2011),
‘Refinanzierung der Banken treibt Target-Verschuldung’.

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 5.4 target2 during the crisis 143

troubled countries as they had done before. The opposite took place
mainly in Spain, Italy and Greece, where banks borrowed from their
NCBs through monetary policy operations. This imbalance accumulated
in the payment system, TARGET2, with a large surplus for the
Bundesbank and large liabilities for troubled countries’ NCBs. In 2012,
these intra-ECB claims reached over 1 trillion euros,52 and the German
surplus reached nearly 30 per cent of its GDP.53 When the imbalances
continued, questions were raised as to their sustainability. The TARGET2
system was feared to accumulate permanent imbalances between
Member States that would lead to eventual collapse of the system.
The views on TARGET2 balances reflected underlying analysis on the
reasons for the imbalances. The main views were labelled as the current
account and capital flight explanations. Both start with identifying that a
Member State’s TARGET2 balance equals its current account plus capital
account. Until the crisis, the current account deficit was balanced with a
capital account surplus.54 The current account explanation sees the
TARGET2 balances as financing of current account deficits. This real
economy-based explanation claims that fundamental balance-of-pay-
ments imbalances in troubled countries were initially financed through
private capital inflows, mostly from Germany, as German banks lent to
banks in deficit countries. As the crisis hit, these private capital flows
were reversed and replaced by lending through ECB monetary policy
operations. This showed up in TARGET2 balances55 and the ECB became
a transfer mechanism that forced NCBs in surplus countries to lend
to deficit countries.56 This view claims that ECB monetary policy
was captured by the needs of capital transfers that originated from
competitiveness problems.57 Furthermore, as differences in government
bond yields were reduced by ECB money creation,58 persistent current

52
ECB Monthly Bulletin (May 2013), ‘Article Target Balances and Mmonetary Policy
Operations’, 103.
53
See Auer (2012), ‘What Drives Target2 Balances?’ and http://bruegel.org/2013/04/italys-
elections-had-little-impact-on-target2-balances/.
54
Cecchetti et al. (2012), ‘Interpreting TARGET2 Balances’ and Sinn and Wollmershaeuser
(2011), ‘Target Loans, Current Account Balances and Capital Flows’.
55
The current account explanation could be added with the impact of capital flights in
some cases such as Ireland and Italy.
56
Schlesinger (2012), ‘The Balance of Payments’, 11–13.
57
Fahrholz and Freytag (2012), ‘Will TARGET2-Balances be Reduced?’, 17–18.
58
Sinn und Wollmershaeuser (2011), ‘Target Loans, Current Account Balances and Capital
Flows’, 30–32.

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 144 5 ecb monetary policy during the financial crisis

account deficits piled up in TARGET2 balances,59 postponing timely

economic adjustments, and even contributing to the prolongation of
the crisis.60
The more official capital flight view on TARGET2 balances sees the
imbalances mainly as reflections of capital accounts rather than current
accounts. Reversed private capital flows were counterbalanced by official
flows. More specifically, a large positive balance is not seen as an NCB’s
risk exposure, but rather an intra-Eurosystem payments feature that
becomes visible because of the separate NCB accounts.61
The risks caused by TARGET2 were heavily debated in Germany due to
the Bundesbank’s enormous positive balance, although all euro NCBs are
liable according to their share of the ECB capital. Hence, any Bundesbank
claim on the ECB would be covered by the ECB, if needed through capital
calls on its owners.62 However, this could be different if the euro area
breaks up.

5.4.1 Constitutional Remarks

An assessment of TARGET2 imbalances is complicated by different per-
ceptions on the underlying causes. Were there design flaws that can be
considered against the principles of the European Macroeconomic
Constitution? Do problems stem from TARGET2 or rather indicate other
problems? Should the possibility of euro area breakup be considered?
The TARGET2 payment system has its legal basis in the ECB’s tasks to
implement monetary policy and to promote the safety of payment
systems. Sustained imbalances do not invalidate this constitutional
assessment, but point constitutional assessment towards underlying
monetary policy measures. TARGET2 is a payment system that supports
monetary policy, but also makes visible some unwelcomed consequences
of the monetary policy measures that were the root causes of imbalances
that piled up in TARGET2.

59
As evidenced in the Greek case, the ultimate option is the Emergency Liquidity
Assistance (ELA) using otherwise ineligible collateral. See, for example, ECB press release
(28 June 2015), ‘ELA to Greek Banks Maintained at Its Current Level’, www.ecb.europa
.eu/press/pr/date/2015/html/pr150628.en.html.
60
Cecchetti et al. (2012), ‘Interpreting TARGET2 Balances’, 12–13.
61
Ibid. and Buiter et al. (2011), ‘The Implications of Intra-euro Area Imbalances’.
62
Jobst et al. (2012), ‘Understanding TARGET2’, 81–91 and Ulbrich and Lipponer (2012),
‘Balances in the TARGET2 Payments System’, 73–76.

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 5.4 target2 during the crisis 145

The imbalances grew quite consistently until mid-2012, hand in hand

with increased ECB lending to the banks. The ECB replaced interbank
markets, which became national or ceased to exist. The ECB became a
new interbank central counterparty. This is problematic for the free
market principle and also potentially problematic for the independence
of the ECB in terms of having enormous exposure to the euro area banks.
TARGET2 imbalances only made it visible. A similar pattern took place
with the PSPP from early 2015 onwards, and with the PEPP since 2020,
and the imbalances reached new records by the end of 2021.
To sum up, TARGET2 does not constitute a transfer mechanism as long
as the EMU does not break up. It sheds light on replacement of euro area
private transfers with official transfers through the ECB. It also makes
some real economy developments visible, such as sustained current
account deficits. However, assuming that the EMU survives, the imbal-
ances should not reflect debt or risk exposures between the Member
States. The underlying causes of the TARGET2 balances, the excessive
liquidity provision and the ECB’s purchases of private and public debt
securities are the real suspects for the intra EMU transfers.63
If analysis allows for the possibility of an EMU breakup, the conclu-
sions change. If a country leaves the euro area or the EMU breaks up,
TARGET2 imbalances could expand up to the point of a break-up, as
capital flight towards safer banks and countries would intensify. It is also
likely that some Member States would default on their euro-
denominated debt and also on their liabilities towards the ECB. The
Eurosystem structure has preserved a real possibility for a full or partial
dismantling of the EMU, as the NCBs are still the centres of their national
banking and even payment systems.
TARGET2 balances are thus mostly canary birds for monetary policy
measures having some unwelcome effects on the euro area economy and
financial market structures. ECB lending to banks has replaced the
market mechanism and is potentially hampering integration and unity
of the euro area financial markets, as has become visible through large
outstanding and sustained TARGET2 balances. With a possible EMU
break-up, TARGET2 balances could create uncontrollable credit relations
between the Member States.

63
This ‘highlight[s] a huge lack of transparency that exists as regards the terms and
conditions of portfolio investment and lending decisions of the ECB’. Buiter et al. (2011),
‘The Implications of Intra-euro Area Imbalances’, 13.

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 146 5 ecb monetary policy during the financial crisis

5.5 Annex: The Measures of Other Major Central Banks

during the Crisis
5.5.1 The Fed’s Operations during the Crisis
The US financial sector was at the core of the financial crisis, and
measures by the Fed are informative on the broader central banking
during the crisis. The Fed Funds rate was cut to nearly zero towards the
end of 2008, and was kept there until 2015. In addition, the Fed engaged
in three types of programs: provision of short-term liquidity to banks,
provision of liquidity directly to borrowers and investors, and expanded
use of open market operations.
Provision of liquidity to banks is closely linked to the Fed’s initial role
as a lender of last resort. After the Lehman collapse, discount loans rose
to a record 111 bn USD and their rate was lowered to a record low of 0.5
per cent. The specific programmes underlined their exceptional and
temporary nature. The TAF extended the discount window to a broader
set of banks. It was fully collateralised, and for a fixed amount. It peaked
at 493 billion USD in March 2009 and was terminated a year later.64 In
addition, primary dealers were ensured short-term funding.
Apart from banks, the Fed provided liquidity directly to borrowers and
investors, hence bypassing the banking sector. One program alleviated
the malfunctions of the important commercial paper market and
another helped money market mutual funds that experienced huge
redemptions by investors.65 Finally, the TALF helped the credit needs of
households and small businesses by supporting the issuance of ABSs
collateralised by loans to consumers and businesses, while the Treasury
provided 20 billion dollars of credit protection.
Expanded open market operations supported the credit markets
through the purchase of an extensive list of government bonds and other
capital market securities.66 The actual quantitative easing (QE) pro-
grammes started with monthly 40 billion purchases of mortgage-backed
securities (MBS) and later 45 billion monthly purchases of Treasury

64
Gilbert et al. (2012). ‘Federal Reserve Lending to Troubled Banks’, 5.
65
Kowalewski (2010), ‘Budgetary Impact and Subsidy Costs’, 28 and www.newyorkfed.org/
markets/mmiff_faq.html
66
The programs started in December 2008 and continued with variable focus and intensity
at least to August 2010. For example, the Fed purchased USD 175 bn bonds issued by
Fannie Mae, Freddie Mac, and Federal Home Loan Banks, as well as USD 1.25 tn in
mortgage-backed securities (MBS) guaranteed by the same Federal agencies. See www
.federalreserve.gov/monetarypolicy/bst_openmarketops.htm.

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 5.5 annex 147

bonds. QE had a broader aim of supporting economic recovery and at

ensuring that inflation was consistent with the Fed’s mandate.67 Citing
improved labour markets and inflation, the Fed ended the programme in
October 2014,68 although it was restarted during the pandemic.
In conclusion, the Fed programs had relatively clear objectives, mostly
in repairing the malfunctions of the financial markets, and many meas-
ures ‒ including emergency credit ‒ had last been used in the 1930s. The
Fed had legal authority to advance credit to individuals, partnerships and
corporations that were not banks, if credit was not available from other
sources and if failure to provide credit would adversely affect the econ-
omy.69 The Fed reacted quickly, and was also quick to end programs that
did not meet their targets. The programs had clear timespans and the
division of labour within the Treasury was explicitly agreed. Most pro-
grams were authorised under Section 13(3) of the Federal Reserve Act
but – in recognition of the potential costs for taxpayers – the Treasury
was consulted when necessary.70 Legal worries related to lending to
banks in trouble,71 as lending to undercapitalised banks was constrained
in order to limit losses that banks can incur before they fail.72
Additionally, the extensive funding of banks was feared to have pro-
longed necessary adjustments in the sector and to have created moral
hazard problems. The Dodd-Frank legislation (2010) aimed to control the
Fed73 and demanded a prior approval of the Treasury Secretary and that
Fed’s programs were ‘not to aid a failing financial company’.74

5.5.2 Bank of Japan (BoJ) Measures during the Crisis

In Japan, ‘normal’ monetary policy has been an exception over the last
three decades. The BoJ is thus a prime example of a central bank that has

67
www.federalreserve.gov/monetarypolicy/bst_crisisresponse.htm.
68
FOMC press release (29 October 2014), www.federalreserve.gov/newsevents/press/
monetary/20141029a.htm.
69
www.federalreserve.gov/faqs/banking_12842.htm.
70
www.newyorkfed.org/markets/cpff_faq.html.
71
Under Federal Reserve Regulation A § 201.5.
72
Section 142 of FDICIA states that with certain exceptions, ‘no advances to any
undercapitalized depository institution and no advances to any undercapitalized
depository institution by any Federal Reserve bank . . . may be outstanding for more than
60 days in any 120-day period’.
73
The Dodd-Frank Wall Street Reform and Consumer Protection Act was signed into law in
2010. www.sec.gov/about/laws/wallstreetreform-cpa.pdf.
74
Federal Reserve Bank of New York (July 2015), ‘The Discount Window’, www
.newyorkfed.org/aboutthefed/fedpoint/fed18.html.

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 148 5 ecb monetary policy during the financial crisis

been trapped into a crisis mode. The official overnight interest rates had
been raised (!) to 0.5 per cent and qualitative easing was in the phasing-
out stage, when Lehman collapsed. Since then, the BoJ has had three
groups of measures according to its own classification: reduction in the
policy interest rate, measures to ensure stability in financial markets,
and steps to facilitate corporate financing. These were largely
interwoven.75
Financial market liquidity was supported by purchases of government
bonds. Additional corporate debt purchases facilitated corporate finan-
cing, which was even globally an exceptional measure at the time that
blurred the line between providing liquidity to financial markets and
assuming private sector risks. Hence, the purchases were introduced as
extraordinary and temporary measures and coordinated with the
government.76
In 2013 the new BoJ management replaced earlier programmes with
the Qualitative and Quantitative Monetary Easing programme. This pro-
gramme had a number of unconventional features. The BoJ fought the
deflationary mentality with an even stronger commitment to the infla-
tion target of 2 per cent, stating that it would achieve the target no later
than in two years. This was backed up by monetary easing.77 The operat-
ing target was changed from overnight interest rate to the monetary
base, which should increase at an annual pace of 60–70 trillion yen,
doubling its size in two years. Such an increase in the monetary base
was unprecedented in developed countries. The relative size of the
Japanese monetary base reached more than three times that of the euro
area and double that of the USA.
In conclusion, the BoJ has gone the furthest among the major central
banks. It has felt compelled to use measures such as buying risky assets
and filling the banking system and economy with liquidity. The aim has
been to reverse the negative trend in the real economy since the early
1990s, characterised by deflationary expectations, a vulnerable banking
sector, and low potential output growth. The ageing population provides
a negative structural element. Questions concerning the mandate of the
BoJ raised less concerns in a centralised nation state, where the govern-
ment and parliament always had the last word. The main worry was the

75
www.boj.or.jp/en/mopo/outline/cfc.htm/.
76
Momma and Kobayakawa (2014), ‘Monetary Policy after the Great Recession’, 82–83.
77
Bank of Japan Press release (2013), ‘Introduction of the “Quantitative and Qualitative
Monetary Easing”’. www.boj.or.jp/en/announcements/release_2013/k130404a.pdf.

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 5.5 annex 149

poor success of the measures and their potentially harmful impact on

the economy’s ability to function normally.

5.5.3 Bank of England (the BoE) Measures during the Crisis

The UK financial system was among the worst hit by the financial crisis.
The UK financial sector was heavily involved in risky operations, and the
relative size of the UK financial sector was the largest among the major
economies. The crisis also hit the UK early, when Northern Rock bank
faced difficulties in August 2007,78 and had to be nationalised.79 This and
later bank rescues were operationalised by the Treasury with taxpayers’
money, although with short-term liquidity from the BoE.
The BoE monetary policy rate was cut from 5.0 per cent in September
2008 to 0.5 per cent by March 2009. However, that was deemed insuffi-
cient, and unconventional policy measures followed immediately with a
QE programme that was expanded several times to peak at 375 billion
pounds, before Brexit and pandemic concerns more than doubled the
amount.80 Interestingly, the BoE tried to make it transparent how QE
could influence the economy. The BoE had a 2 per cent inflation target,
and its argumentation tried to make the link between QE and inflation.
According to the BoE, purchases of government bonds increase private
sector money holdings. This affects other asset prices, when sellers
rebalance their portfolios by buying other assets. This implies lower
borrowing costs for companies and households, while higher asset prices
also stimulate spending by increasing wealth. A further asset price effect
should come through the liquidity effect particularly during major dis-
ruptions in the financial markets.81 The BoE also mentioned a more
general boost in economic expectations and consumer confidence as well
as the exchange rate channel. However, empirical evidence as to the
impact on GDP or inflation remains relatively weak. QE has also raised
concerns that it leads to a new asset price boom and that it hampers the
functioning of bond markets. It is also acknowledged that QE is effect-
ively government deficit financing with central bank money.82

78
House of Commons Select Committee on Treasury Fifth Report (24 January 2008).
79
Edmonds et al. (2011), ‘The Economic Crisis’. SN/BT/4968. The nationalisation was based
on the Banking (Special Provisions) Bill.
80
Claeys (2014), ‘The (not so) Unconventional Monetary Policy’.
81
Bank of England (12 July 2012), ‘The Distributional Effects of Asset Purchases’ www
.bankofengland.co.uk/publications/Documents/news/2012/nr073.pdf.Ibid., 4–5.
82
Joyce et al. (2012), ‘Quantitative Easing and Unconventional Monetary Policy’, F271–
F288.

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 6 The Prelude to the Sovereign Debt
Crisis: Events, ECB Verbal Interventions
and EU Rescue Programmes

ECB measures during the financial crisis developed gradually as dis-

cussed in Chapter 5. Even unconventional monetary policy measures
were incremental evolutions from the existing operational framework.
The ‘new’ element was generally the size, length or the rationale of the
measure that made it different from pre-crisis monetary policy. In con-
trast, the sovereign debt crisis shook the foundations of the euro area
economic framework and also ECB measures marked a clear change
from the past. The measures were increasingly directed at easing eco-
nomic and financial market stress concerning individual Member States’
public finances. At the same time, constitutional concerns over the ECB’s
mandate became more pronounced, as it engaged in activities that were
mostly controversial from the start.1 The measures included verbal
interventions, drafting and monitoring rescue plans, and finally outright
purchases of government bonds. This chapter focuses on other measures
and selected bond purchases demand their own chapter.

6.1 The Sovereign Debt Crisis: Events

The financial markets globally and also in the euro area were normalis-
ing towards the end of 2009. The exception was euro area government
bond markets, where interest rate differentials were increasing.2 In
particular, the interest rate on Greek government debt started to edge

1
All the major cases of the CJEU and the FCC, including Pringle, Gauweiler and Weiss, have
some links to the ECB’s role in sovereign debt crisis.
2
Lane (2012), ‘The European Sovereign Debt Crisis’, 56.

150

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 6.1 the sovereign debt crisis 151

higher with fears about the sustainability of Greek public finances.3

A severe turn to the worse took place in late 2009, when the incoming
Greek government revealed that Greek public finances were in far worse
shape than reported by the previous government. The public deficit was
larger, but even the level of public debt was far higher due to grave
misconduct.4 Greece was effectively excluded from market funding and
faced two options: to default or to turn to other sources of funding. The
latter included rescue packages by the euro area Member States and
the IMF. In addition, the European Financial Stability Facility (EFSF)
and later the European Stability Mechanism (ESM) were founded to
facilitate the bailouts.5
The first Greek rescue package in Spring 2010 did not ease the situ-
ation, which created a feeling of failure and helplessness that spilled over
to other vulnerable countries. From late November 2009 to early May
2010, the interest rate on Greek ten-year government bonds increased
from less than 5 per cent to 12 per cent.6 Irish and Portuguese govern-
ment bond yields started to increase from mid 2010 onwards, and the
interest rate differentials, the spreads, between troubled countries and
Germany widened even more due to safe haven flows to Germany (See
Figure 7.1).7 There, reasons differed, though. In Portugal, fiscal deficits
stemmed from persistent competitiveness problems, while Ireland
experienced the bursting of the real estate bubble that led to a banking
crisis.8 The first stage of the euro area sovereign debt crisis culminated in
rescue packages for Greece, Ireland and Portugal in mid 2011, after
which the worst fears concerning Ireland and Portugal started to calm
down and their bond yields edged lower.

3
The initial downgrade was by Fitch (April 2010), see www.theguardian.com/business/
2010/apr/09/greece-financial-crisis-fitch-downgrade. See also Financial Times Interactive
timeline of the Greek debt crisis at www.ft.com/intl/cms/s/0/003cbb92-4e2d-11df-b48d-
00144feab49a.
4
European Commission (January 2010), ‘Report on Greek Government Deficit and Debt
Statistics’, COM(2010) 1 final and Rauch et al. (2011), ‘Fact and Fiction in EU-
Governmental Economic Data’, 243–255.
5
www.efsf.europa.eu/about/key-figures/index.htm.
6
www.bloomberg.com/quote/GGGB10YR:IND/chart/.
7
De Santis (2012), ‘The Euro Area Sovereign Debt Crisis’.
8
In November 2010, the EU and the IMF agreed to an 85 billion euro bailout package to
Ireland. In May 2011 a similar package of 78 billion euros was agreed for Portugal, but
with the euro area Member States and the IMF.

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 152 6 th e prelude to the sovereign debt crisis

6.1.1 The Main Worry Shifts to Spain and Italy

The Greek situation remained chaotic, and Greek government bond
yields continued to rise to reach more than 35 per cent before debt
restructuring in March 2012.9 Even more seriously, concerns over the
fiscal situation in Italy and Spain started to gain ground in the second
half of 2011.10 Spain had witnessed a bursting of its real estate bubble
and banking problems similar to those of Ireland. Italy was not as hard
hit by the financial crisis, but weak growth and the weakness of the
Berlusconi government bonded poorly with the high level of public debt.
This risked a self-enforcing negative spiral through rising debt servicing
costs, particularly after rating downgrades in September and October
2011.11 The Italian bond spread relative to Germany peaked during the
political crisis leading to Monti’s government taking over in late 2011.
A major factor in the evolution of the sovereign debt crisis was the
ECB’s enormous three-year LTROs funding to banks in December
2011 and February 2012, which temporarily supported government bond
auctions, as banks were even encouraged to buy government bonds with
this funding.12 However, the measure and also the relief were tempor-
ary, as negative news concerning Italy’s economic fundamentals and also
the euro area sovereign debt crisis were taking their toll on confidence.13
In addition, there was a fear of contagion from the Greek referendum on
its second bailout package.14
Indeed, Spanish government bond yields increased again from early
March 2012 onwards, as its banking and real estate markets deteriorated
further and the amount needed to recapitalise banks increased. This
undermined Spanish consolidation measures to regain sustainability of
public finances.15 Italian yields also edged higher, although remaining

9
Zettelmeyer et al. (2013), ‘The Greek Debt Restructuring’, 3–8.
10
The ECB used the SMP to purchase Italian and Spanish government bonds from August
2011 onwards.
11
See www.bloomberg.com/news/articles/2011-09-19/italy-s-credit-rating-cut-one-level-to-a-
by-s-p-as-government-debt-mounts and also www.reuters.com/article/us-italy-moodys-
debt-idUSTRE7936R420111005.
12
De Pooter et al. (2015), ‘Cheap Talk and the Efficacy of the ECB’s Securities Market
Programme’. 49 and 51–98.
13
Zoli (2013), ‘Italian Sovereign Spreads’.
14
See, for example, Tuori and Tuori (2014), The Eurozone Crisis.
15
This was evidenced by the nationalised Bankia group, the third largest bank in Spain.
Initially government interventions were not deemed necessary but in the course of
spring 2012, the estimated amount of new capital soared to tens of billions. See Johnson
(2012), ‘Spain to Spend Billions on Bank Rescue’.

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 6.1 the sovereign debt crisis 153

well below the level reached in late 2011. A further problem was that
Italian and Spanish bond yields were largely moving in parallel, which
increased the risk that adverse developments in either country could be
transmitted to the other country as well. Worries over the sustainability
of the euro area as a whole gained momentum towards the summer of
2012. The freshly established ESM alone could not handle both Spain and
Italy, as their combined public debt totalled more than 2,900 billion
euros. At the same time, calls for further ECB measures intensified,
when the temporarily positive three-year LTROs turned out to have
negative longer-term implications. The bulk of funding had gone to local
banks to invest in Spanish and Italian government bonds.16 Hence, three-
year LTROs enforced the link between government finances and local
banks, particularly in Italy and Spain.17 In this situation, rising govern-
ment bond yields (declining bond prices) in Spain and Italy added to
sustainability concerns over local banks. The initial positive expectation
of substantial profits from declining yields was turned on its head.
Towards the summer of 2012, credit default swaps for many large banks
increased substantially, as banks in troubled countries faced both macro-
economic risks but also risk related to their new government bond
holdings.18
All in all, vulnerabilities were piling up in the euro area economic
framework. The overall situation contained elements from banking
sector liquidity problems, banking solvency issues stemming from the
real estate boom and bust, large cyclical and also structural fiscal deficits
having led to large government debts, major political uncertainty and
the risk of contagion within the euro area.19 Poor euro area economic
growth worsened public sector imbalances and the overall situation was
described as ‘a burning building with no exits’.20 These multiple prob-
lems did not follow the lines of responsibility between policy areas,
which complicated finding the most effective solutions, and put the
burden disproportionally on the ECB.

16
‘Spanish and Italian banks were the biggest users of the December and February LTROs,
using a chunk of the money to buy government debt’. Financial Times, ‘Lenders Plot Early
LTRO Repayments’, www.ft.com/intl/cms/s/0/7a74819a-2e65-11e2-8f7a-00144feabdc0
.html#axzz43eU05i3w.S.
17
Gai et al. (2013), ‘Bank Funding and Financial Stability’, 237–252.
18
ECB Financial Stability Review (June 2012), 10–13, 52.
19
Lane (2012), ‘The European Sovereign Debt Crisis’, 49–68.
20
By the UK Foreign Minister William Hague, www.bbc.com/news/uk-politics-15098567.

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 154 6 th e prelude to the sovereign debt crisis

However, in the course of 2012, many structural improvements also

took shape. In March 2012, the enormous second Greek package finally
included government debt restructuring.21 The ESM Treaty passed the
scrutiny of the FCC, and the ESM started operating in October 2012.22 In
June 2012, the Spanish government asked for a 100 billion euro bailout
for its banks and Greek voters agreed to the austerity measures
demanded in the bailout package.23 In the meanwhile, austerity meas-
ures showed some positive effects as well. For example, the primary
deficit of the euro area as a whole was reduced from nearly –4 per cent
of GDP in early 2010 to –1 per cent by early 2012. The Spanish economy
improved, particularly in the course of 2012, and the Italian primary
surplus reached 2 per cent in 2012.24 From July 2012 onwards, the most
intense period of the sovereign debt crisis appeared to have passed. These
events provide the background to multiple measures by the ECB, includ-
ing ongoing communication, participation in rescue packages, as well as
selective bond purchases, the SMP in 2010 and the OMT in 2012.

6.2 ECB Verbal Interventions

Communication is an essential part of contemporary central banking
through which central banks influence the plans and decisions of house-
holds, companies and market participants. Communication guides
expectations of future central bank measures but also conveys its view
on the economy. During the crises, communication became even more
important as economic policy, including monetary policy, was conducted
in uncharted territory, where expectations were not guided by
previous experience.
ECB verbal interventions on the sovereign debt crisis can be defined as
ECB communication that exceeded its normal fiscal analyses as part of
its regular economic assessment. ECB monetary policy decisions had
always discussed also the fiscal situation from a structural and some-
times also cyclical perspective, and at the euro area level. The ECB
refrained from discussing individual Member States’ fiscal policy, and
importantly, its comments on public finances were normally perceived

21
Zettelmeyer et al (2013), ‘The Greek Debt Restructuring’.
22
www.esm.europa.eu/about/index.htm.
23 24
Having initially rejected them in May 2012. https://sdw.ecb.europa.eu

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 6.2 ecb verbal interventions 155

as expert assessments on issues that are relevant to its policy but not
under its responsibility.25
This approach changed during the escalation of the Greek situation.
First, the ECB demanded that Greece and other countries ‘fully respect
the Stability and Growth Pact, and fully respect the excessive deficit
procedure’.26 In doing so, the ECB addressed a single Member State on
a specific issue outside its direct responsibility. Ever clearer policy
change took place in March 2010, when the ECB issued a special state-
ment on Greek government fiscal consolidation measures.27 With this
statement, the ECB presented itself as a key policy actor that could help
in achieving fiscal sustainability in Greece. The statement perhaps aimed
at convincing financial markets of Greek adjustment measures, although
with limited success. Another reason could have been to convince the
Greek people of the need for fiscal consolidation.28 Nevertheless, the
statement could have created expectations about the ECB’s involvement.
The ECB statement was followed by President Trichet’s support for the
decision by Heads of State or Government that ‘euro area Member States
will take determined and coordinated action if needed to safeguard
financial stability in the euro area as a whole’. He also caused surprise
by stating that ‘I do not believe that it would be appropriate to introduce
the IMF as a supplier of help through stand-by arrangements or through
any such kind of help’. He thus explicitly disregarded the only bailout
mechanism that was readily appropriate and available, implicitly advo-
cating an EU bailout mechanism. The verbal interventions by President
Trichet on the looming Greek default were similarly strong. When asked
‘can you, in your position, as of now categorically rule out a Greek
default?’ he replied: ‘I would say that based on all the information that
I have, default is not an issue for Greece’.29 In the same vein, he replied
that ‘we are firmly of the view that Greece will not default’.30 Naturally,

25
For example, the regular ECB press conferences discuss fiscal policy, often relating the
fiscal situation to the needs of the SGP.
26
Trichet (4 February 2010), ‘Introductory Statement with Q&A’ in Frankfurt am Main.
27
ECB press release (3 March 2010), ‘Statement by the ECB’s Governing Council on the
Additional Measures of the Greek government’, www.ecb.europa.eu/press/pr/date/2010/
html/pr100303.en.html.
28
The Governing Council internal deliberations will become public later, but only the
formal version that pre-empts the later publication.
29
Jean-Claude Trichet (8 April 2010), ‘Introductory Statement with Q&A’ in Frankfurt
am Main.
30
Jean-Claude Trichet (6 May 2010), ‘Introductory Statement with Q&A’ in Frankfurt
am Main.

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 156 6 th e prelude to the sovereign debt crisis

these verbal interventions could be seen as mere attempts to calm down

financial market fears, but the central bank always has the financial
firepower to enforce its views, which in turn can create expectations.
There was no preceding ECB Governing Council decision on the ECB
position concerning its stance on country defaults within the euro
area.31 The commenting could also be compared to Trichet’s earlier
comments on bank defaults, in which he explicitly distanced the ECB
from any responsibility.
In conclusion, verbal interventions by the ECB and particularly by
President Trichet could have created the perception that the ECB was
an important participant in rescues. When the ECB states, for example,
that default by a certain country is not an option, it is not only a wish. It
can be perceived to signal that the ECB will use its tools to avoid a
default. Given the financial resources available to the ECB, it is reason-
able to assume that these interventions created expectations of later
measures if needed.32 Furthermore, the increased expectations that no
euro area government was allowed to default, could even have reduced
possibilities of achieving an early market-based solution to Greek debt.33

6.3 ECB Involvement in Rescue Plans

A broad range of measures and packages were planned and designed
during the sovereign debt crisis. The ECB’s role in these processes was
often on the borderline between formal and informal participation. The
first Greek package was drawn up by the euro area governments and the
IMF, involving 45 billion euros in loans from euro area governments and
the IMF to cover financing needs for 2010. The ECB was involved in
assessing whether Greece had used all other options and needed rescue
funding.34 For some euro area leaders, a leading role for the IMF in intra-

31
Trichet mentioned on May 6th that ‘. . . we did not discuss anything like default or such a
default procedure at all. On the contrary, as you know, we are firmly of the view that
Greece, which is the country that I quoted in my introductory remarks, will not default.’
and he later followed ‘I think that default is out of the question. It is as simple as that.’
32
The actual impact of verbal interventions would need further study, but at least market
commentaries took them seriously.
33
See also article on IMF report in www.wsj.com/articles/
SB10001424127887324299104578527202781667088
34
Directorate-General for Economic and Financial Affairs of the European Commission
(2010), ‘The Economic Adjustment Programme for Greece’. See also ‘The Commission
Adopts a Recommendation for a Council Decision according to Articles 126(9) and 136 of
the Treaty’ (4 May 2010).

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 6.3 ecb involvement in rescue plans 157

euro area rescue operations was seemingly embarrassing, as the IMF was
perceived as a US-led organisation.35 Furthermore, the views of the IMF
and its European counterparties, particularly the ECB and the
Commission, conflicted on critical elements such as the need for Greek
debt restructuring.36
Nevertheless, the package was unable to prevent Greek government
bonds being downgraded to below investment grade status (junk bonds).
It was quickly replaced by a more comprehensive three-year plan, in
which the euro area governments and the IMF agreed on funding of
110 billion euros. From here on, the ECB was closely involved, as a
member of the Troika concluding negotiations for the adjustment
programmes with the Greek government.37 This formal participation
was expressed by the term ‘in liaison with the ECB’.38
Another element of the ECB’s involvement in fiscal adjustment pro-
cesses was President Trichet’s communication with finance ministers
and heads of government that became a critical part of the ECB’s rela-
tionship with Member State governments. An example is a letter from
President Trichet to the Irish Finance Minister Brian Lenihan in
November 2010. The letter demanded that:
only if we receive in writing a commitment from the Irish government vis-a-vis
the Eurosystem on the four following points that we can authorise further

35
See the strained relationship between President Trichet and the IMF in Blustein (2015),
‘Laid low’.
36
www.euractiv.com/section/euro-finance/news/imf-says-sorry-for-greek-crisis-handling-
eu-commission-in-denial/.
37
The Troika was formally expressed as ‘the European Commission, in liaison with the
ECB, and the International Monetary Fund’. See for example ECB press release (2 May
2010), ‘ECB Assesses the Greek Economic and Financial Adjustment Programme’, www
.ecb.europa.eu/press/pr/date/2010/html/pr100502.en.html.
38
The involvement of the ECB was perhaps motivated by a desire to limit the role of the
IMF in euro area rescue operations. Trichet mentioned on May 6th that ‘we were also
asked by the Heads of State and Government, to make an independent judgment on
whether or not it was appropriate for them to activate the bilateral loans that they
envisaged. Their own decision would be taken only on the basis of our independent
judgment, as well as that of the European Commission.’ and further ‘we considered that
we were ourselves sufficiently aware of the recovery programme of Greece and
determined to approve this recovery programme. We had to be consistent with this
judgment as regards the eligibility of the Greek government bonds.’ However, the same
day Trichet also said that ‘[w]e have had absolutely no involvement in any other cases in
which the ECB has itself negotiated the recovery programme, made a judgment on the
recovery programme, and told the Heads of State or Government that they themselves
had to invest in the form of bilateral loans’, thus indirectly confirming the ECB’s
involvement in the programme.

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 158 6 th e prelude to the sovereign debt crisis

provisions of ELA to Irish financial institutions: 1) The Irish government shall

send a request for financial support to the Eurogroup; 2) The request shall
include the commitment to undertake decisive actions in the areas of fiscal
consolidation, structural reforms and financial sector restructuring, in agree-
ment with the European Commission, the International Monetary Fund and the
ECB; 3) The plan for the restructuring of the Irish financial sector shall include
the provision of the necessary capital to those Irish banks needing it and will be
funded by the financial resources provided at the European and international
level to the Irish government as well as by financial means currently available to
the Irish government, including existing cash reserves of the Irish government;
4) The repayment of the funds provided in the form of ELA shall be fully
guaranteed by the Irish government, which would ensure the payment of imme-
diate compensation to the Central Bank of Ireland in the event of missed pay-
ments on the side of the recipient institutions.39

President Trichet sent similar confidential letters to Prime Ministers

Berlusconi (Italy) and Zapatero (Spain) in August 2011,40 but the letter
to Berlusconi was immediately made public. In the letter, Trichet (and
his successor Mario Draghi) demanded large-scale reforms in Italy and
even had a view on the legal forms of these measures.41
Furthermore and more structurally, the ESM Treaty assigned a formal
role to the ECB in operationalising ESM assistance. The main task related
to activation of financial assistance.42 These tasks were formally based
on the ECB’s task of supporting the general economic policies in the
Union rather than a monetary policy task.43

6.4 Changes in ECB Collateral Requirements and Liquidity

Provision Directly Linked to the Sovereign Debt Crisis
The collateral policy changes in April 2010 discussed earlier were already
accused of conferring preferential treatment on Greek government

39
The letter was published by the Irish Times, see www.irishtimes.com/business/economy/
jean-claude-trichet-letter-to-brian-lenihan-1.1989801.
40
Corriere della Sera (6 August 2010). See also Crisi: il Corriere della Sera pubblica la lettera di
Draghi e Trichet a Berlusconi.
41
It was even claimed that the ECB demanded the resignation of Berlusconi as a condition
for its support. www.ecb.europa.eu/pub/pdf/other/2011-08-05-letter-from-trichet-and-
fernandez-ordonez-to-zapateroen.pdf?e5c1a67f9627c5f087d5c7f02168e0da.
42
The tasks included assessing requests for stability support and their urgency, negotiating
the MoUs and conditionality as well as monitoring (Arts. 4(4), 13(1–3) and 13(7) ESM
Treaty).
43
Treaty Establishing the European Stability Mechanism. T/ESM 2012/en 1.

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 6.5 constitut ional remarks 159

bonds. However, this discussion was soon eclipsed by the ECB decision to
suspend application of the minimum credit rating threshold for debt
issued by the Greek government. This happened after the Troika had
concluded negotiations with Greece. The justification was that the ECB,
as part of the Troika, had assessed the Greek adjustment programme and
considered it also to be appropriate from the risk management perspec-
tive:44 ‘[w]e had to be consistent with this judgment as regards the
eligibility of the Greek government bonds’.45 Collateral policy relaxation
continued with Ireland in March 201146 and with Portugal in July
2011,47 using similar justifications.
The escalation of the Greek situation also postponed the process of
unwinding the exceptional liquidity-creating measures. This time the
liquidity measures were claimed also to be designed for the purpose of
providing incentives for banks to invest in government bonds. As men-
tioned earlier, in late 2011 the ECB announced two 3-year LTROs to
support bank lending and money market activity, giving nearly 1,015
billion euros of funding to banks. Arguably, this unlimited long-term
funding was motivated by the situation in the sovereign bond markets.48
The scale and length of the LTROs provided banks with ample incentives
to go for longer-maturity asset purchases such as government bonds.

6.5 Constitutional Remarks

The constitutionality of the ECB’s participation in the sovereign debt
crisis could be assessed from the perspective of the European
Macroeconomic Constitution. Were the measures part of ECB monetary
policy? How should they be seen in relation to the independence of the
ECB or the prohibition on public financing by the ECB?

44
Decision of the ECB of 6 May 2010 on temporary measures relating to the eligibility of
marketable debt instruments issued or guaranteed by the Greek Government (ECB/2010/
3).
45
Trichet (6 May 2010), ‘Introductory Statement with Q&A’.
46
ECB press release (31 March 2011), ‘ECB Announces the Suspension of the Rating
Threshold for Debt Instruments of the Irish Government’, www.ecb.europa.eu/press/pr/
date/2011/html/pr110331_2.en.html.
47
ECB press release (7 July 2011), ‘ECB Announces Change in Eligibility of Debt
Instruments Issued or Guaranteed by the Portuguese Government’, www.ecb.europa.eu/
press/pr/date/2011/html/pr110707_1.en.html.
48
ECB press release (8 December 2011), ‘ECB Announces Measures to Support Bank
Lending and Money Market Activity’, www.ecb.europa.eu/press/pr/date/2011/html/
pr111208_1.en.html. In addition, the ECB halved the reserve ratio from 2 per cent to
1 per cent and also relaxed collateral availability further by including bank loans.

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 160 6 th e prelude to the sovereign debt crisis

The verbal interventions and participations in the rescue mechanisms

generally point to non-monetary policy motivations. The ECB never
claimed that these were based on monetary policy considerations as
such, let alone its monetary policy tasks.49 Hence, the ECB’s involvement
was not based on any Treaty-based task except perhaps the ECB’s support
of general economic policies in the Union. Expanding the list of eligible
collateral and the three-year LTRO funding for banks were formally
based on the ECB’s monetary policy task, but they could also be seen as
the ECB’s engagement in the sovereign debt crisis. For example, the
exceptional inclusion of downgraded government bonds as collateral
was hardly solely based on monetary policy or price stability consider-
ations. Similarly, three-year unlimited LTROs provided banks with incen-
tives to buy government bonds, whether this was the main motivation or
not. However, given the broad discretion allowed to the ECB as an expert
organisation, it is difficult to classify the three-year LTROs or collateral
policy changes as manifestly different from monetary policy, unless
there are clear indications of the main motivation being outside the
spectrum of monetary policy.
The principle of central bank independence could be assessed differ-
ently in relation to the ECB’s participation in the rescue packages and its
verbal interventions. For example, as a member of the Troika, the ECB
negotiated with Member States on their adjustment programmes. In this
role, the ECB also became formally involved in ESM decisions, which
could be considered detrimental for its independence. The FCC and the
Advocate General stressed that the ECB was to be ‘kept away from the
political debate’.50 However, there are hardly fiercer political debates
than those related to Member States’ adjustment programmes.
Membership in the Troika had a more direct effect as well. When the
ECB agreed on an adjustment programme that included purchases in the
primary markets, this could have created expectations of ECB bond
purchases as well.51 However, the CJEU did not see a link between
independence and participation in the adjustment programmes.

49
This was also the CJEU’s view in the Pringle case concerning the role of the ECB in
the ESM.
50
Opinion of Advocate General Cruz Villalón in Case C-62/14 Gauweiler, EU:C:2015:7,
para. 109.
51
The Advocate General saw the OMT as sufficiently separate from the adjustment
programmes, but at least discussed the issue. Furthermore, he saw the ECB’s direct
involvement in the financial assistance programme as problematic. Opinion of Advocate
General Cruz Villalón in Case C-62/14 Gauweiler, EU:C:2015:7, paras. 156 and 203.

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 6.5 constitut ional remarks 161

Participation in the negotiating and monitoring adjustment pro-

grammes imposed practical constraints on ECB measures in monetary
policy fields, as was acknowledged by the ECB with regard to its collat-
eral policy. This consequently increased the ECB’s financial risks,
which can be problematic for its independence. More broadly, the
ECB became a large lender to the troubled Member States’ banks –
lending partly based on government bonds as collateral. And as dis-
cussed, banks used the funding to buy even more government bonds,
meaning that the ECB became exposed to potential defaults by the
Member States on multiple fronts.
The ECB’s verbal interventions raise some constitutional issues as well.
Verbal interventions – particularly by Jean-Claude Trichet – could have
created justified expectations among people and market participants. In
some cases, these interventions led to confusion concerning the insti-
tutional balance and responsibilities in euro area macroeconomic man-
agement. Against this background, it can be claimed that the insistence
that Greece is not allowed to default and the negative view on IMF
involvement in rescue operations could have questioned the no-bailout
clause and even suggested that the ECB would stand ready to prevent a
Greek default. The ECB’s actions could thus have worked against the
principle of national responsibility over fiscal policy.
Additionally, when the ECB was involved in demanding measures
from Member State governments, this could have weakened its position
against Member States. The ECB does not wield legal measures against
the Member States, but has effective means to impose its demands.
Countries in trouble were dependent on ECB support, both verbally
and later through its bond purchases and acceptance of emergency
liquidity assistance (ELA). The letters sent by the ECB showed how the
SMP and emergency liquidity assistance could have been used as pres-
sure tools against governments.
In conclusion, ECB involvement in the sovereign debt crisis both
expanded the scope of monetary policy and also involved measures that
were clearly outside the ECB’s Treaty-based tasks. Looking at the ECB
involvement overall in the sovereign debt crisis, the picture is complex.
It is evident that the interplay between national economic policies and
the common monetary policy faced situations that were outside the
constitutional model.

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 7 Selective Government Bond Purchases

The ECB’s selective bond purchase programmes raised constitutional

questions from the start. The Securities Market Programme (SMP) was
criticised for overstepping the lines of EU monetary policy and for
questioning the principles of EMU constitutional architecture. It was
followed by an even more unusual programme, Outright Monetary
Transactions (OMT), which was never used to purchase bonds, but was
still claimed to be a success by the ECB. The discussion got a formal legal
status through the judgments by the CJEU and the FCC. As the new
measures pushed the boundaries of the constitutional model, concepts
such as the conduct of monetary policy needed to find their legally
relevant meaning. The CJEU chose an approach that monetary policy
was not defined in the Treaty through its content or even its instru-
ments, but through its objectives.1 This approach can lead to an obscure
definition of monetary policy considering that it also forms the border-
line between common monetary policy and national economic policies.
The principle of conferral risks becoming void if the independent ECB
can effectively dictate its own mandate.2 Therefore a more economic
definition of monetary policy could be warranted.
Selective bond purchases will be assessed through an iterative process.
Broad legal questions are first sketched to discover the relevant eco-
nomic questions that, in turn, are analysed to provide the basis for
constitutional conclusions. Four types of legal issues are evoked: classifi-
cation of the programmes as monetary policy; their relation to the
prohibition on public financing of the Member States; their impact on

1
ECLI:EU:C:2012:756.
2
The issue of boundaries is thoroughly discussed in FCC case 2 BvR 2728/13, paras 59–64.

162

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 7 selective government bond purchases 163

the independence of the ECB; and their compliance with the overall
European Macroeconomic Constitution.3
The most important question concerns monetary policy, as selective
purchases are not part of traditional monetary policy, even according
to the ECB.4 Whether the programmes nevertheless are something
that could be considered monetary policy requires that they could
be proportionally employed to achieve the primary objective of the
ECB monetary policy, namely, price stability. The discussion is pri-
marily of an economic nature. If the programmes fail to amount to
monetary policy, they would fall under the broad umbrella of eco-
nomic policies, which remains as Member State competences in the
EMU. Specific questions relate to the role of government bonds in the
transmission of monetary policy, and also to the risk of contagion
or even of currency redenomination as justifiable reasons to go for
selective purchases.
The second question tackles the prohibition on public financing.
Primarily, this is stipulated in Article 123 TFEU, but in addition
Article 125 TFEU, the no-bailout clause, might also need to be assessed.
The programmes did exclude primary purchases of government
bonds, but refrained from discussing the prohibition apart from a very
formalistic reading. The third question concerning ECB independence
can be addressed both in relation to the broader role of the ECB in
fiscal rescue operations and to emerging creditor–debtor relationships
with Member States. The programmes also exposed the ECB to credit
losses that could limit its financial independence. Finally, the selective
purchases could be assessed on the basis of their conformity with the
overall European Macroeconomic Constitution. For example, the open
market economy principle could be jeopardised as the programme
explicitly operated against market pricing on the basis that the
markets were malfunctioning.5 Before the analysis, the programmes
are briefly described.

3
A similar classification in Helm (2012), The ECB’s Securities Markets Programme.
4
It has been consistently labelled an unconventional monetary policy measure by the ECB.
5
A paradox in ECB communication was that on one hand it insisted that it was successful
in correcting market failures in bond markets and on the other that it was not affecting
the market mechanism. See Ghysels et al. (2014), ‘A High Frequency Assessment of the
ECB Securities Markets Programme’ and Trichet (2010), ‘The ECB’s Response to the
Recent Tensions in Financial Markets’, www.ecb.europa.eu/press/key/date/2010/html/
sp100531_2.en.html.

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 164 7 selective government bond purchases

7.1 The Securities Market Programme

The SMP was the most controversial measure up to that point, when it
was announced on 10 May 2010 as part of a larger package to address
severe tensions in the financial markets – tensions that were hampering
the conduct of monetary policy.6 The SMP contained interventions in the
euro area ‘debt securities markets to ensure depth and liquidity in those
market segments which are dysfunctional . . . to address the malfunc-
tioning of securities markets and restore an appropriate monetary policy
transmission mechanism’.7 The SMP was also a surprise. Only a few days
earlier President Trichet had denied that the ECB would even have
discussed such a measure.8 During the weekend in between, the EU
Council had held a crisis meeting to agree measures to preserve financial
stability, where Trichet had urged for European-based rescue solutions.
Also exceptionally, some NCB officials leaked information and ques-
tioned the stated rationales of the SMP.9
The SMP assigned the Governing Council the power to instruct NCBs to
buy government bonds of the troubled Member States, as ‘bond spreads
for several euro area countries widened beyond any reasonable level’.10 It
was formally part of monetary policy to address only the above-
mentioned malfunctions. Monetary policy stance was not affected, as
the purchases were sterilised.11 The purchases took place in the second-
ary markets in order not to directly breach Article 123 TFEU, without
specifying any safety margins around primary issues. The bonds had to

6
Preamble (2) and (3) of the ECB Decision establishing a securities markets programme on
14 May 2010 (ECB/2010/5, 2010/281/EU).
7
Press release (10 May 2010), ‘ECB Decides on Measures to Address Severe Tensions in
Financial Markets’, www.ecb.europa.eu/press/pr/date/2010/html/pr100510.en.html.
8
ECB press conference (6 May 2010), ‘Introductory Statement with Q&A’, www.ecb
.europa.eu/press/pressconf/2010/html/is100506.en.html and Trichet (2010), ‘The ECB’s
Response to the Recent Tensions in Financial Markets’.
9
The following day, Bundesbank President Weber said that he had opposed the decision
and stated: ‘[d]er Ankauf von Staatsanleihen birgt erhebliche stabilitätspolitische
Risiken’. Some unnamed senior bankers from the Bundesbank even raised the suspicion
that Trichet was simply trying to save French banks from incurring large losses on Greek
government debt. Spiegel Online (31 May 2010), ‘German Central Bankers Suspect
French Intrigue’.
10
Trichet (2010), ‘The ECB’s Response to the Recent Tensions in Financial Markets’.
11
The ECB absorbed the liquidity provided through the SMP by means of weekly liquidity-
absorbing operations until June 2014. See. www.ecb.europa.eu/mopo/implement/omt/
html/index.en.html.

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 7.1 securities market programme 165

fulfil the eligibility criteria on monetary policy instruments, the applica-

tion of which had been suspended for Greece a week earlier.12
The programme started off immediately after the decision, initially
involving Greek, Irish and Portuguese bonds. During the first two weeks,
the ECB bought 26.5 billion euros of bonds. The purchases were more or
less halted in July 2010, and only reactivated a year later in August
2011 to now include Spanish and Italian government bonds. The last
purchases took place in February 2012, when the total amount peaked at
218 billion euros.13 The ECB maintained full discretion whether to pur-
chase any bonds, and the purchases did not seem to react to observable
market situations.14 The decision did not address risk-sharing within the
Eurosystem, but it was assumed that full risk-sharing took place.
The legal basis was the ECB mandate in the field of monetary policy.
The decision referred to the task of defining and implementing monetary
policy (Article 127(2) TFEU)15 but not to supporting the general economic
policies in the Union (Article 127(1) TFEU) or to contributing to the
smooth conduct of policies pursued by competent authorities relating
to the prudential supervision and the stability of the financial system
(Article 127(5) TFEU).

7.1.1 The Aims of the Programme

The main constitutional questions concerning the SMP relate to its
underlying economic aims. Was the SMP primarily monetary policy or
did other aims motivate the ECB? The actual decision provided limited
insight into the ECB’s economic considerations, which can be collected
from ensuing speeches, press conferences and articles. The main argu-
ment was that severe tensions in certain market segments hampered the
monetary policy transmission mechanism and thereby the effective

12
Article 2 of the ECB Decision establishing a securities markets programme (ECB/2010/5)
and ECB press release (3 May 2010), ‘ECB Announces Change in Eligibility of Debt
Instruments Issued or Guaranteed by the Greek Government’, www.ecb.europa.eu/press/
pr/date/2010/html/pr100503.en.html.
13
Later, when the ECB revealed the composition of SMP purchases, the largest holdings
were in Italian (101 billion euros), Spanish (44 billion euros) and Greek (34 billion euros)
government bonds. ECB press release (21 February 2013), ‘Details on Securities Holdings
Acquired under the Securities Markets Programme’, www.ecb.europa.eu/press/pr/date/
2013/html/pr130221_1.en.html.
14
Ghysels et al. (2014), ‘A High Frequency Assessment of the ECB Securities
Markets Programme’.
15
In addition, the decision referred to Articles 12.1, 3.1 and 18.1 Statute. The ECB Decision
establishing a securities markets programme (ECB/2010/5).

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 166 7 selective government bond purchases

Government Bond Yields

15.0
14.0
13.0
12.0
11.0
10.0
9.0
8.0
7.0
6.0
5.0
4.0
3.0
2.0
1.0
0.0
2008

2009

2010

2011

2012

2013

2014

2015

2016

2017

2018

2019

2020

2021
–1.0
–2.0

Euro area Italy Spain Portugal Ireland Greece

Figure 7.1 Euro area bond yields

Source: OECD, obtained from FRED, https://fred.stlouisfed.org/.

conduct of monetary policy. A temporary bond purchase programme

could ‘address the malfunctioning of securities markets and restore an
appropriate monetary policy transmission mechanism’.16 The bond
yields of some Member States (see Figure 7.1) and particularly the spread-
s between euro area government bond yields had reached levels that
were deemed detrimental to monetary policy, and purchases of these
bonds were assumed to overcome this problem.
The ECB elaborated how the SMP should have ensured the transmis-
sion of monetary policy stimulus to output and prices. In normal times,
the ECB steers the economy by setting policy rates, which in turn directly
influence money market interest rates. This affects all the interest rates
by changing expectations concerning current and – more importantly –
expected short-term rates as well as risk compensation. These, in turn,
shape the interest rates faced by households, companies and govern-
ments that affect their savings and investment decisions.
The main issue was the role of government bond markets that
according to the ECB affect other markets through three channels.

16
Preamble (2) and (3) 1 of the ECB Decision establishing a securities markets programme
(ECB/2010/5).

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 7.1 securities market programme 167

First, government bond yields are references for other yields that are
defined by adding risk compensation on top of the benchmark bond
yields (in practice German Bund rates).17 In the euro area, some evidence
suggested that the compensation for credit risks was excessively low
before the crisis and possibly too high during the crisis. Second, govern-
ment bonds are widely used as collateral in the interbank markets and
central banking operations.18 If their market malfunctions, it can dis-
rupt interbank markets and reduce liquidity,19 with serious implications
for bank lending to households and companies. Third, a balance sheet
channel means that lower bond prices reduce banks’ own capital, which
in turn can constrain bank lending.20 All these three channels can
hamper the monetary policy transmission mechanism so that ECB mon-
etary policy impulses might not be transmitted through financial
markets and banks to the real economy. Hence, the aim of the SMP
was to affect the government bond markets in the troubled euro area
Member States.
This monetary policy transmission mechanism explanation has also
been questioned, even by members of the ECB Governing Council.21
Some elements of the argumentation are also specific to the euro area
institutional and economic structure, which limits available theoretical
and empirical research. The euro area bond markets are between a
unified single financial market and a collection of separate national
financial markets. This makes national bond markets both sub-markets
of the euro area government bond markets and still also national, where
national factors stem from the national responsibility for fiscal policy
and financial stability.

17
Giordano et al. (2012), ‘The Determinants of Government Yield Spreads’ and Barrios et al.
(2009), ‘Determinants of Intra-euro Area Government Bond Spreads’.
18
In many countries only government bonds are accepted as collateral.
19
Liquidity refers to the ability of the markets to satisfy the needs of banks with regard to
supply or demand of interbank funding.
20
Trichet (2010),’The ECB’s Response to the Recent Tensions in Financial Markets’.
21
Most notably, the German Bundesbank was vocal against the programme from the start
and questioned the monetary policy transmission argument. www.bloomberg.com/apps/
news?pid=newsarchive&sid=aRlRfmRIPrRw.
Bundesbank president Weber also resigned unexpectedly in April 2011 apparently on
the basis of his opposition to the policy. www.ft.com/intl/cms/s/0/4e388020-35f8-11e0-
b67c-00144feabdc0.html#axzz3ZqWMFEwW. In addition, at least the President of the
De Nederlandsche Bank, Knot, was critical. See Bloomberg (13 April 2012), ‘ECB Seen
Favoring Bond Buying Over Bank Loans’, www.bloomberg.com/news/2012-04-12/ecb-
seen-favoring-bond-buying-over-bank-loans-as-crisis deepens.html. See also Issing (2011),
‘The Wrong Kind of Union’.

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 168 7 selective government bond purchases

7.1.2 An Economic Analysis of the SMP and Its Aims

Economic analysis needs to approach the borderlines of monetary policy
and its appropriate aims – for example, whether the concept of monetary
policy includes structural issues concerning monetary policy transmis-
sion and even government bond markets. The ECB claimed that national
government bond markets functioned as the basis for other re-
nationalised financial markets,22 which was probably an exaggeration.
The euro area financial markets remained largely uniform during the
crisis, with some sector and country variation.23 The euro area lacks
federal sovereign bond markets, but German Bunds are used as
benchmarks because they have the lowest risks and best liquidity,24
although their pricing is still affected by German economic fundamen-
tals as well.
The euro area sovereign bond markets have been studied both theor-
etically and empirically since the crisis. The starting point is that if
fundamental factors generate interest rate differentials (spreads)
between euro area sovereign bonds, there is no role for public sector
intervention. Risk factors can be divided further into credit risks, liquid-
ity risks, and general investor risk appetite. Other factors such as conta-
gion or currency redenomination risks can lead to self-fulfilling spirals
barring a policy response, including a monetary policy response from the
ECB. ‘Legitimate fear of contagion can cause policymakers to take
actions that they would not normally consider.’25
Research on sovereign bond yields in the euro area stresses credit risk
as the main explanation for spreads. Credit risk can be explained by
information on public finance and economic sustainability: government
debt and deficit, interest expenditure, growth prospects, unemployment,
and even inflation.26 Additionally, during the crisis bank rescues

22
As if financial market pricing in California was based on the interest rates on the bonds
issued by the state of California rather than US Treasury securities alongside the
instruments of the Fed.
23
ECB Annual Report, ‘Financial Integration in Europe’ (April 2014), 29–30, www.ecb
.europa.eu/pub/pdf/other/financialintegrationineurope201404en.pdf.
24
For example, the spreads of the euro area sovereign bond yields are often expressed in
relation to German Bunds although the euro area benchmark yield curve would formally
be more correct. ECB Monthly Bulletin (May 2014), ‘The Determinants of Euro Area
Sovereign Bond Yield Spreads during the Crisis’.
25
Forbes (2012), ‘The Big C’.
26
Codogno et al (2003), ‘Yield Spreads on EMU Government Bonds’, 503–532; Geyer et al.
(2004), ‘Measuring Systematic Risk’, 171–197; Bernoth et al. (2012), ‘Sovereign Risk
Premiums’, 975–995; Favero et al. (2010), ‘How Does Liquidity Affect Government Bond

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 7.1 securities market programme 169

resulted in transformation of private debt into public debt,27 which

increased public credit risk in those Member States.

Contagion and Currency Redenomination Risks

The traditional analysis is inconclusive on the appropriate compensation
for default risks of sovereign states. In addition to the traditional param-
eters mentioned above, the crisis might have introduced new elements.
For example, a country’s default probability could depend on many
elements that are outside the sphere of economics. For example, the
ability of the political system to respect countries’ obligations is a factor
that can be signalled by making politically difficult decisions, even
constitutional changes.28 In situations of heightened risk-awareness,
problems in one country can create expectations of similar problems
emerging in similar countries. As such, contagion can be rational.29 If an
event becomes detrimental for one country and its government bonds, it
is rational that investors become wary of similar risks in other countries.
In general, a contagion should be prevented if the root causes can be
repaired in the source country and even more so if instability is not based
on economic fundamentals.30 In the EMU, a contagion risk or a currency
redenomination risk (break-up of the EMU) could further promote policy
responses, if the markets are pricing risks that the political system finds
unacceptable. The classification of these policies as monetary policy is
another matter.
Against this background, it could be analysed whether sovereign bond
yields behaved in a way that was not based on economic fundamentals –
for example, whether some market reactions could be explained mainly
by fears of contagion between the Member States. Unfortunately, analy-
sis of euro area sovereign bond yields does not prompt firm conclusions.
Even an ECB Monthly Bulletin article states that ‘[a] relatively robust
finding of the literature on the determinants of sovereign bond spreads

Yields?’, 107–134; Gerlach et al. (2010), ‘Banking and Sovereign Risk’ and von Hagen
et al. (2011), ‘Government Bond Risk Premiums’, 36–43.
27
Attinasi et al. (2010), ‘What Explains the Surge in Euro Area Sovereign Spreads’,
595–645.
28
An example is the Spanish constitutional change in August 2011 and the decisions by the
Monti government in Italy in November 2011. The cases could have signalled political
will to honour their debts even beyond traditional party lines.
29
Bi and Traum (2012), ‘Estimating Sovereign Default Risk’, 161–166.
30
Forbes (2012), ‘The Big C’ and also Alter and Beyer (2013), ‘The Dynamics of Spillover
Effects’. This could be described as multiple equilibria, such as in Constâncio (2012),
‘Contagion and the European Debt Crisis’, 109–121.

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 170 7 selective government bond purchases

is that measures of a country’s creditworthiness, traditionally related to

credit premia, have become more relevant to explain sovereign bond
spreads since the start of the financial crisis and, to an even larger
extent, since the sovereign debt crisis’.31
Later, ECB communication began to stress the currency redenomina-
tion risk as a key factor in why the euro area financial markets became
re-nationalised. International investors were claimed to price-in the pos-
sibility that some Member States would leave the euro. In those circum-
stances both the Member States and their financial systems could face
risk-pricing well above levels justified by economic fundamentals,32
although the link between a country’s default and its currency redeno-
mination is not straightforward. A default on government debt should
not force exit from the EMU as such. Currency redenomination could
take place if the defaulting country sees it as the most (or only) appropri-
ate way to regain economic sustainability. However, defaults and cur-
rency redenomination can result from the same underlying source, an
inability to prosper in the EMU.
In conclusion, it is difficult to prove that government bond pricing was
not in line with economic fundamentals. Some evidence can be detected
of malfunctioning and of currency redenomination risks in the euro area
government bond markets, but most market reactions can be explained
by economic fundamentals. A self-fulfilling market perception might
have played a role in Greece, but actual developments turned out to be
even worse. Thus, the economic reasons for protecting the conduct of
common monetary policy with measures directed at national govern-
ment bond markets were plausible but not necessarily strong enough to
make a case for the SMP. Against this background, it is appropriate to
assess whether there could have been other explanations for the SMP.

Banks and Euro Area Fragmentation

The EMU complicated the relationship between monetary policy and
national banking sectors. Some evidence suggests that euro area govern-
ment bonds were more affected by banking risks than was the case with
non-euro area countries. In this regard, the EMU made bank problems

31
ECB Monthly Bulletin (May 2014), ‘The Determinants of Euro Area Sovereign Bond Yield
Spreads during the Crisis’, 69 and D’Agostino and Ehrmann (2013), ‘The Pricing of G7
Sovereign Bond Spreads’.
32
This redenomination argumentation gained in importance only later. It was not
mentioned when the SMP was introduced.

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 7.1 securities market programme 171

worse for the Member States that were already facing other difficulties.33
This also motivated the SMP, as was explained by the link between the
government bond markets and liquidity, and the impact of government
bond markets on banking sector solvency.34 However, it should have
been clear that the ECB was never in a position to take responsibility for
the soundness of euro area banks.
In the euro area, banks still account for the majority of external
financing to companies and households. Banks have also remained rela-
tively national, except for the euro area interbank market, which
was very large and integrated before the financial crisis. The recurring
crises led to some additional fragmentation in funding costs for corpor-
ations, but household funding costs have remained similar across the
euro area.35 This undermined the claim that financing conditions
became nationalised beyond what could be explained by economic
fundamentals.
A somewhat different picture of fragmentation and also one of the
clearest examples of exceptional pressures on the euro area banking
market was visible in bank credit default swaps (CDS).36 The CDSs for
longer-term funding of euro area banks deviated substantially from the
US ones from April 2010 onward, when the sovereign debt crisis started
to undermine the credibility of euro area financial markets. However, for
the funding of the euro area banks this was less critical, as public
deposits had continued to grow from 2008 onwards – a growth that
continued after mid 2010 with no general loss of confidence in banks.
Euro area interbank cross-border money market transactions continued,
and only in 2012 did banks in troubled countries have more domestic
than other money market counterparties. Other euro area banks
still continued to make money market transactions predominantly with

33
See, for example, Dieckmann and Plank (2012), ‘Default Risk of Advanced Economies’,
903–934.
34
Trichet (2010), ‘The ECB’s response to the recent tensions in financial markets’.
35
The CDS is a financial instrument that only measures the price that is put on the default
probability of a given bank. ECB Annual Report, ‘Financial integration in Europe’ (April
2014), 29–30, www.ecb.europa.eu/pub/pdf/other/financialintegrationineurope201404en
.pdf.
36
CDS refers to credit default swap which is a credit derivative product that measures the
compensation demanded for the risk a country defaults in the case of sovereign CDSs.
A CDS can be seen as an insurance against non-payment that is defined by the markets.
See for example, www.investopedia.com/terms/c/creditdefaultswap
.asp#ixzz3ZqlAFwmZ.

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 172 7 selective government bond purchases

non-domestic counterparties.37 For bank funding, the most relevant

issue was ECB funding, which reached new heights.38 Therefore, not all
the facts were supportive of claims of euro area financial market frag-
mentation and malfunctioning.
Considering the claim that increased government bond yield differen-
tials led to unjustified differentiation between corporate financing con-
ditions between the Member States, the development in uncovered
corporate bond yields was not confirmative as cross-country dispersion
in corporate bond yields remained generally small. For large euro area
corporations, financing conditions showed remarkably small differenti-
ation between countries.39
Government bond markets as the best quality reserve asset do facili-
tate liquidity in interbank markets and the ECB operational framework.
Before the crisis the ECB even mentioned increased needs for govern-
ment bonds as collateral, and some initial evidence did point to an
increased need for collateral in the interbank markets in 2007.40
However, after 2008, the main problem was the drying-up of cross-
border interbank lending due to lack of trust, not a collateral shortage.41
This was compensated by ECB funding, where government bonds were
not very important (Figure 4.4). The collateral pool for ECB liquidity
operations was increased, and government bonds played a small and
declining role.42 Thus, it can be claimed that the link between the SMP
and the interbank liquidity situation was vague at best. Furthermore, the
amounts purchased and the importance of those assets as collateral
argued against any significant impact on interbank liquidity.
The final argument for the importance of government bonds for
monetary policy transmission suggested that the ECB bought govern-
ment bonds to reduce potential losses to banks. The assumption was that
malfunctioning government bond markets produced wrong prices and

37
ECB Annual Report, ‘Financial Integration in Europe’ (April 2014), 16, www.ecb.europa
.eu/pub/pdf/other/financialintegrationineurope201404en.pdf.
38
Allen and Moessner (2013), ‘The Liquidity Consequences’, 3. 39
Ibid., 21.
40
Heider and Hoerova (2009), ‘Interbank Lending’.
41
A Bank of International Settlements report stated that ‘there was plainly no such
squeeze in 2010’ referring to potential collateral shortage, although a potential shortage
could have resulted from the ECB LTRO lending in 2011 and 2012. Allen and Moessner
(2013), ‘The Liquidity Consequences’.
42
In Greece, lending from the ECB accounted for 10 per cent of liabilities in 2009 and
increased above 15 per cent in 2010. A similar development took place in Ireland and in
Portugal, followed by Italian and Spanish banks in late 2011 and early 2012 related to the
ECB’s three-year LTROs and liquidity provision.

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 7.1 securities market programme 173

that banks suffered losses from their bond holdings, which hampered
their financial intermediation capability and consequently also the trans-
mission of monetary policy. While possible, the first hurdle is the
assumption that bond prices were out of line with fundamentals, other-
wise it would be pure solvency support to banks.
More generally, the link between monetary policy and banking sector
balance sheets is at best a grey area.43 Monetary policy measures often
have an impact on banks’ balance sheets and these effects can even be a
factor in decision-making. However, an actual attempt to use public
funds to improve banks’ balance sheets is a monetary transfer that is
outside the scope of monetary policy.44
In conclusion, it is questionable whether the SMP could be considered
as monetary policy in its economic meaning. The ECB did not make a
convincing case that government bond markets faced genuine malfunc-
tioning. Increased credit risk had become a factor in the pricing of
government bonds in the euro area, but probably not to the extent of
market malfunctioning. Contagion and currency redenomination risks
deserve the benefit of the doubt, although the link between the SMP
and currency redenomination risk appears to be weak. Finally, using
central bank money to improve banks’ balance sheets cannot be con-
sidered monetary policy.
Accordingly, it is necessary to assess whether some other reasons
could have motivated the SMP. These other rationales would risk step-
ping outside areas of exclusive Community competence. Two candidates
are supporting government finances and supporting banks. The claim
that the SMP was effectively financing governments is a key critique
against the SMP.45 The clearest link between the SMP and the financing
of governments was the Greek case, in which the ECB also decided to
accept Greek government debt as collateral against its own collateral
policy.46 For the first time, the Governing Council was not unanimous in
its decision.47 Bundesbank President Weber pointed out that ‘measures

43 44
See the discussion in FCC 2 BvR 859/15. FCC 2 BvR 2728/13 para. 89.
45
Sinn (2013), Verantwortung der Staaten und Notenbanken in der Eurokrise, 17–19.
46
President Trichet justified this on three grounds: the ECB’s involvement in the Greece
austerity programmes, the ECB’s view that the programmes were sufficient and the
ECB’s advice to governments on loan programme for Greece. ECB press release (3 May
2010), ‘ECB announces change in eligibility of debt instruments issued or guaranteed by
the Greek government’, www.ecb.europa.eu/press/pr/date/2010/html/pr100503.en.html.
47
Press conference (6 May 2010), www.ecb.europa.eu/press/pressconf/2010/html/is100506
.en.html, Trichet stated that ‘we were unanimous in asking Greece to embark on a

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 174 7 selective government bond purchases

that damage the fundamental principles of the currency union and the
trust of the people would be mistaken and more expensive for the
economy in the longer term’.48
The solvency of euro area banks arguably motivated rejection of
restructuring of Greek debt in May 2010, as its default would have
caused large losses for euro area banks, particularly in Germany and
France. Notwithstanding any conspiracy theories, the fact remains that
euro area rescue measures mainly paid out interest and capital on
outstanding Greek bonds at full value.49 This was an enormous windfall
gain for private bond holders, whose holdings of Greek debt changed
from private to public hands. The SMP was part of that transfer. Large
losses for banks would have required substantial capitalisation of banks
at least in Germany and France, which made rescues and SMP purchases
indirect support for the German and French governments, not for the
governments of troubled countries. This criticism concerns most euro
area bailout programmes concerning Greece, not only the SMP.

7.2 The Outright Monetary Transactions (OMT)

Worries concerning Spain and Italy had resurfaced towards the summer
of 2012, when ECB President Mario Draghi gave a speech in which he
pointed to the irreversible nature of the euro, saying that measures had
been taken to make it even more irreversible. The main headline was the
sentence: ‘[w]ithin our mandate, the ECB is ready to do whatever it takes
to preserve the euro. And believe me, it will be enough’. He added that
‘to the extent that the size of these sovereign premia hampers the

recovery programme. We were unanimous in forming a positive judgment on the

recovery programme that has been negotiated by the European Commission, in liaison
with us, and by the IMF. We were unanimous in making the judgment . . . that there was
a case for activating the loans which, together with the IMF, would finance the program.
We had a very important discussion on how to be consistent with these three unanimous
decisions in the present circumstances and whether or not we had a better
understanding, taking all that into account, or whether rating agencies had a better
understanding of what the situation was in Greece. An overwhelming majority was of
the opinion that we had to take the decision that was taken last Sunday, in order to be
fully consistent.’
48
www.bloomberg.com/news/articles/2010-05-10/ecb-to-buy-government-bonds-in-
unprecedented-bid-to-save-euro-stop-crisis. He also stated that ‘[t]he purchase of
government bonds poses significant stability risks, and that’s why I’m critical of this
part of the ECB Council’s decision’, in Börsen-Zeitung (11 May 2010), ‘Interview mit
Bundesbankpräsident Axel Weber: ‘Kaufprogramm birgt erhebliche Risiken’.
49
See Blustein (2015), ‘Laid Low’.

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 7.2 outright monetary transactions 175

functioning of the monetary policy transmission channel, they come

within our mandate’.50 A formal ECB statement was published in
August, after a Governing Council meeting that ‘discussed the policy
options to address the severe malfunctioning in the price formation
process in the bond markets of euro area countries. Exceptionally high
risk premia are observed in government bond prices in several countries
and financial fragmentation hinders the effective working of monetary
policy.’ The statement also pointed out that ‘risk premia that are related
to fears of the reversibility of the euro are unacceptable, and they need to
be addressed in a fundamental manner’.51 The ECB insisted that the
EFSF/ESM should be activated for bond market interventions. In this
context the ECB ‘may undertake outright open market operations’. The
ECB revealed that the Bundesbank had reservations about the ECB
buying government bonds.52
The OMT programme was launched in the form of a press release
Technical Features of Outright Monetary Transactions without any ensuing
legal documents. The aim was to safeguard appropriate monetary
policy transmission and the singleness of monetary policy, and pur-
chases had to be warranted from the monetary policy perspective. The
SMP was terminated. A key element was a conditionality requirement
that was guaranteed through a formal link to EFSF/ESM adjustment
programmes.53 The involvement of the IMF was not a condition. No ex
ante quantitative limits were set for purchases that were to focus mainly
on bonds with a remaining maturity of between one and three years.
Purchases were to be fully sterilised.54 Importantly, the legal documen-
tation was to clarify that the ECB accepted the same (pari passu) treat-
ment as other creditors.55

50
Verbatim of the remarks made by Draghi in a speech at the Global Investment
Conference in London 26 July 2012, www.ecb.europa.eu/press/key/date/2012/html/
sp120726.en.html.
51
Draghi in the ECB press conference (5 July 2012), ‘Introductory Statement and Q&A’ in
Frankfurt am Main, www.ecb.europa.eu/press/pressconf/2012/html/is120705.en.html.
52
Draghi in the ECB press conference (5 July 2012), ‘Introductory Statement and Q&A’ in
Frankfurt am Main, www.ecb.europa.eu/press/pressconf/2012/html/is120705.en.html.
53
Also precautionary programmes sufficed (Enhanced Conditions Credit Line), if they
included the possibility for primary market purchases by the EFSF/ESM.
54
In effect, this was largely a formality as the ECB was at the same time providing all the
liquidity that was requested by banks.
55
ECB press release (6 September 2012), ‘Technical Features of Outright Monetary
Transactions’, www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html.

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 176 7 selective government bond purchases

7.2.1 Economic Assessment of the OMT Programme

The economic assessment of the OMT remains partly abstract, because it
was never activated. The assessment draws on the assessment of the
SMP, a more fully fledged programme with legal acts and purchases.
For that purpose, the assessment starts with a comparison of the two
programmes, including some assumed reasons for changes. This leads to
the question of the monetary policy nature of the OMT, as the initial
comments raised two interlinked assumed motivations: credit concerns
over Italy and Spain as well as EMU break-up risk.56

Why Was the SMP Replaced by the OMT?

Although in operation from May 2010 until early 2012, the SMP was
never considered a success. It failed to have any lasting improvement on
government bond markets. It might even have worsened the situation.57
Hence, if the ECB wished to continue intervening in a Member State’s
government bond markets, it needed another approach. There is perhaps
some unintentional truth in Draghi’s reply on the OMT: ‘[i]t is an effort
that, I would say, is very different from the previous Securities Market
Programme and one that falls squarely within our mandate’.58 One main
problem with the SMP was the ECB’s preferential treatment in debt
restructuring. It was legally dubious that a bond’s seniority changed
when the ECB purchased it.59 However, it is clear how this self-appointed
seniority would hamper the functioning of the bond market. In a
looming debt restructuring, a key issue for pricing is: how much debt
will be cut in relative terms? If the share of high seniority debt increases,
the position of other creditors weakens. Worse still, in the Greek case,
potential buyers could not know the proportion of high seniority
debt because it depended on the ECB’s purchases before restructuring.60

56
For analyst responses, see http://blogs.wsj.com/eurocrisis/2012/09/06/band-aid-or-leap-
forward-reactions-to-ecb-plans/.
57
See Dobson and Moses (2012), ‘ECB Greek Plan May Hurt Bondholders While Triggering
Debt Swaps’, www.bloomberg.com/news/articles/2012-02-17/ecb-plan-to-shield-its-greek-
bonds-may-subordinate-some-holders-ubs-says and the same also in www.isda.org/
uploadfiles/_docs/PAI_for_Issue_No_2012022401.pdf.
58
Draghi in ECB press conference (2 August 2012), ‘Introductory Statement and Q&A’ in
Frankfurt am Main, www.ecb.europa.eu/press/pressconf/2012/html/is120802.en.html.
59
See www.telegraph.co.uk/finance/economics/11907490/European-Central-Bank-sued-by-
200-investors-over-Greek-debt-deal.html.
60
A simple example could clarify the mechanism. If a country has 100 units of debt, and
the sustainable level is 75 units, the debt needs to be cut by 25 units. With equal
creditors, the loss of 25 units is spread evenly and amounts 25 per cent. However, if the

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 7.2 outright monetary transactions 177

The situation was made much worse by the other rescue packages that
were used to pay all the maturing interest payments and capital in full.
Every payment made the remaining private creditors worse off. All in all,
it became clear that the European rescue mechanisms and the SMP
actually made the government bond markets dysfunctional rather than
the opposite.61 Therefore, OMT purchases did not receive preferential
status and the SMP was terminated.
The SMP was limited to periodic interventions without clear market
triggers, so it was not a lender of last resort function for the Member
States that they could count on in extreme market situations.62 The
OMT had the potential of making the ECB a temporary lender of last
resort to Member States.63 The monetary policy transmission argu-
ments of the SMP were not fully credible, as purchasing bonds in
various maturities and keeping them until maturity was more finan-
cing of the Member States than monetary policy. The OMT focused on
short-term bonds and made no commitment to hold them until matur-
ity. The longest targeted maturity – three years – was equivalent to the
longest ECB LTROs, which stretched its monetary policy nature, but it
was more defendable than the SMP. The OMT had the same full risk-
sharing as the SMP.64
Another explicit difference was the link to euro area rescue mechan-
isms. The OMT made a formal link to the rescue programmes, while the
SMP had been fully independent. A Member State first needed to commit
to economic and particularly fiscal stability; only then could the ECB

Eurosystem had bought 50 units of debt from the market before the restructuring, the
remaining private holders of 50 units of debt would face a cut of 25 units or 50 per cent.
61
The problems with programmes have been discussed for example, in Lane (2012), ‘The
European Sovereign Debt Crisis’, 49–68.
62
De Pooter et al. (2015), ‘Cheap Talk and the Efficacy of the ECB’s Securities Market
Programme’ and also Buiter and Rahbari (2012), ‘The ECB as Lender of Last resort’.
63
See Illing and König (2014), ‘The European Central Bank as Lender of Last Resort’, 16–28
and De Grauwe (2011) ‘Only the ECB can halt eurozone contagion’. The classic lender of
last resort function is related to the banking sector, not governments. The concept was
transplanted from the banking context to government finances, which has created some
confusion. It has even been claimed that the lenders of last resort function with regard to
governments is always part of central banking or even inherent in the very concept of
central banking, which is not the case.
64
Cœuré (2013), ‘Outright Monetary Transactions’, www.diw.de/documents/
dokumentenarchiv/17/diw_01.c.426892.de/coeure_omt_konferenz_2013.pdf and also
Mario Draghi in ECB press conference (22 January 2015), ‘Introductory Statement and
Q&A’ in Frankfurt am Main, www.ecb.europa.eu/press/pressconf/2015/html/is150122.en
.html.

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 178 7 selective government bond purchases

restore the functioning of its government bond markets and indirectly

monetary policy transmission. Commitment took place through the
adjustment programme of EFSF/ESM assistance.
Although not explicitly mentioned, the OMT had the potential of
becoming substantially larger than the SMP. SMP purchases had not
helped and the new problem countries, Italy and Spain, were too large
even for the ESM. The backing of adjustment programmes and rescue
facilities allowed the ECB to ‘guarantee’ the functioning of the shorter
end of the government bond markets, particularly if the ESM’s fire-
power became questioned. The link to the EFSF/ESM contained an
additional political element, as their programmes were generally
agreed unanimously, and in all cases required the approval of the
larger Member States. Thus, the ECB gave an indirect veto to
Member States on the activation of the OMT, which could also have
rendered the ESM programmes more difficult to activate. A country
that disagreed with OMT purchases could have hesitated to agree on
rescue programmes.

The Economic Effects of the OMT

An economic assessment of the OMT is subject to considerable uncer-
tainty, as it was never activated. The legal content is relatively well
known, but many details remain uncertain – for example, concerning
amounts, the relationship with the rescue programmes, and actual trig-
gers for purchases. Two approaches are utilised for economic analysis.
Theoretically, it can be assessed how the programme could have repaired
monetary policy transmission. Empirically, it has been studied what
economic effects the announcement had.
First, at the theoretical level, analysis of the differences between the
SMP and OMT is relevant. Again, the rationale of malfunctioning monet-
ary transmission in individual Member States remains elusive. The OMT
did not define a malfunctioning bond market, but it appears that the
threshold for the malfunctioning transmission mechanism was higher
than with the SMP. Some elements of the OMT, particularly the more
limited maturity spectrum and the lack of hold-to-maturity, were more
in line with the monetary transmission argument. Additionally, the
conditionality requirement could be read favourably. If financial assist-
ance was provided by the relevant authority, the ECB could focus more
strictly on monetary policy.
The unspecified features of the OMT led to some speculation that it
was an ECB guarantee of an upper bound for government bond spreads

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 7.2 outright monetary transactions 179

within the euro area.65 Accordingly, if a euro country was seen to be

trapped in a self-fulfilling negative spiral, this could be corrected by the
ECB as a lender of last resort to governments.66
Turning to empirical studies, the question of the effect of announcing
the OMT is relevant. The ECB has declared the OMT a success, even to the
point that it was ‘probably the most successful monetary policy measure
undertaken in recent times’.67 The claim is that the announcement or
even the ‘whatever it takes’ speech were catalysts for a relative calming
down of the sovereign bond markets in the euro area. Three dates could
be assessed: Draghi’s speech in London in July 2012; the Governing
Council’s initial meeting in August; and the September press release.
The financial markets effects could have been gradual, as each step could
have increased the likelihood of the programme. Naturally, many other
issues have been ignored in the analyses of the OMT that have also
influenced market behaviour in that period. For example, although the
creditworthiness of Italy and Spain deteriorated until the first half of
2012,68 the negative news flow peaked in the summer. From thereon, it
was more balanced with some evidence of the consolidation measures
turning the trend in fiscal deficits. Also, the worst fears about banks in
Spain were not realised and the ESM support needed was less than half of
the agreed 100 billion euros.69
One ECB study found a full 2 percentage point reduction in Spanish
and Italian government short-term bond yields stemming from the
OMT.70 It credits all the decline to the OMT announcement, which is
excessive given that most market stress simply vanishes over time. It is
possible, even likely, that market nervousness over the fiscal situation in
Spain and Italy would have eased, when the news flow became more
balanced. Indeed, the view that the decline in sovereign debt yields
stemmed only from the OMT announcement makes assumptions about
the causes of elevated bond yields. Such causes could have been the

65
Ibid.
66
Sapir (2012), ‘The SMP is Dead. Long Live the OMT’, http://bruegel.org/2012/09/the-smp-is-
dead-long-live-the-omt/.
67
www.ft.com/cms/s/0/35f29c6c-ce99-11e2-ae25-00144feab7de.html#axzz44lEhPopC.
68
www.moodys.com/research/Moodys-downgrades-Spains-government-bond-rating-to-
Baa3-from-A3.
69
www.esm.europa.eu/assistance/spain/.
70
Altavilla et al. (2014), ‘The Financial and Macroeconomic Effects’.

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 180 7 selective government bond purchases

increased risk of currency redenomination (euro break-up) but also a

self-fulfilling risk of public sector debt defaults.71
Indeed, the link between currency redenomination risk and the OMT
may be realistic, but the OMT was probably not the sole factor that
reduced the risk of euro area break-up. The OMT might have made the
euro less reversible, as large-scale purchases of bonds of troubled
Member States would have increased the cost of euro break-up for other
Member States. This element in Draghi’s speech has often been omitted.
As the aim of the programme was to increase the cost of the euro area
break-up, was the target also the euro area policy-makers? In contrast, if
EMU economic fragmentation was the primary cause of break-up pres-
sures, the OMT only treated its symptoms.72
Against a self-fulfilling spiral, in which increased interest rates could
make a Member State’s fiscal position unsustainable, the OMT could
have been an appropriate tool. High interest rates on outstanding gov-
ernment bonds do not increase interest expenses, only high interest rates
of primary issues do. The OMT could have guaranteed that Member
States had shorter-term funding available to sort out their public
finances without committing to unsustainably high interest rates.
Naturally, this amounts to financing of Member States, regardless of
whether it took place in the primary markets (mostly by the ESM) or
through the favourable pricing and liquidity in the secondary markets.
The primary source of the announcement effect probably resulted
from the ECB’s guarantee that it would ensure funding at reasonable
rates. For that, the announcement only needed to be credible, which was
enhanced by the link to the EFSF/ESM programmes that provided finan-
cial guarantees for a Member State in trouble. Importantly, this march-
ing order would have ensured an implicit political backing for the OMT
purchases also from Germany, which was among the least enthusiastic
to use central bank money to finance governments.

71
This links to traditional banking theory concepts also related to adverse selection and
moral hazard. Bank interest rates have a threshold level after which only excessively
risky debtors would take the loan, and hence no rational creditor would grant a loan. See
Jaffee and Russell (1976), ‘Imperfect Information, Uncertainty and Credit Rationing’,
651–666.
72
The Bundesbank’s statement on the FCC Gauweiler judgment. FCC 2 BvR 2728/13, 2 BvR
2729/13, 2 BvR 2730/13, 2 BvR 2731/13, 2 BvE 13/13, paras. 13–15 and www.zerohedge
.com/news/one-chart-explain-why-draghis-blunt-tool-cant-fix-europe. www
.bundesverfassungsgericht.de/SharedDocs/Entscheidungen/EN/2014/01/rs20140114_
2bvr272813en.html.

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 7.3 constitutional assessment of bond purchases 181

A critical assumption was that the EFSF/ESM programmes were suffi-

cient to ensure the sustainability of Member State finances. Failing that,
the OMT could have led to negative spirals. For example, if the OMT
programme had been available for Greece in 2010, Greek bond rates
would have called for ECB intervention on the basis of the monetary
policy transmission argument. However, as the problem was the unsus-
tainability of Greek public finances, the purchases could have led to the
ECB owning all the bonds up to three years’ maturity. Neither the
adjustment programme nor the purchases would have solved
Greek problems.

7.3 Constitutional Assessment of ECB Selective

Bond Purchases
The constitutional assessment of ECB selective bond purchases starts by
asking whether the purchases can be classified as monetary policy. The
second question relates to the prohibition of public sector financing and
the fiscal responsibility of the Member States. The third question evalu-
ates the impact on central bank independence. Finally, the assessment
ends with a broader look at the compatibility with the European
Macroeconomic Constitution. The CJEU has provided its view on ECB
selective bond purchases in the Gauweiler case,73 which can be read
alongside the FCC’s request for a preliminary ruling.
The Gauweiler case offered the CJEU’s interpretation of broad discretion
that is allowed to the ECB in implementing monetary policy. The CJEU
stressed that monetary policy involves technical choices and complex
assessments without specifying this concretely. Clearly, monetary policy
entails making choices of a technical nature,74 but alongside it can also
involve value-based policy choices. I would argue that this borderline
should be at the heart of judicial deliberation.75 Furthermore, the CJEU
employed only the test of manifest errors for the ECB’s use of its broad
discretion. For some reason, it ignored the tests of ‘a manifest error of
appraisal’, ‘a misuse of powers’ and the legislature having manifestly

73
Case C-62/14 - Gauweiler and Others. ECLI:EU:C:2015:400.
74
The CJEU’s remarks on earlier judgments did not elaborate on the differences between
the scientific substance of the issues nor the qualifications in the earlier cases. Case C-62/
14 - Gauweiler and Others. ECLI:EU:C:2015:400, para. 68.
75
Tuori (2013), ‘Expert, Stakeholder or Just Politician? New Roles of European
Central Bank’.

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 182 7 selective government bond purchases

exceeded ‘the limits of its discretion’ that it had used in some earlier
cases.76 For example, the ‘error of appraisal’ could be an interesting test
for the SMP concerning the purchases of Greek bonds against clear lack
of creditworthiness. Furthermore, the CJEU states that broad discretion
demands a review of certain procedural guarantees. These include the
obligation for the ECB ‘to examine carefully and impartially all the
relevant elements of the situation in question and to give an adequate
statement of the reasons for its decisions’.77 It could be claimed that an
impartial examination would also require assessment of policy measures
from the perspective of their main criticism, which was lacking in the
ECB communication as well as in the CJEU judgment.

7.3.1 Selective Bond Purchases as Monetary Policy Measures

The most critical question is whether selective bond purchases can be
monetary policy measures under 127(2) TFEU. The principle of conferral
(Art. 5(2) TEU) demands that the ECB ‘must act within limits of the
powers conferred upon it by primary law and it cannot therefore validly
adopt and implement a programme which is outside the area assigned to
monetary policy by primary law’.78 Selective purchases were never
claimed to be traditional conduct of monetary policy. They were argued
on the basis that they ensured the singleness and transmission of mon-
etary policy across the euro area.
The concept of singleness remains vague. The CJEU sees that ‘safe-
guarding the singleness of monetary policy contributes to achieving the
objectives of that policy in asmuch as [. . .] monetary policy must be
“single’’’,79 but it clarified that singleness did not mean that the ECB
should operate by means of general measures that would be applicable to
all Member States.80 In practice, singleness could not mean either that
monetary policy impulses are the same throughout the euro area,
because that is simply not possible. Even the basic channel of monetary
policy differs across the euro area as real interest rates depend on

76
See Case C-343/09 – Afton Chemical.
77
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400, para. 69.
78
Ibid., para. 41 and Article 5(2) TEU. The monetary policy aspect was central in the FCC
judgment: ‘[t]he monetary policy is to be distinguished – and thereby further defined –
according to the wording, structure, and purpose of the Treaties from (in particular) the
economic policy, which primarily falls into the responsibility of the Member States’.
79
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400, para. 48. 80
Ibid., para. 55.

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 7.3 constitutional assessment of bond purchases 183

inflation.81 Following the CJEU, perhaps the most appropriate interpret-

ation is that singleness and proper monetary policy transmission are
more or less the same, because ‘the objective of safeguarding an appro-
priate transmission of monetary policy is likely to preserve the single-
ness of monetary policy’,82 and hence the independent legal value
monetary policy singleness is limited.
The CJEU’s assessment whether the purchases guaranteed the
singleness of monetary policy or the effectiveness of monetary policy
transmission was in the proportionality test. Was the programme pro-
portionate to achieve its objectives? According to the CJEU, the main
economic reason for the OMT was the currency redenomination risk.
The CJEU refers to the ECB’s assessment that the interest rates, the
spreads and the volatility of troubled countries’ government bonds could
not be explained by country-specific factors, and hence they reflected
euro break-up risks.83 This heightened risk of redenomination affected
the financing conditions in the troubled countries, caused fragmentation
of the financial markets and undermined monetary transmission mech-
anisms.84 The CJEU did not consider the opposing views raised by the
FCC85 or that the economic analysis did not find strong evidence that
monetary policy transmission would have required the buying of gov-
ernment bonds of troubled Member States.
The fundamental difficulty with selective bond purchases is that they
could be rationalised by many reasons, of which monetary policy trans-
mission is only one. The CJEU did not balance the ECB’s explanation with
other expert assessments.86 For example, the Bundesbank questioned
both the link to monetary transmission and the existence of severe
mispricing in government bond markets.87 The CJEU claimed that ‘it is
undisputed that interest rates for the government bonds of a given State

81
The resulting destabilising deviations call for other policy areas to take charge. On the
role of real interest rates see Friedman and Schwartz (1963), A Monetary History of the
United States and in the euro area context. for example, Report of the Tommaso Padoa-
Scioppa group, www.institutdelors.eu/media/tpsreportptt-presentation.pdf?pdf=ok and
Odendahl (2014), ‘The Eurozone’s Real Interest Rate Problem’.
82 83
Case C-62/14 - Gauweiler and Others. ECLI:EU:C:2015:400, para. 49. Ibid., para. 72.
84
Ibid., para. 73.
85
The factors of a country’s credit spread are manifold and at best estimations, as
evidenced by the fundamentally flawed assessment by the ECB’s perception of Greece in
2010. The Bundesbank’s explicit views challenged the ECB’s views at the expert level.
See, FCC 2 BvR 2730/13, paras. 13–15.
86
Case C-62/14 - Gauweiler and Others. ECLI:EU:C:2015:400, para. 74.
87
FCC 2 BvR 2728/13.

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 184 7 selective government bond purchases

play a decisive role in the setting of the interest rates applicable to the
various economic actors in that State’.88 However, the areas the CJEU
claimed to be undisputed, have been disputed in the euro area context. It
is not clear that the link between the official rates and bank lending rates
was disrupted.89 Even the ECB did not show evidence on how the link
was disrupted and how the purchases could have corrected the prob-
lem.90 No other central bank has tried to influence financing conditions
in some geographical part of their financial markets.
Government bonds and retail bank interest rates can have the same
fundamental drivers. For example, a recession can be a common factor
affecting both; a correlation not a causality from government bonds to
bank interest rates.91 In addition, the problem of bank solvency
caused by declining bond prices stems from insufficient bank capital
or excessive risk-taking,92 neither of which is a monetary policy
responsibility even if the ECB was involved in creating the problem
in the first place with its three-year LTROs. Reckless risk-taking is
further encouraged if the ECB provides protection against bond value
declines. The final claim that banks’ ability to obtain liquidity was
affected by government bonds is generally correct, but statistics point
to limited importance, particularly as ECB funding had replaced
interbank funding.
The currency redenomination risk is an acceptable reason, but it does
not directly justify the purchase of government bonds as such, in par-
ticular, if other measures could have been available.93 Importantly,
against fundamental problems, mainly fundamental remedies would
suffice. For example, postponing Greek debt restructuring did not help
to stabilise the situation.94 Similarly, had Italian and Spanish

88
Case C-62/14 - Gauweiler and Others. ECLI:EU:C:2015:400, para. 78.
89
FCC 2 BvR 2728/13 para. 7 and ECB Monthly Bulletin (August 2008), ‘The Role of Banks in
the Monetary Policy Transmission Mechanism’.
90
Mojon (2000), ‘Financial Structure and the Interest Rate Channel’. In early 2012 when
Greek government bond yields stood at more than 30 per cent, the bank interest rates on
new housing loans in Greece declined and stood at below 4 per cent. www.bankofgreece
.gr/Pages/en/Statistics/rates_markets/deposits.aspx.
91
Neri (2013), ‘The Impact of the Sovereign Debt Crisis’.
92
Zoli (2013), ‘Italian Sovereign Spreads’.
93
One suggestion was for the ECB to provide insurance against currency redenomination.
Gave (2012), ‘Putting the ECB’s Money Where Its Mouth Is’.
94
See IMF Country Report No. 13/156 (June 2013), ‘Greece: Ex Post Evaluation of Exceptional
Access under the 2010 Stand-By Arrangement’.

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 7.3 constitutional assessment of bond purchases 185

creditworthiness continued to decline, no interventions could have pro-

vided permanent relief.95
The objective of the programme was deemed critical for legal review.
Both singleness and restoring monetary policy transmission need to
contribute to the price stability objective. In addition, purchases could
also contribute to other objectives, such as the stability of the euro
area.96 The classification is complicated by the Pringle case, in which
the CJEU allowed the ESM to purchase government bonds on the basis
that it was not monetary policy. Now, the same purchases had to be
included in both ECB monetary policy and the ESM.97 The CJEU’s view
was that the announced objectives are sufficient to make a difference
between monetary policy and economic policy.98 Furthermore, the CJEU
made a peculiar link between the ECB’s other instruments, namely
setting key interest rates, and the buying of government bonds. That is,
if these monetary policy tools were available for the institution, then
buying government bonds was also part of monetary policy.99 This is
difficult to defend. The ECB’s bond purchases were explicitly discon-
nected from the instruments the CJEU mentions as requirements. In
reality, the stability of the euro area and the singleness of monetary
policy might both have been threatened by EMU break-up. The CJEU’s
argumentation on the decisive role of the objectives could thus be of
limited use in differentiating between ECB and the ESM purchases of
government bonds. The main differences stem from the decision-making
organs and the liability structure in their balance sheet, central bank
money or direct government liabilities, which is also the borderline
between exclusive EU competence and national competence.
Apart from monetary policy, another plausible explanation for select-
ive bond purchases might have been supporting the financing conditions
of the euro area Member States or euro area banks.100 If the programmes
were designed to help Member States in trouble by buying their govern-
ment bonds from the secondary markets, they would not be monetary
policy. Even the ECB advocated for assigning to the ESM the capacity
to intervene in government bond markets if necessary against the

95
See, FCC 2 BvR 2730/13, paras. 13–14.
96
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400, paras. 51 and 56.
97
Case C-370/12 – Pringle, EU:C:2012:756, para. 56.
98
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400.
99
Case C-370/12 – Pringle, EU:C:2012:756, 95–96.
100
Following the Occam’s razor method: among competing hypotheses, the one with the
fewest assumptions should be selected. See Baker (2016), ‘Simplicity’.

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 186 7 selective government bond purchases

risks to financial stability.101 Could the same measures with the same
operational target be defined either as exclusive community competence
or as Member State competence depending on the stated ultimate
objectives?102
In conclusion, the assessment of the monetary policy nature of
selective bond purchases remains mixed. On the one hand, the inconclu-
siveness of the economic evidence supports the ECB’s claim that the
purchases were monetary policy, although it would not be unreasonable
to place the burden of proof on the ECB either.103 The CJEU’s view was
that if the ECB defined the purchases as monetary policy and if the
programme was operationalised through the ECB’s financial market
transactions, they are included in ECB monetary policy competence.104
The CJEU thus settled for a formalistic definition and avoided discussing
the differences between policy areas and the borderline between EU and
national competences.105 At the same time, it arguably refused to take
into account information available from other sources that would have
resulted in a more balanced assessment. The FCC demanded that the
measure has to be monetary policy against some generally acceptable
criteria.106 As monetary policy content draws the line between the mon-
etary policy competence conferred on the EU and national economic
policy, the democracy principle would demand that the mandate of the
ECB ‘must be shaped narrowly’ and it needs to be fully subjected to
judicial review.107 The CJEU’s fairly superficial review may have ques-
tioned this principle, even if a more balanced review might have led to
the same conclusion.

101
This would even take place if the ECB recognised exceptional market conditions and
risks to financial stability. ECB press conference (4 August 2011), www.ecb.europa.eu/
press/pressconf/2011/html/is110804.en.html.
102
Case C-370/12 – Pringle, EU:C:2012:756.
103
Helm (2012), The ECB’s Securities Markets Programme, 32–35. Here it could be pointed out
that macroeconomic evidence is rarely very conclusive, and hence the question could
actually be mostly on the burden of proof.
104
Sester (2012), ‘The ECB’s Controversial Securities Market Programme’. See also ‘The
Role of ECB in Relation to the Modified EFSF and the Future ESM. A Presentation’,
www2.uni-hamburg.de/fachbereiche-einrichtungen/handelsrecht/ECFR_/Sester.pdf.
105
The formalistic, literal, tautological and even doctrinal approach has been pointed out,
for example, by Sarmiento (2016), ‘The Luxembourg “Double Look”’, 49; Baroncelli
(2016), ‘The Gauweiler Judgment in View of the Case Law of the European Court of
Justice’, 90 and Joerges (2016), ‘Pereat Iustitia, Fiat Mundus’, 106.
106 107
FCC 2 BvR 2728/13, paras. 63–64. FCC 2 BvR 2728/13, para. 58.

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 7.3 constitutional assessment of bond purchases 187

7.3.2 The Member State Fiscal Responsibility and the Prohibition

of Public Financing
The relationship between common monetary policy and national fiscal
policies was a key concern in the EMU. Strong institutional and legal
safeguards were built to maintain national fiscal responsibility and to
avoid moral hazard. For the ECB, this was manifested particularly in the
prohibition of central bank financing of governments and the no-bailout
clause. The applicability of the no-bailout clause to the ECB has been
questioned on the grounds of lex specialis derogat legi generali interpret-
ation, claiming that Article 123 TFEU is a special provision for the ECB
that excludes application of Article 125 TFEU.108 However, it can be
argued that the Articles are not identical, and since the Member States
are ultimately liable for the ECB, the no-bailout clause needs to include
the ECB as well. Articles 123 and 125 TFEU should thus be read together.
The prohibition of public finances is complicated by the fact that the
ECB, like most central banks, uses government bonds in monetary policy
operations. For the ECB, pre-crisis use was only for collateral in standard
lending operation and payment systems. Outright purchases contain
more problems. The ECB becomes the owner of government bonds, a
creditor of its Member States, and thus directly exposed to losses.
Historically, central banks became major owners of government bonds
mainly from a sub-ordinated position vis-à-vis the executive.
Of the ECB measures to have violated Articles 123 and 125 TFEU, the
selective bond purchases, the SMP and OMT, are the most likely candi-
dates. Selective purchases deviated from normal monetary policy oper-
ations. Also the CJEU’s starting point is that Article 123(1) TFEU prohibits
all financial assistance from the ECB to Member States,109 but it does not
prevent the ECB from buying government bonds for strictly monetary
policy purposes and only from secondary markets without undermining
the effectiveness of the prohibition.110 This aims to ensure that the ECB
is not financing governments, but rather it is seen to ‘encourage the
Member States to follow a sound budgetary policy, not allowing monet-
ary financing of public deficits’. The CJEU did not mention the market
discipline as part of the constitutional protection for sound public

108
Häde (2011), ‘Kommentarteil Art. 123 [Verbot monetärer Haushaltsfinanzierung]’,
1585–1587.
109
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400, paras. 94 and 95.
110
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400, para. 97.

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 188 7 selective government bond purchases

finances111 nor did it assess the principle of central bank independence

that was protected by Article 123 TFEU, which rendered its teleological
interpretation of Article 123 TFEU incomplete.
The courts and scholars have mixed views on how to apply Article 123
TFEU. Many stress the demarcation between primary market and sec-
ondary market purchases.112 The purchases are perceived as short-term
interventions in the bond markets similar to some other fine-tuning
operations by the ECB.113 The circumvention argument is disregarded,
which also ignores the hold-to-maturity feature that calls into question
the short-term and fine-tuning nature of the purchases. In the SMP,
bonds were kept to maturity, directly replacing private creditors. The
CJEU points to two qualifications. First, secondary market purchases
should not take place ‘under conditions which would, in practice, mean
that its action has an effect equivalent to that of a direct purchase of
government bonds from the public authorities and bodies of the Member
States, thereby undermining the effectiveness of the prohibition in
Article 123(1) TFEU’.114 Second, circumvention could be prevented by
imposing sufficient safeguards for secondary market purchases.115 The
threshold for the safeguard was set very high by demanding that the
initial buyers need to know for certain ‘that those bonds will be pur-
chased by the ESCB after their issue’.116
In other analyses, violation of Article 123 TFEU is similarly clear.117
The ECB’s aim, namely to influence the financing conditions of troubled
Member States, and permanent use of the central bank balance sheet
revealed the prohibited motivations of financing Member States, directly
or indirectly.118 The FCC linked Article 123 TFEU to the national respon-
sibility of sound public finances119 and warned against a situation in
which ‘the Eurosystem would not only take over the function of a “bad
bank” for the banks in the participating states; it would also indirectly
contribute to the financing of their budgets’.120

111
Although this was already raised by the Delors Committee.
112
Louis (2010), ‘Guest Editorial: The No-bailout Clause and Rescue Packages’, 975.
113
See Herrmann (2010),’EZB-Programm für die Kapitalmärkte verstöÔt nicht gegen die
Verträge’, 645.
114
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400, para. 97.
115 116
Ibid., paras. 100–102. Ibid., para. 107.
117
Ruffert (2011), ‘The European Debt Crisis’, 1788.
118
Cottier et al. (2014), The Rule of Law in Monetary Affairs, 251.
119
FCC, 2 BvR 1390/12 – paras. (1–245), para 171.
120
The FCC considered that the ECB Statute did not allow for ‘the authorisation to take
large and unnecessary risks of losses’. FCC 2 BvR 2728/13, para 89.

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 7.3 constitutional assessment of bond purchases 189

The other side of the prohibition – national responsibility for fiscal

policy – is a fundamental part of the European Macroeconomic
Constitution. National responsibility allows national discretion to the
extent that safeguards limit the risk of negative externalities. These
safeguards include a prohibition on public sector financing by the ECB,
the excessive deficit procedure and the no-bailout clause of Article 125
TFEU. The FCC called this the independence of national budgets, which
relied partly on market incentives to discipline the Member States. If
market discipline was undermined by the ECB’s selective bond pur-
chases, national discretion would be similarly questioned.121
National discretion on fiscal policy can also be jeopardised by the fiscal
burden caused by ECB measures. The FCC pointed to the potential costs
involved in selective bond purchases, but the CJEU was not moved: ‘even if
it were established that that programme could expose the ECB to a signifi-
cant risk of losses, that would in no way weaken the guarantees which are
built into the programme in order to ensure that the Member States’
impetus to follow a sound budgetary policy is not lessened’.122 This is ironic
considering what happened in Greece, which was a programme country.
The CJEU added that the ECB Statute has procedures to tackle losses.123
To conclude that selective purchases do not breach the prohibition on
public sector financing and are compatible with the principle of Member
States’ responsibility requires strong assumptions. The purchases need
to be regarded as monetary policy tools, and not be motivated by the
financing of Member States or their banks. The CJEU’s criterion for the
permissibility of purchases only focuses on procedural safeguards that
are deemed sufficient to ensure that the impact of secondary market
purchases is not comparable to primary market purchases.124 This
threshold is so high that it renders the prohibition insignificant.125

7.3.3 Impact on ECB Independence

The independence of the ECB is pivotal in the European Macroeconomic
Constitution.126 It ensures that the ECB makes its decisions solely based
on the needs of monetary policy and the price stability objective. This is

121
FCC 2 BvR 2730/13, para. 71.
122
Case C-62/14 – Gauweiler and Others. ECLI:EU:C:2015:400, para. 123.
123 124
Ibid., para. 125. Ibid., paras. 102 and 104.
125
Belke (2010), ‘Driven by the Markets?’, 357–363. The same conclusion is also found in a
note by the European Parliament IP/A/ECON/FWC/2009-040/C9. See also Puccio (2012),
‘The pressure inflicted by the financial crisis’, 86.
126
Article 130 TFEU prohibits the ECB from taking any instruction.

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 190 7 selective government bond purchases

confirmed by the CJEU: ‘Article 130 TFEU is intended to shield the ESCB
from all political pressure in order to enable it effectively to pursue the
objectives attributed to its tasks.’127 Independence also limits the meas-
ures available to the ECB, as stated by FCC: ‘[t]he constitutional justifica-
tion of the independence of the European Central Bank is, however,
limited to a primarily stability-oriented monetary policy and cannot be
transferred to other policy areas.’128 The monetary policy mandate relies
on the narrow and externally justifiable definition of monetary policy
that draws the borderlines of independence.129
To arrive at the question of independence, selective purchases first
have to be considered monetary policy. If they are aimed at supporting
Member States or their banks, they would blur the line between fiscal
and monetary policy.130 The problem would be worse if the ECB was seen
to bow to external pressure. The SMP was launched just days after the EU
leaders’ meeting to decide on the EFSF that could rescue Member States
also through purchases of government bonds. However, the ECB was in a
position to start purchasing bonds immediately while the EFSF took time
to become operational. This raised suspicions that the ECB had given in
to political pressures.131
One risk for the ECB’s independence is that purchases make the ECB
financially exposed to troubled Member States. The amounts involved
are substantial: the SMP exceeded 200 billion euros and was deemed
insufficient. The OMT could have amounted to well in excess of the
ECB’s capital buffers. In addition, the link between the ECB and EU
rescue programmes, particularly the EFSF and the ESM, can jeopardise
the independence of the ECB. The ECB claimed to have maintained full

127
Case C-62/14 - Gauweiler and Others. ECLI:EU:C:2015:400, para. 40.
128
The FCC also pointed out that the independence of the ECB was an important part of the
FCC decision on the Maastricht Treaty. FCC 2 BvR 2730/13, para. 32 and 59 with a
reference to BVerfGE 89, para. 155.
129
Baroncelli (2016), ‘The Gauweiler Judgment in View of the Case Law of the European
Court of Justice’, 79–98. See particularly the FCC Maastricht judgment BVerfGE 89, 155.
This link is perhaps sometimes misunderstood, when the FCC is seen as critical towards
the ECB’s use of independence. See van der Sluis (2014), ‘Maastricht Revisited’, 108.
130
This was claimed by ECB Executive Board member Stark, who later resigned on account
of policy disagreements. Interview with Jürgen Stark (Kurm-Engels, Steingart, and Vits
(2012), ‘Das Vertrauen in die EZB geht verloren’, www.handelsblatt.com/politik/
deutschland/juergen-stark-das-vertrauen-in-die-ezb-geht-verloren/6363952.html).
131
See, for example, Whelan (2011), ‘The Changing of the Guard at the ECB’. See also www
.iiea.com/blogosphere/the-changing-of-the-guard-at-the-ecb-the-smp–draghis-poisoned-
chalice#sthash.ESE1pn2k.dpuf and The Economist (6 October 2012), ‘Europe’s Monetary
Opposition’, www.economist.com/node/21564245.

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 7.3 constitutional assessment of bond purchases 191

independence when deciding on the purchases. Nevertheless, the SMP

had an informal link to the rescue programmes132 and the OMT made
the link a formal condition.133 This type of dependence is detrimental to
independence.134

7.3.4 Other Constitutional Issues

Selective bond purchases aim explicitly at influencing the functioning of
the government bond markets. This raises questions concerning the
principle of an open market economy.135 A measure aimed at restoring
the functioning of the markets could be motivated by the market principle.
The controversial part is the existence of market malfunctioning. The
claim that the Greek bond markets were malfunctioning and attached
too high a risk to Greek government bonds was proven wrong by proceed-
ing events. Furthermore, even if the ECB’s claim about market malfunc-
tioning was correct, it remains debatable whether selective purchases were
the most compatible with a market economy. In the FCC judgment, the
Bundesbank challenged that the ECB could know that some government
bond yields were wrong, but the CJEU did not question the ECB’s ability.
From the institutional balance perspective, the selective purchases
extended the ECB’s operating area even substantially. If the ultimate
reason was the threat of a euro area break-up, it could have been admit-
ted. Classifying selective purchases as exceptional measures, falling
between the traditional lines of monetary and fiscal policy, could even
have been interpreted as the ECB’s contribution to economic policies in
the EU. In that case, the ESM assistance decision could also be viewed as
formulating ‘economic policies in the EU’ leaving it open for the ECB to
contribute to those policies, price stability permitting. Intrusion in
national policy-making and the potential redistributive effects would have
taken place with the consent of the governments.136

132
As highlighted by President Trichet when he said that the fiscal consolidation
programmes were necessary commitments that allowed the SMP to continue. Trichet
(2010), ‘The ECB’s Response to the Recent Tensions in Financial Markets’.
133
FCC 2 BvR 2730/13, para. 82.
134
The situation would be best described by a famous quote by Jean Paul Getty: ‘If you owe
the bank $100 that’s your problem. If you owe the bank $100 million, that’s the bank’s
problem.’
135
According to Article 127(1) TFEU ‘the ESCB shall act in accordance with the principle of an
open market economy with free competition, favouring an efficient allocation of resources’.
136
On the notion of redistributive effects and their structural importance, see Wendel
(2014), ‘Exceeding Judicial Competence in the Name of Democracy’, 263–307.

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 192 7 selective government bond purchases

Finally, CJEU legal practice insisted that the ECB’s selective bond pur-
chases to fight the sovereign debt crisis were compatible with EU law
without any questions or conditions. This constituted an ultimate insti-
tutional empowerment for the ECB as it was allowed to define its own
mandate, and it was also assigned a major role in defining the economic
policies of Member States facing economic problems.137 The FCC interpret-
ation was less far-reaching from this perspective. Perhaps a more balanced
conclusion by the CJEU could have highlighted the exceptional circum-
stances and stressed the need for the ECB to explain its measures extensively
ex ante and also ex post, which for the SMP might have been uncomfortable.

137
Tridimas and Xanthoulis (2016), ‘A Legal Analysis of the Gauweiler Case’, 17–39.

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 8 The ECB’s Quantitative Easing

In autumn 2014, more than six years after the eruption of the financial
crisis, euro area economic growth was still sluggish, unemployment
stubbornly high, and declining oil prices pushed headline inflation into
negative territory. Many conventional and unconventional monetary
policy measures had been used and most even claimed successes, but
the euro area economy remained fragile. In this situation, ECB President
Draghi hinted at measures to expand the ECB’s balance sheet, in prac-
tice, through extensive purchases of bonds.1 Existing measures already
gave banks liquidity at zero interest rates and with relaxed collateral
requirements, but the demand for liquidity was, if anything, declining. If
the ECB wanted to increase its balance sheet, it had to impose extra
liquidity on banks.2 The concrete measure was a quantitative easing
programme (QE) to buy an initial 60 billion euros monthly of mostly
private sector holdings of government bonds. This aimed to force private
money towards riskier assets, which in turn, was to increase asset prices
and support bank lending, and ultimately lead to growth and inflation.
As a result, the ECB, which was prohibited from financing governments,
became the largest creditor of the euro area Member States.3
The constitutional assessment of the PSPP could follow the CJEU’s Weiss
case that provides a simple conclusion similar to the Gauweiler case.4 In
short, to the extent that the ECB declares the PSPP a monetary policy
measure and claims that it facilitates achieving the price stability objective,

1
Draghi (2014), ‘Monetary Policy in the Euro Area’.
2
The QE was dubbed the ECB bazooka. Perhaps a more correct analogy would be feeding a
goose rather than shooting a bazooka.
3
ECB press release (8 December 2016), ‘Monetary Policy Decisions’, www.ecb.europa.eu/
press/pr/date/2016/html/pr161208.en.html.
4
Case C-493/17 – Weiss and others, EU:C:2018:1000.

193

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 194 8 th e ecb’s quantitative easing

a highly superficial legal review suffices. The prohibition on public sector

financing in practice prevents only primary market purchases of govern-
ment bonds. The ECB maintains its extensive discretion. However, to
understand the broader constitutional implications of the PSPP, the pro-
gramme will also be assessed in the light of the European Macroeconomic
Constitution as well as the FCC’s Weiss judgment. The chapter starts by
introducing the PSPP and its key features. Constitutional questions are
defined to frame the questions for an economic assessment. The economic
assessment starts with the ECB’s economic justification for the PSPP. This
is followed by comparisons with similar programmes and by a broader
economic analysis. The chapter ends with a constitutional assessment.

8.1 Key Features and Legal Basis of the PSPP

In January 2015, the ECB Governing Council decided on a new pro-
gramme called the Public Sector Purchase Programme (PSPP).5 The legal
decision followed in March.6 The PSPP was formally part of a broader
asset purchase programme (APP) from October 2014 – a programme that
included covered bonds7 and asset-backed securities.8 However, com-
pared to existing programmes the PSPP had unprecedented features: it
used government bonds for the first time, it specified a large monthly
purchase amount and it had a minimum running period of one and a
half years. The programme was later prolonged several times, halted by
the end of 2018 and restarted in early 2020 due to the pandemic.9

5
ECB press release (22 January 2015), ‘ECB Announces Expanded Asset Purchase
Programme’, www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html.
6
Decision (EU) 2015/774 of the ECB of 4 March 2015 on a secondary markets public sector asset
purchase programme (ECB/2015/10). OJ L 121, pp. 20–24. The aims and the underlying
economic analysis were discussed in press communications, an ECB Monthly Bulletin article,
speeches and even replies to letters. www.ecb.europa.eu/press/html/index.en.html.
7
Decision (EU) 2014/828 of the ECB of 15 October on the implementation of the third
covered bond purchase programme (ECB/2014/40). OJ L 335/22, 22.11.2014, pp. 22–24.
8
Decision of the ECB of 19 November 2014 on the implementation of the asset-backed
securities purchase programme (ECB/2014/45).
9
Draghi in an ECB press conference (10 March 2016), ‘Introductory Statement’ in
Frankfurt am Main, www.ecb.europa.eu/press/pressconf/2016/html/is160310.en.html.
ECB press release (8 December 2016), ‘Monetary Policy Decisions’, www.ecb.europa.eu/
press/pr/date/2016/html/pr161208.en.html. Draghi said that the programme was
anticipated and ‘priced-in’. The Swiss National Bank decided to discontinue its minimum
exchange rate policy vis-à-vis euro to anticipate the ECB decision on QE. SNB press release
(15 January 2015), ‘Swiss National Bank discontinues minimum exchange rate and lowers
interest rate to –0.75 per cent’. A similar reaction was the Danmarks Nationalbank
decision to cut its policy rate. www.snb.ch/en/mmr/reference/pre_20150115/source/pre_
20150115.en.pdf.

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 8.1 key features and l egal basis of t he pspp 195

The original decision was preceded by a long and even explicit public
discussion on the merits of a euro area QE, and the final decision was
anticipated by the media, financial markets and even other central
banks.10 The ECB provided inputs for these discussions, such as state-
ments that the ECB balance sheet should return to the level of early
2012.11 However, these expectations also put pressure on the Governing
Council to make a decision,12 which reflects the fine balance between
orderly conduct of monetary policy through directing expectations on
one hand and putting decision-making bodies in a position of limited
discretion on the other.
With the PSPP, the ECB committed to buying debt securities (bonds)
issued by euro area central governments, certain agencies established in
the euro area as well as certain international or supranational institu-
tions located in the euro area. The bonds had to fulfil the ECB Guideline
on collateral eligibility,13 which was equivalent to the lowest investment
grade rating.14 However, bonds with a lower rating could also be
included if they were issued under a financial assistance programme
and the credit threshold was suspended by the Governing Council.15

10
Draghi in an ECB press conference (22 January 2015), ‘ECB Announces Expanded Asset
Purchase Programme’, www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en
.html.
11
This was included in the Governing Council Statement in November 2014 meeting, but
President Draghi had already introduced the idea a month earlier in Washington. ECB
press conference (6 November 2014), ‘Introductory Statement’, and www.bloomberg
.com/news/articles/2014-10-11/draghi-says-growing-ecb-balance-sheet-is-last-stimulus-
tool-left.
12
In a survey of euro area economists conducted by the Financial Times in mid December
2014, twenty-six economists out of thirty-one forecast the ECB would start purchasing
government bonds in 2015. See www.ft.com/intl/cms/s/0/3496a4fa-91aa-11e4-bfe8-
00144feabdc0.html#axzz3X6twS9GH. The Governing Council was put under pressure to
make the anticipated decision, which was a common comment before and after the
decision. For example, the former head of the ECB operations Francesco Papadia
calculated that a QE programme of 500 billion euros was expected and a smaller
programme would be a disappointment. http://moneymatters-monetarypolicy.eu/will-qe-
surprise-on-the-upside-or-the-downside/. The anticipation was also described in the
financial media as well as the fact that the programme exceeded expectations with its
size. www.ft.com/intl/cms/s/0/aedf6a66-a231-11e4-bbb8-00144feab7de
.html#axzz3Y8xM4NlI.
13
A first-best credit assessment of at least credit quality step 3 (CQS3) Guideline of the ECB
of 20 September 2011 on monetary policy instruments and procedures of the
Eurosystem (recast) (ECB/2011/14). OJ L 331, 14.12.2011.
14
According to the Eurosystem credit assessment framework (ECAF) that supplements
rating agencies with assessment by the national central banks of the Eurosystem. (see
www.ecb.europa.eu/paym/coll/risk/ecaf/html/index.en.html).
15
Article 3(2)c of the Decision (EU) 2015/774 of the ECB.

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 196 8 th e ecb’s quantitative easing

Hence, the PSPP could be used to buy any euro area government bonds
deemed appropriate by the Governing Council. The programme set relative
but not absolute limits on the specific bond issuer and specific bond issues
in order to limit the impact on the markets, in particular by avoiding a
blocking minority in debt restructuring. The initial limit of 25 per cent for
each bond issue was increased to 33 per cent in September 2015. A further
limit was 33 per cent of each issuer’s outstanding debt in the PSPP matur-
ity spectrum from one up to thirty years.16 Financial assistance bonds were
exempted from these restrictions and the limits on international organisa-
tions and multilateral development banks were gradually loosened.17
The purchases were only in the secondary markets given that Article
123 TFEU explicitly prohibits purchases from primary issues. To avoid
clear circumventions of the prohibition, the ECB determined time and
maturity limits around primary issues during which purchases are not
permitted. This so-called ‘black-out period’ safeguarded that bond issuers
could not rely on the ECB purchases,18 although details were not pub-
lished.19 Bonds issued under the financial assistance programme were
subjected to other limitations.20 The list of eligible counterparties for
PSPP was very broad,21 and the effectiveness of the PSPP was potentially
enhanced by purchasing bonds directly from a broad list of banks.22

16
Article 3(3) of the Decision (EU) 2015/774 of the ECB. www.ecb.europa.eu/press/pr/date/
2015/html/pr150122_1.en.html. To avoid a blocking minority, the 33 per cent threshold
includes all the holdings of the ECB (Eurosystem) in an issue. Other holdings resulted
from the SMP and investment holdings by the NCBs.
17
Preamble (6), Article 5 (1) and Article (2) of the Decision (EU) 2015/774 of the ECB and
Draghi in ECB press conference (10 March 2016), ‘Introductory Statement’ in Frankfurt
am Main, www.ecb.europa.eu/press/pressconf/2016/html/is160310.en.html.
18
Article 4(1) of the Decision (EU) 2015/774 of the ECB.
19
Member States announce their issuances with different frequencies that make effective
black-out periods difficult to operationalise. A tentative auction calendar is often
provided annually, but actual issuances are announced closer to date, in cases only a few
days in advance. See, for example, Bundesrepublik Deutschland – Finanzagentur GmbH
press release (17 December 2014), ‘German Tentative Annual Schedule. German Federal
Government Debt Issuance Outlook for the Year 2015. 6/14’, www.bundesbank.de/
Redaktion/EN/Downloads/Service/Bundeswertpapiere/annual_forecast.pdf.
20
Article 4(2) of the Decision (EU) 2015/774 of the ECB. Eligibility is based on the successful
implementation of MoUs between the Troika and the Member State, controlled through
periodic reviews. The purchases were to be conducted during a period of two months
after a successful review.
21
Article 7 of the Decision (EU) 2015/774 of the ECB (a reference to the Annex I of the
Guideline ECB/2011/14).
22
Using only the largest counterparties could have alleviated the concerns that Member
States (through their respective NBCs) could use local banks in effect to
finance themselves.

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 8.1 key features and l egal basis of t he pspp 197

The main feature of the programme was its size and length. Initially,
the whole APP totalled 60 billion euros monthly, of which some 50 billion
euros were on the PSPP.23 The PSPP was intended to last until September
2016 and ‘in any case, be conducted until the Governing Council sees a
sustained adjustment in the path of inflation’.24 It was prolonged several
times, first increasing the monthly amount and later gradually phasing
out purchases towards the end of 2018, before it was restarted in March
2020.25 The initial amount reached 1.1 trillion euros, roughly one tenth
of euro area GDP, and the extensions had by the end of 2021 pushed it
past 2.4 trillion euros in public sector bonds and 3.2 trillion euros
in total.
The programme did not exclude purchases of bonds with negative
yields, as long as yields were above the ECB deposit rate,26 which initially
stood at –0.2 per cent and was later cut to –0.5 per cent. The threshold
rate reflected the uneasiness about buying bonds at negative interest
rates, effectively paying money to bond issuers. A special feature of the
PSPP is limited risk-sharing between the NCBs. Normal risk-sharing
within the Eurosystem only accounts for 20 per cent of the programme,
and the remaining 80 per cent is at the risk of each NCB and hence the
respective Member State.27 The reason was to ‘mitigate the concerns that
many participating countries in the euro area have about the unintended
fiscal consequences of potential developments in the future’. Limited
risk-sharing was a concession to worries that the PSPP could turn into
a fiscal transfer mechanism between the Member States.28
The purchases were allocated to the NCBs according to their share in
the ECB capital key. Decentralised implementation required constant

23
No exact amounts have been communicated except informally. See www.bloomberg
.com/news/articles/2015-01-22/the-what-and-why-of-ecb-bond-buying-for-how-watch-
this-space.
24
Preamble (7) of the Decision (EU) 2015/774 of the ECB.
25
www.ecb.europa.eu/mopo/implement/omt/html/index.en.html.
26
Article 3(5) of the Decision (EU) 2015/774 of the ECB.
27
Of the 20 per cent risk-sharing, initially 12 per cent concerned purchase of securities of
European institutions, allocated to selected NCBs. The ECB was to purchase and hold
directly 8 per cent of the bonds. The risk-sharing part was later divided equally between
European institutions and ECB purchases. ECB press release (22 January 2015), ‘ECB
Announces Expanded Asset Purchase Programme’, www.ecb.europa.eu/press/pr/date/
2015/html/pr150122_1.en.html. Draghi in ECB press conference (10 March 2016),
‘Introductory Statement’ in Frankfurt am Main, www.ecb.europa.eu/press/pressconf/
2016/html/is160310.en.html.
28
Draghi in the ECB press conference (22 January 2015), ‘ECB Announces Expanded Asset
Purchase Programme’, www.ecb.europa.eu/press/pressconf/2015/html/is150122.en.html.

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 198 8 th e ecb’s quantitative easing

monitoring and even control by the ECB.29 Instead of focusing only on

the most creditworthy bonds in the euro area,30 the PSPP purchased all
the euro area government bonds.31The communication left open what
would happen to purchased bonds should they lose their eligibility.
Although a clear solution would be to dispose of the bonds, this is
unlikely. If he largest holder of bonds sold its holding after a downgrade,
it would create a panic.
The PSPP’s main legal form was a ECB Governing Council decision32
that referred to the first indent of Article 127(2) TFEU as well as Article
12.1 in conjunction with Articles 3.1 and 18.1 Statute as its legal basis.
This made it clear that the PSPP was based on the task of conducting
monetary policy through buying marketable securities outright.33 The
decision made explicit reference to the monetary financing prohibition,
declaring it non-applicable, but circumvention of the prohibition was not
addressed.34 The legal basis was practically the same as with the selective
bond purchase programmes.35 However, the PSPP did not aim to repair
the perceived malfunctioning of the bond markets or the transmission
mechanism of monetary policy in individual Member States. Also, the
conditionality requirement of the OMT was absent.

8.2 The Aims of the PSPP

The main aim of the PSPP was to achieve the price stability objective. The
ECB stated that most indicators of both actual and expected inflation had
declined to historical lows, risking a broader deflationary development if
these expectations were incorporated into wage- and price-setting behav-
iour. Traditional monetary policy, (particularly official interest rates)

29
The reference to Article 12.1 Statute underlined that the Governing Council adopts
guidelines as well as takes decisions as a means to formulate monetary policy. These
decisions and guidelines form the basis under which the ECB Executive Board
operationalises monetary policy, for example, by giving binding instructions to NCBs.
30
At the time the PSPP programme was launched, only Germany had the highest credit
rating from all the major rating agencies. Close to the highest rating were also given to
Austria, Finland and the Netherlands. www.tradingeconomics.com/euro-area/rating.
31 32
With the exception of Greece. Decision (EU) 2015/774 of the ECB.
33
Article 18.1 Statute placed the measures of the PSPP under open market and credit
operations. Preamble (1) of the Decision (EU) 2015/774 of the ECB.
34
Council Regulation (EC) No 3603/93 of 13 December 1993 specifying definitions for the
application of the prohibitions referred to in Articles 104 and 104b (1) of the Treaty. OJ
L 332 , 31/12/1993.
35
FCC 2 BvR 2728/13 and Case C-62/14 - Gauweiler and Others. ECLI:EU:C:2015:400.

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 8.2 the aims of t he pspp 199

was in full use.36 Hence, easing the monetary policy stance required
new measures.
The ECB’s economic rationale for the PSPP follows the idea that large-
scale purchases of government bonds ease monetary conditions, leading
to cheaper financing for firms and households. This, in turn, should
support investment and consumption, and finally contribute to higher
inflation. Three specific channels were mentioned. First, the decision
itself supports inflation expectations, which reduces expected real inter-
est rates in a zero interest rate environment. Second, the PSPP reduces
government bond yields that act as benchmark interest rates for other
securities and financial instruments such as bank loans, corporate loans
and even equity. Third, the PSPP increases financial asset prices partly
through reallocation of portfolios to other assets.37 The ECB stressed the
portfolio rebalancing effect as the primary means through which
the PSPP should influence financial markets, bank lending, and finally
the real economy and prices. The portfolio rebalancing ‘reduces returns
on safer assets’ and ‘this encourages investors to shift to riskier, higher-
yielding assets. Pension funds, banks and other market participants that
we buy securities from are likely to substitute these for other long-term
assets, thereby eventually pushing up prices more broadly.’38
In contrast, the ECB did not mention the exchange rate channel as a
source of increased inflationary pressures, although ECB President Draghi
mentioned a significant impact on the exchange rate.39 The exchange rate
was not a target for monetary policy more generally, although the ECB
admitted that the exchange rate was important for both price stability
and growth. Foreign currencies can be considered financial assets and
should be similarly affected by the PSPP, but the euro exchange rate
could not be an explicit target due to competence issues.40
In conclusion, the ECB described the PSPP as a monetary policy meas-
ure aimed at ensuring the price stability objective, which was threatened
by potential deflationary developments. The PSPP’s main function was

36
ECB press release (22 January 2015), ‘ECB Announces Expanded Asset Purchase
Programme’, www.ecb.europa.eu/press/pr/date/2015/html/pr150122_1.en.html.
37
ECB Letter from the ECB President to Mr Enrique Calvet Chambon, MEP, on the extended
asset purchase programme titled Re: Your letter (QZ-21) 10 March 2015. L/MD/15/139.
38
www.cnbc.com/id/102494922.
39
www.reuters.com/article/2015/03/26/ecb-draghi-forex-idUSR1N0VD01F20150326.
40
Article 219 (1) TFEU gives the ECOFIN council the power to ‘conclude formal agreements
on an exchange-rate system for the euro in relation to the currencies of third States’, but
does not give it exclusive mandate on all subjects related to exchange-rates.

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 200 8 th e ecb’s quantitative easing

through a portfolio rebalancing effect that led to higher asset prices and
generally better financial market conditions, more lending as well as
consumption and investment. In addition, the programme signalled the
ECB’s commitment to higher inflation that increases inflation expect-
ations and lowers expected real interest rates.

8.3 Economic Analysis and Comparison with Other

QE Programmes
The PSPP’s economic aims need to be assessed to qualify whether the
PSPP can be considered a monetary policy measure. These aims should
have a proportional relationship to their content, backed up by economic
theory and empirical analysis. The question can be divided into sub-
questions. First, is there a sufficient theoretical link between the PSPP
and price stability? Second, how has QE functioned empirically? Third,
have major central banks considered similar programmes as monetary
policy? Fourth, could there be other aims for the PSPP? Unfortunately,
the economics of QE is notoriously ambiguous to the point that former
Fed Governor Bernanke stated ‘the problem with QE is that it works in
practice, but it doesn’t work in theory’.
In traditional economics, the case for QE is relatively weak. When a
central bank purchases government bonds, it simply changes the term
structure of state liabilities from longer-term to shorter term, from
bonds to central bank money, which should not affect consumption or
prices.41 A new approach was inspired by the deflationary situation in
Japan in the mid 1990s. The constraint of zero interest rates prevented
normal monetary policy easing. The question was whether the zero
interest rate constraint could be overcome by central bank asset pur-
chases. However, QE alone was assumed to have a limited impact on
inflation or economic activity, but with a credible central bank commit-
ment to a price-level target it could help to overcome the constraint.42
A commitment to higher inflation even after the worst was over could
further increase inflation expectations, which would lead to lower real
interest rates and support growth.43 Theoretically QE could thus support

41
Wallace (1981), ‘A Modigliani-Miller Theorem’, 267–274. The article uses the basic
Modigliani-Miller Theorem in government finances and shows that the irrelevance also
holds in that environment.
42
Eggertson and Woodford (2003), ‘The Zero Bound on Interest Rates and Optimal
Monetary Policy’.
43
Bernanke and Reinhart (2004), ‘Conducting Monetary Policy’, 85–90 and the discussion
on avoiding liquidity traps in Krugman (1998), ‘It’s Baaack! Japan’s Slump and the
Return of the Liquidity Trap’.

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 8.3 economic analysis and comparisons 201

economic activity if it was combined with a central bank commitment to

higher inflation, sometimes labelled ‘committing to being irrespon-
sible’.44 This could explain why the PSPP decision was accompanied
by the commitment to use it until ‘a sustained adjustment in the path
of inflation’.45 Even more explicitly, the ECB stated that a medium-
term approach to inflation means that very low inflation was
followed by inflation exceeding the 2 per cent target: ‘if the inflation
rate was for a long time below 2 per cent, it will be above 2 per cent
for some time’.46 This was later formalised in the ECB strategy
review 2021. However, the problem remains that the ECB’s overriding
price stability objective makes any commitment to higher inflation
less credible.
Additional theoretical support for QE can be found by incorporating
the financial markets situation. The idea is that when asset prices are
low due to financial instability (banking crisis), central bank purchases
can have positive effects. In normal times, central banks are less efficient
in providing loans than private institutions. In financial crises, when
private banks have insufficient capital and are unable to get market
funding, central banks’ financing of the economy in the form of buying
risky assets can increase welfare.47
Turning to empirical analysis, the question is the impact on financial
markets and on the economy. Direct effects can include falls in yields on
the securities in question and their close substitutes such as other types
of longer-term public and private debt. Low-yielding government bonds
are replaced by other securities that could increase asset prices more
generally. This could increase consumption and investments, and ultim-
ately consumer prices. Studies have focused on three specific effects: the
central bank’s signalling effect, the portfolio rebalancing effect, and the
liquidity effect.48 The results are tentative due to the short and excep-
tional time periods involved.
Empirical studies started with Japanese monetary policy from the late
1990s onwards and also US monetary policy after the technology bubble

44
Eggertsson (2006), ‘The Deflation Bias and Committing to Being Irresponsible’.
45
Preamble (7) of the Decision (EU) 2015/774 of the ECB.
46
Draghi in ECB press conference (10 March 2016), ‘Introductory Statement’ in Frankfurt
am Main, www.ecb.europa.eu/press/pressconf/2016/html/is160310.en.html.
47
Cúrdia and Woodford (2011), ‘The Central-Bank Balance Sheet as an Instrument’, 54–79;
Gertler and Karadi (2011), ‘A Model of Unconventional Monetary Policy’, 17–34 and He
and Krishnamurthy (2013), ‘Intermediary Asset Pricing’.
48
Hancock and Passmore (2014), ‘How the Federal Reserve’s Large-Scale Asset Purchases
(LSAPs) Influence’.

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 202 8 th e ecb’s quantitative easing

burst in 2000. These studies showed that central bank communication

can affect expectations of future policy and that large-scale asset pur-
chases by central banks can have some effect on the interest rates
involved.49 Evidence even suggested some impact on economic activity
but less so on inflation.50 More recent studies on the Fed’s first QE
programme in November 2008 revealed significant declines in interest
rates of safe assets, such as government bonds and highly rated corpor-
ate bonds, but other corporate bonds were not affected. Some evidence
pointed to increased inflation expectations, supporting the signalling
effect,51 although the effect on longer-term forward rates was less sup-
portive.52 The results for the second QE programme (late 2010) were less
convincing, as it was perhaps anticipated or more stable financial
markets reduced its scope.53 The BoE QE was estimated to have had a
clear impact on government bonds but less on other assets.54 Some
effects on economic growth and even on inflation were also detected.55
The studies thus found evidence that QE can have some impact on
financial market variables, particularly on purchased assets and their
close substitutes. The signalling effect also found some support, but the
results on the real economy and on inflation are not very convincing, if
still supportive of QE. However, most studies are conducted in central
banks: unsurprisingly, these did not conclude that programmes had
been failures.
The way central banks have classified their QE programmes provides
additional information. All recent QEs were activated when official
interest rates were basically zero. In the USA, decisions on QEs
were made by the FOMC, the organ responsible for monetary policy.56

49
Bernanke et al. (2004), ‘Monetary Policy Alternatives’.
50
Berkmen (2102), ‘Bank of Japan’s Quantitative and Credit Easing’.
51
Krishnamurthy and Vissing-Jorgensen (2011), ‘The Effects of Quantitative Easing on
Interest Rates’; Krishnamurthy and Vissing-Jorgensen (2012), ‘The Aggregate Demand
for Treasury Debt’; D’Amico and King (2012), ‘Flow and Stock Effects of Large-Scale
Treasury Purchases’; Gagnon et al. (2010), ‘Large-Scale Asset Purchases by the Federal
Reserve’; Li and Wei (2012), ‘Term Structure Modelling with Supply Factors’.
52
Jarrow and Li (2014), ‘The Impact of Quantitative Easing on the US Term Structure of
Interest Rates’, 287–321; Hamilton and Wu (2012), ‘The Effectiveness of Alternative
Monetary Policy Tools’.
53
Fawley and Neely (2013), ‘Four Stories of Quantitative Easing’.
54
Joyce et al. (2010), ‘The Financial Market Impact of Quantitative Easing’.
55
Kapetanios et al. (2012), ‘Assessing the Economy-Wide Effects of Quantitative Easing’.
56
In the USA, the FOMC decides on the open market operations and the Board of Governors
is responsible for the discount rate and reserve requirements. www.federalreserve.gov/
monetarypolicy/fomc.htm.

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 8.3 economic analysis and comparisons 203

The first QE was linked to financial market conditions in addition to the

overall economic situation.57 The second QE was based only on monetary
policy ‘to promote a stronger pace of economic recovery and to help
ensure that inflation, over time, is at levels consistent with its man-
date’.58 The third US QE was to ‘put downward pressure on longer-term
interest rates, support mortgage markets, and help to make broader
financial conditions more accommodative’,59 and was accompanied by
a very long forward guidance on policy rates.60
The first UK QE programme (March 2009) had the dual aim of affecting
specific credit market segments as well as relaxing the overall monetary
policy stance. The facility was announced by the Ministry of Finance, but
was operationalised by the BoE.61 The programme was to boost the
supply of money and credit, ‘in due course raising the rate of growth
of nominal spending’, and was accompanied by a cut in official interest
rates.62 The programme was increased seven times, always based on
inflation expectations and the decisions were made by the Monetary
Policy Committee.63 The Bank of Japan employed QE to achieve the price
stability target of 2 per cent, but also referred to financial stability
considerations as an additional target.64
The size of the PSPP is comparable to other major central banks’ QEs.
The US programmes reached 4,200 billion US dollars and nearly one-
quarter of GDP before they were put on hold in October 2014.65 In Japan,

57
FOMC press release (25 November 2008).
58
FOMC press release (3 November 2010) on QE2.
59
FOMC press release (13 September 2012) on QE3.
60
FOMC press release (13 September 2012), ‘Exceptionally Low Levels for the Federal Funds
Rate are Likely to Be Warranted at Least through Mid-2015’.
61
Fawley and Neely (2013), ‘Four Stories of Quantitative Easing’.
62
The BoE News Release (5 March 2009), ‘Bank of England Reduces Bank Rate by 0.5
Percentage Points to 0.5 per cent and Announces £75 Billion Asset Purchase
Programme’. www.bankofengland.co.uk/archive/Pages/digitalcontent/historicpubs/
newsreleases.aspx.
63
The BoE News Release (5 July 2012), ‘Bank of England Maintains Bank Rate at 0.5 per cent
and Increases Size of Asset Purchase Programme by £50 billion to £375 billion’. www
.bankofengland.co.uk/publications/Pages/news/2012/066.aspx.
64
See, BoJ (16 November 2011), ‘Statement on Monetary Policy’, referring to financial
stability and, for example, Bank of Japan (28 October 2010), ‘Statement on Monetary
Policy’. www.boj.or.jp/en/announcements/release_2010/k101028.pdf.
65
FOMC press release (29 October 2014) and also FOMC (October 28–29 2014), ‘Minutes of
the Federal Open Market Committee’, 9. www.federalreserve.gov/newsevents/press/
monetary/20141029a.htm and www.federalreserve.gov/monetarypolicy/files/
fomcminutes20141029.pdf. A ll Federal Reserve Banks – Total Assets, Eliminations from
Consolidation https://research.stlouisfed.org/fred2/series/WALCL.

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 204 8 th e ecb’s quantitative easing

holdings of government bonds continue to increase, having passed one-

half of GDP already in 2015.66 A new programme in Japan called QQE with
a Negative Interest Rate was launched in 2016.67 The UK’s QE led to the BoE
holding more than one quarter of GDP-worth of government bonds even
before it was relaunched amid Brexit uncertainties.68 The relative size of
the PSPP exceeded 20 per cent of GDP by 2018, making it similar to the
USA and the UK in relative terms.69
The ECB’s views on QE have varied. For a long time, the ECB was
cautious about QE due to institutional and legal considerations.
President Draghi addressed the issue after being nominated: ‘we should
not try to circumvent the spirit of the Treaty. No matter what the legal
trick is, I think what matters for the people and what matters for the
confidence and credibility of the institution is the spirit of this provision
of the Treaty’. Also in comparison to the USA and the UK President
Draghi referred to the Treaty: ‘each central bank has its institutional
set-up, within which it operates. The ECB operates within the limits of
the Treaty, and I said a moment ago what our primary mandate is, and
especially what the Treaty says the ECB cannot do. I think any central
bank is constrained by its institutional set-up. In the United States, as
you know, the primary mandate of the Federal Reserve is completely
different from ours. And the same is true of the Bank of England.’70
When the ECB finally made the decision, it presented the PSPP as
monetary policy in the strict sense and always made an explicit link
between the PSPP and ensuring price stability. The monetary policy part
of the decision was unanimous. Other reservations about the PSPP
remained,71and already in December 2014 the Bundesbank stated that:
‘[t]here’s a whole row of economic reasons that speak against

66
Bank of Japan (31 October 2014), ‘Monetary Policy Statement: Expansion of the
Quantitative and Qualitative Monetary Easing’ and www.breakingviews.com/bank-of-
japan-bond-vault-may-resemble-a-black-hole/21172069.
67
Bank of Japan (12 May 2016), ‘Statement concerning the Bank’s Semiannual Report on
Currency and Monetary Control’. www.boj.or.jp/en/announcements/press/koen_2016/
ko160512b.htm/.
68
For further comparison of the earlier programmes, see Fawley and Neely (2013), ‘Four
Stories of Quantitative Easing’.
69
Government bond holdings by the Bank of Japan were roughly 2.4 trillion euros in
May 2016.
70
Draghi in ECB press conference (8 December 2011), ‘Introductory Statement’. www.ecb
.europa.eu/press/pressconf/2011/html/is111208.en.html.
71
Draghi in ECB press conference (22 January 2015), ‘Introductory Statement’. www.ecb
.europa.eu/press/pressconf/2015/html/is150122.en.html.

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 8.3 economic analysis and comparisons 205

government-bond purchases, even before you consider the legal question

of whether they’re compatible with the ban on monetary financing . . .
a broad QE program can – bypassing parliaments and governments –
lead to a redistribution of risks between taxpayers in the member
countries, unless the purchases are limited to the countries with the
highest credit rating or each central bank purchases bonds at the risk of
its own country.’72
The weakness in the ECB’s description is the link between the PSPP
and price stability. In late 2014 inflation was on the low end of the price
stability definition and headline inflation was temporarily negative due
to oil prices. However, the ECB’s argumentation of the passage from
PSPP purchases to higher inflation was a statement – but not an eco-
nomic assessment.73 The actual decision was similarly thin in terms of
the economics of the PSPP and its objective.74
The ensuing communication mentioned the moral hazard consider-
ations involved in euro area public finances. On risk-sharing President
Draghi said that monetary policy measures can always have some fiscal
consequences and ‘these fiscal implications are dealt with easily within a
one-country framework, between the central bank and the treasury. But
in the euro area . . . each national treasury gives an implicit or explicit
indemnity to its own central bank, but not the euro system as a whole.’75
A speculative but relevant economic question is whether there were
other aims for the PSPP that could explain the decisions, its size, features
or timing. Three possibilities have surfaced: reducing the euro exchange
rate; increasing asset prices to reduce financial instability; and financing

72
www.bloomberg.com/news/articles/2014-12-16/weidmann-rejects-sovereign-bond-
buying-even-if-deflation-emerges. President of the Öesterreichischen Nationalbank,
Nowotny echoed these worries: ‘to be honest I did not support this decision,’ he said,
adding ‘I think of course it has advantages but the risks are not insignificant.’ www
.reuters.com/article/2015/01/23/us-ecb-policy-nowotny-idUSKBN0KW0KY20150123.
73
The decision stated that ‘these asset purchase programmes are aimed at . . . contributing
to returning inflation rates to levels closer to 2 per cent’ by ‘enhancing the transmission
of monetary policy, facilitating credit provision to the euro area economy, easing
borrowing conditions of households and firms’. This was to support consumption and
investments. Preamble (2) and (4) of the Decision (EU) 2015/774 of the ECB.
74
As was also pointed out by the FCC in the Weiss case (FCC 2 BvR 859/15).
75
He stressed that concerning the effectiveness of the PSPP limited risk-sharing had a
small negative effect and did not hide that he was against it. Draghi in ECB press
conference (22 January 2015), ‘Introductory Statement’ in Frankfurt am Main. www.ecb
.europa.eu/press/pressconf/2015/html/is150122.en.html.

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 206 8 th e ecb’s quantitative easing

Member States in trouble.76 First, a lower exchange rate is an even more

likely outcome of QE than higher inflation.77 An increase in the quantity
of money should reduce its value relative to other assets, such as
equities, bonds and other currencies. The ECB did not mention the euro
exchange rate aim for the PSPP,78 probably because responsibility over
the euro exchange rate lies with the ECOFIN Council.
Second, the link between financial stability and the PSPP was absent in
the ECB communication, except indirectly through the loan supply
argumentation. The PSPP did aim at influencing asset prices, but the
link between asset prices and financial stability is not straightforward.
As could be recalled, rising asset prices and credit expansion contributed
to the financial crisis in the first place.79 However, if elevated and debt-
financed asset prices risk forming self-enforcing negative trend, monet-
ary policy could even target asset prices to stabilise the economy, as was
the case with the first US QE. The situation is very different if asset prices
are already high, as was the case when the ECB announced the PSPP in
2015. Further increases in asset prices could even increase financial
instability going forward.80 Also proponents of the programme pointed
to risks of another asset price bubble.81 Against this background, the
more dubious financial stability consideration of the PSPP could stem
from the ECB’s banking supervision responsibility since 2014. If the ECB
became aware of problems in some banks, the PSPP could have been used
to stabilise the situation by increasing the liquidity and prices of finan-
cial assets held by banks.

76
www.ft.com/intl/cms/s/0/10a0f880-a25c-11e4-9630-00144feab7de.html#axzz3XNLF5xLQ,
www.bloomberg.com/news/articles/2015-01-12/ifo-s-sinn-says-ecb-using-deflation-risk-
as-excuse-for-qe.
77
Also, in theoretical and empirical considerations, there is evidence of the effect on
exchange rates and asset prices, see Peiris and Polemarchakis (2015), ‘Quantitative
Easing in an Open Economy: Prices, Exchange Rates and Risk Premia’ and Dupuy and
Lacueille (2013), ‘The Effects of US and UK Quantitative Easing Policies on Exchange
Rates’, 61.
78
See, for example, De Grauwe (2015), ‘The Sad Consequences of the Fear of QE’.
79
As pointed out early on by Borio and Lowe (2002). ‘Asset Prices, Financial and Monetary
Stability: Exploring the Nexus’.
80
The potential for an asset price bubble was asked from President Draghi in the European
Parliament. Draghi (23 March 2015), ‘Introductory Remarks and Q&A on Hearing at the
European Parliament’s Economic and Monetary Affairs Committee’. www.ecb.europa
.eu/press/key/date/2015/html/sp150323_1.en.html.
81
Pisani-Ferry (2015), ‘The ECB and Its Critics’. Governor of the Bank of England Carney
stated: ‘in an environment of low interest rates and quantitative easing there can be
excessive risk-taking.’ www.theguardian.com/business/2015/jan/24/mark-carney-davos-
warns-risk-quantitative-easing.

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 8.4 a constitutional assessment of t he pspp 207

Third, financing of the Member States was often claimed as motivation

for the PSPP. The need to create a lender of last resort for governments
was a repeated argument in euro area economic policy discussions.82
However, this was never officially mentioned in the context of the PSPP
not least because Article 123 TFEU explicitly prohibits the central bank
from financing governments. Nevertheless, the PSPP aimed at facilitat-
ing government bond markets and even at lowering the borrowing costs
for Member States. An economic distinction between a monetary policy
aim and a government financing aim is difficult to make.

8.4 A Constitutional Assessment of the PSPP

The PSPP is part of ECB unconventional monetary policy, although QEs
had become more conventional among central banks by 2015.
Nevertheless, such a programme was not foreseen in the European
Macroeconomic Constitution.83 Hence, a constitutional interpretation
of the PSPP requires economic and institutional analysis. The question
is whether the PSPP is a monetary policy measure that can be used in the
specific EMU context of supranational monetary policy guarded by legal
and institutional constraints. The constitutional assessment boils down
to two main questions. First is the classification of the PSPP as monetary
policy in its specific context. Was it a proportionate and reasonable
measure that was not primarily based on other than monetary policy
motivations? Second, were there constraints such as Article 123 TFEU
that safeguard the principle of Member State fiscal responsibility, protect
the ECB’s independence and ultimately guarantee price stability?
Additionally, the PSPP should be assessed in the light of the broader
European Macroeconomic Constitution.
Classifying the PSPP as monetary policy determines whether it falls
under EU or Member State competence. The discussion should take a
substantive perspective rather than the CJEU’s formal threshold in the
Weiss and Gauweiler cases.84 The ECB is the expert body that enjoys
reasonable discretion in deciding about appropriate measures at any

82
De Grauwe (2103), ‘The European Central Bank as Lender of Last Resort in the
Government Bond Markets’ and also Buiter and Rahbari (2012), ‘The ECB as Lender of
Last Resort for Sovereigns in the Euro’.
83
In the late 1980s and early 1990s, QE was not discussed in monetary theory or central
banking practice.
84
The formal criteria ultimately only demanded that the ECB claimed a measure as
monetary policy and a need to ensure price stability as in Gauweiler and Weiss cases.

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 208 8 th e ecb’s quantitative easing

given time, and a constitutional review of the ECB does not offer protec-
tion against poor policy choices. However, it should protect national
sovereignty and try to avoid manifest errors of assessment.85
The economic assessment above and comparable programs by other
major central banks seem to qualify the PSPP as a policy measure that
could aim at price stability in specific circumstances. Other central
banks used QE for the purpose of providing monetary policy stimulus
to the economy, and in some cases to support financial stability. The
counterargument that theoretical evidence is relatively weak, for
example, compared to traditional monetary policy measures, is miti-
gated by the fact that QE was used only when other measures were in
full use. Furthermore, the evolution in macroeconomics and monetary
theory has shown the limits of present-day knowledge.
Hence, the question whether QE can also be regarded as monetary
policy in the EMU context could be answered in the affirmative. The aim
to influence inflation and inflation expectations can be considered
equivalent to the ECB price stability objective.86 The CJEU as guardian
of the principle of conferral reached the same conclusion, but it did not
engage in an economic definition of monetary policy, but stressed the
objectives of the measure and to a lesser degree its instruments.
However, even if the PSPP can be classified as monetary policy, there are
further questions concerning its actual use. The courts use the concept of
proportionality to discuss, for example, the suitability of the PSPP for
attaining the ECB’s objectives in the specific situation. The proportionality
needs to consider the economic situation of the decision to check whether
the PSPP was primarily used for monetary policy aims or, alternatively,
whether there were other more likely reasons or outcomes.
The economic situation in late 2014 and early 2015 provides the
initial economic framework for the PSPP. The worst instability and
particularly the sovereign debt crisis were over, but inflation and
inflation expectations had declined below the ECB numerical definition
of price stability (close to but below 2 per cent), and declining oil prices
even pushed headline inflation temporarily into negative territory. The
main factors in this economic background were slow economic growth
and low inflation, worries concerning banking sector capitalisation in

85
Case C-62/14 - Gauweiler and Others. ECLI:EU:C:2015:400, para. 74.
86
The UK QE was linked to the full use of conventional monetary policy, and the purchases
were to be unwound when the official interest rate reaches a level where it could also be
properly cut if needed. Bank of England (February 2014), ‘Inflation Report’.

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 8.4 a constitutional assessment of t he pspp 209

some countries and fairly elevated asset prices, including government

bond prices. Hence, there was room for monetary policy stimulus, and
conventional monetary policy was in full use,87 which could justify
turning to QE.
The CJEU points to low inflation or even a deflation risk environment
before the launch of the PSPP, and also refers to studies provided by the
ECB that ‘show that large-scale purchases of government bonds can
contribute to achieving that objective by means of facilitating access to
financing.’88 Here, the FCC takes a broader stance. It sees that the PSPP
has significant economic policy effects apart from monetary policy
effects, which demands that the effects are ‘weighed and balanced
against one another’, as a critical part of the proportionality
assessment.89
Against that background, the monetary policy nature of the PSPP
could be tested by asking whether it had other than monetary policy
aims. In particular, if these other aims were the primary reasons and
even contradictory to the monetary policy aims, they would disqualify
the PSPP as a monetary policy measure. The assessment is complicated
by the fact that monetary policy measures generally affect the finan-
cial markets. The CJEU devoted some space to disregarding the other
effects of the programme, for example, on asset prices, on banks’
balance sheets and on interest rates. They were deemed either normal
or at least indirect effects of monetary policy.90 The FCC took a
broader perspective on the effects of the programme, and saw more
problems in incorporating the PSPP within the monetary competence
of the ECB.
A difficult economic question with the PSPP is its impact on asset
prices. The most suitable situation for QE, both theoretically and empir-
ically, prevails when financial markets are under stress, as was the case
when the USA and the UK programmes started.91 In contrast, the PSPP

87
The MRO rate was at 0.05 per cent from September 2014. ECB press release (4 September
2014), ‘Monetary Policy Decisions’, www.ecb.europa.eu/press/pr/date/2014/html/
pr140904.en.html.
88
Case C-493/17 - Weiss and others, EU:C:2018:1000, paras 71–77.
89
2 BvR 859/15. This is most clearly stated in FCC Press Release No. 32/2020 of 05 May 2020.
90
Case C-493/17 - Weiss and others, EU:C:2018:1000, paras 49, 53, 58–59, 61–64 and 66–67.
91
US purchases started in December 2008 and ended in October 2014, whereas the UK QE
ran from March 2009 until late 2012, although it was reactivated after the
BREXIT referendum.

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 210 8 th e ecb’s quantitative easing

started with asset prices close to their peaks.92 This starting point can be
relevant for the effectiveness of the programme as well as for financial
stability considerations. Could this also disqualify the PSPP as a propor-
tionate monetary policy tool? The link between the PSPP and economic
stimulus is arguably weaker than with other central banks. In the PSPP,
the explicit aim of affecting asset prices is thus a concern.
The timing of the PSPP could also hint at other than monetary policy
motivations. The ECB had just become deeply involved in the euro area
banking sector, when it had conducted a comprehensive assessment of
all the major banks and taken them under direct supervision. However,
the quality of this comprehensive assessment became doubted when
some major banks were perceived becoming insufficiently capitalised
soon afterwards. Furthermore, in the preceding crisis years, and encour-
aged by the ECB’s three-year LTROs, many banks particularly in Italy and
Spain had accumulated large government bond holdings, and thus their
ability to lend became negatively correlated with bond prices. As a result,
it could be claimed that the ECB’s credibility was vested in major banks,
mainly in Italy and Spain, which in turn were dependent on government
bond prices. Whether this was a motivation for the PSPP or only a
positive side effect, cannot be verified.
Some special features of the PSPP raise further questions. Other cen-
tral banks purchased the lowest risk benchmark government bonds, but
the ECB purchased the bonds of all Member States.93 If the only aim was
to signal a commitment to increase inflation and to ease financing
conditions through portfolio rebalancing, these could have been
achieved by purchasing only the most creditworthy bonds. The ECB’s
approach was thus more intrusive in terms of market pricing of risk.
Portfolio rebalancing did not take place only from the least risky assets
to other assets, but rather the ECB preselected a broader list of assets, the
government bonds of all Member States.
Nevertheless, it could be concluded that the PSPP passes the monetary
policy test even against some more substantive criteria than those used
by the CJEU. The PSPP could be classified as a mistimed or even ill-
advised monetary policy, but the threshold for unconstitutionality is
higher to protect the discretion awarded to the ECB. The other potential

92
In particular, highly rated government bonds had exceptionally low yields already
in 2014.
93
With the exception of Greece. See changes and holdings at www.ecb.europa.eu/mopo/
implement/omt/html/index.en.html.

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 8.4 a constitutional assessment of t he pspp 211

motivations for the programme could have been present, but their
verification is difficult. Here, the FCC chose to put more responsibility
for the ECB to make its case.94
The second constitutional question concerning the PSPP is whether
there were constitutional constraints against it, mainly the Treaty pro-
hibition on public financing, although problems with the selective pur-
chase programmes (SMP and OMT) were more fundamental. As could be
recalled, in those cases the CJEU’s view on the non-applicability of Article
123 TFEU relied partly on its assumed telos of protecting sound public
finances. In the OMT, this was covered by the conditionality criterion,
which does not apply to the PSPP.
For the PSPP, the CJEU stated again that Article 123 TFEU ‘prohibits all
financial assistance from the ESCB to a Member State’ but this does not
preclude the purchase of bonds previously issued by that state. The
critical question is: what makes a programme equal to financial assist-
ance?95 The CJEU excluded one natural possibility, namely the necessary
outcome. With the PSPP, the ECB and NCBs had replaced private invest-
ors as creditors of Member States and become the largest holders of
Member State government bonds for other than short-term monetary
policy purposes. The ECB and NCBs issued central bank money to
become creditors of Member States, which was monetising government
debt in economic terms, regardless of whether it took place through
primary or secondary markets. This outcome of the PSPP is the same as it
would have been if the ECB issued central bank money and lent it
directly to governments.
The CJEU did not mention the outcome, but imposed two further tests.
First, secondary market purchases cannot have ‘an effect equivalent to
that of a direct purchase of bonds.’96 Second, the ECB needs to have
sufficient safeguards to ensure that the PSPP does not ‘reduce the
impetus which that provision is intended to give the Member States to
follow a sound budgetary policy’.97 These are defensible tests, but their
application turned them into formalities. The first condition, again, did
not include the above-mentioned outcome of the PSPP. Similarly, the
requirement of not having an equivalent effect was watered down by

94
The FCC demanded that the ECB conducts a proper proportionality assessment of the
PSPP. FCC 2 BvR 859/15.
95
Case C-493/17 - Weiss and others, EU:C:2018:1000, paras 103–104.
96 97
Ibid., paras 105–106. Ibid., para 107.

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 212 8 th e ecb’s quantitative easing

insisting that primary purchasers of bonds should know with certainty

that their bonds will be bought.98
Furthermore, if the PSPP encouraged Member States to issue debt, it
worked against the fiscal responsibility principle, as it even resulted in
negative interest rates for many governments. The ECB and CJEU saw a
limited impact on Member States’ public finances, referring to a list of
reasons (no certainty of purchases, minority holdings of up to 33 per
cent, capital key vs size of the bond markets, temporary nature and
eligibility criteria).99 While these reasons arguably had some validity,
they hardly curtailed the actual impact of the PSPP on Member
States’ financing.
A different and even surprising way around Article 123 TFEU could be
through its ultimate telos. The prohibition stems from the historical and
theoretical concerns that excessive money supply leads to high inflation.
Central bank financing of governments is equivalent to money supply,
which should over time lead to inflation according to the quantity theory
of money.100 With the PSPP this telos turns around. The price stability
objective was deemed to require higher inflation, which could be
achieved by increasing the money supply, operationalised by purchasing
low risk assets such as government bonds using central bank money.
Accordingly, central bank bond purchases could be against the letter of
Article 123 TFEU but in conformity with its ultimate telos of maintaining
price stability.
Turning to a broader constitutional assessment of the PSPP in the light
of the European Macroeconomic Constitution, one issue is the relation-
ship between the ECB and Member States. The risk-sharing structure of
the PSPP was designed to alleviate the risk of hidden fiscal transfers
between the Member States, but it also reduced the indivisible nature
of common monetary policy and its risk-sharing. Through the PSPP,
exclusive EU monetary policy of the ECB imposed on Member States
obligations to take risks when the ECB ordered the NCBs to buy bonds
from the market.
An indirect institutional balance issue between the ECB and the
Member States takes place through the ESM, a non-Community

98
Ibid., paras 113–117.
99
For example, by avoiding a blocking minority, applying black-out periods and insisting
on the pari passu principle. See Draghi in ECB press conference (22 January 2015), ‘ECB
Announces Expanded Asset Purchase Programme’, www.ecb.europa.eu/press/pr/date/
2015/html/pr150122_1.en.html.
100
Assuming that other parts of the equation remain the same. See Chapter 2.

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 8.4 a constitutional assessment of t he pspp 213

institution of the Member States. If the ECB purchases the bonds of

assisted countries, how do its activities relate to those of the ESM, and
what is the institutional balance between the two institutions?
Presumably, the ESM should be better equipped to tackle issues involving
fiscal transfers between the Member States, as it is accountable to demo-
cratically elected bodies through its Board of Directors. The ECB could
also become a major buyer of bonds issued by the ESM. Although the
purchases are based on the ECB’s own assessment and hence formally
contain no conflict of interest, the ECB could be assumed to fund the
rescue operations given its role in the Troika and the ESM. A web of
mutual dependencies could develop in which the ECB effectively
becomes dependent on the fiscal sustainability of some Member States.
This concern was voiced by the Advocate General in the Gauweiler and
Weiss cases, but ignored by the CJEU.
A deeper constitutional issue with the PSPP is its aim of increasing
asset prices in the euro area, which raises the question whether the ECB
is employing a redistributive policy. Some redistributive effects can
result from conventional monetary policy as well, as was also explained
by the CJEU, but with the PSPP these effects are more explicit. Whether a
policy that aims at increasing wealth differences within the euro area
should still be suitable for an independent expert, needs to be
explicitly discussed.
The limited risk-sharing of the PSPP could also be seen from the
perspective of a potential EMU break-up. The OMT had full risk-sharing,
and the ECB saw it as important that the OMT should increase the cost of
an EMU break-up. With the PSPP this effect was excluded. When each
NCB mostly holds its own government bonds, an EMU break-up could be
more manageable. Considering that a Greek exit was a topic also at the
time of the decision, it seems plausible that the PSPP took that into
account. This could be problematic for the constitutional principle of
advancing European integration and unity of monetary policy.
Finally, conformity with an open market economy was worse with the
selective bond purchase programmes based on the claim that market
pricing was incorrect. The PSPP did aim at influencing market pricing
well beyond standard monetary policy operations, but it still took place
more ‘at arm’s length’. However, the scale of the programme has raised
serious worries that it has hampered the functioning of the government
bond markets and capital markets more generally.
In sum, the PSPP could be seen as a monetary policy measure quite
similar to those previously activated by other central banks for the

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 214 8 th e ecb’s quantitative easing

purpose of advancing their objectives (price stability, growth, and finan-

cial stability). There are also some important differences between the
PSPP and other programmes, particularly concerning the prevailing
economic and financial environment. However, these differences hardly
make the PSPP a manifest error by the ECB under a constitutional
review. A more problematic relation is found with Articles 123 TFEU,
where a literal and economic reading would seem to question the con-
stitutionality of the PSPP. Taking a broader economic constitutional
perspective, the PSPP also raises a few uncomfortable issues, such as its
aim of increasing wealth differences, which is close to a redistributive
policy and potentially shapes the social fabric of the euro area in a
profound manner. The same impact can also prove to be detrimental
for the sustained financial stability of the euro area. The FCC Weiss
judgment101 was perhaps more sensitive to these concerns but it was
largely ignored in the heated debates that mostly revealed some funda-
mental differences in the economic-constitutional approaches.

101
FCC 2 BvR 859/15.

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 9 The Banking Union: The ECB Takes
Over Banking Supervision

The path towards EU banking union and the ECB’s responsibility over
prudential supervision deviated from monetary policy responses dis-
cussed earlier. The objective was financial stability rather than price
stability and the decision-maker was the EU Council, not the ECB. Still,
it was another crisis response that utilised the availability of a strong EU
institution, again the ECB. The euro area banking union became oper-
ational in late 2014, when some 120 of the largest banking groups were
subjected to direct supervision by the ECB and the remaining 3,500
smaller banks continued to be supervised by national authorities under
ECB guidelines.1 This was an enormous change in euro area economic
management, adding an internal market dimension to the EMU.
Originally, banking supervision had a strong EU-level internal market
and microeconomic substance that was now transferred to euro area
macroeconomic management, even becoming part of the European
Macroeconomic Constitution. An EU microeconomic efficiency and
integration issue was subjected to a euro area macroeconomic
stability framework.
The ECB’s role in the banking union raises new types of constitutional
questions and requires a different analytical framework. The focus is on
the ECB’s banking supervision, but it needs to be seen as part of the
broader banking union. A formal legal assessment, particularly on the
legal basis for conferring specific tasks on the ECB under Article 127(6)
TFEU, is complemented with a broader economic constitutional analysis.
First, it is necessary to understand the context in which the banking
union was initiated as well as the problems it aimed to solve. This is

1
www.bankingsupervision.europa.eu/press/pr/date/2014/html/sr141104.en.html.

215

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 216 9 th e banking union

followed by an economic and institutional discussion on the merits and

caveats of combining banking supervision and monetary policy.
A specific question is whether the banking union could still be regarded
fundamentally as a microeconomic internal market issue that was only
temporarily addressed in the macroeconomic framework due to stability
concerns. This could allow a later resurgence of internal market consid-
erations. The chapter concludes with constitutional remarks on the
ECB’s banking supervision.

9.1 Background and Evolution towards EU Banking Union

The process of creating unified markets for financial services had already
started with the Treaty of Rome, but the integration of Member States’
financial sectors and their regulation was slow. The right to provide
financial services within the internal market only gained speed from
the 1986 Single European Act onwards. The single market for financial
services relied on freedom of capital movement, the right to establish
branches, and freedom to offer financial services across borders. The
single market was operationalised through mutual recognition, not har-
monisation.2 This approach of a European banking passport and home-
country supervision was built on a few directives that left considerable
national discretion.3
The EMU did not change the basic approach to financial services. They
remained an internal market issue with national responsibility over
financial supervision. Cooperation between EU supervisors gained pace
within the ESCB, where the internal market and thus the EU perspective
meant that the respective ECB Committee had an EU-wide not a euro
area composition. In addition, financial regulation had an important
international dimension, where the BIS and its Basel Committee were
central.4

2
Santangelo (1997). ‘The Single Market for Financial Services’.
3
The main regulations were the Council Directive on Own Funds 89/29/EEC of April 17
1989, Council Directive 89/647/EEC of 18 December 1989 on a solvency ratio for credit
institutions (OJ L 386, 30.12.1989, pp. 14–22) and the Second Banking Directive 89/646/
EEC of 15 December 1989 providing a single banking licence.
4
The Basel Committee was founded by G10 central banks to facilitate regular cooperation
on banking supervisory matters. It enhances financial stability by improving the quality
of supervision and regulation by setting minimum standards, for example on own capital.
See www.bis.org/bcbs/history.htm.

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 9.1 evolution towards eu banking union 217

During the initial stages of the financial crisis, the national, EU and
international as well as also microeconomic approaches prevailed.
Failures in financial supervision and regulation were responded to by
numerous initiatives to enhance the single market for financial services,
including changes in prudential requirements for banks, new harmon-
ised rules for deposit insurance and new rules and practices to handle
failing banks. The aim was a single rulebook for the financial actors in all
twenty-eight Member States. Bank failures remained a national responsi-
bility, paid for by the home country’s taxpayers.5
The EMU and the European Macroeconomic Constitution held the
premise that banking supervision was excluded from the model for
macroeconomic management that was built around ECB competence in
monetary policy. In the Maastricht Treaty, banking supervision was
deliberately – and against the wishes of many central bank governors –
excluded from the tasks of the ECB. The ECB was only ‘to promote’
instead of ‘ensuring’ the smooth operation of payment systems. The
governors had wished to get the task ‘to participate as necessary in the
formulation, coordination and execution of policies relating to pruden-
tial supervision and the stability of the financial system’, but this was
downgraded to ‘contribute to the smooth conduct of policies pursued by
the competent authorities relating to the prudential supervision of credit
institutions and the stability of the financial system’.6 Some flexibility
was incorporated in Article 127(6) that allowed granting specific tasks in
the field of supervision to the ECB.7
The exclusion of prudential supervision and financial stability respon-
sibilities for the ECB was based on several considerations. The advisabil-
ity of combining monetary policy and banking supervision was an
unresolved and debated topic. In the Maastricht negotiations, the view
persisted that the responsibilities and tasks allocated to the new and
highly independent ECB should be limited.8 Also more generally,

5
With occasional EU or euro area pressure to bail-out banks’ creditors, as when the ECB
was claimed to have put pressure on Ireland to take over all the liabilities of the banks.
See, for example, Brennan (2010), ‘The difference between Iceland and Ireland’.
6
James (2012), Making the European Monetary Union, 426–427.
7
‘The Council, acting by means of regulations in accordance with a special legislative
procedure, may unanimously, and after consulting the European Parliament and the
European Central Bank, confer specific tasks upon the European Central Bank concerning
policies relating to the prudential supervision of credit institutions and other financial
institutions with the exception of insurance undertakings.’
8
See James (2012), Making the European Monetary Union and Smits (1997), The European Central
Bank.

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 218 9 th e banking union

independent central banks had more limited responsibilities in financial

supervision, as was the case with the Bundesbank, and the Fed. Of the
major EU countries, only the Banca d’Italia had full banking
supervision responsibility.
The institutional development in EU financial regulation gathered
pace when it became part of the response to the financial crisis. The
EU followed the international reform agenda until the sovereign debt
crisis became the overriding problem for the euro area. One major step
was the establishment of the European Banking Authority (EBA) in
January 2011 to foster closer cooperation between EU supervisors,9 and
European System of Financial Supervision. Among its first actions, the
EBA repeated the EU-wide bank stress tests that had been conducted by
its predecessor, the Committee of European Banking Supervisors (CEBS)
a year earlier.10 Unfortunately, the stress tests failed again to restore
confidence in EU banks and also in EU supervisors. Soon thereafter it was
clear that the EBA, a London-based EU-wide institution, could not cred-
ibly integrate EU financial supervision.
The change in approach towards the EMU macroeconomic manage-
ment framework was demonstrated in a European Council mandated
report by four presidents The completion of the Economic and Monetary Union
(EMU) covering all the essential building blocks.11 The building blocks covered
both macroeconomic and microeconomic issues: the establishment of
the Single Supervisory Mechanism (SSM) for banks, enforcement of
Capital Requirements and the framework for bank recapitalisation dir-
ectly by the ESM. The second step included setting up a euro area

9
The other changes included as well as the establishment of the European System Risk
Board by Regulation (EU) No 1092/2010 of the EP and of the Council of 24 November
2010 on EU macro-prudential oversight of the financial system and establishing a
European Systemic Risk Board, L331/1 and the European System of Financial Supervision
(ESFS) as a broader umbrella.
10
Bank stress tests were conducted globally to assess the resilience of that banks’ capital
buffers were sufficient to withstand foreseeable shocks. If a bank failed the test, it
needed more capital, either from private or public sources, or it had to reduce its
activities. Importantly, the test aimed at restoring public confidence in banks. US
2009 test was successful, while the EU tests were criticised for excessive lenience,
whereby they could actually have reduced trust in banks and supervisors.
11
In June 2012 the European Council mandated the President of the European Council
together with the Presidents of the Commission, the Eurogroup and the ECB to draft a
plan for ‘the achievement of a genuine Economic and Monetary Union’. This resulted in
Van Rompuy, Barroso, Juncker, and Draghi (2012), ‘Towards a Genuine Economic and
Monetary Union’.

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 9.2 concept and legal basis 219

resolution authority.12 The report stressed the link between ECB monetary
policy and banking supervision, as the crisis responses had strengthened
the link between sovereign debt problems and banking sector problems.
Indeed, sovereign debt problems had become EMU problems, when
sovereign defaults were deemed too risky in the context of heightened
overall uncertainties and risks of contagion.13 This view was taken in
May 2010 for Greece, but the consequences of this choice became clear
only gradually. Namely, if individual euro area country defaults were
excluded, failing countries had to be rescued by other euro area coun-
tries. This had important institutional repercussions. First, banking
problems that could cause sovereign debt problems, such as in Ireland
and Spain, became EMU problems. Second, it is more efficient to rescue
banks directly than to rescue Member States that are defaulting because
of their attempts to save banks. This in turn means that the ESM should
be able to finance bank recapitalisations. Third, in this new setting,
national discretion in banking supervision loses its legitimacy and even
creates moral hazard problems, when national responsibility over banks
is replaced by an ultimate EMU responsibility.
As a consequence, the link between monetary policy and banking
supervision developed through a peculiar link between banking prob-
lems and individual Member State public finance problems that were
arguably made worse by ECB LTRO funding to purchase government
bonds. Banks (and failed supervision) had burdened some Member
States’ public finances, which had forced other Member States to come
to the rescue (also through the ESM). This questioned the justification for
national supervision, and once national supervision was removed, bank
resolution needed to follow. However, this quick and top-down driven
approach ignored the multitude of practical and detailed problems that
could also have broader legitimacy and accountability implications.

9.2 The Banking Union: Concept and Legal Basis

The banking union is an EU concept that appeared initially as an
umbrella for many banking-related reform proposals.14 Formally, it

12
Ibid., 4–7.
13
The topic of individual country default in the EMU context is discussed in Tuori and
Tuori (2014), The Eurozone Crisis.
14
Parallels could be drawn with the formation of the US Federal Reserve System in
1913 and with the fundamental reforms caused by the Great Depression.

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 220 9 th e banking union

was introduced in a Commission communication A Roadmap towards a

Banking Union (2012).15 This was followed by the aforementioned report
by four presidents that proposed institutional and regulatory changes in
three areas: the single rulebook, the single supervisory mechanism and the
single resolution mechanism. Deposit insurance was moved to the single
rulebook due to lack of political consensus for a uniform euro area
deposit insurance.16
The single rulebook contained the main regulations for financial insti-
tutions in the EU. The rules covered capital requirements for banks,
protection for depositors, and prevention and management of bank
failures, and they implemented new global standards on bank capital.17
The deposit insurance system was harmonised to increase the level of
protection, but it still relied on national deposit guarantee schemes.18
The single rulebook also envisaged a change in the bank resolution
system, including a euro area resolution mechanism.19
The Single Supervisory Mechanism (the SSM) was a euro area construction
with the ECB at the centre.20 From November 2014 onwards, the ECB has
directly supervised some 120 of the largest banking groups after they
passed its comprehensive assessment.21 National supervisors cover the
remaining banks, classified as less significant institutions, following the

15
European Commission (2012), ‘A Roadmap towards a Banking Union’.
16
Draghi (2014), ‘Recovery and Reform in the Euro Area’.
17
The Basel III agreement by the G20 in November 2010. www.bis.org/bcbs/basel3.htm.
18
Directive 2014/49/EU of the European Parliament and of the Council of 16 April 2014 on
deposit guarantee schemes. OJ L 173, 12.6.2014, pp. 149–178.
19
The national resolution funds are based on contributions by banks. The target level of
funds is to be reached by the end of 2024. Directive 2014/59/EU of the European
Parliament and of the Council of 15 May 2014 establishing a framework for the recovery
and resolution of credit institutions and investment firms and amending Council
Directive 82/891/EEC, and Directives 2001/24/EC, 2002/47/EC, 2004/25/EC, 2005/56/EC,
2007/36/EC, 2011/35/EU, 2012/30/EU and 2013/36/EU, and Regulations (EU) No 1093/2010
and (EU) No 648/2012, of the European Parliament and of the Council. OJ L 173,
12.6.2014, pp. 190–348. And also, Regulation (EU) No 806/2014 of the European
Parliament and of the Council of 15 July 2014 establishing uniform rules and a uniform
procedure for the resolution of credit institutions and certain investment firms in the
framework of a Single Resolution Mechanism and a Single Resolution Fund and
amending Regulation (EU) No 1093/2010. OJ L 225, 30.7.2014, pp. 1–90.
20
Non-euro EU countries can join the SSM, and even have to if they want to join the euro
area, as with Bulgaria and Croatia.
21
130 banks were tested and a capital shortfall of only 25 billion euros was detected that
had to be covered by banks in a maximum period of nine months before they could be
supervised by the ECB. www.bankingsupervision.europa.eu/banking/comprehensive/
html/index.en.html#Bank_by_bank.

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 9.2 concept and legal basis 221

ECB guidelines. The ECB can take any bank under its direct supervision.
The main supervisory tasks of the ECB are supervisory reviews, on-site
inspections, granting and withdrawing banking licences, ensuring com-
pliance with prudential rules and setting higher capital requirements
based on financial risks.22 The early hesitation concerning the central-
isation of the banking supervision task was resolved by the CJEU in
Landeskreditbank Baden-Württemberg case which confirmed that the ECB
has an exclusive supervisory task.23
The third element of the banking union was the Single Resolution
Mechanism (SRM) for banks covered by the SSM.24 Accordingly, a reso-
lution process is initiated if the ECB notifies a potential bank failure. The
SRM resolves banks through the Single Resolution Board (SRB) and the
Single Resolution Fund (SRF).25 The target level for the SRF is a minimum
1 per cent of the covered deposit in the euro area. The SRB is an inde-
pendent EU agency financed by banks. It has wide discretion in conduct-
ing bank resolutions to find approaches that minimise costs for
taxpayers and for the economy. It decides on relevant resolution tools,
including the use of SRF financing. National resolution authorities assist
the SRB and implement decisions using national laws, but the SRB can
override national authorities and give direct orders to banks. However,
SRF funds are likely to cover a small part of the financing needs and the
rest is covered by the ESM.
For the ECB, the SSM responsibility was a major change. It was turned
into the ultimate banking supervisor in the euro area that directly
supervises more than 80 per cent of euro area banking assets and directs
national supervisors concerning smaller banks. Within the Eurosystem
and non-central bank supervisors, the supervision function is organised

22
Listed Article 4 Council Regulation (EU) No 1024/2013 of 15 October 2013 conferring
specific tasks on the ECB concerning policies relating to the prudential supervision of
credit institutions. OJ L 287, 29.10.2013, pp. 63–89.
23
(CJEU) of 8 May 2019 (C-450/17 P Landeskreditbank Baden-Württemberg v European Central
Bank).
24
Directive 2014/59/EU.
25
The SRB became operational in January 2015 established by Regulation (EU) No 806/2014
of the European Parliament and of the Council of 15 July 2014, establishing uniform
rules and a uniform procedure for the resolution of credit institutions and certain
investment firms in the framework of a Single Resolution Mechanism and a Single
Resolution Fund and amending Regulation (EU) No 1093/2010. OJ L 225, 30.7.2014,
pp. 1–90.

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 222 9 th e banking union

by an ECB regulation.26 The tasks were conferred on the ECB, not on the
broader ESCB or the Eurosystem.27 The SSM imposed major changes to
the ECB’s organisation. The original monetary policy and payments
system tasks are very different from banking supervision, in substance
and from an organisational perspective. Furthermore, the conduct of
supervision has to be separated from monetary policy tasks, not least
to mitigate the inherent conflicts of interest between the two areas.
Supervision is a totally new function within the ECB, organised in four
new departments.28 Decision-making on banking supervision is separ-
ated from monetary policy by assigning it to a Supervisory Board that is
the practical decision-making body for supervisory issues supported by a
new Secretariat that drafts its supervisory decisions.29 The Board has an
unusual composition:30 a Chair, a Vice Chair, four members nominated
by the ECB, and one member from each participating country (heads of
local supervision). The Chair and Vice Chair are appointed by the ECOFIN
Council.31 The Chair is an independent figure, while the Vice Chair is a
member of the ECB Executive Board. The four ECB representatives are
not involved in monetary policy tasks.
The Supervisory Board is not mentioned in the Treaties and therefore
has no formal position or decision-making powers. The Governing
Council is the formal decision-making body on all issues of the ECB
and the Eurosystem. The regulation bypassed this by making the
Supervisory Board a preparatory body for decisions that are formally

26
Regulation (EU) No 468/2014 of the ECB of 16 April 2014 establishing the framework for
cooperation within the Single Supervisory Mechanism between the ECB and national
competent authorities and with national designated authorities (SSM Framework
Regulation) (ECB/2014/17). OJ L 141, 14.5.2014, pp. 1–50. The broader legal and
regulatory framework for the SSM includes many regulations, rules, interinstitutional
and other agreements, memoranda of understanding, guidelines and decisions at
various levels. See also the updated list of legal acts related to the General framework of
the SSM in www.bankingsupervision.europa.eu/legalframework/ecblegal/framework/
html/index.en.html.
27
Council Regulation (EU) No 1024/2013 on the basis of 127(6) TFEU.
28
Two departments focus on the day-to-day supervision of the largest banks, one conducts
the oversight of national supervisions of smaller and less significant banks and one
tackles horizontal themes ranging from authorisation to new supervisory policies.
29
Regulation (EU) No 468/2014. Fromage (2022), ‘Assessing and (re-)situating today’s ECB in
the EU’s institutional landscape’.
30
The main tasks, structure and nomination procedures in Article 26 of Council
Regulation (EU) No 1024/2013.
31
On a proposal by the ECB approved by the European Parliament. In this regard, the
procedure differs from the one in place for the ECB President in whose framework the
European Parliament is only consulted, but has no binding powers.

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 9.2 concept and legal basis 223

adopted by the Governing Council through a peculiar procedure.

A decision is presumed adopted unless the Governing Council reacts to
it.32 If the Governing Council does not agree, an internal body called the
Mediation Panel33 gives a no-binding opinion on the rejected draft
decision.34
The independence of the supervisory function gained some attention.
It was claimed that effective supervision required independence from
political influences and from banks. This is facilitated by a non-
renewable five-year term of the Chair of the Supervisory Board as well
as some guarantees for institutional, personal and financial independ-
ence.35 Another discussion related to independence of supervision from
monetary policy decision-making, although justifications were not par-
ticularly convincing,36 as the ECB Governing Council also became the
ultimate decision-maker in the field of supervision.37
The concerns about national sovereignty, which had excluded ECB
banking supervision in the Maastricht Treaty, resurfaced to raise con-
cerns as to democratic legitimacy and accountability of the new ECB
banking supervision. The existing ECB accountability mechanisms were
designed for common monetary policy, and cannot properly include
supervision. This led to experimental arrangements to ensure that a
‘shift of supervisory powers from the Member State to the Union level
should be balanced by appropriate transparency and accountability
requirements’.38 The ECB as a supervisor was required to increase its
accountability towards both the European Parliament and national
parliaments. The procedure at the European Parliament broadly follows
the model of monetary policy. The ECB submits an annual report on

32
Further complications would arise if the SSM included non-euro countries. See Article 26
(8) and also Article 7(7 and 8) of the Council Regulation (EU) No 1024/2013.
33
‘The setting up of the panel, and in particular its composition, should ensure that it
resolves differences of views in a balanced way, in the interest of the Union as a whole.’
Article 25(5) and Recital 73 of the Council Regulation (EU) No 1024/2013.
34
Article 10 Regulation (EU) No 673/2014 of the ECB of 2 June 2014 concerning the
establishment of a Mediation Panel and its Rules of Procedure (ECB/2014/26). OJ L 179,
19.6.2014, pp. 72–76.
35
Recitals 70, 75–77 and Article 19 of the Council Regulation (EU) No 1024/2013. See Zilioli
(2016), ‘The Independence of the European Central Bank and Its Banking
Supervisory Competences’.
36
Article 25(4) Council Regulation (EU) No 1024/2013: ‘[t]he ECB shall ensure that the
operation of the Governing Council is completely differentiated as regards monetary and
supervisory functions. Such differentiation shall include strictly separated meetings and
agendas.’
37
Goldmann, (2018), ‘United in Diversity?’ 38
Council Regulation (EU) No 1024/2013.

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 224 9 th e banking union

execution of supervisory tasks. The Chair of the Supervisory Board

participates in public hearings on request by the Parliament’s commit-
tee. In addition, the ECB provides the committee with a ‘comprehensive
and meaningful record of the proceedings of the Supervisory Board that
enables an understanding of the discussions, including an annotated list
of decisions.’39 The same reports are forwarded to national parliaments,
which can address questions to the ECB and even invite a representative
of the Supervisory Board to participate in discussions.40
Responsibility for prudential supervision was conferred on the ECB
through an EU Regulation. The lengthy preamble lists reasons for
assigning euro area prudential supervision to the ECB, although the
reasons for euro area and EU level supervision are confused.41 The
regulation did not provide any reasoning for considering Article 127(6)
applicable for conferring full supervisory tasks on the ECB apart from
hinting at problems in the Commission proposal to amend Article 127(6)
TFEU.42 The reference to Article 127(6) TFEU as the legal basis for the
SSM continues in other legal acts. A simple explanation is that Article
127(6) was perceived as an ‘EMU’ legal basis that was the most appropri-
ate regardless of its applicability problems.43 The option of using the
internal market legal basis, namely Article 114 TFEU, was never officially
considered for the SSM.

9.3 The Arguments for a Euro Area Banking Union

The need for a complete overhaul of the existing banking supervision
and financial stability framework stemmed from the perceived failure of
national responsibility. Bank problems had euro area-wide macroeco-
nomic consequences that, it was argued, needed to be addressed in the
euro area for four reasons. First, reforms of the EU (and global)

39
Interinstitutional Agreement between the European Parliament and the ECB on the
practical modalities of the exercise of democratic accountability and oversight over the
exercise of the tasks conferred on the ECB within the framework of the Single
Supervisory Mechanism (2013/694/EU). OJ L 320, 30.11.2013, pp. 1–6.
40
With regard to the supervision of credit institutions in the Member State jointly with a
national supervisor. Article 21 and Recitals 55 and 56 of the Council Regulation (EU) No
1024/201. See on the varying relationship between the EP and the ECB in the areas of
banking supervision and monetary policy in Fromage and Ibrido (2018), ‘The
Banking Dialogue’.
41
Council Regulation (EU) No 1024/2013.
42
Recital 85 of the Council Regulation (EU) No 1024/2013.
43
Interinstitutional Agreement 2013/694/EU.

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 9.3 the arguments for a euro area banking union 225

regulatory frameworks had not been sufficient to address threats

to financial stability in the euro area. Second, euro area cross-border
spill-overs of banking problems had become more likely due to common
monetary policy and financial integration. Third, the link between
sovereign debt and banking problems had become a stability concern
for the whole euro area. Fourth, fragmentation of the EU banking
markets undermined the single market for financial services as well
as common monetary policy.44 These stated rationales deserve to be
analysed in order to understand the economic rationale for ECB
banking supervision.
The first argument – namely, that the reforms at the G-20 and Basle
Committee, national and also at the EU level were insufficient – is
difficult to assess. The G-20 and the Basle Committee reforms were
extensive, but only gradually becoming effective. Most causes for the
financial crisis were global, as most systemically important institutions
and markets functioned globally. Arguably, reforms that incurred costs
for banks could even become counter-productive if imposed only unilat-
erally. This of itself underlines the need for a global framework regard-
less of the supervisory locus within the EU.
The second argument – namely, that common monetary policy had
made economic and financial cross-border spill-overs more important
than within the whole EU – cannot be verified statistically. Economic
integration in the euro area is not significantly deeper than in the EU.
Integration of financial liabilities in the euro area was deeper but in a
peculiar and even undesirable way. External creditors held assets mostly
in Germany and France, while investors in Germany and France accumu-
lated higher-yielding assets in the peripheral euro area countries. Two
regulatory incentives were blamed for this pattern: all euro area govern-
ment bonds had a zero regulatory risk-weight and all euro area govern-
ment bonds had the best collateral status in the ECB operational
framework.45
The link between sovereign debt and banking problems – the vicious
circle – is an important topic. If a country’s creditworthiness becomes
questioned by financial markets, this often causes difficulties for its
banks, particularly if they have large government bond holdings.

44
European Commission (2012), ‘A Roadmap towards a Banking Union’.
45
ECB press release (3 May 2010), ‘ECB Announces Change in Eligibility of Debt
Instruments Issued or Guaranteed by the Greek Government’, www.ecb.europa.eu/press/
pr/date/2010/html/pr100503.en.html.

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 226 9 th e banking union

And the other way around, if banks face serious difficulties, this can
question the sustainability of their home country. Examples of the first
pattern are Greece (Cyprus) and even Italy. The latter pattern took place
in Ireland and Spain, where healthy government finances were ruined by
banking rescues.46 How EMU sovereign debt problems turned into
banking problems could have demanded deeper understanding.47
Banks in developed countries normally hold a small share of their assets
in government bonds. In 2008, they represented less than 3 per cent of
bank assets in Spain and less than 5 per cent in Italy. The government
bonds of troubled countries were mainly held by other investors among
which French and German banks stood out. No vicious circle should have
resulted even if the values were written down promptly and correctly,48
as some bank recapitalisations would not have questioned French and
German public finances.
During the sovereign debt crisis, banks in the troubled countries
increased their government bond holdings, which was fuelled by excep-
tional ECB LTRO funding,49 particularly in late 2011 and early 2012.
Roughly half of this one trillion euros was used to buy government bonds
and only slightly more than 13 per cent went to real economy lending.50
In Cyprus, the destabilising blow for the financial sector came from
Greek debt restructuring in 2012, when conscious risk-taking turned
sour. An IMF study has concluded that banks increase government bond
holdings during crises as they are lured by higher yields. This can reduce
other bank lending and even be detrimental for the real economy.51
The fragmentation of the EU banking markets was another argument
for banking union that undermined the single market for financial
services and hampered the effective transmission of monetary policy.
The ECB has published an annual report on financial integration since

46
Fitzgerald (2014), ‘Ireland’s Recovery from Crisis’ and Norris and Byrne (2015), ‘Asset
Price Keynesianism’.
47
Gennaioli et al. (2014), ‘Banks, Government Bonds, and Default: What Do the Data Say?’.
48
In EU, the writing down of bond values was slow and resulted in increased uncertainty
related to expectations of further substantial losses. For example, by the end of 2009, the
Commission report estimated a need for write-downs of between 500 and 800 billion
euros. See European Commission Directorate-General for Economic and Financial Affairs
(2009), Economic Crisis in Europe: Causes, Consequences and Responses, 10. An IMF Report
estimated an even larger figure for unrealised losses. See International Monetary Fund
(2009), Global Financial Stability Report.
49
Gennaioli et al. (2014), ‘Banks, Government Bonds, and Default: What Do the Data Say?’.
50
Whittall and Gore (2014), ‘Eurozone Banks’ Sovereign Exposure Hits New High.’
51
Gennaioli et al. (2014), ‘Banks, Government Bonds, and Default: What Do the Data Say?’.

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 9.3 the arguments for a euro area banking union 227

2005. The 2012 report pointed to a deterioration in financial integration

both in the euro area and in the EU. Geographical origin had become an
important risk pricing factor, which was also reflected in credit default
swaps across economic sectors and countries. In addition, cross-border
unsecured transactions declined.52 The report also saw excessive vari-
ation and even overestimations of sovereign credit risks. This evidence of
fragmentation could be further assessed, as cross-country and cross-
sector variation commonly decreases in upturns and increases in eco-
nomic and financial downturns.53 Euro area economic differences
between countries were large and could explain divergent financial
conditions. However, it could be recalled that in the preceding economic
upturn, the limited euro area ‘fragmentation’ in risk pricing was also
considered a market failure.
Fragmentation and transmission of monetary policy is a more complex
issue. It was an argument for the selective bond purchase programmes,54
as bank lending rates were claimed to be based on domestic government
bonds. Basically, if bond rates differ across the euro area, the monetary
policy stance varies between countries. This argumentation is not with-
out caveats, as was discussed in Chapter 7. Many issues affect monetary
policy transmission and an equal and uniform pass-through of monetary
policy impulses across regions of monetary union is not possible.
Moreover, the key elements of monetary policy transmission are
debated, for example, the importance of the so-called bank lending
channel that focuses on the factors of bank loan supply for the transmis-
sion of monetary policy.55
In summary, the economic case for a euro area rather than an EU-
based banking union remains inconclusive. Nevertheless, it was a key
reason for assigning banking supervision to the ECB instead of to a
specific EU institution. The main concern was that bank problems in
individual Member States had broader macroeconomic consequences

52
ECB Annual Report, ‘Financial Integration in Europe’ (April 2014), 29–30, www.ecb
.europa.eu/pub/pdf/other/financialintegrationineurope201404en.pdf.
53
It could be explained by joint reduction in risk premia particularly during longer
upswings that become partly unravelled when risk consciousness raises its head.
54
See Decision of the ECB of 14 May 2010 establishing a securities markets programme
(ECB/2010/5), www.ecb.europa.eu/ecb/legal/pdf/en_dec_2010_5__f_sign.pdf?
d69f741524fa86e19f437bc9177292d3.
55
On the more sceptical side, Angeloni et al. (eds.) (2003), ‘Monetary Policy Transmission in
the Euro Area’ and Ashcraft (2006), ‘New Evidence on the Lending Channel’. Some
studies during the crisis have been more positive, such as Gambacorta and Marques-
Ibanez (2011), ‘The Bank Lending Channel: Lessons from the Crisis’.

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 228 9 th e banking union

and even hampered the stability of the euro area as a whole. Economic
arguments had some validity, but it was less clear how euro area banking
union would be effective in repairing the problems. The most apparent
link between macroeconomic crisis management and fundamentally
microeconomic financial market regulation was the ESM, as it was
decided that the ESM could be used to recapitalise banks only after the
single supervisory mechanism was put in place.56 This actually was a key
reason to elevate banking supervision to the euro area level. At the same
time, and following that decision also bank resolutions and recapitalisa-
tions became partly a euro area responsibility.

9.4 Economic Arguments for and against Combining

Monetary Policy and Banking Supervision
The economic and institutional reasons to elevate banking supervision to
the euro area level did not dictate whether this euro area (or EU) function
should be assigned to the ECB or to a specialist organisation. Indeed, the
question whether central banks should also supervise banks has been
discussed for decades, and both systems have continued to exist.57 No
definitive conclusion has emerged and the arguments have largely
remained the same.
The discussion is complicated by the unsettled nature of financial
supervision. Broadly four types of functions have been included in finan-
cial supervision. First, traditional banking supervision, labelled micro-
prudential supervision, focuses on individual banks and other financial
institutions, ensuring their solvency by means of risk reporting, on-site
inspections, and checking for sufficient capital buffers and risk manage-
ment practices. Second, investor protection is often assigned to financial
supervisors to control that the issuance of financial products incorpor-
ates the needs of investors and the market place. Third, macro-prudential
supervision became fashionable some two decades ago, when the relation-
ship between major banking disturbances and adverse macroeconomic
developments became better understood. It aims to recognise potential
sources of systemic risk and to reduce them by influencing market

56
See, for example, European Commission Press Release (12 September 2012),
‘Commission Proposes New ECB Powers for Banking Supervision as Part of a Banking
Union’, http://europa.eu/rapid/press-release_IP-12-953_en.htm?locale=en.
57
The former President Bernanke promoted the Fed’s participation in supervision.
Bernanke (2010), ‘The Federal Reserve’s Role in Bank Supervision’.

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 9.4 economics of central bank banking supervision 229

infrastructures and even by imposing higher capital requirements in

cyclical upturns. Fourth, customer protection issues have become part of
financial supervision in many countries.58 Furthermore, all the above
functions can be relevant not only for banks and markets but also for
insurance companies, securities firms and pension funds. Central bank
financial supervision commonly covers only supervision of banks59 from
both micro- and macro-prudential perspectives, but less often investor
and particularly consumer protection perspectives. In contrast, countries
with specialised supervisors more often have integrated supervisory
functions that cover most financial institutions.60
The bank resolution model can also affect the central banks’ role in
supervision. Traditional banking systems could be described as clubs
with many informal and tradition-based rules, where the central bank
functioned as primus inter pares. Problems were handled within the club,
and the central bank used its monetary, supervisory and other coercive
powers to enforce resolutions.61 The scope of the club model has
declined since the 1980s, as structural changes in the form of inter-
national competition, financial deregulation and also technological
development made informal arrangements difficult to maintain. The
transparent and inclusive ECB monetary policy framework exemplified
this evolution, where central banks’ traditional means of ‘soft coercion’
became less effective. Consequently, bank rescues became more formal,
transparent, and also increasingly funded by taxpayers.62 This in turn
resulted in legitimate requests for more democratic guidance.63
Turning to arguments promoting a combined monetary policy and
banking supervision functions at the central bank, these can be found
both on the monetary policy and banking supervision sides. The conduct
of monetary policy can benefit from supervision mostly by gaining

58
Ibid., 3.
59
Juncker, Tusk, Dijsselbloem, Draghi, and Schulz (2015), Completing Europe’s Economic and
Monetary Union (also known as ‘The Five Presidents’ Report’) and A Blueprint for a Deep and
Genuine EMU (2012).
60
Masciandaro (2004), ‘Unification in Financial Sector Supervision: The Trade-off between
Central Bank and Single Authority’.
61
Goodhart and Schoenmaker (1995), ‘Should the Functions of Monetary Policy and
Banking Supervision Be Separated?’, 542.
62
Ibid., 554.
63
The most studied model has been the US Federal Deposit Insurance Corporation (FDIC)
that becomes active when an insured depository institution is likely to fail and takes
necessary measures to resolve it. www.fdic.gov/bank/historical/reshandbook/ch2procs
.pdf.

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 230 9 th e banking union

additional information and expertise. Through supervision, central

banks have access to timely information on banks’ balance sheets and
risks that can help the conduct of monetary policy. For example, assess-
ment of the monetary policy stance can be enhanced by information on
the pass-through of monetary policy impulses through banks.
Furthermore, the risks of operational frameworks can be better con-
trolled for with supervisory information.64 However, there is even sur-
prisingly limited evidence that central banks with supervisory functions
have been more successful in liquidity management or in their conduct
of monetary policy. The two central banks often presented as models for
other central banks, the Bundesbank and the Swiss National Bank, did
not have supervision.65 Previously, even the ECB saw limited benefits
arising from the supervisory function for the conduct of monetary
policy.66
Most recently, crisis management became pivotal for monetary policy
as well. In crisis, the information advantage stemming from supervisory
functions could be useful. For efficient emergency liquidity assistance,
supervisory information can help to distinguish between a solvent but
illiquid bank deserving funding and an insolvent institution that should
be recapitalised or resolved.67 The Fed insisted that ‘having the legal
authority to directly obtain information – through on-site examinations
or otherwise – can prove critical to understanding and responding
quickly to a financial crisis’.68
The benefits of combining functions also run from monetary policy to
banking supervision. Again, the most frequently mentioned argument is
information synergy. Central banks gain information on money and
financial market developments from their daily conduct of monetary
policy. Also, liquidity operations can make banks more cooperative in
other ways as well.69 This could facilitate reducing systemic risks, which
is linked to macro-prudential supervision focused on aggregate financial

64
The Board of Governors of the Federal Reserve System (2010), ‘The Public Policy Case for
a Role for the Federal Reserve in Bank Supervision and Regulation’, 6.
65
Swiss Federal Banking Commission (2008), ‘Annual Report – Key Themes’, 12.
66
ECB (2001), ‘The Role of Central Banks in Prudential Supervision’, 4, www.ecb.europa.eu/
pub/pdf/other/prudentialsupcbrole_en.pdf.
67
Ibid., 4, www.ecb.europa.eu/pub/pdf/other/prudentialsupcbrole_en.pdf.
68
The Board of Governors of the Federal Reserve System (2010), ‘The Public Policy Case for
a Role for the Federal Reserve in Bank Supervision and Regulation’, 6–8 and Coy (2008),
‘Volcker Shuns the Blame Game’.
69
ECB (2001), ‘The Role of Central Banks in Prudential Supervision’, 4, www.ecb.europa.eu/
pub/pdf/other/prudentialsupcbrole_en.pdf.

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 9.4 economics of central bank banking supervision 231

stability and on the link between macroeconomy and financial systems.

It has been argued that a central bank supervisor is more likely than
independent supervisor to focus on macro-prudential issues and sys-
temic considerations,70 although this has hardly prevented systemic
risks from occurring. For example, central bank supervisors were not
better able to detect systemic risks on the way to financial crisis.
A new argument is that central bank independence in the conduct of
monetary policy can also be extended to facilitate supervision. The ECB
put it: ‘[i]ndependence of supervisory authority from political interfer-
ence is important for effective supervision’.71 The connection between
banks and political parties can be a problem that calls for institutional
guarantees against undue political influence, although the theoretical
case for an independent monetary policy does not cover financial super-
vision. The independence of central banks is an exception to normal
procedures in public administration that has its rationale in the time-
inconsistency problem of monetary policy. Financial supervision natur-
ally benefits from practical independence like any other expert organisa-
tions, but the case for constitutional independence is a different issue.
The arguments against prudential supervision in central banks have
centred on a few themes: conflict of objectives, reputational risk, risks
for financial stability, reduction in transparency and accountability and
legitimacy problems. The most fundamental problem is the conflict of
objectives in supervision and monetary policy. The independent central
banking model aimed at a clear and controllable mandate and objectives.
The (social) cost involved in achieving price stability was reduced by
giving the central bank the sole objective of price stability. If this object-
ive was complicated or compromised by supervisory objectives, it could
be detrimental for monetary policy and price stability. For example, if
the central bank was worried about bank profitability due to supervisory
concerns, it might refrain from a needed monetary tightening. The
temptation to solve supervisory problems or to hide failures could
become irresistible.
However, the conflict between price stability and financial stability is
not likely to occur often, as supervisory worries arise mostly in down-
turns, when inflation declines and reductions in policy rates can be
justified on price stability grounds alone. In the euro area, differences
in financial structures complicate the picture. Bank profitability reacts

70 71
Ibid., 4–5. Ibid., 5.

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 232 9 th e banking union

differently to short-term interest rates across countries, because banks’

balance sheets and income structures vary across the euro area.72 In
countries where deposit rates are insensitive to short-term interest rates
and deposits are a major funding source, higher interest rates increase
bank profits. In other Member States, bank interest income and profits
react negatively to higher short-term rates. Hence, although lower
policy interest rates stimulate the economy, there can be substantial
short-term variation in bank profits between countries. Hence, the
conflict of objectives could even be a divisive feature across the euro area.
Reputational risk refers to the idea that financial supervision is
prone to recognisable failures. If the central bank needs to explain
supervisory failures, this could compromise its credibility in monetary
policy. The credibility of low-inflation monetary policy takes time to
build and involves social costs. Hence, central banks are particularly
wary of any unnecessary risks to their reputation.73 It could be subopti-
mal to put that reputation at risk by involving supervision in the same
organisation unless there are considerable balancing benefits.
Finally, financial stability problems can stem from the market percep-
tion that central banks will come to the rescue in adverse market condi-
tions. The term Greenspan put describes how the Fed, under the
chairmanship of Alan Greenspan, was perceived as reacting to financial
instability with monetary policy tools.74 This support to – or even rescu-
ing of – markets was claimed to have contributed to ensuing reckless
market behaviour and subsequent boom and bust cycles. However, this
moral hazard problem stems from the central bank reaction to financial
instability, not from its supervisory responsibilities as such.

9.5 Constitutional Remarks on ECB Supervisory Powers

and the Euro Area Banking Union
Constitutional assessment of the ECB’s banking supervision differs from
previous assessments of the ECB’s monetary policy measures. It consists

72
Goodhart and Schoenmaker (1995), ‘Should the Functions of Monetary Policy and
Banking Supervision Be Separated?’
73
See, for example, BIS Central Bank Governance Group (2009), Issues in the Governance of
Central Banks, 151.
74
The term ‘Greenspan put’ was initially financial market jargon, but has been picked up
by academia as well. It was coined in 1998 after the Fed cut interest rates following the
failure of Long-Term Capital Management, a large hedge fund with the largest banks as
main creditors. See, for example, Stiglitz (2010), Freefall, 135; also see www.investopedia
.com/terms/g/greenspanput.asp.

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 9.5 constitutional remarks on supervisory powers 233

of two main topics: Article 127(6) as the legal basis for assigning banking
supervision to the ECB and a broader constitutional assessment of the
banking union from the perspective of the European Macroeconomic
Constitution.
Article 127(6) is not an obvious legal basis for the assignment of
extensive supervisory powers to the ECB through a Council regulation.75
The drafting of the Maastricht Treaty explicitly rejected assigning super-
visory powers ‘as necessary’ and opted for ‘special tasks’. References to
supervision and financial stability were removed from the ECB’s basic
tasks, and the resulting Article 127(5) TFEU merely gave the ESCB an
assignment to ‘contribute to the smooth conduct of policies pursued by
the competent authorities relating to the prudential supervision of credit
institutions and the stability of the financial system’. In this context, the
specific tasks in Article 127(6) TFEU should be seen both by reference to
the basic tasks of the ECB and also to the competent authorities. Clearly,
it was not intended to overrule either Article 127(2) or 127(5) TFEU, even
partially.76 A possibility to transfer prudential supervision from national
level to the ECB would have been formulated differently.
The content of ‘special tasks’ was ignored in the preparatory work for
the Council regulation.77 A textual interpretation would suggest that a
special task would be something that is limited by content or by time.78
The interpretation that the ‘special tasks’ in Article 127(6) should be read
narrowly is strengthened by the fact that the special tasks were ‘concern-
ing policies relating to the prudential supervision’, which again refers to
national policies (in the plural). This is different from ultimate responsi-
bility over prudential supervision granted by the Council regulation. In
addition, the explicit exclusion of insurance undertakings is informative.
Financial conglomeration, already an issue at the time, requires that
various forms of supervision work closely together to avoid gaps and
sub-optimal supervision. It is difficult to draw a distinction between
banking products, insurance products and other types of financial ser-
vices. If the Treaty had envisaged a possibility to transfer full banking
supervision to the ECB, it would have been counterintuitive to build
constitutional hindrances for effective financial supervision.

75
Council Regulation (EU) No 1024/2013.
76
Article 127(2) TFEU on the basic tasks and Article 127(5) TFEU task of contributing to the
policies of competent authorities.
77
Council Regulation (EU) No 1024/2013.
78
The history of central banking has seen a large variety of specific roles for the central
banks acting as agents for the government.

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 234 9 th e banking union

A further issue concerning Article 127(6) TFEU is the ECB as the

addressee of the ‘special task’ ‒ not the ESCB or the Eurosystem. The
regulation that assigned full supervisory responsibility to the ECB –
Article 127(6) – thus imposed a division between the euro area and
non-euro area banks, and even within the Eurosystem.
The justification for using Article 127(6) TFEU as the legal basis for a
Council regulation was addressed by the FCC, which concluded that the
SSM Regulation did not ‘manifestly exceed the authorisation under
Article 127(6) TFEU, given that it does not fully confer on the ECB the
supervision of all credit institutions in the euro area’. The FCC stressed
the remaining national competences and that the ECB is competent only
for supervising significant credit institutions. Such a view on the
remaining national competences was regularly expressed during the
initial years of the SSM, but the CJEU’s Landeskreditbank Baden-
Württemberg case clearly stated that SSM Regulation conferred the
banking supervision competence on the ECB.79 Perhaps surprisingly,
the FCC found more problems with the SRB and SRM Regulations with
regard to the principle of conferral, and it urged that the SRB should act
strictly within the limits of the tasks and powers assigned to it.80
A broader constitutional assessment of the banking union and ECB
banking supervision can be conducted by using the European
Macroeconomic Constitution as a yardstick. From this perspective, cen-
tral bank independence raises concerns with regard to ECB banking
supervision and financial stability objectives. Extensive independence
rested on the idea of a single, clear and controllable price stability
objective. That was also the basis for the ECB’s accountability and even
its democratic legitimacy. In a narrow central banking model the pri-
mary objective and the means for achieving it can be defined and con-
trolled for with some precision, which is lost with a balancing of
objectives. In a banking union, the problem of the ECB’s dual objectives
was alleviated by assigning supervisory objectives to the Supervisory
Board. Unfortunately, this is of limited comfort, as the ECB is responsible
for monetary policy and banking supervision, and internal divisions of
responsibility do not make any substantial difference.
Central bank independence and accountability are also linked to
transparency and democratic legitimacy. The model of an independent

79
(CJEU) of 8 May 2019 (C-450/17 P Landeskreditbank Baden-Württemberg v European Central
Bank).
80
2 BverfGE 1685/14, 2 BverfGE 2631/14.

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 9.5 constitutional remarks on supervisory powers 235

central bank requires transparency. In contemporary monetary theory,

transparency even facilitates the successful conduct of monetary policy,
as its efficiency is enhanced if the general public understands why and
how the central bank functions.81 Nearly all issues in monetary policy
can be published, immediately or after a short period of time. As a
consequence, central bank independence, accountability, transparency
and the effectiveness of monetary policy form a natural combination,
which helps to overcome the limitation that Article 15(3) TFEU makes an
exception on the ECB regarding the right of access to documents.
Banking supervision is different by nature. The supervisor, which acts
as an agent for the public, has access to private information on banks
and their clients that could not be provided to the public. This allows
only limited transparency.
The democratic legitimacy of the ECB is based on a model in which the
institutional set-up and the objective of monetary policy were decided
democratically in the Maastricht Treaty. Monetary policy decision-
making was not assumed to contain the balancing of different values.
Whether this was ever a reality with monetary policy is one question,
but this model became even more complicated with banking supervi-
sion. Supervisory function involves risks to taxpayers, and thus exclud-
ing democratic inputs altogether is problematic. The ECB’s exceptional
independence from democratic decision-making was defended by eco-
nomic considerations supporting independence in the conduct of monet-
ary policy, which was also noted by the FCC in its Maastricht decision:
‘[t]his modification of the principle of democracy . . . is justifiable,
because it takes account of the special factor, established in the
German system and also scientifically proven, that an independent cen-
tral bank is more likely to protect monetary value . . . while maintaining
economic liberty than are sovereign governmental institutions.’82 This
exception to the principle of democracy does not extend to
banking supervision.
Similar concerns are voiced in a report requested by the European
Parliament.83 The report questions the establishment of the SSM on the
basis of Article 127(6) TFEU: ‘this provision only means the conferral of
“specific tasks”; it covers neither a conferral of the entire supervision nor

81
Some central banks operated mainly through communication with limited actual
financial transactions or administrative measures.
82
FCC BVerfGE 89, 155.
83
Repasi (2012), ‘Limits and Opportunities for the ECB in the Multi-tier Governance’.

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 236 9 th e banking union

of a set of specific tasks that de facto corresponds to an entire supervi-

sion’. The report emphasises that the general rule of entrusting EU
institutions with tasks by secondary law does not extend to the ECB, as
it is ‘protected by the independence clause in Article 130 TFEU from any
political influence on their work. Therefore, the EU legislator cannot
entrust it with other tasks than those foreseen by the Treaties and the
Statute.’84 The FCC pointed to ‘the diminished level of democratic legit-
imation that results from the independence of supervisory and reso-
lution authorities’ that it deemed to require both limits and
justification. It also found that the diminished level of legitimation was
a cause for concern also ‘because it is additional to the monetary policy
mandate of the ECB, which in itself is far-reaching and difficult to
contain’. However, the FCC saw it as acceptable ‘because it is compen-
sated by specific safeguards serving democratic accountability’, which
presumably refers to the procedures at the EP and also national
parliaments.85
The above constitutional assessment relating to the combination of
independence, accountability, transparency and ultimately democratic
legitimacy suggests that extending the monetary policy set-up to
banking supervision contains constitutional problems. This could even
be made worse by the conflict of interest between monetary policy and
banking supervision. In the Maastricht Treaty, the conflict was solved by
assigning to the ECB Governing Council an overriding responsibility for
monetary policy aiming at price stability, while it only contributed to
national policies in the supervisory field. Banking supervision and finan-
cial stability were subordinated to monetary policy objectives and tasks.
This model was fundamentally changed when the ECB was assigned
responsibility also for banking supervision in the euro area.
The conflict of objectives between monetary policy and supervision
could become the most fundamental problem with the ECB’s banking
supervision. Paradoxically, separating monetary policy and supervision
can even help to avoid moral hazard and contribute to the maintenance
of financial stability, although during the crisis, quicker monetary policy
reactions to financial instabilities could facilitate speedier recovery. The
EMU has made the situation more complex, and the perceived conflict of
interest can cross national boundaries in problematic ways for the
sustainability of the EMU. The boundaries between the costs and benefits

84 85
Ibid. 2 BverfGE 1685/14, 2 BverfGE 2631/14.

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 9.5 constitutional remarks on supervisory powers 237

of achieving the respective objectives are likely to be drawn unevenly

between countries, which might put the ECB in the middle of national
rivalries. If the ECB, for example, is perceived to risk price stability in
order to save some banks, the damage to its credibility could be difficult
to repair.
The accountability and even democratic legitimacy of the ECB as the
guardian of the common currency rests on its ability to convince people
that it acts at a high professional and ethical level in the best interests of
the whole euro area. Transparency and even the effectiveness of
common monetary policy demand that the actions of the ECB can be
fully and thoroughly explained. There is no ultimate democratic back-
stop such as the parliament that can resolve the conflict of interest for
the benefit of the whole area. This alarmed many euro area central
bankers, most vocally Bundesbank President Weidmann, who insisted
on a Treaty change. Alternatively, a new institution could take responsi-
bility for the SSM.86
Finally, the previous financial regulation rested on a combined EU and
national approach that emphasised mainly microeconomic aims of effi-
ciency and integration in addition to financial stability. These other aims
were side-tracked when the broader euro area macroeconomic and
stability-based model took over that focused on the short-term problems
stemming from the crises.87 Should this modus operandi be maintained
in the medium-term, euro area banking supervision could even increase
financial sector fragmentation. Costs and other administrative burdens
have increased substantially with limited differentiation according to
the size of the bank,88 which has increased economies of scale and
pressures for concentration in the banking sector. Public sector involve-
ment in the financial sector through regulation and supervision is
always a balancing act between stability, efficiency and innovation. The
macroeconomic and stability-oriented approach inherent in ECB super-
vision might be excessively focused on stability considerations and disre-
gard efficiency and innovation. Furthermore, integration is an important
EU objective. Separation between euro area banking union and the EU
internal market for financial services can have harmful effects for the

86
www.centralbanking.com/central-banking/news/2309366/weidmann-says-ecb-
governing-council-must-give-up-ssm-oversight.
87
Generals prepare to fight the last war and the economic measures to combat crisis carry
the seeds of the next crisis.
88
Some small bank managers claim that it is like a small diesel generator and a nuclear
plant having the same safety requirements.

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 238 9 th e banking union

internal market. Peaceful coexistence rather than rivalry between two or

more areas of financial services is naturally possible, but, for example,
the case between the ECB and the UK concerning the clearing of secur-
ities was alarming.89 Protectionist measures on the grounds of financial
stability can become worse if the SSM leads to competitive disadvantages
for euro area banks. A natural way to resolve the problem would be
to establish EU-wide banking supervision either under the aegis of the
ECB or as a separate institution.

89
On the basis of its oversight task, the ECB demanded that euro-denominated securities
are settled in the euro area, not in London. The British Treasury sued the ECB on the
basis that the policy was discriminatory and hampering the single market. The EU
General Court judged against the ECB, and forced it to annul its policy based on lacking
competence. Case T-496/11 United Kingdom v European Central Bank. ECLI:EU:T:2015:133.

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 10 ECB Measures during the
Covid-19 Pandemic

In early 2020, the global economy faced a new obstacle in the shape of
the spread of the Covid-19 virus, which the WHO classified as a pan-
demic in January 2020.1 The virus was first identified in China in
December 2019, and it was also the first country to start large-scale
containment measures to reduce the transmission of the disease, but
with massive negative economic consequences. The virus and also
recourse to containment measures spread quickly across the world, with
Italy and some other European countries at the forefront. The pandemic
put countries and policy-makers in front of new policy questions, as
most tested policy measures were unlikely to reach the core of the
problems. When most economic difficulties resulted directly from con-
tainment measures, traditional demand or even supply measures were
inefficient. The chosen policy approach was to find ways to help the
economy (and society) through the crisis with as limited sustained losses
of output as possible so that the recovery would be as strong as the
decline. The enormous increase in unemployment and in public deficits
as well as decline in overall well-being was deemed unavoidable.
Provision of liquidity, bridge financing and many forms of direct finan-
cial support were implemented to help households and companies to
survive the containment period without losing their productive capacity.
The relatively low mortality in the working age population was a rare
positive feature of Covid-19 that made it less destructive for longer-term
output than some earlier pandemics.2

1
www.who.int/news-room/detail/30-01-2020-statement-on-the-second-meeting-of-the-
international-health-regulations-(2005)-emergency-committee-regarding-the-outbreak-of-
novel-coronavirus-(2019-ncov).
2
IMF (2020), World Economic Outlook: The Great Lockdown.

239

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 240 10 ecb measures during the covid -19 pand emic

In the euro area, the ECB took a central role in fighting the economic
consequences of the pandemic. The ECB’s response was mostly a com-
bination of earlier measures that were either re-activated or expanded.
However, the peculiar nature of the crisis also called for more targeted
measures. The ECB’s measures were part of a broader set of measures at
the national and EU level, including proposals by the Commission.3 The
unity and ability of the EU to be a centrifugal force was undermined by
distinctively national early responses to the pandemic. From the consti-
tutional perspective, the pandemic raised new types of questions. While
the EU leaders convened and made statements, the national perspective
was overwhelming and mainly guided by the WHO as the relevant expert
organisation. This was reflected in the economic sphere and the func-
tioning of both layers of the European economic constitution. The micro-
economic side was affected at its core, when (economic) freedoms and
the internal market had to stand back in the face of health concerns. In
particular, free movement of labour and services faced a re-emergence of
national borders, and even temporary borders within the Member States
themselves. However, in this chapter the focus is on the ECB and the
European Macroeconomic Constitution. The chapter starts by describing
the measures adopted by the ECB, followed by an economic analysis of
the measures that provides the basis for their constitutional assessment.

10.1 ECB Pandemic Measures

The ECB gave its first statement concerning the pandemic in early March
2020, and the first ECB monetary policy measures that were motivated
by the pandemic started in the same month.4 The measures had multiple
and overlapping aims. The main aim was to create monetary and finan-
cial conditions that would facilitate restoration of economic activity,
particularly by preserving the flow of credit to households and firms
and ensuring the transmission of monetary policy to bank lending rates
to households and firms in all sectors and countries. A related aim was to
ensure favourable financing conditions for the Member States that were
at the forefront of fighting the pandemic.

3
The most fundamental proposals by the Commission were, however, more controversial
and took time to be agreed upon, which in turn places more emphasis on the ECB.
4
The ECB Press Release (2 March) ‘Statement by the President of the ECB’ www.ecb.europa
.eu/press/pr/date/2020/html/ecb.pr200302~f2f6113f52.en.html.

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 10.1 ecb pandemic measures 241

The initial measures targeted the financing conditions of companies

and households. The first step was to continue and re-shape earlier
monetary policy measures to ensure that banks had sufficient funding.
The next scheduled TLTRO III in June was a key tool and its conditions
were further relaxed. Banks were also offered additional immediate
longer-term refinancing up to that point with full allotment and at
(negative) interest rates of the deposit facility.5 The operations gave
incentives to banks to maintain their lending levels through a reward
negative interest rate on funding. A further €120 billion private sector
assets were purchased accompanied with a statement that the ECB
would continue net asset purchases until it started raising policy rates.6
Liquidity measures were added with new pandemic emergency longer-
term refinancing operations (PELTROs)7 that aimed at helping money
markets during the pandemic. The PELTROs effectively provided money
markets with a backstop through a preannounced auction calendar until
December 2020 that extended outstanding funding to various dates in
the second half of 2021. The fixed-rate and full-allotment PELTROs had a
very low interest rate of –0.25 per cent. Thus, any euro area bank with
some collateral would get liquidity up to the amount of collateral they
had available and until the latter half of 2021. This effectively set an
upper bound to the interbank rates at –0.25 per cent.
Liquidity support was added with an emergency collateral package.
First, the ECB allowed a wider use of credit claims as collateral to
increase bank funding against loans to corporates and households. In
practice, the NCBs were allowed to accept loans with lower credit quality
and to debtors that were not accepted in the ECB framework. These also
included government and public sector guaranteed loans to corporates,
SMEs and self-employed individuals and households, as specific guaran-
tee schemes had been common measures by the Member States to fight
the pandemic. The ECB also suspended the minimum size threshold for
domestic credit claims. A general increase in the risks of the ECB credit

5
Decision of the ECB of 22 July 2019 on a third series of targeted longer-term refinancing
operations (ECB/2019/21), and its amendments.
6
ECB Press Releases (12 March), ‘Monetary Policy Decisions’, ‘ECB Announces Easing of
Conditions for Targeted Longer-Term Refinancing Operations (TLTRO III)’, and ‘ECB
Announces Measures to Support Bank Liquidity Conditions and Money Market Activity’,
www.ecb.europa.eu/press/pr/date/2020/html/ecb.mp200312~8d3aec3ff2.en.html.
7
The ECB Press Release (30 April 2020), ‘ECB Announces New Pandemic Emergency Longer-
Term Refinancing Operations’, www.ecb.europa.eu/press/pr/date/2020/html/ecb
.pr200430_1~477f400e39.en.html.

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 242 10 ecb measures during the covid -19 pand emic

operations was achieved by reducing collateral valuation haircuts by

20 percentage points.8 A further step with collateral requirements
related to the risk that some investment grade assets were downgraded
below minimum credit quality requirements. The idea was that if a
downgrade happened due to the pandemic, the assets maintained their
eligibility as long as they had certain credit quality (often at or above
credit quality step 5 or a rating of BB). Even future issuances by the same
issuer were eligible provided they fulfil all other collateral eligibility
criteria. These included eligible covered bond programmes and ABSs
but not non-marketable assets.9
On top of the liquidity measures that worked through the banking
sector, and as a sign of the rapidly deteriorating situation, the ECB
announced the Pandemic Emergency Purchase Programme (PEPP) on
18 March 2020. This was a temporary asset purchase programme of
private and public sector securities. The purchases had an envisaged
amount of €750 billion until the end of 2020. The PSPP was a continu-
ation of the previous asset purchase programmes including the PSPP.10
In principle, it followed the ECB capital key benchmark allocation for the
purchases of public sector bonds, but the programme stressed flexible
implementation. Greek government bonds were also accepted, even
though they did not meet the eligibility criteria. At the same time, the
corporate sector purchase programme (CSPP) was expanded to non-
financial commercial paper. The purchases started immediately and
were to continue until the end of the year or longer if the pandemic
phase was not over. Already in early June, the ECB decided to expand the
PEPP with another 600 billion euros and a further 500 billion euros were
added in December. The total of 1,850 billion euros were to be bought
until March 2022 or until the ECB ‘judges that the coronavirus crisis
phase is over’.11

8
The ECB Press Release (7 April 202), ‘ECB Announces Package of Temporary Collateral
Easing Measures’, www.ecb.europa.eu/press/pr/date/2020/html/ecb.pr200407~2472a8ccda
.en.html
9
ECB Press Release (22 April 2020), ‘ECB Takes Steps to Mitigate Impact of Possible Rating
Downgrades on Collateral Availability’, www.ecb.europa.eu/press/pr/date/2020/html/ecb
.pr200422_1~95e0f62a2b.en.html.
10
ECB Press Release (18 March), ‘ECB Announces €750 Billion Pandemic Emergency
Purchase Programme (PEPP)’
11
ECB Press Releases (4 June), ‘Monetary Policy Decisions’ and ECB Press Releases (10
December), ‘Monetary Policy Decisions’.

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 10.2 the economic aims of the covid-19 measures 243

Apart from monetary policy-related measures, the ECB’s Single

Supervisory Mechanism (SSM) announced temporary reliefs on capital
and operational requirements. This allowed banks under the ECB’s direct
supervision to operate temporarily below a specified minimum level of
capital in addition to relaxation of the countercyclical capital buffers by
the national macroprudential authorities. The ECB also volunteered to
discuss individual measures with banks, such as rescheduling on-site
inspections, extending deadlines, and even considering action on non-
performing loans.12

10.2 The Economic Aims and Content of the

Covid-19 Measures
The measures to address the pandemic crisis reflected the unclear and
barely quantifiable problems caused by the pandemic. The bulk of the
measures to counter health risks and the broader economic and social
difficulties caused by the pandemic were taken at national and even local
levels to ensure sufficient flexibility and reactiveness. Also, the pandemic
economic policy responses needed to reflect the unique nature of the
economic problems, many of which stemmed from the containment
measures. Most clearly, measures to support aggregate demand would
have failed to reach the most affected sectors of the economy. Therefore,
the economic policy responses mainly aimed at minimising longer-term
losses of output and welfare.
However, similarities with the financial crisis and the sovereign debt
crisis were clear in many areas of financial markets, which also alerted
central banks not to allow negative spirals to gain speed. For example,
equity prices and many risks in the bond markets demonstrated uniform
patterns of global increase in the pricing of risks. This analysis starts by
assessing the economic reasoning of the ECB. This is then compared to
measures by the Fed and BoE, which provides the basis for some conclu-
sions concerning the measures and their aims.

10.2.1 The Reasoning of the ECB

The ECB measures were announced through many statements and deci-
sions. However, they should be seen as an overall response to the

12
ECB Press Release (12 March 2020), ‘ECB Banking Supervision Provides Temporary
Capital and Operational Relief in Reaction to Coronavirus’, www.ecb.europa.eu/press/pr/
date/2020/html/ecb.pr200312~45417d8643.en.html.

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 244 10 ecb measures during the covid -19 pand emic

pandemic crisis. The measures had some common elements that were
elaborated in press releases as well as in other communications by the
ECB. The features could be discussed under headings of a temporary
nature, monetary transmission, liquidity provision and the broader eco-
nomic outlook. As such, price stability considerations played a limited
direct role.
The main motivation for all ECB measures was to fight the overall
economic devastation caused by measures to contain the pandemic. The
actual routes through which this affected the economies and societies in
the euro area were so manifold and interlinked that sketching a full
picture of the economic effects or even to address them using only
monetary policy language would have been superfluous. Similarly, the
rapid pace of new measures and adjustments indicated the reactive
operating mode of the ECB. As new needs and risks arose, the ECB aimed
to react sooner rather than too late. The overall response was to fight the
historic decline in economic output caused by the pandemic, and more
specific details reflected information, even if very limited, on the risks to
the sustainability of the economy, both at aggregate euro area level and
also in specific areas and countries within the euro area.13
The temporary nature of the measures underlined their rationale as
uncertain pandemic responses. At the time, it was impossible to know
with any certainty how long the pandemic or the related economic
shutdown would last. The ECB measures depended on the uncertain
nature of the disease and the need to continue to impose containment
measures, which were all beyond the expertise of the ECB. The main
initial check-point was set at the end of 2020, although some funding
was due to last beyond that point. Against this background, all the
measures were temporary, and some even stressed the temporary and
exceptional nature of the pandemic, including the temporary ‘turning a
blind eye’ to the rating downgrades resulting from the pandemic.
A key stated aim was to counter the serious risks to monetary policy
transmission mechanism and the outlook for the euro area. Concerning
the transmission of its monetary policy, the ECB insisted on mitigating
any risks ‘in all jurisdictions of the euro area’. Monetary transmission
was seemingly closely related to the aim of supporting ‘all citizens of the
euro area through this extremely challenging time’ by ensuring that
households, companies and governments benefit from ‘supportive

13
ECB Press Conference (22 April 2020) and, for example, Lane (2020), ‘The Pandemic and
ECB Monetary Policy’.

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 10.2 the economic aims of the covid-19 measures 245

financing conditions’. The ECB also stressed its readiness to increase the
size of its asset purchase programmes and to adjust their composition,
by as much as necessary and for as long as needed.
The specific central bank area responsibility is the interbank market.
The ECB measures were to ensure that banks had sufficient collateral for
the ECB liquidity operations and that banks could continue providing
funding to the euro area economy. As discussed earlier, the role of the
ECB in the interbank markets had already exceeded the limits of trad-
itional central banking. In many ways, the ECB operational framework
had replaced the interbank markets, and this did not change with the
pandemic. One symptom of this replacement was the TARGET2 balances
that reached new heights with surplus countries exceeding 1,500 billion
euros, which resulted from both ECB funding measures and its asset
purchases.14

10.2.2 Central Bank Responses Elsewhere

Central banks worldwide were involved in responses to the economic
fallout of the pandemic. The fundamental substance of their reactions
was similar, but the actual programmes varied considerably. As the
reach of the public sector and particularly social security systems differ
across countries, also the need for discretionary programmes was
similarly different.
The US response relied on a large scale of measures that were initiated
and agreed upon by the United States Congress, the Ministry of Finance
and the Fed. The main response was the CARES Act that provided the
framework for the lending measures of the Treasury and the Fed. The
Fed based its response on a mandate to promote maximum employment
and stable prices, but also stability of the financial system. Apart from
the strictly monetary policy measure of lowering rates to zero, the Fed
utilised measures in four areas. First, open market operations to restore
market functioning started in March 2020 with large-scale purchases of
government bonds and agency MBSs to ensure that their market and the
transmission of monetary policy functioned. The purchases provided a
quick reaction to stress signals and could be slowed down quickly.
Second, specific measures ensured short-term funding for banks. Third,
longer-term credit to households, companies and state and local govern-
ments was ensured through a number of joint programmes with the

14
ECB Economic Bulletin 2/2016, ‘TARGET Balances and the Asset Purchase Programme’.

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 246 10 ecb measures during the covid -19 pand emic

Treasury. These included purchasing corporate bonds and even direct

lending to companies. The emergency lending programmes relied on the
CARES Act, through which Congress granted taxpayer’s money to the
Fed’s lending programmes. As a supervisory authority, the Fed also
relaxed the capital requirements for banks to support their lending.15
Similarly, the BoE’s monetary policy aimed ‘at supporting businesses
and households through the crisis, and limiting any lasting damage to
the economy’ while still achieving its statutory objectives of price stabil-
ity. It supported the economic policy of the British government, and
acknowledged that monetary policy cannot prevent losses of revenue
and income for companies and households. However, monetary policy
can counter the tightening in financial conditions by supporting cash
flows and the flow of credit, and even asset prices, which supports the
recovery once the containment measures are eased. Specific monetary
policy measures included cutting the Bank Rate to 0.1 per cent, introdu-
cing a funding scheme with additional incentives for SMEs, and £200
billion additional bond purchases of the government and non-financial
investment-grade corporate bonds. Furthermore, the BoE, in a non-
monetary policy capacity, reduced countercyclical capital buffers to zero
among other supervisory actions.
These two examples show that central bank responses were quite
similar. The public sector response to the pandemic contained a few
elements. First, the main responsibility of the response relied on the
governments that were supported by other public and private actors
including the central banks, as was deemed necessary. Both state and
local levels took on very large burdens. In countries where the overall
automatic involvement of the public sector in economic life was more
limited, many discretionary measures were initiated to support the
economy and society. In other countries, the existing social security
network became extensively utilised. Second, the burden on public
finances was very large, as taxpayer’s money was utilised to cover for
massive social security spending, health expenditure, and many forms of
guarantees and support. Both discretionary measures and the so-called
automatic stabilisers resulted in major deteriorations in public finances.
Public deficit to GDP ratios climbed to double digit figures and public
debt increased rapidly. Third, the emergency operating mode was often
accompanied by some emergency powers, which allowed for much

15
Powell (2020), ‘Coronavirus and CARES Act’.

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 10.2 the economic aims of the covid-19 measures 247

deeper inroads into the lives of individuals. Fourth, central banks

supported the broader functioning of the financial system. In particular,
they targeted the flow of credit to households and companies as well
as the broader liquidity of the financial markets. Strict borderlines
between various functions and objectives were not followed in practice,
and the link to the inflation target played less of a role. Fifth and finally,
all the measures were conducted under exceptional levels of
uncertainty, which made the responses reactive and sometimes tailored
to specific problems.

10.2.3 Economic Assessment

The economic impact of the pandemic was perceived to be devastating
but also different from any economic shock. As the economic slowdown
was caused by the containment measures, any support for the overall
demand was deemed to fail. At the same time, vast numbers of house-
holds and companies were deprived of their normal sources of income,
which contained the risk of making the effects of the pandemic more
devastating and also more permanent. Apart from households and com-
panies, the public sector was also heavily burdened. As fiscal deficits
were increasing more or less everywhere, the early fear was that govern-
ments’ funding costs would start to increase. However, apart from a
small spike in yields in March 2020, the bond yields of the major
countries declined since the outbreak of the pandemic. Riskier bonds,
either government or company, did see major increases in yields, as
would be expected in an environment of heightened risk and increased
demand for funding.
The impact on inflation was complicated. An initial decline in inflation
was caused by a decline in energy prices, but the impact of the pandemic
on inflation dynamics was unclear. The prices of goods and services most
hit by the containment measures were expected to react only moderately
as any lowering of prices was unlikely to affect demand. In the areas
where the pandemic caused increased demand, even clear price increases
were to be expected. However, with a longer perspective, increased
unemployment and lower capacity utilisation were expected to keep
inflation pressures under control.
In this context, the ECB measures could be seen in economic terms as
very similar to other central banks. The main target was overall liquidity
and availability of credit for the economy to avoid longer-term damage.
The less clearly announced aim – particularly of the ECB – was to
maintain cheap funding for the Member States, which were facing

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 248 10 ecb measures during the covid -19 pand emic

rapidly increasing expenditure and declining revenues. The ECB wanted

to avoid a situation in which market pressures on some Member States
would lead to higher bond yields at a time of substantial debt issuance.
In the euro area context, this was achieved mainly through the PEPP,
which was even characterised as a backstop.16 PEPP purchases of €1,850
billion were larger in relative terms than, for example, in the UK or the
USA. The PEPP amounted to 19 per cent of euro area GDP (even before
calculating normal PSPP), while the UK’s 250 billion pounds-worth of
purchases amounted to 12 per cent of GDP and the US purchases of
roughly 2000 billion US dollars by the end of 2021 were some 10 per
cent of GDP. However, both the BoE and the Fed, unlike the ECB, could
also lower their policy rates.
The economic substance of the flexibility of the PEPP requires some
further analysis, because its explicit backstop function made it similar to
the OMT in some regards. The PEPP was also used to ensure that finan-
cial markets continued to provide funding. Arguably, as was the case
with the OMT in 2012, the key concern related to the Italian government
bond markets. Again, the risk was that government bond yields would
edge higher and eventually reach a level where debt servicing costs
would make the debt burden unbearable. The economic devastation
caused by the pandemic was expected to cause a massive widening in
the Italian public deficit and to increase Italian debt from 135 per cent of
GDP to 155 per cent by the end of 2020. At the same time, the gross
financing needs of the Italian government stood at around 28 per cent of
GDP in 2020, as budget deficits added to the busy maturing schedule of
outstanding debt.17 In this situation, a prolonged period of high real
interest rates on government bonds could have led to a self-fulfilling
spiral towards a debt default. The ECB seemingly aimed to assure the
markets that Member States would not be forced to finance themselves
at unsustainable interest rates.
Turning to the economic effects of the ECB measures, the results are
very tentative. The clearest impact was visible in capital markets, where
an initial market panic in March 2020 was followed by a broad-based
recovery or even a boom in most asset classes. This was not a specifically
euro area phenomenon, as US equities recovered to their all-time high

16
Lagarde (4 June 2020), ‘Introductory Statement’ www.ecb.europa.eu/press/pressconf/
2020/html/ecb.is200604~b479b8cfff.en.html.
17
www.europarl.europa.eu/RegData/etudes/BRIE/2018/624406/IPOL_BRI(2018)624406_EN
.pdf.

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 10.3 assessment of covid-19 measures 249

levels by July 2020, when US government bond yields also reached their
lows. The ECB provided some early estimates of the effects of the PEPP,
which suggested that it helped to bring down euro area government
bond yields by some 20 basis points and eased pressures towards euro
area fragmentation. However, early indicators of the economic effects
of the pandemic did not show any meaningful differentiation between
the euro area countries, as they mainly reflected the starting point of
each country, not their dynamics during and after the pandemic.
A special new feature was central bank activity as bank supervisors on
the basis of the needs of the macroeconomic situation. The ECB, the Fed
and the BoE were relaxing supervisory criteria in order to help banks.
These relaxations were hardly controversial as they mainly implemented
counter-cyclical capital buffers and eased the workload during a very
difficult period. However, more far-reaching relaxations in supervisory
criteria could also raise some concerns. If supervisors react to heightened
risks by reducing capital requirements and imposing less stringent
monitoring, this could become counterproductive for the functioning
of the banking sector. Supervisors should act as agents for other banks
and the general public, whose task is to monitor and ensure the safety
and soundness of banks. Supervisory information perhaps also facili-
tated ‘understanding and responding quickly to a financial crisis’.18 In
the response to the pandemic, it was not emergency liquidity assistance
in a traditional, individual bank sense, but a similar reaction at the
whole banking sector level. The overall macroeconomic and broader
societal considerations overshadowed the traditional prudential
supervision perspectives.

10.3 Constitutional Assessment of ECB Responses to

the Pandemic
The pandemic was a new and unforeseen event for the ECB and for the
European Macroeconomic Constitution. However, constitutions should
be able to handle exceptional times as well as normal times. The
responses to the pandemic raised similar constitutional questions as
before: were the responses part of the ECB task to conduct monetary
policy? Could they be based on other tasks? Did they respect the fiscal

18
The Board of Governors of the Federal Reserve System (2010), ‘The Public Policy Case for
a Role for the Federal Reserve in Bank Supervision and Regulation’, 8.

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 250 10 ecb measures during the covid -19 pand emic

responsibility of the Member States and the prohibition of central bank

financing? What was the impact on the ECB’s independence? And were
other elements of the European Macroeconomic Constitution affected?

10.3.1 Responses to the Pandemic as Monetary Policy

The global pandemic was a completely new challenge to policy-makers,
which complicated the allocation of tasks between various policy areas.
Each policy actor contributed by means available and as deemed useful.
The bulk of the ECB measures were described as monetary policy,
although they were designed and decided upon under highly unusual
circumstances where strict monetary policy considerations needed to be
balanced with urgent needs arising from Member States. This was not
easy to synchronise with the CJEU’s earlier legal practice, which
stressed objectives as a means of classifying measures belonging to
the monetary policy or economic policy domain. Indeed, the first pan-
demic measures hardly had any meaningful reference to the objective
of price stability, as the outlook for prices was very uncertain. Rather,
they were reactions to rapidly evolving economic and – particularly –
financial market distress.
The main constitutional concerns with regard to the monetary policy
nature of the measures relate to the enormous asset purchases under the
PEPP. In the ECB communication, the PEPP was said to have two monet-
ary policy aims: operationalising monetary policy stance and ensuring
the functioning of monetary policy transmission across asset classes and
particularly jurisdictions. For the monetary stance part, the constitu-
tional questions are basically the same as with the PSPP discussed earlier.
The monetary transmission question is more complicated, as the
PEPP clearly aimed at pushing down the interest rates on government
bonds, amidst increased pressures on the public finances of most euro
area Member States. Whether this was motivated by monetary policy
transmission reasons or Member State financing reasons cannot be veri-
fied. The ECB had already earlier tied the two issues together in its
argumentation concerning the role of bond markets in monetary
policy transmission.
Comparisons to the US and the UK measures revealed that the PEPP
was larger than the pandemic purchase programmes of other central
banks, which could relate to the additional aims of the programme.
However, the ECB could not lower its main policy rate, as was the case
with the BoE and the Fed, which could have put more bias on the ECB
asset purchases.

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 10.3 assessment of covid-19 measures 251

However, the assessment of the PSPP applies only partly to the PEPP.
The more flexible features of the programme that addressed monetary
transmission issues, make it, by design, more selective than the PSPP.
Formally, the PEPP is only ‘guided, on a stock basis, by the respective
NCBs’ subscription to the ECB capital’,19 while the PSPP decision stated
that ‘the distribution of purchases across jurisdictions shall be
according to the key for subscription of the ECB’s capital’.20 This ter-
minological difference was made explicit also in ECB communication
that stressed the flexibility of purchases allowing for fluctuations in the
distribution of purchases over time, across asset classes and among
jurisdictions. The early indications of actual PEPP allocations pointed
to relatively large Italian and Spanish as well as commercial paper
allocations.21
Moreover, the ECB made the backstop function of the PEPP clear in its
communication, stating that it will ‘raise the share of purchases above
the capital key in countries facing severe risks of fragmentation.’22 This
was similar to the selective bond purchases of the SMP and the OMT, and
thus raises similar constitutional concerns particularly if the selective
purchases turn out to become more than temporary reactions to unfore-
seen market panics, indicated by sustained deviations from the capital
key. However, and given the overall amount of the PEPP, even purchases
following the capital key can have a sustained impact on the funding
conditions of individual Member States. Here, the rationality of the
monetary policy transmission argument is relevant. The special circum-
stances of the pandemic could allow a more favourable reading of
the monetary transmission argument than was the case with selective
bond purchases earlier. Both the required monetary impulses were
presumably different from the time of the selective bond purchase
programmes, but also the shock was more clearly an external one.
From the same monetary policy perspective, the inclusion of non-
investment grade Greek government bonds could be considered
somewhat problematic, but nevertheless understandable. In contrast,

19
Article 5.1 of the Decision (EU) 2020/440 of the ECB of 24 March 2020 on a temporary
pandemic emergency purchase programme (ECB/2020/17).
20
Article 6.2 of the Decision (EU) 2015/774 of the ECB of 4 March 2015 on a secondary
markets public sector asset purchase programme (ECB/2015/10).
21
www.ecb.europa.eu/mopo/implement/pepp/html/index.en.html for the end-May
2020 allocations.
22
Isabel Schnabel (10 June 2020), Remarks at an online seminar hosted by the Florence
School of Banking & Finance.

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 252 10 ecb measures during the covid -19 pand emic

the expansion of the CSPP to non-financial commercial paper can quite

easily be deemed compatible from the monetary policy transmission and
liquidity creation perspectives.
Other monetary policy measures were also quite exceptional. The
provision of very large amounts of funding to banks at negative interest
rates, even at –1 per cent, aimed at providing both extreme incentives for
banks to continue lending. At the same time, it could also be classified as
capital support for banks.
The overall relaxation of collateral requirements could be assessed
similarly. The ECB, alongside other major central banks, knowingly
increased the level of risk in its operations. This is more problematic
for the ECB, because its mandate requires adequate collateral and it
cannot ask for taxpayer back-up. The ECB was thus pushing its boundar-
ies with regard to monetary policy. However, given the exceptional – and
assumed temporary – circumstances, it could be assessed as feasible to
the extent that it did not contain even indirect capital support for failing
banks or corporations. However, the use of exceptional circumstances as
a justification places a major responsibility on the ECB to use this
additional discretion with utmost care and to avoid any permanent
damage to its constitutional position.

10.3.2 The Fiscal Responsibility of the Member States and the

Prohibition on Central Bank Financing
Of the pandemic responses, again the PEPP raised most concerns with
regard to the Member States’ fiscal responsibility principle and the
related prohibition on central bank financing of governments of Article
123 TFEU. For the most part, the constitutional assessment is the same as
with the PSPP. Purchases of government bonds could work against the
Member States’ responsibility to ensure sound public finances, and
they also can overstep to the area of economic policy, following the
argumentation of the FCC in the Weiss case. As the PEPP was less strictly
tied to the capital key of the ECB and had more flexibility than the PSPP,
it was even more questionable from this perspective. Furthermore, the
PEPP also had similarities with the OMT concerning the fiscal
responsibility principle.
The PEPP follows 20 per cent risk-sharing for government bonds, i.e.
its PSPP part, and full risk-sharing for other bonds. As with the PSPP, the
20 per cent is defined in terms of purchases by the ECB and of the bonds
of European institutions. However, with the amounts purchased in a
relatively short time, the full risk-sharing part including corporate bonds

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 10.3 assessment of covid-19 measures 253

can be very large. In addition, the limited risk-sharing part is somewhat

complicated as well, as the bonds are purchased by issuing central bank
money, which is a euro area liability. If a Member State defaulted, this
liability would probably need to be addressed with some creative
accounting, as the NCB, which holds defaulted government bonds, is
also part of the defaulting central government. Thus, the specific cir-
cumstances of the PEPP can make it even more problematic for the fiscal
responsibility of the Member States, should the economic hardships
caused by the pandemic become fundamentally destabilising for some
Member States. Hence, the use of PEPP as a means of fiscal transfers is
hardly an uncomplicated solution regardless of what is considered neces-
sary or even inevitable.
The similarities between the PEPP and the OMT stem from their back-
up function, but differences are also relevant. The PEPP allows purchases
of basically all types and maturities of bonds, while the OMT could only
purchase government bonds of up to three years maturity. This makes
the PEPP, if only a temporary programme, still a major source of longer-
term funding for Member States. The risk-sharing feature is slightly
more complicated. The OMT had full risk-sharing between the
Eurosystem central banks, but the PEPP only partial. However, for a
constitutional assessment also in light of the Gauweiler case, a key differ-
ence is that the OMT stressed the conditionality involved. A Member
State whose bonds the ECB would have purchased with the OMT needed
to be subject to an adjustment programme under the EFSF/ESM set-up.
This introduced the conditionality of the financial assistance pro-
grammes also to the OMT. This also replaced market discipline in main-
taining the fiscal soundness of the Member States. Conditionality was
not present in the PEPP, and the ECB even waived the eligibility require-
ments for Greek government debt.
In summary, through the PEPP, the ECB arguably became the lender of
last resort to the Member States and even to some corporations facing
credit downgrades due to the pandemic. This position is highly problem-
atic from the perspective of the Member States’ fiscal responsibility in
the EMU. The PEPP also lacked some of the mitigating factors with
regard to the prohibition on central bank financing of government that
were present with the PSPP and the OMT. On the other side, the general
and even global need for excessive public expenditure and related issu-
ance of new government debt resulted in an overall increase in demand
for debt financing that was expected to lead to higher interest rates. In
the euro area context, this could have been destabilising if the interest

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 254 10 ecb measures during the covid -19 pand emic

rates of the already indebted countries, most prominently Italy and

Greece, would have risen substantially. Similar expected increases in
government bond yields also motivated other central banks to restart
their QE programmes. Arguably, due to the fully external nature of the
pandemic, the problem with the borderline between national economic
policy and common monetary policy was not as prominent, and national
fiscal responsibility was perhaps not permanently jeopardised by the
PEPP. A further balancing factor is that the exceptional circumstances
imposed by the pandemic could allow some extra discretion for the
authorities, including the ECB.

10.3.3 Impact on ECB Independence and Other Principles of the

European Macroeconomic Constitution
The pandemic measures maintained the decision-making independence
of the ECB. The measures were decided on the basis of the ECB’s own
assessment, although the link to the price stability objective was, even
understandably, relatively weak. The main risks to the ECB independ-
ence stemmed from the potential outcome of the measures. In this
regard, the problems are similar to those with its QE programme, the
selective bond purchases and even the longer-term LTROs. The involve-
ment of the ECB in the economic fortunes of individual Member States
and even individual banks could burden the ECB’s conduct of monetary
policy from the perspective of the whole euro area and the price stability
objective. In this regard, it is mainly the scale of the pandemic measures
that could put additional pressure on the ECB’s independence. The
holdings of individual Member State bonds have reached levels that are
very large in comparison to the capital of the ECB or even the whole
Eurosystem. When these are added to the ECB’s exposure to the banking
sector that also involves government bonds as collateral, the ECB is even
more profoundly tied to the fiscal success of individual Member States.
The ECB has stressed financial independence as a critical element of its
and the NCBs’ constitutionally protected independence. The consciously
increased level of risks in the Eurosystem balance sheets could be prob-
lematic from this perspective. In addition, a new and undebated issue
with the response to the pandemic is the reduction in the expected
profits of the ECB. The ECB’s monetary income could be expected to
decline even dramatically, if financial market conditions remain as
they were since the outbreak of the pandemic. The liability side of the
ECB balance sheet contains mainly elements that have a zero
interest rate, cash and central bank money, although some deposits have

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 10.3 assessment of covid-19 measures 255

a –0.5 per cent interest rate. The asset side will be dominated by lending
to banks that will mostly be at negative interest rates in the range
of –0.5 and –1 per cent. Of other central banks’ assets, government bond
holdings have on average very low or negative yields to maturity. The
situation is even worse for those NCBs whose government bonds have
clearly negative yields. Thus, the net interest income of the ECB and
most NCBs could be expected to turn negative in the future, which could
be harmful for the ECB’s financial independence. Furthermore, even a
welcomed increase in inflation expectations could lead to substantial
losses from the ECB’s and NCBs’ bond holdings.
The ECB’s responses to the pandemic have also raised additional con-
cerns for the European Macroeconomic Constitution, but most of these
have been covered with the earlier crisis measures. The principle of an
open market economy had been seriously questioned by the earlier
measures and the pandemic responses hardly improved the situation.
The interbank market was, even more than before, replaced by ECB
measures. When the ECB started to provide all the desired liquidity with
negative interest rates, there was no need for a functioning euro area
interbank market. Similarly, the market pricing of government bonds
was explicitly affected by the PEPP.
The role of objectives as a decisive factor in the judicial review of the
ECB’s measures was further complicated by the responses to the pan-
demic. They seemingly combined the price stability and financial
stability objectives with broader economic prosperity and the ability of
societies to maintain health and security. Therefore, the model for the
ECB independence and accountability that rested on a clear and control-
lable price stability objective could not be applied. The responses to the
pandemic required a balancing of objectives and also of the risks
involved. Arguably, during the pandemic response, problems with the
ECB’s independence and accountability were alleviated by the extensive
transparency and visibility of the ECB measures that were fuelled by the
sense of urgency. The maintenance of public health arguably demanded
that all the public officials, including the ECB, also saw their action from
that perspective.

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 Part III
The ECB from a Central Bank of
Stability to a Central Bank of Crisis

This book is about central banking and money, and about countries
agreeing upon a common framework for the economy and economic
policy. The euro was introduced as a further step towards linking the
economic destinies of the EU Member States together with a hope of
bringing economic stability and prosperity to their peoples. To these
ends, the Member States relinquished their national currencies and
surrendered part of their economic policy sovereignty. However, rather
than replacing national democratic economic policies with a supra-
national economic policy, the Member States deemed it possible to agree
on the key parameters of their economic framework, such as stable
prices and sound public finances, and commit to them at the level of
an international treaty, the Maastricht Treaty. The same treaty also
assigned implementation of the common monetary policy to an inde-
pendent expert organisation, the ECB.
Part I of the book searched for the content of this new economic and
institutional framework for macroeconomic management in the EMU.
To that end, it was reconstructed as the European Macroeconomic
Constitution, which complemented the original European economic con-
stitution that relied mainly on the four economic freedoms and the rules
for competition and state aid. The EMU and the European
Macroeconomic Constitution, I argued, had three different foundations.
The philosophical foundation was economic constitutional thinking with its
roots in the German ordoliberal approach to the economy and society at
large. The economic foundation was built on the evolution in central
banking and economics that had culminated in an inflation-targeting
consensus towards the late 1980s. The institutional foundation was an
economic, political and legal development in the EU that placed demands

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 258 part iii a bank of stability to bank of crisis

on macroeconomic integration in the form of a common currency, but

also facilitated it as a further step forward. These three interlinked
foundations happened to share a common ground in the early 1990s
that made the EMU possible. It had not been possible one or two decades
earlier and most likely it would not be possible at present.
The economic-constitutional approach of the book, namely the recon-
struction of the economic constitution, takes place through a search for
coherence and internal logic amongst diverse Treaty provisions and
constitutional principles. Part I of the book derives the key constitutional
principles of the European Macroeconomic Constitution that could be
seen to form a coherent if incomplete whole that was based on its three
foundations. The foundations are both informative about the substance
of the principles and provide justifications for those principles. The
initial test of reality for these principles was the establishment of the
ECB. The constitutional assessment of the ECB, as it was set up and
functioned until 2007, paints a picture of a central banking system that
had a narrow, price-stability oriented mandate. From a strictly legal
perspective, this model is still in force, and arguably also the ECB’s
strategy review of 2021 followed the model.
Part II of the book assessed the many unconventional and contested
decisions and measures by the ECB during the recurring financial, eco-
nomic, sovereign debt and even pandemic crises. Detailed constitutional
assessments conclude each chapter. Here the European Macroeconomic
Constitution provides the necessary yardstick, a normative premise to
understand how the new measures should be seen in the light of the
constitutional architecture of the EMU.
Part III takes a broader perspective. Details are important but they can
also hide the essence of the whole picture and the potential changes that
have happened. That essence could perhaps be revealed by asking some
fundamental questions that do not necessarily follow any exact border-
lines between the scientific disciplines involved. Three fundamental
questions address the constitutional implications of the financial, eco-
nomic, fiscal, pandemic and even institutional crises in the EMU context.
The first fundamental question is an inquiry into what happened to
the key constitutional principles of the European Macroeconomic
Constitution during the crises. Rather than looking at individual meas-
ures, the focus is on the objectives, tasks as well as institutional choices
and safeguards, in particular concerning the ECB as a constitutionally
established and protected independent guardian of the EMU. Does the
ECB still fulfil the preconditions of an independent expert, particularly

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 part iii a bank of stabil ity t o bank of crisis 259

from the perspectives of accountability and democratic legitimacy? And

if these mechanisms are in doubt, what are the implications for the
perception of the EU as a community based on law and for the integra-
tion-through-law approach. A tentative conclusion is that the European
Macroeconomic Constitution as it was reconstructed in Part I can no
longer be found in a coherent form in today’s economic and legal reality
of the EMU.
The second fundamental question addresses the potential change in
the main objectives of the EMU. The Maastricht Treaty made price
stability objective the cornerstone of the European Macroeconomic
Constitution and assigned the main responsibility for it to an independ-
ent central bank. The price stability objective as such seemingly fared
well during the recurring crises. However, over the last decade, the
economic and institutional surroundings of the price stability objective
might have changed fundamentally. Even with regard to inflation, the
main focus has shifted from controlling or maintaining low inflation
into fighting deflationary pressures arising from cyclical and also struc-
tural forces. However even more fundamentally, the ability of the price
stability objective to ensure economic stability and prosperity has come
under a growing cloud of doubt when a series of crises threatened the
euro area.
This has led to the emergence of new practical and also increasingly
formal objectives for the European economic constitution that have
motivated many institutional decisions and measures, and to some
extent also found their way into the legal practice of the CJEU. This
emergence of new objectives could be seen as a process of economic
constitutionalism, when economies and societies more broadly change
and the formal legal framework remains rigid. The objectives I wish to
discuss more thoroughly include financial stability, structural economic
adjustment and most lately environmental sustainability. Of these, the
objective of (financial) stability of the euro area as a whole can be
detected in many measures adopted by the EU and its Member States
during the crises. Moreover, even the ECB’s measures and its deeper
involvement in the economic life could increasingly be argued as being
on the basis of restoring the stability of the euro area. The other new
objectives are also responses to the seeming inability of the European
Macroeconomic Constitution to ensure stability and prosperity is a
sustainable manner.
Against this background, the final discussion of the book relates to the
change in the ECB from a central bank of stability to a central bank of

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 260 part iii a bank of stability to bank of crisis

crisis, which in turn would turn the whole logic of the European
Macroeconomic Constitution on its head. If the economic-constitutional
model makes the euro area prone to face recurring or prolonged crises,
this will make the ECB an economic fire brigade on stand-by until it has
consumed all its means and perhaps also its credibility. Indeed, the
financial stability objective has already engaged the ECB to both cyclical
and also more structural problems. It is foreseeable, that the environ-
mental crisis and economic adjustment problems are further burdening
the European Macroeconomic Constitution and the ECB as its main
expert institution with demands that would well exceed monetary
policy capabilities.
As an Epilogue, the book takes a forward-looking perspective, and asks
whether it is still possible to return to the model of the European
Macroeconomic Constitution with its price stability objective and the
independence of the ECB at its core or, alternatively, is it possible to
reconstruct a new European Macroeconomic Constitution on the basis of
financial stability as its main objective?

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 11 The Fate of the European
Macroeconomic Constitution

11.1 The Principles of the European Macroeconomic

Constitution after Two Decades
Part I of the book reconstructed the new European Macroeconomic
Constitution in the set of constitutional principles that were described
in Chapter 3. Assessment of the ECB, as it was set up and functioned
until the eruption of the financial crisis in 2008, argued that the new EU
central banking system was designed and acted in a way that respected
not only the provisions of the Maastricht Treaty but also the principles of
the European Macroeconomic Constitution (Chapter 4).
Economic reality put the EMU and the constitutional principles to
extreme tests. Unforeseen crises hit developed countries, starting with
a financial crisis in 2008 that turned into an economic crisis and in the
euro area also into a sovereign debt crisis in 2010. The euro area was in
the middle of a slow recovery when the pandemic crisis hit in early 2020.
The ECB has been deeply involved in resolving all these crises with an
increasing set of measures that have pushed the boundaries of the
exclusive EU competence of monetary policy.
Initially, the ECB was not at the forefront of central banks in imple-
menting new measures. In most nation state settings, governments were
leading the overall public sector responses, and other major central
banks acted more as part of the state executive together with their
respective Ministries of Finance. Governments were also involved in
unconventional monetary policy measures if they caused risks to taxpay-
ers or otherwise fell in the grey area between monetary and fiscal policy.
In contrast, the ECB is not a nation state central bank and the EU does
not have a central executive in economic policy that could act as the
ECB’s counterpart, providing it with additional flexibility in exceptional

261

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 262 11 fate of the european mac roeconomic constitution

times through explicit approvals or by knowingly turning a blind eye

until the situation normalises. The EMU institutional framework expli-
citly excluded coordination with the executive in both normal and in
exceptional times.
The constitutional principles of the European Macroeconomic
Constitution functioned as normative premises for constitutional assess-
ment of the ECB measures in Part II. Assessment of the unconventional
measures revealed how constitutional principles were stretched to the
limits and beyond. As we will discuss next, the ECB measures raised even
more serious concerns about their constitutionality in light of the fun-
damental features of EMU constitutional architecture. This regards the
objectives and also institutional choices and safeguards of the European
Macroeconomic Constitution.

11.1.1 Objectives of the European Macroeconomic Constitution

The internal market objective is the main economic objective of the EU
that continued to be underlined in the Maastricht Treaty. The common
currency was to support the completion of the internal market, as indi-
visible monetary policy became an exclusive EU competence. This
included Member States’ obligation to join the EMU.1 Thus the
Maastricht Treaty adhered to the principle of the unity of the EU with
regard to its exclusive monetary policy that complemented and sup-
ported the EU (not only euro area) internal market.
For the euro area, the internal market objective was largely respected
during the crises. The objective indirectly justified some exceptional
measures that were motivated by avoiding the dismantling of the EMU
such as selective bond purchases (Chapter 7), so that the internal market
objective could indirectly have mutated into an implicit euro area stabil-
ity objective. For the EU as a whole, the fate of the internal market
objective was different. Even before the crisis, joining the EMU ceased
to be an obligation for the Member States. During the crisis, the involve-
ment of the ECB and euro area governments in the euro area economy
could have made the demarcation between the EU and the euro area
more profound, negatively affecting the internal market objective for the
whole EU. A clear illustration of interference with the internal market
was the transfer of banking supervision responsibility to the ECB, creat-
ing a borderline within the internal market for financial services leading

1
With the exception of the UK and Denmark. Indruchová, ‘European Union Member States
Outside the Euro Area’.

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 11.1 constitutional principles after two decades 263

to a potential conflict between the internal market and euro area stabil-
ity objectives (Chapter 9). In the pandemic response, the demarcation
found a new form, where the economic policy response took an EU
perspective, while the monetary policy and financing backstop extended
only to the euro area.
The Pandemic response was very different, and it hit the core of the
internal market. The containment measures were affecting particularly
the free movement of people, as workers and service providers. Although
some measures were creating borders also within Member States, the
first stage was characterised by the re-emergence of a strong nation state
operational mode.
The price stability objective was introduced in the Maastricht Treaty as
the main new macroeconomic objective guiding all economic and mon-
etary policy activities in the EU.2 This was given an exceptionally pro-
tected and independent position in the EMU constitutional architecture,3
as the Treaty gave price stability a stand-alone role in facilitating social
stability and progress.4 This constitutional ‘overkill’ perhaps compen-
sated for the lack of social embeddedness of the ECB and its main
objective among policy-makers, social partners and the general public.5
The objective seemingly fared well also during the crises. Inflation
remained below the ECB target, if anything erring on the downside.
Most ECB measures were linked to the price stability objective, some
more credibly than others. However, the further the ECB travelled into
uncharted territory with its measures, the less control it arguably
exerted on longer-term inflation. The initial liquidity-creating measures

2
‘The Union shall . . . work for the sustainable development of Europe based on balanced
economic growth and price stability’ (Art. 3(3) TEU). Article 3a(3) TEU on Principles states
that the economic policy activities of the Member States and the Community shall entail
compliance with the guiding principles of stable prices, sound public finances and
monetary conditions and a sustainable balance of payments.
3
The statutes of the Federal Reserve System in the USA or the Bank of England provide a
less fundamental role for price stability. Perhaps only in Switzerland are some of the key
elements of the monetary policy framework stipulated in the constitution. Article 99 of
the Federal Constitution. www.snb.ch/en/mmr/reference/Bundesverfassung_Art_99/
source/Art_99_Geld_und_Waehrung_en.pdf.
4
The FCC stated: ‘d1) Pursuant to Title VI, chapter 2 of the EC Treaty, the monetary union
is designed as a community based on stability [Stabilitatsgemeinschaft], the primary
objective of which is to maintain price stability.’ It continued: ‘This concept of the
monetary union as a community of stability is the basis and object of the German Act of
Consent.’ BVerfGE 89, 155.
5
Majone (2012), ‘Rethinking European Integration after the Debt Crisis’ and Quaglia
(2007), Central Banking Governance in the European Union.

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 264 11 fate of the european mac roeconomic constitution

with very low interest rates still remained in the sphere of traditional
monetary policy that could be adjusted quickly and independently to
new information on inflation expectations (Chapter 6). However, select-
ive bond purchases (Chapter 7) were already more difficult to justify on
the basis of price stability. Paradoxically, the most problematic for the
price stability objective was the ECB’s quantitative easing programme,
the PSPP (Chapter 8). Monthly purchases of vast amounts of government
bonds were rationalised as a means to fight deflation risks. However, it is
questionable whether the PSPP was the most suitable measure, especially
if the sole aim really was to ensure price stability. The exact route in
terms of how the purchases affect consumer prices remains ambiguous,
particularly in the context of elevated asset prices since 2015. Moreover,
it is unclear how the winding-up of the PSPP would take place if inflation
expectations rose. A reduction in the ECB’s government bond holdings
due to inflation scares could lead to serious instability in the financial
markets and in some euro area economies, making the PSPP a potentially
destabilising measure in the longer-term. The pandemic PEPP adds to the
worries concerning the PSPP with its huge amount and explicit govern-
ment financing backstop function. The total holdings of public debt is
exceeding 4 trillion euros, which makes the ECB a completely dominant
player in the euro area government financing. In its Weiss judgment, the
FCC seemed to share the concerns that the price stability objective has
only a limited role in explaining the ECB’s asset purchases. However, this
might also indicate a fundamental change in the role of the price stabil-
ity objective as we will discuss later in Chapter 12.
The principle of an open market economy and free competition supports
the internal market objective. Initially, the Treaty of Rome stated that
competition in the common market should not be distorted, and later
the Maastricht Treaty assigned the principle of an open market economy
and free competition as an obligation to economic policy-makers. For the
ECB, the principle was clear, and the design of the operational framework
aimed to have only a limited effect on the functioning of the free market
economy.6 However, the crises put the principle under serious doubt.
Gradually, the ECB operational framework replaced the euro area inter-
bank markets. Hardly any market mechanism, properly speaking, is left
in the money markets, as banks have become used to obtaining unlimited
liquidity at zero or negative interest rates from the ECB. Although many

6
This is stressed by the ECB in The Monetary Policy of the ECB [2004], 72 and Issing (2008), The
Birth of the Euro, 120–130.

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 11.1 constitutional principles after two decades 265

other central banks have also provided extensive liquidity to the banking
sector, the scale and permanent nature of ECB’s funding is exceptional
and hardly in line with an open market economy principle.
In addition, also other ECB measures have demonstrated a diminish-
ing trust in the ability of the market mechanism to provide correct or
desired pricing and allocation decisions within the euro area economy.
Selective government bond purchases were justified partly on the basis
of market failure.7 The PSPP made deeper inroads into the price
mechanism than the QE programmes of other central banks, and the
PEPP aimed directly at correcting unwelcome market outcomes in gov-
ernment financing. As a consequence, the functioning of the market
mechanism in the largest section of financial markets, the government
bond market, was seriously hampered and the information content of
the government bonds yields has become limited.

11.1.2 Institutional Choices and Safeguards

The institutional choices and safeguards that completed the overall EMU
architecture hardly remained unscathed during the crisis. The most
important for the ECB was the independence of the central bank that –
alongside the price stability objective – became a cornerstone of the
monetary policy framework and even of the whole European
Macroeconomic Constitution. The ECB is only bound by the price stability
objective – and even that is specified by the ECB Governing Council. In
addition, financial independence requires that the ECB and the NCBs
possess sufficient means to fund their operations, mainly stemming from
monetary income. However, independence has some legal boundaries,
and it should not shield the ECB from the demands of accountability.8
The formal independence of the ECB has not been jeopardised during
the crises, but in practice it was affected by financial stability and public
finance problems that have fundamentally changed the role of the ECB and
its relationship with Member States. During the sovereign debt crisis, the
ECB’s involvement ranged from giving favourable treatment to govern-
ment bonds in its operational framework to outright purchases of troubled
government bonds (Chapter 7, 8 and 10). Furthermore, the ECB was
actively designing and monitoring rescue plans as part of the Troika. In
the process, the ECB’s credibility and its financial position became

7
Although it mainly proved to be a failure in the ECB’s analysis of the Greek situation.
8
Case C-11/00 Commission of the European Communities v. the European Central Bank and
Amtenbrink and de Haan (2002), ‘The European Central Bank’, 69–70.

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 266 11 fate of the european mac roeconomic constitution

dependent on the financial position of individual Member States and their

banks, which amounts to reduced independence as such. The changed
relationship and the institutional balance between the ECB and troubled
Member States was further manifested in the letters that the ECB sent to
those governments, insisting on policy and legislative changes.
After the PEPP and other pandemic measures, the dependence of
Member State governments on the ECB is deeper than ever. The amount
of government bond holdings has reached new heights and a new threat
to independence is the loss of monetary income due to negative interest
rates on government bonds and ECB lending to banks. Against this
background, and with the formal independence still in place, the ECB’s
actual dependence on Member States is substantial. Arguably, in the
course of the crises, the ECB was increasingly given the role of the
‘saviour’ of the euro area, which has burdened its main source of power,
the monopoly issuance of currency, to the extreme. One could even
describe this process as subordination through glorification.
Narrow mandate of the ECB excluding political value judgments was an
integral part of the distinction between ECB monetary policy and
Member State economic policies, the borderline between national and
EU competences. The independence of the ECB had the counterpart that
the Treaty enumerated the tasks allocated to the ECB – tasks that were
directly linked to monetary policy and excluded political value judg-
ments and explicit distributional functions.9 This narrow central
banking model was the ultimate protection for national economic policy
competences, which embodied the principle of conferral and assumed
that the ECB could be controlled by judicial means. However, this model
did not survive the crises. Many of its economic assumptions have been
contested. At the same time, ECB measures could be and have been
challenged on multiple grounds. The new measures also have far deeper
influence on societies than was the case earlier (Chapters 7 and 8), which
was also stressed in the FCC Weiss judgment. The ECB’s new explicit
tasks such as banking supervision (Chapter 9) and also implicit tasks and
responsibilities including acting at the forefront of pandemic responses
have redefined the borderlines between the EU and national compe-
tences, and judicial review by the CJEU proved to be a minor hindrance.

9
‘Financial support measures potentially involving the significant transfer of credit risk
from financial institutions to the taxpayer clearly fall within the realm of fiscal policy.’
Trichet (2009), ‘The ECB’s Enhanced Credit Support’.

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 11.1 constitutional principles after two decades 267

Prohibition of public financing made it clear that monetising public debt

should never be an option and that the ECB should not take a creditor
role towards governments.10 The prohibition protected price stability by
maintaining central bank control of the money supply,11 but it also
helped to maintain market discipline on Member State public finances.
The loophole was that the Treaty imposed a strict prohibition only on
purchasing bonds directly from governments.12 Subsequently, the pro-
hibition came under challenge by most unconventional monetary policy
measures. Even if the ECB refrained from direct lending to governments,
it – together with the NCBs – has interfered in government bond markets
in ways that would have been unthinkable before the crises. Selective
bond purchases already held the idea that the ECB should react against
unwelcome pressures in government bond markets. With the PSPP, the
ECB and the NCBs became the largest creditors of all the euro area
Member States, and finally the PEPP provided an effective backstop for
the financing of governments. When the ECB holds more than 4 trillion
euros of public sector securities, more than one third of the euro area
GDP, this can only be described as monetary financing of governments.
National responsibility for economic policy with safeguards against
unsound fiscal policies was a critical element in the Maastricht Treaty.
Member State sovereignty in economic policy contained substantial
national discretion that risked causing moral hazard problems with
negative repercussions for other Member States and for the ECB.
Markets alone were seen as providing insufficient discipline. This
required institutional constraints in the Treaty provisions, including an
obligation on Member State to avoid excessive government deficits, and

10
Article 123 TFEU: ‘[o]verdraft facilities or any other type of credit facility with the
European Central Bank or with the central banks of the Member States in favour of
Union institutions, bodies, offices or agencies, central governments, regional, local or
other public authorities, other bodies governed by public law, or public undertakings of
Member States shall be prohibited, as shall the purchases directly from them by the
European Central Bank or national central banks of debt instruments’. A Council
regulation clarified Article 123 TFEU, pointing out that ‘purchases made on the
secondary market must not be used to circumvent the objective of that Article’. Council
Regulation (EC) No 3603/93 specifying definitions for the application of the prohibitions
referred to in Articles 104 and 104b (1) of the Treaty [1993] OJ L 332, 31/12/1993, 1–3.
11
Clarida and Gertler, ‘How the Bundesbank Conducts Monetary Policy’ and Committee of
Governors (Document 1669/1670).
12
The ECB has been explicit on the prohibition, pointing out that the prohibition must be
interpreted extensively in order to ensure its strict application, Legal Opinion CON/2008/
46.

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 268 11 fate of the european mac roeconomic constitution

means to correct them should they nevertheless occur,13 and the no-
bailout clause that prohibited shared liability for government debt.
However, a fundamental and largely unresolved issue was that, in effect,
national fiscal policy became more important due to loss of national
monetary policy. The importance of national fiscal policy increased,
requiring sufficient leeway for Member States while negative external-
ities required strict EU constraints. For example, reacting to country-
specific economic shocks relied on national fiscal policy.
The fate of public finance safeguards was partly sealed already with the
application of EMU entry criteria on the basis of political considerations.
Similarly, application of the excessive deficit procedure contained a polit-
ical element that was confirmed by the CJEU in the case against Germany
and France.14 Furthermore, the European Macroeconomic Constitution
arguably failed to foresee a crisis as deep and as devastating on Member
States’ public finances as the one that took place from 2008 onwards. It is
historical second-guessing to wonder whether stricter adherence to
Member State fiscal responsibility and the resulting defaults could have
resulted in a more sustainable path forward. In the critical moment in
May 2010, the EU leaders did not follow that path, which started an
evolution in EU macroeconomic management that is yet to find a consist-
ent form, as is most lately demonstrated by the pandemic responses.

****
In summary, very few of the original constitutional principles were left
untouched by developments and decisions during the crises. The whole
EMU economic constitutional architecture as reconstructed in the
European Macroeconomic Constitution was shaken to the core. The
requirements of coherence and internal logic are no longer met, which
in turn could have implications for the accountability and legitimacy of
the ECB discussed next.

11.2 The Accountability and Legitimacy of the ECB as an

Independent Expert
In the process of creating the Community and particularly its economic
framework, some key elements were considered sufficiently objectively

13
The multilateral surveillance procedure, set out in Article 121 TFEU and further
specified by Regulation 1466/97.
14
C-27/04 Commission vs Council ECLI:EU:C:2004:436.

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 11.2 accountability and legitimacy 269

determined choices that did not need continuous democratic inputs and
that even should be protected from short-term political pressures.
Majoritarian decision-making at the national level was not replaced by
similar procedures at the EU level, but by an economic constitution.
Implementation of the economic constitution relies partly on the judicial
enforcement, through which rights and obligations as well as mandates
and constraints acquired more refined contents. In addition, the eco-
nomic constitution needs some flexibility, as it could become too rigid if
it relies solely on the application of legal provisions. Here the role of
independent experts is essential, but also raises questions concerning
their accountability and ultimately their legitimacy.

11.2.1 The Role of Independent Experts

The role of the independent expert is a central but complicated part of a
constitutionally protected economic framework. Experts bring flexibility
and learning capability to an inherently rigid constitutional model. An
expert is not a rule. If it was possible to define a process in detail without
any need for discretion or learning capability, independent experts
would have no role. Assigning societal functions to independent experts
involves separating specific tasks and objectives from general executive
powers and delegating them with the aim of cumulating scientific know-
ledge, but often also shielding decision-making from external elements
and even undue influences. However, this delegation contains a balan-
cing act: the more independent the expert needs to be and the more
important the function is, the more it needs to be controlled and con-
strained. An independent expert with substantial powers and with no
control is a threat to democratic self-governance.
The European economic constitution has relied on expert institutions
to take care of important and relatively well-defined tasks. The
Commission as an independent expert has implemented competition
rules and controlled Member States’ state aid and later also public
finances. In addition, the CJEU has acted as the expert in maintaining
and developing the EU legal order. The ECB became the main independ-
ent expert of the European Macroeconomic Constitution. Hence, the key
tasks of operationalising the European economic constitution have been
assigned to independent experts that derive their objectives and tasks –
but fundamentally also their legitimacy – from the Founding Treaties.
However, during the crises, the ECB embarked on many measures that
challenge the boundaries of its competence, even given the discretion

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 270 11 fate of the european mac roeconomic constitution

allowed for expert organisations in EU law. This raises questions con-

cerning the accountability and legitimacy of the ECB.
The main question is whether the ECB has gone beyond the role it was
assigned in the European Macroeconomic Constitution and particularly
with what implications. The questions of legitimacy and constitutional
control stem from the ECB’s specific constitutional model. When mon-
etary policy was insulated from democratic inputs, its legitimacy relied
on two elements. First, democratic legitimation took place in the
Maastricht Treaty. Using the democratic processes of each Member
State, the EU monetary system was transnationalised and constitutional-
ised, including its specific objectives and institutional set-up. Second, a
weaker form of legitimacy can be derived from so-called output legitim-
acy, according to which the ECB could be considered legitimate (only) as
long as it provides economic stability and prosperity to the people(s) of
the euro area.15 An additional form of constitutional control would
need to be assumed for the activities outside the Treaty framework,
in particular the SSM function, in which the European Parliament and
even national parliaments were assigned a controlling role that would
need to complement a weaker democratic legitimatisation of a mere
Council Regulation.

11.2.2 The Accountability and Legitimacy of the ECB

For the first element of ECB legitimacy, the democratic decision on the
Maastricht Treaty, the borders of legitimacy were defined in the Treaty
and further elaborated in the constitutional principles of the European
Macroeconomic Constitution. However, as discussed earlier, these prin-
ciples and their envisaged constitutional control mechanisms have
struggled with the ECB’s far-reaching measures during the crises. For
example, the means of transparency and accountability work only if the
ECB is trusted to reveal all its aims, instead of describing its measures
according to the legal mandate rather than the economic substance.
The initial accountability of the ECB16 combined public deliberation
such as the Monetary Dialogue in the European Parliament (Article 284
(3) TFEU) with the backstop of the CJEU’s judicial review. ECB independ-
ence was not expected to shield it completely from majoritarian

15
Fritz Scharpf has provided the main substance for the concept. See, for example, Scharpf
(2003). ‘Problem-Solving Effectiveness and Democratic Accountability in the EU’.
16
Fromage et al. (2019), ‘ECB Independence and Accountability Today: Towards a
(Necessary) Redefinition?’.

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 11.2 accountability and legitimacy 271

democracy, although formally the TFEU only gave it tasks and responsi-
bilities, of which the closest to accountability were reporting obligations.
The ECB’s own definition of being accountable included being held
responsible for its decisions and being required to justify and explain
them. This accountability was mainly seen as ‘an obligation vis-à-vis the
“political order” prevailing within the EU and as a crucial cornerstone of
the legitimacy of the ECB and its policies’. This included constant scru-
tiny of the ECB by the public and its representatives.17 Unfortunately,
the complexity of the crises, and fundamental questions concerning the
motivations of the ECB measures have undermined the accountability
model that clearly did not take into account the possibility that the ECB
measures would extend well beyond the scope of a narrow central
banking model.
The safety valve for constitutional control is judicial review by the
CJEU. However, the main cases before the court that have dealt with the
ECB, namely Pringle, Gauweiler and Weiss,18 demonstrated the CJEU’s
reluctance to act as a guardian of the EU legal order in the area of
macroeconomics. The discretion previously allowed to experts in highly
technical fields was extended to monetary policy without acknowledging
its more contested and even political nature. The CJEU took for granted
all the ECB’s stated motivations, even though the most fundamental
questions with regard to its constitutional control it was called upon to
exercise related to the very motivations of the ECB. This effectively
closed the door for a substantive judicial review with a major negative
impact on democratic conferral as a legitimation mechanism, which was
part of the FCC’s resentment in its Weiss judgment. This can be explained
by the extreme circumstances and also by the CJEU’s reluctance to
discuss substantive macroeconmic issues. However, it demonstrates
more fundamental problems with regard to addressing macroeoconomic
issues at the constitutional level.
Hence, if it was assumed that the envisaged constitutional control
mechanisms – accountability and judicial control – were no longer
sufficient for the new reality, the question of the ECB’s democratic
legitimacy would need to be readdressed. In particular, the preconditions
for the acceptance of an independent expert could be questioned. Using
constitutional control mechanisms designed for an independent expert

17
ECB Monthly Bulletin, November 2002, pp. 45–48.
18
Case C-370/12 - Pringle, EU:C:2012:756; Case C-62/14 - Gauweiler and Others. ECLI:EU:
C:2015:400 and Case C-493/17 - Weiss and others, EU:C:2018:1000.

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 272 11 fate of the european mac roeconomic constitution

to control fundamentally political decision-making does not work. In

conclusion, the ECB’s democratic legitimacy could have become a prob-
lem due to the new measures it has adopted that have challenged the
principles of the European Macroeconomic Constitution, and the inabil-
ity of the judicial review to address these questions substantively. The
worst outcome would be a situation in which fundamentally political
decisions were made under the secrecy of an independent expert and in
the guise of application of scientific knowledge. This would prevent
public discourse and scrutiny demanded by the value choices involved.
A weak form of democratic legitimacy for the new ECB measures could
come from the consent of the Member States. Here the ECB’s main
counterpart is the Eurogroup. It could be assumed, if not verified,19 that
the euro area Ministers of Finance have been either informed of or at
least have understood the ‘non-monetary policy’-based motivations of
the ECB measures. If this were the case and if the Ministers actually
could have effectively voiced their resentments, some weak form of
democratic legitimacy could have held. Similarly, the discussion at the
European Parliament could have brought some democratic legitimacy in
particular to the ECB’s banking supervision activities, although it
remains to be analysed whether the discussions have in reality
provided more information or put more pressure on the ECB than its
standard communication.
A further problem stemming from the ECB’s recourse to measures
outside the scope of an independent expert in the EU context relates to
the rule of law in the EU. The ECB as an independent expert is a creation
of its legal system, in this case primarily the EU legal order. If the ECB
does not or even cannot act in a way that respects the legal order, this
challenges the validity of the very legal order itself. An EU institution that
is allowed to discard the requirements of an independent expert is not
only a legitimacy problem, it is a problem for the rule of law and the EU
legal order as a whole. Consequently, I could argue that both the rule of
law and the very idea of the EU as a community based on law could have
been jeopardised by the CJEU’s case law related to the ECB. The CJEU
would have reached more or less the same outcomes, even if it had defined
the borderlines of the ECB’s competence more substantively. In contrast,
the CJEU only demands that the ECB claims to be guided by the price
stability objective, which renders the judicial control of the ECB void.

19
The Eurogroup does not publish agendas or minutes of its deliberations.

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 11.2 accountability and legitimacy 273

Output legitimacy is even more difficult to judge. Outcomes are almost

impossible to assess objectively, as the other alternatives are necessarily
abstractions. However, it would also be difficult to claim that the EMU
has been a success when the euro area has been the worst hit by the
economic downturns and its recoveries have been painfully slow. The
ECB measures are similarly difficult to assess. It has eagerly promoted
the idea that it saved the euro and that its measures were essential in
restoring the economy. At the same time, many of its measures could
also be considered harmful in one way or the other, and some – like the
SMP – even outright failures. Against this background, it is perhaps quite
far-fetched to claim that the EMU and the ECB could be considered
legitimate merely on the basis of output legitimacy.
In conclusion, the fate of the European Macroeconomic Constitution
as reconstructed in Part I is seriously jeopardised as a result of the events
and measures during the crises. The coherence and internal logic of this
constitutional model cannot sustain the level of discretion allowed for
the ECB as an independent expert or the flexibility of interpretation of
the key provisions of the Maastricht Treaty. On the basis of the assess-
ments of Part II and the conclusion of this chapter, the European
Macroeconomic Constitution on the basis of the Maastricht Treaty and
its foundations cannot pose validity claims as the constitutional model
for the current EMU. Whether this is permanent and irreparable could
depend on the validity of the underlying economic assumptions of the
European Macroeconomic Constitution. Rather than re-working the eco-
nomic assumptions – that needs to wait until the situation stabilises-
I choose to focus on the changes in the objectives. The question is
whether the price stability objective still has validity as the main corner-
stone of the European Macroeconomic Constitution or whether it
has been challenged by other objectives such as economic growth and
structural adjustment or more concretely financial stability. In addition,
the objective of environmental sustainability is making its way to the
economic constitution. This is the topic of the last chapter.

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 12 The Objectives for the ECB and
the Macroeconomic Constitution
Going Forward

The previous chapter concluded that most principles of the European

Macroeconomic Constitution had either seen major changes or been
omitted more or less completely. As a consequence, the broadly coherent
and internally logical constitutional whole has been replaced by a series
of ad hoc decisions and measures with largely unknown longer-term
implications. At the same time, the EMU’s promise of stability and
prosperity has hardly been fulfilled. By the end of 2021, the euro area
GDP was barely larger than in 2008, which by any comparison is an
epically bad achievement only eclipsed by some individual euro area
Member States. In this situation, if the economic-constitutional model
was still deemed feasible, it would need to adjust.
Given their legal and institutional importance, the adjustment of the
economic-constitutional model would need to start with its objectives.
The background is that stability has always been a key objective of the
EU and its economic framework, although it has taken various forms
and shapes over the years. After WWII, Europe was a continent in
desperate need of stability, and the Treaty of Rome and the EEC aimed
at guaranteeing economic and even geopolitical stability by tying
European economies closer together. Since then this broad economic
stability has covered a multitude of European stability needs, some of
which have also found formal legal and institutional expressions. The list
includes, at least, economic stability, exchange rate stability, economic
policy stability, monetary stability, stability of public finances, agricul-
tural stability, price stability, and financial stability.
The EMU was deemed to have covered many of these stability needs.
The ECB became the guardian of the new common currency, and in that
capacity, also the main guardian of the stability-oriented macroeconomic
framework. It was expected that a coherent and constitutionally

274

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 12 the ecb and the macroeconomic constitution 275

enshrined legal architecture would facilitate stability throughout the

EMU. The focus on price stability by the independent ECB anchored the
whole macroeconomic framework in a mutually re-enforcing relation-
ship with the broader European economic constitution and its internal
market objective. Most importantly, the price stability objective was to
lead to broader economic prosperity and stability within the euro area.
The safeguards for national economic policies were hoped to re-enforce
economic policy stability and stability of public finances, which all
contributed also to financial stability.1
Thus, the great promise of EU economic-constitutional thinking was
that the properly designed and constitutionally protected economic
framework would guarantee economic stability and prosperity.
Unfortunately, this extensive and carefully designed stability frame-
work, the European Macroeconomic Constitution, has failed with its
promise. Both design flaws and flaws in implementation have been
blamed for this outcome. In particular, the sole focus on price stability
objective and constraints for national economic policy failed to ensure
economic, fiscal, or even financial stability. In addition, as the recurring
crises hit the euro area, the European Macroeconomic Constitution did
not provide sufficient means for the EU leaders that they could consider
feasible or dared to recourse to, such as a Member State’s default. The
operational mode changed from maintaining the framework for longer-
term stability to fighting short-term instability. This required, apart
from operating outside the EU legal framework, utilising the concept
of stability of the euro area as a whole, which ‒ together with establish-
ment of the European Stability Mechanism and new ECB measures ‒
provided the main tools for trying to restore stability. At the same time,
the price stability objective has turned into preventing deflation or
during the pandemic even irrelevant as a policy guide.
This last chapter is devoted to this fundamental transformation of the
European Macroeconomic Constitution and particularly its objectives
during the last decade. This evolution has also changed the ECB from a
central bank of stability to a central bank of crisis that, albeit cautiously,
was also reflected in the ECB 2021 strategy review. The ECB seeks to
readjust its role in the euro area economy by incorporating new object-
ives, without being very specific on either their mutual relations or the
tools used to achieve these objectives.

1
Agricultural stability was solved by the radically reduced agricultural work force and the
Common Agricultural Policy.

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 276 12 the ecb and the macroeconomic constitution

The discussion starts by analysing how and why the role of price
stability has changed. This is followed by assessments of how the broader
stability objective have gained more practical and eventually also formal
importance. Furthermore, the objectives of structural economic adjust-
ment and increasingly environmental sustainability are discussed as the
new candidates for the objectives of the European Macroeconomic
Constitution and the ECB. As an Epilogue, the book concludes with a
broader forward-looking perspective on the options available.

12.1 The Role of the Price Stability Objective

The pivotal role of the price stability objective in the original EMU
constitutional architecture was thoroughly discussed in Part I. The
objective had links to all the foundations of the EMU and it became the
main cornerstone of the European Macroeconomic Constitution that
glued its various elements together. It even fared better than most other
constitutional principles during the crises that have hit the EMU for
nearly one and half decades. Economically, inflation has remained close
to the ECB’s quantitative target and constitutionally, the CJEU has used
price stability as a critical factor to define the area of monetary policy.
Yet, its strong guiding role is turning into a major question mark going
forward, as the underlying economics that elevated the price stability
objective to its Treaty position could have changed. Even the ECB
2021 strategy review perhaps indicated a change of heart by stressing
that the ECB takes the primary objective as given in the Treaties instead
of elaborating on the virtues of price stability as was done in the original
ECB strategy.
The key assumption of the EMU constitutional model was that, by
focusing on low inflation, the central bank makes the best contribution
to economic stability and prosperity. Institutionally, this is achieved
through central bank independence accompanied by an overriding price
stability objective that together solve the time-inconsistency problem
stemming from the government’s temptation to achieve better growth
through surprise inflation. This model also assumes that the central
bank has effective means to maintain low inflation, mainly by reducing
inflationary pressures through short-term interest rates. The model
seemingly worked well from early 1990s until 2007, and in Germany
even from the 1950s onwards. It was also an important scientific element
in the FCC’s Maastricht judgment that allowed the exception from the
normal democratic governance.

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 12.1 the role of the price stabil ity objective 277

However, the key assumptions of the model have recently been called
into question by economic reality. Most fundamentally, it is less obvious
that low inflation in itself guarantees economic stability and prosperity.
This change in the underlying economics of EMU constitutional model
can be analysed by dividing it into specific economic, economic-political,
and institutional questions that have occupied economists, political sci-
entists, and lawyers for more than a decade. Why is deflation suddenly a
bigger threat than high inflation? Do central banks have as effective
means against deflation as they have against inflation? Is the time-
inconsistency problem still relevant, if the objectives of the government
and central bank are aligned? If not, what is the rationale for central
bank independence? Does price stability guarantee or even enhance
financial stability? Answering these questions could provide more infor-
mation about the relationship between price stability and other potential
objectives of the ECB and the European Macroeconomic Constitution.

12.1.1 Economic Substance Changing from Preventing Inflation

to Avoiding Deflation
A key 1970s change in central banking was that central banks were seen
as having efficient means to control inflation. This made it possible that
monetary policy was understood as an independent policy area that
affects the economy mainly through short-term interest rates in order
to maintain low inflation. The main threat to price stability stemmed
from inflationary pressures, in particular from wage-inflation spirals
that led to high inflation and high unemployment that also hampered
longer-term growth prospects. With the inflation-targeting central bank
model emerging as a consensus, the global economy witnessed a long
and steady decline in inflation from early 1980s onwards that was largely
attributed to successful monetary policy by central banks.
However, in developed countries for the last decade or so ‒ and in
Japan already for three decades ‒ the main threat to price stability has
increasingly shifted to deflation. The persistence of deflationary pres-
sures is found to have both cyclical and structural factors, which compli-
cates the analysis from the monetary policy perspective. Furthermore,
monetary policy has proven to be considerably less efficient against
deflation, particularly when structural factors play a major role.
Indeed, deflation can be divided into more harmful cyclical demand-
driven deflation and supply-driven deflation. Demand deflation is
broadly symmetrical to demand inflation, and it is mainly caused by
demand shocks that are accompanied by large output gaps and often also

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 278 12 the ecb and the macroeconomic constitution

asset price shocks. The demand-driven cyclical deflation calls for a mon-
etary policy reaction to avoid demand shocks turning into very harmful
debt-deflation spirals.2 This has advised the ECB alongside other central
banks to react vigilantly against these fears.
However, it could be argued that a major part of the deflationary
developments of recent decades has had an important structural com-
ponent. Increased globalisation ‒ particularly the emergence of China as
the main industrial hub ‒ has caused sustained downward pressures on
industrial product prices across the world. The same impact could be
described as a major increase in the globally available workforce that has
reduced the pricing power of labour. In addition, technological develop-
ments and digitalisation have changed the pricing logic in many trad-
itional economic sectors with mainly a downward pressure on prices. As
opposed to cyclical factors, these structural factors do not call for trad-
itional monetary policy actions, but mainly structural adjustments.
Furthermore, the economic definitions of deflation vary. A narrow
definition stresses negative consumer prices or the risk of negative con-
sumer price changes. For example, during the crises the ECB often
referred to risks of negative consumer price changes. However, two
other definitions are often considered more accurate measures of serious
deflation threats to the economy that would call for monetary policy
reactions. A behavioural definition stresses the perceptions of households
and companies. Deflation becomes a major negative feature in the econ-
omy if it causes households and companies to postpone their overall
consumption or investment decisions in a wait for lower prices. Also
the ECB has mentioned the relevance of the behavioural definition, but
considered it difficult to operationalise. A particularly negative form of
deflation relates to a destabilising debt-based deflation process, in which
high real interest rates and declining asset prices reinforce each other
into a negative economic spiral. The latter two definitions have serious
negative economic consequences, while the first ‒ decreasing consumer
prices ‒ mainly acts as a useful but only partial indicator of the latter
two. Consequently, the deflationary global economic environment of
recent decades could have misled central banks to react to structural
deflationary developments, if they focused too narrowly on headline
consumer prices.

2
IMF (2003), Deflation: Determinants, Risks, and Policy Options – Findings of an Interdepartmental
Task Force.

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 12.1 the role of the price stabil ity objective 279

12.1.2 Price Stability without Economic or Financial Stability

Apart from wrong signals to fight deflation caused by structural factors,
another fundamental rethinking facing the inflation-targeting
central banking model is that it could even have allowed destabilising
developments to gain force. For example, when the economics assessed
the so-called Great Moderation in the mid-2000s, central banks were
largely credited for achieving a stable economic environment with
limited economic fluctuations and low inflation. The Great Moderation
was seen as a proof that inflation-targeting monetary policy had fulfilled
its promise of growth and stability. Unfortunately, it paved the way
for the Great Financial Crisis with a long build-up of excesses and risk-
taking that turned into the steepest post-WWII recession throughout
developed countries.
This inability of the price stability objective to prevent piling-up of
instabilities has slowly become evident for central banks. Consequently,
pure inflation-targeting is no longer the central banking consensus, but
nor is any other pure central banking paradigm, either. The price stabil-
ity objective has not lost its relevance for central banking, but its guiding
value and thus its ability to serve as the sole basis of central bank policy
and also accountability has been cast into doubt. This was apparent also
in the ECB 2021 strategy review that took far broader perspectives on
economic developments, also from a structural adjustments perspective.
However, the final conclusions still remained faithful to the Treaty and
its primary objective of price stability.
The problematic assumption with the inflation-targeting model is
that, in addition to economic stability, the price stability objective also
leads to financial stability. Clearly, economic reality showed that success
in price stability alone did not guarantee financial stability. Moreover, as
the discussion on the Great Moderation indicated, successful inflation
targeting could even have increased financial vulnerabilities through
increased risk-taking. Here, a new perspective is an inclusion of financial
cycles to the analytical framework to complement the traditional busi-
ness cycles perspective.3 A financial cycle refers to a longer cycle that is
amplified by mutually reinforcing increases in credit and property prices
that can lead to major financial instability when this positive spiral is
reversed with declining credit and asset prices. Inflation-targeting makes

3
Work on the role of financial cycles has been conducted at the BIS already since the early
2000s particularly by Claudio Borio.

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 280 12 the ecb and the macroeconomic constitution

financial cycles steeper, if central banks’ success in mitigating short-

term fluctuations in economic growth and consumer prices actually
supports lending and higher asset prices. Frequent and smaller risks
are replaced by infrequent major risks that households, companies and
banks are unable to manage.
Although the ECB has never been a pure inflation-targeting central
bank, the successes ‒ and also failures ‒ of inflation-targeting also apply
to it. The ECB defines the primary objective of price stability in terms of
numerically specified increases in consumer prices. Most of its monetary
policy measures have also been justified through consumer price devel-
opments, including the PSPP from 2015 onwards. At the same time, the
importance of monetary factors and credit aggregates was gradually
reduced to mere financial market indicators. It could thus be argued
that the ECB’s strategy is still very close to inflation-targeting, and
therefore any negative findings concerning over-reliance on consumer
price developments and the build-up of financial excesses fully apply to
the ECB. The new ECB strategy attempts to incorporate the cost of owner-
occupied housing to the inflation definition, which acknowledges that
the consumer price definition can be too narrow. However, it does not
remove the major problem that inflation-targeting can lead to a build-up
of excessive risks.

12.1.3 Price Stability and the Independence of the ECB

The price stability objective and central bank independence are closely
interlinked. The theoretical basis for central bank independence stems
from the time-inconsistency problem in achieving price stability dis-
cussed in Chapter 2. Moreover, the ECB’s extensive independence was
largely based on the idea that it provided the best means for maintaining
price stability. This was underlined by a history of high inflation in many
euro area Member States, which required institutional guarantees that
the EMU would follow the low-inflation tradition instead.
However, the rationale of central bank independence could be
reassessed if governments and the ECB were to have the same incentives
or targets, and even with more or less the same planning horizons. This
would invalidate the time-inconsistency problem and consequently the
need for central bank independence would have to find new justifica-
tions or be removed. Indeed, Part II of the book questioned whether
controlling ‒ or, even less so, reducing ‒ inflation had been a key motiv-
ation for ECB measures during the crises. The explicit and sometimes
implicit motivations ranged from supporting growth and increasing

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 12.2 the financial stabil ity objective 281

inflation, to correcting for instabilities in Member State government

bond markets or in their financial systems. The direction or timing of
ECB measures were hardly structurally different from what the
Eurogroup (Member State governments) would have hoped for, leading
to the conclusion that the time-inconsistency problem was unlikely to
have been present. This puts the rationale for the ECB’s independence in
doubt, at least for that unusual period.
In conclusion, the price stability objective as the sole guidance for the
ECB has faced pressures from multiple sides. For one, the information
value of price stability might have declined due to structural deflationary
pressures. If the information value is reduced, inflation targeting is not
necessarily a better guide for monetary policy than is economic growth.
For two, inflation-targeting was even perceived to have aggravated the
financial cycle and paved the way for the Great Financial Crisis. And
finally, it can be doubted whether price stability objective has actually
directed the ECB policy during the last decade. Two further consider-
ations could follow. First, the time-inconsistency problem could have
largely lost its validity if the ECB is reacting to a combination of eco-
nomic growth and financial stability, which would call for a reconsider-
ation of the need for ECB independence. Second, it could be argued that
the ECB has gradually become dependent on the financial stability of the
Member States or their banking sectors, which would, in effect, amount
to a factual disappearance of the ECB independence. The difference
between a potential theoretical need for independence and the ECB’s
factual dependence on Member States and their financial sectors could
become apparent in the longer-term consequences. In the first case, the
ECB would be in a position to react appropriately if the validity of the
inflation threat and thus also the validity of the time-inconsistency
problem returned. In the latter case, the longer-term price stability
objective would have been undermined by other needs with very harm-
ful consequences, should the inflationary pressures return.

12.2 The Financial Stability Objective

As the role of the price stability objective has declined, the most apparent
new objective for the European Macroeconomic Constitution during the
last decade has been the broad financial stability.4 It became the main

4
The author has developed the ideas related to financial stability, the EU macroeconomic
framework and the EU legal order together with Fernando Losada, for example, in Tuori

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 282 12 the ecb and the macroeconomic constitution

policy driver for the EMU and its Member States, when recurring crises
and financial instabilities were making the EMU dysfunctional and even
raised fears for its very existence.
The starting point was the unprecedented financial crisis from
2008 onwards that the ECB, alongside most other central banks, fought
by supporting the interbank markets. In addition, various national meas-
ures aimed to ease the situation through bank recapitalisations and
closures. In the EU, fiscal policy coordination intensified but national
responsibility remained intact, until a major turn in spring 2010 with
the sovereign debt crisis. The stability concerns shifted to public sector
instabilities and on the stability of the euro area as a whole. During the
ensuing two or three years, the survival of the euro area was threatened
by fears of contagion, links between banks and sovereigns, and even by
the ad hoc policy measures failing to provide sustainable relief, such as
the SMP.5 The EU rescue measures were also given more solid institu-
tional forms through the establishment of the EFSF and the ESM.
In addition, the involvement of the ECB in fighting stability threats
intensified beyond any previous constraints, as was discussed in Part II.
A further step took place in 2020 with the covid-19 pandemic and the
measures to alleviate the consequences of its containment. The pan-
demic created new instabilities well beyond the economic sphere, where
the initial reaction was mainly at the national level. At the EU level, the
ECB provided the most active and immediate support, first and foremost,
by guaranteeing favourable funding conditions for the Member States as
well as financial support to companies, households, and banks. These
were followed by an agreement by EU leaders on a €750 billion recovery
effort in the form of direct aid and loans to Member States. The package
was labelled Next Generation EU that combines rebuild support after the
pandemic with investment support for the green and digital transitions,
where the main instrument is the Recovery and Resilience Facility (RFF)
that was formally agreed upon only in 2021.6

and Losada (2021), ‘The Emergence of the New Over-riding Objective of Financial Stability’
and in Losada and Tuori,( 2021), ‘Integrating macroeconomic into the single EU legal
order: the role of financial stability in Post-Crisis Europe’. See also, Smoleńska and
Beukers, ‘The ECB and Financial Stability’.
5
As mentioned in Part II, the ECB’s three-year LTROs and the SMP could be questioned
from this perspective.
6
Regulation (EU) 2021/241 of the European Parliament and of the Council of 12 February
2021 establishing the Recovery and Resilience Facility

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 12.2 the financial stabil ity objective 283

Part II of the book described, how the objective of ensuring or

regaining financial stability found its way to ECB measures, arguably
replacing the objective of price stability as their main rationale.
However, this evolution also bears consequences for the broader EMU
constitutional architecture, including the broader economic policy at the
EU and Member States levels. As a consequence, the overall euro area
economic framework has arguably been given a new, even overriding,
objective of financial stability of the euro area as a whole, with some
important implications.7 The following will first describe, how financial
stability emerged as a legal objective, before assessing it as a new
constitutional objective going forward.

12.2.1 The Emergence of the Objective of the Financial Stability

of the Euro Area as a Whole
Not only the measures of the ECB, but also other European rescue
measures from 2010 onwards became exceedingly difficult to justify
within the existing EU legal and particular constitutional framework.8
Here, the new objective of restoring financial stability provided a seem-
ingly feasible solution to the constitutional problems arising from the
rescue measures and the new institutional structures. Already the first
loan agreements with Greece in 2010 stressed the need to safeguard the
financial stability of the euro area as a whole,9and financial stability also
motivated the establishment of the ‘Union stabilisation mechanism in
May 2010 to preserve financial stability in the European Union’ against ‘a
serious threat to the financial stability of the European Union as a
whole.’10

7
Tuori and Losada (2021), ‘The Emergence of the New Over-riding Objective of
Financial Stability’.
8
The initial approach was textual interpretations of Articles 122(2) and 125(1) TFEU that
risked becoming problematic for the coherence of the legal framework.
9
Statement on the support to Greece by Euro area Members States MEMO/10/123, 11 April
2010. http://europa.eu/rapid/press-release_MEMO-10-123_en.htm. Press Release:
Statement by IMF Managing Director Dominique Strauss-Kahn on Greece. April 11,
2010 Press Release No. 10/143. www.imf.org/en/News/Articles/2015/09/14/01/49/pr10143
and Statement by Commissioner Rehn on Greece. http://ec.europa.eu/economy_finance/
articles/eu_economic_situation/2010-04-29-statement-commissioner-rehn-on-greece_en
.htm (last visited 12 Jan 2018).
10
O. J. 2010, L 118. Council Regulation (EU) No 407/2010 of 11 May 2010 establishing a
European financial stabilisation mechanism. The EFSM was an EU not a euro
area vehicle.

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 284 12 the ecb and the macroeconomic constitution

In these first monetary transfers, the financial stability rationale was

derived from Article 122(2) TFEU that stressed difficulties stemming
from external factors such as natural disasters or exceptional occur-
rences beyond Member States’ control. However, this approach was soon
replaced by a combination of a TFEU amendment, the ESM Treaty, and
the Fiscal Compact (the Treaty on Stability, Coordination and
Governance in the Economic and Monetary Union). The new Article
136(3) TFEU stated that euro area Member States could establish a stabil-
ity mechanism to safeguard the stability of the euro area as a whole with a
requirement that the provision of any financial assistance was made
subject to strict conditionality.11 However, the meaning of the new 136
(3) TFEU has remained somewhat unclear, apart from introducing the
objective of (financial) stability in primary law.12 The CJEU’s reading of it
was that Article 136(3) TFEU ‘confirms that Member States have the
power to establish a stability mechanism’ and ensures, through strict
conditionality, that the mechanism will ‘comply with European Union
law’.13At the same time, the European Council stated that Article 122(2)
of the TFEU would no longer be needed nor should it be used for such
purposes.14
The ESM Treaty became arguably the most critical element in
empowering the Community to foster the financial stability of the euro
area as a whole. Following Article 136(3) TFEU, the ESM could assist the
Member States to safeguard the financial stability of the euro area as a whole
and of its Member States but this assistance needed to be subject to strict
conditionality.15 The financial stability concept was made very broad
with the ultimate aim of preserving the economic and financial stability

11
European Council Decision of 25 March 2011 amending Article 136 of the Treaty on the
Functioning of the European Union with regard to a stability mechanism for Member
States whose currency is the euro (2011/199/EU). O.J. L 91/1.
12
It can be recalled that the ESM was established before Article 136 was amended.
13
Case C-370/12 – Pringle, EU:C:2012:756, para 72.
14
Preamble (4), European Council Decision of 25 March 2011 amending Article 136 of the
Treaty on the Functioning of the European Union with regard to a stability mechanism
for Member States whose currency is the euro (2011/199/EU). O.J. L 91/1. Does this mean
that EU competence was replaced by Member State competence?
15
ESM Treaty Preamble 2, 6 and Article 3 and 12.1. Also, ESM assistance needed to be
indispensable to ‘safeguard financial stability of the euro area as a whole and of its
Member State’.

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 12.2 the financial stabil ity objective 285

of the EU (euro area),16 also through a further strengthening of fiscal and

macroeconomic surveillance.17
The ESM also demanded some legal creativity to allow the financial
stability objective to overcome the hurdle of the no-bailout clause
(Art. 125 (1) TFEU). This is where the CJEU first discussed financial
stability. The CJEU argued that the article did not prohibit all financial
assistance, as Article 122(2) TFEU already and explicitly allowed assist-
ance without making a derogation.18 Both the no-bailout clause and the
ESM aimed at maintaining stability, the former preventively and the
latter if a crisis nevertheless occurred. However, for assistance to be
compatible with Article 125(1) TFEU, the CJEU insisted that it needed
to ensure that the Member States remained subject to the market pres-
sure that encourages them to ‘maintain budgetary discipline’.19 This was
ensured by the strict conditionality of assistance, which ‘contributes at
Union level to the attainment of a higher objective’ of maintaining the
stability of the EU.
The establishment of the ESM was also a key tool for imposing other
elements that were deemed necessary for the new macroeconomic
framework for ensuring and repairing stability. First, the signing of the
Fiscal Compact was a precondition for new ESM assistance programmes.
In that context, the stability of the euro area as a whole was linked to the
new fiscal policy constraints, as ‘the need for governments to maintain
sound and sustainable public finances [. . .] is of essential importance to
safeguard the stability of the euro area as a whole, and accordingly
requires the introduction of specific rules, including a balanced budget
rule’.20 Second, as may be recalled from Chapter 9, the ESM was also
used as leverage to trans-nationalise euro area banking supervision at the
ECB, as a means to both restore and also to maintain financial stability
going forward.
An extensive discussion on the concept of financial stability of the euro
area as a whole took place in the aforementioned Pringle case. The CJEU
chose to stress the differences between the ESM financial stability

16
This was also stressed in the ECB Opinion. ECB opinion of 17 March 2011 on a draft
European Council Decision amending Article 136 of the Treaty on the Functioning of the
European Union with regard to a stability mechanism for Member States whose
currency is the euro (CON/2011/24).
17
Opinion CON/2011/13.
18 19
Case C-370/12 - Pringle, EU:C:2012:756, paras 120, 130 and 131. Ibid., para 135.
20
Preamble, Treaty on Stability, Coordination and Governance in the Economic and
Monetary Union.

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 286 12 the ecb and the macroeconomic constitution

objective and the ECB’s monetary policy objective of price stability, by

concluding that the ESM was to ‘safeguard the stability of the euro area
as a whole, that is clearly distinct from the objective of maintaining price
stability’21 and that the ‘grant of financial assistance to a Member State
however clearly does not fall within monetary policy’.22 This argumen-
tation, as well as that stressing the preventive role of Article 125(1) TFEU,
could be seen as a means to find a way out of the legal deadlock that the
EU was facing with the European Macroeconomic Constitution and the
new measures. The CJEU made a further distinction in stating that
safeguarding the financial stability of the euro area as a whole was equal
‘to support[ing] the stability of the euro’, which, it argued, was not part
of monetary policy. The area covered by the ESM was thus economic
policy, a Member State competence that was merely constrained by the
EU economic governance framework.23

12.2.2 The ECB Turned to Monetary Policy Transmission Mechanism

as Financial Stability Rationale
The assessment of the ECB crisis measures in Part II revealed that the
ECB has been reluctant to use financial stability justifications for its
measures even before the Pringle case. All the adopted measures, except
for the one that conferred banking supervision upon the ECB, were
argued solely on monetary policy and price stability grounds. At the
same time, as the analysis revealed, on most occasions pure price stabil-
ity considerations were, at best, only partial rationales for the measures.
Broad financial stability concerns, related mainly to banks and Member
State public finances, have been constantly present in the ECB measures
starting from the SMP and exceptional three-year LTRO funding for
banks all the way to QE and pandemic responses. Indeed, similar meas-
ures by other central banks were often argued also on financial stability
grounds, and some central banks such as the BoE were even given the
task to maintaining both monetary and financial stability.24
For the ECB measures, the rationale of restoring or ensuring the
transmission of monetary policy became largely equivalent to financial
stability considerations, both substantively and also in comparison to
other major central banks. Indeed, since 2010, when the ECB started to
correct the malfunctions of monetary transmission, it reacted against

21
Case C-370/12 – Pringle, EU:C:2012:756, para 56. 22
Ibid., para 57.
23
Ibid., para 59–60.
24
This took place with the Financial Services Act 2012, see www.bankofengland.co.uk/.

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 12.2 the financial stabil ity objective 287

instabilities in the banking sector and in the government bond markets.

This was particularly the case with selective bond purchases (Chapter 7),
but even the three-year LTROs (Chapter 6) and QE programmes
(Chapter 8) could have had similar motivations. Finally, with the PEPP
(Chapter 10), the ECB was explicit about the objective of maintaining
favourable financing conditions for the Member States, when it stated
that the PEPP also acted as a backstop for the government bond markets.
This was equivalent to acting as a lender of last resort to Member States,
and as such maintaining the broad financial stability of the euro area.
Hence, many ECB measures alongside the measures adopted by the EU
and its Member States were broadly aligned to restore the financial
stability of the euro area and particularly some of its Member States. In
this setting, the CJEU’s reading of the financial stability objective that
stressed both its non-monetary policy nature and also its Member State
economic policy perspective was not followed by most of the ensuing
decisions, actions, and statements taken by the EU institutions and the
Member States. This could be indicative of the difficulties involved in
giving the financial stability objective a more sustained position as a key
objective of the European Macroeconomic Constitution going forward.
Hence, a more thorough look at the financial stability as an EU law
objective is warranted.

12.2.3 Financial Stability as an EU Law Objective

The financial stability of the euro area as a whole has become the main
objective and rationale for most new elements introduced in the broad
field of EU macroeconomic governance over the last decade. Hence, it
could be a prime candidate to become a new constitutional objective for
the European Macroeconomic Constitution that could restore its ability
to provide stability and prosperity going forward. Unfortunately, this is
less than straightforward.
In the broad context of EU law, financial stability has contained a few
features. First, ensuring financial stability through financial assistance
falls under economic policy. The CJEU has clearly defined safeguarding
financial stability as fundamentally different from maintaining price
stability, and accordingly it could not be an underlying objective of the
ECB’s monetary policy.25 Second, the objective of financial stability is
read as an underlying objective of Article 125(1) TFEU and also Article

25
Ibid., para 160.

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 288 12 the ecb and the macroeconomic constitution

122(2) TFEU, and perhaps it could be an underlying objective of some

other Treaty provision, including the internal market provisions. Hence,
it is an EU objective that has created non-exclusive EU competences.
Third, the financial stability of the euro area as a whole includes exist-
ential issues concerning the whole EMU, and it has been employed also
against an exit pressure of an individual Member State. Finally, risks to
the financial stability of the euro area as a whole can stem from prob-
lems in individual countries, thereby allowing necessary assistance but
also justifying deep inroads into national economic policy.
The main problem with financial stability as a legal objective is that it
is based on an elusive economic concept that lies at the intersections
between macroeconomics, public finances, financial markets, and finan-
cial institutions.26 It may be and has been defined in many ways both
substantively and seemingly also in formal texts, as even statements by
EU institutions, legal acts and judgments addressing it convey different
underlying perceptions of financial stability or stability of the euro area
as a whole. On the positive side, this lack of precise definition allows
the concept of financial stability to be used to rationalise surprisingly
many actions that might have been necessary to compensate for
the rigidity of the economic-constitutional framework. For example,
the means of safeguarding financial stability since the eruption of the
crises have included: austerity measures to improve public finances;
macroeconomic adjustment programmes to repair lost competitiveness
even through lowering wages; control over budgetary processes in the
form of a European Semester; capitalisation of banks and other insti-
tutions; and also central bank financing of governments and banks (also
through emergency liquidity assistance to banks). However, for an effect-
ive constitutional objective, this ambiguity and multiplicity of defin-
itions is equivalent to arbitrariness that by definition is detrimental for
the rule of law.
For the ECB, the financial stability objective entails the further compli-
cation that Article 127 TFEU explicitly addresses financial stability and
gives the ECB (only) a secondary task to contribute to the policies devised

26
Even before the most recent outburst of studies, the financial stability considerations
have been analysed from many perspectives, both in micro- and macroeconomics
starting from the earlier discussed debt-deflation theory by Irving to Boyd and Prescott
(1986), ‘Financial Intermediary-Coalitions’; J. Stiglitz (1985), ‘Credit Markets’ and
continuing to roles of banks and markets, for example in Levine (1997), ‘Financial
Development and Economic Growth’ and Davis (1995), Debt, Financial Fragility, and
Systemic Risk.

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 12.2 the financial stabil ity objective 289

by the competent authorities (of which the ECB was made one through
the SSM). Hence, any broader financial stability task through the monet-
ary policy transmission mechanism argumentation should be activated
cautiously. The borderlines drawn with the SMP and particularly the
OMT could represent the outmost extensions, and they also act as
reminders of the risks involved. For the OMT, the link to the ESM
adjustment programmes maintained the institutional marching order
and also fulfilled the conditionality requirement of the CJEU. The PEPP
and its flexibility of the purchases had a similar aim of acting as a
backstop for the government bond markets as was the case with the
OMT, which could be seen as a financial stability rationale. However, the
PEPP arguably pushed the monetary policy transmission argumentation
beyond the previous limits by omitting the conditionality requirement.
I would thus argue that financial stability is fundamentally a crisis
concept that has been used in EU law to rationalise and to legitimise
measures that were deemed necessary but lacked well-defined under-
lying authorisations or that even contradicted existing mandates and
constraints. While this seemed to have been useful in judicial reviews
of crisis measures, it also has revealed serious caveats in using financial
stability as a constitutional objective going forward. The financial stabil-
ity objective’s relationship with other objectives and principles is
unclear, which makes its balancing with other economic objectives,
including internal market, price stability or growth very difficult and
the problems of balancing become impossible, even violent, with
broader societal objectives, including social policy objectives.
Consequently, it could have translated the use of political discretion
even into an overriding legal objective, which would constitute a disrup-
tion in the legal order with detriment to the rule of law within the EU.
For the ECB, and as its strategy review 2021 also demonstrated, financial
stability is an important consideration for the conduct of monetary
policy, but should be given more limited stand-alone value than was
the case in practice. The strategy review considered financial stability
under other considerations, mainly as a precondition for price stabil-
ity.27 This leads us to the other potential objectives for the ECB that could
complement the price stability objective in ensuring more stability and
prosperity in the future.

27
www.ecb.europa.eu/home/search/review/html/ecb.strategyreview_monpol_strategy_
overview.en.html.

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 290 12 the ecb and the macroeconomic constitution

12.3 The Objectives of Structural Economic Adjustment

and Environmental Sustainability
The previous discussion has shown that price stability as the main
objective for the ECB and the European Macroeconomic Constitution
was insufficient and that financial stability was too ambiguous and also
otherwise problematic as a stand-alone objective. The economic-
constitutional model might thus need other objectives to regain its
ability to enhance the longer-term stability and prosperity of the euro
area. Such new objectives should address the failures of the economic-
constitutional model, but they would also need to have a clear Treaty
basis in order to remedy the existing constitutional problems rather than
creating new ruptures in the EU legal order. Unfortunately, the Treaty
does not give very clear guidance. As discussed earlier, both the broader
economic policy, and also the ECB’s monetary policy, should contribute
to the achievement of the Union’s objectives. These broad objectives of
Article 3 TEU include balanced economic growth, a highly competitive
social market economy aiming at full employment and social progress,
and a high level of protection and improvement of the quality of the
environment. However, the usefulness of these broad objectives is
limited by their declarative nature and the absence of a hierarchical
relationship among them.
The Treaty holds mostly a structural and longer-term perspective on
the issues that are covered by the economic-constitutional approach.
Shorter-term and cyclical economic policy, apart from monetary policy,
has remained a responsibility of the Member States, as a manifestation of
their democratic self-governance. Substantive further transferrals of
competences to the EU level are not foreseen in the Treaty, and they
could even be detrimental for the Member States’ responsibility to
address asymmetric shocks to their economies.
The most recent economic policy reading of the Treaty and the new
objectives can be found in the EU responses to the pandemic (the RFF)
and also in the ECB 2021 strategy review. They also try to provide
perspectives to analyse the main threats to EMU economic stability and
prosperity – in addition to price and financial stability concerns dis-
cussed earlier. The assessment of these threats brings up two broad
issues, namely the ability of Member States to adjust economically in
the EMU context, and environmental sustainability. Accordingly, these
could be assessed as the potential new objectives for the European
Macroeconomic Constitution and also the ECB.

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 12.3 economic adjustment & sustainability 291

12.3.1 New Objectives in the Light of the Foundations of

the European Macroeconomic Constitution
The assessment of the new objectives could start from the foundations
of the European Macroeconomic Constitution discussed in Chapter 2.
First, the economic-constitutional thinking does include structural
economic adjustment, but not as a unifying concept but rather as an
area that has divided the economic policy models of the major EU
countries. The German and particularly ordoliberal view sees eco-
nomic adjustment taking place mainly through the decisions of pri-
vate parties, as a key feature of the liberal economic model. The public
sector mostly maintains the appropriate frameworks, including tax
and competition policies. In contrast, the French tradition sees the
public sector as a key actor in actual investment and even consump-
tion decisions. This planification model vested considerable thrust in
bureaucracy’s ability to allocate investments and direct the economy.
Arguably, these two approaches are visible in the Treaty, whereby the
German approach dominated the economic and monetary policy
areas, and the French footprints are visible in various industrial and
cohesion policies and funds. The pandemic responses, particularly the
RFF, fall more on the planification than on the framework approach,
where the structural adjustment funds for mainly digital and green
transformations follow an administrative model with the Commission
at the helm.
For the objective of environmental sustainability, the economic-
constitutional thinking provides more uniform justifications, where
the differences between constitutional approaches appear in the means
rather than in the objective as such. Even the ordoliberal tradition
analysed and provided tools to incorporate environmental consider-
ations in the private decision-making processes. Without a public
sector involvement, the environmentally harmful consequences of
private decisions appear as negative externalities that are omitted in
the decision-making. Whether these negative externalities are incorp-
orated to economic decisions by framework-based procedures or by
active public policies and investments, could, again, divide the
constitutional traditions.
Turning to the second foundation, the economic theory and economic
policy practice, the structural economic adjustments have been and
continue to be a heavily contested topic. Arguably, the trust in large-
scale policy initiatives to support economic transitions has increased of

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 292 12 the ecb and the macroeconomic constitution

late at least at the level announced programmes.28 However, the eco-

nomic theory on public investments is largely dependent on the assump-
tions of the efficiency of public investments and their impact on other
investments and decisions in the economy. In the actual policy pro-
grams, including the RRF, the effectiveness of the investments is largely
assumed or they are based on private investments that are only sup-
ported by public funding. The actual theoretical discussion on the merits
and caveats of various forms of investments has remained limited, and it
would be far-reaching to conclude that the economic consensus has
changed to advocate public investments as the primary means to address
structural economic adjustments.
Currently, one often mentioned and also critical element in public
investments is the low level of long-term interest rates. Naturally, if
public investments are valued by using a discount factor of nearly zero,
many investments will be assessed positively. This looks like too good to
be true, which it also is. Current extremely low, even negative, longer-
term interest rates are a result of the central banks’ QE programs, not a
market-pricing of inflation, growth or risk projections. This leads to a
false picture, however. The actual new lending by the public sector is not
taking the form of longer-term bonds, but that of the issuance of central
bank money. So the actual interest rate on public sector investments is
the extremely short-term rate of central bank money, including bank
deposits at the central bank, which could change very quickly if infla-
tionary pressures increased and the ECB needed to increase rates. The
perception that the public sector can borrow at zero interest rate for a
very long time, is thus an illusion or a fallacy.
The economic theoretical discussion on environmental sustainability
is very active, but the actual means to incorporate sustainability in the
broader economic framework are still finding their shape. In some fields,
such as emission rights and environmental taxation, the environmental
microeconomics have provided many useful tools. However, the macro-
economic side is still largely inconclusive with multiple approaches, and
a largely inconclusive overall perspective,29 but the next few years
should provide important new innovations and solutions.

28
In addition to the NGEU (and RFF), the Biden administration announced large public
investment packages.
29
Dunga et al. (2019), ‘Social capitalism: Incorporating sustainability factors into
macroeconomic analysis’, Yale University (2019), ‘Environmental Performance Index’.
Schubert (2018), ‘Macroeconomics and the Environment’, and Daly (1991), ‘Towards an
Environmental Macroeconomics’.

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 12.3 economic adjustment & sustainability 293

Finally, the development in the institutional foundations of the

European Macroeconomic Constitution has arguably been the most
advanced with respect to both structural economic adjustments and also
environmental sustainability. First, during the crises, structural adjust-
ments in the form MoUs played a major role, and the EU institutions
were heavily involved in their design. The ESM, albeit formally not part
of the EU legal framework, can be considered as part of the European
Macroeconomic Constitution, and as a vehicle for addressing structural
problems. Similarly, the new medium-term orientation of the SGP with
its Medium-Term Budgetary Objectives as well as the Macroeconomic
Imbalance Procedure both take more structural perspectives on Member
States’ public finances and economies.30 This structural perspective was
maintained with the pandemic responses, although with a slightly
bizarre link between a clearly cyclically justified and also allocated
pandemic support and the structural aims of the RFF. As a result, the
legal questions related to the EU’s role in structural economic adjust-
ments have emerged concerning most of these measures and changes.
The legal science has to assess the problems with regards to the conferral
and the potential negligence of Treaty provisions on public finances.
From the institutional and legal perspective, environmental sustain-
ability differs substantially from structural economic adjustments. It
even has its own, albeit sparingly used, Treaty provision in Article 11
TFEU. Environmental sustainability is also substantively linked with the
internal market in many ways, and the most substantive advances have
been achieved in many industry-specific programmes and regulations
that have cemented the role of the EU in the field. In fact, the pandemic
RRF and its allocation of funds to Green transition could be seen as a link
between the macroeconomic and microeconomic areas of the EU
economic-constitutional model, which is a task for the future academic
research as well.

12.3.2 Objectives for Whom?

The analyses showed that both structural economic adjustment and
environmental sustainability have been penetrating the broad sphere
of the EU economic constitution. Whether they could be perceived as
part of the economic constitution, as disruptions to the constitutional
model or as still finding their shape and ultimate relevance, remains an

30
Regulation (EU) No 1176/2011 of the European Parliament and of the Council of
16 November 2011 on the prevention and correction of macroeconomic imbalances.

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 294 12 the ecb and the macroeconomic constitution

open question. Both are clearly addressed at the EU level and in the field
of economic management, but substantively they might exhibit
clear differences.
Structural economic adjustment remains primarily a national respon-
sibility, as most of the issues involved have direct links to the broader
economic and social fabric of the Member States. The role of the EU in
this field has increased with many institutional changes, whereby the
Commission has been given a substantial monitoring and even control-
ling role, to which new and temporary allocative tasks through the RRF
have been added most lately. Thus, structural economic adjustment has
become an EU objective also.
For the ECB, the objective of structural economic adjustment is
important, because the problems and failures in that field have affected
and will continue to affect the conduct of monetary policy in the EMU.
However, with the means available to the ECB, structural adjustments at
the EU and also at the Member State level cannot be assigned to the ECB
as its actual objective. The monetary policy transmission argument could
in theory be available as a rationale for country-specific monetary policy
measures, but as was claimed already when discussing the financial
stability objective, the monetary transmission argument has been
stretched to the limit already. This does not exclude, quite the contrary,
that the ECB takes structural economic adjustments into account when
deciding on common monetary policy, but it does exclude that it
becomes an actual ECB objective. Another issue, or risk rather, is the
exposure of the ECB to the failures in structural adjustments through its
holdings of government bonds.
The environmental sustainability objective has had a clear EU dimen-
sion from the start. As the key problems exceed national boundaries, the
EU level is the natural locus for the Member States, but also a means to
gain leverage at the important global level. Furthermore, as explained
earlier, most areas of the EU economic-constitutional model are linked to
environmental sustainability. It could thus be argued that environmen-
tal sustainability can be seen as an objective for the European
Macroeconomic Constitution, and also for the broader economic
constitution. It remains for the institutional and legal development to
make it a more efficient objective with clearer remedies and directing
powers. Through such constitutionalisation, environmental sustainabil-
ity could be seen to form a new layer in the EU economic constitution,
alongside micro- and macroeconomic layers, but that is a subject for
another book.

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 12.3 economic adjustment & sustainability 295

As for the ECB, environmental sustainability was thoroughly discussed

in the strategy 2021 review. The willingness of the ECB to support efforts
towards environmental sustainability was clear, but the actual means
remained relatively vague. The main initiative was the incorporation of
sustainability considerations as criteria for the favourable treatment of
assets in the ECB operational framework. The actual impact of this
might remain symbolic, at least as long as the ECB operational frame-
work is pushing liquidity to the economy by almost any means. In
addition, at the principle level the allocative decisions by the ECB do
not bode particularly well with its independent expert position, even if
an environmental bias in decisions could be interpreted as the ECB’s
contribution to the economic policies in the EU. Hence, the most import-
ant environmental impact of the ECB’s monetary policy is likely to be
based on intellectual persuasion rather than actual market impact
through purchases or other allocation of funds.

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 Epilogue: Where Do We Go from Here?

Things have not gone as planned. The EMU and the ECB as its guardian
were assumed to guarantee stability and prosperity for the euro area, but
the reality has been anything but. Consequently, the ECB is a very different
creature today from what it started off as – or indeed what is should be on
the basis of the European Macroeconomic Constitution. Most changes have
taken place as reactions to new and unforeseen situations, and could be
defended on economic grounds, if not always on the grounds that were
presented by the ECB itself. Unsurprisingly, the ECB has described the
measures it has adopted as successes, which follows a long history in
central banking of claiming successes and never admitting mistakes.
However, in order to sketch ways forward, it is first necessary to conclude
where we are now and what are the main constitutional problems at hand.
A broad economic and constitutional assessment reveals two main
interrelated imbalances. First, the increasingly discretionary reach of
the ECB and its constitutional model of a narrow central bank, which
also relates to the aim to control the ECB through constitutional object-
ives that are becoming increasingly vague. Second, the increasingly
political scope of the whole European Macroeconomic Constitution on
one hand and the excessive reliance on the ECB as its main guardian on
the other hand, that has led to a serious overburdening of monetary
policy. The first imbalance is mainly a constitutional and democratic
problem, while the has a more economic reach.
The background for both imbalances is that the ECB today penetrates
financial markets, euro area economies and societies in ways that it
hardly understands itself. Most recently, through PSPP and PEPP bond
purchases, the ECB has intentionally affected basically all the asset prices
in the euro area, which in turn shapes euro area wealth distribution in a
profound manner through a transfer of wealth to those who already own

296

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 epilogue: where do we go from here? 297

from those that are only aspiring to own in the future; fundamentally
also a wealth transfer from young to old. However, and in contrast to
most nation states, the economic-constitutional approach to the econ-
omy consciously limits discretionary interventions in the economy. This
regards in particular the areas that are assigned to independent experts
such as the ECB. The narrow central bank model and its accountability
and legitimacy mechanisms are a poor fit with the roles the ECB has
taken or has been forced to take.
This leads to the specific question concerning the objectives of the
European Macroeconomic Constitution and the ECB. The shift in ECB
objectives from price stability towards broader objectives has coincided
with the changing and more nuanced role of the price stability objective
more generally, in both global central banking and also monetary
theory. Price stability, or inflation-targeting more precisely, alone is no
longer assumed to guarantee broader economic and societal stability,
because a singleminded price stability focus can lead to a build-up of
longer-term instabilities. Consequently, if the ECB’s focus on price sta-
bility does not guarantee economic and financial stability, the argument
could go, it would need to ensure them by other means. This is arguably
also the new reality in the EMU, where many ECB measures are more
readily explained by other rationales than price stability alone.
From a constitutional perspective, the new reality is not without
problems. The discussion on other objectives showed that the ECB can
support policies to facilitate financial stability, structural adjustments or
environmental sustainability. However, making these other objectives
an actual responsibility of the ECB would conflict with the constitutional
model and with the ECB’s extreme formal independence. Its discretion in
the choice of policies and even instruments should be counterbalanced
by controllable tasks and objectives.
The legal cases with the price stability and financial stability objectives
underline the development. The CJEU has relied almost solely on the
price stability objective as a means to distinguish between the area that
has been conferred to the ECB, monetary policy, and national economic
policy. The CJEU has refused to take recourse to any economic or sub-
stantive definitions of monetary policy beyond its objective of price
stability. This judicial review contrasts with the economic and institu-
tional reality that is more ambiguous and multifaceted – in particular
with the increased role of financial stability considerations also in ECB
measures. In this setting, if the price stability objective has lost its
relevance as the main rationale for ECB measures, there is an imbalance

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 298 where do we go f rom here?

between the judicial review of the ECB and its actual measures. The CJEU
could correct this by reassessing its legal argumentation by basing it on a
more comprehensive and substantive economic assessment of monetary
policy. Such a reassessment could lead to demands for the ECB to clarify,
which measures are actual monetary policy and which are supporting
economic policies in the Union. And the latter ones would need to be
balanced with the principle of conferral and Member States competences.
The second imbalance takes the broadest perspective to acknowledge
that, the discrepancy between the increasingly political scope of the
European Macroeconomic Constitution and the reliance on the ECB is
increasingly overburdening monetary policy. Indeed, as the scope of the
European Macroeconomic Constitution has increased, the EMU macro-
economic governance has become increasingly political. The assump-
tion, or illusion as some would call it, of apolitical and scientifically
directed field of monetary policy and framework for Member States
fiscal policy, has not survived the test of reality. The EMU macroeco-
nomic governance, including the ECB, now consists of highly political
decisions that include monetary transfers and value judgments at
multiple levels.
In the process, the reliance on the ECB as the main guardian of the
European Macroeconomic Constitution has constantly increased, which
has overburdened monetary policy beyond any earlier experience.
Following the Tinbergen Rule, the ECB should not have more goals than it
has policy instruments, where the main complication is the definition of a
policy instrument. Proponents of the ECB’s expanded role claim that the
ECB has multiple tools, including interest rates, bond purchases and
targeted liquidity measures. However, I would argue that most of these
instruments are basically different manifestations of one, namely of the
monopoly issuance of legal tender, money. Consequently, this one instru-
ment has now been harnessed to maintain price stability, to achieve finan-
cial stability, to support growth and to facilitate Member State public
finances. This overburdening could be considered extremely risky, a gamble
with very high stakes. Apart from relying on luck, the solution could be
either to reduce the actual objectives of the European Macroeconomic
Constitution or to have more guardians with a legitimate political backing.
This leads to the final considerations on the future of the ECB, the
common currency and the European Macroeconomic Constitution. I could
sketch three paths for the future with different legitimacy implications.
First, the ECB continues with its path of becoming the central bank of
crisis, the euro area fire brigade. It remains the key euro area economic

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 epilogue: where do we go from here? 299

policy actor that aims to ensure the (financial) stability of the euro area
as a whole against any conceivable threats. It also continues to ensure
extremely favourable financing conditions for governments, even
employing its financing tools more directly to advance structural adjust-
ments and environmental sustainability. The pandemic response was
illuminating from this perspective. The ECB engaged in a large variety
of measures that were more extensive than the ones put in place by other
major central banks (PEPP) and made deep inroads to the economy
through various support mechanisms for governments, banks and com-
panies. The ECB also takes its decisions unilaterally, in contrast to other
major central banks that act as part of the broader executive with a
democratic backing. Undoubtedly, the EU Council and particularly the
Commission will continue their work towards a more sustainable eco-
nomic policy model for the EU, including the public finances of Member
States. This takes place through increased transfer mechanisms or
through more surveillance or both. In any case, Member States discre-
tion will decline. The pandemic package gave some insights of this path.
It was an unusual combination of mainly structurally rationalised meas-
ures to fight a temporary downturn. It assigned new allocative capabil-
ities for the EU Commission particularly in the areas of digitalisations
(economic adjustment) and green transition. Following this path, it is
possible that the euro area could even start to function as a currency area
proper with increased labour mobility and wage flexibility, and finally
regain its ability to generate prosperity and stability.
The legitimacy that could become available the soonest is output
legitimacy. Constitutional problems with the approach would disappear
only through a Treaty change that would solve the main legitimacy
problems by restoring a Treaty basis for the new measures and hence
the rule of law. In that case, many of the constitutional mutations of the
crises would become permanent and the Maastricht constitutional
model would be replaced by a New European Macroeconomic
Constitution that would try to address the malfunctions of the EMU by
centralising economic policy powers and frameworks, such as common
unemployment insurance. The ECB’s broad discretion, vast economic
reach and accountability would need to find a sustainable balance in
the New European Macroeconomic Constitution that does not rely on
judicial review. The constitutional position of the ECB, and in particular
the fate of its independence, would be a major political contest.
Regardless of any Treaty changes, the main economic risk with this
model remains that the ECB over-extends its role and capabilities for

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 300 where do we go f rom here?

the short-term urgencies. The current situation is already alarming:

massive and sustained monetary stimulus has made the euro area exces-
sively vulnerable to even a relatively modest sustained increase in infla-
tion and interest rates.
Second, as an alternative path, the ECB could choose to opt for more
transparency, accountability, and self-restraint through its own actions,
particularly if the situation first stabilises. The main question relates to
the role of price stability as a means of ensuring economic stability and
prosperity. If price stability is considered, again, the main contribution a
central bank can and should make to society, the ECB could re-emerge as
the independent expert it was designed to be. Its interventions would be
wound up gradually, including the enormous government bond hold-
ings. Banking supervision would be either renationalised or more likely
transferred to a new EU institution. The ECB would regain its original
legitimacy stemming from the Maastricht Treaty, and the European
Macroeconomic Constitution reconstructed in Part I could regain valid-
ity. The needs for structural adjustments and environmental sustainabil-
ity would be addressed by the Member States and the EU, while the ECB
would support these policies as it deems appropriate.
Finally and unfortunately, the EMU could collapse with limited
advance warnings. The constant stream of problems and instabilities

12,000,000 12,000,000
11,000,000 11,000,000
10,000,000 10,000,000
9,000,000 9,000,000
8,000,000 8,000,000
7,000,000 7,000,000
6,000,000 6,000,000
5,000,000 5,000,000
4,000,000 4,000,000
3,000,000 3,000,000
2,000,000 2,000,000
1,000,000 1,000,000

2000 2005 2010 2015 2020

Figure 13.1 ECB total assets (bn euros)

Source and copyright: ECB Statistical Data Warehouse.

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 epilogue: where do we go from here? 301

could indicate that the EMU is more a source of problems than of

solutions, mainly because it never was and is unlikely to become an
optimal currency area. The history of central banking and monetary
regimes has shown that the will of authorities can keep dysfunctional
models operational for some time, but not forever. So far, the main
solution to all the euro area problems, including those caused by the
pandemic, has been to create more money and liquidity (Figure 13.1).
This puts enormous weight on monetary policy that derives its abilities
from the issuance of legal tender. If this money-issuance became over-
burdened, it could finally lead to an uncontrollable situation with high
inflation and a run out of money. The possibility of this alternative
should put enormous pressure on authorities to design policies that
acknowledge the old truth: what cannot continue forever has to stop.

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 Index

accountability, 28, 51, 90, 98, 116, 123, 223, Bundesbank, 9, 15, 29, 50, 62, 98, 143, 175,
236, 255, 270–271, 279, 297 183, 191, 204, 237
ad hoc measures, 2, 129, 133 Act, 26, 78
adjustment programmes, 157, 159, 175, model of, 73, 75
178, 253, 289
Advocate General, 160, 213 capital flight explanation, 143
allotment central bank independence, 39, 50, 74, 121,
fixed, 131 160, 231, 234, 277, 280
full, 131, 133–134, 241 circumvention of prohibition, 188, 196
Annual Report, 116, 223 collateral, 110, 114, 127, 241
asset price boom, 33, 52, 149 eligible, 111
Asset Purchase Programme, APP, 197, 242, framework, 111
245 policy, 111, 120, 135, 139, 158, 160, 173
asset-backed security (ABS), 146, 242 pool, 172
assumptions, 29, 45, 91, 266, 273, 277 requirements, 142, 242, 252
asymmetric shocks, 124, 290 shortage, 172
use of, 112
bailout, 80, 151–152, 154–155, 174 Commission, 53–55, 58–59, 66, 70, 82, 87,
balance sheet channel, 167 118, 157, 220, 240, 269, 291, 294
Banca d’Italia, 13, 218 Committee of European Banking
Bank for International Settlements (BIS), Supervisors (CEBS), 218
115, 216 Committee of Governors (CoG), 59, 65
Bank of Canada, 133 communication, 115–116, 131
Bank of England (BoE), 30, 123, 149, 202, central bank, 50, 100, 202
243, 246, 286 of crisis measures, 140, 154, 157, 170,
Bank of Japan, 110, 123, 203 182, 198, 205, 244, 250–251
banking crisis, 130, 151, 201 competition rules, 54, 59, 269
banking supervision, 28, 52, 76, 100, 206, conferral, 4, 182, 234–235, 266, 271, 293, 298
217, 224, 262, 272, 300 principle of, 57, 76, 162, 182, 208, 234,
banknotes, 30–31, 33, 104, 113 266, 298
Banque de France, 13 constitutional
benchmark bond, 167–168, 199, 210 acceptability, 120
Bernanke, Ben, 200 architecture, 72
bond spread, 151–152, 164, 166, 168, 178, 183 assessment, 7, 92, 144, 207, 212, 232, 252
borrowing cost, 149, 207 assumptions, 1
Böhm, Franz, 15–16, 18 central bank, 125
breakup concerns, 121, 150, 236, 250, 283, 299
of the euro area, 144–145, 169, 176, 180, control mechanisms, 90, 270
183, 191, 213 court, 4, 56
Bretton Woods system, 23, 27, 59, 61 framework, 69

329

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constitutional (cont.) deflation, 35, 40, 48, 97, 119, 198, 259, 275,
model, 2, 13, 28, 53, 89, 127, 162, 255, 277
269, 274, 276, 293 in gold standard, 24, 30
objective, 283, 287 in Japan, 148, 200
order, 5, 21, 69 risk, 209, 264
pluralism, 4 structural, 281
principles, 5–6, 67, 78, 80, 254, 258, 261 Delors Report, 63–64, 73
review, 208 deposit facility, 110, 134, 241
thinking, 15, 29, 81, 257, 291 direct effects, 201, 209
traditions, 51, 291 disinflationary policies, 41, 43, 50
constitutionalism, 64, 259 disintegration, 70, 140
convergence, 63, 65 Draghi, Mario, 158, 174, 176, 180, 193, 199,
criteria, 66 204–205
legal, 71 Duisenberg, Wim, 121
report, 67, 124
convertibility, 32 ECOFIN Council, 65, 72, 87, 98, 106, 116,
corrective arm, 79 206, 222
counterparty, 145 Economic and Monetary Affairs Committee,
Court of Justice of the European Union, the 117
CJEU, 3–4, 10, 53, 56–58, 73, 82, 85, 87, Economic Bulletin (Monthly Bulletin), 117,
91, 122, 141, 160, 162, 181–182, 190, 169
207–208, 221, 250, 270–271, 276, 285, economic constitution, 2, 9, 15, 21, 26, 258,
287, 297 269, 294
covered bonds, 134, 139, 141, 194 economic crisis, 132, 261
covid-19 pandemic, 1, 147, 194, 239, 261, economic foundation, 29, 52, 257
263–264, 266, 282, 290, 293, economic freedoms, 6, 8, 54, 56, 84, 240
299, 301 economic policy, 1–2, 9, 13, 16, 25, 37, 40,
credibility, 29, 34, 43, 47, 49, 51, 96, 123, 47, 54, 59–60, 74, 79, 254, 290
204, 210, 232, 265 coordination, 79
damage to, 237 effects, 209
credit default swap (CDS), 171 framework, 257
credit operations, 77, 105, 110 national, 124, 186, 266, 288, 297
risk, 242 neutrality, 85
credit quality, 113, 136, 241–242 pandemic, 243
current account explanation, 143 stability of, 24, 275
cycle U-turn in France, 62
boom and bust, 232 EMI, European Monetary Institute, 66, 124
business, 44, 52, 279 Erhard, Ludwig, 16–17, 25
financial, 52, 279 EU legal principles, 6, 53, 56, 59, 86
Eucken, Walter, 15, 22
debt Eurogroup, 158, 272, 281
default, 152, 154, 157, 170, 174, 176, 180, European Banking Authority (EBA), 218
196, 226, 248 European Council, 63, 66, 94, 218, 284
Greek public, 150, 159, 173 European economic constitution, 29, 53, 56,
instruments, 111, 136, 139, 164 59, 70, 81, 240, 269
issuance of, 108, 212, 253 legitimation discources, 89
monetising, 211, 266 European Financial Stability Facility (EFSF),
problems, 226 151, 175, 178, 253, 282
public, 1, 44, 67, 77, 80, 123, 145, European Monetary System (EMS), 61, 63,
152–153, 168, 248 74, 79
debt-deflation, 34–35, 278 European Parliament (EP), 62, 116, 223, 235,
decentralised, 22 270, 272
economic model, 24, 81 European Stability Mechanism (ESM), 141,
monetary policy, 105–106, 197 151, 153, 158, 160, 175, 178, 180, 185,
default, 80, 112, 145, 161, 169, 219 212, 228, 253, 282
Greek, 155, See debt default assistance, 178, 191, 289
Member State, 275 Treaty, 154, 284

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European System of Central Banks (ESCB), decisions on banking supervision, 223

116, 190, 216, 222, 233 disagreement, 173, 175
excessive deficit, 79, 87 Members, 94, 121
procedure, 67, 87, 155, 189, 268 government debt, 124
Exchange Rate Mechanism (ERM), 61, 67 government deficit, 67, 79, 85,
Executive Board, 75, 93–94, 116, 222 123, 267
exposure, 130, 132, 144 Great Depression, 23, 33, 40
ECB risk, 136, 141, 145, 294 Greece
banks, 226
Federal Funds rate, 125, 146 bond yield, 254
Federal Open Market Committee (FOMC), convergence criteria, 68, 124
36, 125, 202 problems, 138, 151, 155, 181, 219
Federal Reserve (US), 123, 204, 218, 230, rescue packages, 151
232, 243, 245 Greenspan put, 52, 232
Act, 33, 147 guideline
Board, 125 for economic policy, 79
Establishment, 32 for monetary policy, 93
financial conditions, 203, 227, 240, 246 on collateral, 195
financial crisis, 1, 51, 127, 129, 133, 137, haircut, 112–113, 120, 136, 242
170, 206, 217–218, 225, 261, 279, 282 harmonised
constitutional assessment, 138 consumer prices, 118
financial stability, 32, 49, 52, 76, 98, 155, deposit insurance, 220
164, 186, 206, 215, 232, 237, 255, 279
and independence, 234 Hayek, Friedrich, 17, 19
ECB mandate, 28, 217 hyperinflation, 23
objective, 260, 281, 283, 286–287, 289,
297 imbalances, 37
Financial Stability Review, 129 balance of payments, 37
fine-tuning operations, 108, 129, 188 economic, 64
fiscal policy, 44, 62 financial, 99
coordination, 282 TARGET, 143
discipline, 61, 124 impossible trinity, 23, 37
importance of, 80, 268 inflation targeting, 38, 46, 51–52,
multiplier, 44 279, 281
national responsibility, institutional choices and safeguards, 69, 74,
161, 189 258, 265
safeguards, 79, 298 institutional foundation of the European
Freiburg School, 15 Macroeconomic Constitution, 7, 52,
Friedman, Milton, 42 257, 293
interbank market, 107, 131, 282
gamble for resurrection, 139 dysfunction, 132, 134, 139, 142, 245, 255,
Gauweiler case, 181, 193, 207, 253 264
German Constitutional Court (FCC), 4, 26, government bonds, 167
154, 160, 181, 188, 191, 209, 234, 252, interdependencies, 19, 21, 81
264, 271, 276 internal market, 215–216, 237, 288
Germany, 15, 37 objective, 70, 73, 117, 262
bond yield, 151 International Monetary Fund (IMF),
economic policy, 60, 62, 79 36, 151, 155, 175, 226
low inflation, 47, 50 Ireland
monetary targeting, 37 banks, 219, 226
gold standard, 23–24, 31, 33, 36, bond yield, 137
39, 90 problems, 151
abandoning, 34 Italy, 37, 143
convertibility, 32 banks, 153, 210, 226
theory, 40 bond yield, 226, 254
Governing Council, 75, 77, 93, 104–105, debt, 124
117, 156, 195, 197, 236 problems, 152, 174

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Jackson Hole consensus, 51 implementation, 105

Japan overburdened, 298
deflation, 277 stance, 107
monetary policy, 110, 147 strategy, 92, 95, 97
QE, 200 monetary targeting, 37, 50
judicial review, 91, 186, 194, 255, 266, 270, money market, 108
289, 297 interest rates, 92, 102, 166
liquidity, 105, 107, 130, 137, 241
Keynes, John Maynard, 40, 42 moral hazard, 52, 80, 120, 123, 139, 187,
keynesianism, 40, 43, 45–47, 61, 83 205, 219, 232, 236, 267
Kompetenz-Kompetenz, 4 mortgage-backed securities (MBS), 146, 245
Müller-Armack, Alfred, 17, 19
legal reasoning
of the CJEU, 53, 86 narrow central banking model, 76, 91, 234,
legitimacy, 3, 51, 89, 219, 269 266, 271
democratic, 2, 62, 91, 223, 234, 236, 270, narrow mandate of the ECB excluding value
272 judgements, 266
output, 270, 273, 299 national central banks,
problems, 299 9, 39, 116, 142
Lehman Brothers National Central Banks, NCBs, 75, 92
collapse of, 132 national parliaments, 116, 223, 236, 270
lender of last resort, 35, 146, 177, 179, 207, neutrality of money, 44, 96
253, 287 New Keynesian
liberal discourse, 89–90 approach, 43, 45
liquidity New Neoclassical Synthesis, 43
crisis, 132, 167, 241 Nixon shock, 37
emergency assistance, 161, 230 normative premise, 6, 262
excess, 108 for the EMU, 7, 125, 258
preference, 40
provision, 32, 102–103, 107, 137, 159, 245 objectives of the European Macroeconomic
shortage, 32, 35, 130, 132 Constitution, 70, 262, 276
liquidity preference for money, 40 official interest rates, 101
longer-term refinancing operations (LTROs), Bundesbank, 28
108, 133, 137, 153, 219, 226, 254, 286 central banks, 132
Lucas critique, 43 ECB, 95, 105
UK, 203
Maastricht judgment, 4 US, 202
Maastricht Treaty, 1, 9, 53, 64, 69, 71, 91, oil price shock, 37, 41, 61
117, 217, 236, 257, 270, 300 OLAF case, 87, 122
negotiations, 67, 233 open market economy and free competition
macroeconomics, 45, 82, 288 principle, 73, 120, 264
in legal cases, 86, 271 open market operations, 107
Macroeconomics, 83 amount of banks, 105
main refinancing rate (MRO), 105, 108, 110, and collateral, 110
130, 134, 137 and crisis (US), 146
market mechanism, 120, 141, 264 counterparties, 109
replacement of, 140 ECB monetary policy, 108
measurement bias, 48, 97 liquidity, 107
Mestmäcker, Ernst-Joachim, 16 US, 126
microeconomics, 55, 81, 83 operational targets, 77, 123
paradigms of, 83 ordoliberalism, 17–18, 25
minimum reserves system, 106 Outright Monetary Transactions (OMT),
monetarism, 42–43 162, 175, 177
monetary aggregates, 28, 37 and rescue programmes, 191
monetary income, 104, 122, 254, 265 and the PEPP, 248, 253
monetary policy, 6, 13, 29, 39, 92, 296 and the PSPP, 213
definition, 46, 277, 298 rationale, 183

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Pandemic Emergency Purchase Programme Public Sector Purchase Programme (PSPP),

(PEPP), 242, 253 194, 198
backstop function, 251, 287 rationale for, 199
flexibility of, 248 risk, 264
paradigm risks, 213
central banking, 279 size, 248
economic, 9, 82, 91
legal, 7 quantitative easing (QE), 146, 149, 193, 200,
payment system, 113 204, 207, 254, 264, 286, 292
principles, 120 quantity theory of money, 39, 42, 212
promotion of, 76, 113, 217
TARGET2, 114, 144 rational expectations, 43, 45, 49
performance-based competition, Real Business Cycles approach (RBC), 44
18, 20, 55, 82 redistribution, 205
Phillips curve, 41, 43 referendum, 118, 152
portfolio rebalancing, 210 repurchase agreement (repo), 110
effect, 199, 201 rescue programmes, 177–178, 190, 293
Portugal reverse transactions, 108
problems, 137, 151 risk premia, 96, 175
President of the ECB, 93–94, 155, role of
174, 193 central bank, 35, 40, 45
press release courts, 85
Fed, 125 experts, 88, 269
OMT, 175 financial stability, 297
pandemic, 244 law, 85
price mechanism, 20, 23 objectives, 185, 255
in ECB operations, 110, 265 price mechanism, 26
safeguards, 24 price stability, 29, 264, 276, 300
price stability, 23, 31, 125 the state, 18, 65
and deflation, 275 Röpke, Wilhelm, 16
and financial stability, rule of law, 10, 20, 28, 55, 85, 272, 288, 299
231, 277, 279 Rüstow, Alexander, 17
and gold standard, 33
and pandemic, 254 safeguards
and Strategy Review, 276 against arbitrary use of power, 55
and the PSPP, 200 against unsound policies, 64, 79,
benefits of, 47, 96 187, 268
criteria, 66 procedural, 189, 211
definition of, 98 safeguards against unsound policies, 79
internalisation of, 50 secondary market, 134, 180
numerical definition of, 86, 95, purchases, 78, 124, 164, 185, 196, 211
97, 118 Securities Market Programme (SMP),
objective, 27, 71, 118, 163, 263 161–162, 164, 176, 178
primary objective of, 65 seigniorage income. See monetary income
rationales, 39 selective government bond purchases, 162,
primary market 265
purchases of bonds, 160, signalling effect, 201–202
180, 194 Single Resolution Board (SRB), 221, 234
principles of the European Macroeconomic Single Resolution Fund (SRF), 221
Constitution, 7, 117, 144, 254, 261, 270, Single Supervisory Mechanism (SSM), 218,
272 220–221, 234, 243, 270, 289
Pringle case, 141, 185, 285–286 social market economy, 17, 19, 70, 290
prohibition of public financing, 73, 78, 267 social policy
proportionality, 56–57, 208–209 objectives, 289
test, 183 ordoliberal, 19
prudential supervision. See banking solvency, 35, 141, 153, 171, 184, 228
supervision support, 131, 173

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sovereign debt crisis, 127, 138, 150–151, time-inconsistency problem, 43, 49, 72, 89,
156, 159, 192, 226, 243, 265, 282 231, 276–277, 280
sovereignty, 79–80 transmission channel, 101, 175
economic policy, 257 transmission mechanism, 96
national, 208, 223, 267 monetary policy, 46, 92, 100
Spain, 143 rationale, 167, 289
banks, 179, 210, 219, 226 restoring of, 164, 178, 244
problems, 152, 174 transparency, 90, 231, 255
Stability and Growth Pact (SGP), 88, 124, and accountability, 115, 270
155, 293 central bank, 28, 39, 50, 234
standing facilities, 105, 110, 133–134 of the ECB, 100, 300
Structural operations, 108 treasury, 205
subsidiarity, 5, 56 Treasury Secretary, 147
sustainability Treaty of Rome, 8, 53, 59, 62, 69, 216, 264
environmental, 244, 273, 290, 294 Trichet, Jean-Claude, 121, 155, 157, 164
of banks, 153 Troika, 157, 159–160, 213, 265
of the euro area, 153, 236 troubled Member States, 188
public finances, 66, 124, 151, 168, 181, and the ECB, 266
213 banks of, 161
Sveriges Riksbank, 133 bonds of, 164, 180
Swiss National Bank, 133, 230 two-tier structure TARGET, 111
systemic risk, 139–140, 228, 231
UK Treasury, 149
TARGET unconventional monetary policy, 10, 131,
payment system, 114, 120 142, 207, 261
TARGET2 US dollar liquidity, 130, 133
imbalances, 142, 245 US Treasury, 33, 41, 146, 245–246
payment system, 114
taxpayers’ money, 149 verbal interventions, 150, 154, 160
tender, 108 Weiss case, 213, 271
fixed rate, 133 CJEU, 193
legal, 298, 301 FCC, 252, 264
variable rate, 109, 130–131
weekly, 134 Werner Report, 60
three-year LTROs, 137, 152, 160, 210 Wirstshaftswunder, 26

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