On the morning of Jan. 14, the Advocate General of the European Court of Justice issued a preliminary opinion on a case involving the European Central Bank's solution to the eurozone's 2012 sovereign debt crisis. The ultimate judgment could have far-reaching consequences in European policy and could become a battleground for the European Court of Justice and the German Constitutional Court. Although the statement is only preliminary, pending a full judgment in four to six months, it gives a strong signal about the likely outcome of the court's eventual ruling.
In July 2012, European Central Bank President Mario Draghi said he would be willing to do "whatever it takes" to save the euro and created a new bond-buying mechanism called Outright Monetary Transactions. The mechanism — which has not yet been used — would allow the bank to buy the sovereign bonds of a country in distress. A group of German academics, unhappy with the European Central Bank's plan to resolve the sovereign debt crisis, took the case to the German Constitutional Court in 2013. The academics felt this was outside the bank's purview, since its primary task is to set interest rates and control inflation, and the German court agreed with them. It decided to refer the case to the European Court of Justice, since it was a Europe-wide issue, but its own view was that Outright Monetary Transactions were illegal unless certain stipulations were met. Once the European court has passed judgment, the case will return to the German court.
This case is important because it touches on several big questions facing the eurozone, where countries share a currency but remain responsible for setting their own tax-and-spend policies. The question of the legality of Outright Monetary Transactions ties into the question of whether or not the European Central Bank can use all the countries' pooled money to prop up member states that need help. It also plays into another broad question under discussion right now: whether or not the bank will undertake quantitative easing. If Outright Monetary Transactions are found to be illegal, quantitative easing might cease to be an option. If the mechanism — and thus quantitative easing and all such products — is found to be legal, the ruling could motivate disgruntled Germans to gather around anti-establishment political party Alternative for Deutschland. This party — founded by the same academics who brought the case to the German court — wants Germany to leave the eurozone. From a constitutional viewpoint, if the European court disagrees with the German court's ruling, and the German court decides to disregard the European judgment, a confrontation between the courts could ensue, potentially causing a lot of damage before it is resolved.
What the Preliminary Opinion Entails
The European Court of Justice's preliminary opinion — as is usually the case with its rulings — came down on the side of European integration, ruling that the bond-buying scheme is legal in principle. It included some minor conditions, such as the European Central Bank should state its reasons before using such an unconventional instrument, but broadly speaking it approved of the mechanism.
The revelations, such as they were, were aimed more at the bigger picture. The opinion stated that the bank itself was the best suited to decide on these matters, since it has access to all available information and expertise to make an informed judgment. It also said that if the European Central Bank wants to undertake Outright Monetary Transactions, the bank then should remove itself from all other parts of the bailout program. Here, the court is referring to the so-called troika — the European Central Bank, the European Commission and the International Monetary Fund — that has designed many of the bailout programs for eurozone countries.
The sentiment that monetary policy should be left to the bank and is not necessarily a matter for the courts has two interesting angles to it. First, it seems to be a message to the German Constitutional Court that it should not be concerning itself with this type of thing. Second, and on a broader level, it raises questions about who is watching the watchers. If the European Court of Justice is not responsible for keeping the European Central Bank in check, what stops the bank from abusing its authority? This question is particularly salient in the current environment, in which Draghi seems to be the only player with the willpower and ability to take action while the French, Italians and Germans argue among themselves. The free hand that this precedent seems to give the bank could come back to haunt Europe in the future.
However, the European court's decision to place a wedge between the European Central Bank and its fellow troika members should diminish some of the political power the bank has enjoyed in recent years. The last 12 months have seen the embarrassing publication of various letters written from former bank head Jean-Claude Trichet to the presidents of beleaguered eurozone countries at the heights of their crises, threatening to cut off funding from the European Central Bank unless the countries adopted bailout programs. This European Court of Justice opinion draws the line between political matters and monetary policy, reminding the bank on which side of this line it belongs. Again, this is particularly relevant in light of recent comments from bank officials indicating that the bank would withdraw liquidity funding if Greece did not continue its agreed-upon bailout program.
The immediate effect of the European court's opinion is the implication that the European Central Bank will face no legal impediment to undertaking quantitative easing at its meeting Jan. 22. In the longer term, the political effects could be significant, particularly in Germany, where the Alternative for Deutschland party will no doubt show its disapproval, and Germans with the same concerns will flock to its banner. The constitutional implications will play out over a longer period. The European court's opinion threw not a crumb of comfort to the German court: It ruled against the German court's judgment, it failed to mention the German conditions, and it even implied this was not the German court's business in the first place.
For its part, the German Constitutional Court will not begin to act on the European court's judgment until it is final. The German court process is not likely to be much swifter than the European court's, so the next chapter might not even unfold this year. When it does unfold, it could open a new front and create new headaches in a eurozone that is already seeing the ties that bind it fraying.