Christine Lagarde, President of the European Central Bank (ECB), has reminded the Bundesbank of its obligation to comply with monetary policy decisions in the euro area. “Under the agreement, all national central banks must participate fully in the decisions and implementation of the monetary policy of the euro area,” Lagarde said in an interview with the Handelsblatt and three other European newspapers (Les Echos, Corriere de la Sera, El Mundo) .
Lagarde responded to a ruling by the Federal Constitutional Court prohibiting the Bundesbank from further government bond purchases within a program that has been running since 2015 unless the ECB provides a more accurate justification for the proportionality of its monetary policy. In the worst case, the Bundesbank could put this judgment in around two and a half months, either in breach of its obligation under European monetary policy or against the judgment of the Constitutional Court.
The ECB does not consider itself bound by the judgments of national courts, but the Bundebank is subject to German jurisdiction as a German authority. The ruling had raised concerns about the existence of the euro zone. Lagarde, on the other hand, emphasized that the euro was “irreversible”.
Monetary policy decisions in the euro area are made by the Governing Council, which consists of six directors and 19 heads of national central banks, including Bundesbank President Jens Weidmann. The national central banks are largely responsible for implementing the decisions.
The ruling by the Constitutional Court concerns a program known under the acronym PSPP, which currently provides for purchases of government bonds for € 20 billion a month. Newer programs specially created for the Corona crisis are not directly affected.
Regarding the proposal of a 500 billion euro reconstruction fund by Chancellor Angela Merkel and French President Emmanuel Macron, Lagarde said that it was “ambitious, targeted and welcome”. She added: “They open the way to long-term bonds from the EU Commission”, they also testified to the “spirit of solidarity and responsibility”.
Read the entire interview here:
Ms. Lagarde, Emmanuel Macron and Angela Merkel propose a reconstruction fund of 500 billion euros. What do you make of it? Is this budgetary effort enough so that the ECB no longer has to bear the burden alone?
The Chancellor and the President’s proposals are ambitious, targeted and welcome. They open the way to long-term bonds from the EU Commission and allow extensive direct aid from the EU budget to be given to the countries most affected by the crisis. This testifies to the spirit of solidarity and responsibility that the Chancellor addressed last week. There can be no strengthening of financial solidarity without greater coordination of decisions at European level.
European countries are gradually coming out of the lockdown. How do you assess the economic shock for the euro zone?
The shock is considerable and is unparalleled in peacetime. We must face it with determination to help our economies recover as quickly as possible while avoiding a social crisis. Our scenarios range from a recession of five to twelve percent for the euro zone this year, with a central assumption of eight percent. We’ll review our projections on June 4th, but in the worst case, we expect gross domestic product to fall 15 percent in the second quarter alone.
In reality, it is difficult to assess the impact of post-lockdown opening in each country, especially when we have to include the assumption of a second wave of the fall epidemic. One element seems likely: if there is a second wave, its economic impact should be less severe as experience bears fruit.
What is the ECB’s mandate in this unprecedented coronavirus crisis? According to the contracts, it does not include growth and employment.
Price stability is at the core of our mandate, with an inflation rate below but close to two percent. In circumstances like today, where inflation and inflation expectations are well below our target and the economy is in a deep recession, the ECB must pursue a monetary policy that is as accommodating as it is to stabilize both inflation and the economy is required.
We have to intervene whenever there is a risk of tightening financial conditions. And we have to make sure that monetary policy is carried over to all countries in the euro area and to all sectors. This is the purpose of our extraordinary instrument, the Pandemic Emergency Purchase Program (Pepp).
So do all countries where monetary policy doesn’t seem to have the desired effects deserve help?
Definitely. The transmission of monetary policy is as important as monetary policy itself.
The 2012 debt crisis and then the 2015 debt crisis in Greece threatened the future of the euro itself. Today’s economic crisis is much worse. Is there a risk of the euro zone breaking apart?
No. The situation is not the same at all. This time it is not a financial and real estate crisis that spills over the entire economy, nor is it a crisis in which a country has sidelined itself because it has used a bad economic policy cocktail. It is a symmetrical shock that affects all economies at the same time. To protect the health of Europeans, politicians have decided to partially shut down their economies. It is therefore important that all countries start again under good conditions and using all available instruments.
So is the risk to the euro zero?
Yes, and I would like to remind you that the euro is irreversible, which is anchored in the Treaties.
The interest rate differentials on government bonds from southern European countries are larger than at the beginning of March, despite the measures you have taken. Are you content?
Let me say it again: it is our job to ensure the proper transmission of monetary policy in all countries in the euro zone. We will continue to act without hesitation. Since March 18, when the Pepp was announced, the Italian spread (against the ten-year Bunds) has declined sharply. This also applies to the Spanish and Portuguese interest rate spreads.
How do you rate policy makers’ response to the crisis? In 2012, your predecessor Mario Draghi’s “Whatever it takes” followed, but did not go ahead with, the promises made by European leaders.
At the national level, governments have understood what is at stake. Between direct aid to households, deferral of fees and guarantees for the private sector, they put the equivalent of 20 percentage points of economic output (GDP) in the euro area on the table. That is a lot. For its part, the European Commission has lifted the constraints of the Stability and Growth Pact and released the state aid mechanisms: this was essential. But there are limits to all of this because the relief efforts are too asymmetrical. Depending on the country, they fluctuate between two and 40 percent of GDP if we combine the direct aids and guarantees. The economically weakest countries, which are sometimes worst affected by the virus, do not have the fiscal leeway to make the necessary efforts to get their economy back on their feet. So the solution is a quick, solid European economic recovery plan to restore symmetry between countries when we get out of the crisis. It is clear that this plan must help those countries that need it most. It is in the interest of every country to provide this collective aid.
What exactly do you expect from the European Council?
The Council has an immense responsibility: it must do justice to the seriousness of the economic damage and social suffering. How far did we get? EUR 540 billion is already potentially available through what comes from the European Stability Mechanism (ESM), the additional guarantees for businesses (with a focus on SMEs) that have been committed by the European Investment Bank and the Commission’s “Sure” plan Co-financing of short-time work to be introduced from June. The ESM credit lines have nothing to do with past bailout packages. These are loan offers of up to two percent of each country’s GDP, at very low interest rates and with minimum conditions. It is sufficient to prove that the funds are intended for direct and indirect health expenditure to combat the pandemic. This package of support measures is to be welcomed, but it is clearly not enough to stimulate the eurozone economy again.
What size do you think is necessary?
We estimate the total additional financial needs of the states that will arise from this crisis for 2020 alone between 1,000 and 1,500 billion euros. Some will easily reach the amounts needed, while others will need the Community’s financial solidarity, the scope and composition of which will depend on the ambition of the Heads of State or Government headed by Charles Michel and Ursula von der Leyen. This European stimulus package, which I hope will be swift and massive, must also focus on investing in common public goods, those that should be financed together rather than alone, because that is more effective. I include health security, the transition to a greener, more digital economy, and one that better protects biodiversity.
If the European Council does not set up a sufficient growth fund, can the most vulnerable countries count on the ECB’s rescue program (OMT)? And under what conditions?
The OMT remains an important tool in the European toolbox, but it was designed for the 2011 to 2012 crisis, which is very different from today’s crisis. I do not think it is the most appropriate tool to deal with the economic consequences of the Covid 19 health crisis. Today, in the face of such a systemic shock, the Pepp, our € 750 billion program to buy public and private securities, is the most appropriate.
Its amount was calibrated in March when we had an imprecise idea of the recession. If your forecasts change in June, will that be the time to correct them upwards?
We were and are very clear on this question: we will not hesitate to adjust the size, duration and composition of the Pepp as much as necessary. We will use all necessary flexibility within our mandate. There are no psychological barriers to our actions.
The budgetary situation in Italy, Spain and France was difficult even before the crisis. Are you not worried about their situation today? Should we give up the Stability and Growth Pact?
Today, the priority is to help economies recover. Government spending and debt will naturally increase and debt to GDP will increase because we are in a recession. Debt is increasing in all countries of the world: According to IMF forecasts, US debt will reach more than 130 percent of GDP by the end of 2020, while the euro zone will be below 100 percent. This is of course an average, there are differences between the countries of the euro zone.
However, in order to assess debt sustainability, we should not focus on the level of debt relative to GDP. You have to take into account the level of growth and the prevailing interest rates. These two elements are crucial.
I believe that this crisis is a good opportunity to modernize the modalities of the Stability and Growth Pact that is now suspended. Innovative proposals have been made in the past, including by the IMF, that should be reviewed. Their relevance and effectiveness must be measured. I believe that the conditions of the Stability and Growth Pact need to be reviewed and simplified before considering its reinstatement after the crisis has been overcome.
What do you think of the idea of corona bonds, a communal debt?
It is important that all European countries become aware of their interdependency: A German car factory can come to a standstill because there are no Italian, Spanish or French spare parts. Trade integration within the euro area is so strong today that it is obviously in the interest of all countries, especially the strongest, for the weakest to recover. Otherwise everyone will lose.
If the European economic recovery program combines Community grants and very long-term loans with low interest rates, which are primarily intended for the countries that need them most, then we have taken a big step forward in European financial solidarity.
What do you call very long term loans? Ten, 30, 50 years?
For the European Growth Fund, the term of the loans should be at least about ten years, but it is clear that longer terms would help spread the cost of the crisis over time. For its part, the ECB buys securities with very long terms of up to 30 years.
What is really at stake in the decision of the Karlsruhe Constitutional Court? The independence of the ECB, the primacy of European law or Germany’s attitude towards the EU – or the euro itself?
We have taken note of this decision. The ECB is subject to European law, it is accountable to the Members of the European Parliament for its activities, and it is ultimately responsible to the Court of Justice of the European Union. In December 2018, the ECJ unequivocally determined that the purchases of government bonds by the ECB (PSPP program) are fully in line with its mandate and European law.
But isn’t this a serious challenge for the European legal order? Europe was built on the right.
Europe is an architecture of law; the European Union is built on a very clear legal system. And the independence of the ECB guaranteed by the treaties is a cornerstone of German monetary policy theory. That is what gives the ECB the strength to fulfill its mandate.
Despite this decision, can you continue to use your government bond purchase programs?
Yes, the judgment of the Federal Constitutional Court itself is clear: it says that the Pepp program decided in connection with the pandemic is not affected by this judgment. I am not worried about either the pandemic program (Pepp) or the previous program that deals with debt purchases from 2015 (PSPP). As I told you before, the European Court of Justice ruled in December 2018 that it was in conformity with the contract. We remain steadfast in pursuing our goal of price stability.
Aren’t you worried that there will be doubts in the financial markets and that this will limit the effectiveness of your policies?
The Pepp is a targeted and limited-time purchase program that responds to exceptional circumstances. The other European institutions have also taken extraordinary measures in this crisis.
Is the legitimacy of the Pepp guaranteed by the exceptional nature of the moment?
It is absolutely justified by this extraordinary shock.
But how will the Bundesbank position itself under these conditions? Will it participate in the ECB programs or not?
The Treaty requires all national central banks to participate fully in the decisions and implementation of the monetary policy of the euro area.
Does the Bundesbank have scope for valuation?
Every national central bank in the euro zone is independent and cannot take instructions from governments. This is laid down in the contracts.
But what is your role as the ECB in this conflict?
My belief is clear. The ECB was given a mandate by the EU Member States to draw up and ratify the treaty. The ECB is subject to the case law of the Court of Justice of the European Union. We will continue to be accountable to the European Parliament and explain our decisions to European citizens.
How will the most indebted countries be able to get rid of the debt caused by the virus in a few years? Are the debts canceled, stretched in time, reduced?
The solution is solid and sustainable growth that, over time, will allow debt to be repaid and our economies to develop in a way that meets our citizens’ expectations.
For some economists, the idea of perpetual debt has had some intellectual success.
It is indeed an … intellectual debate.
You headed the IMF in Washington and came back to Europe a few months ago. What did you notice?
I have returned to Europe with the same beliefs: Our growth models must change, profoundly, to prevent and slow climate change; Inequalities are a danger; globalization must respect people more. From this point of view, Europe has fundamental and valuable values that inspire the rest of the world and that we must defend.
Ms. Lagarde, thank you very much for the interview.
In addition to our correspondent Thomas Hanke, Dominique Seux, Frederico Fubini and Carlos Segovia were also involved.
More: How the ECB ruling from Karlsruhe puts the federal government under pressure.