While the ECB's actions can be seen as technical measures to ensure the singleness of euro area monetary policy and to achieve the ECB’s inflation objective, they are better seen as an act to preserve the euro.
Among the few things that monetary policy commentators across Europe agree on is that Mario Draghi’s pledge to do «whatever it takes» saved the euro. This promise has been implemented chiefly through the establishment of the ECB’s various asset purchase programs. The ECB’s other tool, its program of Outright Monetary Transaction (OMT), has so far never been needed.
Surprisingly, the ECB itself has never presented its asset purchase programs as intended to save the euro. Rather, it has asserted that they were technical monetary policy measures intended to safeguard the monetary policy transmission mechanism and to provide further monetary stimulus to prevent inflation from falling too far from its «below but close to 2%» objective.
This argument has run into trouble with the German Constitutional Court which recently held that it was unable to determine whether the ECB had considered the «economic policy» effects of its asset purchases. The court went on to say that the ECB should have balanced these against the positive monetary policy effects.
It is of course true that if the transmission mechanism were to malfunction in parts of the euro area, the singleness of the ECB’s monetary policy would evaporate. And it would face a hopeless task in maintaining price stability, its primary policy objective according to the Treaty. Not surprisingly, the ECB’s argument has been accepted by the Court of Justice of the European Union.
Nevertheless, it is a curious argument. Even in normal times, the strength of the monetary transmission mechanism varies across the euro area. For instance, in Germany about half of the population own their housing and mortgage rates tend to be fixed for long periods. Elsewhere in the euro area, such as in Ireland, home ownership is higher and households borrow at interest rates that are very sensitive to ECB’s policy rates. Loan-to-value ratios also tend to be higher in these countries. Such differences in the ownership rates of housing and mortgage finance matter hugely for the monetary transmission mechanism.
Similarly, parts of the euro area have well-functioning pension systems with payments not immediately tied to the state of financial markets. In countries with less well-developed retirement schemes, households often buy their housing and amortise the loans so as to reduce their living costs in retirement. And they may buy housing and use the rental income in lieu of pensions. Idiosyncrasies in retirement arrangement also influence the transmission mechanism.
Finally, households' portfolios differ. For instance, German households hold much less equities, more bank deposits and more life insurance products than the average euro area household. They have therefore been less impacted by monetary policy measures than households elsewhere in the euro area, at least until recently.
Given these differences in the transmission mechanism, one wonders why the ECB did not justify its asset purchases by stating that they were intended to protect the euro, as most commentators apparently believe.
Such a policy would seem to stand on firm legal ground. The euro is the currency of the European Union, although some members have not yet adopted it. The Treaty of the Functioning of the European Union says that «without prejudice to the objective of price stability, the ESCB shall support the general economic policies in the Union.»1 Plainly, maintaining the euro as the EU’s currency is such a «general economic policy.» The ECB is therefore required to support that goal, provided that doing so does not put price stability into peril.
Fortunately, economic crises, except those caused by monetary policy, are generally deflationary. Inflation was indeed too low in the aftermath of the financial crisis. And the covid crisis has led it to decline sharply again. A conflict between the primary objective of maintaining price stability and the secondary objective of maintaining the euro as the EU’s currency is unlikely to arise. The reason is that concerns about the euro’s viability only arise when concerns about public debt prevent countries from using fiscal policy. Too low an inflation rate then reflects too little government spending. Of course, if a conflict were to arise, the price stability objective would have to take priority.
This interpretation does not mean that the ECB’s bond purchases were intended as monetary financing. Monetary policy measures that lower market yields, including cuts in policy rates, always facilitate borrowing by governments, the public and firms alike. It is not sufficient for a policy to reduce borrowing costs for it to constitute monetary financing.
The ECB’s actions since 2012 have saved the euro. While they can be seen as technical monetary policy measures seeking to ensure the singleness of euro area monetary policy and to achieve the ECB’s inflation objective, they are better seen as intended to preserve the euro. They are not in conflict with the Treaty but in fact required by it.
1 See TFEU, Art 127.