Happy Sunday,

Friday marked the 75th anniversary of the end of WW II in Europe. Of course, this year the traditional military parades were cancelled because of COVID-19. Instead, we got a number of more somber events to mark this important day when the war was replaced by the beginning of new friendships, cooperation and hence of prosperity across Europe.

Central to this unprecedented change in outlook was the generosity by the Western victors, first and foremost the US, and Germany’s ability to come to terms with its past crimes while anchoring itself in future European integration.

Tellingly, Brandenburg Tor was lit to say “8 May 1945 Thank You” – in Russian, English French and German - and up Unter den Lindon, in front of Neue Wache, which houses Kathe Kollwitz’ possibly finest anti-war sculpture, President Steinmeier spoke incredibly eloquently of the broken hearts of the past and the commitment to “hold Europe together, also during and after this pandemic”. His speech is here in English: 75th anniversary of the end of the 2nd World War

… and all this after a week which brought more bad news on the economic impact of the pandemic as well as on the challenges of holding Europe together. On these two themes, I’ll today argue that:

■      Our “most-bearish-in-class” forecast for 2020 GDP (in both Europe and the US) still look right to me, but the emerging narrative of terrible long-term impacts of the crisis on growth is overdone.

■      The German Constitutional Court’s ruling on the ECB’s QE is flawed both in terms of economics and (I dare say) legally. It will not derail ECB policies, but the Court is an important institution and Germany needs to (and will) manage this carefully.

 

1.      While the recent data are bad, the emerging narrative of a terrible long-term outlook is overdone.

I take no pleasure in reiterating that our “most bearish in class” forecasts for both Europe and the US for 2020 continue to look just about right to me. This past week’s data releases were awful as they illustrate the very deep hit to activity now under way. For example, German industrial production dropped by 9.2% mom in March with car production down by 31%. Italian new car registrations were down no less than 98% yoy in April. The French INSEE said that they think the pandemic has caused French activity to drop by 33%. In the US, more than 20 million people lost their job in April, and unemployment skyrocketed to 14.7%, the highest level since WW II.

I struggle to understand why consensus and official institutions, including the European Commission, the IMF and the OECD, continue to have 2020 GDP forecasts barely half as bad as our numbers of -13% for the eurozone, -10% for the US and -10.5% for the UK. I’m not concerned about differences of a percent or two, but about the order of magnitude. (That said, this past week we were sort of surpassed when the Bank of England published an “illustrative scenario” of a 14% decline in UK GDP this year.)

Granted, some indicators, e.g. German trucking activity, suggest that we may be approaching the bottom, but there are no signs yet of growth. And, as I have discussed in recent weeks, I see no sign at all of a strong recovery in H2, which would be needed to limit the annual average to the -5%-10% range currently being shopped around by consensus.

It was therefore with particularly great interest that I joined the EIB’s annual chief economists’ roundtable – by video - this past week to discuss the outlook. This is a forum of economists from the private and public sectors which meets to discuss the key issues we all struggle with.

I had been asked to lead off the segment on the growth outlook, and had been expecting some robust pushback on our outlook, given what everyone else is forecasting. But there was no such pushback. Rather, I found a chorus of people expressing very serious concerns about the longer-term prospects for Europe. In the view of most of those who spoke, potential output will come down significantly post-pandemic as many good companies will be destroyed during the crisis. And those who survive will see their potential earnings decline, so they’ll have to cut back – while struggling with whole new structures of relative growth in this new world that (supposedly) awaits us after COVID-19. And add to that the vast increase in debt among both sovereigns and companies.

I’ll discuss this narrative in greater detail another day, but let me say already now that I don’t share this longer-term doom and gloom. Yes, it’ll be a somewhat different world post-COVID-19, but the vast majority of companies will get through the crisis and the new world that awaits us is not all for the worse. Change can be good…

I can easily agree that potential growth will suffer across the OECD. We think eurozone potential GDP may decline by something like ¼% - to 1.0%-1.3%, and the US by something broadly similar, but still then sitting some ½% higher than Europe. Not great, but not a disaster either – and that’s before the prospect of possibly better structural policies, more Europe and new opportunities get clarified.

The doom and gloom outlook for the post-COVID-19 era seems to be based on the following four arguments:

First, the European policy response is seen as vastly insufficient. I too think it is insufficient, but not vastly so, and not in Northern Europe, or in Italy once the next round of measures comes through (and on balance, I think the European model of employment support schemes and guarantees may be more efficient than the US’ “check-writing” fiscal policy response.)

Second, the thinking seems to be that in a world of near-permanent “distancing policies”, a lot of service industries, including airlines and restaurants, will no longer be commercially viable. This argument obviously rests on an assumption that we’ll never get widely available medical treatments and vaccines for the virus, but that seems overly pessimistic to me. The scientific community still seems to suggest that such treatment will be widely available within maybe 18-24 months, and when that happens why shouldn’t we return to some sort of normal life? The key is to keep companies alive until then – which is exactly what most policies seem focused on. Yes, the “post-pandemic normal” will be different than what we were used to, but once the virus no longer poses a risk to life, “distancing policies” will no longer be needed. And if this new post-pandemic world means that we do more video conferencing rather than travel, well then that’ll be good for the environment, and such change will surely come with efficiency gains as many of us spend less time hanging around airports....

Third, de-globalization (via policies to return production to Europe or the US) will lower productivity. Yes, but for some years the process of bringing back such production to Europe will surely boost growth in itself.

Fourth, both governments and companies will be burdened with additional debt, and that’ll be a drag on growth. Sure, but again, the degree of such a drag will depend on interest rate levels (hence lower for much longer). It’ll also depend on whether the private sector will begin to accumulate precautionary savings, as it has done following other crises (which – incidentally – would further compress interest rates, of course).

So, all in all, yes, it’s a horrific crisis we are in, but its man-made by lockdowns, and while I’m skeptical about an early return to normal, longer term (post-pandemic) I’m less worried than most of my peers seem to be. To be explored in greater detail another day.

Granted, this all depends on continued supportive policies by both fiscal and monetary authorities – and of that I have no serious doubt, in spite of Tuesday’s ruling by the German Constitutional Court, which surely complicates matters.

 

2.      The German Constitutional Court ruling on the ECB – and what it means.

On Tuesday, the German Constitutional Court (the BVerfG, but I’ll call it the GCC here) in Karlsruhe shocked most of us with its ruling that the ECB’s PSPP (aka QE) is illegal because “proportionality” has not been verified. Strictly speaking, since they don’t have jurisdiction over the ECB, the Court ruled that the German government and Bundestag have violated the constitution by failing to monitor and correct the ECB on this requirement.

Consequently, the GCC ruled that unless such proportionality can be proven within three months (presumably then to be verified by the GCC, but what gives them the right to define three months as the appropriate period of continued illegality?), the Bundesbank must stop participating in the program, and establish a strategy how to divest its holding of securities bought in violation of German law. And, it said, the PSPP must have a pre-agreed end and exit strategy, presumably regardless of economic conditions...

The ruling came as a shock to me primarily for two reasons: First, in an earlier ruling, the GCC had deemed the ECB’s (open-ended) OMT legal, so why not the seemingly more restrictive PSPP? Second, the GCC had asked the Court of Justice of the European Union (the CJEU) in Luxembourg for its assessment of the PSPP, and the CJEU had ruled that it’s fine.

Market reactions were modest, short-lived and all focused on Italy. The Italy-focus was driven by the fact that the ECB has been buying proportionately big amounts of Italian debt lately, and by concerns about rating actions to be announced this past Friday. The spread between Italian BTPs and German bunds widened by about 15bp on Tuesday, while e.g. Spanish debt hardly moved. As pointed out by my colleague, Luca Cazzulani, the move was only the 10th biggest of the year, and on Friday Italian debt recovered somewhat as shorts were covered ahead of Moody’s “non-event” announcement and as it became clear that the ECB was not just about to be run over by the German court.

As I’ll argue below, while the ECB will find a way through this, it’s a legal mess. In a very good Project Syndicate piece, Columbia law professor Katharina Pistor frames the legal issue beautifully as follows: “An independent court has attacked the legality of a ruling by another independent (and with respect to EU law, superior) court, for the latter’s supposed failure to police an independent central bank. The age-old question, “Who governs the governors” , has never been more relevant.” Pistor’s piece is here: Germany’s Constitutional Court Goes Rogue

Before I head out of my “economics reservation” and into the “legal reservation”, let me note – with amazement - how the GCC judges prepared themselves before they ventured out of their “legal reservation” and into the economics one. They called on ten supposedly economics experts in monetary and economic policy matters. All ten were middle-aged men, half of whom make a living as lobbyists for German banks and insurance companies, according to Bruegel’s Guntram Wolff. In addition, a majority of them have “a conservative bent”, according to Eurointelligence. (For the record, the number of legal experts I have consulted this past week was – admittedly - smaller, but definitely more diverse.) Well, may I suggest that you get the advice you ask for!

According to Professor Pistor, case law has refined the proportionality test into three parts: Effectiveness, necessity and a “least-restrictive-means” assessment. In the view of the GCC, the CJEU had failed to fully evaluate the third aspect of this test, and the German court therefore rendered the entire CJEU ruling “meaningless”.

In its own assessment of proportionality, the GCC seems to view the “least-restrictive-means” test as a question of a balance of positive vs. negative effects of the policy. But doing so, I found it curious how the Court mentions the cheaper financing for some countries, like Italy, and the negative effects on some German groups (savers), but fails to reflect on the overall benefit to Germany. According to the Bundesbank, the German state saved EUR 437bn in interest payments between 2008-19 because of ECB policies, compared to, e.g. EUR 421bn saved by the French state and EUR 299bn by the Italian state.

More importantly, a definition of proportionality as a question of a “balance” between positive and negative effects is more troublesome than these numbers illustrate. As highlighted in a tweet-thread by former Banque de France and IMF official Jean-Pierre Landau, it leads you to two problematic issues. First, by definition, it gives executive and legislative branches of government the right – indeed an obligation - to assess, ex ante, the calibration of monetary policy, which is in direct contradiction of its legally established operational independence. Second, what happens if, one day, both inflation and unemployment were to be higher than desirable? The ECB would then, presumably, tighten policies to pursue its target. But this definition of proportionality would then allow any government or parliament to legally challenge the ECB because “balance” between positive and negatives might not have been properly assessed.

So what will this ruling mean for the ECB’s ability to conduct monetary policy for the eurozone, and thereby fulfil its mandate?

You’ll have seen the ECB’s laconic press release that it “takes note” of the judgment by the GCC, that it “remains fully committed to doing everything necessary within its mandate to ensure that inflation rises” to the target, and … by the way “The Court of Justice of the European Union ruled … that the ECB is acting within its price stability mandate.”

Fundamentally, the ECB has two choices, none of which is attractive:

It can insist that it’s not for them to reply since the GCC ruling addresses the German government and Bundestag, while the ECB answer only to the European Parliament and hence – in legal terms – to the CJEU. So, the German government and/or the Bundestag, over to you!

However, while the FT and others have reported that the ECB is leaning this way, I have my doubts. To be sure, purely legally, I don’t understand how the GCC’s demand that the Bundestag must secure that the ECB’s policies meet the comparability criteria when Art 88 of the German Constitution says that the ECB should be independent in its pursue of price stability. Suddeutsche Zeitung’s Cerstin Gammelin has this great piece on the confusion the ruling has caused among the politicians:  So reagieren die Abgeordneten auf das EZB-Urteil. Also, the European Treaty’s art 130 says that neither the ECB nor any national central bank “shall … take instructions from …any government … or from any other body”.

But legality aside, this route of saying “we don’t care” seems politically untenable to me.

An alternative path for the ECB would be to write a paper that explains that the PSPP indeed meets the proportionality test. While tedious, it’s an easy paper to write. After all, according to the minutes of the Governing Council meeting from 2015 when the program was agreed on, proportionality was indeed considered. Also, as ECB president, Draghi explained it in a hearing to the European Parliament later on, and several GC members have discussed it repeatedly, including Isabel Schnabel in her speech in – no less – Karlsruhe earlier this year.

How the GCC could ignore all this is beyond me – unless you accept my hypothesis that this is really not about ECB policies, but about judiciary supremacy between the GCC and the CJEU, which I’ll come back to in a second.

While easy enough to write, such a response, however, implies two risks. First, the GCC might reject whatever they write as insufficient evidence. However, if you accept that this is not really about the PSPP but about legal territory, you’ll also conclude that the odds are that the GCC will be generous in its assessment of such a paper because it has already established its bigger point. Second and more importantly, if the ECB is seen to accept legal supremacy of the GCC, all hell will break lose – politically in every eurozone country (including in apart from Germany), and other national supreme courts would surely line up with their own demands.

My guess, therefore, is that a pragmatic solution will be found in which the German government and Bundestag will write the paper explaining that everything is fine. If they were to ask the Bundesbank for help with this task (a natural thing to do), it might, however, cause Jens Weidmann some embarrassment (given his public statements on QE and his quick press release after the court ruling that he shares some of the concerns). But I’m sure others – equally competent - would be willing to help. And as I said, I’m sue the GCC would then express satisfaction with the situation.

This would then take care of the present predicament, but it’ll surely trigger additional legal challenges to ECB policies, including the PEPP.

… which leads me to my final point:  The issue of judiciary supremacy.

With European integration came the need to transfer some competencies from national institutions to European institutions. Politically, this is never an easy process, but nowhere has it been more complicated than when it comes to the courts. And the stronger the legal and political standing of a national supreme court, the harder they have fought back and hence the tougher the issue for the political class. And few national institutions enjoy the standing of the GCC in Germany, protected by both the complications of changing the German constitutions and by its stellar standing in German public opinion.

In reality, the GCC probably never really accepted the CJEU’s supremacy in EU matters. Tellingly, when the GCC asked the CJEU for an opinion on the OMT, it was the first time ever it had deferred any matter to the CJEU.

Mistakenly, I took the 2018 decision by the GCC to ask (for the second time) the opinion of the CJEU as a peace pipe of sorts. On Tuesday, reading the scathing put-down of the ECJ’s ruling (claiming they had gone outside their reservation and had made “objectively” wrong decisions), that 2018 request for an opinion looks a whole lot more like a honey trap than a peace pipe – and, in the words of Ifo President Clemens Fuest, “a declaration of war”.

On Friday, the CJEU issued a brief press statement noting that “in general … a preliminary ruling is binding on the national court for the purpose of the decision to be given in the main proceedings … that’s the only way of ensuring the equality of Member States in the Union they created.” – and they’ll “refrain from communicating further on the matter.” And when (German) member of the European Parliament, Sven Giegold wrote to the Commission asking if the GCC doesn’t challenge European sovereignty, Commission President Von der Leyen replied (within two hours) that the Commission is still studying the judgment, but that on the basis of its findings “we are considering possible next steps, including infringement proceedings”. (Some impressive communication between two Germans of rather different political affiliations, I must say.) 

I don’t know how this will play out on the European stage, but I doubt the political fabric in Berlin today can match the institutional power of the GCC in German society. But the embarrassment of the ruling for the Bundestag – and the inconvenience - is visible, as illustrated when Bundestag President, and long-time ECB critic, Wolfgang Schäuble said to RND that “it may well be that the existence of the euro is now being questioned in other EU member states – because every national constitutional court can judge for itself”, adding that “it’s difficult even if the GCC cannot recognize a decision of the CJEU as binding”.

I rather suspect that Macron and other European political leaders will be pushing hard on the German government and Bundestag to sort out this internal institutional German mess – even though they know that – realistically - it can’t be done via a change in the German constitution.

So what’s the solution? My guess is that we’ll get a German report that verifies proportionality, and the GCC accepts it- and that several more lawsuits will be forthcoming. But the GCC is a slow-working institution so it’ll probably take another 3-5 years for it to consider each of them.

Meanwhile, of the eight judges in the GCC’s Second Senate, where these matters are considered, President Andreas Voßkuhle retired on Wednesday and will be replaced by GCC Vice President Stephan Harbarth, a former Bundestag member for CDU and presently at the GCC’s First Senate. (I don’t know his leanings on European and monetary policies issues.) But two additional members of the Second Senate will retire and be replaced in 2022, another two in 2023, and one further in 2024.

I suspect the Bundestag majority, which on present opinion poll numbers will remain heavily pro-European, will make sure the balance of future courts will understand European issues, and monetary policy, a whole lot better than the present bench seems to do.

 

And on that note, I wish you a continued good Sunday,

Best

Erik



link indicati nel testo:
 The age-old question, “Who governs the governors” , has never been more relevant.” Pistor’s piece is here: Germany’s Constitutional Court Goes Rogue

Suddeutsche Zeitung’s Cerstin Gammelin has this great piece on the confusion the ruling has caused among the politicians:  So reagieren die Abgeordneten auf das EZB-Urteil. 
https://www.project-syndicate.org/commentary/german-constitutional-court-ecb-ruling-may-threaten-euro-by-katharina-pistor-2020-05
https://www.sueddeutsche.de/wirtschaft/ezb-anleihenkauf-bundestag-1.4900347