July 05
Anjum Shabbir
Anjum Shabbir
29th June 2020
Banking & Finance Institutional law Justice & Litigation

Op-Ed: “The ECB is Responding to the Federal Constitutional Court of Germany: A Comparison of Monetary Policy Accounts” by Phedon Nicolaides


On 5 May 2020, Germany’s Federal Constitutional Court (FCC) ruled that the Court of Justice of the European Union (CJEU) acted ultra vires in finding that the Public Sector Purchase Programme (PSPP) of the European Central Bank (ECB) did not violate the principle of proportionality as defined in Article 4 TEU.

The FCC did not find convincing evidence that the ECB had demonstrated that the PSPP did not weaken the incentives of Member States to maintain sound budgetary policies. In addition, the FCC considered that the ECB did not take sufficient account of the impact of the PSPP on other parts of the economy such as pensions, savings, corporate survival, and so on. For these reasons, the FCC concluded that the PSPP could encroach on policies outside the monetary field because the ECB failed to demonstrate that the PSPP did not go beyond what was necessary to achieve its stated objective of raising the rate of inflation to close but below 2%. I have already argued that the FCC defined a proportionality test that was wider than that in the case law of the CJEU. Moreover, by requiring the ECB to take account of many and imprecisely specified effects, the FCC set an unachievable standard of evidence of the proportionality of unconventional monetary instruments.

In a terse press release on the same date as the judgment by the FCC, the ECB announced that it ‘takes note of today’s judgment by the German Federal Constitutional Court regarding the Public Sector Purchase Programme (PSPP). The Governing Council remains fully committed to doing everything necessary within its mandate to ensure that inflation rises to levels consistent with its medium-term aim and that the monetary policy action taken in pursuit of the objective of maintaining price stability is transmitted to all parts of the economy and to all jurisdictions of the euro area. The Court of Justice of the European Union ruled in December 2018 that the ECB is acting within its price stability mandate’.

Subsequently, there was much speculation as to whether the ECB would respond to the request of the FCC for proof that the PSPP complied with the principle of proportionality. Not surprisingly, no such proof has been sent to the FCC. Instead, various members of the Governing Council have reiterated through press interviews that the ECB is accountable only to the European Parliament and subject to the jurisdiction only of the Court of Justice of the European Union.

Despite its defiant response, there is now evidence that the ECB is trying to avoid future conflict with the FCC. The ECB has taken unusual steps to demonstrate that its monetary policy decisions and the unconventional instruments they utilise are compliant with the principle of proportionality pursuant to Article 4 TFEU.

At the same time, the explanations of the ECB corroborate the view that the FCC has indeed set the standard of evidence impossibly high. We will see that the ECB has not really proved that the benefits from an asset purchase programme such as the PSPP outweigh any negative effects in any other sector or part of the economy. The ECB has been able to show only that positive effects exceed negative effects for specific sectors such as banking. If the ECB could demonstrate the proportionality of PSPP across the whole economy it would have done it. But it couldn’t, for the simple reason that there is no model that can aggregate the effects in diverse sectors and add them up in any meaningful measure.

Since, of course, the ECB has not admitted that it is responding to the FCC, the evidence that is presented below is inferred from a comparison between the latest explanation of monetary policy in the ‘monetary policy account’ that was published on 25 June 2020 and previous monetary policy accounts which serve as a benchmark.

The monetary policy account is a report of the issues that are discussed in meetings of the Governing Council without attribution to any particular member. The monetary policy account published on 25 June 2020 refers to the decision-making meeting of 3-4 June 2020 which was the first meeting after the judgment of the FCC on 5 May 2020.


The benchmark meetings

Between January 2018 and April 2020, 21 accounts of monetary policy were published. These 21 accounts have been searched to identify use of the most critical words with respect to the application of Article 4 TFEU: ‘proportionality’, ‘proportional’, ‘proportionate’, ‘outweigh’, ‘outweighed’. A policy is proportional or proportionate when its positive effects or benefits outweigh its negative effects or costs. The positive effects stem from the achievement of the objectives of the policy, while the negative effects are generated from the costs it causes or from its impact on the effectiveness or efficiencies of other policies.


Comparison between the meeting of 3-4 June 2020 and the benchmark meetings

This section presents first the findings from the accounts of benchmark meetings and then the findings from the account of the meeting on 3-4 June 2020.


Use of ‘outweigh/outweighed’ in the benchmark meetings

Of the 21 accounts that make up the benchmark only two use the word ‘outweigh’ or ‘outweighed’!

The account of the meeting of 5-6 June 2019 states that ‘Members also broadly shared the assessment that, at current levels, the ECB’s negative interest rate policy continued to support loan growth and, ultimately, economic growth and inflation. The immediate costs of the negative interest rate policy arising from banks paying a negative rate on their excess reserves and deposit facility holdings were considered to be overall limited in size. So far, these costs were outweighed by the overall benefits from the generation of larger lending volumes and the reduction of risks and loan loss provisions due to the more favourable macroeconomic developments fostered by negative interest rates’. (Emphasis added.)]

Here indeed there is consideration of the proportionality of the positive and negative effects of monetary policy. Although it is not explicitly stated that the benefits were reaped by the banks, it can be inferred that they concerned mostly the benefits for the banks from increased lending volumes and reduction of loan-loss provisions. Therefore, here the test of proportionality is limited to the impact on banks, not to the whole range of effects identified by the FCC that a monetary policy instrument such as the PSPP could have.

The only other use of the word ‘outweigh’ appears in the account of the meeting of 11-12 March 2020, just after the COVID-19 pandemic broke out. According to that account, ‘Demand would be negatively affected as a result of job losses and any reduction in household income growth, as well as the impact of increased uncertainty on confidence and investment. It was argued that, in the short term, the shortfall in demand could be expected to outweigh any supply-side effects’. (Emphasis added.)]

It is clear that the word ‘outweigh’ is used here to describe the effect of COVID-19 on the economy, not the effect of monetary policy.


Use of ‘outweigh/outweighed’ in the meeting of 3-4 June 2020

The meeting of 3-4 June 2020 was the first after the judgment of the FCC and the second meeting after the decision of the Governing Council on 18 March to launch the EUR 750 billion Pandemic Emergency Purchase Programme.

The account of the Governing Council meeting of 3-4 June 2020 states the following: ‘Overall, there was broad agreement among members that while different weights might be attached to the benefits and side effects of asset purchases, the negative side effects had so far been clearly outweighed by the positive effects of asset purchases on the economy in the pursuit of price stability. However, it was also noted that it could not be ruled out that unintended effects could increase over time and eventually outweigh the overall positive effects. It was thus seen as important to continuously assess the effectiveness and efficiency of the monetary policy measures, their transmission channels and their benefits and costs. In this context, it was remarked that all expansionary monetary policy instruments contributed to a low interest rate environment. Therefore, the associated side effects of low rates were not a distinguishing feature of asset purchases, such as under the PSPP or the PEPP, but were a factor pertaining to all policy instruments that contributed to a low interest rate environment.’ (Emphasis added.)

It is obvious that the ECB was addressing the concerns of the FCC. Not only does the account refer to the positives outweighing the negatives of PEPP but, interestingly, it also hedges the position of the ECB in relation to critical issues in the judgment of the FCC, such as the weight that could be attached to the various effects, possible unintended effects of monetary policy, the effectiveness and efficiency of monetary instruments and the impact of low interest rates. Here the ECB argues, correctly, that low interest rates are an outcome of expansionary monetary policy, not just of asset purchase programmes. Therefore, any side effects (i.e. negative effects), that had featured prominently in the reasoning of the FCC, should not be taken into account in any test of proportionality of asset purchase programmes because they are inherent in monetary policy.


Use of ‘proportionality/proportionate/proportional’ in the benchmark meetings

Similarly to the use of ‘outweigh/outweighed’, only two meetings appear to have considered the proportionality of monetary instruments.

The account for the meeting of 11-12 September 2019 reveals that ‘All members agreed that a further easing of the monetary policy stance was warranted to support the return to sustained convergence to the Governing Council’s inflation aim. The September staff projections had further revised down the real GDP growth outlook for 2019 and 2020, mainly owing to the weaker global environment, and inflationary pressures had remained muted. At the same time, the point was made that the monetary policy response should be proportional to the contingency faced. In this respect, it was noted that, despite the downward revision in the projections, some of the fundamental driving forces for a pick-up as foreseen in the baseline scenario were still in place and deflation risks were absent at the current juncture. Monetary transmission was functioning well, with long-term yields at historical lows both for the euro area and across countries’. (Emphasis added.)

No other direct explanation is provided as to why the response was indeed proportional.

By contrast, the account of the meeting of 18 March 2020 contains a more elaborate and detailed explanation of proportionality. The PEPP of EUR 750 billion was unprecedented and required much justification. Accordingly, the “Governing Council would explore all options and all contingencies to support the economy through this shock; (c) emphasise that, to the extent that some self-imposed limits might hamper action required to fulfil its mandate, the Governing Council would consider revising these to the extent necessary to make its action proportionate to the risks faced’. (Emphasis added.)

‘A large majority of members supported the proposal by Mr Lane to launch a new pandemic emergency purchase programme (PEPP) for private and public sector securities with an envelope of €750 billion until the end of the year. Such a temporary programme, targeting the specific consequences of the spread of the coronavirus, was seen as the most appropriate response to address a severe and common shock of unprecedented proportions that affected the euro area economy as a whole. The amount of €750 billion would add to the envelope of €120 billion decided at the 11-12 March meeting and, hence, provide a powerful response to counter the serious risks to the monetary policy transmission mechanism and the outlook for the euro area. The size and duration of the new programme was seen to be proportionate to the risks that the Governing Council was facing, in full respect of its price stability mandate. It was also noted that the additional asset purchases would effectively complement actions by euro area governments, while respecting the Treaty provision on the separation between monetary policy and fiscal policy.’ (Emphasis added.)

‘In this context, the PEPP, which was temporary in nature and targeted to the specific shock and contingency at hand, was seen as an appropriate course of policy action, proportionate to the risks faced. A powerful policy response was indeed warranted to address dislocations in financial markets, supporting the transmission of monetary policy to ease funding conditions for the euro area real economy. At the same time, acknowledging the ultimately temporary nature of the coronavirus-related shock, it had to be highlighted that – in compliance with the proportionality principle – the Governing Council would end net asset purchases under the PEPP once it judged that the coronavirus crisis phase was over, but in any case not before the end of the year.’ (Emphasis added.)

‘Members largely supported the proposal by Mr Lane to signal that, to the extent that self-imposed limits might hamper action that was needed to fulfil its mandate, the Governing Council would consider revising the limits to the extent necessary to make its action proportionate to the risks faced. It had to be stressed that the Governing Council would support the smooth transmission of its monetary policy in all jurisdictions of the euro area. At the same time, it was underlined that the Governing Council’s policy actions had to remain clearly within its remit and fully proportionate to the risks to the ECB’s price stability mandate. It was also noted that new debt issuance by euro area governments, agencies and European institutions in view of increased financing needs to support the economy was likely to alleviate potential feasibility constraints implied by the current purchase parameters set for the APP.’ (Emphasis added.

It is obvious that the Governing Council, aware that the size of the PEPP was the largest ever, was at pains to demonstrate that it was proportional to the impact of COVID-19 on the Eurozone economy. Since, of course, it had no knowledge of the judgment of the FCC at that time, all its references to proportionality were limited to the risks to price stability, not to other risks and costs outside monetary policy, as identified by the FCC. We will see below that at its next meeting, the Governing Council considered the impact of its asset purchase programme far beyond the confines of monetary policy.


Use of ‘proportionality/proportionate/proportional’ in the meeting of 3-4 June 2020

The relevant parts of the account that was published on 25 June 2020 are as follows. ‘In order to counter these pandemic-related negative revisions to the inflation outlook, the appropriate policy response was to increase the size of the PEPP envelope. In March, the Governing Council had decided to launch the PEPP “to counter the serious risks to the transmission mechanism and the outlook for the euro area posed by the outbreak and escalating diffusion of the coronavirus”. As expressed in the preamble to the PEPP legal act: “It is also clear that this situation hampers the transmission of the monetary policy impulses and adds severe downside risks to the relevant inflation outlook. Against this background, the PEPP was a measure which was proportionate to counter the serious risks to price stability, the monetary policy transmission mechanism and the economic outlook in the euro area, which are posed by the outbreak and escalating diffusion of COVID-19”’. (Emphasis added.)

‘In terms of the overall monetary policy strategy, purchases of government bonds under the PEPP and the APP were an effective tool for delivering on the Treaty-assigned price stability objective in the current environment. This was especially the case given the already low levels of the ECB’s policy rates and the crucial role of sovereign yields in determining the financing conditions of firms and households. These measures were also efficient, especially in combination with other policy measures, since other instruments would require extraordinary adjustment to generate the same impact on inflation dynamics. The easing of credit conditions would help viable businesses continue to operate and retain as many workers as possible. In turn, preserving jobs was the most important factor in determining incomes and the financial security of individuals and families in the euro area. The Governing Council’s measures played a key role in supporting credit intermediation through banks, not least since the business prospects of the banking system depended first and foremost on the macroeconomic outlook. Accordingly, the PEPP and the APP were proportionate measures under the current conditions for pursuing the price stability objective, with sufficient safeguards having been built into the design of these programmes to limit potential adverse side effects, including risks of fiscal dominance, and to address the monetary financing prohibition.’ (Emphasis added.)

‘Members also put forward some broader considerations with regard to the effectiveness and efficiency of using asset purchases as a monetary policy tool in the pursuit of the ECB’s price stability objective, including in the light of the upcoming review of the monetary policy strategy and with a view to explaining the Governing Council’s monetary policy deliberations in a more comprehensive way to the public. It was argued that the proportionality assessment of any monetary policy measure had to consider, among other things, the degree to which the measure contributed to achieving the monetary policy objective, on the one hand, and possible unintended side effects, on the other hand. It required a judgement as to whether other policy measures were available that were as effective and efficient while offering a better balance between intended and unintended effects.’ (Emphasis added.)

Again, it is as if the ECB was directly addressing the FCC and its concerns. The ECB went on to provide more evidence supporting its policy and to point out that ‘There was now ample evidence from an exhaustive literature showing that asset purchase programmes in general and the PSPP in particular had proven effective in achieving their intended effects on the euro area economy and thereby in maintaining price stability. … Although the quantitative estimates varied to some extent and were subject to the usual model uncertainty, the overall evidence underpinned the view that the PSPP had had a positive impact on macroeconomic outcomes, confirming the assessment that it was a policy measure that was effective in putting upward pressure on inflation and inflation expectations as intended’.

The ECB stressed, correctly, that ‘In assessing the benefits and costs of asset purchases, the relevant benchmark was not the status quo, but a counterfactual situation in which policy accommodation through asset purchases had not been provided. There was ample evidence that the euro area economy would have fared much worse without the policy stimulus from asset purchases’. Defining a counterfactual is always a speculative exercise. At most, what can be demanded is that the counterfactual is based on reasonable assumptions. There can be no certainty in this kind of exercise. It is unknown whether this degree of uncertainty would meet the criteria of the FCC. At any rate, this shows the difficulty of reaching the standard of proof demanded by the FCC.

The ECB also explained why the PEPP complied with Article 123 TFEU on the prohibition of monetary financing of national debt. As may be recalled, the FCC used the proportionality test to assess whether the ECB has encroached on fiscal policy. ‘With regard to the potential interactions between monetary policy and fiscal policy, a clear focus on the primary objective of maintaining price stability, combined with safeguards which ensure the respect of the prohibition of monetary financing, was viewed as essential to the lasting success and credibility of monetary policy, and ultimately to acceptance and trust in the euro as a common currency.’

Lastly, the ECB addressed the often expressed complaint in Germany, and in the FCC judgment, that low interests harmed savers and pensioners. ‘As regards the impact of the ECB’s monetary policy measures on households, there was ample evidence from numerous studies on the impact of low interest rates and asset purchases on household income. … It was also noted that the effects of lower interest rates arising from asset purchases were similar to the effects of using conventional monetary policy instruments. Moreover, to judge the overall effects of low interest rates on household income, all transmission channels, not just savings income, had to be taken into account. The significant macroeconomic effects of asset purchases contributed to higher wages and higher employment, and thereby positively affected households’ disposable income and consumption.’

It should be evident from all these explanations that the ECB was at pains to point out that its policies have more channels of impact on incomes and savings than the direct effect of interest rates. At the same time it stressed that in assessing a policy it is not sufficient to just look at its observable effects, as the FCC did in its judgment. It is also necessary to consider the counterfactual, that is, what would have happened in the absence of that policy.

Despite all these efforts of the ECB, it also amply evident that the ECB could only claim that its policies (PSPP or PEPP) had positive effects and that negative effects were limited. Not surprisingly, there was no quantification of the size of the effects in different sectors or areas of the economy.



Although the ECB does not consider itself accountable to the FCC, it does not mean that it is inured to criticism or that it is so naïve that it does not understand that its effectiveness depends on having the authorities in Germany, the largest European economy, to support its policies. It is certainly responding to the FCC judgment with more explanation and justification of the proportionality of its unconventional monetary instruments.

However, it is also evident that the balancing of effects in different policy areas, as required by the FCC, is a very difficult if not an impossible task to carry out.

Nonetheless, as they say, every cloud has a silver lining. Although the FCC judgment has been widely criticised, it may have stung the ECB into considering more carefully the side-effects of its decisions and to be more transparent about them. This can only be a good outcome for the rest of us.


Phedon Nicolaides is Professor at the University of Maastricht; Visiting Professor at College of Europe, Bruges; Luiss University, Rome.



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