Martin Hellwig is the director of the Max Planck Institute for Research on Collective Goods, and he joins Macro Musings to talk about the Eurozone and the implications of the recent German Constitutional Court (GCC) ruling for the future of the monetary union. David and Martin specifically discuss the background of the perceived Eurozone crisis, the power struggle between the GCC and the European Court of Justice, and how this case may lead to a total breakdown of the Eurozone.
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Note: While transcripts are lightly edited, they are not rigorously proofed for accuracy. If you notice an error, please reach out to [email protected].
David Beckworth: Martin, welcome to the show.
Martin Hellwig: Well, thank you for having me.
Beckworth: I'm glad to have you on. We are in two very different time zones. So I really appreciate you taking time in the evening to join me here in the morning. This is one of the beauties of the internet that we can connect like this across the Atlantic, two very different places.
Beckworth: Now recently, I had your good friend and co-author Anat Admati on the show. And of course, the two of you've co-authored that really popular book *The Bankers' New Clothes* as well as other research, in fact, Anat mentioned the great article you have on the ratcheting effect of leverage of firms. But we want to put that to the side for now. In fact, listeners can go back and listen to the recent show we had with Anat on those issues.
Beckworth: Because today, I'm thrilled to have you here to talk about the German Constitutional Court ruling. And as a matter of fact, I've had several listeners email me, contact me and say, "Get someone on who can speak to this." So it was great timing that we got you as soon as we did. So I want to talk about those issues today, the future of the Eurozone, what this court really meant. Before we get into all that, though, can you tell the listeners a little bit about yourself, maybe, how did you get into economics? What do you do?
Hellwig: Well, I got into economics because I really wanted to do history, and eventually wanted to go into economic history. But there were so many interesting problems that I first needed to solve before shifting to history that I never got there. Of course, most of the interesting problems I still haven't solved. Most of my academic work in economics is very abstract theory as Anat notes. By the way, there are segments of the population with whom our book is anything but popular.
Beckworth: Fair enough.
Hellwig: Now, I got into policy work in the mid-late '90s, first through joining an advisory committee for the German Economics Ministry. Then through joining the German Monopolies Commission which is an advisory committee on matters involving competition law and competition policy. Two features of that work were very interesting. One, the interplay between law and economics. I learned that one must have a certain amount of respect for the needs of the legal framework. At the same time, I also learnt that the lawyers couldn't care less about the appropriateness of whatever statements they make about the economy. In one paper, I cited a pronouncement of the European Court of Justice and commented materially false but legally binding. Because they had made a statement that was crazy. But nevertheless, it formed the foundation of a legal tradition.
Hellwig: In the course of the financial crisis, I got into various advisory committees. Quite importantly, from 2011 to 2015, I was chair and vice-chair of the Academic Scientific Committee advising the European Systemic Risk Board. And in that function, I was also a member of the General Board which was actually quite amusing because you had all the central bank governors and all the tops of the supervisors, advisory authorities, plus representatives of other institutions. My comment was, "If one wants to get an impression of what the diet of the Holy Roman Empire looked like, this might be a good place to start."
Hellwig: 80 or 100 people or more, of course, all their advisors as well, assembled in one room for deliberations about whatever was to be decided upon. By the way, how should I put it, the entertainment value of seeing the human comedy is a major element that makes such activities worthwhile.
Hellwig: Over the past 10 years, I was over and over again shocked by the dysfunctionality of public discussion, internal discussion and decision making in dealing with A, the financial crisis, B, the euro crisis and C, the relation between European competences and national competences in the context of European Monetary Union and in the context of fiscal issues and in the context of banking union. So, this is how I got into this and why I have some fairly strong opinions on what was said Tuesday.
Beckworth: So, you have a rich background in the European community. You've been involved in all these organizations, advised governments, you've been writing, you've been researching, teaching, and I want to get to this big court ruling from this week. Before we get to it, though, it might be useful for our listeners, if we can provide kind of the context, the backstory.
Beckworth: There's kind of a longer backstory, the Eurozone crisis itself and there's the more immediate kind of backstory, the previous court rulings. So maybe you could briefly summarize for us what you think is the Eurozone crisis and how that led up to the current place where we are where there's these ongoing court rulings. So, walk us through your take of the Eurozone crisis briefly and then lead us up to where we are today.
The Legal Backstory of the Eurozone Crisis
Hellwig: The term, “the Eurozone Crisis” is a misnomer. The underlying flaws developed quite early on in the early 2000s up to 2008. We had a system which basically involved the central bank providing money through loans to the commercial banking sector and other financial institutions, reallocating funds among themselves with very significant cross border flows. And so, the problem that the central bank is dependent on the commercial banking sector for allocating funds, for allocating money in the various geographical sub-segments of the Eurozone. That problem was kept under control through interbank markets.
Hellwig: These interbank markets disappeared in 2008, post-Lehman, and even more so, in 2011. I'll come to that in a minute. The ECB stepped in and basically provided Greek or Italian banks or Spanish banks that could not get funds from German banks anymore because interbank markets didn't work and replaced that funding. In the process, allowing those short term money market loans from German banks or Dutch banks or Finnish banks to be repaid.
Hellwig: Since then, the distribution of central bank money across the Eurozone has been in the hands of the ECB rather than private markets because cross border interbank markets have not really picked up again. What were the macro developments underlying this? Well, much of it was an interplay of current account surpluses in Germany and current account deficits in say Spain or Greece. Why?
Hellwig: Well, if the local inflation rate is at 5%, in Spain and at 1% in Germany, and you have the same nominal rate, that means the real rate in Spain is very low and in Germany it's high. If you think about a builder, a builder in Spain thinks at real rate, that's low, it's wonderful to engage in building projects. German builder doesn't think that way. So, the constellation of significant differences in real rates and with equal nominal rates played a major role in driving capital flows from a country like Germany to a country like Spain. You can add to that different labor market conditions, different product market developments. You can also add government borrowing in Italy, Spain... Well, Spain actually not so much, Italy, Portugal, Greece.
The constellation of significant differences in real rates and with equal nominal rates played a major role in driving capital flows from a country like Germany to a country like Spain.
Hellwig: Although, for each country, probably private sector borrowing was at least as important. Public sector debt in the countries I mentioned was high, but it had been high before. So much of that broke out in a second crisis in 2010 when Greece couldn't service its debt. Again, the rolling over of short term debt had come to an end. At that point, rather than leave the banks and the Greek government fend on their own, renegotiate, restructure, whatever the debt, political institutions stepped in and provided support. Where I would guess the major part of the funding actually went right back to service the debt and repay the debt that otherwise would not have been repaid. Politically that was more comfortable for the German or the French government than to say we need another bank rescue.
Hellwig: In 2011, they started to say, well, we must have private sector involvement. The private creditors to Mediterranean governments or the Irish government should participate in this as well. That triggered a run of American money market funds on European institutions because they were afraid that European institutions would be made insolvent by the haircut. It also accelerated the run of Northern financial institutions on southern governments and banks. For example, at one point in July 2011, Deutsche announced that they've got rid of 88% of holdings of Italian government debt.
Hellwig: And again, the ECB neutralized that by lending to the banks in question. It followed up with the so-called long term refinancing operation in December 2011, January 2012, adding roughly one trillion to central bank money in the Eurozone. And it followed further with the announcement, whatever it takes and the announcement of the so-called OMT program, Outright Monetary Transactions, don't ask me why it's called that way, in September 2012,
Hellwig: Outright Monetary Transactions with the European Central Bank are going to buy government debt of problem countries on secondary markets. And by the way, asymmetrically, just government debt of problem countries provided these countries have put themselves under the support of the European stabilization mechanism, the mechanism for mutual fiscal support. And under a program imposing austerity or other types of conditionality on these countries.
Hellwig: That program was never used, but it immediately gave rise to a lawsuit before the German Constitutional Court. The German Constitutional Court argued this all looks illegal to us, sent the matter to the European Court of Justice in Luxembourg, and told them what do you think? This all looks illegal to us. The European Court of Justice came back and said, "It doesn't look illegal to us. But you're right, maybe there should be certain conditions attached." The German Constitutional Court grudgingly accepted that and gave all the conditions that the European Court had mentioned, the rank of German constitutional law.
Beckworth: And when did that original lawsuit get filed in Germany?
Hellwig: September 2012. That was immediately when the OMT program never was realized. Because the moment the lawsuit came, the ECB put that on ice.
Beckworth: I see.
Hellwig: In fact, it didn't have either to use it. Because the moment they had said this, markets believed them. And capital flows went in reverse.
Beckworth: That was the whatever it takes comment by Mario Draghi.
Hellwig: That was Mario Draghi's whatever it takes. Previous to that you had lots of outflows from Spain. And the fear is that the Euro might fall apart and Spanish currency or a Spanish jurisdiction currency would be devalued after whatever it takes, and after the announcement of the OMT program, even though the OMT program was not actually used, the money flowed back.
Hellwig: Now, why were the lawsuits initiated? The claim was, this is a violation of the treaty prohibition on monetary financing of states. There are two problems with that claim. The first is the treaty is actually not clear in the matter. The word monetary financing of states is prohibited, doesn't appear in the treaty. Article 121 of the European Treaty says, "Neither one of the national central banks, nor the ECB is allowed to provide loans to governments or to buy bonds directly from governments."
Hellwig: Article 18 of the statute of the European System of Central Banks and the ECB states, "The central banks can buy market traded securities however they wish." And of course, the OMT announcement was an announcement that they were going to buy market traded government debt.
Beckworth: So, the OMT announcement was legally in line with the regulations of the treaty.
Hellwig: Well, the question is given these two norms, how do you interpret them? Do you interpret Article 18 as saying literally they can buy anything they want even what the governments have issued is just a mechanism of circumvention of the prohibition of direct financing? Or do you apply what the lawyers call a teleological interpretation? In considering this permission, we must take account of the fact that the prohibition of direct financing must not be infringed. And actually, both courts, the German Court, and the European Court took the latter view which in some sense is reasonable. But raises the question what do you mean by monetary financing of states.
The question is given these two norms, how do you interpret them? Do you interpret Article 18 as saying literally they can buy anything they want even what the governments have issued is just a mechanism of circumvention of the prohibition of direct financing? Or do you apply what the lawyers call a teleological interpretation? In considering this permission, we must take account of the fact that the prohibition of direct financing must not be infringed.
Hellwig: The European Court took the view that the central bank must not provide incentives for governments to issue debt assuming that it would be purchased by the central bank anyway. The German court basically took the view, the central bank must not facilitate conditions under which governments can issue debt. So a decrease in the interest rate that follows an open market purchase of government bonds might in itself be treated as evidence of monetary financing of states and might in itself be illegal.
Beckworth: What's the high standard?
Hellwig: Well, it's ridiculous because the standard effect of monetary policy is to work through decreases in interest rates and increases in interest rates.
Beckworth: Right. Now, this was the case for the OMT, right?
Hellwig: This was the OMT case. The German court had its first decision to present this to the European Court in 2014. And the European Court ruled later in 2014. The German court had its final rulings where it basically gave in to the European Court in the summer of 2015.
Hellwig: So, this really goes back to the discussion about quantitative easing in 2015. In which by the way, the president of the Bundesbank was very much opposed on the grounds... and this is an argument that has played a significant role, on the grounds that such purchases might involve losses for the central bank. These losses would harm taxpayers. And the harm would be particularly obnoxious if they were enough to require a recapitalization of the central bank with funds from taxpayers.
This really goes back to the discussion about quantitative easing in 2015. In which by the way, the president of the Bundesbank was very much opposed on the grounds that such purchases might involve losses for the central bank. These losses would harm taxpayers.
Hellwig: Now, under the treaty, the court in charge of interpreting the treaty is the European Court of Justice. So why do these people go to the German Constitutional Court? And what was the German Constitutional Court thinking when it presented the OMT case and the QE case to the European Court of Justice?
Hellwig: Why did they go to the court where the actual complaint was the following, the ECB is violating the terms of the treaty. It's acting ultra vires, beyond the powers that it has been given. It would be incumbent on the German government and the German parliament to sue the ECB in the European Court of Justice. By failing to do so, the German government and the German parliament are infringing on our constitutional rights, namely the constitutional right that anything which belongs to the sovereignty of the German parliament must not be dealt with by another institution. And if the ECB uses powers that it has not been given, that's such an infringement. And that is a violation of our constitutional rights.
Hellwig: By the way, these individual constitutional rights that's the analog of the Bill of Rights in the American Constitution. In its first judgment on European Monetary Union, the German Constitutional Court extended the interpretation of those basic rights in a remarkably creative way.
Beckworth: So what you're saying then is the Germans brought this court case, a number of them brought the court case, in response to the ECB’s QE program, and they brought it before the German Constitutional Court first. It went to the European Court of Justice. And the European Court of Justice ruled in favor of the ECB. And they had some legitimate reasons they claimed. They claimed they were buying sovereign bonds proportional to the size of each country's economy. They weren't going to buy more than a third. And so they had that in place.
Beckworth: Now, I guess that's kind of the broad context there. What triggered this decision this week at the German Constitutional Court again? Were they responding to the decision made by the European Court?
Hellwig: I'm afraid I have to go a little bit more into the legal structure. One response of the German Constitutional Court to all these cases would have been to say this is none of our business, forget it. Or they might have said, “Yeah, you're right. There was a certain suspicion that the ECB stepped over the bounds. We'll enjoin the German government to sue in the European Court.” They did something else. They asked the European Court to assess the merits of the matter. Under a provision of the treaty, where national courts can present such questions to the ECJ, and afterwards they're bound by the ruling. Why did they do so?
Hellwig: Well, they wanted to have the last say. The real issue underlying this is a power struggle of the German court against the European court. The German court wants to be in charge of interpreting the treaty. And you can imagine the European court does not like that. As for the other countries, I think each country's constitutional court would love to be in charge of interpreting the treaty. But they certainly would not like the German Constitutional Court to have that job.
The real issue underlying this is a power struggle of the German court against the European court. The German court wants to be in charge of interpreting the treaty. And you can imagine the European court does not like that. As for the other countries, I think each country's constitutional court would love to be in charge of interpreting the treaty. But they certainly would not like the German Constitutional Court to have that job.
Beckworth: Right. Every country will want their own constitutional court to make the decisions.
Hellwig: You can see here how the national stance of the German constitutional court can be explosive for the entire system.
Beckworth: Martin Sandbu of the Financial Times has a great piece titled *The German Court Has Set a Bomb Under the EU Legal Order.* So my question to you is how consequential is this? Are we going to see long-lasting reverberations because of this. Is this really become a straw that might break the camel's back in terms of the Eurozone? Might Germany leave the Eurozone? And what are the ramifications that you see from this?
Potential Ramifications of the German Constitutional Court Case
Hellwig: My assessment is that Tuesday's ruling involves a breach of the treaty and can be interpreted as an invitation to the European Commission to start treaty infringement proceedings before the European Court.
My assessment is that Tuesday's ruling involves a breach of the treaty and can be interpreted as an invitation to the European Commission to start treaty infringement proceedings before the European Court.
Beckworth: What does that mean? What can they do to Germans?
Hellwig: That means that the European Court can enjoin Germany to not give in to this judgment from its own Constitutional Court. And then you have the power struggle between the two courts confronting each other with the prospect that EU might dissolve.
Beckworth: Would you also have a power struggle within Germany between the constitutional court and parliament, the Bundesbank, and everybody else going on? I mean, sounds like not every German agrees with this decision, I assume. So there's going to be some power struggle within Germany too?
Hellwig: The question is whether the government and the parliament prefer a German constitutional crisis or a European constitutional crisis.
Beckworth: Pick your poison, huh?
Hellwig: By the way, when I say I consider this to be a breach of the European Treaty, I do not want to just let this stand in a vacuum. The German court asks the German government to request information from the ECB about the ECB's justifications for quantitative easing. Article 130 of the treaty prohibits the ECB from subjecting itself to pressure from any international institution, government, or any other national institution. And that's precisely what we're talking about here. The treaty says the mandate of the ECB is to work for price stability. The ECB has justified its QE program with the need to work for price stability to fight deflation.
Hellwig: The German court is now saying they should also have taken into account the effects of what they did on interest rates and thereby on lots of things such as the earnings that savers get, such as the potential for having zombie firms survive because they're so easy. The potential for having banks get into trouble because they no longer can earn margins, and all of that.
Hellwig: Meaning, the German court is introducing sub mandates, additional concerns, additional objectives which are not included in the treaty. And this is in contradiction to its own judgment in 1993 saying, well, abandonment of sovereignty to a supranational institution is really problematic. But if the supranational institution has a single mandate, you find in terms of price stability, it may be acceptable.
Hellwig: Now, they want to replace the single-mandate defined in terms of price stability by something mushy, involving the effects of interest income, that say the upper middle classes earn and similar effects. By the way, when the Bundesbank ran all this, they never bothered an iota about interest rate increases that deepened recessions and added half a million people to the unemployment rolls. I suspect that even now, they don't realize the distributional can of worms that they've opened.
Beckworth: One of the ironies here is that the German Constitutional Court is fighting a battle that effectively harms central bank independence which is one of the pillars of the Bundesbank when it was the central bank. So it's kind of going up against a very important German creed or something that defines Germany as an independent central bank. So I find that kind of ironic. I do have a question, though, for you-
Hellwig: I have a straightforward answer to that. I am the Lord thy Constitutional Court. Thou shalt not have other independent institutions besides me.
Beckworth: Wow. Okay, pretty straightforward.
Hellwig: That includes both the ECJ and the Bundesbank, and the ECB.
Beckworth: Well, that leads me to the next question I was going to ask actually. I've had some previous guests on the show who are German. And they've stressed that in Germany, lawyers play a much more important role than the US. Whereas in the US, economists are important policymakers, they have vice presidents here. You can be a pretty prominent economist in the US and have a lot of influence. And they argue in Germany, lawyers tend to play that role more than economists.
Beckworth: This seems to fit in with this court, calling the shots over maybe policymakers, over economists. You mentioned that the court didn't think through the economic side, but they just kind of made a decision based on what they thought was appropriate. But do you agree with that, or do you think that the influence of lawyers here over economists is consequential in this outcome?
Hellwig: I think the influence of lawyers is important. From what I've seen about the US, I'm not convinced that in the US, it's any different. One thing that's different is that in the US, you have lots of lawyers who use either economics or make believe economics in order to further their own ideological programs. That's less common in here. Ultimately, the difference really has to do with the difference in judicial practices. In the practice of law, that's true for say competition cases, for civil law cases, just as for public law constitutional law cases. The legal profession has not imported much from economics. In fact, many of them are proud of that. And many of them do not really see the problem.
I think the influence of lawyers is important. From what I've seen about the US, I'm not convinced that in the US, it's any different. One thing that's different is that in the US, you have lots of lawyers who use either economics or make believe economics in order to further their own ideological programs. That's less common in here. Ultimately, the difference really has to do with the difference in judicial practices.
Beckworth: And that's a challenge. One of the things we do in economics, we try to think in terms of general equilibrium and that is a hard nut to crack. And it's something that I think some of these lawyers, some of these judges are wrestling with or failed to wrestle with successfully. Let me ask a different but related question. You mentioned the German Constitutional Court's decision goes against an earlier decision they made in previous time.
Beckworth: To what extent do you think this is tied to the rise in populism, nationalism around the world? I mean, everywhere you look, the US, Europe, there's a rising strand of us versus them, at least more of an awareness of this issue. Do you think to any extent this played a role here?
Hellwig: Well, nationalism certainly does play a role. At some level, nationalism is endemic to the legal profession, at least in countries other than the US, where the legal profession thinks more in terms of imperialism. If you take the German legal profession, its domain of application, it's German jurisdiction, German law, and German jurisdiction.
Hellwig: So, the conflict between the two courts, the German Constitutional Court, and the European Court actually found its expression as early as 1973, where a judgment of the German court said we have problems with the treaty provisions saying that we must abide by the European court's rulings. In between and the 80s, they softened their stance. But since the Maastricht Treaty, they hardened it again. I suspect that the rising populism of the past decade provided them with an environment where they felt it was safe to really go forward.
Beckworth: If this court ruling does turn out to be very consequential for the existence of the EU, how do you see it unfolding or breaking up? What would be the steps that would lead to the breakdown of the Eurozone?
How the German Constitutional Court Ruling Could Cause a Eurozone Breakdown
Hellwig: That's difficult to foresee. I mean, the simplest scenario, or the simplest development that I can foresee might go something like this. The German government asks the ECB for justification of its policies as requested by the German court. The ECB might, as a matter of principle, respond by saying that's none of your business, you're violating article 130 of the treaty. But in case you're interested, here is whatever material we have already published, and we're not going to provide you with anything more. At that point, the German government might look at this stuff, might either go to Luxembourg to sue in order to get more. Not very likely. It might go back to Karlsruhe and say this is what we foresee and we see no problem.
Hellwig: At that point, the plaintiffs of the original suit would immediately scream and complain and say the German government's not seeing any problem, it's an infringement of our constitutional rights. Please enjoin the German government to sue in Luxembourg. If the German government refuses, we have a constitutional crisis in Germany. If the German government goes ahead, I'm pretty sure that Luxembourg is going to rule against the German government.
Hellwig: At that point, the German Constitutional Court might tell the Bundesbank get out of these programs which would provide justification for the commission to sue for treaty infringement. Because the Bundesbank is no longer fulfilling its obligations under the treaty. That suit is likely to be successful meaning you're likely to get a ruling from the European Court. The Bundesbank must participate.
Hellwig: And the other question is what do they do? If at that point the German government says, "We're going to abide by the ruling from Karlsruhe," the answer is going to be a call for a renewal of the treaty, a change in the treaty. The problem is there are many... most treaty changes that might make sense would not be acceptable to the German court because they would reduce the power of the German court. And at some point, they might have a treaty change saying let us forget about monetary union. Perhaps, let us forget about European Union altogether.
At some point, they might have a treaty change saying let us forget about monetary union. Perhaps, let us forget about European Union altogether.
Beckworth: What do you think, though, would be the reception by the public? I mean, I imagine… the Germans love the EU.
Hellwig: The markets would not give them even the time to have any considerate deliberation. I mean, once the scenario that I've just sketched develops, some things may develop very quickly.
Hellwig: As for the German political constellation, this is what I'm wondering about because if you pose the question abstractly, in terms of what do you think of the EU, my guess is there would be something between 60% and 80% of the population saying, "We need that." And we should definitely not abolish that. But this is not the way the question is being posed. The question that's being posed is what do you think of the ECB's making it impossible to earn interest on savings?
Beckworth: So, let me ask this question, could you foresee a scenario where Germany leaves the Eurozone but stays a part of the EU so it becomes what the UK was before Brexit?
Beckworth: So it's all or nothing. If it leaves the Eurozone, it leaves the EU too.
Hellwig: It's very simple. This is something that people in Germany are not really aware of. Germany's participation in the Eurozone is a major factor in other countries accepting the internal market. This is something that many people in Germany don't realize, behind all this, there is the question of why should other countries accept German surpluses in terms of intra-European trade? Why should other countries accept the fact that German surpluses in relations with third countries such as the US keep the exchange rate high and make it more difficult for Greek or Italian or Spanish companies to sell stuff abroad?
This is something that people in Germany are not really aware of. Germany's participation in the Eurozone is a major factor in other countries accepting the internal market.
Hellwig: So, we cannot see the politics of all this without considering the trade balance and the extraordinary surpluses that Germany has been running. I'm reasonably sure that a country like France is going to question the internal market the moment Germany puts the Euro into doubt.
Beckworth: Oh, very interesting. One of the first thoughts I have when I read this decision, read the news stories is why would the court want to harm itself? It's in a great position within the Eurozone. It's getting these trade surpluses because it has the Euro, not the Deutsche Mark. If it had the Deutsche Mark, it probably be a much stronger currency than the Euro. So it's benefiting immensely from being a part of the EU and the Eurozone from a big picture perspective. So it is interesting to watch and see.
Beckworth: It was interesting to see in the news today that I think four of the members of the governing council kind of dismissed this court ruling. They said they're not going to take it seriously. So it would be interesting to see how this all plays out going forward. Well, with that our time has come to an end. Our guest today has been Martin Hellwig. Martin, thank you so much for joining us.
Hellwig: Thank you for having me.
Photo by Sebastian Gollnow via Getty Images