ABSTRACT
ABSTRACT
This article investigates why the European Central Bank's (ECB's) unconventional monetary policies were relatively modest during the crisis, focusing specifically on the design of its government bond purchase programmes. Building from available explanations of the ECB's behaviour in the political science and public policy literature, we extrapolate a number of testable propositions with a view to helping to account for the specific features of the policies under investigation. These propositions build from scholarly works that emphasize three distinct fundamentals of the ECB's behaviour: legal; doctrinal; and institutional. We then provide evidence supporting our propositions by evaluating the ECB's policy settings during the crisis. In addition, we identify other factors that have shaped the design of the ECB's bond buying policies, namely the ECB's conception of its own independence.
1. INTRODUCTION
For institutions that are so inclined to ‘boring’ policy-making, as the former governor of the Bank of England once put it (King Citation2000), central banks’ recent adoptions of non-standard policies has been remarkable. And for a central bank that is often characterized as a particularly conservative institution, the embracing of non-standard policies by the European Central Bank (ECB) is, if possible, even more remarkable. Since the start of the crisis, the ECB has not only acted on the main refinancing rate, but has also granted banks unlimited access to liquidity against a broadened and riskier range of collateral, and intervened directly in some market segments through asset purchases. Further the ECB has also revised its communication strategy by providing guidance on the expected future path of its monetary policy stance.
While the ECB's crisis response puzzled many observers because of its unusual vigour for a central bank whose monetary strategy was designed to err ‘on the side of caution’ (Issing Citation2006), the designs of its unconventional monetary policies (UMPs) have been criticized for their limited scope and duration (e.g., Lagarde Citation2013). For instance, Paul De Grauwe notes that the ECB ‘structured [the Securities Market Programme (SMP)] in the worst possible way … By announcing the program would be limited in size and time, the ECB mimicked the fatal problem of an institution that has limited resources’, thus hopelessly impairing its effectiveness (De Grauwe Citation2012). The ECB's modest use of its balance sheet to counteract the crisis has nurtured the view that it is reluctant to take assertive, pre-emptive actions.Footnote1
This article investigates why the ECB's UMPs were relatively modest during the crisis. Specifically, we focus on the design of a specific set of balance sheet policies, government bond buying programmes, and attempt to explain their policy settings.Footnote2 We answer the question of why the ECB selected the specific operational features of these programmes, including the scope of application (market segment and extent of intervention), duration and eligibility criteria.
In order to address this question, we build on available explanations of the ECB's behaviour from political science and public policy literature. In particular, three explanations as identified in the literature are extensively discussed below. The first explanation indicates that legal constraints are the most important determinants of the ECB's behaviour. From this perspective, the design of the ECB's policies is largely explained by its overarching price stability mandate and the interpretation of the prohibition of monetary financing, stipulated in Article 123 of the Treaty on the Functioning of the European Union (TFEU). The second explanation emphasizes the influence exerted by the ECB's economic doctrine. It is hypothesized that the ECB's policies are meant to secure monetary dominance, in order to ensure that fiscal authorities abide by the sound budget principle. Finally, the third explanation of the ECB's behaviour emphasizes the influence exerted by institutional factors, such as the composition and decision-making structure of the ECB's Governing Council. From this perspective, national interests are likely to be influential in the policy-making process.Footnote3
In what follows, we apply these arguments to the bond buying policies adopted by the ECB since the start of the crisis in 2008–9. Specifically, for each explanation we extrapolate a number of testable propositions in order to help account for the specific features of the policies under investigation. We then provide evidence for our propositions by evaluating the ECB's policy settings since the start of the euro area crisis in 2010 until the end of the calendar year 2014. We also identify another factor that has shaped the design of the ECB's bond buying policies, namely the ECB's conception of its own independence. Although the ECB's independence is enshrined in its legal mandate, we maintain that this explanation should be treated as a distinct driving feature of the ECB's policy settings because of the unique interpretation of its independence, stemming from its supranational status.
This study contributes to the political science literature that investigates the determinants of central banks’ preferences and policies (e.g., Bernhard et al. Citation2002; Drudi et al. Citation2012; Dyson and Marcussen Citation2009; Golub et al. Citation2015; Moschella Citation2015) by clarifying the role of political factors in the design of the ECB's monetary policy during the crisis. Our analysis also contributes to the literature on the European Union's (EU's) economic policy response to the crisis, adding to the scholarly works that examine changes in other policy areas, including fiscal policy, economic governance and financial regulation (e.g., Begg Citation2009; Copeland and James Citation2013; Hodson Citation2013; Howarth and Quaglia Citation2013).
Before proceeding, some clarifications are in order concerning the scope of the analysis, the dependent variables and the methodology. In terms of scope, we focus solely on a specific type of balance sheet policy – government bond buying programmes – because, as will be further discussed below, these have been the most controversial owing to their distributional consequences across national lines and the potential fiscalization of monetary policy. However, balance sheet policies are comprised of more than the mere purchasing of public securities, and the ECB has also employed other types of balance sheet policies during the crisis, including private sector asset purchases.
The dependent variables in this article are the ‘settings’ selected for the bond buying policies. By ‘settings', we mean the distinct operational features that policymakers assign to a policy instrument. As Peter Hall famously put it, there are three central variables that are involved with policy-making: ‘the overarching goals that guide policy in a particular field, the techniques or policy instruments used to attain those goals, and the precise settings of these instruments’ (Hall Citation1993: 278). Indeed, the same instrument may be designed in several different ways. To follow Hall's example: ‘if the goal of the policy is to alleviate the financing problems of the elderly, the chosen instrument might be an old age pension, and the setting would be the level at which benefits are set’ (Hall Citation1993: 278). Applied to the policy under investigation, in designing bond buying policies, policy-makers need to decide on: the scope of application, including the market segment in which to intervene and the extent of intervention; the duration of the asset purchases; and the criteria to follow in deciding what securities to buy. The scope of application, duration and eligibility criteria of bond buying programmes are thus our dependent variables. Against this backdrop, this article does not provide an explanation of why the bond buying policies were adopted in the first place. For instance, we do not address the question of whether the ECB acted in anticipation, or as a consequence of the fiscal and structural adjustments undertaken by euro area member states (on this issue see, for example, Howarth [Citation2004]).
Finally, in terms of methodology, it is worth reminding the reader that the ECB has only recently started publishing the minutes of its policy meetings.Footnote4 This means that we cannot ascertain how specific policy choices were derived within the meetings. However, we try to make up for this limitation by triangulating among three sets of empirical data: official documents (such as ECB statements and publications); financial press reports; and speeches and interviews of the ECB's Governing Council members, as extracted from the Bank for International Settlements’ (BIS) database.
The rest of the article is organized as follows. Section 2 reviews the main factors that are used to account for the ECB's monetary policy choices. For each of them, we extrapolate propositions with a view to help account for the policy settings of the ECB's bond buying policies. Section 3 examines the operational features of the ECB's bond buying policies, and Section 4 provides a systematic account of how the settings of each of these policies can be explained in light of the derived propositions. Section 5 concludes by reflecting on the findings and discussing their potential implications for future research.
2. EXPLANATIONS OF THE ECB'S BEHAVIOUR
There is no shortage of academic studies on the ECB. In political science, attention has often focused on questions related to the central bank's independence and accountability (Elgie Citation1998; Jabko Citation2003; Verdun Citation1999) and to the contribution of the ECB to the functioning of the Economic and Monetary Union (EMU) (Dyson Citation2000; Hodson Citation2011; Howarth Citation2004; Howarth and Loedel Citation2003). This literature also contains important insights that help explain the ECB's bond buying policies by unveiling some of the sources of the ECB's preferences. Specifically, we identify three strands of scholarship, each of which emphasizes distinct fundamentals for explaining the ECB's behaviour: legal; doctrinal; and institutional.Footnote5 From each explanation, we extrapolate a number of propositions with a view to helping to account for the design of the ECB's bond buying policies (). These propositions will be empirically tested in Section 4.
Table 1 Factors and expectations for the choice of the policy settings of the ECB's bond buying policies
2.1. The legal fundamentals
The ECB's behaviour can often be explained by the mandate and legal provisions governing the central bank's activity. The Treaty on the Functioning of the European Union (TFEU) mandates the ECB to pursue price stability and, without prejudice to this objective, to also support the general economic policies of the EU. But the ECB's mandate clearly prioritizes price stability over all other macroeconomic objectives.Footnote6 As some ECB officials have put it, ‘The primary mandate of the ECB is enshrined in primary legislation (Article 282.2 TFEU) and has to be followed in whatever circumstances, be it in goldilocks or stormy times’ (Salines et al. Citation2012: 671). The traditionally strict interpretation of the mandate is reinforced by the dominant belief within the ECB that the maintenance of price stability is ‘the best monetary policy can do to foster a high rate of growth of output’ (Issing et al. Citation2001: 67; Jabko Citation2003). Based on this view, the ECB must design its policy settings such that they can be justified as consistent with the price stability mandate.
The prohibition of monetary financing (Article 123 TFEU) is also expected to constrain the ECB's policy decisions (Yiangou et al. Citation2013), as the ECB is not allowed to provide ‘overdrafts or any other type of credit facilities’ to public entities, nor can the ECB purchase directly ‘debt instruments’ from these public entities. Given that the bond buying programmes could be misinterpreted as a violation of Article 123, it is plausible to expect that legal considerations were front and centre throughout the designing process.
Bond buying programmes are especially controversial because of associated distributional implications among savers, debtors and the government budget.Footnote7 Furthermore, in a monetary union, these programmes entail distributional implications across national lines; giving rise to concerns over risk sharing and moral hazard. Risk sharing arises if purchased bonds are centrally held and losses from such purchases are shared across member states. Additionally, bond purchases may encourage moral hazard through two channels. First, if governments believe that they have an effective backstop in case their debt becomes unsustainable, they may be less inclined to be fiscally prudent or to implement difficult measures to put debt on a sustainable path. Second, bond buying policies facilitate cheaper financing of government debt, and therefore may lessen the urgency of fiscal adjustment. The ECB therefore may have attempted to mitigate the risk of its policies being assimilated to the act of financing government spending by thwarting the perception that its policies may fuel moral hazard from national governments.
From these insights we derive two propositions that may help explain the ECB's behaviour when choosing the policy settings for its bond buying programmes.
Proposition 1: The ECB designs policy settings of bond buying programmes with the aim to reduce the deviation from the primary objective of price stability.
Proposition 2: The ECB designs policy settings of bond buying programmes with the intention to reassert a strict interpretation of the prohibition of monetary financing by limiting the risk of moral hazard from national governments.
2.2. Economic doctrine fundamentals
The ECB's monetary stance is often explained by the policy consensus at the origins of the creation of EMU. In particular, a consensus gradually emerged, and was eventually incorporated in the Maastricht Treaty and the ECB statute, according to which EMU should be built around the concept of stable money (Dyson and Featherstone Citation1999; Issing et al. Citation2001: 3; McNamara Citation1998; Verdun Citation1999). This consensus has important implications for the relationship between monetary and fiscal policy. It is worth remembering that the outlook for price stability in the medium term is influenced not only by the central bank's decisions, but also by fiscal measures adopted by national governments. For instance, economic literature has shown that fiscal policy can affect monetary policy through the impact of the government's inter-temporal budget constraint and fiscal policy settings on aggregate demand, interest rates and sovereign spreads, among other variables.Footnote8
Hence, in order for the central bank to effectively manage inflation, fiscal authorities should be ready and willing to apply fiscal levers (revenues and primary spending) to stabilize debt at a given interest rate, as set by the central bank. In economic jargon, monetary dominance requires passive fiscal policy. Fiscal dominance prevails when these roles are reversed: monetary policy stabilizes real government debt while inflation is determined by the needs of fiscal policy.Footnote9
In EMU, the co-ordination of monetary and fiscal policy is further complicated by the existence of diverse fiscal policies in member countries. Although there is controversy over the extent to which fiscal indiscipline by one or more euro area members threatens price stability,Footnote10 the endorsement of stable money as the governing principle of EMU, as enshrined in the ECB's legal mandate, has its mirror image in the principle of fiscal rectitude, as enshrined in the Stability and Growth Pact (SGP).Footnote11
From this perspective, the ECB's policies aim at ensuring monetary dominance. This leads us to the following expectation:
Proposition 3: In deciding the settings of its bond buying policies, the ECB opts for mechanisms that actively push domestic authorities to achieve fiscal discipline.
It is worth noting that the logic here differs from that suggested by the legal provision against monetary financing discussed above. Whereas the prohibition of monetary financing implies that the ECB engineers policy settings to ensure that it does not facilitate fiscal indiscipline, the ‘monetary dominance’ argument suggests that the ECB designs settings that actively search to induce fiscal discipline. In addition, the former constitutes a legal requirement by the ECB and its interpretation of this requirement, whereas the latter is concerned with economic ideologies concerning the role of monetary and fiscal policies within EMU.
2.3. Institutional fundamentals
Finally, the scholarship on EMU also draws attention to the institutional factors that shape the ECB's policy preferences, focusing on the uniqueness of the composition and structure of the ECB's Governing Council and the potential role of national interests in decision-making (e.g., Hodson Citation2011). Specifically, only 6 out of 24 members of the Governing Council are appointed by the EU, the remainder being the 19 central bank governors of the euro area member countries. This suggests that, at least in principle, the Eurosystem decision-making structure provides state interests significant access and voice in the decision-making process. However, according to Article 130 of the TFEU: ‘neither the European Central Bank, nor a national central bank, nor any member of their decision-making bodies shall seek or take instructions from Union institutions, bodies, offices or agencies, from any government of a Member State or from any other body'. Yet, differences in cultural values and ideologies with respect to the role of the EU in national and cross-national policies, as well as how the ECB's mandate should be interpreted, do seep into the Governing Council's deliberations. In short, ‘cultural differences’, as a former member of the ECB's Governing Council put it (Stark Citation2015), and national interests are far from having disappeared in EMU, notwithstanding the underlying macroeconomic consensus that underpins it (Verdun Citation1999).
This notion that national representatives play a prominent and asymmetric role in the ECB's decision-making has been used to justify why the ECB is often a reluctant player in the expansion of the community dimension of EMU, in contrast to the supranational preferences of other EU institutions (Hodson Citation2011: ch. 2). These important insights can be extended to the design of its UMPs to explain why the ECB acted as a ‘reluctant rescuer’.Footnote12 This brings us to the following expectation:
Proposition 4: The ECB designs policy settings with the view to assuage political opposition within the monetary policy committee.
2.4. Explaining policy settings: the additional factor of the ECB's independence
Although the factors discussed thus far help illuminate most of the ECB's monetary policy choices, we emphasize another specific aspect of the ECB's functioning that is often not adequately incorporated into analyses explaining the central bank's behaviour: the ECB's interpretation of its independence as an instrument to achieve the price stability objective. In order to understand this, we should take into consideration the difficulties faced by a central bank operating as a supranational institution in a multi-country polity.
Indeed, while all central banks risk being subject to political pressures that may hinder the pursuit of price stability, the risk is particularly high for supranational institutions, such as the ECB. In the words of a team of prominent ECB economists, given the peculiar political context that underlie the EMU, ‘[n]ational interest groups would find ways to characterize monetary policy as contrary to, or in favour of, the welfare of their own country, thus exercising pressure on council members’ (Issing et al. Citation2001: 132). From the ECB perspective, such a risk is minimized by a strict interpretation of its political independence. That is to say, the ECB sees itself as the quintessential example of an independent agency that is not meant to be responsive to national governments, but rather to what has been assigned by an essentially inviolable international treaty (Posen [Citation1993]; see also Issing [Citation2011]; Jabko [Citation2003]). As Howarth and Loedel (Citation2003: 130) note, the ECB takes ‘its institutional protection of political independence seriously’ and ‘has not once backed down on any serious decision it has made', despite the political pressures that have been directed at it since its creation.
Based on the centrality of the view of its independence, we suggest an additional Proposition yet to be accounted for in the literature explaining what motivates the ECB's decisions:
Proposition 5: The ECB designs policies with a view to signal its independence from government during policy formulation and restrict political interference or influence during policy implementation.
3. THE POLICY SETTINGS OF THE ECB'S GOVERNMENT BOND BUYING PROGRAMMES
Since the start of the global financial crisis in 2007–8, the ECB has been on the front lines of repairing financial market dysfunctions and restoring the foundations necessary for sustained economic growth in the euro area. In addition to its traditional weaponry, the central bank adopted various UMPs that it recognizes as ‘non-standard’ and ‘unprecedented in nature, scope and magnitude’.Footnote13 The combined effects of the standard and non-standard policies on the ECB's balance sheet are illustrated in Figure 1.
Published online:
14 August 2015
Figure 1 Eurosystem assets (January 2007–December 2014)
The ECB has relied extensively on non-standard liquidity facilities, including US dollar swap arrangements (included in ‘Claims on euro-area residents denominated in foreign currency' in Figure 1), fixed-rate full-allotment tender procedures (captured by ‘Main refinancing operations' in Figure 1), and longer-term refinancing operations – which had the largest impact on the balance sheet among the non-standard policies. It also introduced forward guidance in July 2013 to further enhance its accommodative monetary policy stance.Footnote14 Finally, the ECB adopted a number of policies involving the purchases of private and public securities (included in ‘Securities of euro area residents denominated in euro' in Figure 1). The majority of private sector purchases have been facilitated through the Covered Bond Purchase Programme (CBPP) that was first introduced in July 2009, with additional rounds announced in October 2011 and September 2014. The ECB also introduced the Asset-backed Securities Purchase Programme (ABSPP) in September 2014.
In addition to these measures, it has developed policy instruments involving the purchases of government securities; the first government bond buying policy being the SMP introduced in May 2010 and later resumed in August 2011.Footnote15 It had four main operational features: assets were purchased on the secondary market; purchases were sterilized; the programme was temporary; and the Governing Council had full control over the scope, timing and type of purchases.
The SMP ceased when a second government bond buying policy was introduced in September 2012: the Outright Monetary Transactions (OMT) programme. Just as the SMP, the OMT programme was adopted to both preserve the singleness of monetary policy and ensure the proper transmission of the monetary policy stance throughout the euro area. The OMT programme shares many features with the SMP, except that it was designed with no ex ante limits. However, this does not mean that the OMT programme allows interventions ‘in an uncontrolled or unconditional way’ (Draghi Citation2012d). The OMT programme also has two additional features: government bonds purchased must have a maturity between one and three years, and eligible assets only include those of countries participating in a macroeconomic adjustment programme with the European Stability Mechanism (ESM), which consists of strict fiscal and structural conditionalities.Footnote16
The sterilization of purchases under both the SMP and OMT programme has been paramount in differentiating the ECB's bond buying policies from the quantitative easing (QE) programmes pursued by other major central banks because it signals an unchanged monetary policy stance (see, for example, ECB [Citation2011: 53]). In the words of former ECB President, Jean-Claude Trichet (Citation2010b), ‘[t]he Securities Markets Programme should not be confused with quantitative easing. In simple words: we are not printing money. This confirms and underpins our commitment to price stability.' Similarly, in deciding on the OMT programme, Draghi forcefully declared that, ‘we act strictly within our mandate to maintain price stability over the medium term’ (Draghi Citation2012a). Specifically, the choice to purchase bonds with maturities between one and three years reveals the Governing Council's attempt to effectively ‘normalize’ its asset purchases; that is, to use the same operational features that characterize its standard monetary policy. As Draghi explained in response to a question following the announcement of the vote on the OMT programme, ‘it is three years because it seemed to us the maximum most effective maturity to target: it is close to our short-term policy rates; it affects also the medium-term yield curve; it is close to the rates that are being used to lend to the private sector’ (Draghi Citation2012a).
Limiting interventions to the secondary market was also instrumental in avoiding a breach to the monetary financing prohibition and minimizing the risk of moral hazard (ECB Citation2012: 7). When the former president of the ECB justified the SMP in front of the European Parliament, he stated that, ‘[t]he Treaty prohibits the direct purchase by the ECB of debt instruments from governments. We are buying bonds on the secondary market only’ and these purchases ‘cannot be used to circumvent the fundamental principle of budgetary discipline’ (Trichet Citation2011). Similarly, in clarifying the decisions to design the OMT interventions to occur solely on secondary markets, Draghi (Citation2012d) indicated that, ‘[i]f interventions take place, they will involve buying government debt from investors, not from governments. All this is fully consistent with the Treaty's prohibition on monetary financing.’ Likewise, circumscribing purchases to securities with one- to three-year maturities can be viewed as an attempt to abide with Article 123 of the Treaty, since governments usually finance themselves with much longer maturities.Footnote17
The ECB designed its bond buying programmes to not only remind governments of their fiscal obligations, but to also promote fiscal discipline. The choice to limit the central bank's purchases to securities with maturities between one and three years reflects this view: as Draghi (Citation2012d) put it, OMT interventions ‘will focus on shorter maturities and leave room for market discipline on longer maturities’.
The choices of time frame as well as the eligibility criteria make it evident that fiscal discipline was a priority when designing the bond buying programmes. For instance, the temporary nature of the SMP ensures that member states not simply abide, but enhance efforts towards fiscal discipline in anticipation of the ECB withdrawing support. As Trichet (Citation2010a) declared, ‘the first – and absolutely necessary – condition for success [of the SMP] is that governments accelerate fiscal consolidation and are unwavering in their implementation of the tough measures that are indispensable’. The influence of the ECB's monetary doctrine is also evident in the time frame and eligibility criteria that define the workings of the OMT programme. One member of the Governing Council presented it as, ‘[t]he design of OMTs has been inspired by the desire to affirm in a lasting manner ‘monetary dominance’, in compliance with the principles enshrined in the Maastricht Treaty’ (Cœuré Citation2012). In particular, the OMTs will be terminated if there is non-compliance with the conditionalities established in the ESM programme. As Draghi (Citation2012b) indicated, ‘Without conditionality you would certainly have what people call fiscal dominance.’
The eligibility criteria of the bond buying programmes should also be read against the backdrop of national preferences and cultural orientations in the euro area. Indeed, since the launch of the SMP, some members of the Governing Council were concerned that the central bank's bond buying policies were dangerously blurring responsibilities between monetary and fiscal policy without addressing the problem in the monetary transmission channel (Weber Citation2010). Given these differing views, it is likely that Axel Weber, and the ECB's former chief economist, Jürgen Stark, voted against the SMP as they both resigned shortly after its announcement, perhaps out of disagreement with the bond buying programme. The vote over the OMT programme was also not unanimous. Although President Mario Draghi refused to name the lone dissenter in the press conference held on 6 September 2012 when the operational details of the OMT programme were announced, there are few doubts that it was Jens Weidmann, President of the Bundesbank. Weidmann has been very public about his institution's opposition to the OMT programme, describing it as ‘a far-reaching collectivization of risks’ whose decisions fall outside central banks’ remit (Weidmann Citation2012).
Although it is difficult to reach firm conclusions in the absence of the minutes of the meetings of the Governing Council, the Bundesbank's vocal opposition was consequential in light of its influential role in the creation of EMU (Dyson and Featherstone Citation1999). Therefore, it is plausible to think that the decision to introduce a strong conditionality element into the OMT programme was to satisfy opposing political forces within the Governing Council. A similar explanation can be applied to the decision to restrict purchases on bonds with maturities between one and three years: indeed, this restriction can be read as a way to appease the concerns of some Governing Council members regarding the central bank's role in dealing with macroeconomic issues outside of the scope of its medium-term inflation objective (see, for instance, Weidmann [Citation2012]).
Despite efforts to assuage the concerns of certain members of the Governing Council, the OMT programme was still referred for review by the German Federal Constitutional Court (GFCC). In February 2014, the GFCC decided that the programme transgresses the ECB's powers and referred the case to the Court of Justice of the European Union (CJEU) for a preliminary ruling before making its final decision. Without a judicial ruling, the OMT programme remains an available policy, subject to the publication of legal provisions for its application.Footnote18
Despite the exercise of the hierarchical role of Germany (e.g., Verdun Citation1999), the operational features of the ECB's bond buying policies also reflect concerns over its independence. With respect to the SMP, the ECB limited the duration of the bond buying policies in order to guarantee the central bank's operational independence in pursuing its mandate. Describing the temporary feature of the SMP, Trichet (Citation2010d) stated, ‘[w]e always act in line with what we observe in terms of market disruption and/or absence of normal functioning. Our working assumption is that we will return to normal functioning. When we are functioning normally, we interrupt all non-standard measures by construction, by definition.’ Similarly, despite the fact that the OMT programme remains a viable policy, the ECB has not implemented it because the announcement itself was sufficient for achieving its objective of restoring the functioning of the transmission mechanism (e.g., De Grauwe and Ji Citation2014; Siekmann and Wieland Citation2014). The ECB went no further than it deemed necessary for achieving its mandate.
Another feature that was meant to support the uncompromising independence of the ECB is its ultimate authority over the scope and timing of the bond buying policies. Under the OMT programme, for example, it is up to the Governing Council to (re)assess the eligibility criteria of its purchases by closely monitoring developments in the countries under an ESM programme (ECB Citation2012: 8–9). The policy certainly had a fiscal element, as Draghi (Citation2012a) explained: both fiscal policy and monetary policy need to work in co-ordination to break the ‘self-fulfilling expectations’ that generate ‘adverse scenarios’. However, the fiscal element was a precursor for the monetary authority to act: the ECB required the fiscal component to be operational in order for the monetary component to be active. Draghi (Citation2012a) clarified that ‘[i]f the central bank were to intervene without any actions on the part of governments, without any conditionality, the intervention would not be effective and the Bank would lose its independence'. Furthermore, Draghi (Citation2012b) specifically stated that, ‘[w]ith conditionality independence of the ECB is protected’.
4. DISCUSSION
To provide a more systematic analysis of how the legal, doctrinal and institutional characteristics of the ECB influenced the policy settings of its bond buying programmes, we will briefly recount how each of the propositions developed in Section 2 help explain the specific policy settings ().
Table 2 Policy settings of the bond buying programmes and applicable propositions
Several of the operational features of the SMP and OMT programme are explained by the ECB's legal mandate, as suggested in Proposition 1. Specifically, the purchases were sterilized in an effort to emphasize that the programmes would lend support to the transmission of monetary policy and singleness of the current monetary policy stance. This ensured that its policy was justified as supporting its ‘standard’ monetary policy. As Trichet (Citation2010c) stated, ‘our monetary policy stance is not affected, and there are no inflationary risks related to [the SMP]'. Similarly, the restricted maturity of assets purchased under the OMT programme were meant to ensure that the policy was directly in line with its ‘regular’ monetary policy timeline, and does not interfere with its mandate to pursue price stability over the medium term. Finally, the Governing Council firmly stated and re-stated that it retained complete discretion over the scope and timing of asset purchases, including the decision to start, continue and suspend purchases as it saw fit for achieving its price stability mandate.Footnote19
Moreover, members of the Governing Council were very clear about how secondary market purchases would abide by the prohibition of monetary financing, as suggested by Proposition 2. The same proposition is supported by the decision to buy securities with short-term maturities: since governments usually finance themselves at much longer maturities, the purchases of short-terms bonds were instrumental to neutralize the impression that the ECB interventions would be a form of monetary financing.
While the strict adherence to the prohibition of monetary financing aligns with the ECB's aim to prevent moral hazard, several design features of the public bond purchasing programmes actively sought to induce fiscal discipline, as outlined in Proposition 3 (see also Yiangou et al. [Citation2013: 234]). Specifically, the temporary nature was meant to accelerate the reaction of national governments to implement structural reforms and pursue fiscal consolidation. Finally, the requirement to be part of a structural adjustment programme and to adhere to the conditionalities strictly ensured that monetary policy was associated with fiscal discipline. The selected policy settings were not simply designed with the aim of safeguarding resources against the risk of moral hazard from national governments, but to also ensure that they not deviate from fiscal discipline.
After several members of the Governing Council were dissatisfied with the SMP, institutional factors clearly had an effect on the design of the OMT programme, as suggested in Proposition 4. Since the programme implied support for sovereign bonds in only a few countries, rather than comprehensive support across the euro area as a whole, it politicized those ‘deep cultural differences’ that exist within the euro area (Stark Citation2015). As a result, features such as the adherence to a structural adjustment programme for the ECB to activate its purchases, or the restriction on the maturity of eligible assets do seem, in part, designed to assuage the concerns of Governing Council members whose cultural values fiercely oppose the blurring of responsibility between monetary and fiscal policy and fear the potential inflation-destabilizing effect of accommodative monetary policies.
The analysis of the operational features of the ECB public bond buying programmes also suggests that they were developed with a view to reassert the ECB's independence, as suggested by Proposition 5. For instance, the influence exerted by the ‘independence’ factor can be ascertained in the temporary design of the SMP, the conditionality of the OMT programme, and the ultimate and uncompromising authority retained by the Governing Council over the scope and timing of purchases. These operational features were meant to ensure that national governments had no influence over the programmes and that monetary policy did not play a fiscal role where one was lacking. As Draghi (Citation2012c) stated about the conditionalities under the OMT programme, ‘this is the necessary condition – it is not also the sufficient condition. So, the Governing Council will take its final decision in total independence.’
5. CONCLUSIONS
Designing asset purchase schemes presents policy-makers with a number of alternatives, including to what extent and in which markets to intervene. It also requires policy-makers to decide on the limits and guiding criteria of asset purchases, namely which securities are eligible to be purchased and which are not. This article has analysed how policy-makers at the ECB addressed these policy choices by shedding light on their political foundations. Specifically, we assessed the extent to which the policy settings of the ECB's government bond buying programmes were influenced by reasoning that can be extrapolated from the ECB's mandate, its monetary doctrine and the institutional set-up of its decision-making structure. As extensively discussed in the previous section, the analysis largely confirms the insights of previous scholarship but also reveals an additional factor that shaped the ECB's decisions on policy design, namely its own conception of independence from national governments.
Although the analysis was confined to the government bond purchase programmes adopted until 2014, the ECB's recent decision to begin purchases of public sector securities under the Public Sector Purchase Programme (PSPP) should be mentioned because it is both unprecedented in scope and size for the ECB.Footnote20 A thorough analysis of the policy settings of the PSPP is outside the scope of this article; however, we will quickly preview how the design of this bond buying policy stands in relation to the aforementioned propositions.
The PSPP has some operational features that parallel that of the SMP and OMT programme, but it also has several novel features. Specifically, the PSPP conducts operations on the secondary market and the Governing Council retains full discretion over the design features of the programme, like with the SMP and OMT programme. These features remain in place to ensure that the ECB is acting within its legal mandate, including how it relates to the prohibition of monetary financing and its price stability mandate, as well as securing its independent decision-making when dealing with public sector assets. Rather than sterilizing purchases to facilitate the effective transmission of its monetary policy, the programme consists of non-sterilized purchases of securities with maturities between 2 and 30 years. These operational settings are a change in the ECB's view that quantitative easing – asset purchases that expand the monetary base – and purchasing longer-term assets can destabilize inflation expectations.Footnote21 But while the SMP and OMT programme aimed at ensuring the smooth transmission of the existing monetary policy stance, the PSPP is actually meant to further ease monetary policy to ensure the ECB adheres to its mandate. Indeed, the circumstances surrounding price stability in the euro area have changed since the Securities Market Programme and Outright Monetary Transaction programme were introduced: the euro area had been facing deflationary pressures for over a year and longer-term inflation expectations were beginning to unhinge before the PSPP was introduced.
In addition to the goal of ensuring price stability, there is evidence that some operational features of the PSPP are included to assuage political opposition to new bond buying schemes. Specifically, purchases of sovereign securities are allocated based on the ECB's capital key and are primarily conducted by national central banks, with only 20 per cent of the risk being shared. Furthermore, in order to prevent manipulation of public sector debt markets and minimize the view of indirect monetary financing, the PSPP has specific purchase limits in addition to a blackout period.Footnote22 Despite these design features, Jens Weidmann (Citation2015) indicated that he voted against public sector asset purchases, citing fears that the programme creates moral hazard.
In light of German opposition to quantitative easing in the EMU, most analysts expected a much more muted response than the programme that has actually been adopted.Footnote23 This decision can be viewed as further testimony to the ECB's ability to resist national pressures, including those of the country with the economic model from which the ECB's mandate has been forged. Indeed, discussions prior to and following the announcement of PSPP suggest that the ECB's understanding of its independence, as directly connected to its performance in achieving price stability, was front and centre in the decision to start a systematic asset purchase programme (see Bini Smaghi [Citation2015]; Draghi [Citation2015]), as was the importance of monetary dominance (see Praet [Citation2015]). Although, it is surely too early to conclude whether a programme that lacks complete political support can reach its goals (Moghadam Citation2014), what this preliminary reading suggests is that the ECB is institutionally equipped to overcome political stalemate when deviations from price stability – both upwards and downwards – raise the spectre of risk for its independence.
| Factors | Expectations |
|---|---|
| Legal mandate | Settings that reduce the deviation from the ECB's primary objective |
| Monetary financing prohibition | Settings that prevent moral hazard from national governments |
| Economic doctrine | Settings that actively push domestic authorities to achieve fiscal discipline |
| Decision-making system | Settings that help assuage political opposition |
| Interpretation of independence | Settings that signal independence from governments during policy formulation and restrict political interference or influence during implementation |
| Policy settings | Programmes | Propositions |
|---|---|---|
| Purchases are sterilized | SMP and OMT | 1 |
| Purchases of public securities are on the secondary market | SMP and OMT | 2 |
| Governing Council retains discretion over the scope and timing of purchases | SMP and OMT | 1 and 5 |
| Purchases are temporary | SMP | 3 and 5 |
| Asset maturities must be between one and three years | OMT | 1, 2, 3 and 4 |
| Conditional on involvement in, and compliance with, EFSF/ESM programme | OMT | 3, 4 and 5 |
ACKNOWLEDGEMENTS
We gratefully acknowledge the Centre for International Governance Innovation (CIGI), Canada, for supporting this research project. We are also grateful to Samantha St. Amand for outstanding research assistance, as well as to the participants of the presentation of an earlier draft at the 2014 ISA's 55th Annual Convention in Toronto. Finally, we also thank the JEPP referees for their helpful comments. The usual disclaimers apply.
Notes
1 As this is being reviewed, the ECB has introduced its public sector purchase programme (PSPP). The PSPP is part of a comprehensive asset purchase programme that also includes asset-backed securities and covered bonds with total monthly purchases of €60 billion. This deviates from ‘modest use’ of the ECB's balance sheet, but still represents a lack of pre-emptive action given the deflationary pressures that inflicted the eurozone for over a year prior to the decision.
2 As will be explained at greater length below, we use the term ‘policy setting’ following Peter Hall's (1993) disaggregation of policy-making in terms of policy instruments, goals and settings.
3 For a different perspective see, for instance, Dyson and Featherstone (Citation1999) and Howarth and Loedel (Citation2003).
4 The ECB started publishing regular accounts of its monetary policy meetings in January 2015.
5 The distinction proposed here is mainly an analytical tool for explaining the settings of the bond buying programmes. We acknowledge that the boundaries among the legal, doctrinal and institutional fundamentals of ECB's behaviour are blurred in practice. However, we also contend that each of the three factors provide distinct motivations for the choice of policy settings and should thus be kept separate for a thorough interpretation of the ECB's policies.
6 On the history of the ECB's monetary policy strategy see Issing et al. (Citation2001).
7 For an analysis of the distributional implications of asset purchase programmes see, for instance, Bank of England (2012). More recently, Mario Draghi (2015) discussed these issues as they relate to the ECB's expanded asset purchase programme.
8 On monetary and fiscal policy co-ordination see, for instance, Alesina and Tabellini (Citation1987) and Debelle and Fischer (Citation1994).
9 For the classic treatment see Sargent and Wallace (Citation1981); for a more recent application see Woodford (Citation2001).
10 For an introduction to these issues see, for instance, Daniel and Shiamptanis (Citation2008).
11 On the rationale of the SGP as an attempt to underpin monetary dominance in the context of strategic interaction between monetary and fiscal authorities, see Artis and Winkler (Citation1998). On the origins and evolution of the SGP see also the detailed analysis of Heipertz and Verdun (Citation2010).
12 See, for example, The Economist (2011) and Filardo and Hofmann (Citation2014) on the implications of decentralized policy decision-making committees for the formulation of forward guidance.
13 ECB website, available at http://www.ecb.europa.eu/mopo/decisions/html/index.en.html, (accessed 8 September 2014).
14 It is worth noting, however, that the ECB's forward guidance differs from those adopted by the US Federal Reserve or the Bank of England (BoE) in some important respects. Whereas the latter committed to a specific path of the policy rate anchored to explicit thresholds, the ECB merely reasserted its views on the likely path of the policy rate given current economic projections (see Lombardi and Siklos [2014] for a comparative analysis).
15 The SMP also included purchases of private securities.
16 A further feature of the OMT programme is that the ECB accepts the same (pari passu) treatment as private and other creditors with respect to bonds purchased.
17 We thank an anonymous reviewer for drawing our attention to this point.
18 Although the CJEU is the final arbiter over EU legal matters, the GFCC developed the ‘ultra vires doctrine’ during the Maastricht judgment which requires EU activity to remain consistent with EU treaties. If, however, an EU institution is found to transcend its powers – like the GFCC suggested of the ECB with the OMT programme – then the law would lack democratic legitimacy and would not be binding in Germany (Petersen 2014). Therefore, if the GFCC rules that the programme is incompatible with German law, then it may also decide that national authorities are not allowed to participate in the policy or that they may even be required to bring a ruling against it (Murswiek Citation2014).
19 Stated in press release on the technical features of the OMT programme on 6 September 2012, available at http://www.ecb.europa.eu/press/pr/date/2012/html/pr120906_1.en.html (accessed 28 July 2015).
20 The PSPP began in March 2015; the programme includes purchases of securities issued by central governments, governmental agencies and supranational institutions.
21 It it is worth remembering that the effects on price stability may be either positive or negative.
22 The holdings limit is 33 per cent of an issuers debt and 25 per cent of any specific issue.
23 We thank one anonymous reviewer for having drawn attention to this point.