The Judgment of the Second Senate of Germany’s Federal Constitutional Court (BVerfG), delivered on 5 May 2020, criticises and ignores a decision of the Court of Justice of the European Union (CJEU). More significantly, it questions the European Central Bank (ECB)’s competence to engage in large-scale purchases of government bonds.
The decision heightens the tension between national law and EU law which has continued to plague European integration. While it carries a different flavour, it can be compared to increasing concerns about fiscal independence and sovereignty within the EU that have triggered other movements such as Brexit.
This note explains how the BVerfG’s decision will potentially contribute to fragmentation within EU law by inviting courts of other Member States to dispute the legitimacy of the CJEU’s judgments. This note argues however that the BVerfG’s concerns, that the ECB’s competence is expanding beyond those conferred on it by treaty, are valid.
Facts in brief
The case concerns the ECB’s Expanded Asset Purchase Program (EAPP). The EAPP is a form of quantitative easing wherein the central banks in the Eurozone (known as the European System of Central Banks (ESCB)) purchase securities issued by the public and private sectors.
Through the EAPP, the ESCB has purchased securities worth over €2 trillion. The ECB’s stated aim is to maintain price stability (i.e. to return inflation to a target of 2%). The EAPP increases liquidity in financial markets, reduces the cost of borrowing for businesses and households, and encourages more spending – at least in theory.
In the proceedings, the complainants contended that the public sector component of the EAPP, the Public Sector Purchase Program (PSPP), went beyond the ECB’s competence granted under the Treaty on the Functioning of the European Union (TFEU). They argued that the German Government’s decision to implement it contravened the German Basic Law.
BVerfG’s conclusion: CJEU is “incomprehensible and arbitrary”
In a preliminary ruling requested by the BVerfG, the CJEU held on 11 December 2018 that the PSPP did not go beyond the ECB’s competences under Art 127 TFEU (see BVerfG Ruling ). In doing so, it accepted that the PSPP is monetary policy and is proportionate to the ECB’s aim of maintaining price stability.
The BVerfG’s disagreement is clear in their judgment.
The BVerfG concluded that the German Government and Bundesbank (Federal Bank) contravened the German Basic Law by failing to scrutinise the effect of the PSPP on German citizens. The BVerfG held that the CJEU ruling is not binding because the CJEU acted ultra vires by failing to properly apply the principle of proportionality to the PSPP (at ).The BVerfG admonished the CJEU for failing to question the ECB’s stated purpose for conducting asset purchases (at ), and not enquiring into the broader economic effects of those policies (at ). It is in this sense that the BVerfG stated that the CJEU’s reasoning was ‘incomprehensible and arbitrary’ (at ). The BVerfG recognised at  the danger of national courts being able to decide on the validity of EU acts. Nevertheless, the BVerfG said, “if Member States were to completely refrain from conducting any kind of ultra vires review, they would grant EU organs exclusive authority over Treaties [underpinning the EU]”. This conclusion was unpalatable to the
BVerfG, which emphasised at - its role in safeguarding German citizens’ inalienable rights to democratic participation in Art 38(1) of the German Basic Law.
Implications for fragmentation
The German government now faces a conflict of obligations between the ruling of its constitutional court and its obligations under the Treaty on the European Union (TEU).
Warnings about a potential disintegration of the EU are not misplaced. In response to the BVerfG decision, the CJEU itself warned: “The [CJEU] alone … has jurisdiction to rule that an act of an EU institution is contrary to EU law. Divergences between courts of the Member States as to the validity of such acts would indeed be liable to place in jeopardy the unity of the EU legal order and to detract from legal certainty.”
In his seminal report, Professor Koskenniemi refers to ‘fragmentation’ to encompass the ‘increasing conflicts’ between various rules, ‘deviating institutional practices’ and a ‘loss of an overall perspective’ within international law. Commonly, potential conflicts arise between international law norms such as UN economic sanctions and human rights.
Fragmentation between international law norms is understandable because there is no centralised system to organise norms into a hierarchy. By contrast, the EU has a norm-organising body in the CJEU. Further, the CJEU has held that EU law prevails over national laws including constitutional laws.
A divergence of views on the competence of the ECB between the CJEU and BVerfG has nevertheless occurred due to a peculiarity of German constitutional law. Starting with the Solange I case (see CJEU decision and unofficial translation of the BVerfG decision), the BVerfG has left open the possibility of disapplying EU law where it is inconsistent with non-derogable rights enshrined in the German Basic Law. Professor Pistor criticises this jurisprudence for allowing the BVerfG to be the ultimate arbiter of EU law.
In this latest decision, the BVerfG has exercised that possibility. The effect is to undermine the supremacy of EU law and the legitimacy of the CJEU. The label “incomprehensible and arbitrary” is now easier for other Member States’ courts to apply to a decision of the CJEU with which they disagree. For example, the Financial Times reported that the head of Poland’s Constitutional Court said: “National constitutional courts are the courts which have the final word”. This is a troubling development for Poland, where the government has recently been criticised by the CJEU for compromising the independence of its judiciary.
Moreover, it continues the recent resurgence of States prioritising sovereignty to the detriment of international and supranational law obligations, such as Brexit, numerous US withdrawals under President Trump, and South Africa and the Philippines withdrawing from the Rome Statute. Even in Australia, the Prime Minister voiced concerns last year about “negative globalism that coercively seeks to impose a mandate from an often ill-defined borderless global community”.
Has the Euro experiment failed?
Notwithstanding the above criticism, the BVerfG’s ruling is justifiable. The decision rests on valid concerns about the encroachment of EU monetary policy on the fiscal independence of Member States. Specifically, the BVerfG’s decision draws attention to the fact that:
- control over monetary and economic policy is separated between the ECB and Member States; and
- the ECB’s independence is enshrined in the TFEU, making it subject to legitimate judicial oversight.
A fine line: monetary policy and economic policy
At the centre of the BVerfG’s concern about the CJEU’s reasoning is the seeming nonchalance with which the CJEU treated the distinction between monetary and economic policy.
Monetary policy refers to the policies chosen by a country’s monetary authority, generally the central bank, to control the country’s short-term interest rates or money supply. Economic (or fiscal) policy refers to the program of taxes and spending funded by the government.
The distinction is important in the EU because while the power to control monetary policy is conferred on the ECB under TFEU Art 127, economic policy remains within the purview of Member States (see ). Allowing the ECB to impinge on economic policy would breach the principle of conferral enshrined in Art 5(1) of the TEU (see ).
However, the distinction has become difficult to draw. After the Global Financial Crisis, short-term interest rates around the world were slashed in an effort to boost spending in the private sector. Some central banks went beyond interest rates and began purchasing longer term debt, such as mortgage backed securities and government bonds, in an effort to further increase liquidity in financial markets. The EAPP is one such policy.
As the Reserve Bank of Australia’s head, Governor Phillip Lowe, suggested in a November 2019 speech, a consequence of asset purchasing policies is the “possible blurring of the lines between monetary and fiscal policy.” In a recent interview, Harvard professors Reinhart and Rogoff take an even stronger view, stating that when central banks conduct asset purchases, they are engaging in fiscal policy by indirectly funding government spending. On this view, the ECB’s asset purchasing usurps the prerogative of Member States to control their budgets through their own revenue streams.
Catch-22: the ECB’s independence
A second issue is the principle of central bank independence. Central bank independence is important for maintaining price stability, as history shows that governments pursue short term political goals by increasing government spending, leading to higher inflation rates. An independent central bank can counteract inflation using monetary policy.
The ECB’s independence is explicitly protected by TFEU Art 130, and functionally protected by a prohibition on monetary financing in Art 123(1). Monetary financing refers to the purchase of government bonds by a central bank. A key reason it is prohibited is because it forces central banks to manipulate the money supply to meet government demands rather than to control inflation and interest rates.
Asset purchasing programs are not the same as monetary financing (although some, such as Dr Gertjan Vlieghe of the Bank of England, argue that they are). This is because the purchases occur on secondary markets, rather than directly from the government. The CJEU found that the PSPP did not violate the prohibition on monetary financing (CJEU Ruling , ); the BVerfG found that this question was not ascertainable (BVerfG Ruling ).
Nevertheless, the threat of monetary financing and diminished central bank independence play an important role in the BVerfG’s critique of the CJEU. At , the BVerfG warns that this independence necessitates, rather than discourages, strict judicial review to ensure the ECB complies with its mandate. Without this scrutiny, the ECB faces no democratic accountability and may expand its competences beyond those conferred upon it (see -). At worst, the ECB may be left vulnerable to pressure from Member States wishing to exploit the ECB’s expanded powers (see ).
The decision does not expand on how this pressure may manifest. One way could be through politicising the appointments of members of the ECB board. A politicised ECB could become an avenue for a Member State to encroach on the fiscal independence of other Member States by manipulating which assets are purchased.
Ironically, this decision has been criticised for itself undermining the ECB’s independence by questioning what the ECB can do. However, the BVerfG recognises that it is not its role to determine how competing economic concerns are weighed (see BVerfG Ruling ). Instead, the decision seeks to mobilise the political branches to scrutinise more carefully, and thereby protect, the ECB’s independence.
The BVerfG’s concerns about the ECB overstepping its competence are understandable given the blurred lines between asset purchases and monetary financing. Expansion of the PSPP could weaken both the separation between monetary and economic policy and the ECB’s independence.
While the BVerfG has chosen an unconventional way to voice its concerns, and potentially triggered a fragmentation crisis in the EU, those concerns need to be addressed. One solution would be to stop the EAPP and force Member States’ governments to address economic crises independently. However, this would be financially catastrophic, moreover the COVID-19 emergency has seen the program expand.
A more feasible, yet equally difficult, solution proposed by Professor Maduro would be to confer budgetary powers on the EU to complement the monetary union with a fiscal union. Two weeks after the verdict, France and Germany unveiled a proposal for a €500bn Covid-19 recovery fund. It will be funded through borrowing on markets, provided to states in the form of grants rather than loans, and repaid through the EU budget. While faced with strong headwinds, the virus recovery fund signals a small step towards increased centralisation. Greater European integration may be the silver lining of this decision that most EU supporters are hoping for.
Jessica Downing-Ide (BEcon/LLB, Hons I) is an Associate to a Justice of the Supreme Court of Queensland. Edward Watson (BEcon/LLB, Hons I) is a Graduate at Herbert Smith Freehills. The views expressed in this article are solely those of the authors and do not reflect the views of Herbert Smith Freehills or the Supreme Court of Queensland. The authors have only read the official English translation of the decision, and not the original decision in German.