Home > ECB, EMU Crisis, Monetary Policy, sovereign debt > A Lender of Last Resort for the EMU

A Lender of Last Resort for the EMU

January 14, 2015 Leave a comment Go to comments

Update: The Court ruled the OMT “Legal in Principle“. The final ruling will be later this year, but it is safe to assume that it will confirm the preliminary one.

Today is an important day for the ECB, as the European Court of Justice will issue an interim ruling on the Outright Monetary Transactions program launched in the fall of 2012. The Court needs to rule, upon demand by the German Constitutional Court, whether the program overstepped the boundaries set by the Treaties to ECB action. The ruling of course may have an impact on furture action by the ECB, notably the decision to launch a round of QE.

I think it is important to clarify once more that QE and the OMT (welcome to the wonderful world of EU acronyms) are not the same thing. If Mario Draghi manages to rally the Governing Council behind him, QE will consist of a vast program of sovereign bond purchases, in order to try to lift the European economy out of deflation. A European version in short, of what was done three years ago by the Fed and other major central banks in the world.

The OMT responded to a very different need, notably the need to defuse speculation on sovereign debt markets and to protect peripheral countries (at the time Spain and Italy) from the risk of default. The summer of 2012 was very difficult, as economic and political problems in Greece caused investors to flee from peripheral countries and spreads on sovereign bonds to increase at unprecedented levels. After the “whatever it takes”  speech in July (But there is another message I want to tell you. Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough), the ECB in September engaged almost unanimously to step in the market for sovereign bonds and, if necessary, to stretch its mandate by acting as a lender/buyer of last resort for countries in trouble.
With the OMT program, the ECB commits to buy unlimited amounts of sovereign bonds of countries in trouble that request assistance, thus de facto transforming itself into a lender of last resort. In exchange for ECB protection countries need to engage in a program of fiscal austerity and structural reforms. In other words with the OMT program the ECB offered insurance in exchange for reforms and austerity. A deal that would entail the loss of a good deal of sovereignty. It is not by chance that Spain always refused to apply for the program, in spite of heavy pressure, and that as of today no country ever used it. At the time the OMT program was wrongly interpreted as a clumsy attempt to implement quantitative easing in the Eurozone. It was instead clear, since the beginning that, as with any insurance scheme, its success would be measured precisely by the fact that the ECB would not have to intervene on bond markets.

So we need to be clear here. The European Court of Justice today and in the next months will not be deciding on QE and macroeconomic management. It will be deciding whether the EMU has the right to rely on an insurance mechanism that all countries have . It will be deciding whether EMU governments borrow in their own currency, or in a foreign one. A major decision indeed.

  1. January 15, 2015 at 10:47 pm

    “Within our mandate, the ECB is ready to do whatever it takes to preserve the euro. And believe me, it will be enough”

    Do we believe this as much as when the Swiss Central Bank claims that the peg is there to stay…

    It is probably true until it’s not true

    Can Europe and its population withstand a decade or two with stagnation, mass unemployment, huge output gap, a very low investment- and consumption level, hysteresis, etc?

    Time will tell. The Germans still think we should save more and that austerity is the solution. The French are clueless and the Italians are discussing…


  2. hanno achenbach
    January 21, 2015 at 10:38 am


    Don’t you think you ought to get your facts straight before posting?

    This is not a ruling by the court. It is simply an opinion of an advocate general (avocat général, avvocato generale – look it up!) who is not a member of the court that will decide. It is not a ruling, not even an interim one.

    It is the advocate generals’ duty to give the court an impartial opinion on legal questions of general interest. Such an opinion is in no way binding on the court. In the present case, the advocate general admitted that he was clueless in the economic questions of the case, cf. Jürgen Stark, FAZ January 21st, 2015.


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