FRANKFURT – European Central Bank head Mario Draghi is defending a central bank program that has been credited with calming market turmoil over the continent’s debt crisis, ahead of closely watched hearings in a court challenge to the program next week.
In the text of a speech to a conference in Shanghai, China, Draghi on Monday rejected criticism of the bank’s program to purchase government bonds, saying it had defused fears the eurozone might break up.
Among the critics of the program is Germany’s Bundesbank central bank, which submitted a legal brief with its objections ahead of hearings in Germany’s constitutional Court June 11-12 in Karlsruhe. The Bundesbank’s head, Jens Weidmann, voted against the program in his role as one of 23 member of the ECB’s governing council.The court ruling is shaping up as a potential source of worry about potential new disruptions to markets in Europe.
Under the program, dubbed OMTs for outright market transactions, the ECB could buy government bonds issued by governments struggling with heavy debts. The purchases would drive down the interest costs those countries would face in the bond market when they sell new bonds to pay off old ones that are coming due, as they must constantly do. The catch is, governments that want help must apply for a bailout loan or credit line from the eurozone’s financial rescue fund, and agree in writing to take steps to reduce its deficits and debt.
No bonds have been bought. But the mere offer has lowered bond-market borrowing costs for indebted countries such as Spain and Italy. That has taken financial pressure off those governments and given them time to get their finances in order without worrying about a spike in borrowing costs. High borrowing costs pushed Greece, Ireland, Portugal and Cyprus to seek bailouts in the form of loans with strict conditions attached from the other eurozone governments.
Draghi answered several of the objections that have been brought against the OMT program — that by lowering borrowing costs it would ease pressure on governments to reform, and that it made decisions by the independent central bank dependent on what governments decide to do.
He said it did not take pressure off governments to reduce their budget deficits and debt because of the requirement to sign up for potentially painful conditions that mean giving up some of the governments’ decision-making authority over spending and taxes to its creditors.
“They can either reform without OMTs and retain economic sovereignty or they can reform with OMTs but give up some of their economic sovereignty,” Draghi said in the speech text. “Either way, they have to persevere in their reform efforts.”
“So it is quite misleading to compare OMTs to historical episodes in which governments relied on central bank support to replace fiscal consolidation,” he said.
Draghi said the bank’s independence was not compromised because it did not automatically have to start bond purchases just because a government had applied for a bailout. The ECB “retains its full discretion,” he said.
Holger Schmieding, chief economist at Berenberg Bank in London, said that the court was unlikely to completely reject the OMT program or bar German support for it.
“But we cannot rule out an awkward verdict in which the court may, for instance, attach conditions to any Bundesbank/German participation in ECB actions and thereby render these actions less effective or even potentially ineffective,” he wrote in a research note to investors.