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Comment on Paul De Grauwe

Internet article by Hans-Werner Sinn, EUROPP Blog, 10. März 2014

Comment on Paul De Grauwe 'Why the European Court of Justice should reject the German Constitutional Court’s ruling on Outright Monetary Transactions'

Paul De Grauwe cites the German Constitutional Court’s decision as follows: "The fiscal component of OMT arises from the fact that the government bonds bought by the ECB can lose value if the governments whose bonds are bought default. If that happens the ECB will incur a loss that can wipe out its equity. As a result, governments of the member countries will have to use taxpayers’ money to recapitalize the ECB."

And he maintains that this is the Court’s "main argument".

This representation of the Court’s argument is erroneous. In fact, while concerned about the potential write-off losses on government bonds if held until maturity, the Court did not go into the details of how, and through which mechanisms, the losses would be transferred into the budgets of member states. Its reasoning is legal, rather than economic. At no stage does the Court argue that the ECB needs to be recapitalized to compensate for the losses.

The economic argument, on the other hand, is trivial. If the ECB has to book write-off losses because a state goes bankrupt, an eternal stream of interest stops flowing to the finance ministries of the Eurozone whose present value is equal to the write-off losses. Given the planned monetary policy stance, or to be more precise, given the time path of the monetary base, the ECB cannot recoup the interest losses by giving more refinancing credit to the banks or buying new bonds, since this would inflate the monetary base. This argument is independent of whether or not the ECB needs to be recapitalized or could even operate with negative equity capital.

The Eurosystem’s true economic equity capital is the sum of the accounting equity capital and the present value of seignorage, the latter being the monetary base if calculated under static conditions. By the end of 2013, the accounting equity was € 353 billion, and the present value of seignorage under static conditions was € 1.262 trillion, giving a sum of € 1.615 trillion. Under dynamic conditions the sum would even be larger, perhaps more than € 3 trillion. The Eurosystem’s true economic equity capital is the present value of the interest income of the Eurosystem to which national treasuries are entitled. Write-off losses would reduce this present value one-to-one and would have to be made good by the taxpayers or through cuts to the income of the recipients of government transfers.

'Why the European Court of Justice should reject the German Constitutional Court’s ruling on Outright Monetary Transactions', Paul De Grauwe, EUROPP Blog, 4. März 2014

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