Maastricht was built on monetarism. But monetarism is a fiction—the fiction that there is a money supply that is controlled by an independent and purely technocratically managed central bank. This dream has nothing to do with reality.
The ruling of the German Federal Constitutional Court of 5 May 2020 on the policies of the European Central Bank (ECB) will go down in history—at least many would agree on this. But what the deeper reasons for such a judgment might be will remain a mystery on all sides for a long time to come. The only thing that seems certain is that future historians will find it difficult to understand what happened. It will not simply be a matter of going to a library to clarify the circumstances and investigate the causes. You will have to know and understand the spirit of the times and its media echo in order to answer the question of how it was possible that demonstrably intelligent people could get so completely lost.
The ‘poor German saver’ is at the centre of the Karlsruhe considerations on proportionality and thus on the ‘side effects’ of monetary policy. But that is exactly where he must stand, albeit in a completely different sense than the court thinks. The ‘poor’ saver in a deflationary situation cannot hope for help from monetary policy, because in a deflationary situation it is precisely about discouraging saving and encouraging indebtedness.
The realization that at a certain point the central bank will not get any further in its efforts to steer the economy and achieve its goal via interest rates is trivial. Even Mario Draghi, former president of the European Central Bank, has said it hundreds of times and called on the states to do more on their part, which of course means getting into debt and ensuring that wages develop sensibly because otherwise there is logically no way out of weak growth and deflationary tendencies. Economic logic is not, however, the domain of jurisprudence, which is why the highest German court was foolish enough to give free rein to its prejudices and attack Italy as well.
The reduction of the general interest rate level supported by the PSPP (public sector purchase program) thus undisputedly relieves the national budgets of the member states. As a result, there is a risk—despite the ‘guarantees’ accepted by the Court of Justice—that necessary consolidation and reform efforts will not be implemented or continued.
The “necessary consolidation and reform efforts”! If only one could say clearly what this is? How does the Senate of the Constitutional Court know what is possible and necessary in Italy? It refers here to the Council of Experts (SVR), but obviously cannot judge what position the SVR takes. That this could be extremely one-sided does not occur to the judges. The SVR position lacks any logic in the case of Italian companies being net savers and a high current account surplus of Germany, Italy’s important trading partner.
Even a national constitutional court that has been dealing intensively with a European matter for years should at some point understand that no country within a community based on rule of law and, above all, a monetary union, can be understood without understanding all the countries that belong to it—and the system in which they operate together.
Monetary Union Is Still Misunderstood
The core of the explosive story is that in Germany the consequences of monetary union are still unknown or are being suppressed. In any case, what is being systematically and permanently suppressed is that it was Germany that drove a huge wedge into EMU in the early years of the euro through German deflation. The German government put pressure on German wages through a variety of measures, thereby increasing the competitiveness of German companies vis-à-vis their currency partners. This is exactly what you cannot do in a monetary union.
Since there is a close empirical and theoretically easily explained relationship between national unit labor cost developments and national inflation rates, the undercutting of the common inflation target by a large nation in the Union inevitably results in large and persistent current account imbalances and deflation. Current account imbalances automatically mean higher debt in the deficit countries. The central bank cannot do anything about this, however, in a monetary union because, logically, it can only be guided by the average price development of all the member states. If the sum of all
the states results in an inflation rate that corresponds to the mandate of the central bank, monetary policy cannot and must not react to the misconduct of a single member.
The ‘poor’ saver in a deflationary situation cannot hope for help from monetary policy, because in a deflationary situation it is precisely about discouraging saving and encouraging indebtedness.
And this is precisely why German wage dumping was the most fundamental and serious violation of the jointly agreed goal of achieving an inflation rate of just under two per cent. If Germany had adhered to the two per cent target as consistently as France, the ECB could have put the states that deviated beyond the two per cent within the limits by raising interest rates. Then the imbalances would only have occurred for a short time and to a much lesser extent.
Germany’s failure to meet the inflation target tied the ECB’s hands: the ECB can only conduct one and the same monetary policy for all member states at the same time. This came in very handy for Germany in the 2000s, although interest rates were too high in relation to German inflation, which hurt German domestic demand, especially investment demand. The German saver was, however, happy. And external surpluses in EMU and gains of market shares on international third markets compensated for what was lost internally.
What has happened in EMU since then follows directly from this. The EMU partners are under enormous pressure to reduce wages in order to limit their foreign debt. This in turn results in weak demand in the European single market, which prevents France and Italy in particular from combating their still-high unemployment. The only remedy that could be used against this—again for purely logical reasons—namely higher public debt—is prohibited in EMU.
The Germans no longer like at present the common monetary policy, which has to react to the deflationary processes in the EMU partner countries. The German saver, and with him the German savings banks and German insurers, are no longer satisfied because there is no one left who can achieve the interest rates that are so readily collected in Germany without having to go into debt and initiate growth through productive investment at home. Germany is currently paying a heavy price for having always relied solely on foreign countries running up debts.
For in the meantime, German production structures have become so skewed in the direction of foreign trade that the whole country is shaken when the willingness of foreigners to take on debt dries up. It was not foreseeable that this would happen so suddenly and comprehensively in the Corona crisis. It has been obvious, however, for a good 15 years that Germany’s strategy has been wrong and highly risky.
But it is precisely this story, which is absolutely central to understanding the euro crisis and the ten years thereafter that has been made a taboo in Germany. Of course, this taboo is also the source of the complete ignorance of the constitutional judges. Can they be blamed for this? I doubt it.
The court reflects the reality of German life, from the farmers’ round table in Lower Bavaria to the crab fishermen on the North Sea, who cannot be accused of only being able to absorb and process what politicians, in conjunction with the major media, make the subject of discussion.
The German government put pressure on German wages through a variety of measures, thereby increasing the competitiveness of German companies. This is exactly what you cannot do in a monetary union.
The ignorance of the Karlsruhe judgment is due to the refusal of politicians and the German public to talk about this German thorn in European flesh. Neither the Social Democrats (SPD) nor the Greens have clearly turned away from their agenda policy. The Federal President, who plays the big European in every Sunday speech, has never said that he (as the chancellor’s main adviser and minister), together with his then-Chancellor Gerhard Schröder, is ultimately responsible for what is happening now. Angela Merkel and her ilk have always been glad that the former Red (Social Democrat)–Green coalition did a ‘job’ that her party would never have dared to do and that it could not have pushed through. The center Christian Democrat/Christian Social Union and the liberal Free Democrat (FDP) have also made it their program to remain silent on the German case.
Monetarism Does Not Exist Any More
In view of such mistakes, it is almost superfluous to state that the original mistakes of the Maastricht construction have not yet been rectified, and are not even being discussed. Maastricht was built on monetarism. But monetarism is a fiction—the fiction that there is a money supply that is controlled by an independent and purely technocratically managed central bank in such a way that the desired inflation rate is ultimately achieved. That is the dream of many economists of neutral money.
The EMU partners are under enormous pressure to reduce wages in order to limit their foreign debt. This in turn results in weak demand in the European single market. This dream has nothing, absolutely nothing to do with reality.
However, because at the beginning of the 1990s, when the Maastricht Treaty came into being, people firmly believed in this fiction, a separation of monetary and economic policy was written into the Treaty, which is completely alien to life. It was precisely this dream that led Germany to insist that monetary policy could operate completely detached from the real world—and it is precisely for this reason that the central bank should not pursue any objective other than price stability, but that everyone else should adapt to the central bank’s requirements. This was exactly the opposite of the proportionality that the Constitutional Court is now demanding.
Constitutional judges do not need to know all this. They do need, however, to get themselves properly informed. No one would trust a structural engineer to inspect a bridge unless he was up to date with the latest technology. If new technical know-how has been gained between the construction of the bridge and its inspection, he has to take it into account. He cannot defend himself against errors in the inspection by arguing that he has carried out inspections based on the state of knowledge thirty years ago.
Monetarism has been put on ice by all the world’s major central banks because money supply management cannot be implemented. Central banks make economic policy via interest rates, what else? Weighing up the effects of this policy on the economy as a whole is therefore a matter of course, and the courts request to examine the issue of proportionality is therefore completely inappropriate.
Whether central banks that simply make economic policy should be independent is a matter of long debate. In any case, the technocratic arguments for independence put forward by monetarism are completely invalid. However, if, despite overcoming the monetarist fiction, independence is chosen, as Europe has done, it goes without saying that such an institution should not take advice on proportionality either from national constitutional courts or from national governments and national parliaments.
For in the meantime, German production structures have become so skewed in the direction of foreign trade that the whole country is shaken when the willingness of foreigners to take on debt dries up.
Moreover, all central banks are much more closely involved in the practical shaping of economic policy than appears to be the case externally. The ECB is present at meetings of the Eurogroup, including preparatory meetings, at G7, G20 and the other international organizations dealing with financial issues. A central bank that is completely detached from politics and makes lonely decisions in an ivory tower does not exist and never has.
The honest thing to do would be to amend the European Treaties, including the Maastricht Treaty, in order to adapt them to new times and new knowledge. But then Germany would have to bid farewell to the illusions it has cherished for decades. Who would trust this country and its policy to finally be honest with itself?
Share this on social media
The support of our corporate partners, individual members and donors is critical to sustaining our work. We encourage you to join us at our roundtable discussions, forums, symposia, and special event dinners.