A. The Direct/Indirect Effects Test of the Court of Justice

Since Pringle, the Court of Justice has used a two-pronged test to distinguish between monetary and economic policy. It asks, first, whether the ECB pursues an objective that belongs to monetary or economic policy and, second, whether the instrument used to achieve that objective can be qualified as a monetary or an economic policy instrument.Footnote ⁴⁸ The second part of this test is easy to apply, since the ECB's monetary policy instruments are enumerated in the Protocol on the ESCB and the ECB. Open market operations are a widely used type of monetary policy instrument. They are carried out, among other means, by buying and selling marketable instruments in financial markets.Footnote ⁴⁹ Both OMT and the PSPP fall squarely within this definition.Footnote ⁵⁰

The first part of the Court's test is more problematic. The purported goals of both OMT and the PSPP are standard monetary policy objectives: repairing the monetary policy transmission mechanism and safeguarding the singleness of monetary policy.Footnote ⁵¹ A functioning monetary policy transmission mechanism is a precondition for benchmark interest rate decisions to influence inflation and hence the ECB's ability to achieve its primary objective of maintaining price stability.Footnote ⁵² Furthermore, Article 119(2) TFEU provides that the Eurozone shall have ‘a single monetary policy’, which is not the case if monetary policy decisions are ineffective in some parts of the Eurozone because of a disruption to the transmission mechanism. This much was not disputed in Gauweiler and Weiss. In response to the submissions of the applicants in the main proceedings, the Court of Justice then added a second step to the analysis that went beyond the stated goals of the measures and inquired into their effects. This second layer of analysis can be seen as an objective corrective to a test that necessarily has to rely on the published rationale behind a measure and, hence, is largely subjective.Footnote ⁵³ The Court held that a measure whose stated aim concerned the promotion of the monetary policy objectives of Articles 119(2) and 127(1) TFEU was not equivalent to an economic policy measure ‘for the sole reason that it may have indirect effects that can also be sought in the context of economic policy’.Footnote ⁵⁴ This test relied on Pringle, where the Court had stated that a financial assistance mechanism that was designed to safeguard financial stability had to be regarded as falling within economic policy and did not become a monetary policy measure for the sole reason that it may have indirect effects on a monetary policy objective such as price stability.Footnote ⁵⁵ Conversely, in Gauweiler and Weiss, the effect of OMT on financial stability and the impact of the PSPP on refinancing conditions of Eurozone governments were, in the opinion of the Court, examples of indirect economic policy effects.Footnote ⁵⁶

From the discussion of indirect effects in Gauweiler and Weiss, it is not easy to understand how the Court's test is intended to operate.Footnote ⁵⁷ Some passages especially in Weiss, which contains the most detailed examination of indirect effects,Footnote ⁵⁸ seem contradictory. For example, the Court acknowledged that the PSPP was capable of having an impact on the balance sheets of commercial banks that sold government bonds to the Eurosystem and that such an effect might also be sought through economic policy measures.Footnote ⁵⁹ In the following paragraphs, it then dismissed the argument that this effect called the monetary policy nature of the PSPP into question, because indirect effects had ‘no consequences for the purposes of classification of the measures at issue’.Footnote ⁶⁰ Taken literally, the Court's example is perplexing. Asset purchases by the Eurosystem have, by definition, a direct impact on the balance sheets of the sellers (and their refinancing conditions) by replacing one asset (government bonds) with another (cash). On the other hand, the one effect that falls undoubtedly within the area of monetary policy—the impact of asset purchases on price stability—is clearly an indirect effect. The ECB has no direct influence over inflation and instead affects price levels through various economic channels. As the Court of Justice emphasised in both Gauweiler and Weiss, such economic effects are a precondition for the ECB's policy decisions to achieve their ultimate objective.Footnote ⁶¹

One possible interpretation of the Court's comments on indirect effects is this: All effects other than those that have an impact on the singleness of European monetary policy and price stability (the monetary policy objectives laid down in Articles 119(2) and 127(1) TFEU) are by definition indirect effects. However, this interpretation would distort the ordinary meaning of ‘direct’ and ‘indirect’. If this is what the Court had meant, it would have been more natural to speak simply of ‘effects’. It would also render the effects-based considerations in Gauweiler and Weiss largely redundant. Provided a measure's purported goal belonged to monetary policy and it had some (direct or indirect) effects on monetary policy objectives, it would qualify as a monetary policy measure. Indirect effects on price stability are, however, widespread when economic policy decisions are taken.Footnote ⁶² A test that did not assess the direct (or alternatively the predominantFootnote ⁶³) effects of a measure would make any objective differentiation between monetary and economic policy therefore largely impossible.

More convincing is an alternative interpretation that is based on the ordinary meaning of ‘direct’ and ‘indirect’ and distinguishes between monetary and economic policy effects by asking whether an effect is a necessary part of the transmission of a monetary policy decision. This interpretation would lead to a clear demarcation of monetary policy and allow us to make sense of the Court's examples in Weiss. Secondary market asset purchases have an impact on a bank's balance sheet and refinancing conditions. Even though these effects are economic in nature, they do not result in a qualification of asset purchase programmes as economic policy instruments, because they contribute directly to the transmission of monetary policy decisions. Or, to put it differently: the direct effects of such a measure belong to monetary policy because they are part of the monetary policy transmission mechanism. The impact that secondary market asset purchases have on the refinancing conditions of Eurozone governments also do not render the measure an economic policy measure, because these are indirect economic effects.

However, it is questionable whether the direct/indirect effects test, thus understood, can justify the conclusion that both OMT and the PSPP are monetary policy measures. Both purchase programmes were intended to, and did, address disruptions to the monetary policy transmission mechanism, and both had some effects on goals belonging to economic policy. But the similarities end there. In order to investigate the precise effects of the two programmes and their differences, a brief description of the monetary policy transmission mechanism may be useful.

Monetary policy decisions are transmitted to the economy in several steps. Simplifying considerably, a central bank sets the interest rates under its control, in the Eurozone in particular the rates on the main refinancing operations (the rate at which the central bank provides short-term liquidity to financial institutions), the deposit facility (the rate at which banks can make overnight deposits with the Eurosystem), and the marginal lending facility (the rate at which banks can borrow money overnight from the Eurosystem). These rates affect the refinancing costs of financial institutions in the money market and, through them, the rates at which banks lend to, and accept deposits from, their customers. These latter rates, in turn, influence asset prices and saving, consumption, and investment decisions of households and firms. Finally, the behaviour of households and firms affects supply and demand in the markets for goods and services and shifts prices in these markets accordingly.

At the time of the OMT decision, the Governing Council of the ECB considered the Eurozone to be in a ‘bad equilibrium’ where concerns about the solvency of some Member States and the continued viability of monetary union had driven up interest rates on government bonds. This made it more costly for Member States to refinance their debts, thus creating the risk that a liquidity crisis would degenerate into a solvency crisis, even if the initial concerns did not (fully) justify the spike in interest rates.Footnote ⁶⁴ The monetary policy transmission mechanism was disrupted because financial institutions in the affected Member States were effectively excluded from international capital and money markets as the macroeconomic environment deteriorated.Footnote ⁶⁵ The ECB's intervention was intended to eliminate the risk premia that reflected the threat that a liquidity crisis might develop into a self-fulfilling solvency crisis.Footnote ⁶⁶ The bank did so by offering to buy potentially unlimited amounts of government bonds from solvent issuers,Footnote ⁶⁷ thus performing a de facto role of lender of last resort for national governments to resolve liquidity (but not solvency) crises.Footnote ⁶⁸

In contrast, the PSPP was adopted because the ECB's standard monetary policy tools had been exhausted. At the time of the initial commencement of the purchase programme in March 2015 and when it was restarted in November 2019, the rates on the main refinancing operations and the marginal lending facility were close to or at their zero bound, and the deposit facility rate was negative.Footnote ⁶⁹ Nevertheless, inflation remained significantly below the central bank's target of close to 2 per cent.Footnote ⁷⁰ The bond purchase programme was initiated because, among other reasons, the ECB was of the view that the adopted monetary policy measures had resulted in a ‘lower than expected monetary stimulus’ and there was no room to loosen monetary policy further by using traditional tools.Footnote ⁷¹ By purchasing government bonds from private institutions in the secondary market, the programme was intended to ‘induc[e] financial intermediaries to increase their provision of liquidity to the interbank market and credit to the euro area economy’.Footnote ⁷²

It is clear from this description that OMT and the PSPP are qualitatively very different measures that have different direct and indirect effects. The (intended and actual) direct effect of OMT was the resolution of a liquidity crisis that imperilled the solvency of financial institutions, governments, and more generally financial stability.Footnote ⁷³ It thus had effects comparable to financial assistance granted by the ESM, which the Court held to be a matter of economic policy in Pringle. As a consequence of the resolution of the liquidity crisis and the restoration of an equilibrium in the money market that was not distorted by self-fulfilling expectations (and hence as an indirect effect of OMT), the ECB's intervention ensured that benchmark interest rate decisions would influence the money market and would be transmitted further to the real economy.Footnote ⁷⁴ The PSPP, on the other hand, operates directly at the second stage of the transmission mechanism by increasing demand for government bonds and hence lowering refinancing costs for financial institutions, which can then be passed on to the institutions’ customers. The Court's direct/indirect-effects distinction, therefore, if it is understood as we suggest here, provides a satisfactory explanation for the classification of the PSPP, but not OMT, as a monetary policy measure.Footnote ⁷⁵

B. The FCC's Proportionality Test

The German Federal Constitutional Court suggested an alternative type of effects-based test to delimit monetary policy on objective grounds. It held in its judgment in Weiss that a measure that was ostensibly adopted to pursue a monetary policy objective exceeded the ECB's mandate if the economic and social policy effects resulting from the measure, for example its effects on ‘public debt, personal savings, pension and retirement schemes, real estate prices and the [preservation] of economically unviable companies’, were disproportionate to its monetary policy goals.Footnote ⁷⁶ The Court of Justice agrees that a bond-buying programme can only be adopted and implemented if it is proportionate.Footnote ⁷⁷ However, the FCC's proposed proportionality test deviates from that of the Court of Justice in two important respects. First, in Gauweiler and Weiss, the proportionality principle was used to constrain the exercise of an existing power,Footnote ⁷⁸ whereas it served to distinguish between monetary and economic policy in the FCC's judgment.Footnote ⁷⁹ A measure that has disproportionate effects on considerations falling within the area of economic policy becomes an economic policy measure, even if it (ostensibly or actually) pursues monetary policy objectives. Second, rather than performing a comprehensive balancing of all economic and monetary policy effects of a monetary policy measure, the Court of Justice simply assesses whether the measure is suitable and necessary to attain its objectives and the risk of losses that asset purchases entail is not disproportionate to the interests promoted by the measure.Footnote ⁸⁰

A number of arguments could be made against the FCC's proportionality test and in favour of the direct/indirect effects test of the Court of Justice.Footnote ⁸¹ First, the FCC relies on proportionality to give substance to the principle of conferral. In the opinion of the FCC, the principle of conferral would be rendered ‘meaningless’ if the ECB's adherence to its monetary policy mandate could not be reviewed fully in light of the principle of proportionality.Footnote ⁸² It is true that the three principles enshrined in Article 5 TEU—conferral, subsidiarity and proportionality—cannot be separated with perfect clarity.Footnote ⁸³ Proportionality may require a restrictive interpretation of the scope of an existing competence.Footnote ⁸⁴ However, the FCC's approach is different. It does not determine the limits of a competence conferred on the Union in an abstract manner but introduces a form of State-dependent definition of the ECB's monetary policy mandate. The scope of the Union's competence in monetary policy matters expands or shrinks depending on the state of the economy and the behaviour of economic actors, for example the savings rate and the preference to hold cash or invest in equity compared with an investment in debt instruments. The approach of the Court of Justice, in contrast, maps on to the distinction in Article 5(1) TEU between the ‘limits’ of Union competences, which are governed by the principle of conferral, and the ‘use’ of these competences, which is governed by the principles of subsidiarity and proportionality.Footnote ⁸⁵

Second, the difference in approach has manifest practical consequences. Any policy decision of the ECB, including a decision belonging to its standard monetary policy tools, for example the setting of a benchmark interest rate, could be challenged on the ground that certain economic effects of the decision had not been considered, or had not been accorded sufficient weight, and would have to be qualified as falling within economic policy if its effects on the real economy were disproportionate. Courts would be required to form a view on questions of a technical and evaluative nature that required special expertise. While it is undisputed, including by the FCC, that the ECB enjoys a margin of appreciation when it assesses the consequences of monetary policy decisions,Footnote ⁸⁶ the judicial review standard required by the FCC involves a more intensive review than the largely proceduralFootnote ⁸⁷ ‘manifest error of assessment’ standard of the Court of Justice.Footnote ⁸⁸ Even if courts generally appreciate the need to afford the ECB discretion, there will be a risk that different perspectives regarding the weighting of the interests at stake will make the outcome of litigation more unpredictable. This, in turn, may cast doubt on the legality of actions that fall within the core area of the ECB's mandate and undermine the legitimacy of its monetary policy in those parts of the Union where people disagree with how the ECB balances conflicting economic interests.

Third, the direct/indirect effects test leads to a clearer dividing line between monetary and economic policy and a more objective approach to delimiting the ECB's monetary policy mandate than the FCC's proportionality test. The FCC envisages a two-step process. The consequences of monetary policy decisions must be ‘assessed’ and then ‘weighed’.Footnote ⁸⁹ Presumably, ‘assessing’ means quantifying. Any quantification of the effects of a monetary policy decision on an intermediate or ultimate target variable, for example asset purchases on yields, involves complex macroeconomic modelling, which is influenced by the assumptions made and the empirical methods used. It is, therefore, not free from subjective choices. This holds even more so for the weighting of the affected interests and the balancing of economic and monetary policy consequences. There is no framework to standardise the effects on different interests (provided they can be quantified in the first place). It is therefore unclear how, say, the risk of deflation can be balanced against the ‘economic and social impact’ of rising real estate and stock market prices.Footnote ⁹⁰ Consequently, it is by no means evident that the FCC's proportionality test reinforces the principle of conferral as much as the FCC seems to think, and indeed more so than the direct/indirect effects test, or in a more principled way.

However, we acknowledge that it is possible rationally to disagree about these points.Footnote ⁹¹ In particular, it is important to be conscious of the fact that the Court of Justice applies review standards of different intensity depending on the context. The clearest difference exists between the review of measures of the Union and national measures. In the former case, the Court is generally reluctant to intervene, unless a measure is manifestly inappropriate or the result of a manifest error or misuse of power.Footnote ⁹² In the latter case, the Court is more demanding and requires a showing that there is no less restrictive alternative.Footnote ⁹³ Further differentiations in the standard of review are a function of the nature of the right or interest invoked by the applicant, the policy area, and the relative expertise of the Court compared with that of the decision-making body.Footnote ⁹⁴ The review standard applied to the ECB is, arguably, at the low-intensity end of a spectrum that has been said to range from very deferential to rigorous.Footnote ⁹⁵ The FCC's holding in Weiss has to be read primarily as a challenge to these perceived double standards, which, in the absence of other effective checks, leave it largely to the ECB to determine its mandate,Footnote ⁹⁶ rather than as an attempt to impose a ‘German understanding of proportionality’Footnote ⁹⁷ on the rest of the EU.Footnote ⁹⁸

In the spirit of the general line of inquiry pursued in this article, we will therefore only probe the FCC's conclusion that the Court of Justice acted ultra vires from the perspective of whether it is rationally defensible. We will approach the FCC's assertion that the decision in Weiss was methodologically untenable from two angles. We will first examine the FCC's response to the test developed by the Court of Justice to distinguish between monetary and economic policy, and we will then ask whether the FCC applied its precedent in Gauweiler consistently in Weiss.

The FCC argued that the Court of Justice, in ascertaining whether a measure fell within the area of monetary policy:

This is a reading of the Court's approach that ignores the ordinary meaning of the term ‘indirect effects’ as used in Gauweiler and Weiss.Footnote ¹⁰⁰ It is true that the Court of Justice did not balance the (direct or indirect) economic policy effects of the PSPP against the objectives of the programme at the third stage of the proportionality test, as demanded by the FCC. However, it is not true that the Court of Justice, by not doing so, failed to accord ‘foreseeable and/or intended … consequences of [a measure of the ECB] in the areas of economic and fiscal policy’ any relevance. As discussed in the previous section, a reading of Gauweiler and Weiss that gives due weight to the ordinary meaning of ‘indirect effects’ implies that direct effects (and certainly direct effects that are foreseeable and intended) change the character of a measure as monetary or economic policy. The difference to the FCC's test is simply that the delimitation operates along a different dimension: direct versus indirect effects as opposed to a weighting of the different effects.Footnote ¹⁰¹

The FCC's view seems to stem from its disagreement with the Court's treatment of ‘foreseeable consequences’. Criticising Gauweiler, the FCC had submitted in its reference in Weiss that the effects of a measure that purportedly pursued a monetary policy objective could not be regarded as indirect if they were ‘foreseeable with certainty’ and hence either ‘intended or knowingly accepted’ by the ECB.Footnote ¹⁰² From the FCC's perspective, this is convincing, since the FCC argues in favour of a comprehensive balancing of monetary and economic consequences, but does not automatically regard a measure as impermissible if (direct or indirect) consequences for economic policy exist.Footnote ¹⁰³ The Court of Justice rejected this wide interpretation, because for the Court, the existence of foreseeable economic policy effects (which, according to the FCC, had to be regarded as direct effects because they were foreseeable and knowingly accepted) would otherwise preclude the ESCB from implementing the measure.Footnote ¹⁰⁴ From the Court's perspective, a broad interpretation of ‘direct effects’ would have thus made it impossible for the ESCB to pursue its monetary policy mandate, which required it to act on economic conditions to influence price levels.Footnote ¹⁰⁵ The FCC and the Court of Justice are, therefore, talking past each other. The passage of the FCC's judgment rejecting the Court's argument that certain effects (namely, indirect effects) may be disregarded even if they are foreseeable and knowingly accepted (which is the passage we reproduced in parts aboveFootnote ¹⁰⁶) quotes selectively one paragraph from the Court's decision in Weiss, where the Court spoke of ‘effects’, rather than distinguishing between direct and indirect effects.Footnote ¹⁰⁷ The FCC then concludes that the Court of Justice disregards the economic policy effects of the PSPP altogether.Footnote ¹⁰⁸ However, the quoted paragraph is a continuation of the Court's discussion of indirect effects and applies only to them.Footnote ¹⁰⁹ The FCC's central point of criticism is therefore a non sequitur.

Second, neither the direct/indirect effects test nor the Court's limited proportionality review of acts of the ECB are new features of the judgment in Weiss. In Gauweiler, the Court of Justice followed an identical methodology to distinguish between monetary and economic policy. It interpreted the term ‘monetary policy’ according to the two-pronged test set out in the previous section and, once it had established that OMT was to be qualified as a monetary policy measure, examined the proportionality of the measure.Footnote ¹¹⁰ Furthermore, the Court's lenient standard of review, under which the ECB is afforded broad discretion because of the ‘technical nature’ of its decision and the ‘forecasts and complex assessments’ that it involves,Footnote ¹¹¹ reflects the Court's application of the proportionality principle in similar circumstances.Footnote ¹¹² In its judgment on OMT, the FCC regarded this methodological approach as ‘tenable and correspond[ing] to the established case law of the Court of Justice’,Footnote ¹¹³ even though the Court used proportionality ‘at the level of the exercise of competences’Footnote ¹¹⁴ and ignored economic policy considerations in its analysis of the proportionality of OMT. It is difficult to understand why the same approach was qualified as not ‘tenable from a methodological perspective’ and ‘objectively arbitrary’ in the FCC's PSPP judgment.Footnote ¹¹⁵ The FCC's judgment is thus methodologically problematic itself and can be challenged for reasons of both using an incorrect premise and being inconsistent with the FCC's own precedent.

A. The ECB's Approach: Conditionality

All forms of financial assistance by the ESM (and previously the EFSF) must be subject to strict conditionality, which ranges from a macro-economic adjustment programme if stability support is provided by way of a loan to more specific eligibility criteria.Footnote ¹²⁵ The precise conditions are agreed between the Commission, ECB, IMF and the recipient Member State and laid down in a memorandum of understanding.Footnote ¹²⁶ They include fiscal conditions intended to ensure the sustainability of the beneficiary Member State's debt, for example the requirement to achieve a specified primary surplus and adopt clearly defined structural policies to meet agreed fiscal targets.Footnote ¹²⁷ The fiscal policy choices of beneficiary Member States are, accordingly, constrained. In particular, if the memorandum of understanding imposes numerical limits on budgetary aggregates, such as the primary deficit, it is easy to monitor whether a Member State adheres to a sound budgetary policy. Thus, once conditionality is in place, moral hazard is greatly reduced. This explains why the ECB insisted on conditionality in its OMT decision and the Court of Justice held in Gauweiler that conditionality ‘preclude[d] the possibility of [OMT] … acting as an incentive … to dispense with fiscal consolidation’.Footnote ¹²⁸

In a different context, the legality of the ESM, it has been pointed out that conditionality cannot guarantee that a Member State will not act irresponsibly in anticipation of receiving financial assistance.Footnote ¹²⁹ The availability of financial assistance, the argument goes, may prompt Member States to leave the path of fiscal prudence before a macro-economic adjustment programme commences and any constraints on fiscal policy apply. Whether this is a serious risk depends on the political cost that is involved in surrendering fiscal autonomy, which can be substantial, as the Greek example has shown, and the extent to which decision-makers factor that cost in when they make fiscal policy choices. More importantly, the moral hazard at issue here is different from that created by the ESM. Under the OMT programme, the ECB does not hold out the possibility of a bailout. Rather, the announcement of OMT removed the risk of a self-fulfilling solvency crisis and thus allowed Member StatesFootnote ¹³⁰ to finance their expenditure at a lower cost than would otherwise have been possible. Increasing expenditure because of lower financing costs does not threaten a sound budgetary position, provided the increase in expenditure reflects the savings from lower interest payments, and may indeed be the welfare-maximising course of action. Once OMT is implemented and the Eurosystem commences its bond-buying programme, a macro-economic adjustment programme must be in place, thus again containing moral hazard.

Consequently, conditionality plays a key role in ensuring that secondary market purchases do not jeopardise the objective of Article 123(1) TFEU. However, the Court of Justice mentioned conditionality in Gauweiler only in passing towards the end of its judgment, after it discussed other safeguards that feature less prominently in the design of OMT at considerable length.Footnote ¹³¹ We turn to these other safeguards and the test developed by the Court of Justice in Gauweiler and Weiss now.

B. The Equivalence/Sufficient Safeguards Test of the Court of Justice

According to the Court of Justice, secondary market asset purchases are incompatible with the prohibition of monetary financing if they are carried out ‘under conditions which would, in practice, mean that [they have] an effect equivalent to that of a direct purchase of government bonds from … the Member States, thereby undermining the effectiveness of the prohibition in Article 123(1) TFEU’.Footnote ¹³² The latter point—not undermining the effectiveness of the prohibition of monetary financing—requires, in the view of the Court, that safeguards are built into ECB interventions in government debt markets that limit the impact of asset purchases on Member State incentives.Footnote ¹³³ This two-pronged test has become the general standard against which the compatibility of an asset purchase programme with Article 123(1) is assessed. We shall examine both prongs in turn.

When the Court speaks of ‘equivalent effects’, it seems to have a test in mind that examines whether secondary market purchases have identical, rather than merely similar, effects to primary market purchases. The Court has held that secondary market transactions are equivalent to primary market transactions ‘if the potential purchasers of government bonds on the primary market knew for certain that the ESCB was going to purchase those bonds within a certain period and under conditions allowing those market operators to act, de facto, as intermediaries for the ESCB’.Footnote ¹³⁴

Requiring certainty establishes a threshold that will virtually never be met. Even in the unrealistic scenario that the Eurosystem committed to purchasing all bonds of a certain issue that were identifiable (thus, all bonds with the same ISIN), sales would presumably only be made under conditions resembling the transactions of an intermediary if the risk that the market price changed between the purchase and sale by the Eurosystem's counterparty was minimal. For this to be the case, the Eurosystem would need to purchase the bonds immediately after they were issued. OMT passed the test easily, because the ECB and national central banks intended to observe a minimum period before purchasing bonds on the secondary market and refrain from making any prior announcement of either the decision to carry out purchases or their volume.Footnote ¹³⁵

In contrast, the main features of the PSPP, in particular the monthly volume of purchases, the duration of the programme, and the allocation of asset purchases among the national central banks, are announced in advance. However, the observance of a ‘blackout period’ before any intervention in the secondary market, the possibility to deviate, within certain parameters, from the monthly purchase guidance, and a 33 per cent cap on purchases of both a particular bond issue and all of the outstanding securities of a government meant, in the opinion of the Court, that private market participants could not foresee with certainty whether the Eurosystem would purchase bonds acquired by them in the primary market.Footnote ¹³⁶ It is evident that certainty is lacking under these conditions. If we accept the narrow definition of ‘equivalent effects’ set out in Gauweiler and Weiss, purchasers of government bonds in the primary market cannot be regarded as de facto intermediaries for the Eurosystem in either OMT or the PSPP, since they bear the risk of price changes until they actually sell to the Eurosystem.

Irrespective of its limited practical relevance, it is questionable whether this prong of the Court's test performs a useful function. The position of private market participants as ‘de facto intermediaries for the ESCB’ has little bearing on the incentives of Member States to increase or reduce their borrowing, and hence on the goal of the prohibition of monetary financing. As explained, purchases on the secondary market lead to a general lowering of yields on government bonds. Whether the Eurosystem's secondary market purchases have identical (or similar) effects to transactions on the primary market depends, from the perspective of the borrower, not on the certainty with which an individual purchaser can resell bonds to the Eurosystem, but on the volume of the intervention compared with a hypothetical direct intervention in the primary market.

The second prong of the Court's test concerns the effect of asset purchases on Member State incentives. In Gauweiler and Weiss, the Court identified a number of safeguards that, in the Court's opinion, ensured that the asset purchase programmes did not ‘lessen the impetus of the Member States concerned to follow a sound budgetary policy’.Footnote ¹³⁷ First, purchases were only conducted to the extent necessary for the maintenance of price stability (PSPP) or to unblock the monetary policy transmission mechanism (OMT) and were then expected to cease.Footnote ¹³⁸ This meant, the Court argued, that Member States could not ‘rely on the certainty that the ESCB will at a future point purchase their government bonds on secondary markets’ and the purchase programmes could not be used to eliminate spreads in interest rates between Member States irrespective of any fiscal differences.Footnote ¹³⁹

Both points are, of course, correct, but they are, arguably, irrelevant to the objective of ensuring a sound budgetary policy. Even a temporary purchase of government bonds reduces yields and hence financing costs for Member States. This shifts a government's budget constraint, and, assuming that the government seeks to maximise the provision of public goods subject to its budget constraint, it will spend more. Thus, monetary financing of public expenditure occurs. As the Court acknowledged in Gauweiler and Weiss, this effect is inherent in all public sector asset purchase programmes, which are explicitly permitted by the statute of the ESCB and the ECB.Footnote ¹⁴⁰ Whether government finances become less sustainable as a result is a different question that depends on the government's fiscal policy after the end of the stimulus package and not on the ‘certainty’ that the purchase programme will continue indefinitely or the elimination of spreads between Member States.

It is easy to see that this is the case by considering a government's intertemporal budget constraint, which models the government's debt dynamics (change in debt) as a function of expenditure, tax revenue and interest payments. Over the duration of an asset purchase programme, the budget deficit remains constant (change in debt is zero) if an increase in expenditure can be financed out of cheaper debt (lower interest payments).Footnote ¹⁴¹ After a central bank's intervention has ended, the budget deficit, of course, only remains constant if expenditure is again reduced. Without any safeguards, it is perhaps unrealistic to expect that this will happen, given the particularities of the political economy of debt.Footnote ¹⁴² However, the structure of an asset purchase programme has nothing to do with this problem. Rather, the necessary safeguards must be in the form of fiscal rules or other controls over fiscal policy.Footnote ¹⁴³

Second, the ECB's asset purchase programmes were limited in size.Footnote ¹⁴⁴ Central banks typically announce the amount of sovereign debt they intend to purchase in a quantitative easing programme each month in advance in order to condition the market. The ECB's PSPP decision is no exception.Footnote ¹⁴⁵ Furthermore, asset purchases under the PSPP are allocated among the euro area national central banks according to a predetermined ratio, based on the key for subscriptions to the ECB's capital (rather than the level of debt of a Member State).Footnote ¹⁴⁶ The Court of Justice argued that Member States, consequently, had no incentive to increase government debt in response to the implementation of the PSPP, which would only result in a comparatively smaller proportion of a State's bonds being purchased by the Eurosystem.Footnote ¹⁴⁷ The OMT programme, in contrast, operates with no ex ante quantitative limits. However, the Court held that OMT was de facto limited in size, since bonds were only eligible for purchase if the issuing Member State underwent a structural adjustment programme, and the Eurosystem was able to sell the purchased bonds at any time.Footnote ¹⁴⁸

Again, it is not clear why these aspects of the bank's asset purchase programmes should be relevant to the question of how moral hazard can be contained. The size of OMT is only limited at the level of the Eurozone as a whole, but not at the level of an individual State.Footnote ¹⁴⁹ Limitations that exist at the level of an individual State, as under the PSPP, limit asset price distortions, but do not ensure that the Member State concerned will follow a sound budgetary policy. As explained, any meaningful secondary market intervention will, by definition, have an impact on government bond yields and hence provide an incentive to increase government expenditure. Moral hazard that arises as a consequence of an asset purchase programme can be controlled through appropriate fiscal rules, but not through volume limits on asset purchases or by allocating purchases within the Eurosystem according to a key that is independent of debt levels. Likewise, the resale of bonds by the Eurosystem in the secondary market does not change the fact that the initial purchase may contribute to the financing of government expenditure. This may create commitments on the part of the Member State that cannot be reversed easily when the Eurosystem's intervention ends and hence may initiate an upward trend in the government's debt ratio. Whether the knowledge that the Eurosystem is able to sell purchased bonds constitutes an effective deterrent that prevents the beneficiary Member State from undertaking such commitments in the first place may be doubted.

Third, asset purchases were restricted to bonds that were either of investment gradeFootnote ¹⁵⁰ or issued by a country subject to a financial assistance programme, notably an EFSF/ESM adjustment programme.Footnote ¹⁵¹ We have argued above that a structural adjustment programme is an appropriate measure to safeguard against a circumvention of Article 123(1) TFEU, since it establishes fiscal rules and imposes other fiscal constraints on a Member State with the goal of safeguarding or restoring the sustainability of the Member State's public debt.Footnote ¹⁵² Whether the risk that a credit rating agency downgrades government debt to below investment grade is sufficient to incentivise a Member State to follow a sound budgetary policy is more difficult to assess. Credit rating agencies will rate an issuer as investment grade only if the issuer has the capacity to meet its financial commitments and respond adequately to adverse economic shocks.Footnote ¹⁵³ A fiscal policy that seeks to deliver sustainable public finances and allows the government to respond effectively to economic shocks may be called ‘sound’ within the meaning of Gauweiler and Weiss. In principle, distinguishing between investment grade and non-investment grade securities is, therefore, an appropriate criterion that promotes the objective of Article 123(1) TFEU.

Two objections may be made to this preliminary conclusion. First, credit ratings are a function of the combined consideration of a variety of institutional, economic, fiscal and monetary variables.Footnote ¹⁵⁴ The effect of changes along one dimension—in the present context fiscal conditions—on the rating outcome is, therefore, attenuated and possibly offset by changes along other dimensions. In theory, this does not call into question the suitability of credit ratings to assess the effect that fiscal policy adjustments have on a country's public debt sustainability and resilience to economic shocks. This is evident for variables that have a direct impact on debt levels and debt sustainability, for example the ratio of government debt to GDP or economic growth.Footnote ¹⁵⁵ It is reasonable to assume that an asset purchase programme does not change a government's incentives with regard to fiscal policy if an increase in the debt-to-GDP ratio is offset by a more positive assessment of an issuer's economy and growth prospects. The increase in the debt-to-GDP ratio might have been triggered by the asset purchase programme or the improved growth forecast (or both), but the position of the country has not changed in comparison with a scenario where the government had not borrowed more, but the economy had also not improved.

The same line of reasoning holds for ‘softer’ variables, for example the accountability of government institutions and the absence of corruption.Footnote ¹⁵⁶ Again, if an increase in borrowing is offset by an improvement in the institutional environment, it is justified to regard an asset purchase programme as not jeopardising the aim of Article 123(1) TFEU, since better institutions make it more likely that the government will manage its debt more competently and prudently. However, the problem with such ‘softer’ measures, and more generally with the drawing up of a matrix of variables and their interactions to determine a country's credit rating,Footnote ¹⁵⁷ is that they introduce a considerable amount of noise. Inevitably, a certain degree of subjectivity is involved in defining and weighting the relevant variables and assessing a country's situation. Thus, it is possible that a country's creditworthiness deteriorates as a consequence of a monetary policy measure, without this being reflected in a corresponding decrease in the country's credit rating.

The second objection is that credit ratings operate retroactively. It is therefore questionable whether the threat of a potential downgrade is enough to incentivise a Member State not to deviate from a sound budgetary policy when presented with a monetary policy intervention that creates favourable financing conditions. As discussed, credit ratings are partially subjective. Therefore, a downgrade cannot be predicted with certainty and its deterrent effect must be discounted accordingly. Furthermore, those who make fiscal policy decision may rationally decide to accept the risk that the government's credit rating could be downgraded in order to be able to pursue economic policy goals that are regarded as taking priority over fiscal reticence.

While the risk of a credit rating downgrade will, therefore, not always be effective, it is important to note that the investment-grade requirement does not operate in a legal vacuum. We have argued above that some control over a Member State's fiscal policy decisions after the termination of an asset purchase programme is essential to prevent the goal of Article 123(1) TFEU from being compromised. Such a control mechanism exists in the EU in the form of the Stability and Growth Pact (SGP) and the Fiscal Compact.Footnote ¹⁵⁸ The SGP has introduced a process of budgetary surveillance and coordinated formulation of the Member States’ annual budgets and economic policies.Footnote ¹⁵⁹ As part of this process, Member States are required to set a medium-term objective for their budgetary position that should be close to balance.Footnote ¹⁶⁰ For signatories of the Fiscal Compact, the structural deficit is limited to 0.5 per cent of GDP, unless debt is significantly below 60 per cent of GDP.Footnote ¹⁶¹ Member States that are at their medium-term objective must ensure that government expenditure does not grow more than predicted GDP growth, and Member States that are below their medium-term objective must formulate an adjustment path that includes a rate of expenditure growth below predicted GDP growth.Footnote ¹⁶²

The Council and Commission monitor compliance with the SGP and issue warnings, recommend policy changes, and, as a last resort, impose sanctions on Member States.Footnote ¹⁶³ In addition, the SGP contains a corrective arm, also known as the excessive deficit procedure, which is triggered if a Member State exceeds a structural deficit of 3 per cent of GDP or a government-debt-to-GDP ratio of 60 per cent.Footnote ¹⁶⁴ The Commission and Council will then recommend adjustments to correct the fiscal imbalances and, if the Member State concerned does not take effective action, step up the excessive deficit procedure, potentially leading to the imposition of fines.Footnote ¹⁶⁵

After the SGP was initially criticised for a lack of enforcement, the excessive deficit procedure has been made more automatic and surveillance and coordination have been strengthened with the adoption of the so-called ‘Six-pack’.Footnote ¹⁶⁶ Recent empirical findings indicate that the SGP now significantly shapes fiscal policy in the Eurozone and gives an impetus for fiscal consolidation.Footnote ¹⁶⁷ It does not seem incoherent to argue, as did the Court of Justice in Weiss, that the threat posed by a potential credit rating downgrade, in an environment where fiscal policy choices of Member States are already constrained, provides a sufficient safeguard against the moral hazard otherwise caused by an asset purchase programme.

A. Monetary Policy Mandate

The PEPP aims to counteract ‘the serious risks to price stability, the monetary policy transmission mechanism and the economic outlook in the euro area’ caused by the COVID-19 crisis.Footnote ¹⁶⁸ Under the PEPP, the Eurosystem purchases eligible securities, including bonds issued by Member State governments, on secondary markets. The allocation of purchases is, in principle, based on the key for subscriptions to the ECB's capital, but the Executive Board may decide to deviate from the capital key.Footnote ¹⁶⁹ Unlike the PSPP, the PEPP decision does not impose quantitative limits on purchases on an issuer basis.Footnote ¹⁷⁰ It also decision does not impose any conditionality on asset purchases, other than that government bonds must be of investment grade,Footnote ¹⁷¹ and furthermore waives this latter requirement for debt securities issued by Greece.Footnote ¹⁷²

The PEPP falls within the mandate of the ECB if it pursues a monetary policy goal, makes use of a monetary policy instrument, has only indirect effects on policy goals not related to monetary policy, in particular on economic policy goals (we have called this condition the Court's direct/indirect effects test), and is proportionate to the goal pursued. It is clear that the first two conditions are satisfied. Asset purchases in secondary markets constitute a monetary policy instrument, and the goals pursued by the PEPP according to the ECB decision establishing the purchase programme fall within monetary policy.

The application of the direct/indirect effects test is more difficult. As currently implemented, purchases under the PEPP are largely in line with the ECB capital key and mirror transactions under the PSPP. Like the PSPP, the PEPP thus has an impact at the second stage of the monetary policy transmission mechanism, and any effects that fall within economic policy, for example on refinancing costs of Member States and general economic conditions, are indirect.Footnote ¹⁷³ However, the financial firepower of the PEPP could also be concentrated on individual Member States. This would directly affect financial stability if the purchases (or their announcement) removed the threat of a self-fulfilling solvency crisis by guaranteeing the liquidity of a Member State (that is, the ECB operated through the PEPP as a lender of last resort). Thus, where a Member State experiences a liquidity crisis, the PEPP could be used to the same effect as OMT. It is unlikely that asset purchases under the PEPP will indeed be deployed in this way, since the credit rating of a Member State that experiences difficulties in refinancing its debt is likely to be downgraded to below investment grade. This would render government bonds—with the exception of Greek bonds—ineligible, unless the PEPP decision was amended to include another waiver. Nevertheless, it is important to note that a consistent application of the direct/indirect effects test imposes limitations on how the PEPP, and more generally a programme that allows for selective asset purchases, can be used.Footnote ¹⁷⁴ A bond buying programme that has a direct effect on financial stability or other economic policy goals is illegal, and there is no need to take recourse to the proportionality test of the Court of Justice, or the FCC's more comprehensive proportionality review, to achieve this result.

The Court's proportionality test constitutes an additional constraint on the discretion of the ECB that is relevant to the question whether the programme's monetary policy goal could have been achieved through other means, for example the use of standard monetary policy tools, a purchase programme with a smaller envelope, or a programme that targeted a narrower range of eligible assets.Footnote ¹⁷⁵ In addition, the risks associated with asset purchases, notably the exposure of national central banks and the ECB to the risk of losses, must not be manifestly disproportionate to the PEPP's objectives.Footnote ¹⁷⁶ As mentioned, the PEPP allows for greater flexibility than the PSPP and entails, arguably, a greater risk of losses, since not all purchased bonds are of investment grade. However, the PSPP currently operates on the basis of the same key for the allocation of asset purchases and the same loss sharing principles as the PSPP. National central banks purchase securities of issuers based in their jurisdiction, and the potential mutualisation of losses is limited to the securities purchased by the ECB.Footnote ¹⁷⁷ Given these features of the PEPP and the wide margin of discretion that the ECB enjoys in deciding how to implement monetary policy, which is reflected in the ‘manifest error of assessment’ standard that the Court of Justice employs in its proportionality review,Footnote ¹⁷⁸ it is therefore likely that the Court will hold that the PEPP is proportionate.

The FCC's criticism of the standard of review of the Court of Justice concerned the fact that the Court only balanced the monetary policy objectives of asset purchases against the risk of losses and not more generally against the ‘adverse effects’ of asset purchases, for example the effect that low interest rates have on household savings.Footnote ¹⁷⁹ In the view of the FCC, this rendered the Court's proportionality review ‘meaningless’.Footnote ¹⁸⁰ The discussion in the preceding paragraphs and in Section III.B demonstrates that this criticism is misplaced. The function of distinguishing between monetary and economic policy measures, and thus protecting the Member States against encroachment on their competences, is performed by the direct/indirect effects test, not the proportionality test.Footnote ¹⁸¹ The Court's proportionality test, on the other hand, has the function of assessing whether the actual monetary policy effects of a measure map on to the purported monetary policy goals of that measure. For example, if the selective purchase of government bonds was justified with the disruption of the monetary policy transmission mechanism in some parts of the Eurozone but not in others, but there was insufficient evidence that that was actually the case, a purchase programme that targeted individual Member States would be disproportionate. In contrast to the FCC's approach, the legal tests developed by the Court of Justice lead to a conceptually clear distinction between the principles laid down in Article 5 TEU.Footnote ¹⁸² The direct/indirect effects test polices the principle of conferral and the proportionality test the exercise of a conferred power.

B. Prohibition of Monetary Financing

The PEPP complies with the prohibition of monetary financing if it does not have effects equivalent to the direct purchase of government bonds on the primary market and provides for safeguards to ensure that Member States have sufficient incentives to follow a sound budgetary policy (equivalence/sufficient safeguards test). The first part of this test requires that secondary market purchasers do not act as de facto intermediaries for the Eurosystem. This is the case if they cannot foresee with certainty that the Eurosystem will purchase bonds acquired by them in the primary market.Footnote ¹⁸³ As mentioned, the Court of Justice relies on a multiplicity of criteria to assess foreseeability, including discretion in the timing of purchases and their allocation among national central banks, the duration of the programme, and the existence of a percentage cap on purchases of a particular issuer and bond issue.Footnote ¹⁸⁴ Under the PEPP, the Eurosystem follows a ‘flexible approach to the composition of purchases’,Footnote ¹⁸⁵ and, similar to the PSPP, it can be assumed that the Eurosystem will not intervene immediately after a bond issue.Footnote ¹⁸⁶ Under these conditions, it is clear that the high threshold of certainty is not met.

Likewise, whether sufficient safeguards exist depends on a consideration of a totality of the circumstances. In Gauweiler and Weiss, the Court highlighted several factors that were important. Purchases were only carried out to the extent necessary to achieve the goals of the programmes, the overall size of the programmes was (de facto) limited, the Eurosystem had the option to sell the purchased bonds at any time, and purchased bonds had to be of investment grade (or, in Gauweiler, purchases were conditional on full compliance with a structural adjustment programme). The decision establishing the PEPP replicates the first three criteria,Footnote ¹⁸⁷ but allows the purchase of government bonds of one Member State, Greece, even if the bonds are below investment grade.Footnote ¹⁸⁸ However, safeguards exist that allow the continued monitoring of the fiscal policy of the Greek government and the implementation of prior commitments to structural reform.Footnote ¹⁸⁹ While this so-called enhanced surveillance frameworkFootnote ¹⁹⁰ imposes less rigid constraints on a Member State's fiscal autonomy than a macro-economic adjustment programme,Footnote ¹⁹¹ it grants the ECB, Commission and Council enhanced powers in comparison with those under the SGP to review developments in the Member State concerned and recommend precautionary corrective measures or require the preparation of a draft macro-economic adjustment programme.Footnote ¹⁹² Considering that the ECB can, therefore, monitor in a targeted manner how government bond market interventions affect fiscal policy choices and that this is just one of several safeguards built into the PEPP, there are good reasons to conclude that the PEPP will pass the Court's equivalence/sufficient safeguards test.Footnote ¹⁹³

The FCC was highly critical of the flexible multi-factor test of the Court of Justice in Weiss, although it ultimately held that a ‘manifest violation’ of Article 123(1) TFEU had not been shown.Footnote ¹⁹⁴ Importantly, it emphasised in its judgment that two conditions were indispensable for a public sector asset purchase programme to be legal: a purchase limit of 33 per cent per ISIN and issuer and the requirement that purchased securities were of investment grade.Footnote ¹⁹⁵ The PEPP does not fulfil either of these conditions. Thus, if the FCC applies its own criteria consistently, it will conclude that the PEPP constitutes prohibited monetary financing.Footnote ¹⁹⁶ However, as discussed in Section IV.B, purchase limits and other criteria that determine whether primary market purchasers act as de facto intermediaries for the Eurosystem do not have a bearing on the question whether Member States have sufficient incentives to follow a sound budgetary policy. Both the FCC and the Court of Justice agree that safeguarding sound public finances is the objective of Article 123(1) TFEU. Under a coherent interpretation of the provision, both courts should, accordingly, come to the conclusion that a purchase limit of 33 per cent is not a necessary condition for compliance with the prohibition of monetary financing.

More generally, a coherent interpretation of Article 123(1) TFEU implies that public sector asset purchase programmes do not constitute prohibited monetary financing if controls over fiscal policy are in place that ensure that a Member State maintains sound public finances while the monetary policy intervention continues and, importantly, also when it ends.Footnote ¹⁹⁷ Such controls can be in the form of, for example, ESM conditionality, the requirement that purchased bonds are of investment grade, or enhanced surveillance of issuers if bonds are below investment grade. On the other hand, it is irrelevant for the prohibition of monetary financing whether percentage limits per issuer and ISIN exist, or whether it can be foreseen when the Eurosystem will purchase bonds, what the monthly purchase volume is, how asset purchases are allocated, and for how long the programme will continue.