MNI INTERVIEW: Flexible ECB Bond Buys Risk Breaking German Law

Germany’s constitutional court may rule against any attempt by the European Central Bank to use proceeds from maturing German bonds bought under its Pandemic Emergency Purchase Programme to buy debt of fiscally weaker countries, advisor to the German finance minister and former chair of the Council of Economic Experts Lars Feld told MNI.

In an interview, Feld also criticised attempts by the ECB to design a new tool to limit any blow-out in peripheral bond spreads, saying it was unacceptable for countries such as Italy to refuse to accept conditions under the existing Outright Monetary Transactions facility. The EU needs to draw in fiscal stimulus as it battles high inflation and the danger of a wage-price spiral, even as Germany’s economy is already stagnating, he said.

“I'm not happy with the information we now have on the anti-fragmentation tool,” Feld, who was named an advisor to Finance Minister Christian Lindner in February and is also Walter Eucken Institut director and a professor at the University of Freiburg, said in an interview late last week. “I have the impression that the ECB is simply doing this particular type of monetary policy ambiguity in order to calm down markets, but I'm sceptical that it will finally work.”

The legal room to design a new tool -- which investors anticipate may be unveiled at the next Governing Council meeting on July 21 -- is limited given rules capping purchases of individual countries’ bonds under other ECB programmes, Feld said. (MNI SOURCES2:ECB Mulls Crisis Tool As Officials Debate Spreads)

“We have an instrument in place called OMT which would be the right way to go,” he said. “I find it unacceptable that countries simply refuse to accept conditionality. I don't think that the other member countries should give in in that regard.”

CONSTITUTIONAL COURT

The ECB also hopes to use proceeds from maturing bonds acquired by PEPP to compress spreads if necessary, but Feld said that may violate German law.

“PEPP was an additional tool, and to say we will use PEPP, or the maturing PEPP bonds that we get from Germany, the Netherlands and others in order to reinvest them in countries where the spreads are going up may nevertheless be unconstitutional regarding the German case,” Feld said.

Much internal EU discord stems from a fundamental disagreement over fiscal policy, according to Feld, who chaired the Council of Economic Experts from 2020 to 2021. Member states should now consolidate their fiscal stances, he said.

“We need to stay away from an expansionary fiscal policy in order not to increase inflationary pressures even more than we currently have,” he said, “You have a divide in the assessment of what fiscal policy actually should do in the current situation. That's the basic problem. It's not the problem of the alignment between fiscal and monetary policy.”

STAGFLATION

Even as prices surge, the growth outlook is weak, with Germany entering stagflation, Feld said.

“We have stagflation already, just because we have stagnation for the third quarter in a row together with high inflation. The outlook for the rest of the year is gloomy. But, overall, I would say that if it remains in a stagnation, it is one of the best outcomes we can hope for.”

Inflation, though, may not have peaked in May, when it hit 7.9% before easing to 7.6% in June, he said.

“The pressure regarding oil producer prices has not relaxed yet, and once that finally translates into consumer price increases, this would mean that we either are on a plateau of high inflation rates, month by month, or we will have further increases and the peak is still waiting for us,” he said, warning of a possible wage-price spiral.

Germany faces significant challenges as it weans itself of Russian gas, Feld said, and in the nearer term shutdown of Russian deliveries could prompt high-energy intensity industries such as glass and ceramic production to relocate to the U.S. or Sweden. The government should change the law to allow for earlier energy rationing for households if necessary, he said, in order to allow companies to grow.

“I know that in international discussions there's the fear that, given its dependence on Russian gas, the German economy will have huge difficulties. But when you look at the state of our firms and the resilience they have developed in these 10-12 good years, I'm not so negative on this outlook even if the worst scenarios materialise,” Feld said.