Photo: Wikimedia Commons
Bundesbank President Jens Weidmann has been one of the most outspoken critics of European Central Bank President Mario Draghi’s plan to buy sovereign bonds, a form of quantitative easing.Ironically, the Bundesbank itself side-stepped its mandate to buy public bonds on the open market back in 1975.
A note from BNP Paribas analyst Evelyn Herrmann describes how it came to pass.
Facing collapsing demand for longer-dated bonds and deteriorating economic growth, the Bundesbank purchased 7.6 billion Deutsche marks of public post, telecom, and sovereign bonds on the secondary market. That was equivalent to about 1 per cent of GDP.
Monetization of debt was forbidden in the Bundesbank’s mandate. However, after Bundesbank President Karl Klasen “accidentally” announced bond purchases at a press conference, they were forced to go through with it.
According to the note, then Chief Economist of the Bundesbank Helmut Schlesinger justified the bond purchases by citing the Bundesbank’s inability to use other tools effectively:
….”we can only operate open market policy in order to regulate the money market, but not to finance the public deficit”. In other words, the Bundesbank needed to purchase bonds in order to maintain monetary policy’s transmission channel. The Bundesbank had set a monetary growth target for the year for the first time, which it risked missing (money growth slowed to 5.7% in May 1975, below the target for the year of 8%).
Debt monetization is also prohibited by the EU treaties, however the ECB has gotten around this law in the past by “sterilizing” its bond purchases—essentially, fighting the inflationary nature of QE by taking away liquidity from elsewhere in the market.
Though the situation of the Euro is obviously different than Germany’s in 1975, Mario Draghi also made an argument about monetary policy transmission in his efforts to justify open market operations. From his August 2nd statement:
“Exceptionally high risk premia are observed in government bond prices in several countries and financial fragmentation hinders the effective working of monetary policy.”
If the Bundesbank’s behaviour is any indication, then there might be room for Draghi to side-step treaty laws and do full-fledged, expansionary QE—purchases of sovereign bonds without removing money from elsewhere in the market. This would devalue the euro (a positive for Spain and Italy), and so do more than just keep borrowing costs for peripheral governments down.
Even if not, Draghi might use this 1975 example as ammunition in his negotiations with the stubborn Bundesbank.