APPLICATION OF RULES OR POLICIES IN THE ECB? LEGAL AND INSTITUTIONAL CHALLENGES IMPACTING THE CLIMATE TRANSITION

2.1. Financial crisis[Up]

As is well known, the financial crisis was sourced in the United States, following the bankruptcy of Lehman Brothers. One of the main features of this crisis was the disconnect between the interest rate on the credit granted for housing purchasing purposes and household indebtedness capacity. All these credits were aggregated, securitised and sold worldwide by special purpose vehicles. The impact on the European banking sector was felt soon after, prompting liquidity and solvency crises (‍Calvão da Silva, 2013: 16).

With the goal of increasing inter-banking loans, Member States jointly approved a banking sector recapitalisation and state guarantee plan — a framework establishing common principles but to be implemented individually by each government^[6]. As a consequence of putting this plan into action, public debt levels soared, placing many Member States on an unsustainable public debt and deficit path. Consequently, rating agencies severely downgraded a number of sovereign debt ratings, prompting the ECB to step in (‍De Grauwe, 2018: 182).

In a statement on 11 February 2010, Heads of State or Government of the EU acknowledged to hold “a shared responsibility for the economic and financial stability in the area. (…) Euro area Member states will take determined and coordinated action, if needed, to safeguard financial stability in the euro area as a whole” (‍European Council, 2010).

This was the moment where the ECB started to gradually transform, by adopting unconventional monetary policy measures (‍Dawson and Bobic, 2019: 1005; ‍Van der Sluis, 2019: 263). First, in 2010, the ECB announced the Securities Market Programme (SMP). Although limited in scope (‍Ioannidis, 2016: 1237) its objective was “to address the malfunctioning of securities markets and restore an appropriate monetary policy transmission mechanism” (‍Decision of European Central Bank, 2010: recital 3), conditioned on Member States’ fiscal frugality.

Further, in 2012 SMP was replaced by Outright Monetary Transactions (OMT), whose objective was to restore an appropriate monetary policy transmission and to safeguard the singleness of monetary policy. Therefore, the ECB framed the programme within article 127 (2) TFEU and article 3 of ECB Statute, as necessary to define and implement the monetary policy of the Union. Of its several features, I would highlight two. First, the ECB can purchase government-issued bonds maturing in one to three years, provided that the government requests financial assistance under the European Financial Stability Fund and European Stability Mechanism — the conditionality principle (‍Megliani, 2020: 674). Most importantly, conditions must not only be agreed but also effectively implemented to enable eligibility. Second, in contrast with SMP, there are no ex ante quantitative limits on the size of transactions (‍European Central Bank, 2012; ‍Falagiarda and Reitz, 2015: 280; ‍Adamski, 2015: 1451).

Lastly, the Public Sector Purchase Programme (PSPP) was adopted in 2015. Contrary to OMT, this programme involved large-scale bond purchases in the secondary market, in particular those issued by national governments, with the aim of increasing inflation. Framing the Decision within the purview of its mandate, the ECB justified it as necessary and adequate. It was necessary for contextual reasons. The central bank argued that interest rates were at their lower bound and purchase programmes focusing on private sector assets were considered to be insufficient and needed to be revamped. It was adequate, given that its portfolio re-balancing effect and the sizable purchase volume of PSPP would further ease monetary and financial conditions (‍Decision of the European Central Bank, 2015: L/121/20).

2.2. COVID-19 pandemic[Up]

On a similar vein, the European Council held a video conference on 10 March 2020. Among its conclusions, the Heads of State or Government of the EU held that, tackling socio-economic consequences would require the Union and its Member States to use all instruments that are necessary. In particular, we will address any impact on liquidity, on support for SME’s and specific affected sectors, and their employees. Flexible application of EU rules in particular as regard State aid and Stability and Growth Pact will be needed (‍European Council, 2020).

On 18 March 2020, the ECB announced the Pandemic Emergency Purchase Programme (PEPP). According to the Governing Council, this programme would be a “new temporary asset purchase programme of private and public sector securities to counter the serious risks to the monetary policy transmission mechanism and the outlook for the euro area posed by the outbreak and escalating diffusion of the coronavirus, COVID-19” (‍European Central Bank, 2020). It would allow the purchase of private and public sector securities in amounts of up to €750 billion, including a waiver of the eligibility requirements for securities issued by the Greek Government.

Similar to other programmes, the aim of PEPP was to protect the monetary policy transmission mechanism as well as to counter the serious risks to the outlook of the euro area. The cause, however, was different. While other programmes, such as OMT, were inspired by the prospect of eurozone disintegration and focused on a few Member States experiencing financial distress, the latter was meant to address a much wider, overreaching and horizontal situation. As President Lagarde announced, “the shock the Eurozone now faces is exogenous and affects all Eurozone Member States” (‍European Central Bank, 2020).

There are also resemblances with PSPP, such as the use of the ECB capital key to purchase allocation, which revealed to be a problem. With the benefit of hindsight, Member States were not equally affected by the pandemic. This is demonstrated, for instance, by the way Next Generation EU was devised, allocating more funds to the most affected States.

However, in contrast to OMT, PEPP is not a selective instrument that allows the ECB to focus on a specific Member State. Ultimately, there must also be purchases of other Member State bonds (‍Van der Sluis, 2020).

Flexibility would be the hallmark of the programme. Whereas the benchmark allocation across jurisdictions continued to be the capital key of the national central banks, the buying operations was expected to see fluctuations over time, across asset classes and among jurisdictions. Resembling Draghi’s statement on 26 July 2012, Lagarde stated that the “Governing Council will do everything necessary within its mandate” (‍European Central Bank, 2020).

The programme was subsequently reinforced, first by €600 billion on 4 June 2020, and by €500 billion on 10 December 2020, to a total €1,850 trillion. On 16 December 2021 the Governing Council decided to discontinue net asset purchases under the PEPP at the end of March 2022. The maturing principal payments from securities purchased under the PEPP will be reinvested until at least the end of 2024.

2.3. Conclusion[Up]

From the foregoing it can be concluded that the ECB has changed its monetary policy actions overtime. During a less complex period, it was capable of delivering a policy commensurate with the rules underpinning its mandate. However, as complexity increased, its task became increasingly more difficult.

In fact, this section has shown the ECB’s actions are increasingly aligned with the European Council’s decisions and Member States individual needs. Notably, it started intervening in Member States’ secondary bond markets, therefore increasing their dependency on the central bank to generate demand and becoming almost umbilically interconnected^[7].

The blurring of the principle of prohibition of monetary financing may not only hinder but principle of price stability (‍Friedman, 1968) but also, most importantly, the principle of central bank independence (‍Lastra, 1992: 33; ‍Kämmerer, 2022: 158). This latter principle is at the core of central banking credibility and was of essence during the negotiations that led to the creation of the ECB (‍Louis, 2020: 797). One of the effects brought about by independence (or autonomy)^[8] is that markets get more assurances that decisions broadly reflect technical expertise, which fosters investors’ foreseeability, confidence and, thus, stability and growth. Without it, however, an element of unpredictability is introduced, which hinders foreseeability and potentially affects capital allocation.^[9]

The next section will focus on how the ECB is addressing climate change and assess whether the same pattern exists and what may the potential legal consequences be.

2.1. Problem of compatibility with price stability[Up]

Article 127 (1) TFEU provides that monetary policy is oriented by primacy of price stability, which means that it must be the overriding concern of the ECB. According to Zilioli and Ioannidis, the environment may, at first glance, have little to do with price stability (‍Zilioli and Ioannidis, 2022: 367). However, as noted in Gauweiler^[12] (among many others, ‍Goldmann, 2014: 265; ‍Kumm, 2014: 203; ‍Fabbrini, 2015: 1003; ‍Borger, 2016: 139) and Weiss^[13] (see ‍Lang, 2018: 923; ‍Van der Sluis, 2019: 263; ‍Dawson and Bobic, 2019: 1005) the CJEU accepts other considerations to be taken into account in order to carry out its primary objective, such as an adequate transmission of monetary policy.

While I will not deal with the appropriateness of such a concept here, suffice to say that actions intended to preserve the transmission mechanism are covered by article 127 (1) TFEU and, therefore, fall within the mandate of the ECB. In fact, the Court considered that the objectives of a measure, as well as the instruments used to implement it, are pivotal in order to establish its nature and, as such, to determine whether it falls under monetary or economic policy. Accordingly, the Court considered OMT as falling within the remit of monetary policy for a number of reasons. First, the objective of safeguarding the singleness of monetary policy does not exceed the mandate, given that it must be single. Second, the objective of preserving the appropriate transmission of monetary policy is not only likely to achieve the referred singleness but also to maintain price stability. According to the Court, the reason for this is that the mechanisms used for effective transmission are essential in price developments. Hence, disrupting these mechanisms necessarily affect the ability to guarantee price stability. And while monetary policy decisions might also spill over to economic policy matters (such as to contribute to the stability of the Euro area) that circumstance does not change its inherent nature.

A similar judicial reasoning may occur regarding climate change. According to Isabel Schnabel, there are several inflation risks. First, the inherent costs associated to climate change (climateflation). As natural disasters and extreme weather events becomes more frequent, the greater the impact on economic activity and prices. Moreover, energy prices, such as oil and gas, have been increasing ever since the COVID-19 pandemic started to subside, in the summer of 2021, and have skyrocketed with the Russian invasion of Ukraine (fossilflation) which has a significant impact on the price of several goods. Third, conducting the green transition requires investments in technological process in the company world. However, especially in the transition period, these investments require a massive amount of metals and minerals. If excessive demand was not already enough to increase prices, supply chain disruptions further deepen the problem (greenflation) (‍European Central Bank, 2022; see also ‍Calliess and Tuncel, 2023: 800).

Governments retain primary responsibility for addressing climate change, notably through fiscal policy. Notwithstanding, the ECB’s mandate requires it to assess the impact of climate change and to further incorporate climate considerations into its policy framework, especially given that physical and transition risks related to climate change have implications for both price and financial stability, and affect the value and the risk profile of the assets held on the Eurosystem’s balance sheet.

Among other measures^[14], corporate sector bond purchases (CSPP) are considered an important instrument, given that they allow a lower cost of capital. However, re-allocate capital to climate-friendly companies is one of the ECB’s most contentious responses. Some in the doctrine argue in favour of such an approach, “given that inflationary pressures might arise from a decline in the supply of goods or from productivity shocks caused by weather-related events such as droughts, floods, storms and sea level rises” (‍Batten, 2018: 1).

Importantly, however, the amount of investment necessary to perform the climate transition is already very significant, and it will continue to be^[15]. One of the problems is that the scale of these investments may disrupt supply-demand equilibrium and create inflation. According to McKinsey:

In this context, it is important to note that, especially with PSPP and PEPP, monetary policy has been very flexible over several years, trebling the ECB’s balance sheet in the 2015-‍2021 period, from €2.780 trillion to €8.564 trillion.^[16] Although, half to two-thirds of inflation may be explained by non-demand components (supply and non-discernible causes) in the Eurozone during the 2017-‍2022 period (‍Gonçalves and Koester, 2022: 73),^[17] increasing to availability of money, via monetary policy, could make for a grimmer outlook for inflation. Especially if we take into account the already large demand of a fiscal nature and a limited amount of goods and services able to deliver so-called “green” products.

Another obligation flowing from article 127 (1) TFEU is that ECB’s action must be conducted in a way that favors an efficient allocation of resources. Importantly, such efficiency is dependent on market neutrality by public authorities. Disregarding such principle necessarily affects asset allocation, as the market incorporates public intervention in its decisions on investment.

Crucially, to increase the ECB’s balance sheet would necessarily introduce an element of discrimination on firms’ bond purchasing and, hence, breach the principle of market neutrality. As Steinbach observes, market neutrality means that the ECB purchases securities without taking the nature of the issuer’s activities into account, in particular their sustainability. As a result, the CSPP portfolio contains a significant share of carbon-intensive sectors, which would have to be re-balanced, by conducting a reassessment of the asset purchasing programmes allocation, potentially excluding certain bonds that conflict with EU decarbonization objectives (‍Steinbach, 2022: 333; ‍Jourdan and Kalinowski, 2019: 23; differently, arguing that market neutrality does not constitute a legally relevant limitation, see ‍Calliess and Tuncel, 2023: 817-‍818).

In the same vein, it is not the task of the ECB to pick winners and losers, given that market neutrality is a powerful tool to pursue price stability while simultaneously preventing market distortions through biased interventions. Indeed, monetary policy should not be tailored to correct market distortions and political actions or omissions (‍Weidemann, 2020; ‍Christie, 2021).

Not only will climate transition take quite some time to conduct but also, and most importantly, EU policies do not envision a fully-fledged green economy, one where the whole economy would function with green standards. On the contrary, the net-zero policies currently in place only imply that human activity is reduced or changed so that greenhouse emissions produced can be totally absorbed by the planet (‍European Commission, 2021: 10). In this context, only the former course of action would adequately address the issue of neutrality. However, since for the foreseeable future such a prospect is not yet realistic, the policies are enacted on the assumption that greenhouse gases will continue to be emitted to the atmosphere and, likely enough, in a very heterogeneous way across sectors and companies. As a result, tailoring monetary policy to favour sectors that are less carbon-intensive effectively excludes many sectors of the economy, potentially on a permanent basis.

In conclusion, price stability is better preserved by following the principle of market neutrality. Hereby lies the ECB’s green paradox: in an effort to rush the transition, one may actually be delaying it. In fact, if inflation deviates too much from target, then the ECB would be obliged to comply with its primary objective and scale back its intervention.

2.2. Problem of compatibility with central bank independence [Up]

Let us assume that climate policy would be in line with price stability. In this situation, the mandate of the ECB can be broader, as the second part of article 127 (1) TFEU states that without prejudice to the objective of price stability, “the ESCB shall support the general economic policies in the Union with a view to contributing to the achievement of the objectives of the Union as laid down in article 3 (3) of the Treaty on European Union”, such as a high level of protection and improvement of the quality of the environment.

Therefore, the ECB can take on other objectives of the Union concomitantly, although to the extent that they do not place price stability in jeopardy. At the outset, one has to question which economic policies are eligible supported by monetary policy? A literal reading of the article, when reference is made to economic policies in the Union, allows a broad interpretation, as to encompass both Union and Member States enacted policies. However, it may do so in a supporting role only. This secondary role makes sense, given that the mentioned objectives “are so broad that an attempt by the ECB to concretize them and support them would de facto require assessments that would amount to autonomous policymaking” (‍Zilioli and Ioannidis, 2022: 370). In addition, in respect of the principle of institutional balance, stipulated by article 13 (2) TEU, policymaking is within the realm of political institutions, which does not encompass the ECB.

So why did the ECB only incorporate environmental concerns in its monetary policy concerns and did not do the same with the other general economic policies? Every secondary goal stipulate in the Treaties is embodied with the same legal value and, consequently, no hierarchy is established. Thus, in principle, each of those secondary policies should be supported on equals terms. While the ECB cannot put the different set of economic policies into practice, Member States have, for instance, comprehensive social policies as well as, together with the Union, scientific and technological policies. However, none of these seem to be specifically targeted by monetary policy, which raises questions not only on the legality of the ECB intervention, but also on the adequateness of its mandate regarding secondary objectives. In fact, by cherry-picking which secondary objectives to pursue, it paradoxically places the ECB in the political realm, raising issues of legality and democratic legitimacy (‍Klooster and Boer, 2023: 740).

In the doctrine, some argue that, in the absence of an established hierarchy, the ECB should look at the prioritisation as given by political institutions (‍Zilioli and Ioannidis, 2022: 384). The bodies responsible for indicating priorities for the purpose of article 127 (1) TFEU are primarily the European Council, but also the Council and the European Parliament. Moreover, this practice should be accompanied by compliance with the principle of proportionality and the duty to state reasons under article 296 TFEU. However, this would be difficult to reconcile with the principle of independence of the ECB which, under article 130 TFEU, prohibits the ECB from seeking or taking instructions from Union institutions when pursuing its objectives. While it is true that deference to the assessments and prioritisations of Union institutions does not amount to issuance of direct instructions or influence exertion, it does make the ECB impacted by third party institutions’ political priorities into account.

Likewise, the European Climate Law could portray the same issues concerning independence. While directly applying to Union’s political institutions, it does not explicitly rule out the ECB from its scope. And, most certainly, the ECB is a relevant institution within the EU, as it holds the competence to an exclusive and impactful policy. Excluding it from the European Climate Law’s scope was already considered as defeating its spirit and objectives, as it requires the Union as a whole to achieve climate neutrality by 2050 (‍Arriba-Sellier, 2023). However, by considering the ECB to be subject to this law would, again, force it to consider the Union’s political priorities. Hence, it would not be inconceivable to consider this kind of effect as periling independence through the back-door.

Importantly, this is where independence and accountability intersect. On the one hand, I would concur that the European Climate Law does not require the ECB to submit its policies to the Commission for assessment. Rather, article 6 requires the Commission to review the consistency of Union measures with the objective of climate neutrality and climate change adaptation, regardless of the author of the measure (‍Arriba-Sellier, 2023). It may require the Commission to take the necessary measures in accordance with the Treaties, ultimately bringing the ECB before the CJEU. Given the aforementioned political priorities, enhanced judicialisation may be anticipated. While accountability through the judicial process is nothing new, one should be careful when adding avenues for institutional conflict, in particular when they seem to be of limited effectiveness and legality. Regarding the former, the CJEU has already shown its limits to its intervention in the realm of the ECB’s monetary policy decisions, as its deferent approach in Gauweiler and Weiss have shown. In fact, the Court has expanded the reach of the ECB’s competences further into the economic field. Given the precedent, similar deference could occur with the climate transition as well.

As for legal grounds, as referred above, the Member States explicitly stated in the Treaties that they wanted price stability to be the primary objective of monetary policy. Therefore, any secondary objectives (including environmental) must be addressed as long, and insofar as it does not hinder price stability. In this regard, it is not difficult to foresee seemingly conflicting monetary and economic (climate) policy decisions, for instance increases in interest rates, reducing central bank balance sheet or reducing liquidity in the economy. It would be odd to see the judicial process getting more involved because the ECB would be caught between choosing compliance with primary law or abiding by political priorities defined by secondary law. Surely, ECB independence does not separate it entirely from Union and exempt it from every rule of EU law. Hence, as the Court in OLAF^[18], there are no grounds which prima facie preclude EU legislature from adopting measures capable of applying to the ECB^[19]. However, and crucially, the European Climate Law presents a materially different situation, whereas the ECB is not being asked to implement internal procedures to prevent fraud or any unlawful activities detrimental to the Union’s financial interests, but to adapt the way it conducts its core task to contextual factors (with a different view, arguing that there is no issue with ECB independence, see ‍Calliess and Tuncel, 2023: 812).

As a result, given the current framework as defined by the Treaties, the ECB should neither cherry-pick the secondary objectives nor be subject to contextual political objectives, either directly or indirectly.

2.3. Opportunity of tackling climate change[Up]

Another issue is related to the opportunity in tackling climate change. At the outset, the Treaty of Maastricht already included respect for the environment, social protection and social cohesion as objectives of the Community (article G [2] of Treaty on European Union), which should be supported by the central bank (article G [25] of Treaty on European Union).

Moreover, both the Member States and the EU have signed the Kyoto Protocol and Paris Agreement. The former was adopted on 11 December 1997 and, due to the ratification process, entered into force on 16 February 2005. It only binds developed countries — therefore, the EU and its Member States — and places a heavier burden on them under the principle of common but differentiated responsibility and respective capabilities, because it recognizes that they are largely responsible for the current high level of emissions in the atmosphere.

The Paris Agreement is a legally binding international Treaty on climate change. It was adopted on 12 December 2015 and entered into force on 4 November 2016. In accordance with article 216 (1) TFEU the Union may conclude agreements with international organisations. It shall do so, for instance, where the conclusion of such agreements is necessary in order to achieve, within the framework of the Union’s policies, one of the objectives referred to in the Treaties. Pursuant to article 216 (2) TFEU, “[a]greements concluded by the Union are binding upon the institutions of the Union and on its Member States”.

Likewise, current article 11 TFEU requires environmental protection to be fully integrated into the definition and implementation of the Union’s policies and activities, in particular with a view to promoting sustainable development (‍Calliess and Tuncel, 2023: 804). Notwithstanding, the importance of environmental protection has been increasing since its first Treaty enshrinement in the 1986 Single European Act, from both a literal and systematic point of view. Indeed, the 1992 Maastricht Treaty amended the provision in order to make it more imperative. But, crucially, the 1999 Amsterdam Treaty and the 2007 Lisbon Treaty changed its systematic location, placing it under Principles and the horizontal clauses, respectively (‍Zilioli and Ioannidis, 2022: 377). Environmental protection has been hailed not only by the political process but also by the judicial branch, as the CJEU has also confirmed its obligatory nature^[20].

Although these Treaty provisions cover all EU institutions and, as such, their actions should have been taken in tandem, it did not happen in practice. As such, it could be argued that the ECB could have anticipated itself to the European Council on this matter. By waiting for the definition of the latter’s political priorities to define its own green policy, it furthers the view that monetary policy in the Union is increasingly influenced by Member States policy priorities or financial situation. Significantly, the ECB does so when reality is intricate and complex, furthering the view of lack of institutional choice in the EU in these situations, as the central bank is the only one with the necessary financial power to make a difference EU-wide (‍Van der Sluis, 2021).

However, regarding the relationship between ECB asset purchases and their effect on Member States, one should look beyond the letter of the law and focus on the raison d’être of those Treaty provisions. In this regard, in its current form, article 130 TFEU primary purpose is to avoid the exercise of political influence over the ECB. That would indeed be the case were direct instructions formally issued. However, from an effects-based perspective, one should admit the possibility that political institutions’ priorities seem to be indirectly influencing the ECB and its policy definition. Moreover, article 130 TFEU does not distinguish between instructions regarding the primary and secondary objectives, as it only refers to the tasks and duties conferred upon the ECB by the Treaties, nor between direct or indirect instructions.

To be sure, this is not to say that the ECB cannot align its policies with other institutions and, in many instances, that may well be the case. However, its policy definition should be effectively autonomous, as the example of the FED shows (as described infra). Unfortunately, the factual description depicted above seems to point in a different direction.