Saturday, March 15, 2014

The German Constitutional Court And Economic Theory

The German Constitutional Court ruled in January that the European Central Bank's bond buying program is illegal according to EU law.  Its ruling was based upon an economic theory that was proven to be flawed during the financial crisis.  The efficient market hypothesis (EMH) assumes that the market will determine the best possible price for financial assets.  If the EMH is correct, then the ECB's purchase of sovereign bonds reduces the yields on sovereign debt in violation of the theory.  The market should be allowed to determine the price (and, therefore the yield) on government bonds. The court also argued that the ECB's purchase of government debt mixes monetary policy with fiscal policy.  It would restrict monetary policy to maintaining price stability.

The University of Chicago's economics department, and its school of law, has a program which trains lawyers to apply economic theory to legal cases.  The economic theories that are taught to the law students assume the correctness of theories that have been developed by economists in the university's conservative economics department.  The EMH is one of those theories.  Conservative economic theory developed in Chicago appears to be alive and well in the German Constitutional Court.  This article argues against the use of a theory that has been discredited by recent history.  It also argues against the limitations that the German court would place on the ECB's function as a lender of last resort. 

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