Jens Weidmann: Fiscal and monetary policy - dancing too close?
Speech by Dr Jens Weidmann, President of the Deutsche Bundesbank, at the École des
Hautes Études Commerciales, Paris, 25 January 2013.
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1. Introduction
Ladies and gentlemen
I would like to thank you for inviting me to be here today, which is a real pleasure for me. The
HEC is, without doubt, one of the most renowned European Business Schools. Looking at
the number of CEOs of Fortune Global 500 companies it provides, HEC ranks as number
four in the world, and as number one in Europe.
But HEC's reach is by no means limited to the business world. There are a number of former
students who have risen to the highest positions in the public domain. These include
François Hollande and WTO Director-General Pascal Lamy.
Therefore, it is an exceptional honour for me to receive the Diplôme HEC d'Honneur. And the
fact that I am already the third German citizen to receive the Diplôme symbolises the close
connections between France and Germany.
Just four weeks ago, France and Germany celebrated the 50th anniversary of the
"ElyséeTreaty", the treaty of friendship as it is called. And the friendship between France and
Germany has come a long way since Charles de Gaulle and Konrad Adenauer met in Paris
to sign the treaty.
However, we still cling to our favourite clichés regarding each other's national cultural
behaviour. Let us look at a recent poll in which French people were asked to name some
typical German traits. According to this poll, Germans are - first and foremost - very
"serious" people. Put in the words of the French writer Stendhal: "It seems that in Paris more
jokes are made in the course of one evening than in Germany during a whole month".
Well, I am German so I would not dare to tell a joke. But as I am in Paris I might try at least to
pass on a little quip I heard the other day. It goes like this: "How many Germans do you need
to change a light-bulb? One, he holds the light-bulb and the rest of Europe revolves around
him".
I'm afraid this quip reflects the impression some might have of Germany at the moment. But
let me add two things: first, the same joke was being told in the 1990s, and back then, the
French where the ones holding the light-bulb. Second, the joke did not reflect actual
circumstances in the 1990s, nor does it reflect them today.
In reality, Europe can only work if all of us move in the same direction. Only together can
France and Germany act as the driving forces of European integration. And only together
can France and Germany help to solve the current crisis.
However, regarding the crisis, there are some issues on which we have different opinions.
And here it is important to address these differences openly, listening to each other and
trying to understand what each of us thinks. Only when we share our thoughts and ideas can
we develop a sensible solution to our problems.
This is why I am happy to be here today. For it gives me the opportunity to share and discuss
my ideas with you. And given that we are at one of the most high-ranking business schools
worldwide, I look forward to listening to your ideas as well. But let me begin with a few
observations on which I think we all agree.
2. Same crisis, different perspectives?
With respect to the current crisis and its origins, we all see more or less the same problems.
We see a sovereign debt crisis; we see high public or private debt and a lack of
competitiveness in some member states; we see current account imbalances, and we see
weaknesses in the framework of monetary union and in its financial system.
With respect to the future, we all are focused on the same objective: a prosperous European
Union and a stable single currency. However, it is the question of "how to get there" where
opinions differ. This should be no surprise because it is indeed a tricky question. To
paraphrase the American politician Hubert Humphrey: The solution is hammered out on the
anvil of discussion, dissent and debate. So, I would like to highlight three issues where I feel
that my view and the view of many decision-makers in Germany might differ from that of
others.
Some say it would hurt growth if countries consolidated their public finances at great speed.
In my view, consolidation is crucial for growth in the long term and not that bad for growth in
the short term.
Some say Germany should do more to rebalance current accounts by reducing its
competitiveness. In my view, instead of making one country weaker we have to make all
countries stronger. Europe as a whole has to become stronger.
Some say monetary policy should do more to solve the crisis. In my view central banks must
focus on price stability, must remain independent, and must not become too closely
intertwined with fiscal policy.
In the next part of my speech I would like to explain the reasoning behind my positions.
3. Solving the crisis - the national and the European level
Let us begin at the national level, in those countries that are at the centre of the crisis. There
we see several deficiencies, but I would like to point out two things in particular: high public
debt and a lack of competitiveness. In countries such as Greece, Portugal, Ireland and Italy
public debt stands well above 100% of GDP. And since the euro was introduced,
competitiveness has declined by 12% in Greece, by more than 14% in Spain and by more
than 8% in Italy.
These are the underlying problems; this is where we have to apply the medicine. And the
medicine of choice seems to be straightforward: governments have to consolidate public
finances and they have to embark on structural reforms to make their economies more
competitive. The ultimate goal, of course, is to strengthen the foundations for sustainable
growth and employment.
Allow me a few words on France at this point. France is the second largest economy in the
euro area. It is home to many renowned firms, it has a strong domestic market, and it has
favourable demographics - in particular when compared to Germany.
However, France also faces structural challenges. The unemployment rate stands at more
than 10%, its world market share of exports has declined by 25% since the beginning of
EMU and at around 90% of GDP public debt has reached a level that could potentially hurt
growth, according to some studies.
But France has acknowledged the importance of sound public finances and a competitive
economy. And with the "National Compact for Growth, Competitiveness and Jobs" the
government has laid the foundation for some very promising reforms. Furthermore, the social
partners agreed on labour market reforms at the beginning of this year. This could be an
important step toward achieving a better functioning labour market.
However, regarding fiscal consolidation, more challenges lie ahead. One of them is to meet
the commitments under the Excessive Deficit Procedure. According to the last projection by
the European Commission, France will not meet the deadline to reduce the deficit 2013 to
below the reference value of 3% of GDP. This has now posed the question of whether the
deadline should be postponed or not.
It is certainly true that it is more difficult to meet deficit targets in the context of weak
economic growth. However, in the current situation we need to recognise that we are faced
with a crisis of confidence. There has been a partial loss of confidence in our fiscal rules as
well as in the will of European countries to consolidate their public finances.
Moreover, there is the criticism that deficit targets may, in fact, become a moving target. In
such an environment it is in my view particularly important for the heavy weights in EMU to
give clear signals, which boost the credibility of the fiscal rules and agreements in EMU and
the credibility of their consolidation strategy.
But coming back to the countries at the centre of the crisis, both remedies, consolidation and
structural reforms, are hotly debated.
3.1. Consolidation vs growth
Regarding consolidation, many people fear that it will hurt growth. Hannes Swoboda, an
Austrian member of the European Parliament claimed that: "Austerity measures won't bring
people out of the crisis. It is like giving poison to a man or woman who is sick."
Personally, I tend to agree more with Christian Noyer. He said: "In the current circumstances
facing Europe, I believe these concerns are misplaced". I, too, believe that these concerns
are exaggerated. It is indeed likely that consolidation will have a short term dampening effect
on growth.
However, to quote Mario Draghi: "What's the alternative?" Putting consolidation off would just
shift the problem into the future. It would buy time but in so doing also worsen matters today
as there is the risk that trust in public finances would erode even more. Moreover, a
widespread lack of trust in public finances weighs heavily on growth. A study by Carmen Reinhart
and Kenneth Rogoff implies that debt levels above 90% will reduce growth.
I do not advocate a strict Ricardian view here. I do believe, however, that peoples' concerns
about increasing adjustment needs in the future will affect their spending and investment
today. Thus, it is important that governments adhere to the consolidation plans they
announced. This will inspire confidence, which is an important prerequisite for the economy
to grow. As Jean-Claude Trichet once said: "When you've lost confidence, when households
have no trust, when businesses have no trust, when savers have no trust, then the best way
to find growth and jobs is to recreate confidence."
In my view, this is true not just for the countries at the heart of the crisis. A failure to signal
the necessary commitment will not contribute to improving the confidence of investors and
consumers in the euro area.
Thus, my appeal for consolidation does not stem from a desire to punish past sins. Rather,
the goal is to make those countries at the heart of the crisis stronger. And if we adhere to our
fiscal rules there is no need to set up the ECB as lender of last resort let alone to call for
inflation as a solution for resolving the debt problem.
3.2. Regaining competitiveness
And the same is true with regard to the second problem I mentioned: the lack of
competitiveness in some member states. The most visible sign of this lack are current
account deficits. Countries such as Spain, Portugal and Greece imported more than they
could export and thus ran current account deficits. Other countries such as the Netherlands
and Germany have been running persistent current account surpluses.
In part, these imbalances are driven by fundamental characteristics of the respective
economies. For instance, countries with an ageing population naturally save more than they
invest domestically. Consequently, they run temporary current account surpluses.
However, to a large degree the imbalances we observe are driven by structural problems
and are not temporary but persistent. And a persistent current account deficit might become
a risk. The longer a country's current account is in deficit the more foreign liabilities this
country piles up. Eventually, these liabilities have to be paid back which might become
difficult if the inflowing capital is not invested wisely. Once the willingness or the ability to
repay comes into question capital flows might reverse. This is highly disruptive as spending
and investment would have to adjust abruptly.
Against this backdrop, current accounts in the euro area have to be rebalanced. Now, the
question is: which countries need to take measures? Those with a current account deficit?
Those with a surplus? Both?
The typical German answer would be this: the deficit countries must act. They must address
their structural weaknesses. They must become more competitive and they must increase
their exports. As a result, the deficits and surpluses would automatically adjust. In other
words: Current account positions are symmetric as regards economics statistics, but not
when it comes to macroeconomic risks. Thus, it is in the interest of deficit countries to adjust.
Naturally, this position has been challenged and a number of renowned economists take a
different view. Christine Lagarde of the IMF for example said: "Those with surpluses could do
a little something. It takes two to tango". Her suggestion implies that the adjustment of
current accounts should be shared between deficit countries and surplus countries. Those
with a surplus would become a little less competitive, while those with a deficit would become
a bit more competitive, and eventually they would meet in the middle.
Well, the question we have to ask ourselves at this point is: "Where would that take us?" For
two reasons I believe it would not take us very far. One reason relates to what would happen
inside the euro area, the other relates to the outside world.
Let us first consider the euro area. Imagine that wages in Germany were pushed up, causing
the economy to become less competitive. For the sake of argument, let us assume a wage
increase of two percentage points. That is, two percentage points on top of what unions and
employers would otherwise agree on.
This is the policy shift we fed into our economic models to calculate its effect on the current
accounts of deficit countries and on the German economy. According to our economic
models, GDP in Germany would decline by 3⁄4% and employment would decline by 1% while
the effect on the deficit countries would be close to zero. This sobering result is mainly due to
the structure of trade flows between Germany and Southern Europe.
After all, we have to acknowledge that Europe is not an island but part of a globalised world.
And at the global level, we are competing with economies such as the United States or
China. If Europe wants to succeed in this world it has to strive for global competitiveness.
The attempt to shield one European country from competition by lowering the
competitiveness of another makes all of us weaker.
Europe as a whole has to become more dynamic, more inventive and more productive. This
is not a new concept; it was already at the heart of the Lisbon strategy. And one thing we
have learned from the failure of this strategy is that commitments should always be binding.
Against this backdrop, the new Macroeconomic Imbalance Procedure is a step in the right
direction.
Nevertheless, in the end, competitiveness is always a relative concept. As the current
accounts of deficit countries begin to adjust, the current accounts of countries with surpluses
will automatically follow. This process is already well under way. Since its peak in 2007,
Germany's current account surplus vis-à-vis the rest of the euro area has about halved. And
looking ahead, we expect the surplus to decline further, provided confidence is restored. This
expectation is in line with what the IMF says in its latest World Economic Outlook.
So, yes, it takes two to tango and countries with surpluses are already on the dance floor.
However, it is the countries with deficits that will have to lead in this particular dance.
4. Solving the crisis - the role of monetary policy
Now that we have mentally entered the dance floor, let us see who else is dancing. Well,
monetary policy certainly is and there are many who would like to see it dance even more.
European politicians, in particular, have conveyed the impression that the ECB is the "last
man standing". Spanish foreign minister José Garcia-Margallo, for instance, claimed that
"only the central bank could put out the fire".
In my view, this is a misguided perception. The ECB is certainly not able to solve the crisis in
a sustainable manner. Earlier on, I talked about the fundamental problems within some
member states: high public debt and a lack of competitiveness. Add to that the weaknesses
in monetary union's institutional framework, and it becomes clear that monetary policy, or for
that matter, exchange rate policy cannot be the solution. These are structural problems that
require structural solutions.
The illness is more than the pain it inflicts and monetary policy is just a pain reliever at best.
Once the effect wears off, a higher dose becomes necessary - as we have seen throughout
the crisis.
Besides, monetary policy has already done a lot to contain the crisis. The ECB Governing
Council reduced interest rates to a mere 75 basis points, decided to provide banks with quasi
unlimited liquidity, and to intervene in bond markets. With all these measures the central
banks of the Eurosystem took on considerable risks, and they became involved in political
issues far beyond the traditional role of central banks.
As Stephen King wrote in the Financial Times: "Monetary policy is doing more to redistribute
income and wealth than to trigger a rebound in economic activity. Central bankers are
making decisions that are more political than economic". Indeed, the measures of the
Eurosystem have contributed to a redistribution among tax payers in different countries.
"Well", you might say, "this is a necessary act of solidarity and a healthy act of pragmatic
monetary policy". Don't get me wrong: I do not question the case for solidarity. My argument
is rather about the question of who decides about solidarity and what it means for the stability
of the single currency.
In my view, it has to be democratically elected parliaments who decide about redistributing
wealth or risks. Besides, we could run the risk of suffering from the tragedy of the commons
in which monetary policy would become a shared resource that would be overused. And this
is not just a theoretical consideration. It is something of practical relevance when it sets the
stage for a discussion about the independence of central banks.
And such a discussion has begun. Joseph Stiglitz recently claimed that: "The notion of the
desirability of an independent central bank was predicated on the belief that monetary policy
was a technocratic matter, with no distributional consequences." From this he concludes that:
"The crisis has called into question the notion of independence". Japan provides a real-life
example of a central bank that has come under political pressure.
I must admit that these developments worry me. They worry me because theoretical
considerations as well as historical experience contain one central message: Independence
and a focus on price stability are crucial for successful monetary policy.
Central banks should not find themselves dancing too closely with fiscal policy. To
paraphrase one of my predecessors: If you dance too close with fiscal policy she will marry
you. And the offspring are usually higher inflation and reduced fiscal discipline.
And here, I am not even referring to the German experience of the 1920s. We just have to
look back to the 1970s. In these years, inflation rates in countries with independent central
banks were comparatively low. While average inflation in Germany stood at 5%, it reached
as much as 14% in Italy and 15% in Spain.
Or think of the French experience of the late 1980s. In 1993 the Banque de France became
independent and Jean-Claude Trichet introduced his policy of the "Franc fort". Only then did
inflation rates decrease from an average of nearly 4% to less than 2%.
So, if we care about stable prices and if we care about purchasing power then we should be
worried. We should be worried because on the European dance floor monetary and fiscal
policy are moving toward each other. Think of Greece: while governments hesitated to
disburse the next tranche of loans, monetary policy stepped into the breach. Nevertheless,
we should not overburden monetary policy with the task of solving a crisis that it cannot solve
anyway. The price would be too high.
5. Conclusion
Ladies and gentlemen, I began my speech with a joke about how to change light-bulbs in
Europe. As you might know, traditional light-bulbs are increasingly being phased out in the
European Union. This is a sign of the changing times we are living in.
But not everything has to change. Proven concepts such as central bank independence
should be preserved. Nevertheless, the most important point of my speech is that we all
share the same objective: a prosperous European Union and a stable single currency. This is
what unites us and keeps us going.
And as I said in the beginning: Only together can France and Germany solve the current
crisis. And as the largest economies in Europe they already contribute significantly through
the rescue mechanisms. Stabilizing monetary union requires that both countries are
economically and politically strong.
But it also requires a common approach. A common approach that is suited to tackling the
underlying causes of the crisis. At the national level, this should include consolidation of
public finances and structural reforms. But that is certainly not enough.
We also have to improve the framework of monetary union. This includes reestablishing
market mechanisms and the liability of investors for their decisions at all levels: We need
mechanisms that allow banks to fail without triggering a systemic crisis - a well-designed
banking union would be a step in the right direction. We also need mechanisms that allow
states not to be bailed out without triggering a systemic crisis - this includes, for instance, the
introduction of capital requirements for government bonds and caps on banks' exposure
visà-vis single countries.
Thus, there are many challenges we have to master and many problems we have to solve.
This makes it necessary for us to share our ideas and discuss those issues where we have
different opinions. In my speech I have tried to shed some light on my ideas, now I'm looking
forward to discussing them with you.
Thank you for your attention.