Jens Weidmann: Keynote speech - "Europe into a new era - how
to seize the opportunities"
Keynote speech by Dr Jens Weidmann, President of the Deutsche Bundesbank and Chairman
of the Board of Directors of the Bank for International Settlements, at the Frankfurt European
Banking Congress "Europe into a New Era - How to Seize the Opportunities", Frankfurt am Main,
17 November 2017.
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1. Introduction
Ladies and gentlemen
Central bank communication can certainly be tricky. That is why Bank of Japan Governor
Haruhiko Kuroda said three days ago, during an ECB conference on this very issue, that the
message needs to be simple. "It should better be straightforward," he told the audience. "That's
the best way."
As was also alluded to at the conference by moderator David Wessel, there might now be a new
option that would allow Governor Kuroda to be taken at face value - in the truest sense of the
word.
Artificial intelligence researchers claim to have found clues in the facial expressions of the Bank
of Japan Governor. Supposedly, Kuroda showed "fleeting signs of 'anger' and 'disgust'" at news
conferences that preceded changes in monetary policy in 2016.
This raises important questions: Can we now make monetary policy changes with the blink of an
eye? And will botox injections be the only way to uphold the maxim "we never pre-commit?"
On a more serious note: Artificial intelligence is a fascinating subject, with wide-ranging
implications not least for economics and finance. But today I will confine myself to more everyday
matters for a central banker - matters which definitely also have wide-ranging implications for
our monetary union.
"Restoring the European project", the title of the upcoming panel, calls for policymakers to live up
to their respective responsibilities. What is required of monetary policy, national governments,
and European institutions? In the next 15 minutes, I will try to briefly sketch out some possible
answers to this question.
2. Monetary policy
Let me start by having a short look at the Eurosystem's monetary policy.
The Eurosystem's expansive monetary policy has contributed significantly to the recovery in the
euro area. Growth rates have been positive for more than four years. The unemployment rate
has almost been reduced to its pre-crisis average. And economic indicators all point to a
continued economic up-swing.
In Germany, indicators now suggest even stronger growth than outlined in our June projection.
Over the last four years, capacity utilisation has steadily increased. And since 2016, the
economy is even running above capacity. The duration and strength of the current recovery is
impressive, especially against the background of high political uncertainty globally.
Inflation, however, has not quite kept pace with the recovery. Price pressures are expected to
remain rather subdued.
Multiple factors seem to be at play here. The recovery has certainly been aided by the fact that
most of the crisis-hit countries have strengthened their competitiveness and turned their current
account deficits into surpluses. But improving price competitiveness through wage restraint is,
naturally enough, also dampening domestic price pressures.
This factor is euro area-specific. But price pressures have been subdued in other countries, too,
in spite of very low unemployment rates. It seems that global factors are affecting inflation as
well. Research at the Bank for International Settlements suggests, for example, that greater
labour market contestability as a result of global value chains are putting a lid on wages and thus
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price pressures.
Given the rather subdued inflationary pressure at present, an accommodative monetary policy
stance remains appropriate in the euro area. But we must be attuned to the fact that the
economic recovery has progressed further than inflation figures currently suggest, and that
domestic price pressures will gradually increase in keeping with a path towards our definition of
price stability.
This is why, in my view, a less distinct loosening of monetary policy in the next year and setting a
clear end date for net asset purchases would have been justified - also against the backdrop of
increasing risks and side-effects, the longer monetary policy remains ultra-loose.
Euro-area monetary policy will remain highly accommodative even after net purchases under the
asset purchase programme (APP) have been discontinued.
First, what is crucial for the overall effect of the APP is not so much the amount of monthly
additional purchases but, above all, the total outstanding volume of sovereign bonds on our
books. And the APP stocks held by the Eurosystem will remain at a very high level even after net
purchases have been discontinued, as the Governing Council of the ECB has decided to reinvest
the proceeds from the maturing bonds.
Second, the Governing Council has decided not to raise interest rates until well after the net
purchases have ended.
Setting a clear end date to net asset purchases would have merely meant refraining from
pushing down on the accelerator even further - not putting the brakes on monetary policy.
One thing has to be clear in any case: As Mario Draghi has pointed out: Monetary policy alone
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cannot bring lasting prosperity for our economies. That is the task of governments and
parliaments.
3. Economic challenges in Germany
In the wake of the sovereign debt crisis, many member states indeed introduced far-reaching
reforms which allowed swifter macroeconomic adjustment. Some of them led to a better labour
market performance. And some improved competition, thus providing new impetus for
innovation.
But more measures are needed, not least in Germany. The challenges Germany faces might
seem more latent than those of other member states. But even if the consequences of an aging
society might present themselves less abruptly than a sovereign debt crisis, the challenge is no
less real. Without policy action, Germany's growth potential is expected to fall below 1% within
the next decade due to the reduction in labour supply.
It would therefore be sensible to modify provisions that discourage participation in the labour
market. To further support the participation especially of women in the workforce, continued
investments in childcare remain imperative as well.
However, Germany's growth potential cannot be strengthened simply by limiting the losses in
labour supply. Germany's economy also has to become more productive.
Here, digitalisation holds untapped potential. Studies show that removing bottlenecks in
broadband connection can raise economic growth, as this increases competition and induces
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innovative products and processes.
To be able to fully capitalise on the digital dividend, investments in skills and education are key.
This would not only boost labour productivity, but also enhance job security. And this, in turn,
would in my view be the most effective antidote to the feeling many have of being threatened by
globalisation and technological progress, both of which are at the root of our economic
prosperity.
By the way, even within the European Union there is not yet a common market for digital
products and the single market for services still has to be completed.
4. Strengthening the euro area's resilience
Facing economic challenges head-on will not only prove a boon to citizens' prosperity: it will also
raise the equilibrium real interest rate. And this will make the job of a central bank substantially
easier, as it adds distance to the lower bound of interest rates.
But while raising growth potential in Germany and the other member states will go a long way
towards strengthening the euro area, it is not the last word in making our monetary union more
resilient.
When it comes to resilience, the question of risk sharing has to be addressed. How can shocks
that hit individual member states particularly hard be cushioned?
In the United States and other large currency areas, shocks are spread through the distribution of
business profits and losses throughout the currency area, because company owners are often
resident in other states. The sharing of losses across state borders in the United States absorbs
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around 40% of an economic shock.
Saving and lending could represent another channel of private economic risk sharing.
Enterprises and households take out loans in different US states during an economic downturn
to bridge a slump in earnings. In the United States, this type of risk sharing smoothes something
like 25% of a shock. To some extent, this includes a contribution of the Federal Deposit
Insurance Corporation to this form of risk sharing. In Europe, however, the conditions for putting
in place a similar euro-area-wide deposit insurance mechanism are not yet met. I will come back
to this point in a few moments.
By comparison, risk sharing through fiscal policy takes a back seat. Only between 10% and 25%
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of all risks are shared by a common fiscal policy in federations like the US or Canada.
It is thus clear that much could be achieved in the euro area if cross-border corporate funding
were strengthened, particularly in the form of equity capital.
A raft of measures would be needed to tear down the walls in European capital markets.
Standardising national insolvency regimes is just one especially important step worth mentioning.
After all, investors need to count on having the same level playing field throughout Europe. Not
only would that promote private risk sharing; it would also reduce capital flows into less
productive businesses and stimulate flows in more productive ones. That, in turn, would boost
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economic momentum, as a recent OECDresearch paper confirms.
On a general note, the development of equity capital markets, including in Europe, is suffering
from the preferential tax treatment given to debt over equity capital.
Interest payments can be deducted from taxable income; equity costs cannot. Eliminating this
bias would encourage businesses to make greater use of equity capital as a funding instrument.
And that would facilitate greater private risk sharing whilst at the same time reducing the debt
bias.
Another way in which risk could potentially be shared in times of crisis might be for enterprises
and households to take out cross-border loans. Yet this mechanism hardly worked during the
crisis in the euro area. Even worse: Depositors in crisis-hit countries lost confidence in their
domestic banking systems and withdrew their deposits. Banks in the euro area also lost
confidence in each other and reined in their lending.
The Banking Union was created in part to overcome the financial fragmentation triggered by the
sovereign debt crisis. With its Single Supervisory Mechanism and rules on bailing-in creditors in
the event of bank failures, the Banking Union bolsters the banking sector's resilience. This makes
a loss of confidence in national banking systems less likely. And less danger of a fragmented
financial system stabilises cross-border lending, particularly in turbulent times.
A common European deposit guarantee scheme could, in theory, even heighten this confidence.
However, as with any insurance policy, one would have to make sure in this case, too, that the
insurance does not encourage imprudent behaviour.
Such risks can arise from carelessly granting credit to the private sector. But they can also result
from providing sovereigns with too much credit. Since the onset of the sovereign debt crisis, at
the latest, we know that loans to general government are not risk-free either.
Banks in the euro area have a sizable share of sovereign bonds on their books. To insure
euroarea bank risks in such a situation would be tantamount to insuring fiscal risks.
Given that the member states themselves still decide freely and independently on the level of
government expenditure and taxes, this ultimately sets the wrong incentives: finance ministers
would see less of a need to pay adequate attention to the sustainability of public finances.
The precondition for a European deposit insurance scheme, then, is that the size of government
bond portfolios that banks hold on their books is limited. Loans to sovereigns should not be
treated any differently from loans to enterprises or individuals.
Another precondition concerns the stock of non-performing loans in the European banking
system. Insurance usually covers future damage, not damage that already exists. Hence, in
order to be eligible for a common deposit insurance, banks in the euro area have to either fully
provision for non-performing loans or divest them.
Non-performing loans not only constitute an obstacle to a common deposit insurance scheme.
They also weigh on financing conditions and, ultimately, growth prospects in the member states
concerned. Banks need to clear up existing non-performing loans. And we need to establish
rules that ensure the prudent management of non-performing loans in the future as well. The
proposals that were recently made by the ECB in this regard strike me as a sensible way
forward.
5. Conclusion
Ladies and gentlemen
Let me conclude.
After all, I would not want to evoke the feelings that a doctor once gave to a patient who craved
immortality.
The doctor informed the patient that immortality was beyond the reach of medicine, but the
patient was insistent: "Is there nothing I can do?" The doctor replied: "Well, there is one thing.
You could marry an economist and move to North Dakota." "And that will make me
immortal?" "No. But that way, even six months will seem like an eternity."
I thank you for your attention and wish you all a stimulating discussion.
1
Auer, R, C Borio and A Filardo (2017), "The globalisation of inflation: the growing importance of global value
chains," BISWorking Papers 602, Bank for International Settlements.
2
Draghi, M (2015), "Monetary policy and structural reforms in the euro area", Speech from 14 December 2015
3
Czernich et al (2011), Broadband infrastructure and economic growth, Economic Journal Vol 121.
4
Asdrubali, P, B E Sørensen, and O Yosha, "Channels of Interstate Risk Sharing: US 1963-1990", in Quarterly
Journal of Economics, 111(4), 1996, pp 1081-1110.
5
Allard, C, P K Brooks, J C Bluedorn, F Bornhorst, K Christopherson, F Ohnsorge, T Poghosyan and an IMF staff
team (2013), "Towards a Fiscal Union for the Euro Area", IMFStaff Discussion Note, 13/09.
6
Adalet McGowan, M and D Andrews (2016), "Insolvency Regimes and Productivity Growth: A Framework for
Analysis", OECD Economics Department Working Papers No 1309.
7
German Council of Economic Experts (2017), "Towards a future-oriented economic policy".