Jens Weidmann: Monetary union - ever a work in progress? The
euro area torn between the Maastricht framework and fiscal union
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 21st RWI (Leibniz-Institut für
Wirtschaftsforschung) Economic Discussion, Essen, 29 November 2017.
* * *
1. Introduction
Ladies and gentlemen
Many a joker in his time has answered the question "How do I get to the philharmonic hall?" with
the punch line "Practice, practice, practice."
As my musical talent would certainly never have got me onto this stage, I am all the more grateful
to you, Mr Schmidt, for the opportunity to talk here today about current monetary policy and the
architecture of monetary union.
I will be discussing what needs to be done to make monetary union stable, and what role
monetary policy plays in this endeavour.
2. Congratulations to Wim Kösters
But first of all, I would like to say a few words about Professor Wim Kösters, who is retiring
today. It is a special honour to pay tribute to his long and successful career as an academic, an
academic manager and a supporter of young talent.
Mr Kösters, you have been a member of the RWI's Board of Directors since 2003 in your
function as an academic manager. It is partly down to you, then, that the RWI ranks among
Germany's foremost economic research and policy consulting institutions. The Leibniz
Association shared this view in its 2012 evaluation, hailing the work of five out of the RWI's six
research areas ratings as "good" to "excellent".
First-rate research and problem-driven policy consulting calls for well-trained and motivated
employees who are the brains and soul of any institution. But as we all know, that kind of talent
doesn't just spring up like mushrooms. Hence the particular importance of nurturing
up-andcoming talent - at the RWI, at the Bundesbank and at the many other enterprises and institutions
across Germany.
Bearing that in mind, Mr Kösters, it is greatly to your credit that you have done so much for so
many years to foster gifted students and doctorate candidates. You have been a member of the
board of the Cusanuswerk scholarship body's gifted education foundation since 2008, as well as
its chairman since 2011. Incidentally, there used to be long-standing ties between the
Cusanuswerk and the Bundesbank - you took over as chairman back then from Hans Tietmeyer,
the former president of the Deutsche Bundesbank. I've had the numbers checked: since you
became a member of the foundation's board, more than 3,000 students have been sponsored.
And at the RWI, too, you helped to create an environment in which the next generation of
academics can reach their full potential. The great many RWI employees who submit their PhD
thesis each year attest to your achievements.
And let's not forget the many academics trained personally by you, Mr Kösters, in your chair,
among them Professor Ansgar Belke, who will be taking part in the subsequent panel discussion.
That panel discussion will be discussing a topic to which you have devoted yourself as an
academic since the 1990s, and one which is close to my own heart: the prerequisites for making
monetary union a union of stability.
3. European integration
Ladies and gentlemen, even though today's event is essentially a gathering of economists, there
is one point which must not be forgotten when discussing monetary union: namely that the euro
was also a political project from the outset. As early as 1949, the French economist Jacques
Rueff declared that money would pave the way to European integration. In his own words:
"Europe will either be built on money or it won't be built at all."
The unification of Europe after the Second World War was a political vision intended to bring
lasting peace and stability to the continent. To put it in the words of Jean Monnet, the great
European and winner of the Charlemagne Prize, and whose name your chair, Mr Köster, also
bears: "By creating Europe, the Europeans are building a true foundation for peace."
Yet it was the integration of Europe's economies that was a major catalyst for European
unification. And this in itself has produced remarkable results. Economic integration - in other
words, the elimination of trade barriers and the harmonisation of regulations - boosts prosperity.
Free trade enables each of us to specialise in what we're best at. Economies of scale can be
harnessed more readily. Plus a bigger market results in greater competition. And this in turn
fosters innovative power and productivity.
It is, of course, impossible to say exactly how the economy would have fared in the absence of
European unification. The impact of the single market on the prosperity of European states,
however, has been considerable. It is estimated that European economic integration has boosted
1 2 3
annual economic output by between 5 and 25 per cent. That's a handsome 1,450 to 7,250
euro per capita.
There is no question that economic and monetary union was the boldest step towards deeper
economic integration. And at the same time, it was a twin promise: of price stability, and of
stronger long-term economic growth.
There is a broad consensus that EMU has so far succeeded in delivering on the first of those
promises. I dare say that significantly fewer people would claim that it has done likewise on the
second.
For one thing, mounting economic competition across borders has been driving change, just like
technological progress has, and many people are afraid of this. If the benefits not just of
economic integration but of innovation as well are to be felt by the greatest number of people, the
framework conditions also need to be right. Flexible economic structures and a good education
system, say, are prerequisites for sustainable growth and for ensuring that many people can
share in the opportunities offered by technological progress and international trade, for example.
For another thing, though, the financial and sovereign debt crisis shook the euro area to its core.
Taxpayers were forced to step in for billions upon billions of euro in bank losses. Joblessness in
some member states rocketed to levels hitherto unseen in the post-war era. To all intents and
purposes, European and global institutions became the ancillary government in individual
countries. And many saw the rescue packages as the first step on the road towards a transfer
union - something which had been categorically ruled out prior to the launch of monetary union.
Many perceived the problems instigated by the crisis to be huge. Some even thought them
irresolvable. Indeed, a number of commentators, particularly on the other side of the Atlantic, but
elsewhere, too, predicted that the euro would come crashing down.
That didn't happen - and it would have been a disaster if it had. At the same time, let's be honest
- the future might also hold regional or sectoral crises in store which put the euro area to the
test. The upbeat economic situation right now shouldn't blind us to the fact that it is one outcome
of a very accommodative monetary policy.
The low-interest-rate environment, then, is contributing to an air of deceptive calm which might
tempt economic and fiscal policy decision-makers to sit back and do nothing. But if a crisis does
materialise, the European house we live in today will need to be sufficiently strong to withstand
these headwinds. There is still much to do, if we are to make that a reality.
4. Ensuring the long-term stability of monetary union
One defining characteristic of European monetary union is that, while it has a common monetary
policy, it also encompasses 19 largely independent national fiscal and economic policies. This,
incidentally, is what makes European monetary union unlike other federal currency areas, such
as the United States or Switzerland.
This particular composition does not only make European monetary union unique, it also
potentially makes it vulnerable. As the crisis made clear, the euro area as a whole ultimately had
no option but to cushion unsound developments in individual member states in order to prevent
the stability of the entire monetary union from being jeopardised.
The underlying context is that, if you are not careful, membership in a monetary union
undermines the incentive to exercise fiscal prudence. This is because the consequences of
excessive debt in one member state can, to an extent, be passed on to the rest of the group.
Mr Kösters, you were not alone in flagging this incentive to run up debt inherent to monetary
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union early on. When a country in a monetary union takes on debt, the interest rate does not
rise quite as sharply as it would have if that country had its own currency. Instead, however, the
interest rates in all of the other member states rise slightly.
Economic theory calls this phenomenon the "common pool problem", and overfishing is often
used as an example to explain it. A single fisherman who catches too many fish leaves fewer
behind for others and ultimately jeopardises the long-term sustainability of fish stocks.
Overfishing, then, is detrimental to the fishing community. But, for an individual fisherman, it is
highly desirable to net as many fish as possible and not consider the interests of other or future
generations of fishermen.
This is arguably one reason why historian and winner of the 2017 Charlemagne Prize Timothy
Garton Ash described the story of monetary union so far as a "crisis foretold".
Yet that remark is not really entirely fair to the founding fathers of monetary union, who most
certainly did have their eye on the particular incentive to run up debt. Their idea was that a
combination of market discipline and fiscal rules would keep budgetary policymaking on a sound
basis.
As you know, the Maastricht Treaty contains a no-bailout clause prohibiting member states from
assuming each other's debts. The treaty also bans monetary financing of government debt by
the Eurosystem. Together, these safeguards aim to ensure that investors themselves - and not
other parties such as the taxpayer - bear the risks of investing in government bonds.
In addition, the Stability and Growth Pact includes rules to restrict government debt and budget
deficits. These aimed not only to ensure that public finances remain on a sustainable path, but
also to create the buffers needed to allow budgets to fluctuate over the economic cycle and to
enable member states to take countermeasures during economic crises without being forced to
call for external aid to fend off looming overindebtedness.
These rules form the principle of national fiscal responsibility. This is the foundation of the
Maastricht framework.
Walter Eucken, a founder of the Freiburg school and pioneer of the social market economy,
summed up this liability principle as follows: "Whoever reaps the benefits must also bear the
liability."
And what goes for the economy goes for countries as well: decisions will only ever be taken
responsibly if those who decide also bear responsibility for the consequences of their actions.
Thus, the Maastricht Treaty largely assigned the power to act and liability in matters of economic
and fiscal policy to the member states.
And yet, government debt in some euro area countries has risen significantly. One reason for
this is the repeated breaches of the budgetary rules - even by Germany, incidentally, at the very
beginning of monetary union. Capital markets, contrary to initial expectations, also did not punish
these infractions by imposing higher risk premiums. The no-bailout clause, it seemed, lacked
credibility.
But another reason for the ballooning debt levels was undoubtedly the financial crisis, which
forced euro area countries to shore up their banking systems. This was another reason why
doubts emerged over the sustainability of some member states' debt in the subsequent
sovereign debt crisis. Rescue measures were swiftly rolled out to prevent the crisis from
escalating.
This episode showed that it might be wise for the euro area, too, to have a lender of last resort to
support countries facing exceptional circumstances in order to limit the negative fallout for the
currency area as a whole.
Hence the establishment of a permanent safety net in the form of the European Stability
Mechanism (ESM). Its financial assistance allows distressed sovereigns to bridge temporary
liquidity bottlenecks and put government finances back on a sustainable footing. This is why
countries are required to commit to reforms so that they can put their finances back in order as
soon as possible.
However, not even the financial assistance programmes have made monetary union
crisisresistant for good. For all their benefits, they added further elements of mutual liability and
softened the principle of independent accountability. At the same time, economic and fiscal policy
remained a national matter. The balance between actions and liability for their consequences,
then, had got out of kilter.
The euro area will only ever be made crisis-proof once and for all if the balance between action
and liability is restored. There are two ways in which this can be achieved. Either through deeper
integration, ie a situation in which every member state surrenders decision-making powers in
fiscal and economic policy matters to the European level, or by returning to an overhauled
Maastricht framework. In the latter case, euro area countries would once again bear greater
liability for their own decisions.
The first solution is the road to fiscal union with centralised decision-making powers. Admittedly,
fiscal union would not guarantee fiscal prudence, and permanent guide rails would need to be
added as a matter of stability policy, though it could curb the aforementioned propensity to run
deficits.
This is why it was obvious to many economists, even before monetary union was launched, that,
in the long term, monetary union must go hand in hand with political union. One of those
economists was you, Mr Kösters. In 1994, you wrote: "It should first of all be clear that in the long
run the EMU can only exist if accompanied by a European Political Union." German Chancellor
Helmut Kohl held a similar view. Addressing the Bundestag in November 1991, he remarked that
"the idea of sustaining economic and monetary union over time without political union is a
fallacy".
True political union proved unfeasible back then, however. It seems to me that not much has
changed in this regard, not least because the necessary transfer of sovereign rights would
require comprehensive changes to the EU Treaty and national constitutions.
That would suggest that option number two currently stands a more realistic chance of restoring
the balance between actions and liability. It essentially means bolstering the principle of
independent national responsibility. Only when public finances are put on a sound footing and
countries stop drifting apart economically will the Eurosystem ultimately be relieved of the
pressure to constantly intervene as a firefighter. And only then will the financial markets do their
job of taking adequate account of risks in their lending activities.
But what would have to change for monetary union's regulatory framework to function better than
it has done in the past?
To paraphrase Johann Wolfgang von Goethe: "Easier said than done." Goethe was not just a
poet, but also finance minister for the Duchy of Saxe-Weimar-Eisenach. Whether or not this bon
mot summed up his experiences in fiscal policy is unclear, however.
In any case, his remark holds true for the fiscal rules in the euro area: established with the best
intentions, but rarely adhered to consistently. The European Union's budgetary and debt rules
have been reformed over and over again. But that did not make them any stricter, to put it mildly. I
have already mentioned that not even Germany set a shining example in the early days.
The latest reform of the Stability and Growth Pact originally set out to strengthen the binding force
of the rules on debt. As it turned out, that reform created considerable discretionary scope,
mainly for the European Commission. We also drew attention to this in our June Monthly
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Report. The Commission has already exploited this leeway on several occasions and invariably
interpreted the rules very liberally in doing so.
The Commission's dual role as the guardian of the EU Treaty on the one hand and as a political
institution on the other is undoubtedly a factor in the repeated compromises made at the expense
of budgetary discipline. After all, as a political institution, the Commission must always strive to
strike a balance between the various political interests of the member states. The outcome is
that individual euro area countries have breached the budgetary rules ever since the financial
crisis erupted.
Austrian comic Werner Schneyder once accurately characterised the situation as follows:
Europe, he quipped, is made up of countries that do not want to be told to do what they have
decided to do themselves.
4.1 Reinforce the binding effect of fiscal rules
What is needed to reinforce the binding effect of the fiscal rules is a straightforward and
transparent design and implementation of the rules. An independent institution taking over
responsibility for fiscal surveillance from the Commission would be a key step towards a less
political approach. That would be a clear marker where unbiased analysis ends and political
concessions begin. That is why one of the Bundesbank's suggestions is to strengthen the role of
the ESM in matters of fiscal surveillance.
One thing does seem obvious to me, however. If member states retain fiscal autonomy, the
sustainability of public finances cannot be safeguarded by rules alone.
This is why it is not just the binding force of the rules that we need to strengthen; we also need
the disciplining effect of the market, just as the founding fathers had envisaged of the monetary
union. In other words, interest rate levels have to be aligned more strongly again with the risks in
government budgets.
That can only be achieved, however, if the credibility of the no-bail-out clause in the Maastricht
Treaty is restored. Investors need to be under no illusion that they risk losing their money if they
buy bonds from governments that have unsound public finances.
This is another reason why I take a critical stance of the Eurosystem's government bond
purchases, because they weaken the market mechanism which prices sovereign solvency risk.
This ends up blurring the boundaries between monetary policy and fiscal policy. And yet a clear
division of responsibilities is vital for a stability-oriented monetary policy in the euro area if
Eurosystem central banks are not to wind up dancing to the tune of fiscal policymakers. This is
why I called for a quick end to government bond purchases at the end of October.
4.2 Automatic ESM maturity extension
And this is also why one of the proposals put forward by the Bundesbank envisages changing the
contractual terms for government bonds in the euro area. In future, the maturities of a country's
bonds ought to be automatically extended as soon as the country applies for financial
assistance.
Under the existing procedure, remember, a large part of the assistance loans go towards paying
off legacy creditors. This lets those legacy creditors, such as banks, off the hook - at the
expense of taxpayers. Extending maturities, on the other hand, would leave them on the hook,
and they could be still held liable if debt is restructured down the line. In an emergency, it can be
very difficult to tell for certain whether a debtor is temporarily illiquid or actually insolvent. An
automatic extension of maturities, however, would grant the ESM far more time to give careful
consideration to the question of debt sustainability - and without releasing legacy creditors from
liability during this period.
A maturity extension would have the added advantage of substantially reducing the need for
financial aid under an ESM programme. This would also broaden the reach of the existing rescue
mechanism. Had we already been able to automatically extend maturities by three years back in
2011, say, Portugal would have only needed around €43 billion by 2014 instead of the total of €76
billion it received in financial assistance.
I am also convinced that when it comes to resolving future crises in the euro area, the IMF will
arguably play a far less prominent role and could, at most, be involved in an advisory capacity.
So this increased clout would certainly be helpful.
Incidentally, the ESM stands for a substantial form of fiscal solidarity. ESM chief Klaus Regling
has said that an ESM loan costs two-thirds less than an IMF loan because the ESM - unlike the
IMF - does not charge a risk mark-up for its loans. In the case of Greece, for instance, the saving
comes to 5.6% p.a. of its GDP.
This is an major transfer to governments in need of assistance. But they are not permanent
transfers and they are tied to strict conditionality in order to eliminate as much moral hazard as
possible. Permanent direct transfers are not necessary in a functioning currency area, as the
United States demonstrates. Quite the opposite, in fact: dividing agents into transfer providers
and transfer recipients risks undermining public acceptance of monetary union in individual
member countries.
Ladies and gentlemen, the proposed automatic extension of maturities will only boost the
disciplinary role of capital markets if restructuring sovereign debt really is a realistic option. But
that will only ever be the case if the financial system really can absorb a haircut, because if a
haircut brought the financial system to its knees, the community of states would still have an
incentive to bail out private creditors.
Politicians and supervisory authorities in the euro area have, on more than one occasion, faced
the following paradoxical situation: a haircut for overindebted countries drags down the banking
system with it. But if banks carrying government bonds at risk of default on their books are
resolved, the necessary rescue measures will plunge the country into financial distress once and
for all.
This reminds me a little of the novel Catch-22 by Joseph Heller, in which a "catch-22" is an
intolerable situation where every apparent alternative only draws the protagonists ever closer
towards their fate. In Heller's novel, it's the contradictory rules that put the American soldiers into
an absurd situation.
In the euro area, it was primarily the lack of rules regarding this dilemma that was pivotal: there
was no rule which stated that, if the worst comes to the worst, it was mainly up to the investors
and creditors to shoulder banks' losses, and not taxpayers.
This is also precisely what makes the new European regime for bank resolution, and its rigorous
application, so very important. Because these are the rules which stipulate that if a bank needs to
be wound up, investors and creditors will be first in line to bear the ensuing losses. Only after that
does a resolution fund financed by banks step in.
Add to that the close-knit sovereign-bank nexus in the euro area, as evidenced by the huge
stocks of government bonds which banks hold on their balance sheets. This is why it is not
enough to just focus on bank resolution.
4.3 Abolish preferential treatment of sovereign bonds
It would be enough to curb banks' appetite for government bonds to force them to treat sovereign
exposures on their books in exactly the same way as private ones.
Because, unlike in the case of corporate bonds, banks are not required to back government
bonds denominated in domestic currency with capital, nor do they have to comply with any
ceilings or caps. This is the case irrespective of the issuing sovereign's credit rating quality - and
even though the euro area debt crisis made it quite plain that government bonds are by no
means risk-free.
Only when banks hold sufficient capital against government bonds and limits are placed on the
size of individual exposures will banks be able to cushion a restructuring of sovereign debt. And
only then will there probably be the political will needed to take this step.
The Bundesbank has put the topic of abolishing the preferential treatment of government bonds
on the agendas of international committees. But the talks, particularly on the Basel Committee on
Banking Supervision, are not straightforward. That's why it's now vital that we give the issue
greater prominence on the European committees and make headway there.
Ladies and gentlemen, toughening the fiscal rules, abolishing the preferential treatment afforded
to government bonds, and automatically extending the maturity of sovereign debt are three
important reforms. They can play a part in putting monetary union on a sound long-term footing.
These proposals put the shine back on the principle of individual fiscal responsibility - which is
the key feature of the Maastricht framework.
At the end of the day, any proposals on the future direction of monetary union need to be
assessed according to how they impact on the necessary alignment between actions and
liability.
In a recent speech which garnered a great deal of attention, French President Emmanuel Macron
put forward his vision for advancing the European project, suggesting that more policy areas
could be communitised - that is, transferred to Brussels and thus funded jointly.
Such proposals are no substitute for strengthening individual national responsibility in the euro
area. Nor, by the same token, do they have to be at odds with the principle of individual
responsibility. Indeed, it is quite possible that issues like preventing climate change, securing
external borders and developing common communications, energy and transport networks can
be handled more efficiently at the European rather than national level.
5. Monetary policy
Ladies and gentlemen
One policy area that we all know has long been dealt with collectively at a euro area level is
monetary policy. And, as far as monetary policy is concerned, I can kick off the last part of my
speech with some good news. The euro area is experiencing an ever more robust economic
upturn which has continued unabated over 17 quarters and spread to all euro area countries.
And this trend looks set to continue for a while yet. In September the ECB's economists raised
their forecasts for 2017 economic growth to 2.2%. And they are anticipating growth rates of
around 2% for the next two years as well.
An updated forecast will be released in two weeks' time, as is customary in December, and that
will be based on detailed country projections. At the moment, there is good reason to believe that
the economic outlook will be just as upbeat then, if not even better. At the very least, several
short-term indicators have made for surprisingly positive reading.
And the economic situation in Germany is looking exceptionally good, too. Employment levels are
at their highest since reunification, business and consumer sentiment is splendid, and the Ifo
business climate index has even hit a new record high. And, going by the latest economic
indicators we have received, the difficulties Germany is experiencing in forming a government
are showing no signs of markedly dampening the mood.
The economic recovery we're seeing in Germany and in the euro area is benefiting in part from
the Eurosystem's exceptionally accommodative monetary policy. This monetary policy stance
was the ECB Governing Council's response to the subdued inflation outlook.
One of the reasons behind the muted rate of price inflation is that some euro area countries are
still in the process of remedying the loss of competitiveness which played a role in triggering the
euro area crisis. But improving price competitiveness generally also means greater wage
moderation.
The ECB Governing Council initially responded to the weak price pressures by cutting its policy
rates. Once it had cut its rates to 0%, it then started to roll out a host of non-standard measures
in an effort to loosen up monetary policy still further.
Since March 2015, these measures have included the Eurosystem's large-scale purchases of
sovereign and corporate assets, currently at a monthly pace of €60 billion per month. From
January this will fall to €30 billion a month - with purchases continuing until September 2018, if
not longer. As you know, these purchases have been hotly debated, particularly in Germany. And
you are no doubt also aware that I myself view these purchases with scepticism, too.
The Eurosystem has now become the largest creditor of the euro area countries. This means
that governments' financing conditions hinge much more directly on our actions than in times of
normal monetary policy. My concern, therefore, is that the ECB Governing Council could end up
facing political pressure to keep rates low for longer than is justifiable from a strictly monetary
policy perspective.
Ladies and gentlemen, my reading of the ECB's projections, however, is that domestic price
pressures in the euro area are gradually building and that the projected path is quite consistent
with our definition of price stability.
For if there is one thing that is clear, it's that even after net purchases have been discontinued,
euro area monetary policy will remain highly accommodative.
October's monetary policy decisions even mean that our foot is still on the accelerator as far as
monetary policy is concerned, just not quite so hard as before. Given the favourable economic
outlook and the pick-up in prices, a somewhat less accommodative monetary policy stance
would also have been justifiable, in my view.
6. Conclusion
Ladies and gentlemen
I've spoken a lot today about how the euro area is managed - its institutional order - and about
monetary policy. On the subject of order, the physicist Georg Christoph Lichtenberg once said
that "order leads to all virtues, but what is it that leads to order?" Today, I've endeavoured to
make the answer clear in the context of the euro area, with the help of various reference points.
In essence, the solution lies in ensuring alignment - though since we are in a philharmonic hall,
perhaps I should say harmony - between actions and liability. In debates about the future of
monetary union I will make sure that this fundamental harmony is not forgotten.
Ladies and gentlemen, I hope you have a stimulating panel discussion. And to you, Mr Kösters,
may I wish you all the very best for your upcoming retirement.
Thank you.
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Boltho, Andrea and Barry Eichengreen (2008), "The economic impact of European integration", CEPR
Discussion Paper No 6820.
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W Kösters (1996) Stability culture as a precondition for the sustainability of the European monetary union (EMU).
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W Kösters (1994). Comments on "European monetary union: sovereignty and hegemony" by Norbert Kloten. In
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Deutsche Bundesbank (2017), Design and implementation of the European fiscal rules, Monthly Report, June
2017, pp 29-44.