Jens Weidmann: Containing the sovereign debt crisis - Germany's role
and contribution
Special address by Dr Jens Weidmann, President of the Deutsche Bundesbank, at the
HighLevel Public-Private Sector Conference, G-20 Agenda under the Mexican Chairmanship,
Mexico City, 24 February 2012.
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1. Introduction
Ladies and gentlemen
First of all, I would like to thank Secretary José-Antonio Meade, Governor Agustín Carstens
and Managing Director Charles Dallara for the invitation to deliver a speech to such a
distinguished audience.
It is the second time since 2003 that Mexico has hosted the G20. A lot has changed since
then, however. Emerging market economies, including Mexico, have significantly increased
their weight in the world economy. At the same time, the role and the standing of the G20
have also changed appreciably. The G20's upgrade among the global fora is partly due to
the worst financial and economic crisis in decades, which hit the world economy in autumn
2008.
Although this crisis largely originated in the advanced economies, it may also have significant
implications for emerging market economies. For example, low interest rates in advanced
economies can swell capital flows to emerging market economies, while distressed banks
may curtail their cross-border investment. Moreover, an economic slump in the advanced
economies squeezes emerging countries' export chances.
Mexico has assumed the G20 chairmanship at a time when the financial crisis, and in
particular the sovereign debt crisis in the euro area, are putting a severe strain on global
growth. Progress on the G20 agenda could contribute significantly to avoiding another global
recession and to promoting sustainable global growth. I am very confident that the Mexican
authorities will make this a successful presidency and I am looking forward to attending the
G20 meetings during the Mexican chairmanship.
I would like to focus my remarks on what is currently still the most severe risk for global
growth, namely the euro-area sovereign debt crisis. In particular, I would like to say
something about the specifics of EMU - Europe's economic and monetary union - and the
role of the euro area's major economic player Germany.
Let me start by correcting a popular misconception about Germany, namely the mistaken
view that Germany, while itself managing to dodge the flames of the current crisis, is now
selfishly refusing to come to the aid of the stricken countries by acting as chief firefighter.
Let us take a look at the facts. First, Germany is doing a great deal to help its partners. Thus
the bulk of the containment measures rely heavily on Germany's financial support and hence
its economic strength and fiscal soundness. Second, Germany is acutely aware of the need
to tackle the root causes and not just the symptoms of the crisis. This is why it is pressing
strongly for institutional reforms of the EMU framework plus structural reforms and budgetary
discipline in the member states. By advocating this approach, Germany is not trying to force
its own economic philosophy on others, but rather is living up to its responsibility to ensure a
stable and sustainable monetary union.
2. The unique features driving the crisis - the specifics of EMU
Why is it that the euro area is suffering from a sovereign debt crisis while other big
economies are not? The answer to that question lies in the specific features of EMU, which
are also the key to understanding the current problems of the euro area. Weighted by GDP,
the euro area as a whole is less indebted than the United States, and even Greece is less
indebted than Japan. So what are the specifics of EMU that explain the difference?
The introduction of the euro eliminated exchange rate risks. This opened the way to welfare
gains from stronger economic and financial integration. You pay with the same currency, no
matter whether you are in Dublin, Helsinki, Lisbon or Rome. More importantly, the euro has
proved to be a very stable currency - with a strong exchange rate and an annual inflation
rate of about 2 % since its introduction.
But while enjoying the upside of a common currency and low inflation, the euro-area member
states also have to contend with the downside that they can no longer offset lost
competitiveness by depreciating. Instead, they need to adjust in real terms. And "to adjust in
real terms" is a very technical description of what is usually a very painful process involving
lower nominal wage growth or even nominal wage cuts. Another implication of the euro
area's single monetary policy is that the key interest rates are set for the currency bloc as a
whole. If this one-size-fits-all monetary policy poses problems in a particular member state, it
must make compensatory adjustments in other policy fields. Otherwise macroeconomic
divergences may arise. Looming credit bubbles, for example, have to be curbed by
macroprudential measures or a more countercyclical fiscal policy.
Unlike the centralised monetary policy, fiscal policy and economic policy remained
decentralised when EMU was launched. This, alongside the single monetary policy, is the
key feature of EMU. Hence, even though member states are closely interlinked through the
single market, trade and their financial systems, they nonetheless retain national autonomy
over their fiscal policy and economic policy.
This combination of a single centralised monetary policy and a plurality of decentralised fiscal
policies harbours some potential risks. Some of them were foreseeable from the start. One
risk is the temptation for governments to overborrow because the economic costs of
excessive public debt, for example higher interest rates, can be more easily shifted to other
member states. A resulting loosening of fiscal discipline in individual member states can
endanger the stability-oriented monetary policy. This potential problem can be greatly
magnified by the possibility of shifting burdens between taxpayers of different member states
via central bank balance sheets - without an explicit mandate from national legislators. This
is an important difference compared with non-EMU central banks that have used their
balance sheets as a policy instrument.
The forward-looking institutional safeguards put in place by the monetary union's founding
fathers were laid down in the Maastricht Treaty and the Stability and Growth Pact (SGP). The
Maastricht Treaty prohibits monetary financing and central bank lending to the public sector,
stipulates a no-bail-out clause and spells out fiscal rules regarding deficit and debt ceilings.
The respective excessive deficit procedures, including financial sanctions, are specified in
the SGP. Moreover, it was expected that these formal checks would be reinforced by market
pressure that would be sufficiently strong to discipline national governments.
However, the markets apparently did not fully believe in the enforceability of the no-bail-out
rule, and they also disregarded the lingering risks in the member states. Therefore, the
markets did not properly perform their expected policing function. Furthermore, the SGP
rules were not taken seriously enough. Even Germany ran up excessive deficits for a few
years and, even worse, championed a reform of the SGP which ultimately further weakened
the application of the fiscal rules.
However, the EMU framework not only failed to avoid excessive deficits, it was also unable
to prevent the build-up of macroeconomic imbalances within the euro area. In some member
states, the sharp drop in interest rates after joining the euro was not used to increase
productive capacities but instead was mis-used to fuel public and private consumption or
domestic housing bubbles. The resulting increase in domestic inflation and wages eroded the
competitiveness of the countries concerned and increased their dependence on capital
imports. Furthermore, the institutional set-up turned a blind eye to increasing risks in the
banking systems of some member states - the latter problem, of course, was not unique to
EMU.
3. How the crisis started
The lax application of the fiscal rules by several member states meant that they entered the
financial crisis with their public finances in bad shape, including large debt levels and high
structural deficits. Investors now started to pay greater attention to persistent current account
deficits and financial sector instability, and so they began to question the sustainability of the
respective countries' public finances, focusing first and foremost on Greece.
Germany, by contrast, had taken a different path prior to the crisis. Structural reforms, in
particular of the labour market, moderate wage agreements, the transition to a more flexible
application of collective bargaining legislation and a clean-up of firms' balance sheets helped
to restore the competitiveness of German companies. Putting this development into
perspective, it should be borne in mind that the German economy had lost a lot of its
competitiveness following the reunification boom in the early 1990s. Consequently, Germany
was regarded as the "sick man of Europe" during the first few years after the introduction of
the euro, given its poor growth performance and continuously rising unemployment.
The task of implementing the reforms and regaining competitiveness entailed significant
political and social costs. However, these efforts, supported by a strong expansion in the
global economy, allowed German growth to rebound after 2005. The country's strong
economic performance helped to consolidate public finances. In 2007, Germany's general
government budget was balanced, and unemployment had already fallen significantly. The
German economy's high exposure to external demand made it vulnerable to the global
demand shock of 2008-09. Nevertheless, the economy recovered very quickly from what
proved to be the worst recession in post-war history, unemployment is still falling and
employment has reached a post-unification high. Moreover, the negative impact of the
sovereign debt crisis on the German economy seems to be rather limited so far. The upswing
has become less dependent on external demand, while domestic growth drivers have gained
in importance. Thus, a key lesson that Germany has learned from the past decade is that
ambitious structural reforms to tackle entrenched domestic problems may be costly at first,
but ultimately they pay off.
Although the German economy has lost momentum over the past few months, we expect
GDP growth to pick up soon. This expectation is, of course, predicated on the assumption
that the sovereign debt crisis will be overcome step by step and will not further intensify. So
what has to be done to overcome the crisis?
4. Containing the crisis
When the sovereign debt crisis first emerged in Greece at the beginning of 2010,
policymakers reacted swiftly with fiscal rescue packages and unconventional monetary policy
measures. Alas, nearly two years on, the crisis is still with us and has even intensified. It has
now spilled over from Greece to other countries. With regard to Greece, some progress has
been made during recent weeks. Let me say that I fundamentally welcome the fact that the
euro-area finance ministers came to an agreement on Monday regarding a second financial
assistance programme for Greece. In order to achieve a turnaround and allow further
assistance, it is now essential for Greece to deliver on the promises that have been made.
Ultimately, Greece cannot be forced to comply with the programme. But it should be clear
that no further disbursements will be warranted if Greece fails to keep its side of the bargain.
A crucial requirement now is to prepare for the eventuality of a further escalation of the crisis
by initiating appropriate ring-fencing measures.
The resilience of the banking system is to be increased by imposing additional capital
buffers. The required size of these buffers has been determined through a stress test
conducted by the European Banking Authority (EBA). It is now up to the banks, where
necessary with the assistance of national government support schemes, to meet these
requirements by the middle of the year.
Policymakers have responded by devising comprehensive measures to make the euro area
less vulnerable. These measures include strengthening the European rescue mechanisms. It
has been decided that the EFSF and the ESM will have a combined lending capacity of
500 billion euros. In March, euro-area political leaders will assess whether it is necessary to
increase this firepower even further. Whatever the outcome is, a disproportionately large
share of the financing of these rescue mechanisms is being and will continue to be borne by
Germany by virtue of the country's top rating and the high degree of confidence it enjoys
among investors.
The IMF has played an important role since the onset of the sovereign debt crisis - by
co-funding assistance programmes, but also by contributing to a thorough analysis of the
root causes of the economic weaknesses in the programme countries. EU finance ministers
committed in December 2011 to providing additional resources for the IMF as part of a
broader international effort. In this context and assuming that there is appropriate
parliamentary support, the Deutsche Bundesbank, which manages the German contributions
to the IMF, has pledged a new bilateral credit line of 41.5 billion euros to go to the IMF's
General Resources Account. Hence, these resources will be available to all IMF members. In
order not to violate the legal framework of EMU, the resources provided to the Fund must
have all the characteristics of a reserve instrument. In particular, the IMF must not become a
vehicle for monetary financing of government deficits.
Another issue that has been discussed in the context of ring-fencing is a stronger role for the
Eurosystem in crisis management. However, this demand ignores the fact that the
Eurosystem has already greatly contributed to containing the crisis via its various
unconventional monetary measures. This has already stretched central banks' mandate
significantly, and going even further would undermine the credibility of monetary policy. I do
not need to tell you that jeopardising the credibility of monetary policy will do absolutely
nothing to preserve the stability of the euro.
This leads to a more general point. The crisis cannot be resolved solely by throwing money
at it. While money can buy us time to tackle the crisis, it is imperative that we use that time in
order to address its root causes. This approach is, by the way, fully in line with one of the
priorities defined by the Mexican G20 presidency: "Economic stabilization and structural
reforms as foundations for growth and employment".
Regarding the situation in the euro area, three things have to be done. First, the member
states have to restore confidence through fiscal consolidation. This is unavoidable and, given
the dire state of public finances, less contractionary than is often assumed. Conversely,
criticising the German authorities for not using their alleged "fiscal space" is quite
inappropriate. Since the spill-over effects of German fiscal policy on the peripheral countries
of the euro area are quite limited, the benefits would be much smaller than the harm of
compromising the consolidation course.
Second, some member states have to boost their competitiveness and their potential for
growth through structural reforms. In this regard, we have seen some promising signs during
recent weeks. Third, we need rules ensuring stricter fiscal discipline in the future. Some
progress has been made with recent amendments to the SGP, the so called "six pack", and
the fiscal compact. But given past experience, rigorous implementation of the new rules is
crucial. Germany has set an example by introducing a national debt brake in 2009. It now
has to set an example by actually sticking to these new rules.
Finally, we have to further increase the resilience of the financial system. This is surely one
of the global lessons we have learned from the financial crisis, but it is especially important in
the context of the euro area, where contagion spread primarily through the financial system.
Therefore, it is essential to ensure that agreed financial reforms are implemented rigorously,
in a timely manner and in a way which promotes consistent results. We must not lose
momentum in completing the first round of financial regulatory reform since the start of the
financial crisis, and I am glad that this is one of the priorities of the Mexican G20 presidency.
It goes without saying, however, that financial regulatory reforms will - by their very nature -
never be definitive or conclusive.
5. Conclusion
Ladies and gentlemen, let me sum up the main points of my speech. I talked about two
peculiarities of EMU that contributed to the sovereign debt crisis - the most important one
being the combination of a single monetary policy and national fiscal policies.
I argued that higher "walls of money" can buy time, but that time must be used to tackle the
roots of the crisis. This includes consolidation of public finances, structural reforms and better
rules at the European level. Germany has been a stability anchor in containing the crisis by
supporting the various rescue mechanisms, but the conviction that tackling the structural
causes of the crisis is both indispensable and holds out the promise of success has been the
essence of the German position throughout the crisis.
In this regard, we have seen some progress over recent months. Nevertheless, success
depends on rigorous implementation of the agreed measures and rules. Personally, I am
confident that, by following this course, we will eventually contain the crisis and that the euro
will remain a stable currency.