Jens Weidmann: The future of the European monetary 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 IHK Rhein-Neckar New Year's
Reception, Mannheim, 31 January 2019.
* * *
1 Introduction
Mr Schnabel,
Mr von Pentz,
Ladies and gentlemen,
Many thanks for your invitation and your kind welcome.
Tradition has it that speeches at new year's receptions look ahead at the topics we will be facing
over the coming twelve months. And the speech I will be delivering here today is no exception.
But before I look forward towards what the future might hold, let me reflect briefly on an event
which took place almost 50 years ago to the day.
It was on 30 January 1969, to be precise. What I would give to have been strolling down London's
Savile Row during my lunch break on what was, like today, a chilly Thursday. Passers-by could
hardly believe their ears. Music was blaring from the rooftop of house number 3. But it wasn't just
1
any old music - it was the Beatles, and they were playing live .
By this point in their career, the Beatles hadn't given a live concert for more than two years,
having decided to concentrate on their work in the studio. Recordings for the Fab Four's latest
LP, which would later be released under the title Let It Be, were being videotaped, and the
highlight of the documentary was to be a live concert at a spectacular location. But the band
ended up simply performing a concert on the roof of their headquarters.
What no-one suspected at the time was that it would be the last time the Beatles ever performed
live. 50 years ago, then, saw the end of a musical era that we still hold dear today. And that's why
the Beatles will pop up at various points during my speech here today.
At first glance, the Fab Four wouldn't immediately appear to have all that much in common with
central bank topics. That said, Raghuram Rajan, the former chief economist of the International
Monetary Fund, does see some parallels between music and monetary policy. A few years ago,
he said: "Central bankers nowadays enjoy the popularity of rock stars."
Now, I'm not aware of any colleagues whose public appearances send the audience as wild as
John Lennon or Paul McCartney did back in the day. But Rajan has given expression to the great
expectations placed upon central banks since the onset of the financial crisis when it comes to
steering the economy, putting out fires, or stepping into the breach for other seemingly
incapacitated policy areas. We can sense this pressure in the euro area, too, of course. Indeed,
the wish list for central bankers here is particularly long. And to some degree, we have only
ourselves to blame.
But I imagine that business people like yourselves mainly want me to tell you what the future
holds in store for the economy and the euro area. And that pretty much outlines the three main
topics I will be covering in my speech here today. Let me begin by looking at the current state of
the economy.
2 Normalising monetary policy
Ladies and gentlemen,
Uncertainty is becoming increasingly prevalent in the public debate about the state of the
economy. And there's no denying that reports from the German economy haven't been good over
the past few weeks and months. Industrial activity, especially, has been disappointing,
particularly among automotive manufacturers. German economic output even contracted in the
third quarter of 2018 - primarily due to the difficulties which car makers encountered in
connection with the new vehicle emissions test procedures.
The Bundesbank's economic experts assumed in their December forecast that the car industry
would quickly get to grips with these issues. Then, moderate growth in export markets and brisk
domestic demand would enable the German economy to even outpace capacity growth rates
somewhat in 2019 and the two years after that.
However, the outturn is far bleaker than this upbeat scenario. Indeed, car production remained
very muted into December, and to make matters worse, output in other industrial sectors also
sagged in November.
On the demand side, there has been little stimulus of any note from exports since the beginning
of 2018. Following an exceptionally good showing in 2017, it was a return to more normal
conditions, you could say.
But the measures adopted in the trade dispute between the United States and China are likely to
be having an impact as well. A model-based analysis by the Bundesbank indicates that the
adopted trade barriers could shrink the two protagonists' respective output levels by 0.5% over
2
the medium term, and world trade would diminish by 1% . Other economies, not least
Germany's, would also take a hit, albeit a milder one.
Like exports, German household consumption also remained sluggish in the second half of 2018,
despite excellent labour market conditions and rising income levels. Explaining this weakness is
altogether more difficult - remember, economists are known for being particularly adept at
explaining today why what they predicted yesterday hasn't come to pass.
One possible cause might be the sharp increase in crude oil prices - like me, you've probably
been annoyed about the high pump prices for petrol and diesel. This throttled consumer
purchasing power during the second half of the year. It was only in December that energy prices
fell sharply.
The relevant sentiment barometers are now pointing to a considerable deterioration in the
business climate. The businesses surveyed reduced their expectations by far more than their
assessment of the current situation, so the stream of bad news from Germany's economy might
well continue for some time to come.
And contrary to our December forecast, the dip in growth looks set to continue into the current
year. So from today's perspective, the German economy will probably grow at well below the
potential rate of 11⁄2% in 2019.
As you can see, I'm not trying to gloss things over. But at the same time, there's no reason for
excessive pessimism. To coin a phrase, one protracted dip in growth does not a crash make - in
other words: I see neither an abrupt slump nor an extended spell of noticeably receding
economic activity.
Despite the current bout of weakness, the economy as a whole is still on an expansion path.
Growth in Germany is building off favourable financing terms, rising employment levels and
increasing wages. Fiscal easing this year will add more stimulus still.
For labour market developments in particular, the short-term fluctuations in activity are of
secondary importance. What this means is that one of the engines of economic growth is still
intact. Gradually, the shortages in the labour market and substantial wage increases will also
begin to stimulate domestic price pressures.
All in all, I still believe that the outlook in our December forecast for the next two years is a
realistic one. Once the German economy has overcome the weak spell, it looks set to go back to
growing at roughly the same pace as its capacity in 2020 and 2021.
That said, uncertainty over the future path of the economy is strong, and the risks for Germany
are skewed to the downside. There are two main reasons for this.
The first is that the global trade dispute still hasn't been resolved. So there is a continued risk that
protectionism might spread worldwide. This would hit German industry, with its exports-driven
business model, particularly hard.
At least a few positive signs emerged from the negotiations between the United States and
China. It would be a real step forward if the negotiations brought forth an agreement which sees
the market being opened up to foreign businesses and intellectual property getting protection.
The second factor is Brexit.
Jeremy Adler, a British poet and scholar of German literature, said last summer that the United
3
Kingdom is heading for a bona fide Shakespearean drama when it leaves the EU . And right
now, who is to say his assessment is wrong?
As things stand at the moment, the UK will leave the EU on 29 March. If the EU and UK fail to
seal a deal, trade will be governed by World Trade Organization (WTO) rules. Compared with
the regime in place today, this would take a considerable toll on goods and services trading.
Over the long term, the UK economy would probably suffer painful losses in income. The
repercussions for the euro area and Germany, by contrast, would be less severe and arguably
manageable.
However, the Bank of England warns of short-term disruptions to trade which could plunge the
UK economy into recession. The "Old Lady of Threadneedle Street" simulated a variety of
4
scenarios to reach these conclusions . In the worst case scenario, UK GDP might slump by as
much as 8%. That would be a more severe recession than after the financial crisis, and it
wouldn't leave us unscathed, either.
Both of these risk factors - the global trade dispute and Brexit - are political by nature, and that's
why they both need to be defused by politicians. The Eurosystem has a mandate to preserve
price stability. But if the economy takes an unexpected turn for the worse, monetary
policymakers don't have much wiggle room at the moment. Unlike the United States, the process
of monetary policy normalisation in the euro area is just taking its first baby steps.
The ECB Governing Council decided in December to put an end to the Eurosystem's net asset
purchases at the end of 2018. It also reaffirmed its intention to reinvest the principal payments
from maturing securities until further notice. This will keep the stock of assets on our books at a
constant level. And it is this stock of assets that counts for the programme's economic impact.
Figuratively speaking, then, the ECB Governing Council is keeping its foot on the accelerator, but
not pushing it down any further. So the degree of monetary policy accommodation will remain
exceptionally high - in fact, roughly as high as it was when the crisis was raging.
In part, this is also due to the persistently low interest rates. The ECB Governing Council has
indicated that it continues to expect key ECB interest rates to remain at their present levels at
least through the summer of 2019, and in any case for as long as necessary.
The next steps towards normalising monetary policy will depend on how inflation pans out in the
euro area. As things stand today, it is primarily the lower crude oil prices which look set to send
the inflation rate this year noticeably lower than the Eurosystem staff had projected in December.
Remember, though, that the ECB Governing Council defines price stability as a medium-term
measure, so we would do well to look beyond these fluctuations. I still expect the persistently
upbeat labour market conditions and strong wage growth to gradually strengthen the underlying
price pressures in the euro area.
Some observers are already calling for a very slow and hesitant normalisation of monetary
policy, for fear that higher interest rates might cause corporate sector debt servicing to balloon
and thus dangerously curtail investment activity. However, recent Bundesbank research
5
indicates that debt servicing will probably have a moderate impact on account of the significant
deleveraging in a number of sectors and countries in recent years.
Whatever happens, the normalisation process will probably take a number of years, which is all
the more reason not to squander any time. You see, monetary policymakers need to regain more
leeway to be in a position to respond to an unexpected economic slump.
3 Stoking the engines of economic growth
Ladies and gentlemen,
Amidst all the urgent questions currently being thrown up by Brexit and the trade dispute, there is
one thing we mustn't lose sight of: the truly profound challenges facing the euro area are
longterm in nature. The European Commission's estimates put its long-term growth potential at just
6
1.3% .
When it comes to ensuring more growth, some look to the central banks. Yet monetary policy
cannot solve structural problems, and when monetary policymakers do attempt to do this, it is to
the detriment of their price stability objective.
Monetary policy can do no more than give the economy a slight nudge or slow it down, if this is
required to ensure stable prices in the medium term. In doing so, it only influences the cyclical
fluctuations around the existing growth trend.
To permanently raise the growth trajectory, the right course has to be set by economic, social
and tax policy. In Europe, it is first up to the individual governments to make economic structures
in their countries competitive. This is an ongoing task that all countries have to face - even
Germany.
On the whole, Germany's standing as a business location isn't bad, but I see three areas we
need to work on: education, corporate taxation, and infrastructure.
Germany's good infrastructure is regularly attested to, but it does have specific weaknesses. We
do need to catch up on providing high-speed internet access, in particular. The expansion of the
fibre optic network is making only slow progress. We definitely need to pick up the pace here.
When deciding where to set up base, enterprises don't just look at the quality of the
infrastructure; the tax burden is also an important factor. The reforms in the United States have
recently added impetus to the discussion of corporate taxation. Other countries, such as France,
have since initiated tax cuts. When it comes to taxes on corporations, Germany is edging its way
to the top of the international league table.
Slightly above average tax rates may be defensible in Germany, but if the difference becomes too
great, our attractiveness as a business location will suffer. That's why I believe corporate taxes
should also be given due regard.
Companies could be granted targeted relief for research and development, for example. This
could set incentives for innovation and bolster competitiveness.
Here in this region, I don't need to explain to you what innovative power is. Mannheim is
traditionally considered a city of inventors. Karl Drais built the first bicycle here, Werner von
Siemens presented the first electric elevator in Mannheim, and the first automobile built by Carl
Benz took its maiden drive on the streets of this city.
At first, Carl Benz only ventured onto the roads at night. And during the day, too, he worked on
the vehicle in secret, afraid that someone might preempt him. He only unveiled his invention to
the public once he had the patent for it. This shows that technological advances do not simply fall
like manna from heaven. They are only made when researchers and developers have an
incentive to do such work.
The economist Paul Romer, who won the Nobel Prize in Economic Sciences last year, has also
contributed to this understanding. Romer asked, for example, what motivates companies to do
research and development. The framework conditions, such as patent protection, are a crucial
factor. Government support for research can also play a role. Germany certainly has room for
improvement in this area.
Thus, it is gratifying that the Federal Government has addressed this issue and has tax
concessions in the works. As the legislative process rolls on, it is vital that the rules are not
worded in a way that is too complicated and overly detailed. This would be an important signal
that we are serious about creating an innovation-friendly environment.
We should also view the topic of innovation through the lens of the two major challenges facing
Germany: digital transformation and demographic change.
The ageing of the German population is slowing long-term growth by reducing the number of
potential workers, making it all the more important to permanently strengthen the drivers of
growth in the German economy. Digital transformation gives us this chance.
It begins with the government itself. A modern, digital public administration benefits everyone. If,
for example, more administrative formalities can be dealt with online, citizens and companies will
save a lot of time and money.
There is still room for improvement here, as shown by a current report of the European
Commission. For the "digital public services" criterion, Germany came in just 21st out of the 28
7
EU Member States . The report identifies Germany as one of the EU countries with the lowest
level of online interaction between authorities and citizens. Only 39% of the population use
electronic public services. By way of comparison, the figure in Estonia is 96%.
Of course, digitalisation still has much greater reach. We are currently experiencing a
fundamental change in the world of work. Digital technologies are making ever greater inroads
into areas that were long thought to be the reserve of human beings.
As we witness these advances, a witticism attributed to the economist Warren Bennis springs to
mind, and I quote: "The factory of the future will have only two employees, a man and a dog. The
man will be there to feed the dog. The dog will be there to keep the man from touching the
equipment."
Digital transformation is changing many job profiles and, as a result, the requirements on
employees. There is an increasing focus on skillsets which a computer cannot replace: social
skills and creativity, for instance.
There's barely a single job that won't ultimately be affected by digitalisation. The key to keeping
pace with the changes is education. Education puts people in a better position to benefit from the
changing environment. Those who deepen, broaden and update their skills will remain equipped
for the future of work. I think it's imperative, then, that we establish a culture of lifelong learning.
Let's consider the European level. Here, too, there is still untapped growth potential that we can
leverage.
Take the EU Single Market: it has been a success story, but the tale isn't over yet. In the digital
world, there are still barriers hindering the free exchange of goods and services.
Copyright law is one example. The national legal systems of the EU countries differ on this point,
and only in rare cases are the rules designed to facilitate cross-border use in the digital era. It is
therefore time for a modern, European copyright law that creates a fair balance between the
interests of creators and users. This would also provide more legal certainty, which enterprises
need when they want to invest.
Another of the fundamental freedoms in the EU is free movement of capital. In practice, though,
this is not applied enough in SME funding. As before, this is dominated by bank loans, often
granted by domestic credit institutions.
A single European capital market would make it easier for companies to tap new sources of
funding, even across national borders. This would come with a cross-border stabilising effect in
the face of shocks hitting individual countries, and we could spare ourselves the discussion of
other, more problematic instruments.
But when it comes to corporate financing, perhaps what some of you fear is new obstacles.
Some among you may be thinking of the stricter banking regulation brought about by the Basel III
regime. The concern is that banks may pare back their lending as a result. The Financial Stability
Board (FSB) of the G20 countries has taken up the issue and is currently examining the role of
financial market regulation for the funding of small and medium-sized enterprises.
Previous studies indicate that there are two effects of tighter capital requirements for banks. In
the short and medium term, they can lead to a reduced credit supply because banks first shrink
8
their balance sheet . In the longer term, the effect on the supply of credit is actually positive
9
because better capitalised banks can obtain cheaper (re)financing .
As is so often the case when it comes to money, the workings are more complex than they first
appear. Anyone wishing to make life a little easier can turn to the Beatles for guidance and
comfort. As they once sang, "I don't care too much for money / Money can't buy me love."
4 Reforming monetary union
Ladies and gentlemen,
Not only did the Beatles shape the music of their time in a way that no other group has ever
managed, they also showed what makes a good band: it needs to be greater than the sum of its
parts. The same is true when musicians come from different musical backgrounds and were
previously solo artists.
Which takes us back to the present and to European monetary union. Some 19 countries
decided to form a band for the long haul. This band has now been gracing the stage for 20 years,
already twice as long as the Beatles. With that in mind, it's more like the Rolling Stones: there is
no end in sight.
And so the euro celebrated its 20th birthday on 1 January. When it was introduced, politicians
made the public one promise: the euro would be just as strong as the Deutsche Mark before it.
With an inflation rate averaging 1.7% over the past 20 years, inflation is converging towards price
stability as defined by the Eurosystem. The original promise of a stable currency has thus been
kept.
Of course, we mustn't forget that part of this period was marked by the financial and sovereign
debt crisis. It put monetary union to the test on more than one occasion. It could therefore be said
that the euro had an easy childhood but a difficult adolescence.
If the crisis did one good thing, then, it was that it opened our eyes to the weaknesses in the
institutional framework of the euro area. Paul Romer summed it up perfectly when he said, "A
10
crisis is a terrible thing to waste."
It would have been a terrible thing if we had learned nothing from the crisis. In the meantime, a
great many problems have been tackled and reforms initiated. If the financial system or individual
euro area countries were to once again find themselves in turmoil, we would be better prepared
to deal with this today than we were back then.
After 20 years, the euro is all grown up. However, it hasn't yet put all of its growing pains behind
it. In other words, monetary union hasn't yet been made crisis-proof once and for all.
In order to be forearmed in the long run, euro area countries first need to be proactive by making
their economies competitive. Second, they need to keep their finances on a sound footing, as is
also set out in the fiscal rules we have all agreed upon.
Going back to our band analogy, this means that every member of the band can and needs to do
their bit in order to make the joint project a success - for instance, by regularly practising their
instruments, turning up to rehearsals on time and sharing the group's core values.
However, it is not just the individual euro area countries that are being called upon to take action
- there is a lot more work to be done at the Community level, too. The monetary union needs a
coherent framework of responsibilities and liability. In this context, striking a balance between
national responsibility and European risk sharing is crucial, and the leitmotif should be the
alignment of actions and liability.
For entrepreneurs such as yourselves, this goes without saying: decisions will only ever be taken
responsibly if those who decide also bear responsibility for the consequences of their actions.
This principle of liability needs to apply to governments, too.
The current plans to reform monetary union need to be live up to this principle. I would like to take
this opportunity to single out two projects for closer examination.
4.1 Strengthening the ESM
A good example of how solidarity and soundness can be aligned is the permanent bailout fund
that is the European Stability Mechanism (ESM). It provides member states with financial
assistance in severe crises, on the condition that the causes of the crisis must be remedied.
In December, the euro area heads of state and government agreed to strengthen the ESM's role
in crisis prevention and crisis management. In principle, I believe this to be a sensible move, as it
has already proved itself to be highly adept at combating sovereign debt crises.
However, the ESM needs to be given the requisite powers in order to deliver on its new
responsibilities. One example that springs to my mind is fiscal surveillance under the Stability
and Growth Pact.
To date, this task has been handled by the European Commission. However, its dual role as
guardian of the treaties and as a political institution is sometimes more of a hindrance than a help
when it comes to insisting on sound fiscal policy.
Thus, Friedrich Heinemann, an economist at the Centre for European Economic Research in
Mannheim, has been critical of the fact that the interpretation of debt rules is being increasingly
steered by political interests. In his view, the European Commission has disqualified itself as a
11
"neutral arbiter" . Now, while you don't have to agree with each and every one of his clear
statements, it is difficult to deny that the fiscal rules' credibility has taken a hit and that their
binding force urgently needs to be strengthened.
4.2 Completing the banking union
The heads of state and government also agreed that the ESM should backstop the Single
Resolution Fund (SRF) in a step towards completing the banking union. If, in the event of a bank
resolution, SRF funds proved insufficient, the ESM would then provide a loan to be repaid by the
banking sector at a later date.
In principle, this common backstop is appropriate because euro area's significantly important
banks are already subject to joint supervision. But before it comes into force, banks' balance
sheets need to be free of legacy assets. If not, risks that arose under national responsibility
would subsequently be communitised.
The same questions arise, and are even more pressing, in connection with a different topic -
namely the proposed single deposit guarantee scheme. It could well increase the credibility of
depositor protection in Europe and thus reduce the risk of a bank run. However, several
conditions need to be met in order to align action and liability and to avoid moral hazard.
First and foremost, the legacy risks lurking on European banks' balance sheets need to be
eliminated. For example, many banks are still sitting on a huge mountain of non-performing
loans.
While it is true that the average non-performing loans ratio has fallen considerably in Europe
since 2014, the problem largely concerns individual, hard-hit countries. In more than one-third of
EU countries, the non-performing loans ratio is still above 5% - in some cases, well above it.
Just for comparison purposes, the figure in the United States and Japan is around 1%. What's
more, banks' risk provisioning to date is nowhere near enough to cover all losses that could
result from non-performing loans.
Looking at government bonds, the situation isn't much better. Many banks hold large stocks of
domestic sovereign bonds that are backed by little to no capital, thereby chaining themselves, as
it were, to the solvency of their national governments. For instance, holdings of domestic
government bonds currently account for around 10% of Italian banks' total assets, which is
actually in excess of their capital levels.
There is a risk of unsound public finances taking their toll on banks, ultimately resulting in the
deposit guarantee scheme having to come to the rescue. For that reason, it is not just about
cleaning up banks' balance sheets to get rid of legacy assets in the here and now. We also need
to prevent an excessive amount of risk from ever building up again in future - risk that would then
be transferred to other countries through a single deposit guarantee scheme.
The sovereign-bank nexus thus needs to be severed once and for all in order to pave the way for
a single deposit guarantee scheme. Banking regulation lies at the heart of the problem. Up to
now, government bonds have been given preferential treatment over loans to the private sector
and households.
On the grounds of prudence, this special treatment is not warranted and needs to be stopped.
After all, the debt crisis clearly refuted the notion that government bonds are risk-free. It would
therefore be a mistake to create a single deposit guarantee scheme without first ensuring that all
the conditions are met.
When it comes to reforming monetary union, thoroughness should be put before speed. I would
prefer to take small steps in the right direction than large strides in the wrong one.
5 Conclusion
Ladies and gentlemen,
The Beatles' impromptu rooftop concert 50 years ago ended after 42 minutes. In my opinion,
speeches shouldn't last longer than rock concerts, so I will now bring this to a close.
Thanks to its University of Popular Music, Mannheim, too, has a special connection to modern
music. But anyone who wants to give their ears a rest for the time being will find an interesting
alternative on offer at the Kunsthalle Mannheim. Until Sunday, it is hosting an exhibition entitled
"Constructing the World: Art and Economy 1919-1939 and 2008-2018".
It's actually two exhibitions in one, and sheds light on the era from 1919 to 1939, during which
time the Great Depression raged, and the period following the outbreak of the financial crisis in
2008. It asks exciting questions such as how does art respond to change and crisis, and where
there are parallels between the two eras.
Whatever answers await you, I can assure you of one thing: the Bundesbank is working hard to
ensure there will be no reason to set up a third section of the exhibition so quickly.
Let's take one last look at that rooftop in London's Savile Row. John Lennon ended the concert
with a comment highlighting his trademark ironic humour: "I hope we've passed the audition," he
said, before leaving the stage.
I, however, will be staying on stage to answer your questions. I look forward to finding out what
you would like to know.
But for now I would like to thank you for your attention!
1
T. Barrell (2017), The Beatles on the Roof, Omnibus Press, London.
2
See Deutsche Bundesbank, The potential global economic impact of the USA-China trade dispute, Monthly
Report, November 2018, pp. 11-13.
3
www.deutschlandfunkkultur.de/der-brexit-als-shakespeare-drama-theresa-may-eine-planlose.1008.de.html?
dram:article_id=421106
4
Bank of England, EU withdrawal scenarios and monetary and financial stability, November 2018.
5
Deutsche Bundesbank, The impact of an interest rate normalisation on the private non-financial sector in the
euro area from a balance sheet perspective, Monthly Report, January 2019.
6
The 2018 Ageing Report. Economic and budgetary projections for the EU Member States (2016-2070),
Institutional Paper 079, May 2018.
7
European Commission, Digital Economy and Society Index Report 2018.
8
Gropp, R., T. Mosk, S. Ongena, and C. Wix (2016), Bank response to higher capital requirements: Evidence from
a quasi-natural experiment, SAFE Working Paper Series 156.
9
Gambacorta, L. and H. S. Shin (2016), Why bank capital matters for monetary policy, BIS Working Papers No
558, April 2016.
10
See New York Times Magazine, 31 July 2009, "A terrible thing to waste",
www.nytimes.com/2009/08/02/magazine/02FOB-onlanguage-t.html
11
Süddeutsche Zeitung, 7 January 2019, "Neuer Schiedsrichter gesucht".