Andreas Dombret: Towards a more sustainable Europe
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, at the Euromoney Germany Conference, Berlin, 25 April 2012.
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1 Introduction
Ladies and Gentlemen
I am delighted to have the opportunity to speak to you today at the Euromoney Germany
conference. Now in its 8th year, the conference has established itself as a first-class
opportunity for policymakers and financial practitioners to exchange views. I firmly believe
that this free flow of ideas is of benefit to us all, and I am looking forward to sharing my views
with you in the next 20 minutes.
We are facing a crisis that is no longer confined to individual countries. Throughout and
beyond Europe, it weighs heavily on people's minds. Some believe, it even challenges the
viability of monetary union in its current form. Given the exceptional scale and scope of the
crisis, it is hardly surprising that views diverge on how to overcome it. But it is worth recalling
that despite intense debates on the best way forward, we share a common vision for the
future of our monetary union: a sound currency, sound public finances, competitive
economies, and a stable financial system.
These are the principles enshrined in the Maastricht Treaty. With the adoption of the treaty,
all euro-area member states committed to a European stability culture. Among those most
eager to join were the countries with first-hand experience of the painful consequences of
deficits spiralling out of control and of a monetary policy not always fully committed to
maintaining price stability.
The unholy "marriage" between Banca d'Italia and the Italian treasury in 1975 is a perfect
example. Banca d'Italia vowed to act as buyer of last resort for government bonds. Up to the
"divorce" in 1981, Italian government debt more than tripled while average inflation stood at
17%. After Banca d'Italia was granted greater independence, inflation rates began to fall
significantly.
The principles of a sound currency, sound public finances and a competitive economy thus
remain the cornerstones of a strong and sustainable monetary union. Far from being a
specifically German conviction, they serve the well-being of citizens throughout the euro
area. And the ongoing validity of these principles is a prerequisite for the public acceptance
of monetary union. Thus, any approach that does not respect and comply with these
principles will not bring about a lasting solution to the crisis.
The current crisis is not a crisis of the euro as our common currency. Since the start of the
euro, inflation has been in line with the Eurosystem's definition of price stability, and the euro
continues to be a strong currency - to some, it actually appears to be too strong. But it is
generally accepted that the two central elements of the crisis are large macroeconomic
imbalances stemming from diverging competitiveness levels, and unsustainable levels of
public debt.
2 The root causes of the crisis: macroeconomic imbalances and
over-indebtedness
No lasting solution to the crisis will be achieved unless these root causes are tackled.
Firewalls can help some countries to cope better with the effects of sudden shifts in investor
sentiment, but, ultimately, all it can do is buy time. As the IMF points out in its recent World
Economic Outlook , firewalls by themselves cannot solve the difficult fiscal, competitiveness
and growth issues that some countries are now facing.
2.1 Macroeconomic imbalances
There is broad consensus that macroeconomic imbalances, which have built up in recent
years, lie at the heart of the crisis. But the best way to correct these imbalances has been the
subject of intense debate.
Exchange rate movements are usually an important channel through which unsustainable
current account positions are corrected - deficit countries eventually see a devaluation, while
surplus tend to revalue their currencies. The reactions that this triggers in imports, exports
and corresponding capital flows then help to bring the current account back closer to
balance.
In a monetary union, however, this is obviously no longer an option. Spain no longer has a
peseta to devalue; Germany no longer has a deutsche mark to revalue. Other things must
therefore give instead: prices, wages, employment and output.
The question now is which countries have to shoulder the adjustment burden. Naturally, this
is where opinions start to differ.
The German position could be described as follows: the deficit countries must adjust. They
must address their structural problems, reduce domestic demand, become more competitive
and increase their exports.
But this position has not gone uncontested. Indeed, well-known commentators suggest that
surplus countries should bear part of the adjustment burden in order to avoid deflation in
deficit countries. They also point out that not all countries can act like Germany, in other
words, not all countries can run a current account surplus. Hence, they suggest that surplus
countries should shoulder at least part of the burden.
But this criticism misses the point of what the correction of domestic imbalances actually
means:
As regards the lingering threat of a protracted deflation, it is rather a one-off reduction of
prices and wages that is required, not a lasting deflationary process. In fact, frontloading
reforms and necessary adjustment has proven to be more successful than protracted
adjustment, as experience in the Baltic states and Ireland shows.
And while not all countries can run a current account surplus, all can become more
competitive - higher competitiveness due to productivity increases or lower monopoly rents
in, up to now, overregulated sectors is not a zero sum game. Structural reforms can unlock
the potential to increase productivity and thus improve competitiveness without inducing
deflation.
There is no way around the fact that Europe is part of a globalised world. And, at the global
level, we are competing with economies such as the United States or China. To succeed,
Europe as a whole has to become more dynamic, more inventive and more productive.
Once the deficit countries start to become more competitive, surplus countries will adjust
automatically. They will become less competitive in relative terms, exporting less and
importing more. And we should acknowledge that this process has already been set in
motion. Exports of a number of peripheral countries have started to grow, bringing down
current account deficits in the process. Correspondingly, German imports from the euro area
have grown strongly over the last two years, almost halving the current account surplus
between 2007 and 2011.
To facilitate the adjustment process, euro area members have committed significant funds
within the framework of the EFSF and the ESM. Germany is contributing the biggest share.
This support is based on the high reputation Germany enjoys among investors. We would
put this trust in jeopardy if we were to give in to calls for fiscal stimulus in Germany in order
to raise demand for imports from the peripheral euro area. But weakening Germany's fiscal
position would lead to higher refinancing costs and, therefore, either reduce the capacity of
the firewalls or raise the borrowing costs for programme countries.
Moreover, studies by the IMF suggest that positive spill-over effects from an increase in
German demand to partner countries in the euro area would be minimal. So, instead of
stimulating exports in peripheral euro-area countries, additional fiscal stimulus at a time when
Germany's economy is already running at normal capacity would be of detriment to all
parties.
2.2 Fiscal consolidation
Turning to fiscal consolidation, it is often stressed that such measures, together with
structural reforms, would be too much of a burden. They would create a vicious circle of
decreasing demand and further budget pressure that would eventually bring the economy
down. But to the extent that the current output level was fuelled by an unsustainable
ballooning of private and public debt, correction as such is unavoidable, and the only
question that remains is that of the best timing.
However, this crisis is a crisis of confidence. While, under normal circumstances,
consolidation might dampen the economy, the lack of trust in public finances and in
policymakers" willingness to act is a huge burden for growth. Thus, frontloaded, and
therefore credible, consolidation would instead strengthen confidence, actually help the
economy to grow and reduce the danger of the crisis spreading to the financial system.
In addition, urgently needed structural reforms and consolidation are often hard to
disentangle. For example, a bloated public sector or very generous pension system are both
a drag on growth and a burden on the budget. The same applies to inefficient companies that
are state-owned or operate in highly regulated sectors.
The risks to growth emanating from immediate fiscal consolidation therefore have to be put
into perspective. Negative short-term effects cannot be ruled out. But to the extent that
consolidation constitutes necessary corrections of an unsustainable development and brings
about greater efficiency, the long-term gains do not only vastly exceed potential short-term
pain, they also help to alleviate it now by restoring the lost credibility in the ability to tackle
the root causes of the crisis.
3 The role of monetary policy
Up to now, the picture has been mixed in this regard. We have seen substantial progress,
often initiated by new, more reform-minded governments, but also some setbacks. A much
clearer pattern has emerged with respect to the expectations placed on monetary policy.
Whenever a new intensification of the crisis looms, the first question seems to be "What can
the central banks do about this?" To me, this is a worrisome development.
Monetary policy has already gone a very long way towards containing the crisis. But we have
to be aware that the medicine of a very low interest rate policy, ample provision of liquidity at
very favourable conditions and large-scale financial market intervention does not come
without side effects - which are all the more severe, the longer the drug is administered.
In the course of this crisis, the role of central banks has changed fundamentally. Before the
crisis, they provided scarce liquidity; now they increasing serve as a regular source of
funding for banks, and this threatens to replace or displace private investors. This may give
rise to new financial instability if, as a result of the measures, banks and investors behave
carelessly or embark on unsustainable business models, for instance, due to substantial
carry trades.
But emergency measures will not become the "new normal". Banks, investors and
governments have to be fully aware of this, and central banks cannot tolerate that their
well-intentioned emergency measures result in a delay in necessary adjustments in the
financial sector or protracted consolidation and reform efforts among governments.
4 Conclusion
Ladies and Gentlemen
In my remarks, I have focused on necessary reforms in the euro area member states. This is
not to say that changes to the institutional set-up of monetary union are not important. If
member states want to retain autonomy with regard to fiscal policy, we need stricter rules to
account for the incentives to accumulate debt that exist in a monetary union. The fiscal
compact is a promising step forward. Now, it is essential that the rules are applied rigorously.
Referring to the motto of this conference "A German Europe or a European Germany", how
should one label the recipe to overcome the crisis that I have just presented? Well, it is, quite
obviously, a European solution. And that is because it fully reflects and respects the letter as
well as the spirit of the European Treaty and therefore of the principles that I stressed at the
beginning. The current crisis is most certainly a defining moment for monetary union. But the
crisis and the measures taken to overcome it should not be allowed to redefine implicitly
what monetary union actually is.
This time we really cannot "let this crisis go to waste", as the former White House chief of
staff, Rahm Emanuel, put it. The crisis has laid bare structural flaws at many levels. It has
questioned the way we adhered to the principles of EMU, but did not invalidate the principles
themselves, quite the contrary. I am confident that having stared into the abyss, Europe will
make the right choices and pave the way for a more prosperous and sustainable future - to
the benefit of Germany as well as of the euro area as a whole.