Jens Weidmann: Speech at the German-British Chamber of Industry &
Commerce Annual Dinner 2014
Speech by Dr Jens Weidmann, President of the Deutsche Bundesbank, to the
GermanBritish Chamber of Commerce Annual Dinner 2014, London, 23 July 2014.
* * *
1. Introduction
Ambassador, Sir Nigel, Dr Fouquet, ladies and gentlemen, I thank you for the invitation and
for the opportunity to speak here today.
According to geological surveys, around 7,000 years ago, Europe looked quite different from
what it looks today. A single land mass, known as Doggerland, stretched from Britain's east
coast to the Netherlands and the western coasts of Germany and Denmark. Britain was not
an island, but an integral part of continental Europe.
The end of the Ice Age seems to have ushered in the end of Doggerland as well. The melting
ice caused the level of the North Sea to rise until the land mass was fully submerged.
An alternative hypothesis suggests that Britain's separation from Europe came with a bang
rather than a whimper. A huge tsunami triggered by a sub-marine landslide off the coast of
Norway, the Storegga Slide, is supposed to have cut Britain off from mainland Europe.
Whatever the ultimate cause, the fact remains that today Britain and Europe are still divided
geographically by the English Channel. But human enterprise has managed to bridge this
divide, or rather, it has tunnelled it. And just as the resolve of the Eurotunnel engineers has
shortened the journey from Paris to London to less than two and a half hours, so the
dedication of post-war statesmen has overcome the political and economic divisions that had
troubled Europe for so long.
Almost to the day a hundred years ago, Kaiser Franz Joseph of Austria-Hungary declared
war on the kingdom of Serbia. That marked the start of the first of two global wars, which
together cost the unfathomable number of more than 80 million lives.
In 1946, only a year after the atrocities originated by Germany had ended, a European
statesman proposed a remedy to this tragedy of Europe. The proposal was as simple as it
was bold - to "re-create the European family".
What sounded utopian at the time is reality today. Rarely has a political vision been more
vindicated than the one laid out by Winston Churchill in Zurich in 1946. Europe has finally
found the peace that had eluded it for so long.
The recent tensions in the Ukraine, however, serve as a strong reminder that we should
never take peace for granted, not in Europe, nor anywhere else in the world.
2. The benefits of European integration
Churchill's vision was a political one. But the re-creation of the European family was
advanced largely by the integration of national economies. And while peace and stability are
rightly the most celebrated achievements of the European Union, economic integration has
produced remarkable results in its own right.
Economic integration raises welfare through two mechanisms: first, via increased trade, and
second, via increased competition, which in turn strengthens innovation and productivity.
Judging economic developments against a non-existing counterfactual, in this case
nonintegration, is obviously a tricky business. But the studies available show that the effect is
sizeable in any case. Europe is wealthier because of economic integration, with estimates of
2, 3
the output boost ranging from 5 % to more than 25 %.1,
And it seems that Britain, too, has gained. Half of its trade is with the European Union, and
studies suggest that EU membership has boosted Britain's trade in goods with other EU
countries by more than 50 %.4 The Center for Economic Performance5 at the London School
of Economics has found that the immediate benefits of increased trade amount to 11⁄4% to
3 % of GDP. And if the longer-term effects of strengthened competition and increased
productivity are taken into account as well, EU membership is estimated to have provided a
boost of up to 10.5 % of GDP.
But as much as the UK gains from being part of the EU, so the EU gains from having the UK
as a member. The EU is stronger today because of Britain's contribution to it. The European
economy is more open and dynamic as a result of Britain's commitment to open and flexible
markets - a position very much in tune with the Bundesbank's, I might add.
3. EU's and EMU's unfinished business
And that commitment to open and flexible markets holds the promise of even bigger returns.
A lot of the potential inherent in our most important European catalyst for growth, the single
market, is still untapped.
The single market has been very successful in facilitating trade in goods. Hence, competition
in this area is intense. The mark-ups that firms are able to charge in addition to their costs
due to market power are low and are comparable to those in the US, for example. When it
comes to services, however, the picture looks different. Mark-ups are higher, on average,
than in the US. It is probably safe to say that the Services Directive has fallen short of
expectations.
Britain, in particular, with its advanced services sector stands to gain from dismantling the
existing barriers to cross-border trade in services. Originally, the Services Directive was
designed to establish the so-called "country of origin principle" that already holds for EU
trade in goods. This principle states that a services firm should no longer be hampered by
regulation in the import country if it has already complied with the national regulations in its
home country.
However, the final version of the directive did not include this principle. Simulations carried
out by the Netherlands' Bureau for Economic Policy Analysis6 show that by dropping it, the
expected output boost as a result of the Services Directive is reduced by some 40 %.
Completing the single market for services therefore holds the promise of substantial
economic gains.
1
Badinger, H. (2005), "Growth Effects of Economic Integration: Evidence from the EU Member States", Review
of World Economics 141, 50-78.
2
Nauro F. Campos, Fabrizio Coricelli, Luigi Moretti (2014), "Economic Growth and Political Integration:
Estimating the Benefits from Membership in the European Union Using the Synthetic Counterfactuals
Method", IZA Discussion Paper No. 8162.
3
Boltho, Andrea and Eichengreen, Barry (2008), "The Economic Impact of European Integration", CEPR
Discussion Paper No. 6820.
4
John Springford, Simon Tilford, Philip Whyte (2014), "The economic consequences of leaving the EU", the
final report of the CER Commission on the UK and the EU single market.
5
G. Ottaviano et. al. (2014) The Costs and Benefits of Leaving the EU, CEP Discussion Paper.
6
Roland de Bruijn, Henk Kox, Arjan Lejour (2008), "Economic benefits of an Integrated European Market for
Services", Journal of Policy Modeling 30, 301-319.
The same goes for bringing the single market into line with the digital age. When it comes to
the digital economy, fragmentations still abound, in particular with regard to legal issues such
as privacy and data protection, content and copyright, liability of online intermediaries,
e-payments and electronic contracts. The EU is still comprised of 28 individual digital
markets rather than one single digital market.
This is holding back innovation, growth and, ultimately, jobs. Studies7 suggest that
establishing a harmonised and well-regulated digital single market holds the same potential
as the introduction of the original one, raising GDP by as much as 4 %. In Germany, for
example, this could imply an additional 427,000 jobs over the period 2015 to 2020.
Some steps have already been taken towards a true single market for the digital economy,
but we are not there yet. Continuing to the end would provide a major boost to European
competitiveness. It is therefore more than worth the effort.
Ladies and gentlemen, the field of policy which has seen the most far-reaching centralisation
in Europe is clearly the field of monetary policy, at least for the 18 member states of the euro
area. But the mutualisation of monetary policy is not only an issue for the euro-area member
states but for all European countries. Our extensive trade links imply that developments in
the monetary union reverberate in the non-euro-area countries as well, as the crisis has
shown very forcefully.
The euro area teams up one common monetary policy with 18 national fiscal and economic
policies. This approach reflects a currency area composed of sovereign member states. It
grants member states sufficient leeway to preserve their diversity, that is, to establish their
own business models or to tailor institutions and policies to their own national preferences. At
the same time, it leaves the consequences of such decisions with the respective member
state and consistently rules out the option of mutualising public debt with other euro-area
states.
But this set-up also creates vulnerabilities. First, a combination of this kind gives rise to a
deficit bias, as it allows the costs of fiscal imprudence to be shifted partially on to others. An
unsustainable fiscal situation in one country has repercussions for monetary union as a
whole. You can compare this to what economists call the "tragedy of the commons". Just as
overfishing creates negative externalities for other countries, excessive public debt harms the
euro area as a whole. Excessive debt in one member state drives up longer-term interest
rates for all euro-area countries.
And second, each member state issues debt in a currency it cannot create. Hence, a high
level of fiscal discipline is needed to ensure that solvency concerns do not spiral out of
control.
For monetary policymakers focussing on maintaining price stability, the question of how to
safeguard public finance is thus of particular concern. As so often, Mervyn King put it most
aptly when he said that "Central banks are often accused of being obsessed with inflation.
This is untrue. If they are obsessed with anything, it is with fiscal policy."
The founding fathers of the euro clearly foresaw the risk of unsustainable public finances for
a stability-oriented monetary policy. That is why precautions were put in place to safeguard
sound public finances and to protect monetary policy. They took the form of a prohibition of
monetary financing of government deficits, the no bail-out clause and the Stability and
Growth Pact.
But the precautions taken in the Maastricht Treaty to ensure sound public finances have
proven insufficient. The rules of the Stability and Growth Pact have been broken numerous
times in the past, not least by Germany, France and Italy. And the no bail-out clause failed to
exert the expected disciplining effect on governments in the run-up to the crisis, as markets
did not account enough for different macroeconomic developments in the countries
concerned. In this way, the markets might have anticipated that concerns about financial
stability would deter the euro-area member states from rigorously applying the no bail-out
clause. And that is precisely what happened when the crisis broke out.
The rescue packages provided to countries which lost market access did help to calm the
situation. But at the same time, they have thrown the balance between liability and control
out of kilter. While spending decisions essentially remain a national prerogative, liability has
become partially mutualised. The tendency to incur further debt is thus strengthened, not
weakened.
What is to be done? Some necessary steps have already been taken. The fiscal rules have
been stiffened, with greater automaticity in the Stability and Growth Pact and the introduction
of the fiscal compact.
However, as we have learned in the crisis, rules have to be applied to fulfil their purpose, and
they can only be the first line of defence. They need to be complemented by a functioning
market discipline to counter the temptation not to observe the rules. Sound public finances
will only be achieved if we rigorously set about restoring the balance between liability and
control.
One way to do this would be a genuine fiscal union. If common debt were matched by
common control, incentives could be aligned. But this would require a quantum leap in terms
of ceding sovereignty to the European level, a leap neither the electorates nor the
governments of the member states seem willing to take.
If a true fiscal union that requires extensive changes to the European Treaties is not on the
cards, then we need to take the second avenue. That implies taking concrete steps towards
restoring a balance of individual control and individual responsibility within the existing
Maastricht framework. A framework which is in line with what Margaret Thatcher once said in
her famous speech at the College of Europe - that improving the workings of the European
Union does not automatically require stronger centralisation.
Individual responsibility requires that sovereigns, banks and investors bear the
consequences of their decisions. This means that it is primarily up to the respective
government and its citizens to come up with the revenue needed to repay public debt. This
holds, in particular, since high levels of public debt often go hand in hand with substantial
private assets.
But it also implies that the risk of non-repayment ultimately lies with the investors, since they
are the ones who reap the return when things go well. And if the fiscal limit has been reached
for real, public debt needs to be restructured without posing a systemic threat to financial
stability.
The introduction of collective action clauses into sovereign bonds was a first step in that
direction. But more steps are needed. The Bundesbank has put forward a proposal for
sovereign bonds to include an automatic maturity extension of three years in case a
sovereign accesses the European rescue mechanisms. This automatic maturity extension
would allow the sovereign in question to tackle its fiscal challenges while preventing
investors from bolting. The amount of official financial support would be reduced, and time
could be bought to figure out if the problem is one of temporary illiquidity or insolvency.
But ultimately, all these questions boil down to the quip of American economist Allan Meltzer:
"Capitalism without failure is like religion without sin. It doesn't work." For the above
proposals to work, we need to make sure that sovereign insolvencies are possible without
bringing down the financial system as a whole.
To that end, doing away with the preferential treatment of sovereign debt in banks' balance
sheets is of the essence. The current regulatory framework permits preferential treatment of
sovereign exposures in various forms.
While bank exposures to a single counterparty are limited, in principle, to a quarter of their
eligible capital, exposures to sovereigns are exempted from that large exposures regime.
Thus, many European banks hold bonds from one sovereign only - their home country. But a
high level of undiversified sovereign exposure is what makes sovereign default a potentially
systemic event. For this reason, the large exposures regime needs to apply to sovereigns as
well.
Moreover, sovereign exposures are privileged by low or zero capital requirements. An
adequate risk-weighting of sovereign bonds would make banks more resilient if the fiscal
position of the respective sovereign were to deteriorate. And it would bring spreads more into
line with the underlying risk, thus sending a disciplining signal to the sovereign.
If additional capital requirements for European banks were imposed to cover sovereign
exposures, the additional capital would be rather small on aggregate - albeit with substantial
differences between banks. The inclusion of sovereigns in the large exposures regime might
lead to more substantial repercussions. But these would be manageable if introduced over a
transition period - which without question has to be granted.
Obviously, establishing a sustainable fiscal framework and consolidating public budgets are
only two of the numerous challenges facing the euro area in becoming more stable. Equally
important is to correct macroeconomic imbalances - through the restoration of
competitiveness in those countries that have fallen behind and through a further reduction of
indebtedness in the private sector there.
Declining unit labour costs and reduced current account deficits due also to increasing
exports show that we have already come a long way in regaining competitiveness. At the
same time private debt declined somewhat, reducing the burden on households' and
enterprises' shoulders a bit.
But as in a marathon, the last kilometres are always the hardest. What remains especially
challenging is the intended increase of growth potential. Additional structural reforms are
certainly needed - and, by the way, not only in the countries under stress but in Germany,
too.
By the same token, further work has to be done with respect to financial regulation, and that
applies not only to the euro area, but globally. Some key objectives in this respect are:
spelling out international standards on the loss-absorbing capacity of systemically important
banks, achieving cross-border acceptance of a bank resolution, peer reviewing measures
regulating the shadow banking sector and establishing saver derivative markets.
4. Conclusion
Ladies and gentlemen, let me come to a close.
Britain and continental Europe may not be connected by Doggerland anymore, but there are
myriad other ties that bind us together to form a common Union.
And it is precisely because our views sometimes differ that we are, together, more than the
sum of our parts. If Britain continues to make its voice heard in Europe, I am confident that
the Union will become more outward-looking, open and prosperous for that.
To those who think Europe would be better off giving in to the temptation of insularity, let me
say it in the words of the Beatles: "You say goodbye, and I say hello."
Thank you for your attention.