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A stable euro in a strong Europe

Karl Otto Pohl Lecture to the Frankfurt Society for Trade, Industry and
Science

30.10.2024 I Frankfurt am Main I Joachim Nagel

Check against delivery.

1 Introduction

2 Sound public finances in the euro area
3 Integrated capital markets in Europe
4 Public confidence in the central bank

5 Conclusion

1 Introduction

Ladies and gentlemen,

Thank you very much for inviting me. It gives me great pleasure to be here with you
today, and I am very honoured to be delivering the Karl Otto Pohl Lecture.

My congratulations on this series of lectures. Nine years ago, it premiered at the
Bundesbank's Regional Office in Hesse at the Taunusanlage in Frankfurt. Since then,
various prominent people have presented their views of monetary union. Two of them
will come up later on in my talk.

But let's stay for now with the lecture's namesake: Karl Otto Pohl. On 30 May 1990, he
addressed the Frankfurt Society for Trade, Industry and Science as President of the
Bundesbank, perhaps even standing right here at this lectern.[1]

Times were turbulent back then: German monetary union had just been decided and
needed to be implemented within the space of just a few weeks. At the same time, the
Delors Report had outlined the transition to a European Economic and Monetary Union.
Its first stage entered into force on 1 July 1990. Germany's "Frankfurter Allgemeine
Zeitung" newspaper wrote back then that the Bundesbank was facing two unprece-

dented historical challenges.

As was his nature, Karl Otto Pohl shied away from neither challenges nor plain speak-
ing. He explained in no uncertain terms where the difficulties and pitfalls of the two
monetary unions lay. At the same time, he left no doubt that he would strive tirelessly
to ensure that they were a success. He concluded his speech back then with the words:
"lam also confident that we will succeed." This combination of plain speaking, drive
and optimism were characteristic of Karl Otto Pohl - and we could do with more of that
today as we strive to overcome the current challenges.

Karl Otto Pohl would have turned 95 this year. We owe him a great deal. His work in
the Delors Commission resonates to this day: It was under Mr Pohl's chairmanship that
the Committee of Central Bank Governors drafted the Statute of the European Central
Bank. Thus, the European Central Bank was modelled on the Bundesbank and created
as an independent central bank that pursues price stability as its primary objective.

However, Mr Pohl was also well aware that these institutional pillars alone are not suffi-
cient to permanently uphold a stable currency for Europe. A firm foundation is needed
for the pillars to stand upon. This foundation consists of sound public finances, inte-
grated markets and public confidence in the central bank. Then as now, it is important
to strengthen this foundation so that the euro can withstand even a storm. I would
now like to talk about what this means specifically in the here and now.

2 Sound public finances in the euro area

Let's start with public finances - and a question: Why should they matter to us in the
first place? The Eurosystem has the task of shaping monetary policy for the euro area.
Fiscal policy is the Member States' responsibility. Why then do central bankers talk so
often about budget deficits, debt ratios and fiscal rules?[2]

Our mandate provides the answer: Unsound public finances are a threat to price stabil-
ity. If the debt burden grows steadily in size, people might lose confidence that the gov-
ernment can continue to shoulder this burden without "inflating it away". Inflation
expectations, and therefore inflation itself, could rise. And monetary policy would have
to push back more vigorously to keep inflation under control. This, in turn, would come
at a greater cost to the economy as a whole.

That is why we must nip in the bud any impression that central banks are under pres-
sure to set key interest rates lower or maintain higher bond holdings than actually war-
ranted by monetary policy out of consideration for public finances. And that is exactly
why we are such outspoken advocates of effective fiscal rules. They are intended as
guardrails for sound public finances. Then monetary policy can safeguard price stability,
and do so with as little cost to the aggregate economy as possible.

Fiscal rules were included in the design of European monetary union from the outset.
This was thanks, in part, to Karl Otto Pohl. Even back in the days of the Delors
Commission, he was already advocating binding budgetary rules. Mr Pohl is also said to
have been the first to introduce the idea of a 3% deficit rule.

Since then, the rules have been amended on several occasions. The latest reform
entered into force in April 2024. On paper, the earlier rules were not bad at all. In prac-
tice, however, they didn't have the desired effect. One reason was that numerous
exceptions and discretionary powers were used to excuse the many instances in which
targets were missed. As a result, the majority of euro area countries have debt exceed-
ing the reference value of 60% of GDP (gross domestic product), with a few even well
above the 100% mark.

Against this background, the rules were redrawn. In the reform, a great deal of empha-
sis was placed on national ownership, the intention being to make Member States feel
more bound to the thresholds. If this overhaul does indeed lead to the rules having
more binding force, that would be very welcome.

At the same time, however, the commitments must also be ambitious enough to signifi-
cantly bring down high deficit and debt ratios. Given a number of vulnerabilities in the
new framework, this is not a matter of course. For example, the country-specific limits
are based on many assumptions, some of which extend far into the future. The spend-
ing limits are ultimately a matter of negotiation. And in practice, response times to
undesirable developments will be very long.

The first acid test is imminent. Spending limits for the first planning period are currently
being agreed upon. The plans should stake out a path for high deficit and debt ratios to
come down reliably. Responsibility for agreeing such plans lies with the Commission and
the Council. In my opinion, Germany should act as a role model in this process. That
means leading by example and committing to a path on which the rules are applied
rigorously.

Given high levels of debt in the euro area, it is important that the reformed rules work
better than the old ones. As I said earlier, sound Member State finances are part of the
foundation of a stable economic and monetary union.

3 Integrated capital markets in Europe

But they alone are not enough. In his speech back then to the Frankfurt Society for
Trade, Industry and Science, Karl Otto Pohl explained that the emerging economic and
monetary union meant, first, an integration of the markets. That was the most impor-
tant thing of all, he said.[3] In particular, he pointed to the increasing integration of
money and capital markets following the lifting of many restrictions on the free move-
ment of capital.

There were, and still are, a number of reasons why it is important that European finan-
cial markets should be as integrated as possible. First, this helps ensure that monetary
policy impulses have equal effect throughout the euro area. Second, in the event of an
economic shock in one Member State, it makes sure that downstream costs are cush-
ioned across the currency area. This contributes to the stability of the economy as a
whole and the financial system. And third, in a deep, liquid capital market with a broad
range of products, it is easier for enterprises to find the financing that suits them best.
This is particularly true of start-ups and growth companies. They need access to a devel-
oped venture capital market. More private capital is also important to boost investment
in the green and digital transformation of the European economy. This investment is
urgently needed to strengthen the EU (European Union)'s productivity and
competitiveness.

So you see, everything points to the benefits of a genuine pan-European capital market.
And the EU (European Union) set itself the goal of creating a capital markets union a
decade ago. Unfortunately, the reality is still very different.

Overall, progress on financial integration in the euro area is disappointing. This was the
conclusion recently reached in a report by the European Central Bank. It states that
"Ibloth price-based and quantity-based financial integration indicators have declined
substantially over the past two years, with no sizeable increase since the inception of
Economic and Monetary Union. Despite significant legislative efforts over the last
decade, cross-border financial market activities and risk sharing have not grown ...".[4]

This finding demonstrates just how big the task is. But there is also good news: We
know fairly exactly where the pain points lie and can start there. Areas for action
include, for example, a more vibrant securitisation market, integrated structures in
financial supervision, harmonised securities legislation, and better-coordinated national
insolvency and accounting rules.

The new Commission now needs to place the pursuit of a European capital market at
the very top of its list of priorities. We must make more rapid progress on this issue
than we have done so far. Policymakers have mostly been united behind the abstract
objectives. However, they have then too rarely found the strength to agree on concrete
measures. A whole host of measures is needed to achieve the objectives. In some cases,
they encroach deeply on national law. If real progress is to be made, all parties will have
to pull together, i.e. the Commission, the Parliament and the Member States.

Happily, the topic has gained fresh momentum this year. Be it the statements by the
Eurogroup and the ECB (European Central Bank) Governing Council or the reports by
Enrico Letta and Mario Draghi - they are all providing tailwinds. Now is the time to use
them!

The Eurosystem itself is also contributing to success in this area, particularly in terms of
financial market infrastructure. For example, we are advocating for new technologies to
make it easier to issue, trade and settle financial instruments. In my view, digitalisation
opens up fresh opportunities to strengthen the efficiency of European financial markets,
while also breaking down boundaries between national financial markets. We have far
from exhausted the potential here!

4 Public confidence in the central bank

A Europe with integrated markets and sound public finances is a stronger Europe. It is a
Europe with stronger resilience in the face of crises, even during turbulent times; a
Europe that allows us to shape our future with self-assurance and on the back of our
own efforts. Achieving this goes beyond the monetary policy foundation; it also
involves the basis of citizens' trust in the EU (European Union).

The general public should be able to have as much confidence in the
EU (European Union) in future as they do now.[5] We, as the Eurosystem central banks,
are also particularly dependent on the confidence and support of the general public.

We act independently of politics. This independence has been deliberately granted to us
for monetary policy so that we can fulfil our mandate free from political influence. We
cannot simply take the public's trust as a given. Only if the people have confidence in us
will they accept the independence granted to us. This trust must be earned time and
time again - by acting in accordance with our mandate and communicating transpar-
ently and comprehensibly with the public. In short: Our deeds and our words should go
hand in hand.

If people have confidence in central banks and their promise of stability, this also helps
to anchor inflation expectations.[6] Well-anchored inflation expectations make it easier
for the central bank to actually achieve its target. And meeting the inflation target, in
turn, reinforces people's confidence in the central bank. In this way, a virtuous circle is
created - a cycle of positive events.

The Eurosystem has repeatedly demonstrated that its promise of stability was not
merely empty words. Perhaps you remember when the then

ECB (European Central Bank) chief economist, Peter Praet, gave his Karl Otto Pohl
Lecture in 2017. At that time, the Eurosystem was struggling with an inflation rate that
remained stubbornly below target. Mr Praet explained what the Governing Council had
done to counter deflation risks that had emerged since 2014.

Alternatively, think back to the economic environment back when Christine Lagarde
spoke with you two years ago. In autumn 2022, euro area inflation had peaked, even
reaching double digits for a time. Against this backdrop, the

ECB (European Central Bank) President underscored the Governing Council's determina-
tion to push inflation down to its 2% target.

Here, too, words and deeds were aligned: by September 2023, we had raised key inter-
est rates by a total of 450 basis points in ten steps - a move that bore fruit. The infla-
tion rate has since fallen significantly. In September of this year, it was below 2% in the
euro area - and that for the first time in over three years. Tomorrow we will get the first
estimate for October. Inflation is also likely to have risen slightly again due to base
effects in energy.

Looking beyond the monthly ups and downs, it can be seen that price stability is no
longer far off, but the last mile of the journey still needs to be traversed. In particular,
services inflation, which has been relatively sluggish in past experience, remains high,
standing at 3.9% at last count.

The ECB (European Central Bank) Governing Council lowered key interest rates in
October for the third time since June. This was appropriate in view of the somewhat
more favourable inflation outlook shown by the data. Our data-dependent approach
has proven its worth, particularly in view of the prevailing uncertainty. A new forecast
will be available to the Governing Council in December, and that will show us whether
we are still on track in terms of inflation developments. I advise you to remain cautious
and not to rush into anything.

Monetary policy needs to ensure that the inflation rate stabilises at 2% over the
medium term. Adhering to our promise of stability is absolutely crucial if we are to
maintain the confidence that the general public have in us, particularly in light of their
inflation experiences in recent years. Accessible communication helps with this.[7]

Karl Otto Pohl had already come to this realisation, back in a time when central banks
were, in some cases, famous (and infamous) for their secrecy. In an interview in 1988,
he said: "I am thoroughly convinced that one of my main tasks is to clarify, to
explain." [8]

Studies also suggest that people with a good financial education tend to trust central
banks.[9] We therefore have a strong vested interest in improving the public's under-
standing of money, currency and central banks. This is where the Bundesbank's educa-
tional resources, such as lectures at schools, training courses for teachers, teaching
materials, explanatory films and the Money Museum, come into play.

The effects of financial education could extend even further: researchers from the
European Central Bank have investigated how people with differing degrees of financial
knowledge responded to the interest rate reversal in 2022 and 2023.[10] People with
basic and advanced financial knowledge were surveyed over several months. It tran-
spired that both groups expected significantly higher interest rates. However, there
were differences between whether the surveyed groups deemed it better to take out
loans or to make savings: those with higher financial literacy adjusted their assessments
more quickly and to a considerably greater degree. The impact of the course of mone-
tary policy on people's behaviour therefore also depends on their financial knowledge.
As a result, then, greater emphasis on financial literacy could help monetary policy mea-
sures to be translated into action on the part of the individual.

A good general understanding of economics and finance has yet more advantages. For
instance, such knowledge enables people to make better decisions about how to
spend, save and invest their money. Studies show that financial knowledge has a posi-
tive impact on households' return on investment.[11] Furthermore, it is more likely to
prevent them from making expensive mistakes or falling victim to fraud.

Financial education also affords opportunities for social advancement. It is therefore
important to promote the acquisition of such knowledge in society at large. If knowl-
edge about planning for retirement and wealth accumulation is only gleaned from
one's parental home, it is primarily those who are already in positions of privilege who
will benefit. This can entrench and even exacerbate societal inequalities.[1 2]

It is all the more worrying that, according to a survey carried out within the

EU (European Union), an average of just over one in two individuals possesses basic
financial knowledge.[13] Although Germany's performance is above average, we still
have plenty of room for improvement. The German government's initiative aimed at
strengthening financial education therefore comes as a welcome development. One
component of this initiative, a national strategy for financial literacy, is currently under
development. The OECD (Organisation for Economic Co-operation and Development)
has provided valuable analyses and recommendations that create a sound basis for
policy.[14]

In any case, there is no lack of interest, especially among young people. According to
an OECD (Organisation for Economic Co-operation and Development) study, 81% of 14
to 24-year-olds would like to learn more in school about options for retirement provi-
sion, 87% about how to handle their money and 73% about investment opportunities.
[15] In addition, 78% of young people in Germany want economics to play a greater
role in school.[16] A stronger focus on economic and financial topics in the school cur-
riculum would fall on fertile ground, then.

5 Conclusion

The Eurosystem is well equipped to maintain stable prices in the euro area through
independence and a clear mandate. But in stormy times especially, we need to be firmly
anchored upon a strong foundation, comprising elements such as sound public
finances, integrated markets and confidence in the central bank. This foundation must
be maintained, and, where necessary, re-laid.

First and foremost, we are, of course, required to say what we are doing and to do
what we are saying. Central bankers would be well advised to adhere to this guiding
principle. However, what is also clear is that we cannot guarantee the strength of the
euro as a currency by acting alone; rather, politicians and society as a whole have their
own parts to play. Pohl's contemporary Helmut Schlesinger, who recently turned 100
years old, coined the term "stability culture" .[17]

I would like to close by citing a quote of Karl Otto Pohl's that holds as true today as it
originally did over 40 years ago: "There is no law of nature stating that we are entitled
to live on an "island of stability". Such a privilege has to be earned through applying a
durable stability policy."[18] Indeed, this is what we in the Eurosystem are working
towards on a day-to-day basis, and I am confident that we will succeed.

Footnotes

1. Pohl, K. O., Rede zur deutschen und europaischen Wahrungsunion vor der
Frankfurter Gesellschaft fur Handel, Industrie und Wissenschaft, 30 May 1990.

2. Allard, J., M. Catenaro, J. Vidal and G. Wolswijk (2013), Central bank communica-
tion on fiscal policy, European Journal of Political Economy, Vol. 30.

3. Pohl, K. O., Rede zur deutschen und europaischen Wahrungsunion vor der
Frankfurter Gesellschaft fur Handel, Industrie und Wissenschaft, 30 May 1990.

4. European Central Bank, Financial Integration and Structure in the Euro Area, June
2024.

. European Commission (2024), Standard Eurobarometer 101 - Spring 2024.
. Christelis, D., D. Georgarakos, T. Jappelli and M. van Rooij (2020), Trust in the

Central Bank and Inflation Expectations, International Journal of Central Banking,
Vol. 16, No 6; Mellina, S. and T. Schmidt (2018), The role of central bank knowledge
and trust for the public's inflation expectations, Deutsche Bundesbank Discussion
Paper No 32/2018; Bursian, D. and E. Faia (2018), Trust in the monetary authority,
Journal of Monetary Economics, Vol. 98.

. Eickmeier, S. and L. Petersen (2024), Toward a holistic approach to central bank

trust, Deutsche Bundesbank Discussion Paper No 27/2024.

. Die Macht des Wortes, interview with manager magazin on 1 June 1988.

9. Nitoi, M. and M. Pochea (2024), Trust in the central bank, financial literacy, and per-

10.

11.

12.

13.

14.

15.

16.

17.

18.

sonal beliefs, Journal of International Money and Finance, Vol. 143.

Charalambakis, E., O. Kouvavas and P. Neves (2024), Rate hikes: How financial
knowledge affects people's reactions, The ECB Blog, 15 August 2024.

Kaiser, T. and A. Lusardi (2024), Financial literacy and financial education: An over-
view, CEPR Discussion Paper No 19185; Deuflhard, F., D. Georgarakos and R. Inderst
(2019), Financial literacy and savings account returns, Journal of the European
Economic Association, Vol. 17, No 1.

Lusardi, A., P-C. Michaud and O. S. Mitchell (2017): Optimal Financial Knowledge
and Wealth Inequality, Journal of Political Economy, Vol. 125(2).

Demertzis, M., L. L. Moffat, A. Lusardi and J. M. Lopez (2024), The state of financial
knowledge in the European Union, Policy Brief 04/2024, Bruegel.

OECD (2024), Strengthening Financial Literacy in Germany: Proposal for a National
Financial Literacy Strategy, OECD Publishing, Paris, https://doi.org/10.1787/81e9559
7-en[https://doi.org/10. 1787/8 1e95597-en].

OECD (2024), Financial literacy in Germany: Supporting financial resilience and well-
being, OECD Business and Finance Policy Papers, https:/Awww.oecd.org/en/
publications/financial-literacy-in-germany_c7a28393-en.html
[https:/vww.oecd.org/en/publications/financial-literacy-in-germany_C7a28393-
en.html]

Bertelsmann Stiftung (2024), Factsheet: Wirtschaftspolitische Interessen junger
Menschen in Deutschland.

Schlesinger, H., Eine europaische Wahrung mufs genauso stabil sein wie die D-Mark,
Handelsblatt, 31 December 1991.

Welt am Sonntag, 12 April 1981.