Andreas Dombret: The euro area - where do we stand?
Speech by Dr Andreas Dombret, Member of the Executive Board of the Deutsche
Bundesbank, at the German-Turkish Chamber of Trade and Commerce, Istanbul,
10 February 2015.
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1. Introduction
Ladies and gentlemen
Thank you for inviting me to speak here at the German-Turkish Chamber of Industry and
Commerce in Istanbul. Isaac Newton once observed that "we build too many walls and not
enough bridges". Istanbul has for centuries been a bridge between two continents - Asia and
Europe. It seems to me that Istanbul is therefore an excellent place to hold this year's G20
meetings. After all, the purpose of these meetings is to build bridges between nations by
fostering dialogue and the mutual exchange of information. And this objective is of course
also pursued by the German-Turkish Chamber of Trade and Commerce.
Moreover, mutual exchange is essential in a globalised world where countries are no longer
isolated islands but part of a closely interconnected community. The global financial crisis
has highlighted how close these connections are and how quickly a problem in one corner of
the world can spread around the globe.
This truth applies all the more to countries sharing a common currency such as the member
states of the euro area. Back in 1999, eleven European countries adopted the euro as their
common currency. Today, the single currency is shared by 19 countries and more than
300 million people, which in my eyes makes it a success story.
That said, it has not always been plain sailing. In the wake of the global financial crisis of
2008, the euro area slid into a financial crisis of its own. This was compounded in 2010 when
Greece entered into a sovereign debt crisis, triggering a sudden loss of confidence in other
member states which eventually brought the euro area to the brink of collapse. Extensive
rescue packages along with non-standard measures taken by the ECB helped to calm the
markets and prevented the crisis from escalating.
To some commentators, the present situation is not much different. Greece is again
capturing the headlines. Unrelated to Greece, the ECB again gave the green light to
nonstandard measures as a means of addressing the risks associated with too prolonged a
period of low inflation.
To obtain a clearer picture, let us take a tour of the euro area to see where we stand at
present and where we are headed in the future. Unsurprisingly, I will begin by focussing on
the growth prospects of the German economy, not only because this is my home country but
also because it is the largest economy in the euro area.
2. The German economy - in good shape but challenges ahead
At the beginning of 2015, the German economy remains in good shape. This is due to a
number of factors. First, enterprises have brought their costs under control, their debt level is
not unreasonably high, and they have an attractive range of products to offer on global
markets, including Turkey. Second, the German economy is being supported by domestic
consumption, while investment remains subdued - I will come back to this issue in a
moment. In addition, unemployment is low, households are not burdened by excessive debt
and real wages are rising on account of low inflation.
As reported by the Federal Statistical Office, the German economy grew by 1.5% in real
terms in 2014. When the Bundesbank published its latest economic projections for Germany,
real gross domestic product was expected to rise by 1.0% this year and by 1.6% next year.
However, this forecast was prepared in November and since then the price of oil has fallen
sharply. If oil prices remain at their current low levels, economic growth could prove to be
markedly higher this year and next, since the low price of oil has the effect of a small
stimulus package.
However, despite the current strength of the German economy, major challenges lie ahead.
In particular, unfavourable demographic trends will have an impact on future growth. The
Bundesbank estimates that potential output is currently growing at a rate of 1% per year and
will continue to do so until the end of the decade. Compared to the 1990s and 2000s this is a
truly underwhelming figure.
So, what can Germany do to improve its growth prospects in the long run? One frequently
voiced proposal these days is that Germany should step up its investment as a lever for
increasing its own growth potential as well as that of the euro area as a whole.
Indeed, the total real investment ratio in Germany was markedly lower in the 2000s than in
the 1990s. And it was also lower than in the rest of the euro area.
Nevertheless, weaker investment in the last decade was largely the result of the construction
boom in the late 1990s which followed German reunification. If construction is excluded from
the investment ratio, Germany's situation is no longer any different from the rest of the euro
area.
In addition, the construction boom witnessed in other euro-area countries also came to an
abrupt end during the crisis, with the result that the ratio for the euro area excluding Germany
has now returned to levels close to the German ratio. This effectively disproves claims that
the German private sector is investing too little, be it by historical or international standards.
In any case, it is not possible to increase private investment by decree. When it comes to
private investment decisions, expectations pertaining to growth and income are of pivotal
importance. And in Germany, demographic change has tended to exert a dampening
influence, the shrinking labour force being a paramount factor hindering economic growth.
Against this backdrop, many commentators point to public investment which can be directly
influenced by the government. With regard to public investment, Germany lags well behind
the rest of the euro area. However, this fact alone does not justify assertions that the state
should invest more.
Even so, public net investment has been negative for some time now, and there indeed
seems to be room for improvement. Infrastructure weaknesses can inhibit growth
considerably and there are certainly regional shortcomings in Germany. Nonetheless, public
funds should only be invested in projects that are economically worthwhile. In this regard,
public and private investments should be driven by the same considerations.
At the end of the day, public investment only represents a relatively small share of total
investment. And as I already indicated: such investment cannot be steered arbitrarily. Rather,
it should reflect demographic trends and productivity gains.
The discussion of lack of investment shows that an economy is a complex system in which
many factors interact in a complicated fashion. It is therefore not possible to solve all these
problems by a single policy measure. This is true for Germany, and it is equally true for the
euro area.
3. The euro area - structural reforms needed
Nevertheless, there are many observers who appear to believe that a single institution holds
the fate of the euro area economy in its hands, namely the ECB. Just three weeks ago, the
Governing Council of the ECB decided upon large-scale purchases of government bonds in
order to address the risks arising from too prolonged a period of low inflation.
As you know, the Bundesbank takes a sceptical view of this government bond purchase
programme. In our opinion, monetary policymakers are not under any acute pressure to act,
as the low inflation rate is mainly attributable to falling energy prices. For the next two years,
we are expecting inflation to pick up gradually; certainly, the risk of deflation is very limited.
What is more, government bond purchases are not simply a monetary policy instrument like
any other where the euro area is concerned. They entail risks which we believe are not
outweighed by the expected effects. For instance, the low interest rates, coupled with high
liquidity, could encourage many investors, in their search for yield, to turn to assets they
previously avoided due to the associated risks. This makes the emergence of price bubbles
more likely, which could compromise the stability of the financial system.
In any case, and here we are in line with the ECB, monetary policy is not a magic bullet.
Monetary policy cannot solve the crisis, nor can it put the euro area back on a solid footing.
In order to achieve that we need structural reforms both at the national and at the European
level.
Let us take a short look at the national level. When the euro-area crisis began five years ago,
many people referred to it as the "euro crisis". However, it was not a currency crisis but a
cocktail consisting of a debt crisis, a banking crisis and a balance of payments crisis. While
the underlying problems differ slightly between individual countries, the key to overcoming
the crisis lies with the affected countries themselves.
In the years following the introduction of the euro, fiscal and economic policies in some
member states failed to meet the requirements of a monetary union. And it was these
countries which experienced strong capital inflows. Unfortunately, the lion's share of this
capital flowed into private or public consumption or into an oversized housing sector.
On the back of heavily exaggerated growth expectations, a decrease in competitiveness
owing to generous wage settlements and insufficient financial regulation, sizable imbalances
accumulated which then contributed to the crisis.
Hence, to resolve the crisis it is the countries themselves that need to adjust. And it has been
clear from the outset that the necessary reforms and adjustment measures require patience.
In the meantime, major progress has been made as most of the crisis countries have
managed to substantially improve their public finances.
In addition, current account deficits have largely been reduced and some countries are now
running a surplus. Price competitiveness in the crisis countries has also improved
significantly. Measured in terms of the deflators of total sales, competitiveness has improved
by 6% in Portugal, 9% in Spain and 14% in Greece.
We have certainly not reached the finishing line yet but there is evidence that the efforts are
bearing fruit. It therefore worries me that Greece might go backwards in terms of its reform
agenda.
Suffice to say, it is not enough to correct misalignments solely at the national level. We also
need structural reforms at the European level. And here, a lot has been done since the crisis
broke out.
First, the rules of the Stability and Growth Pact were tightened and a fiscal compact was
adopted in order to restore confidence in public finances. Second, a procedure for identifying
macroeconomic imbalances at an early stage was established. And third, a crisis mechanism
was set up to serve as a "firewall", safeguarding the stability of the financial system in the
euro area.
In addition to these measures, the euro area took a major step toward deeper financial
integration. On 4 November 2014, the first pillar of a European banking union was put in
place. On that day, the ECB assumed responsibility for supervising the 123 largest banks in
the euro area. Together, the banks concerned account for more than 85% of the aggregate
balance sheet of the euro area's banking sector, making the ECB one of the biggest banking
supervisors in the world.
Taking banking supervision from the national level to the European level has three concrete
benefits.
First, European banking supervision allows banks in the entire euro area to be supervised in
a uniform manner according to the same high standards. These harmonised standards will
emerge from the cross-border sharing of experience, noting the best aspects of each
national approach to banking supervision and adopting these for use at the European level.
Second, European banking supervision makes it possible to effectively identify and manage
cross-border problems. This is essential because large banks are usually active in more than
one country.
Third, taking banking supervision from the national to the European level will add a degree of
separation between supervisors and the banks they supervise. This will prevent supervisors
from handling their banks with kid-gloves out of national interest.
As you can see, we have come to expect a lot from European banking supervision. And in
2016, the Single Supervisory Mechanism will be supplemented by a European resolution
mechanism for banks. This will be the final step on the road to banking union and a major
step forward in designing a better framework for the European monetary union.
4. Conclusion
Ladies and gentlemen
Looking at current events, some of you may feel reminded of what happened in 2010 and in
2012. Nevertheless, it should not be forgotten that, in the past five years, we have made
considerable headway in resolving the crisis and in putting the euro area back on a solid
footing. We have achieved a great deal but much still remains to be done - both at the
national and at the European level.
If we are to overcome the multiple challenges that lie ahead, all the member states of the
euro area will need to work together in a spirit of cooperation and demonstrate a firm
commitment to the common currency. On that basis, I am confident that the euro area will
remain a stable and prosperous economy.
Thank you for your attention.