Axel A Weber: Challenges and opportunities for the competitiveness of
EMU member states. The euro in the financial crisis - the German
experience
Presentation by Professor Axel A Weber, President of the Deutsche Bundesbank, at the
Copenhagen Business School, Copenhagen, 22 March 2010.
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1 Introduction
Dear President Johann Ross (Copenhagen Business School),
dear Professor Peter Birch Sørensen (Chairman of the Economic Council, Denmark),
dear Gouverneur Christian Noyer and Governor Niels Bernstein,
ladies and gentlemen
The global financial crisis that we have been experiencing since the autumn of 2007 has
been a challenge for monetary and fiscal policy in nearly all industrialised countries. In
addition, it called our regulatory regimes into question and caused a profound reform process
to be initiated at the national, European and global level. With respect to European Monetary
Union (EMU) the financial crisis has made clear just how important the euro is as a
stabilising factor for the economies of its member states.
Nonetheless, the challenges that lie ahead after the financial crisis and the economic
downturn that accompanied it have not diminished. In particular, the financial crisis has led to
a renewed debate about perceived imbalances in the euro area. This discussion is not new,
as divergencies have been building up steadily since the launch of the euro. However, during
the years preceding the financial crisis, the strong global economic expansion and the
ongoing economic integration within the euro area partly masked the problems arising from
these differential developments. As the financial crisis has called unsustainable business
models into question and ruthlessly revealed the structural nature of the disparities, they
have now moved centre stage. Taking the specific adjustment processes in a monetary
union into account, we have to think about the conditions for sustainable growth in all
euroarea economies and about how they can be achieved.
In my following remarks, I will address these two aspects of the recent experiences within the
euro area. First, the advantages of monetary union during the financial crisis. Second, the
challenges that will have to be overcome in order to resolve the divergencies that have built
up within the euro area. The current debate focuses on the differences in price
competitiveness between EMU member states. However, in my view losses in
competitiveness are not the root of the problem but rather a symptom of underlying
unsustainable structural developments in some member states. Accordingly, the marked
gains in price competitiveness the German economy has experienced have been a result of
necessary structural reforms that were finally addressed in 2003 when domestic problems
such as high structural unemployment, rising social security contributions and repeated
excessive public deficits became more and more pressing. I will therefore take a closer look
at this German experience trying to draw some conclusions for those countries that have lost
competitiveness since the launch of the euro.
2 Euro - what have we gained?
My positive assessment of the first ten years of monetary union results mainly from the fact
that EMU clearly contributed to a favourable climate for economic growth within the euro
area. Throughout the financial crisis, however, the euro proved to be far more than a growth
factor for the euro area. In several respects it has stabilised the member economies. As
market participants' risk aversion increased, any additional risk would have depressed their
propensity to invest. Therefore, the absence of exchange-rate risk within the euro area has
represented an additional benefit during the crisis.
More specifically, even though the effective exchange rate of the euro area rose sharply in
the financial crisis - before falling again more recently - the euro prevented EMU member
states from witnessing a scenario that Europe had experienced in former times, for example
during the crisis of the European Monetary System (EMS) in 1992/93. At that time, the EMS
had been exposed to a massive flight primarily into the D-Mark, which resulted in significant
tensions among EMS currencies. This caused massive adjustment problems for those
economies with appreciating currencies and inflationary pressure.
Finally, the fact that banks within the euro area obtain short-term liquidity through the
Eurosystem at the same terms and conditions has proved to be a great advantage during the
financial crisis. It has significantly mitigated money market tensions and therefore served as
a buffer against global financial market shocks. This has protected smaller economies
especially. Otherwise some of them would probably have needed to make additional efforts
to defend the credibility of their currencies, for example in the form of higher interest rates,
interventions on the foreign exchange market or swap agreements with other central banks.
3 Economic divergencies - a challenge for EMU
3.1 Increasing intra-EMU heterogeneity
The search for the causes of the financial crisis has intensified the discussion about global
imbalances. What is often overlooked in this discussion is the fact that the euro area as a
whole has an almost balanced current account. Consequently, the euro area has not
contributed to the build-up of global imbalances. However, the economic divergencies within
EMU do need addressing.
One important reason for growing heterogeneity within the euro area is that the benefits of
monetary union, in particular lower interest rates and the elimination of exchange rate risk,
have not always been used wisely and have tempted some countries to live beyond their
means: Too often inflowing capital did not reach the most productive sectors, and in some
cases cheaper and easier access to funding led to excessive credit dynamics facilitating a
rise in household and corporate debt and ultimately causing the real estate markets to
overheat. In addition, fiscal policy often failed to use higher growth and lower interest rates to
reduce deficits sufficiently. In economies with rigid or only partly flexible labour markets all
these large expansionary stimuli resulted in accelerated wage increases that were well in
excess of productivity growth, reducing price competitiveness and exports of domestic firms.
Consequently, price competitiveness has diverged significantly from one euro-area member
state to another since the introduction of the euro. Whereas a small group of countries, led
by Germany, has achieved gains in price competitiveness, a larger group suffered significant
losses, amongst others Greece, Italy, Spain and Portugal. These underlying economic
divergencies within the euro area are also reflected in persistent discrepancies in the current
account positions of EMU member states. As long as a flourishing world economy and the
growth dynamics within the euro area masked the associated problems, those developments
were neglected. However, the financial crisis has revealed the unsustainability of this state
and therefore increased awareness of the risks it involves. These risks imply depressed
future growth prospects, disturbances in capital flows if markets doubt the sustainability of
large external borrowing requirements as well as difficulties for monetary policy as a result of
the growing heterogeneity of euro-area member states. Hence, correcting the structural
problems that are at the root of the economic divergencies is one of the major challenges for
the future: For example, domestic firms have to become more competitive by increasing
productivity and keeping costs in check, labour market flexibility has to be increased in order
to mobilise a larger share of the working age population and to facilitate reallocation of
workers to more profitable sectors. And structural deficits have to be brought down to
sustainable levels by broadening the tax base or, preferably, cutting expenditure on
government consumption and certain transfers.
Taking the current account as one indicator of the extent of these divergencies, one could
get the impression that the financial crisis has halted the trend of growing heterogeneity
within the monetary union, since current account positions have narrowed significantly in the
years 2008 and 2009 (except for Italy and France). However, a closer look at the
developments that underlie the changes in current account deficits shows that the reductions
are still largely cyclical as they have been driven mainly by sharply falling imports rather than
increasing export market shares. Hence, more profound and far-reaching changes have to
be undertaken in countries that have lived beyond their means and thereby driven the
divergencies within the euro area.
In order to sketch how structural reforms can initiate the necessary adjustments and bring
back heterogeneity within the euro area to a natural and sustainable level, I will now turn to
the experience of Germany which has just undergone such an adjustment process.
3.2 The German experience
This adjustment process is often perceived and portrayed as a significant improvement in
price competitiveness due to ongoing wage moderation and major reforms on labour markets
and in the social security system. However, this perception misses the point of what actually
occurred in past years.
The price competitiveness of the German economy had indeed declined dramatically in the
years 1990 to 1995. During the reunification process, a number of domestic imbalances had
built up and became apparent as of the mid-1990s. The most prominent were an oversized
construction sector and strong wage and price increases despite a decline in average labour
productivity owing to the inclusion of the eastern German economy.
The German corporate sector reacted to this extremely unfavourable position on domestic
and international markets by a painful, but eventually successful restructuring process
including innovation, outsourcing, wage moderation as well as a balance sheet clean-up. It
should be noted that these were market-based adjustments neither initiated nor managed by
policy makers.
However, what actually forced the German government to undertake a set of major reforms
was a couple of intensifying domestic problems which depressed growth and increasingly
constrained policy makers' scope of action. In the economic downturn following the burst of
the "New Economy" bubble in the early 2000s, persistently high unemployment peaking at
more than 5 million people in 2005 as well as overburdened social security systems led to
high fiscal deficits and a protracted period of only meagre GDP growth. Thus, adjustments in
the areas of economic and social policy had become inevitable. Finally, in 2003, bold labour
market reforms were introduced, which modernised the labour market structure and lowered
the high employment threshold of economic growth. They were accompanied by fiscal
consolidation and adjustments in the social security systems, in particular the pension
system. These structural reforms have paved the way for further necessary market-based
corrections, for example in wage setting and intra-plant working-time flexibility, to take place.
They have been painful, but the economy was in much better shape afterwards. In my view,
this is the core lesson that can be drawn from Germany's experience.
It is true that economic growth in Germany was unusually dependent on foreign trade during
the last upswing between mid-2003 and early 2008, but we would be ill-advised to deduce
from this experience the need for actively propping-up domestic demand, for example via
encouraging higher negotiated wages. Rather, German exports were boosted by strong, but
ultimately unsustainable global economic growth, whereas a pick-up in private demand once
high unemployment started to decline was repeatedly burdened by exogenous forces. For
example, the need to cut excessive public deficits required a more restrictive stance of fiscal
policy and the rapid rise in energy prices in 2008 absorbed the sizeable pick-up in nominal
disposable income as the upswing was about to broaden to the domestic economy. What is
therefore often neglected is that Germany was able to serve as an important buffer for world
demand at the height of the financial crisis via its still robust private consumption as well as
large fiscal stimulus packages.
Looking ahead and bearing in mind the prospects for global economic growth as well as its
regional breakdown, the German economy is unlikely to replicate the growth profile of the
most recent upswing. In an external environment characterised by a less steep but hopefully
healthier expansion, German enterprises will naturally have to focus more on the domestic
market than before. Political coordination of this process which goes beyond the purpose of
setting a framework for a market-induced, smooth reallocation of resources is neither
necessary nor helpful.
4 Conclusion
Ladies and gentlemen,
the adjustment process the German economy underwent after reunification and during the
first years of monetary union has shown that a market-based correction even of severe
domestic structural problems is possible if the necessary reforms are addressed. In addition,
the effort and inconvenience associated with those adjustments will pay off as they lead to
strengthened economic conditions in the individual economies and the euro area as a whole.
The EMU urgently needs such market-based adjustments as they are a prerequisite for
economic divergencies to come to a halt, for sustainable economic growth within the euro
area and thereby for the continuing success of the euro.