Axel A Weber: The macroeconomy and financial systems in normal times
and in times of stress
Dinner speech by Professor Axel A Weber, President of the Deutsche Bundesbank, at the
joint Bundesbank-Bank of France conference on "The macroeconomy and financial systems
in normal times and in times of stress", Gouvieux-Chantilly, 8 June 2009.
* * *
1 Introduction
Ladies and Gentlemen,
I warmly welcome you to this dinner on the occasion of the joint Bundesbank-Banque de
France conference here in Gouvieux. The regal ambience of this castle may help us to
momentarily forget our everyday events and concerns; however, this will certainly not last.
The global financial crisis has been keeping the world on edge for nearly two years now. The
turbulence in the international financial markets that erupted in August 2007 developed into a
full-blown global financial crisis in September 2008 with the collapse of US investment bank
Lehman Brothers. The deterioration of the situation in the financial market caused the decline
in global economic output, which was already starting to take hold, to take a dramatic turn for
the worse. Industrial and emerging economies underwent a nearly completely synchronised
sharp economic downturn in the last two quarters.
Despite growing signs that the intensity of the downturn is subsiding, past experience has
shown that the economy is generally very slow to recover from recessions that are
associated with real estate and financial crises. Although the forecast uncertainty is currently
particularly high, the crisis is likely to put a strain on global financial markets and the real
sector for some time to come.
To quote the opening lines to the Tolstoy novel Anna Karenina: "Happy families are all alike;
every unhappy family is unhappy in its own way." This pearl of wisdom is also relevant in
times of financial crisis. Although virtually the entire world was bowled over by the sheer
force of events, it is small details that set the individual transmission channels apart.
Allow me to briefly cite Germany as a case in point. In August 2007, right at the beginning of
the financial crisis, Germany was the first country to see two banks encounter difficulties,
even though we had not had any local asset price bubbles. Since the financial crisis is clearly
a global problem, the risk-bearing capacity of many internationally active financial institutions
has now been affected severely on a worldwide scale.
Turning to developments in the real sector, it is striking that Germany saw a particularly
sharp drop in overall economic activity relative to the rest of the world. Germany's GDP fell
by 3.8% in the first quarter of this year, and the Bundesbank predicts a fall of 6.2% for the
year 2009 as a whole, making Germany one of the industrial countries currently being
affected particularly seriously by the crisis.
The reasons are not hard to find. Germany has an extremely open economy and is
accordingly heavily dependent on exports. In addition, the range of German exports contains
a large share of capital goods, that is to say goods for which global demand has slumped
particularly distinctly on account of the crisis. The German example therefore demonstrates
that the growing export specialisation of an economy is associated with stronger swings in
the business cycle - at least in those cases in which the world economy is hit by a common
global shock. To complete the picture, though, it needs to be noted that the German
economy has benefited very strongly in the past few years from the cyclical stimuli emitted by
exporters and their downstream industries. Diversifying the export portfolio by region or
product, however, ultimately will not protect an open economy such as Germany's from
veritable global shocks.
Let me finally add with a view to the German banking system that lending by banks in
Germany to German non-banks grew with an annual rate of merely 0.8% on average in
precrisis years (ie 2004 to 2006). Hence, during that time, German banks profited strongly from
portfolio investments in structured financial products and booming real estate markets
abroad.
2 Financial crisis and economic research
Let us return to the global view of the financial crisis. There is no disputing the fact that a
whole cocktail of micro and macro-level factors caused the global financial crisis. The variety
of causes leading to the current crisis is also reflected in this conference's programme.
This is already the second research conference jointly organised by the Bundesbank and the
Banque de France. You will certainly be aware that research plays an important role in
central banks. Joint projects, conferences and discussions between researchers both within
and outside the world of central banking have contributed time and again to further
expanding and improving the theoretical foundations of economics and to backing them up
empirically.
The financial crisis has once again underlined clearly that, in this context, the interests of
researchers and central bankers are very closely related, and not just in the area of monetary
policy. A by-product of the crisis, so to speak, is that it has provided numerous ideas for the
advancement of research in this area. It presents an opportunity to rethink, and examine with
scepticism, some of the assumptions found in theoretical models. One example that comes
to mind is modelling how economic agents form expectations, or the degree of sophistication
with which the financial system can be integrated into macro models.
There is another quite interesting question from the empirical side. How can the available
data in the area of the financial world be better used to identify systemic risks - or do they
need to be supplemented by certain additional data? Some of the papers presented at this
conference have found very promising approaches.
Answers to these and similar questions will amplify the meaningfulness and practical
relevance of future research findings. This is of great interest to central banks, not least
because we use the knowledge gained from research as an input in our monetary policy
decisions. Allow me to discuss two relevant cases in which current events have stimulated
research.
2.1 Segmentation in the money market
One concerns the question of how central banks can most effectively supply the financial
system with liquidity. After the US investment bank Lehman Brothers had filed for insolvency,
the ability of whole financial market segments to function was severely constrained, requiring
central banks around the world to inject a massive volume of liquidity into the money
markets.
Against this background, a Deutsche Bundesbank study1 identified segmentation in the
German money market. For the behaviour of German banks in the money market, the study
finds signs that the size of a bank has a systematic effect on the price of liquidity. Taking a
number of other factors into account, larger banks end up paying less for liquidity than
smaller banks. This effect is even more pronounced when there is an increase in the
imbalance of the liquidity positions.
Thanks to its very broad range of counterparties, the Eurosystem was able to ensure that all
banks active in the euro area, whether large or small, were given equal access to the ample
supply of central bank liquidity from the beginning of the financial crisis onwards. In addition,
over a year ago the Eurosystem had already expanded the range of maturities of its
refinancing operations and now provides liquidity in the form of a fixed-rate tender with full
allotment with a maturity ranging from one week to 12 months.
As is borne out by the results of our study, these measures are likely to have made it easier,
particularly for the smaller institutions that are less active in the money market, to obtain
access to liquidity in these turbulent times. The Eurosystem has thus made a decisive
contribution to stabilising the European money market, including the longer-term maturity
segment.
2.2 Monetary policy issues
Moreover, the financial crisis has pushed the interplay between monetary policy and financial
market developments back into the centre of attention. In the past, research was often
focused on how central banks dealt with growing asset price bubbles. However, reality
indicates that this focus was too narrow. After all, maintaining an overly expansionary
monetary policy for too long in some currency areas was probably one of the framework
conditions that contributed to the emergence of the global financial crisis.
Boom-bust cycles in financial markets cannot develop completely independently of monetary
policy. One of the good things a stability-oriented monetary policy can do is to monitor such
movements in the financial sector and - where possible and consistent with the price stability
mandate - to dampen them. This requires a more symmetrical monetary policy that already
recognises growing risks in times when monetary and credit aggregates are growing
dynamically, asset prices are skyrocketing and market participants' perception of risk is
decreasing.
I think the Eurosystem is well equipped for this task. First, our (often-criticised) monetary
analysis is a valuable analytical tool that forces us to include the medium and long-term
development of monetary and credit aggregates in our monetary policy decision-making
process. Second, the liquidity policy crisis measures taken thus far still enable us to exit from
the policy of ample liquidity injection quite easily. Should the overall economic picture
improve, the Eurosystem will absorb the extra liquidity provided as quickly as possible. In this
manner, we will counter potential risks to price stability early on and, at the same time, make
a contribution to avoiding future financial crises.
3 Conclusion
Ladies and gentlemen, this conference will be dealing with a host of other issues I could
discuss at great length. However, allow me to follow a particularly useful suggestion to dinner
speakers: "Start at the beginning. And when you get to the end, stop." And this is where I
have arrived. I thank you for your attention and wish everyone "bon appétit".