Jens Weidmann: Rebalancing Europe
Speech by Dr Jens Weidmann, President of the Deutsche Bundesbank, at Chatham House,
London, 28 March 2012.
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1. Introduction
Thank you, Mr Popham, for the words of welcome. This is a very special event for me.
Chatham House has been held in great respect for almost a hundred years - not only in the
UK but also in Germany and across the globe. The privilege I feel is underscored by the
distinguished audience that has gathered here today. I feel truly honoured to speak to you in
such a famous venue.
About six weeks ago, I came across an article in the Frankfurter Allgemeine Zeitung, a
leading German daily. The author of the article, an economist at the London School of
Economics, had chosen the title: "The fanatic central bank - where there is a will, there is
always just one way".
Well, I did come here wearing the hat - or rather the suit - of a central banker, and of a
"Bundesbanker" at that. The ideas that I am going to present might therefore be seen as
fairly conservative and principled. But, as I hope to convince you, they are still well short of
being fanatic. I did not come here to deliver a lecture. I am, in fact, deeply convinced that
sharing and discussing ideas will lead to better solutions. During the next quarter of an hour,
I will try merely to outline my line of reasoning in order to leave enough scope for discussion.
But first, a brief look at where we currently stand in these challenging times.
2. Europe off balance
We face a crisis that is no longer confined to individual countries. Throughout Europe, it
weighs heavily on people's minds and challenges the viability of monetary union in its current
form. It is obvious to all of us that the crisis has to be resolved and future crises must be
prevented.
The first step must be to contain the crisis, to prevent it from spreading. To this end,
policymakers have surrounded the crisis with a "Wall of Money", which has meanwhile
reached a height of €500 billion. Ring-fencing is certainly a sensible approach, but just like
the "Tower of Babel" the "Wall of Money" will never reach heaven. If we continue to make it
higher and higher, we will, in fact, run into more worldly constraints - both financial and
political ones.
And, whether we like it or not, we are also changing the rules of the game in monetary union
and might set incentives that lead to new problems in the future.
In any case, we must realise that all the money we put on the table will not buy us a lasting
solution to the crisis. As Mervyn King frequently and rightly states: "all we can buy is time" -
time that must be used to address the root causes of the crisis.
I think we all agree that the crisis has two major causes: first, the macroeconomic
imbalances that have built up in recent years and, second, public and private debt that has
ballooned in some member states. Both problems must eventually be addressed. Europe
has to be rebalanced.
But views on how to achieve this goal differ. Given the unprecedented character of the crisis
and its complexity, this seems only natural to me. Still, I hope that the fault lines will converge
at some point in the future and that a consistent approach will emerge.
Now, what are the specific questions we have to address?
3. Rebalancing Europe
Frankly, there are about a million questions to be answered. But to simplify matters a bit and
to keep my outline reasonably short, I will ignore some of them. Altogether, I will address just
two questions today.
The first one relates to the macroeconomic imbalances. Their most prominent symptom are
diverging current accounts - countries such as Greece run persistent current account
deficits, while countries such as Germany run persistent surpluses. The question is: which
countries have to adjust? Those with a current account deficit? Those with a surplus? Both?
The second question looks at the additional problem of public debt. It is obvious that public
deficits have to be brought down significantly. But is it sensible to consolidate while
simultaneously correcting macroeconomic imbalances by deleveraging and by rebalancing
the current account?
3.1 Rebalancing current accounts
Let us begin by looking at the first question. Normally, exchange rate movements are an
important channel through which unsustainable current account positions are corrected -
eventually, deficit countries devalue, while surplus countries revalue their currencies. The
reaction this triggers in imports and exports then helps to bring the current account closer to
balance.
In a monetary union, however, this is obviously no longer an option. Spain no longer has a
peseta to devalue; Germany no longer has a deutsche mark to revalue. Other things must
therefore give instead: prices, wages, employment and output.
Which brings me back to my original question: which countries have to adjust?
The typical German position could be described as follows: the deficit countries must adjust.
They must address their structural problems. They must reduce domestic demand. They
must become more competitive and they must increase their exports.
But this position has not gone uncontested. Indeed, a number of renowned economists take
a different view. They fear that it would be too much of a burden for the deficit countries
alone to adjust. They consequently suggest that surplus countries should shoulder at least
part of the burden.
To avoid confusion, it is important to make a distinction at this point. A distinction between
the adjustment as such and the burden it entails. Only the burden can be shared. I think most
people would agree that the adjustment itself has to take place in the deficit countries. It is
true that surplus countries have benefited through higher exports. But ultimately, it was the
deficit countries that operated an unsustainable model defined by a credit-fuelled boom in
domestic demand, and this model has to be reformed. Not every deficit country needs the
same reforms, of course, but all require some sort of adjustment.
By contrast, it is sometimes suggested that rebalancing should be undertaken by "meeting in
the middle", that is by making surplus countries such as Germany less competitive. This
suggestion implies that the adjustment as such would be shared between deficit and surplus
countries. But the question we have to ask ourselves is: "where would that take us?"
The competitive edge some economies enjoy did not come for free. It is the result of often
painful adjustments among workers and within firms. Giving part of it up to ease the pressure
on deficit countries might make these countries better off in relative terms. But would it not
make everyone poorer in absolute terms?
We have to acknowledge that Europe is not an island but part of a globalised world. And at
the global level, we are competing with economies such as the United States or China. I ask
you: how can we, how can Europe succeed in this world if we willingly give up our hard-won
competitiveness? To succeed, Europe as a whole has to become more dynamic, more
inventive and more productive.
To make a more popular comparison: imagine that in the Champions League Barcelona
were denied Lionel Messi just so that the other teams, including Bayern Munich, had a better
chance of winning. Would that be a sensible way to rebalance the competitiveness of
Europe's top teams?
In my view, we will gain nothing if we try to rebalance by actively shifting weights at both
ends of the scale.
A second point is this: a large proportion of the current account deficits and surpluses result
from trade with countries outside the euro area. Even if surplus countries expanded their
imports, this would help their fellow euro-area countries to increase their exports only
marginally. The latter must first offer something other euro-area countries would want to buy
from them rather than from someone else.
To achieve this, the deficit countries must take measures that unlock their potential to
increase productivity and improve competitiveness. This would considerably reduce the cost
of adjustment and the time it takes.
The OECD and other organisations have for years been promoting a long list of reforms.
These aim at making labour markets more flexible, opening up product markets and making
the public sector more efficient. A number of reforms have already been announced and, in
some instances, implemented in countries such as Portugal, Spain and Italy. And we are
already seeing some promising results, especially in Ireland. But despite these first steps,
there is still a long way to go.
Such an adjustment will initially place a huge burden on the people in deficit countries, even
taking into account the extraordinary boom in the years prior to the crisis. But will the burden
be too heavy to bear? A central fear is that of deflation. Unless productivity growth increases
miraculously, it is certainly true that prices and wages will have to fall in many cases. But we
must not confuse such a one-time adjustment with full-fledged deflation.
And we must acknowledge that surplus countries are already helping to ease the burden of
adjustment. What are the rescue packages other than publicly guaranteed interim loans to
facilitate the adjustment?
Another thing we should not forget is this: of course, surplus countries will eventually be
affected as deficit countries adjust. Not every country on earth can run a current account
surplus - unless we trade with "space aliens" as Paul Krugman recently suggested.
As the deficit countries import less and become more competitive exporters, surplus
countries will run lower surpluses. The key issue is whether this happens as a result of
market processes or as a result of efforts to fine-tune aggregate demand in the euro area. I
would welcome the former, but I object to the latter.
3.2 Consolidating public budgets
Reforms aimed at promoting growth are an important part of the adjustment process - I think
everybody agrees on that. But what about consolidation? A frequently cited argument is that
it would be too much of a burden for countries to correct macroeconomic imbalances and
consolidate public debt at the same time. The result, it is said, would be a vicious cycle of
falling demand and slowing economic growth.
It is true that consolidation might, under normal circumstances, dampen economic growth.
But structural reforms and consolidation are often hard to disentangle. For example, a
bloated public sector or very generous pension system are both a drag on growth and a
burden on the budget. And another question is: are these normal times? It is quite obvious
that everybody views public debt as a major threat. The markets do, politicians do and
people on the street do.
A wide-spread lack of trust in public finances weighs heavily on growth: there is uncertainty
regarding potential future tax increases, while funding costs rise for private and public
creditors alike. In such a situation, consolidation might inspire confidence and actually help
the economy to grow.
In my view, the risks of consolidation are consequently being exaggerated. In any case, there
is little alternative. The Chancellor of the Exchequer George Osborne recently said: "You
can't borrow your way out of debt". In my opinion, he is absolutely right; the only promising
approach is to "cut" your way out.
3.3 A bigger role for the Eurosystem?
"Stop", some might say at this point, "it is true that member states will eventually have to
reform, and governments will have to tighten their belts. But that still leaves the ECB.
Shouldn't the ECB temporarily ease the pressure even more?"
Usually, the boundary between monetary and fiscal policy is clear-cut for good reason. Once
a central bank becomes involved in fiscal policy, it eventually loses its independence and its
credibility as an inflation-fighter. This is the story told not only by economic theory but also by
historical experience.
Just think about the unholy "marriage" between Banca d'Italia and the Italian treasury in
1975. Banca d'Italia promise of marriage was to act as buyer of last resort for government
bonds. Until the "divorce" in 1981, Italian government debt more than tripled, while average
inflation stood at 17%. After Banca d'Italia was granted greater independence, inflation rates
began to fall significantly. Or think of the UK: after the new monetary framework was
established in 1993 and the Bank of England was granted greater independence, inflation
rates also came down.
However, during a crisis the boundary between monetary and fiscal policy can become
blurred. To contain the crisis, central banks have to act more flexibly and accept more risks
on their balance sheets. I think this is unavoidable, and the Eurosystem has already
undertaken tremendous efforts in this direction.
But although there are times when things are not black and white, I do not think clear
distinctions are completely irrelevant. This is particularly pertinent in a monetary union where
member states retain their autonomy in fiscal and economic policy. In such a setting,
governments have an incentive to accumulate debt; this is known as a deficit bias. To
counter that incentive, the EU Treaty explicitly prohibits monetising public debt.
If central banks went down this route, they would be redistributing fiscal risks and costs
among the taxpayers of the euro area. However, this is the prerogative of national
parliaments. If central banks' balance sheets are used to bring about redistribution and if the
implied costs become apparent, this could have a highly corrosive effect on the credibility of
central banks and on their independence. Credibility and independence are, however,
indispensable to maintain price stability and to ensure the acceptance of monetary union as
a whole. This would be too high a price to pay, and again we would merely be buying time.
4. Conclusion
This brings me back to the beginning of my speech: we must not just contain the crisis, we
must resolve it. To achieve this goal, we must address two central issues: the problem of
excessive public debt and the problem of macroeconomic imbalances.
Countries with current account deficits and excessive public debt must act. They must
implement structural reforms and they must consolidate their budgets to get back onto a
stable growth path. Of course, adjustment is a huge challenge for the people in these
countries but the status quo is clearly unsustainable, and doing nothing will lead to even
sharper corrections. By contrast, taking up the challenge will open the doors to a more stable
and more prosperous future.
In my speech, I have focused on the member states. This is not to deny that an overhaul of
the institutional framework of monetary union is equally pressing. Member states have made
it clear that they want to retain their autonomy in fiscal policy. But in that case we need
stricter rules to counter the deficit bias that I mentioned before. Some progress has been
made on this issue. Now, it is decisive that the rules are applied rigorously.
In addition, placing monetary union on a sounder footing is closely linked to regulatory
reforms in the financial system. But I will leave these important issues for the discussion,
rather than going into them right now.
Admittedly, the crisis has opened our eyes to structural flaws at many levels. But this
sobering experience has also provided the impetus to correct these shortcomings. The time
has come to move from containing the crisis to resolving it. If we have the will to make the
right choices, we will be able to rebalance Europe and lay the foundation for a stronger, more
stable monetary union. As Winston Churchill said: "Difficulties mastered are opportunities
won".
Ladies and gentlemen, I have presented my ideas to you and I now look forward to
discussing them with you.
Thank you for your attention.