Jens Weidmann: Towards a more stable monetary union - what is
the right recipe?
Keynote speech by Dr Jens Weidmann, President of the Deutsche Bundesbank and Chairman
of the Board of Directors of the Bank for International Settlements, at the Conference "Economic
and Monetary Union - Deepening and Convergence", Linz, 5 July 2018.
* * *
1 Introduction
Dear Ewald
Dear President Mahrer
Ladies and gentlemen
It is always a great pleasure for me to visit Austria.
One year ago, almost to the day, I was in Vienna to talk about the future of the monetary union.
Back then, the key issue was how to ensure that the union is permanently preserved as a union
of stability. Today, we are still dealing with this issue. In fact, it concerns us now more than ever.
The meeting of the EU's heads of state or government last week marked yet another milestone
on this journey.
As Austria has just taken over the presidency of the Council of the EU, it plays a key role in
moderating the reform process. In that sense, we are in exactly the right place to discuss the
way forward for the economic and monetary union.
I am particularly pleased to be here in Linz. Since it is my first visit, I am looking forward to tasting
Linzer Torte, the nutty jam-filled cake named after the town.
The first recorded recipes for Linzer Torte date from the 17th century. It is therefore believed to
be the oldest known cake recipe in the world. And from the outset, there wasn't just one recipe,
but a range of variants with slight differences in ingredients and ways of preparing it.
Thus, there is one problem that every baker has to solve: which is the "right" recipe?
When we talk at this conference about the future of economic and monetary union, we are in a
somewhat similar position. There are a large number of proposals on the table concerning the
future design of the euro area. All proposals share the ambition to make the monetary union
more stable and more resilient. But it is an open question which of the recommendations are
appropriate to this end.
Allow me to approach this question in three stages. I will set out with the basic ingredients for a
stable union. As you will see, these are largely not in dispute. Then I will turn to the institutional
framework which, one might say, resembles the fundamentals of baking. Finally, I will discuss
some recent reform proposals - or specific baking instructions, if you like.
2 Basic ingredients
Turning to the basic ingredients, you won't be surprised that, as a central banker, my
considerations start from monetary policy geared to price stability.
The European treaties provide us with an ideal framework for this: the Eurosystem is equipped
with wide-ranging independence and has a clear mandate with price stability as its primary
objective. And that has paid off. With an inflation rate of 1.7% on an average of the past 20 years,
price developments have broadly been in line with our definition of price stability. The promise of
a stable currency has thus been kept.
But the success of monetary policy also depends on conditions which it cannot create on its
own. In particular, it is dependent on a stable financial system.
After the "Great Inflation" of the 1970s, advanced economies experienced a long period of
remarkable economic stability that came to be known as the "Great Moderation". Academics
were still debating the specific role of monetary policy in bringing about this period of economic
calm when the global financial crisis ended it.
Important lessons have been drawn from the crisis. The regulation of banks, insurers and
financial markets has been strengthened. And, along with the reform of traditional supervision,
macroprudential policy has been established as a new policy field. It can be deployed against
regional and sectoral pockets of exuberance in case they are suspected of posing a systemic
risk.
As the sovereign debt crisis has painfully reminded us, such risks can also arise from unsound
public finances.
In a monetary union, the risk of excessive debt is greater than in countries which have their own
currency. Saying that, I do not so much mean the lack of the option to service government debt
simply by printing money. For a central bank committed to price stability, that is a complete
nonstarter anyway - whether in a monetary union or not.
Something else is more important: in a monetary union, the incentive to run up debt is greater
because the negative consequences are smaller. For instance, interest rates may not rise as
much in response to fiscal profligacy. In order to prevent such behaviour, the member states
agreed on joint fiscal rules. But rules can only be of help where there is a will to observe them.
In retrospect, ever since the euro was introduced, there has not been a single year in which all
countries have kept their new borrowing below the ceiling of 3% of GDP. The Commission
projects that this will be achieved this year for the first time. That would be good news indeed, but
it is no cause for jubilation, as the Stability and Growth Pact calls for more to be achieved in two
respects.
First, the 3% mark is not a benchmark, but a ceiling. Fiscal policy should be focused on the
medium-term objective, which requires that member states have a structurally close-to-balance
budget.
Consequently, we have to consider the economic environment when assessing fiscal policy. And
the underlying conditions have improved remarkably in recent years: the robust economic upturn
means higher revenues from taxes or social security contributions and lower outlays for
unemployment benefits.
Moreover, government interest spending has fallen thanks to low interest rates. According to
Bundesbank calculations, this has generated savings of approximately one trillion euros in the
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euro area over nine years.
In times such as these, fiscal policy should not be satisfied with merely adhering to the 3%
threshold: it should be aiming for the zero mark or surpluses. That would give governments the
leeway they need to take fiscal measures in the future, when economies may enter another
downturn.
It would also help to reduce the overall debt burden, which - and that is my second point - is
much too high in some countries. As things currently stand, just 7 out of 19 euro area member
states meet the debt ceiling of 60% of GDP. For the euro area as a whole, debt stood at 87% of
GDP last year. And these figures do not account for implicit future burdens in connection with
demographic change. When considering such implicit debt, public finances in most countries -
and certainly including Germany - face demanding challenges.
Elevated debt levels must not become permanent, also because persistent breaches harm the
binding effect of the common fiscal rules. Benjamin Franklin already warned us that it is easier to
prevent bad habits than to break them.
Moreover, high levels of government debt limit the fiscal room for manoeuvre. They make it
difficult to channel government spending towards investment, weaken resilience and thereby
raise uncertainty, which is very likely to dampen economic growth in the long term.
And this brings us to the last basic ingredient for a stable monetary union: competitive
economies which are resilient enough to withstand or recover from adverse shocks.
Unlike countries with their own currency, euro area member states cannot resort to the
instruments of monetary policy and exchange rate flexibility when they face country-specific
shocks. And the single monetary policy looks only at the euro area as a whole. It can respond to
the specific situation of individual member states only in so far as they affect euro area
aggregates.
In the wake of the crisis we witnessed that some countries bounced back quite quickly from the
economic slump, while in others growth remained low and unemployment stayed high for a long
time. If the monetary union is to function free of tensions, member countries have to improve the
underlying structures so that their economies become - or remain - competitive and resilient.
One element, for instance, is that easier market entry for new enterprises - and easier market
exit for failing firms - can unlock the innovative potential of companies. Both would facilitate what
the great Austrian economist Joseph Schumpeter called "creative destruction", which he
described as a process that "incessantly revolutionizes the economic structure from within,
incessantly destroying the old one, incessantly creating a new one."
OECD research suggests that policy-induced exit barriers matter for productivity growth,
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because unproductive firms that do not exit the market lock workers into unproductive jobs.
According to OECD estimates, reducing barriers to restructuring could, for instance, add more
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than 2 percentage points to productivity growth within laggard firms in Italy.
Beyond pro-competitive regulations for product markets, there is a wide range of possible
policies for enhancing resilience, including such diverse areas as the quality of institutions,
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political stability, infrastructure and labour market reforms.
3 Fundamentals of baking: an act of balancing
Ladies and gentlemen
We have identified four basic ingredients for a stable union: monetary policy geared towards
price stability, a sound financial system, healthy public finances, and resilient economies.
Four basic ingredients are also needed for shortcrust pastry, the base of the Linzer Torte: flour,
sugar, eggs, and butter.
One secret of the pastry is the right level of gluten. It provides the dough with stability and
elasticity, and it forms when proteins in the flour build a network of chains. This happens by
adding liquid to the flour and kneading the mixture. However, the gluten content must be limited in
order to produce a tender short pastry. Too much gluten makes the dough tough. Therefore, it is
important to refrain from kneading too much.
A similar act of balancing is required for a stable monetary union, when we frame the basic
ingredients within a crisis-proof institutional set-up to provide the right incentives for responsible
behaviour. The particular architecture of monetary union doesn't make things any easier. In the
euro area one single monetary policy co-exists with 19 autonomous fiscal and economic
policies.
The autonomy reflects and enables the diversity of member states in terms of their economic
and social structures, which is an expression of our societies' distinct preferences and identities.
In my view, such great variety is an asset and contributes to Europe's richness. It is not by
chance that the official motto of the European Union is "in varietate concordia" - "united in
diversity".
But the asymmetric construction also makes the monetary union vulnerable.
The original recipe as enshrined in the Maastricht Treaty focussed on a no-bailout clause that
would unleash the disciplining power of financial markets. This framework did not prevent the
crisis, nor did it provide any mechanisms or tools to overcome it.
Since the crisis, however, the design of the union has already been adapted in some important
aspects. The establishment of the ESM as a permanent rescue facility and the creation of the
banking union remedied design weaknesses that were either ignored or overlooked when
monetary union was founded.
However, the euro area is not yet permanently crisis-proof. And that's why there is a broad
consensus that further institutional reforms are needed.
The proposals that are currently under discussion differ on one point in particular, namely on the
extent to which risks should be shared. Some place their faith in greater joint liability, while others
would like to strengthen individual responsibility.
However, the true challenge consists in striking a balance between actions and liability. That
means the decision-making power and responsibility for the effects of the decision have to be
placed on the same level. Responsible decisions are taken only if the decision-makers also bear
the consequences. Why, for example, should a government refrain from risky policies if, at the
end of the day, the community has to pay the bill?
In the 2010 sequel to the classic movie "Wall Street" the fictional character Gordon Gekko,
played by Michael Douglas, explains the problem more eloquently than I ever could: "Moral
hazard is when somebody takes your money and is not responsible for it."
Rebalancing actions and liability by no means rules out a greater sharing of risks. In order to
maintain the balance, however, the relevant powers would have to be transferred along with the
risks to the European level.
Having said that, I can identify very few member states that display a willingness to forgo national
competences. Quite the opposite: over the past few weeks it has again become apparent that
those who may call the loudest for greater risk sharing explicitly insist on their national
sovereignty in fiscal policy matters.
And that highlights the current dilemma: demanding greater solidarity of the community and, at
the same time, rejecting any transfer of competences to the community does not match up. The
saying "You can't have your cake and eat it too" also applies to this trade-off between national
sovereignty and risk sharing.
4 A closer look at some instructions
Ladies and gentlemen
At last week's Euro Summit in Brussels, the heads of state or government identified the need for
further discussion in many areas with regard to the framework underpinning the EMU. This has
prompted a great deal of criticism and calls for faster decisions. But I am in favour of putting
thoroughness before speed. Further debate ought to take priority over preconceptions or hasty
decisions.
Nevertheless, the governments confirmed that further reductions in risks are necessary before
the banking union can be completed by introducing the European Deposit Insurance Scheme
(EDIS).
The Bundesbank has long recommended that risks which banks incurred under national
responsibility should not be retroactively mutualised through the EDIS. To a casual observer the
proper sequencing has always been a matter of common sense. In the end, when you have just
crashed your car, it's too late to take out insurance with comprehensive coverage.
Obviously, reducing risks requires addressing the legacy of non-performing loans on banks'
balance sheets. But we cannot stop there. Going forward, more needs to be done to rein in future
risks by severing the sovereign-bank nexus. It is crucial that we abandon the preferential
treatment of sovereign debt in banking regulation. If this matter is not resolved, further steps
towards completing the banking union would imply a significant increase in fiscal risk sharing.
In the coming months, discussions will also focus on possible new fiscal tools.
At this point, allow me a general word of caution. We need to be mindful of public debt: higher
budget deficits today mean higher taxes tomorrow.
Given the burden of government debt in the euro area, the creation of additional possibilities for
borrowing is precisely what we should not be aiming for. Instead, we should start by considering
the specific tasks that are to be performed at the European level and the value added that these
tasks are supposed to create.
As I set out earlier, the promotion of competitiveness and convergence is an important objective.
A euro area budget designed for this purpose could be a welcome advancement and refinement
of the existing European structural and investment funds.
That does not necessarily mean an increase of the overall size of fiscal transfers. Instead, it
would be desirable for this to be part of a fundamental reform of the EU budget as a whole, with
the focus resting squarely on designing and efficiently carrying out projects that can deliver
added value for Europe.
As far as new European stabilisation facilities are concerned, we have to keep in mind that a lot
of the declared stabilisation objectives can be achieved in a much less complex national form
within the existing framework.
In the event of a recession, member states with sound finances can themselves take fiscal
countermeasures. There is nothing in the European fiscal rules that stands in the way of such
action. And if a crisis threatens to overwhelm a member state financially, the ESM is on hand to
grant aid on condition that reforms are carried out.
I believe there is considerable promise in strengthening the ESM. However, it is important to
preserve the principle of solidarity in connection with joint agreements, and not to weaken it by
granting largely unconditional access to the programmes.
Finally, further progress towards a capital markets union would foster private risk sharing within
Europe and, in this way, facilitate macroeconomic adjustment following asymmetric shocks.
After all, we should bear in mind that in federations like the USA and Canada, economic risks are
primarily shared through private channels. By comparison, fiscal policy takes a back seat, as
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only 10% to 25% of risks are shared in this way.
The Bundesbank is therefore explicitly backing the project of the European capital markets union.
I am sure that this will be one of the key projects as we move ahead.
5 Conclusion
Ladies and gentlemen
A permanently stable economic and monetary union will benefit all of us. It will create the basis
for a stable currency and robust economic growth, thus ultimately safeguarding our prosperity in
Europe.
It would be wonderful if there were a single and straightforward recipe for eliminating EMU's
shortcomings. But, I am afraid, there is no such thing as the "right" recipe. Instead, I have
stressed that any viable reform must entail a rebalancing of actions and liability.
In a similar vein, what makes the Linzer Torte so distinguishable is the combination of the typical
lattice of dough and the layer of jam beneath. Nevertheless, the recipe can be adapted to different
tastes. Our Austrian hosts may forgive those who choose raspberry jam for their cakes. I, for my
part, prefer the traditional Linzer Torte with redcurrant jam.
When it comes to preferences, however, it is essential that voices from all over Europe are
heard in the debate on the future of EMU. And that is exactly why conferences like this one are so
important.
Karl Popper, another great Austrian thinker, went even further when he wrote: "All that is needed
is a readiness to learn from one's partner in the discussion, which includes a genuine wish to
understand what he intends to say. If this readiness is there, the discussion will be more fruitful
the more the partners' backgrounds differ. Thus the value of a discussion depends largely upon
the variety of the competing views. Had there been no Tower of Babel, we should invent it."
Thank you for your attention.
1
Deutsche Bundesbank, The development of government interest expenditure in Germany and other euro-area
countries, Monthly Report, July 2017, 33-67.
2
M A McGowan and D Andrews (2016), Insolvency Regimes And Productivity Growth: A Framework For Analysis,
OECD Economics Department Working Papers, No. 1309.
3
M A McGowan, D Andrews and V Millot (2016), Insolvency Regimes, Technology Diffusion and Productivity
Growth: Evidence from Firms in OECD Countries, OECD Economics Department Working Papers, No. 1425.
4
In particular, a Bundesbank study has argued that greater wage flexibility would probably have helped overcome
the crisis and safeguard employment in some euro area countries. See Deutsche Bundesbank, Wage
dynamics amid high euro-area unemployment, Monthly Report, December 2016, 33 55.
Allard, C, P K Brooks, J C Bluedorn, F Bornhorst, K Christopherson, F Ohnsorge, T Poghosyan and an IMF staff
team (2013), Toward a Fiscal Union for the Euro Area, IMF Staff Discussion Note, 13/09.