jens weidmann : sound public finances for a stable monetary union speech by dr jens weidmann, president of the deutsche bundesbank, at the institute for law and finance, frankfurt am main, 12 december 2012. * 1. * * introduction professor baums ladies and gentlemen thank you very much for your invitation. i am delighted to have the opportunity to speak to you today at the institute for law and finance. there are many transmission channels between the “ house of finance ” and the bundesbank. the lively exchange of ideas between the two institutions has proven to be exceptionally fruitful, and it gives me great pleasure to further strengthen this dialogue today. i will, however, resist the temptation to speak about “ regulatory and fiscal policy aspects of the change of course in energy policy ”. fascinating though this subject may be, giving a qualified lecture on this topic might ask a little too much of the central banker standing before you. and after all, it is the bundesbank itself that regularly warns against too much being asked of central banks. these warnings normally centre around central bankers ’ traditional fears about an excessively close relationship between monetary policy and fiscal policy. mervyn king, governor of the bank of england, once summed up these concerns in slightly exaggerated terms by saying : “ central banks are often accused of being obsessed with inflation. this is untrue. if they are obsessed with anything, it is with fiscal policy. ” but where does this “ obsession ” come from? why does escalating government debt pose problems for monetary policy? the reasons for this are not immediately apparent. after all, monetary policy – in the industrial countries, at least – is usually independent and equipped with a clear mandate to safeguard price stability. one could, therefore, incorrectly conclude that unsound public finances are not relevant to monetary policy. however, a closer look reveals that monetary policy is reliant on fiscal policy with regard to safeguarding price stability. escalating public debt inevitably drives prices higher. but growing government debt can still pose a threat to price stability even before it begins to spiral out of control. furthermore, a host of empirical studies suggest that high levels of public debt dampen growth over the long term. seen from this angle, the prevailing situation in the euro area – but also in other industrial countries such as the united states and japan – might lead one to assume that there is a broad consensus in favour of rapidly and resolutely reducing budgetary deficits

. a crucial requirement of the second option – returning to a system of national fiscal responsibility – is that solvency risks are not extensively mutualised and that financial market bis central bankers ’ speeches players bear the risks of their investment decisions themselves. this would lead to financial market discipline playing an even greater role. however, with a view to a future stable regulatory framework, it is not helpful that decisions have been made that weaken this disciplinary effect. regardless of which path monetary union takes, it must be ensured that, in future, budgetary imbalances of one country do not automatically jeopardise financial stability. otherwise, other countries would feel compelled to use all means necessary to prevent a sovereign insolvency for the sake of safeguarding financial stability, so that a disciplining effect on fiscal policy would be unlikely from the outset. for this reason, too, a resilient financial system is central to a stability - oriented monetary policy and a functioning monetary union. a well - structured banking union, which severs the problematic ties between sovereigns and banks, can make an important contribution to this. i could easily speak about banking union for another half an hour, but i will leave it at that for now. instead, i would like to sum up this issue as follows. price stability requires sound public finances, and sound public finances call for a coherent framework for monetary union. however, the question of designing the overall framework does not solve the problem of the current deficits. 4. consolidation versus growth since the outbreak of the sovereign debt crisis, a number of euro - area countries have introduced steps to consolidate their budgets. critics, such as the american economist paul krugman, caution that such consolidation will cause more harm than good in the present circumstances. in order to reduce the deficit, he argues, countries either have to cut public spending or increase taxes. but, he adds, both of these measures are the wrong remedy in the light of the current economic slowdown as they would further dampen the already weakened aggregate demand and hence trigger a downward economic spiral. this debate has gathered further momentum following a study performed by the imf2 on the size of fiscal multipliers in the crisis. this multiplier indicates how strongly economic growth reacts to a change in budgetary policy. the imf ’ s study arrives at the conclusion that the multiplier amounts to approximately 1. 7 and is thus larger than originally assumed. this would imply that growth losses would be much greater