jens weidmann : striving for a stable framework for monetary union – an old debate revisited speech by dr jens weidmann, president of the deutsche bundesbank, to the ambassadors conference, berlin, 26 august 2013. * * * introduction your excellency dr guido westerwelle minister of state ms cornelia pieper minister of state mr michael link state secretary ms emily haber state secretary mr harald braun heads of germany ’ s missions abroad your excellencies the ambassadors ladies and gentlemen thank you very much for inviting me to this conference. i'm delighted to have the opportunity to speak to you here today. inviting the president of the bundesbank of all people to an ambassadors conference might appear somewhat unusual at first glance. after all, central bankers are hardly renowned for having the most thrilling of professions. “ boring is best ” is how the former governor of the bank of england mervyn king once aptly put it. but whether we like or not, my profession has been attracting ever greater attention. rarely was monetary policy such a topic of intense public debate in the international arena as it is today. and incidentally, there are many channels which connect the federal foreign office and the bundesbank. these notably include the secondment of bundesbank employees to embassies and consulates in the major financial centres. as representatives at germany ’ s missions abroad, they provide information to interested local parties on european monetary policy, on the bundesbank ’ s role in the eurosystem and on the german banking system. but information naturally flows in the opposite direction, too. these representatives regularly report on the latest economic and monetary developments in their host countries. this benefits the bundesbank ’ s analyses and, i would hope, those of the foreign office as well. and the extent to which an additional perspective can broaden our perception of economic relationships was illustrated not least by the financial crisis. the outbreak of the crisis was not just a painful wake - up call reminding us that our theoretical models sometimes paint only a very incomplete picture of reality. work is therefore quite rightly under way – at the bundesbank and elsewhere – to develop a superior analytical toolkit that can be deployed in day - to - day work. this crisis has also been a stark reminder for us economists that looking back can offer valuable pointers for the future. “ history does not repeat itself, but it does rhyme. ” this saying by mark twain quite aptly describes economic developments

is vital for a functioning market economy. it is important, therefore, to be able to allow banks to fail without governments – and thus also taxpayers – having to foot the bill. and that is why we need the european recovery and resolution mechanism. its job will be to ensure that if a credit institution needs to be restructured or wound up, its owners and creditors will bear a fair share of the losses. this guarantees that those benefiting from investment income also carry responsibility for the associated risk. but the feedback loop between sovereigns and banks needs to be severed in the other direction, too. the close ties linking sovereigns to banks are largely the result of the substantial volumes of government bonds which banks have in their books. this is where we need to make a further incision. first, government bonds should be backed by a sufficient quantity of capital. second, the volume of loans that banks can extend to individual sovereign debtors needs to be capped. in a nutshell, over a medium - term horizon, government bonds should be treated just like other bonds or loans to enterprises. for the previously held notion that government bonds are entirely free of risk runs counter to the principle of individual responsibility as well as recent experience. appropriate risk - weighting would drive yields higher for unsound sovereigns and raise their refinancing costs. hence, the market mechanism would force these governments to exercise greater fiscal discipline. yet the inadequate capital backing required for government bonds is not the only reason why they harbour risks for financial stability. risk diversification is a key principle for investors. but this is a rule which european banks often tend to disregard where government bonds are concerned. as i mentioned earlier, european banks frequently only have bonds issued by one government in their books, mostly those of their home country. in fact, these banks ’ holdings of government bonds as a percentage of their total assets are sometimes even higher than those of banks which spread their exposures across several sovereign debtors. this tightens the negative feedback loop between banks and sovereigns further still. and that is why we need limits on large exposures to individual governments as a vital addition to appropriate risk - weighting. i am well aware that such a reform at the current juncture of the crisis might exacerbate the financing problems that some countries are experiencing. that ’ s why i think that transitional periods might be acceptable as well. but abandoning a reform like this to suit short - term considerations would be the wrong approach. work on