“The communitisation of fiscal policy is not envisaged” Interview for the supplement „Wohlstand für Alle – Vorteil Marktwirtschaft“ of the Ludwig-Erhard-Stiftung
Interview with Jens Weidman conducted by Dorothea Siems.
The coronavirus crisis is shifting the balance between the state and the economy. In view of the great future challenges we face, should the state permanently play a bigger role?
It was right for the state to take massive action during the pandemic to support people and the economy. At the same time, the crisis itself has shown just how innovative our economic system is. The example of vaccine development illustrates that the role of the state and the support it provides cannot simply be measured by the size of government expenditure. The underlying research received government funding and was carried out in state universities. Yet the swift success we have seen was thanks to innovative and courageous businesspeople who used that research to develop vaccines. The state is responsible for the overarching framework and, for example, providing infrastructure, a good education system and research funding. But the task of developing and supplying convincing products should still be left to the private sector.
Does the same apply to climate change? At this year’s World Economic Forum, Federal Chancellor Merkel and European Commission Presidentvon der Leyenargued that more state intervention is needed in this area.
That isn’t a contradiction. For effective climate action, we need adequate pricing of CO2 emissions so that people adjust their behaviour accordingly. At present, the prices for CO2 emissions do not sufficiently reflect their impact on the climate. Here, the state can take action in the form of emissions trading or a carbon tax. The price mechanism is very powerful and efficient. It should therefore play a pivotal role in tackling this problem. However, an ambitious and credible path for reducing emissions as well as international cooperation on cross-border effects will also be crucial.
The big tech companies are based in the US and China. Should Germany and the EU opt for a strategic industrial policy to pave the way for similar market leaders with certain monopolistic tendencies?
Monopolists are not usually more innovative than companies with competitors. You may recall what it was like when there was still a telecommunications monopoly in Germany. Competition brought huge improvements and expanded the range of services on offer – as well as cutting prices. Would we be likely to succeed in starting a new Silicon Valley from scratch in Stuttgart Valley, or anywhere else for that matter? The crisis has shown that we have leading businesses in key areas. To ensure that more of these innovative businesses spring up, we need to see improvements, for example, in the conditions for venture capital or for research cooperation between universities and enterprises.
The pandemic is leaving a major dent in the government budget. Is the sustainability of government finances in jeopardy?
No. We were in a relatively good position when the pandemic first hit, and the associated burdens will probably be largely temporary. The crisis has shown how important it is to be able to take ad hoc fiscal action. At the same time, we are facing major fiscal challenges, particularly in terms of addressing demographic change. That is why we need to return to a sound fiscal path after the pandemic.
So the debt brake isn’t obstructing investment?
Absolutely not. First of all, the debt brake has proved its worth, and it has not stood in the way of the massive fiscal response to the pandemic. Relative to economic output, government spending – excluding interest expenditure – has been rising substantially for quite a few years now, and will probably have reached new highs by the end of the crisis. In the end, it is more a question of prioritisation than of debt financing. Of course, the debt brake could be adjusted to take account of investment too. But then it would be crucial to ensure that its design still reliably underpins sound government finances. I’m not sure whether this would ultimately succeed. In any case, national and European fiscal rules must also help to shield the single monetary policy from pressures caused by unsound fiscal policy in order to ensure that monetary policy does not stay expansionary any longer than is needed to safeguard price stability.
For the first time, the European Union is incurring joint debt on a grand scale. There are already growing calls to make the NextGenerationEU recovery fund permanent. Would that make sense?
Weidmann: Emergencies like the pandemic are exceptional events; they can justify exceptional joint borrowing. Permanent solutions, on the other hand, need to fit into the regulatory framework of the monetary union. This framework does not envisage a communitisation of fiscal policy. The member countries insist on their right to determine their own fiscal policy. But that means they also have to shoulder the responsibility for their own debt. Otherwise, action and liability part ways, and there are undesirable incentives to take on excessive debt.
And what about the funding of joint EU projects?
Joint tasks involving shared decision-making are already funded jointly. That makes particular sense when there are cross-border effects, as with climate action or border protection. But the crux of the matter is whether they are funded from current revenue, as has been the case until now, or whether joint borrowing is absolutely necessary. Joint borrowing does not fit into the present design of the EU. If there is a desire to fundamentally change that design, then we need an open political debate on the matter, and it would probably require far-reaching treaty and constitutional changes. Ultimately, it needs to be clear that if the EU borrows funds, even though the public may be less aware of this debt than of national debt, it will still need to be serviced by EU citizens in the future.
In Europe, debt has shot up rapidly. Is budget consolidation now completely impossible for many countries because it would stifle growth?
Of course, countries should not now exit the crisis measures prematurely while the economy is still fragile and in need of support. Afterwards, though, we need to see a lasting fall in debt ratios, particularly where they are very high. In the medium to long term, excessive government debt tends to dampen growth.
Inflation has recently risen. Could this be a danger?
Contrary to what some claim, inflation is not dead. The current debate underscores the fact that central banks should not just focus on possible deflationary risks. From a monetary policy perspective, the inflation figures do not concern me at the moment. Although inflation in Germany could temporarily get as high as around four percent at the end of the year, as things stand, medium-term price pressures here and in the euro area have returned to somewhat below two percent.
What is driving up prices?
In Germany this year, it is primarily down to certain one-off effects: the end of the temporary VAT reduction, the climate package, higher oil prices, and a statistical effect with regard to package holidays. Although all of these factors are, of course, reducing the public’s purchasing power, their effect on the inflation rate is only temporary, and monetary policy takes more of a medium-term perspective. An important question concerning future price developments is how pent-up consumption demand due to the crisis will be unleashed – as we know, the containment measures and the risk of contagion eliminated a lot of consumption opportunities. What would be troubling for us central bankers is the threat of lasting, excessive price pressures – but I don’t see any sign of that at the moment.
Can the European Central Bank nonetheless, as it has signalled, definitely keep interest rates this low on a lasting basis?
It hasn’t set such a rigid course. The Eurosystem has a clear mandate: Our primary objective is price stability. Interest rates are low because that is currently necessary to safeguard price stability. And they will need to increase if that is necessary based on the medium-term inflation outlook.
Is the European Central Bank’s mandate still that clear? Haven’t we been seeing a growing politicisation of the monetary policy stance for some time now? After all, the bond purchase programme is particularly benefiting countries like Italy, with a disproportionately large number of their government bonds being purchased. Isn’t this also intended to prevent the populists from gaining in strength?
Yes, the mandate really is that clear. And no, of course monetary policy should not be aimed at influencing elections! That kind of strategy would destroy monetary policy acceptance and credibility. That is why I believe it is particularly crucial to maintain a clear separation between monetary and fiscal policy and to restrict government bond purchases as far as possible.
Can and should monetary policy help in achieving climate targets?
Central banks have to pay more attention to climate change. In terms of banking supervision, we need to ensure that banks take adequate account of the financial risks stemming from climate change and climate policy. We need a good way of capturing the associated financial stability risks. And central banks should also appropriately record the climate-related financial risks attached to the bond holdings on their balance sheets. But this must not be confused with central banks having their own climate policy. We must not blur the boundaries between the responsibilities of the different policy areas. It is the task of economic policymakers to promote or sanction certain economic activities where necessary. It is not the place of a central bank to correct the results of the democratic process because we are in favour of more or faster climate action. Politicisation would ultimately threaten our independence, as part of being independent is having a narrow mandate. And we need this independence to fulfil our primary objective: safeguarding price stability.
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