Opinion expressed by Professor Axel A Weber, President of the Deutsche Bundesbank
at the public hearing of the Budget Committee of the German Bundestag on the Draft Act Assuming Guarantees in connection with the European Stabilisation Mechanism
Tensions in the markets for government bonds of some euro-area countries increasingly escalated in the first week of May on an unexpected scale. There was a threat of severe contagion effects spreading to other euro-area member states and beyond. This would also have entailed a considerable risk to global economic activity. Thus, faced with the need for urgent action, the Ecofin Council reacted on 10 May by adopting a comprehensive package of measures. Given the acute dangers, this package is justifiable all in all. This assessment is specifically posited on the agreements reached on the comprehensive consolidation of public finances and pressing measures to be taken by particularly endangered countries. These decisions nevertheless place a severe strain on the institutional foundations of monetary union. In order to effectively combat the associated additional risks to the sustainability of member states’ public finances in the future, the fiscal rules crucially and urgently need to be tightened. This is all the more imperative if there is no intention to create a far-reaching, democratically legitimized political union and, instead, member states themselves are to retain ultimate decision-making authority for their national fiscal and economic policies. Reforms aimed at tightening the fiscal rules have to be instituted in numerous areas. A variety of possible measures have already been suggested. Thus besides moves to strengthen the existing arrangements in the Stability and Growth Pact, the establishment of a sovereign insolvency procedure has also been put forward as a key element of a reformed framework. In the light of the recently agreed decisions, implementation of these proposals would make an important contribution to safeguarding monetary union as a community of stability also in a changed overall environment.
At the end of April, the deteriorating budget and economic situation in Greece ballooned into a crisis of confidence from which the country was unable to liberate itself single-handedly. This was the upshot of developments over many years during which Greece had massively and irresponsibly breached European agreements and rules. Looking back, its budgetary and economic policies stood in stark contrast to the stability requirements of a single currency area. Once the full extent of these failings had come to light, the financial markets began to fundamentally question Greece’s ability to continue to meet its debt-servicing and repayment obligations in future without a comprehensive correction of its fiscal and economic policies, in the wake of which Greece found it virtually impossible to raise new funds on the capital markets. In this very fragile situation, a sovereign default by Greece could have triggered a considerable contagion risk for other member states of the euro area. The euro-area finance ministers therefore decided to grant financial assistance to Greece based on strict conditionality, and in Germany this assistance was approved by the Bundestag on 7 May 2010. In its opinion on the relevant draft legislation, the Bundesbank put aside its fundamental reservations and assessed Germany’s participation in this assistance package as being justifiable under the exceptional circumstances, despite the high risks involved.
Before the package was definitively approved, the situation in the capital markets worsened further. The aim of containing the threat of contagion emanating from Greece was not attained. Despite the decisions taken, there was a growing danger that the swelling tensions might snowball into an unstoppable avalanche which could have impaired the stability of European monetary union and might also have entailed grave consequences for the entire global economy. This was the unanimous conclusion reached the weekend before last by numerous international institutions and the major central banks – including the Deutsche Bundesbank. Given this serious and immediate danger, the EU finance ministers adopted a package of stabilisation measures on 10 May 2010. This package finalised the assistance for Greece that had been agreed earlier. The announcement of the support programme was accompanied by a pledge to accelerate the consolidation of public budgets and reform the fiscal rules and the intention to set up a European financial stabilisation mechanism. There are two purposes to this stabilisation mechanism. One is to enable the EU to provide financial assistance to member states seriously threatened with severe difficulties caused by exceptional occurrences beyond their control. The other is, should the envisaged funds not suffice, to set up a special purpose vehicle, due to expire after three years, which can grant loans to euro-area member states. The necessary resources would be raised in the capital market and guaranteed on a pro rata basis by the other euro-area countries. The European Financial Stabilisation Mechanism is to be supplemented by credit lines from the International Monetary Fund.
With regard to the envisaged European Stabilisation Mechanism, it is important that any drawdown of funds be subject to strict economic and fiscal policy conditionality. The intended financial and material involvement of the International Monetary Fund in the agreed assistance programmes, such as in the Greek precedent, is therefore logical. Moreover, it is also important that the granting of assistance be subject to agreement with the guarantors – especially Germany as the largest single contributor. The interest terms must be designed to create a tangible incentive to rapidly regain the confidence of potential donors and resume capital market financing. The terms and conditions of assistance to Greece are a suitable benchmark. It is equally important that the special purpose vehicle which forms the second part of the European Stabilisation Mechanism is a limited-term facility. By contrast, the first part of the mechanism is of unlimited duration and thus, despite its limited volume, opens the door to a permanent mechanism financed by EU borrowing. The provision of such a permanent safety net for countries threatened with insolvency severely strains the underlying principle of monetary union, namely that member states are individually responsible for their own public finances; it is therefore more problematic than the assistance given to Greece, which was ad hoc and granted only on very specific terms and conditions, or the temporary assistance offered by the special purpose vehicle. This creates moral hazard both for governments and for holders of government bonds. This moral hazard can be contained by attaching strict conditionality to drawings on these resources and imposing far-reaching consequences for violations of this conditionality on the member state in question. For instance, the mechanism should only be capable of being activated if financial stability is in jeopardy throughout the euro area. The aim must under no circumstances be to mitigate a member state’s financing problems on a discretionarybasis. On the contrary: strict fiscal and economic policy conditionality should motivate the member state to quickly return to a sound budgetary position and regain access to capital market financing.
All in all, the decisions taken on 10 May 2010 by the EU finance ministers appear justifiable in the light of the risks to the stability of European monetary union and the development of the global economy. The decisions, however, place a severe strain on the foundations of monetary union. Rapid and resolute action is therefore necessary to stabilise and reinforce the weakened foundations of monetary union so that similar escalations can be avoided in future. It is particularly crucial to underpin the rescue measures, as envisaged, with moves to improve statistical reporting and especially to tighten the existing fiscal rules. A major requirement is to attach greater importance to the debt criterion in future. Rules should be laid down for debt ratios in excess of 60% spelling out a timetable for their reduction and the sanctions for non-compliance. The deficit criterion can be strengthened by closing the loopholes introduced by the last reform of the Stability and Growth Pact and attaching greater importance to ex ante compliance with the rules. In general, responses to policy aberrations must be expedited and hence the current procedure accelerated. A key need is to improve the hitherto often inadequate implementation of the rules, eg by making the imposition of sanctions less subject to political bargaining and more rule-bound. Another sensible measure would be a commitment to anchor the European fiscal framework – especially the medium-term budgetary objectives – more strongly in national budgetary legislation, as Germany has done with the introduction of a debt brake. In clear cases of misguided policies, increased macroeconomic surveillance at the European level is doubtless also called for. However, in the current framework, not only the independence of monetary policy but also the subsidiarity principle needs to be observed. Wholesale moves towards centralisation and fine-tuning would by all means be dubious. For instance, the relatively broad-brush expansion of deficits and debt in the context of the European Economic Recovery Programme needs to be critically appraised in the light of whether it may, in fact, have helped to worsen the current problems in some countries. Recent calls for a more expansionary fiscal policy and wage increases in Germany likewise give reason to doubt that stronger policy coordination would necessarily contribute to tackling the root causes of the crisis.
If the support measures necessitated by the debt crisis in some countries are not followed up in the foreseeable future by efforts to create a far-reaching, democratically legitimized political union and, instead, member states themselves continue to retain ultimate decision-making authority for their national fiscal and economic policies, monetary union will have to be reinforced as a community of stability by additional reforms that extend beyond tightening the current fiscal framework. A variety of possible measures have already been suggested. Thus, besides moves to strengthen the existing arrangements in the Stability and Growth Pact, the establishment of a sovereign insolvency procedure has also been put forward as a key element of a reformed fiscal framework. In addition, further-reaching sanction mechanisms should be considered in the event that a member state which draws on a support programme fails to implement the necessary measures to maintain its stability and thereby consciously jeopardises the union's existence. In the light of the recently agreed decisions, implementation of these proposals would make an important contribution to safeguarding monetary union as a community of stability even in a changed overall environment.
The Eurosystem, with its single monetary policy, will remain committed to the goal of ensuring price stability in the euro area. It is the task of fiscal policy, through sound public finances and a suitable institutional framework, to ensure that monetary policy is appropriately supported in a monetary union that rests on a foundation of stability. Recent developments have revealed weaknesses in the existing fiscal framework and exposed the economic consequences of many years of diverging competitive positions across the euro area. If monetary union is to be placed on a firm long-term footing, it is vital that policymakers use the current brief respite to initiate reforms.