Speech delivered at the 10th anniversary celebration of the House of Finance
Check against delivery.
Minister President Bouffier,
Ladies and gentlemen,
I am delighted to be able to celebrate ten years of the House of Finance with you today. To mark the occasion, allow me to first of all look back a little bit in time – several centuries, to be precise.
Three academics reach the entrance to Ali Baba’s famous treasure cave: a physicist, a chemist and an economist. Now how are they going to get that immense stone door open?
The physicist suggests constructing a mighty lever to clear the way. He tries this for a week, but the rock won’t budge. Next, the chemist proceeds to create a mixture of substances intended to blast the rock, but this is also to no avail.
Meanwhile, the economist sits on the sidelines, taking it easy. Finally the other two men, frustrated, challenge him to come up with his own idea for opening the door. Then says the economist, “
I don’t know why you’re getting so worked up, my friends. Let’s just assume that the door is open.”
For a long time, macroeconomists treated the financial system like this sealed treasure cave. In their models, they simply assumed that the financial system was always working efficiently and smoothly, chanelling savings into the most productive potential uses. Economic development, particularly since the 1990s, also seemed to confirm the economists’ view. The financial industry increased in size and importance, while growth and inflation became ever more steady. Some saw a causal relationship here. On the basis of a highly stylised model, economists at the Federal Reserve, for instance, argued in 2006 that “financial innovation should be added to the list of likely contributors” to the decline in macroeconomic fluctuations.
During this time, Goethe University Frankfurt began carrying out holistic and interdisciplinary research into the function and significance of the financial system for the overall economy. The importance of this approach was, unfortunately, brought into sharp focus soon after the House of Finance first opened its doors in the spring of 2008, with the financial crisis triggering the most severe global economic slump in post-war history. Since then, the explicit consideration of the financial industry, its idiosyncracies and its interconnections has been a core project of the macroeconomy, if not the core project.
In retrospect, it seems almost inevitable that the House of Finance would be founded. After all, Frankfurt is a major European financial centre, as well as being the seat of the ECB and the largest national central bank in the Eurosystem. Yet history does not follow an inevitable course; rather, it is the result of seized opportunities. The construction of a new university building was certainly one such opportunity. It represented a chance to unite the various residents of the House of Finance under one roof.
2 The Bundesbank and the House of Finance
Many key figures have provided the House of Finance project with hands-on support, among them Karl-Otto Pöhl and, of course, Otmar Issing. The House of Finance was, you see, a thoroughly welcome development for the Bundesbank, too. Working together was ultimately an obvious choice. And this exchange “across the park” has borne fruit on many levels, giving rise to joint research projects, amongst other things. This year, for example, Dirk Bursian and Ester Faia have published a joint paper which highlights the significance of households’ trust in central banks for monetary policy decisions.
Many PhD students of Goethe University Frankfurt work as research assistants in the Bundesbank’s Research Centre. Emanuel Mönch, Head of the Research Centre, also teaches as a professor, and Björn Imbierowicz is Academic Director of the Financial Risk Management Programme at Goethe Business School in the House of Finance.
In addition, joint seminars, workshops and conferences take place on a regular basis. That’s not to mention the jointly-organised presentations by top-class speakers, including World Bank Group President Jim Yong Kim and IMF Managing Director Christine Lagarde, Italy’s former Minister of Economy and Finance Pier Carlo Padoan, and General Manager of the Bank for International Settlements Agustín Carstens.
Regardless of the subject matter – the “too big to fail” problem, the sovereign-bank nexus or the effects of monetary policy on financial stability – the cooperation between the House of Finance and the Bundesbank serves as an opportunity to gain new insights and to deepen and review existing knowledge.
2.1 Reforming European monetary union
Two years ago, Pier Paolo Padoan held a speech here in which he outlined a European agenda which remains current to this day. This includes opening up labour and product markets, investing in European public goods, creating sound government finances and completing the banking union and the capital markets union – to highlight just a few points.
It is essential that citizens regain trust in Europe and its institutions and that monetary union is made more resilient to crisis. Naturally, opinions differ on how to achieve this.
I believe that any reform of monetary union must restore the balance between action and liability. By no means does this exclude greater fiscal risk sharing. However, this would also imply that more sovereign rights be transferred to the European level. But as long as Member States insist on being independent when it comes to financial matters, no further steps should be undertaken towards joint liability. For as long as that is the case, individual national responsibility needs to be strengthened.
We must ensure that, specifically in the context of completing the banking union, any residual risk from the era of individual national responsibility is sufficiently reduced before a single deposit insurance scheme is created. What I am getting at here are the in some cases high volumes of non-performing loans (NPLs) and government bonds on bank balance sheets. In addition, we must prevent risks from national fiscal policy spreading to the banking system in the future. It is therefore necessary to do away with the practice of giving government bonds privileged regulatory treatment and to sever the sovereign-bank nexus.
The fact that this nexus represents a sensitive point for monetary union has also been shown by a research paper published by the House of Finance. The economists Carlo Altavilla, Marco Pagano and Saverio Simonelli have shown in an empirical analysis that public, bailed out and poorly capitalised banks, in particular, purchased larger volumes of debt issued by their own governments than other banks. This, in turn, made them significantly more vulnerable to potential fiscal turbulence in their own countries.
2.2 Macroeconomic effects of uncertainty
The topic of uncertainty, which Mr Padoan highlighted as being an important factor at the time of giving his speech – just a few months after the Brexit referendum – is of no less relevance today. The risk with uncertainty, as Padoan said, is that it holds back investment decisions and that weak demand could cause permanent damage to the economy through hysteresis effects.
Since then, various developments and events have renewed the impression that we find ourselves in exceptionally uncertain times. In this context, the change in the US administration is often identified as marking a new chapter in foreign trade policy. However, the feared slowdown in demand has not materialised. Instead, growth in the global economy, trade and investment has been boosted over the past year.
Nevertheless, uncertainty is now a straining factor again. According to its October World Economic Outlook, the IMF estimates that the increase in global economic output for 2018 and 2019 will be just as strong as in 2017. The OECD projects only a slight slowdown for 2019.
Based on an empirical study, the Bundesbank, too, recently came to the conclusion that the relationship between uncertainty and the real economy is not as close as is often supposed. This is true, in particular, with regard to political uncertainty. And it is clear that political risks, in particular, also play an important role for the economic outlook at present. Just take a look, for instance, at foreign trade policy, the geopolitical tensions, Brexit and various other developments on the European continent.
2.3 Monetary policy
The head of the IMF, Christine Lagarde, already called for a greater willingness for global cooperation in a speech at the House of Finance two and a half years ago. In addition, she appealed for the individual countries to implement structural reforms in order to elevate global GDP to a steeper trajectory in the long term. She also recommended that most advanced economies maintain their accommodative monetary policy stance.
In the light of the progress made towards achieving price stability, the ECB’s Governing Council indicated some months ago that it intended to discontinue the Eurosystem’s net asset purchases from the start of 2019 onwards. However, it also stated that monetary policy in the euro area would remain exceptionally accommodative even after that. On the one hand, this is because the principal payments from maturing securities will be reinvested for an extended period of time, and in any case for as long as necessary. On the other hand, the ECB’s Governing Council recently stated that it continues to expect key interest rates to remain at their present low levels at least through the summer of 2019, and in any case for as long as necessary. Ending net asset purchases is therefore only the first step in the long process of gradually normalising monetary policy.
Ladies and gentlemen,
The magic phrase “Open Sesame” would have cleared the path to Ali Baba’s treasures for the three protagonists I mentioned at the beginning of my speech. According to one hypothesis, this phrase is based on the properties of the sesame plant – one of the oldest cultivated plants in the world.
The valuable seeds of this plant, which were already used by peoples in ancient times to make oil, are protected by the fruit capsule. Only once the seed is ripe does the capsule open up and release its treasure. However, do not be fooled into thinking that patience alone is the key to success. Because if you wait too long, you will realise that the wind has swiftly carried away the valuable seeds from the opened capsule. It is crucial, therefore, that we take decisive action when the time is ripe.
With regard to monetary policy, it is evident that the next few steps towards normalisation depend on how the data develop. Nevertheless, I believe that we should not waste any time. A highly accommodative monetary policy also brings with it risks and side effects, especially the risk of misguided incentives in the financial system.
Ladies and gentlemen,
If the creation of an institution is deemed to have been necessary in retrospect, I think it is safe to describe it as a success. The House of Finance may not have found a magic formula yet, but from my point of view, it has become the treasure cave itself by contributing towards gaining insights and thereby metaphorically opening doors.
In the meantime, it is up to us to apply these insights. Both Jim Yong Kim and Christine Lagarde quoted Johann Wolfgang von Goethe in their speeches: “
Knowing is not enough; we must apply. Willing is not enough; we must do.”
On that note I would like to congratulate Wolfgang König and the House of Finance on its ten-year anniversary and look forward to many more years of working together productively.
Thank you for your attention.
- Dynan, K., D. Elmendorf and D. Sichel (2006), Can financial innovation help to explain the reduced volatility of economic activity?, Journal of Monetary Economics, Vol. 53, pp. 123-150.
- D. Bursian and E. Faia (2018), Trust in the monetary authority, Journal of Monetary Economics, Vol. 98, pp. 66-79.
- Padoan. P. C. (2016), Promoting growth, employment and solidarity in Europe after the British referendum, speech held on 21 October 2016, http://www.mef.gov.it/en/ufficio-stampa/articoli/article.html?v=/en/ufficio-stampa/articoli/2014_2018-Pier_Carlo_Padoan/article_0162.html
- Altavilla, C., M. Pagano and S. Simonelli (2016), Bank exposures and sovereign stress transmission, CEPR Working Paper No 539.
- Deutsche Bundesbank, The macroeconomic impact of uncertainty, Monthly Report, October 2018, pp. 49-64.
- Lagarde, C. (2016), Decisive action to secure durable growth, speech held on 5 April 2016, https://www.imf.org/en/News/Articles/2015/09/28/04/53/sp040516