“Accommodative monetary policy must not be permanent therapy”

In a speech delivered in Berlin, Bundesbank President Jens Weidmann urged a timely exit from the ultra-accommodative monetary policy. At a ceremony in Berlin marking the centenary of the Federal Association of Public Sector Banks, he said it had to be ended once there were visible signs that inflation was sustainably approaching the level of below, but close to, 2% over the medium term. Weidmann added that, while the desired benefits would subside over time, the risks and side-effects were mounting.

He cited diminishing profitability in the banking sector as one of the side-effects of ultra-accommodative monetary policy, adding that this was hampering the build-up of additional capital, creating financial stability risks, and could ultimately also dull the effectiveness of monetary policy. “Banks that don’t have capital reserves cannot issue any new loans,” Weidmann said. Banks needed to re-think their business models, tap new sources of income and cut costs. “And monetary policy makers must not blind themselves to these impacts on the monetary transmission process,” the Bundesbank’s president added.

Do not shift red lines

In his remarks in Berlin, Weidmann reiterated his sceptical views on sovereign asset purchases under the particular conditions of a monetary union in which the individual nations are responsible for fiscal and economic policy. To his mind, it is crucial that the current asset purchase programme largely does not provide for loss-sharing and does not introduce communitised liability through the back door. He added “that there must be certain limitations and ‘lines in the sand’ to ensure a sufficient safety margin to monetary financing of governments”, emphasising that “in monetary policy, but also elsewhere, one of the salient features of a red line is that it is not noved back whenever it’s approached, but that it is defended with greater determination.”

Given that inflation pressure in the euro area has been weak for quite some time, Weidmann believes that an expansionary monetary policy is still necessary in order to ensure price stability. Looking at the forecast of the European Central Bank (ECB), in which the euro-area inflation rate will gradually rise, Weidmann admonished listeners not to forget “that the rising inflation rates will lead anyway to a further reduction in real short-term interest rates and thus to a perceptible additional monetary policy easing”.

Meanwhile, he rejected the idea of a targeted inflation overshooting in order to offset the low inflation rates of the past years, explaining to the audience that such price-level targeting was not compatible with the ECB Governing Council’s current monetary policy strategy. “It is precisely in the current environment that a strategy shift could cause massive damage to the credibility of monetary policy,” Weidmann stressed.

“No Basel IV”

In his speech, Weidmann also addressed the coming finalisation of the Basel III capital regime for banks. He noted that “we need rules that do not place an undue strain on entrepreneurial risk-taking yet at the same time protect financial stability effectively”.

In his view, regulatory approaches should be macroeconomically optimised such that the stability gains of additional regulation needed to exceed the costs they imposed, such as through a decline in lending. “I believe this condition has been met thus far,” Weidmann said. He thought that the reform of the capital regime should not lead to an additional significant increase in banks’ minimum capital requirements, underscoring that “Basel III must not turn into Basel IV”.

Transatlantic partnership

Weidmann called for a response of calm and serenity following Donald Trump’s victory in the US presidential election. He held that Trump should be taken at his word with regard to his statements following the election victory. Weidmann quoted Trump’s statement announcing that he would deal fairly with everyone – all people and all other nations, and that he would seek common ground, not hostility, and partnership, not conflict. “Fair partnership has, since time immemorial, been the basis for all international relations, and particularly trans-Atlantic relations,” Weidmann said. “And it should stay that way,” he added.