"Soundness must not take a back seat to flexibility"

Jens Weidmann at the New Year reception of the Chambers of Industry and Commerce in Ulm and Oberschwaben-Bodensee
Jens Weidmann at the New Year reception of the Chambers of Industry and Commerce in Ulm and Oberschwaben-Bodensee

Bundesbank President Jens Weidmann has warned against further weakening the binding effect of the euro area's fiscal policy rules. "I fear there is a growing sense of, if you don't want to, you don't have to," said Mr Weidmann at the New Year reception of the Chambers of Industry and Commerce in Ulm and Bodensee-Oberschwaben in Biberach an der Riss. He explained that although the stricter fiscal rules were, in principle, a step in the right direction, they had recently become considerably more complex. "A great deal of scope for interpretation and discretion has now been opened up," Mr Weidmann told the audience of around 800 people. Weidmann criticised the fact that greater emphasis had recently been placed on the use of "flexibility", in a reference to the European Commission's plans to accept investment and structural reforms as an excuse for weaker consolidation efforts in future.

In Mr Weidmann's opinion, the key to overcoming the crisis lay chiefly with the affected countries themselves. "These structural problems cannot be resolved by printing money," he said.

The President of the Bundesbank also reminded listeners of the role played by the Eurosystem under the Maastricht Treaty, which cemented the independence of the central bank. In return for this independence, however, the Treaty placed clear constraints on the Eurosystem's mandate, as reflected in the ban on the monetary financing of governments and the fact that central banks were prohibited from engaging in economic policymaking, although "the line drawn between monetary and economic policy can vary in width," he said. The President went on to explain that the Advocate-General at the European Court of Justice had likewise made it clear in his ruling on the OMT programme that the practice of subjecting the European Central Bank to legal constraints was beyond dispute.

Efforts already bearing fruit

Mr Weidmann said that although central banks had played a significant role in preventing an escalation during the crisis, they could not take the place of the necessary adjustment processes. Some crisis countries had already made progress, he added, but none had yet crossed the finishing line. "But it is becoming increasingly clear that the efforts are bearing fruit," commented Mr Weidmann, pointing to improved unemployment figures and economic growth in the crisis countries.

However, he continued, it was not enough to correct undesirable developments at the national level, because the crisis had also revealed weaknesses in the institutional framework of the euro area. It was important to reinforce the principle of individual national responsibility. The alternative to this would be a genuine fiscal union, he explained, but there was no willingness right now to relinquish extensive national sovereign rights in fiscal policy matters. Weidmann emphasised that monetary union could also function without political union, but that, besides adhering to the agreed rules, further steps would be needed to achieve this. He explained that the principle of individual national responsibility ultimately meant that governments, too, must be allowed to fail financially, and that one of the key lessons of the euro crisis was therefore to place euro-area banks on a more robust financial footing. An important step in this direction was the gradual introduction of stricter capital and liquidity requirements. The close links between credit institutions and sovereigns also needed to be severed. Mr Weidmann therefore called for an end to the preferential regulatory treatment afforded to sovereign debtors which could be seen, for instance, in the fact that sovereign bonds did not have to be backed with capital.

Challenges faced by the German economy

Mr Weidmann also used his speech to look at the prospects for the German economy. "The economy is currently in good condition," said the Bundesbank President, pointing to the fact that unemployment remained low, household debt was not excessive and real wages were increasing. Furthermore, both industry and consumers had benefited from the sharp fall in oil prices, he added.

However, Mr Weidmann also stressed that, despite real growth of 1.5% in 2014, major challenges still lay ahead for Germany. Specifically, he cited unfavourable demographic trends, energy policy shifts and the repercussions of globalisation as factors that would have a dampening effect on growth. In his view, the digitisation of the economy and the persistently high level of government debt were also weighing on Germany's long-term growth prospects.

The Bundesbank President rejected calls for Germany to generally step up its investment. "It cannot be said, either by historical or international standards, that the German private sector is investing too little," Mr Weidmann continued. He stressed that public funds should also only be invested in areas that paid off. Mr Weidmann dismissed the notion of a European stimulus package, stating that increased investment in Germany was unlikely to have significant spillover effects on the rest of the euro area. Nor was such an initiative compliant with the principle of individual fiscal responsibility that underpins the Maastricht Treaty.

Measures to reverse the decline in labour potential

One key cause of Germany's sluggish growth in potential output was its diminishing labour potential, Mr Weidmann said. He identified three factors that could counteract the dampening macroeconomic effect of this. One was to increase the number of women in work. Germany needed to further reconcile work and family life, the Bundesbank President explained. However, he conceded that some provisions – such as non-contributory inclusion in the statutory health insurance scheme and the childcare supplement – created less of an incentive to seek gainful employment.

The second lever identified by Mr Weidmann was to extend working life. In this respect, he criticised the option allowing long-term contributors to the statutory pension insurance scheme to draw a full pension at 63 as a step in the wrong direction. "Instead of setting incentives for employees to go into early retirement, they should be encouraged to work longer," Mr Weidmann said.

But this was far from enough to offset the decline in labour potential because, third, Germany relied on attracting skilled workers from abroad. It was important for Germany to project an image as an open, cosmopolitan country that welcomed new citizens and offered them a level playing field. "Immigrants need to be more than just integrated into the workplace – they need to become part of our society," Mr Weidmann concluded.