"Structural problems cannot be resolved by printing money"
Bundesbank President Jens Weidmann has warned that political pressure on central banks could intensify as a result of the Eurosystem's latest government bond-buying programme (quantitative easing or QE). In the end, the purchases would make national central banks the most important creditors of their governments, he said in his speech to representatives of the City of London.
"Certainly, structural problems cannot be resolved by printing money," Weidmann noted. If the impression were to arise that central banks will repeatedly step in to take the place of effective policy action, his concern is that government bond purchases could delay necessary structural reforms and budget consolidation in the euro-area member states. Weidmann welcomed the assertions made by a number of European heads of government that the QE programme must not be a substitute for structural reforms. At the same time, however, he voiced his scepticism by citing Goethe:
"I hear the message well, but lack Faith's constant trust".
"Government bond purchases are not an instrument like any other"
In his speech, the Bundesbank President emphasised his doubts about the necessity of the QE programme.
"All the economic forecasts predict that inflation rates will rise over the medium term, albeit at a rather sluggish pace," he remarked. Most members of the ECB Governing Council believe, like him, that the risk of self-reinforcing deflation is still very low, Weidmann said. Although the impact of QE on inflation is hard to gauge, Weidmann believes that it can probably be assumed to be weaker in Europe than in the United States, for example, adding that this is because interest rates in Europe today are already much lower than when QE was launched in the United States. Moreover, the funding of US enterprises was much more capital market-based than that of European businesses, he continued. Wealth effects were generally smaller, too.
Furthermore, he pointed out, government bond purchases in a monetary union with a single monetary policy and 19 independent fiscal policies are not an instrument like any other because, in principle,
"it could introduce common liability through the back door" via the central banks' balance sheets. However, it is up to elected governments and parliaments to make such far-reaching decisions, he remarked. In this connection, he also acknowledged that the Governing Council of the ECB has adopted measures that take into account concerns related to earlier government bond-buying programmes – such as limiting loss-sharing to just a small part of the programme and setting caps on purchases of individual issues and of debt from a single state.
Steps towards resolving the crisis
According to Weidmann, the persistent crisis in the euro area reveals shortcomings in the set-up of the monetary union. In order to overcome this crisis once and for all, he believes several steps have to be taken. For example, the economic adjustment processes at the national level need to be continued – despite initial successes, the work here is not yet complete. It is all the more important that previous achievements are not compromised.
"The risk of a backlash is particularly high in Greece," Weidmann warned. However, he firmly believes that it is also in Greece's own interest to tackle the structural reforms and fiscal problems it is facing.
Weidmann also suggested further reforms to the monetary union framework, whereby the primary objective would have to be creating greater incentives for making sound and responsible decisions in the euro area. To this end, he argues it is important to bring liability and control into balance. Since the option of a fiscal union, which would necessarily involve surrendering substantial fiscal powers to the European level, is blocked for the foreseeable future, as shown dramatically by the Greek government's recent responses, ultimately, he said, the only remaining option is to strengthen the liability principle.
"The principle of individual national responsibility ultimately means that governments, too, must be allowed to fail financially," emphasised Weidmann.
The close ties between banks and sovereigns would naturally make a sovereign default a challenge, he told his audience. In order to get the euro area back on track, therefore, the financial system has to be made more resilient and banks must become less vulnerable. Amongst other things, this would be contingent on banks setting aside sufficient capital for their lending to sovereigns and complying with limits in future.