Weidmann: Clear end date to net purchases would have been appropriate

In a speech delivered in Paris, Bundesbank President Jens Weidmann addressed the most recent monetary policy decisions by the Governing Council of the European Central Bank (ECB). On 26 October 2017, the Governing Council made the decision to halve monthly Eurosystem asset purchases to €30 billion from January 2018, with asset purchases to continue at this pace until at least September 2018. At the same time, the Governing Council decided not to signal when the purchases would end. "From my point of view, it would have been appropriate to set a clear end date for net purchases," said Mr Weidmann, acknowledging that this is because he is especially critical of government bond purchases in the monetary union. "Ultimately, purchases of this kind blur the boundary between monetary policy and fiscal policy," he explained.

Economy could show more dynamic growth than expected

Given the somewhat subdued inflationary pressure at present, the Bundesbank President believes that an accommodative monetary policy stance remains appropriate in the euro area. "Admittedly, opinions can differ on how much we should step on the accelerator in terms of monetary policy and what instruments ought to be used for that," said Mr Weidmann. As he sees things, euro area monetary policy will remain highly accommodative even after the net purchases under the asset purchase programme have been discontinued. He noted that what is crucial for the impact of the purchase programme is not so much the amount of monthly additional purchases but, above all, the total outstanding volume of bonds on the Eurosystem central banks’ books. He also emphasised that the amount held by the Eurosystem will remain at a very high level even after net purchases have been discontinued because the ECB Governing Council has decided to reinvest the proceeds from the maturing bonds.

On the other hand, Mr Weidmann pointed out that the Governing Council has decided not to raise interest rates until after the net purchases have ended. "We are not talking about putting the brakes on monetary policy, but merely about not pushing down on the accelerator any further," he summed up, explaining that, against the backdrop of the ongoing, increasingly broad economic upswing, he did not think that was necessary.

Private risk sharing contributes more to the stability of currency areas than fiscal union

Mr Weidmann went on to mention that in other large economic areas such as the US or Canada, it is not fiscal but first and foremost private forms of risk sharing which enable the burden of economic shocks to be spread to other states and provinces. He explained that these economic shocks are cushioned, for example, through the distribution of company profits and losses throughout the currency area.

Mr Weidmann emphasised that strengthening private risk sharing in the euro area would require national insolvency regimes to be standardised, amongst other things, because investors need to rely on having the same level playing field throughout Europe. "Not only will that promote risk sharing; it will also divert the flow of capital away from less productive businesses into more productive ones," he said. "It will also boost economic momentum." In addition, he called for an end to the preferential tax treatment given to debt over equity capital on the grounds that interest payments can be deducted from taxable income whilst equity costs cannot. "Eliminating this bias would encourage businesses to make greater use of equity capital as a funding instrument," he commented, noting that this would facilitate greater private risk sharing whilst at the same time reducing the debt bias.

By contrast, permanent direct fiscal transfers are not necessary for a currency area to function, according to Mr Weidmann. Instead, he argued, a division into the roles of provider and recipient risks creating false incentives as well as potentially undermining public acceptance of monetary union in the individual member countries. In his opinion, the loans granted under the European Stability Mechanism (ESM) already constitute an important transfer to governments in need of assistance.

In view of this, a proposal put forward by the Bundesbank envisages changing the contractual terms for newly issued government bonds in the euro area by introducing an automatic three-year maturity extension for all bonds, which would be activated the moment a government applies for an ESM programme. The automatic maturity extension would thus buy time to distinguish between illiquidity and insolvency without releasing investors from their liability and the risks being transferred to the taxpayer. "This would also significantly reduce the need for financial assistance under an ESM programme and greatly broaden the scope of the rescue mechanism," said Mr Weidmann.

A strong France

Mr Weidmann also touched on the labour market reforms in the euro area. "The labour market reforms implemented by the member states are working," he said. "They are helping more people to get into work than before the crisis." Although the current unemployment rate in the euro area is still slightly higher than its pre-crisis level, Mr Weidmann highlighted the fact that the employment rate is up on the 2007 figure. The reforms implemented by the French government are also a template for successful labour market reform in his eyes, which he considers good news for the entire euro area because, he concluded, "it is in Europe’s interest for France to have a strong economy".