Jens Weidmann holding a virtual speech in the Bundesbank studio ©Nils Thies

Weidmann: Do not commit to very loose monetary policy stance for too long

President Jens Weidmann reiterated his call for monetary policy as a whole to be normalised if required to achieve the objective of price stability. “Ultimately, that also means reducing large bond holdings,” he said at the ceremony to mark the change of office at the Bundesbank’s Bundesbank Regional Office in North Rhine-Westphalia.

Mr Weidmann warned against permitting monetary policy’s current pandemic mode to persist indefinitely, explaining that the emergency measures are linked inextricably to the pandemic and must be brought to an end as soon as the crisis has been overcome. In his view, it is also important to not apply the increased flexibility of the pandemic emergency purchase programme, or PEPP for short, to other programmes.

Pay attention to risk of excessively high inflation rate

The key question for the general orientation of monetary policy is how persistent the increased inflationary pressures in the euro area will prove to be, the Bundesbank President explained, adding that the inflation rate in Germany has risen more sharply in recent months than had been predicted by Bundesbank experts. “One thing is for sure: current inflation is eroding purchasing power considerably. And people are worried – not just in Germany but in other euro area countries, too,” he remarked. At the same time, he pointed out that the Bundesbank expects the strong upward pressure on prices in Germany to retreat again. One reason cited for this was that one-off factors such as the effect from the cut in VAT rates will lapse. In addition, supply bottlenecks are set to ease and the surge in demand to ebb.

“Our experts currently expect the inflation rate in Germany to peak at almost 6% this month before going back down,” Mr Weidmann explained. According to the Bundesbank’s experts, however, the unanticipated inflation seen in recent months means that the inflation rate will probably not fall below 3% until the end of next year. The Bundesbank President stressed just how uncertain the price outlook is at present. However, he sees risks as being clearly tilted to the upside – if anything, even more significantly of late. In the euro area, it may well be the case that the inflation rate does not fall back below 2% over the medium term. “With that in mind, it is vital that monetary policymakers focus not just on the risk of an inflation rate that is too low but also on the risk of one that is persistently too high,” he urged.

Do not commit to very loose monetary policy stance for too long

Given the exceptional level of uncertainty about the price outlook, Mr Weidmann made the case for not committing to a very loose monetary policy stance for too long. He also made clear his position in the debate on weighing up risks for monetary policy. “Some see it as the less risky option to maintain a highly expansionary monetary policy stance for longer than is necessary: the central banks need to neutralise the threat of inflation rates staying too low for too long, and monetary policy should therefore under no circumstances be normalised prematurely, they argue. (…) “I’m not convinced by this line of reasoning.”

Interest rates have been very low for quite some time now: leverage amongst enterprises, households and governments has increased and the financial system has become more vulnerable to interest rate changes, the Bundesbank President warned. An abrupt, steep interest rate hike could lead to problems in the financial system that could in turn adversely affect the economy and, ultimately, price stability. This is a risk that, as Mr Weidmann sees it, also needs to be factored into the overall assessment of the situation.

He told the audience even a timely and gradual normalisation of monetary policy is unlikely to meet with much approval – either in the financial markets or by governments. But the central banks must not allow themselves to be deterred by outside pressure. They need to start communicating clearly now that “we will safeguard price stability even if that clashes with the objectives of other policy areas. It was precisely for scenarios such as this that central banks were granted independence.”

Stronger economic recovery likely just pushed back

Looking at the current state of the economy, Mr Weidmann stated that the German economy might find itself treading water in the current quarter. The strong boost delivered by the reopening of services sectors has already dissipated. At the same time, he said, the problems that industry is experiencing were lasting longer than expected. Meanwhile, current infection rates are likely to have an impact on the economy as well. “For this reason, economic output will probably not yet return to its pre-crisis levels in the current quarter either. And the average rate of growth in the German economy in 2021 as a whole will probably be considerably lower than projected in our June outlook,” he continued. Given the well-filled order books, though, he added that a stronger economic recovery has likely just been pushed back.

Thanks to the outgoing Regional Office President

At the ceremony to mark the change of office, the Bundesbank President thanked Margarete Müller, who has held the office of President of the Regional Office in North Rhine-Westphalia for the past eight years and has worked at the Bundesbank for a total of almost 40 years. She is leaving her successor a regional office described by Mr Weidmann as being unique in spirit. Ms Müller retires from office at the end of November. The new Regional Office President will be Jochen Metzger, who was most recently Director General Payments and Settlement Systems.

Outgoing President Müller thanked staff at the Regional Office for their fruitful working relationship and Mr Weidmann for the lines of communication that were always open between the Regional Office and Central Office. Her successor Mr Metzger expressed how motivated he is to take on the new task ahead, announcing that one of his focal points during his term of office will be digitalisation.