Jens Weidmann ©Frank Rumpenhorst

Weidmann: Greater monetary policy leeway needed

Bundesbank President Jens Weidmann sees Brexit and the global trade dispute as the two largest risks to Germany’s economy. In a speech delivered in Mannheim, he called on politicians to resolve the conflicts. “Both of these risk factors [...] are political by nature, and that's why they both need to be defused by politicians,” according to Mr Weidmann. He also emphasised the need to not squander any time in the process of monetary policy normalisation “because monetary policymakers need to regain more leeway to be in a position to respond to an unexpected economic slump”. Unlike the United States, the process of monetary policy normalisation in the euro area was just taking its first baby steps, he noted.

Economy as a whole still expanding

Mr Weidmann expects the German economy to remain in a slump for longer than previously thought. In his words: “And contrary to our December forecast, the dip in growth looks set to continue into the current year. So from today's perspective, the German economy will probably grow at well below the potential rate of 1½% in 2019.” The Bundesbank had assumed growth of 1.6% as recently as this past December. However, Mr Weidmann warned against excessive pessimism, saying “I see neither an abrupt slump nor an extended spell of noticeably receding economic activity”. Growth in Germany is building off favourable financing terms, rising employment levels and increasing wages.

Stoking the engines of economic growth

Mr Weidmann furthermore called on euro area governments to make their economic structures more competitive. “To permanently raise the growth trajectory, the right course has to be set by economic, social and tax policy,” he said. “When it comes to ensuring more growth, some look to the central banks. Yet monetary policy cannot solve structural problems,” Mr Weidmann stated. Monetary policy could do no more than give the economy a slight nudge or slow it down if required to ensure stable prices in the medium term.

Reforming monetary union

In his remarks, Mr Weidmann also addressed the euro’s 20th birthday on 1 January, noting that the founding promise of a stable currency had been kept, the average rate of inflation over the past 20 years being 1.7%. At the same time, he called for reforms to the monetary union to keep it resilient over the long haul. “The monetary union needs a coherent framework of responsibilities and liability, and its leitmotif should be the alignment of actions and liability.” Mr Weidmann cited the European Stability Mechanism (ESM) as a good example of how solidarity and soundness can be aligned. He was in favour of the strengthening of the ESM adopted by euro area heads of state or government in December, in principle. However, in his view, the ESM needed to be given the requisite powers in order to deliver on its new responsibilities. One example he noted was fiscal surveillance under the Stability and Growth Pact.

Completing the banking union

Although a single deposit guarantee scheme certainly has the potential to enhance the credibility of deposit protection in Europe, according to Mr Weidmann, several conditions need to be met in order to align action and liability and to avoid moral hazard. One example given by Mr Weidmann was that banks were holding high stocks of domestic sovereign bonds against which little or no capital had to be held, thereby chaining themselves, as it were, to the solvency of their national governments. He believes the preferential treatment of sovereign bonds by banking regulators needs to be stopped in order to sever this sovereign-bank nexus once and for all. “It would be a mistake to create a single deposit guarantee scheme without first ensuring that all the conditions are met,” Mr Weidmann said.