Jens Weidmann bei einer Rede ©Nils Thies

Weidmann: Scale back the debt ratio after the crisis

Bundesbank President Jens Weidmann has cautioned that it is too soon to hope for a swift economic recovery. “Our economy will need time to recover,” he declared in an online speech delivered at the Übersee-Club Hamburg. Mr Weidmann explained that the recovery will hinge on how the coronavirus pandemic plays out, adding that the number of new coronavirus cases in Germany and its major partner countries was trending back upwards. Even if an increased infection rate does not lead to more stringent containment measures, a risk scenario could raise the threat of damage to the economy because people will become more cautious and reduce their social contact out of concern for their health. However, Mr Weidmann also cautioned that “the problems must not be allowed to burrow deeper into the economy via second-round effects. For example, a broad wave of corporate insolvencies needs to be avoided”. This, he remarked, risks breaking up functioning corporate structures and destroying a great number of jobs, besides potentially leading to a sharp rise in the number of credit defaults, which could pose a risk to financial stability.

Balancing act for economic and fiscal policymakers

Combating the impact of the crisis is a matter, first and foremost, for economic and fiscal policymakers, the Bundesbank President explained. They have the right resources for this task and a democratic mandate to support people and businesses directly. The government has taken resolute action to address the threat of a downward spiral in the economy by rolling out numerous measures, such as bridging loans, tax deferrals for enterprises and the special arrangements for short-time working benefits. At the same time, it needs to constantly re-examine the scope and duration of its assistance programmes to assess their appropriateness, and also to gauge the extent to which they might create misguided incentives. Mr Weidmann brought up the short-time working benefits scheme as one topic of heated debate. Most economists considered it appropriate that the period of entitlement to these benefits has been extended to up to 24 months during the crisis. But at the end of the day, the government needs to mitigate the risk that enterprises might use short-time working benefits as a way of propping up business models that simply do not have a future. That is why, Mr Weidmann reasoned, it would be important to scrutinise the merits of other special arrangements under the short-time working benefits scheme, such as the provision that the government pays the social security contributions. All in all, the coronavirus crisis is forcing economic and fiscal policymakers to perform a tricky balancing act, Mr Weidmann told his audience: “... supporting the economy in the short term, but not obstructing the necessary change or losing sight of the longer-term challenges”. 

Reduce the debt ratio after the crisis

The Bundesbank estimates that German government debt will rise sharply, from around 60% of GDP to somewhere in the vicinity of 75% this year. In Mr Weidmann’s view, Germany can shoulder this debt burden. However, it is important that all measures are of limited duration, as then the burdens on public finances will recede. “Fiscal policy should not get used to a lax stance, nor should it rely on interest rates remaining as low as they are today in the long run. That’s why it will be essential to scale back the increased debt ratio again once the crisis has subsided,” Mr Weidmann said. The pandemic is a clear reminder of the importance of sound public finances. The government has acted swiftly and comprehensively in the coronavirus crisis. But finding a way out of crisis mode will be equally important.  

Debt financing should remain a defined crisis measure

With regard to the EU countries that were harder-hit by the pandemic, Mr Weidmann pointed out that, in times of acute crisis, solidarity is the order of the day. “How far this support goes is a matter for politicians to decide, of course. After all, they have been democratically elected to make decisions of this kind,” Mr Weidmann explained. The EU has agreed on a recovery fund, which, by means of reforms, should play a role in helping strengthen Member States’ resilience. “Reforms of this kind are rarely popular, but they would also be an expression of solidarity in this case because they would relieve the Community in the next crisis,” according to Mr Weidmann. One new feature of this Recovery and Resilience Facility is the partial funding by EU borrowing, which Mr Weidmann views with scepticism: “Debt financing of the EU budget should remain a clearly defined crisis measure and should not open the door to permanent EU debt. Europe can function very well indeed without large-scale transfers between Member States.

Government bond purchases harbour risks

Mr Weidmann also continued to advise caution where large-scale government bond purchases by central banks are concerned, since they harbour the risk of blurring the boundary between monetary and fiscal policy. For instance, the purchase programmes have already led the Eurosystem to become the Member States’ biggest creditor, causing incentives to achieve sound public finances to dissipate. Mr Weidmann thus deems it important that the pandemic-specific emergency purchase programme (PEPP) have a time limit and be explicitly tied to the crisis: “The emergency monetary policy measures must be scaled back when the crisis is over,” the Bundesbank President stressed. Monetary policy as a whole must be normalised if the price outlook requires this.