Bundesbanker Weidmann remains critical of the ECB
On his 10th anniversary, Germany's top central banker said emergency bond buying and cash are fine.
Berlin-Jens Weidmann celebrated his 1oth anniversary as president of the Bundesbank, Germany's central bank, on Saturday 1 May. He took office at the age of 43, the youngest Bundesbank president ever. Weidmann was an early critic of the European Central Bank's (ECB) monetary policy during the then-brewing debt crisis. To this day, he favours caution.
At the time, the ECB had "entered completely uncharted territory," Weidmann said after the German cabinet approved his second term in 2019. In that respect, he said, his first eight years as Bundesbank president had been very eventful. Weidmann is often discussed as a person who relies on softer tones and the power of arguments. We talked to him about the ECB's low interest rate policy, which has lasted for almost a decade, its pandemic support measures, Weidmann's perspectives on the e-euro and European integration.
Berliner Zeitung: In 1987, author Hans Magnus Enzensberger published a volume of essays entitled "Ach Europa" - a pamphlet about the central administration of Europe in Brussels. "Forced unity, homogenization" threatened us, he wrote. And, "What saves us is our diversity." By contrast, then-Commission president Jacques Delors asked, "Who can fall in love with a single market?" Mr. Weidmann, how do you feel about the European Union today?
Jens Weidmann: My background is a very European one. I left after graduating from high school to start my studies in France because I was curious about our neighbor. I wanted to gain a different perspective. And that's an important part of what it should be about: being open, learning about the idiosyncrasies, the peculiarities, the advantages of other societies in Europe, and learning that we are stronger together than we are alone.
Allow us to look back at the Bundesbank Monthly Report of October 1990 and how it discussed the monetary community that was established in Maastricht in 1992. This report stated that such a union would be "a solidarity community that can no longer be terminated," which would require "a far-reaching commitment in the form of a political union" to ensure its lasting existence. At the time, there were some voices beyond the Bundesbank that expressed concern that monetary integration could not function in the long term without real economic alignment and a common economic and fiscal policy. 30 years later: What's your view today?
One core idea is that the European Union will only be accepted by its citizens if it delivers on the promises it has made. Among other things, this means that the European Union - and the European Monetary Union in particular - should be a stability union. Certain preconditions are necessary for this. That is what this discussion was about, and what it is still about today. Ultimately, the starting point is that the member states agreed at the time to establish a common monetary policy, but were not prepared to relinquish fiscal sovereignty. The countries insisted that they would continue to take essentially autonomous decisions on economic and fiscal policy.
What are the consequences from your perspective?
The design of the monetary union is very demanding and can lead to tensions. In perspective, it can also become a problem for the stable orientation of the monetary union - if, for example, high government debt exerts pressure on monetary policy to ease this debt burden through low interest rates. One way to prevent this is to discipline national budgets. First, via clear and binding rules, especially for budget management. On the other hand, via the financial markets, in that unsound budgets entail higher financing costs. Overall, in retrospect, this has unfortunately not always worked well.
What is the alternative?
The other option for maintaining the balance between action and liability is a common fiscal policy. It does not guarantee a stability union per se, because even a common fiscal policy can be unsound. But fiscal decisions are taken jointly, and there is joint liability for them. Among other things, this entails the risk that one country may incur debt at the expense of the others, thus creating a greater incentive to incur debt than would be the case if each country operated on its own account. However, the countries were not prepared to do this when the monetary union was founded. In my view, they still aren't. The budget rules - as we currently have and implement them - are a very mild form of coordinating national fiscal policies. But even that is often accepted only reluctantly. And even central decisions would have to be supported democratically.
From the outset, observers and stakeholders were concerned that monetary union could be a debt union. Given the developments surrounding measures such as the ESM (editor's note: European Stability Mechanism), haven't we arrived there now?
The ESM was created in the course of the sovereign debt crisis and Germany's participation was also approved by the Bundestag. In the current crisis, too, the states have decided to show solidarity and support each other financially. Joint debt, as is now envisaged in the NGEU reconstruction fund, should be limited in time and closely linked to the crisis. Otherwise, the EU's regulatory framework would possibly be shifted further and further, and without a conscious and transparent decision to go down this path. A fiscal union must not be introduced through the back door. In my view, there needs to be an open social discussion about how Europe should be shaped in the future - and also about the conditions for stability and solidity. This promotes acceptance, so that citizens can then also rally behind this idea. And once you've decided on a path, you have to anchor it solidly in law. It is right that the Constitutional Court keeps bringing this discussion back to where it belongs - namely to parliament and ultimately to society.
Another aspect that was repeatedly criticized like this, especially during the debt crisis, was that the European institutions, with their crisis programs, primarily propped up banks that were in danger of collapsing a second time in the debt crisis after the financial crisis. During the corona crisis, there were again discussions about companies that were propped up by public funds - such as Lufthansa in Germany.
You raise the too-big-to-fail problem, that is, that certain banks may be too significant to the financial system to be allowed to fail if they get into trouble. But if the government is expected to step in when needed, that may tempt banks to become lax or too reckless. I believe that citizens have every right to expect those responsible in politics and supervision to tackle this problem. And substantial progress has been made here since the financial crisis. At the same time, we must not forget: Stabilizing the banking system also protected savers' deposits. It avoided considerable macroeconomic distortions and has thus ultimately benefited all citizens. Generally speaking, in crises, policymakers have to make decisions during conditions of high uncertainty. In such a situation, the state must act to prevent things from getting worse - even if it turns out in retrospect that one or two things could perhaps have been done better. That's why the state reacted quickly and broadly in the current crisis. And there was not only aid for large companies, but also for smaller firms, the self-employed and private households. Now one can argue about the implementation: Was it fast enough? Was it too bureaucratic? Did it reach the right people? But in order to mitigate the consequences of the crisis, it is important that help is provided.
Since the debt crisis and the support measures, the very loose monetary policy of the European Central Bank has been discussed over and over. If we look at the developments on the stock markets, which can also be described as a consequence of this monetary policy, this seems to be a topic that is difficult to communicate to the population. Some are on a government-funded partial furlough, but stock values are going through the roof again - with a short interruption by the pandemic-related crash in March 2020. Many indices, such as the German benchmark index, are trading at all-time highs these days. Apparently there is confidence among stock market participants that the ECB will not raise the key interest rate for the time being. Can this continue indefinitely?
By also supporting the economy with favorable financing conditions, monetary policy is helping to prevent many people from losing their jobs in the crisis. So it has a broad impact - on banks, companies and private households - and must not be reduced to its effects on asset markets. But of course you are right. Interest rates play a fundamental role in the valuation of company shares. After all, such shares provide entitlements to a company's future profits. The lower the interest rate, the more the expected income stream is worth today. Also, the interest burden on companies falls, and when the economic outlook improves, profit expectations rise. However, our standard models currently tend to suggest a high valuation in the equity markets.
What expectations do you have as to when and how this overvaluation will decrease again?
Such model statements should be treated with great caution. Share prices may well deviate from their fundamentally justified values over a longer period of time. And of course, the models are not a perfect representation of reality and are themselves subject to uncertainty. Nor do I wish to make stock price predictions here. For the sake of understanding: assets such as stocks or real estate have to do with future prospects, i.e. thoroughly subjective assessments. What we are seeing right now, especially on the stock markets, is that the assessment of the pandemic there is running ahead of what is currently happening. And if you as an investor assume that interest rates will remain low, you are more willing to pay a higher price for an asset like a stock than if you assume that monetary policy is about to normalize.
Let's assume we see a development there that doesn't just describe a moment, but stays: Stock markets that are decoupled in their development from the rest of what's going on and that sometimes also plunge states into crises - as we saw, for example, with Greece in the debt crisis. In addition to a common fiscal policy in the EU, don't we also need more control over the stock markets?
The stock markets were certainly not the cause of the debt crisis. Generally speaking, price formation on the stock markets fulfills an important economic function. Ultimately, it ensures that capital generally flows to where it is most productively used. Thus, investors can earn returns on the stock market, but they also take corresponding risks. If they are wrong, they also make losses. From a macroeconomic perspective, this is not a problem, as long as it does not jeopardize the functioning of the financial system. It would be different if banks got into difficulties, because this in turn could lead to them being unable to grant loans and the financial system no longer fulfilling its function for the economy.
But the markets have not always been right in their assessment in the past ...
That's an important point, but look: There are often situations where there are different views about the future or about the value of certain technologies. Consider the question of the extent to which IT has an impact on productivity and economic growth. The productivity paradox, according to which productivity gains hoped for from IT innovations are not yet reflected in the figures. Some say that the new technologies are not that revolutionary compared to earlier waves of innovation, such as the industrial breakthrough with the invention of the steam engine. Others say that it may simply take time for economic structures to adapt and that we will still see the productivity boost. Think back to the dotcom bubble. There, many had the idea that the New Economy would be an immediate "gamechanger" that would fundamentally change the world all at once. Ultimately, we saw that expectations were exaggerated at the time, and there was a correction on the stock markets. The stock market is also a competition for innovation.
Another effect of the ECB's crisis monetary policy is that much more than usual is being financed through credit, because interest rates are so low and credit is therefore very cheap. What is your perspective on this?
In the unique current situation, we see that the money supply is growing strongly. On the one hand, this development is being driven by private individuals and companies taking out precautionary loans and holding more liquid assets in response to the crisis. On the other hand, our monetary policy measures are an important factor. Against this background, there is currently a debate as to whether the strong growth in money supply is contributing to a sustained significant increase in inflation. I do not see this happening at present. In the past, a close correlation between money supply and inflation was visible at medium and high inflation rates. At present, however, inflation is low, and this correlation is not proving to be very meaningful. Moreover, we are in principle in a position to counteract this with a more restrictive monetary policy, i.e. ultimately higher interest rates. In my view, this is then a question of will: Are the central banks also prepared to roll back their measures in good time if price stability requires it? Or are concerns about possible side effects, for example on financial stability or sovereign financing costs, dominating the debate, so that the reins are tightened too late?
In the debate, there is continuous talk of zombie companies ...
These are unprofitable companies that should have gone bankrupt and are only being kept alive by repeatedly extending loans at low interest rates. The concern is that the low interest rate environment is fostering such a development. In some euro countries, the share of such firms has indeed risen during the financial crisis and the subsequent sovereign debt crisis, according to studies. But it is not clear whether or to what extent the low interest rates are responsible for this.
How do you assess the situation in Germany?
In Germany, the proportion of these problem companies has actually decreased in the low interest rate environment. Of course, the pandemic has created a completely new situation. On the one hand, many companies are coming under acute pressure. Business models are also being called into question. On the other hand, government support measures are helping. Ultimately, we expect the number of insolvencies to rise again from a very low level when the measures expire. As a result, loan defaults at banks are also likely to increase - but from today's perspective on a scale that the banking sector in Germany can cope with. This is helped by the relatively comfortable capitalisation of the institutions. This is also thanks to the banking regulatory reforms after the financial crisis.
In addition to your office as president of the Bundesbank, you also head the board of governors of the Bank for International Settlements, which in turn is responsible for the Basel Committee and to which, among other things, the stricter capital adequacy rules for banks following the experience of the financial crisis can be traced. Your Bundesbank vice president, Claudia Buch, recently warned at the spring meeting of the International Monetary Fund against rolling back this financial regulation in the pandemic. In turn, the European banking regulator, which resides at the ECB, has cautioned that some models calibrated to the IFRS 9 balance sheet standard for calculating default probabilities are so "desensitised" that they "artificially" reduce the measurement of credit risk. What is your assessment of this?
These are two different issues. Regulators and supervisors have responded to the corona crisis by relaxing their requirements to some extent. In particular, they have allowed banks to use capital and liquidity buffers when necessary - with the aim of ensuring that banks do not overly restrict their lending and that the financial sector thus does not further exacerbate the crisis. But these are temporary measures. The point Claudia Buch made was that one should not question the Basel framework as a whole. Supervision will, of course, revert to the tried and tested and negotiated standards after the crisis.
It is no secret that you are critical of the ECB's bond purchases. You warned of side effects back in 2012. What is your view of the ECB's current course?
Purchases of government bonds can be an effective and legitimate instrument of monetary policy. But they also entail significant risks - especially in a monetary union of independent member states. That is why I have always said that government bond purchases should be an instrument for emergencies. The pandemic is a classic emergency situation in which, in my view, bond purchases are justified. But here, too, the right measure is important, and the central bank must not engage in monetary government financing. We were already the largest creditor of the euro area member states before the pandemic began. Together with the government bonds that had already accumulated before, the holdings of the Eurosystem, i.e. the ECB and the national central banks, in public bonds could move toward an order of magnitude of 40 percent of the euro area's economic output next year. When the Eurosystem launched its first purchase program around 10 years ago, some hoped that this instrument would only be used temporarily. That did not prove to be the case. My concern at the time that fiscal policy was increasingly embracing monetary policy continues to drive me. This mixing of monetary and fiscal policy can also make it more difficult for monetary policy to ensure price stability.
What are the effects of this "embrace"?
If the central bank buys government bonds on a large scale, the member states are partly shielded from the capital markets. This can weaken the market discipline of fiscal policy. As mentioned at the beginning, it is actually an important element alongside fiscal rules. Incidentally, the purchases ultimately tie the financing costs for this part of government debt to short-term central bank interest rates via the balance sheet link between the central bank and government finances: In this respect, what is currently relevant is the interest rate paid by the central bank on the banks' high deposits. This means that every treasury pays the same interest rate for the government bonds held on central bank balance sheets - regardless of their creditworthiness.
However, this means that future changes in key interest rates will have a greater impact on government finances. Particularly in view of the sharp rise in debt as a result of the pandemic, this could in turn put monetary policy under pressure to keep interest rates low for longer.
In the public debate, there seem to be only two ways out: One way out seems to be through a debt union managed jointly by fiscal policy. The other, that states go bankrupt.
No, these dire predictions are exaggerated. A debt union and sovereign insolvencies are extreme scenarios, and good policy consists precisely in avoiding them.
But we central bankers should make it quite clear that we will tighten monetary policy again if the price outlook requires it, regardless of whether this raises sovereign borrowing costs. Otherwise, false expectations might be raised and additional debt taken on, which would further increase the pressure on the central bank. But the central bank should not even be put in a dilemma in which it can only decide to subordinate its price stability objective on the one hand or to accept financial stability risks or sovereign debt crises on the other, which could result from higher sovereign financing costs. That's exactly why we have fiscal rules. That's exactly why we need market discipline. And that is precisely why monetary policy should not be too closely interwoven with fiscal policy.
In 2020, the Bundesbank increased its risk provisions by €2.4b to €18.8b euros and thus did not distribute a profit, the first time it has done so since 1979 - an absolute exception since its establishment 64 years ago. By contrast, the Banca d'Italia distributed a profit of €6.3b. The Italian central bank's total assets now stand at €1.296t. It bought bonds for €116b last year alone and now holds bonds worth €473b on its books. What view do you have of this?
The effect of bond purchases on the profit and risk situation varies greatly from central bank to central bank. This is also because we deliberately decided not to introduce a liability union for sovereign default risks via the central bank balance sheet. For example, the Banca d'Italia only holds bonds issued by the Italian government, which have a comparatively high interest rate due to the risk premiums on Italian debt, while our books contain federal bonds with a lower interest rate. Due to the low interest margin, the Bundesbank has particularly low interest income in a cross-comparison - on very safe bonds. This means that changes in interest rates can also lead to losses for us more quickly. The Bundesbank assesses risks on the basis of recognized risk measures and with the help of model calculations. This model-based assessment has indicated an increase in risks and we have therefore increased our risk provisioning.
What is your time horizon for the two issues of a turnaround in interest rates and an end to the bond-buying program?
A prerequisite for monetary policy normalization is progress toward our target, namely an inflation rate of below but close to 2 per cent in the euro area in the medium term. In its latest forecast, the ECB staff expects an inflation rate of 1.4 per cent for 2023, the end of the forecast period. At the same time, forecast uncertainty is particularly high at present, and inflation could well temporarily rise more sharply in the coming quarters. However, our target is medium-term, and monetary policy looks through short-term fluctuations in the inflation rate in the euro area. That is why the financial markets do not expect a significant tightening of monetary policy in the foreseeable future. In any case, the first step would be to scale back bond purchases before raising key interest rates. This has also been clearly communicated by the ECB Governing Council.
What do you expect to happen in the next 10 months, for example?
Of course, I don't forecast any decisions by the ECB Governing Council. But this much can be said: The emergency purchase program PEPP (Editor's note: Pandemic Emergeny Purchase Program) is clearly linked to the pandemic and will end when it has been overcome. However, no one can reliably estimate when exactly that will be. In this respect, we are driving on sight.
Economic processes are becoming increasingly interlinked and therefore more susceptible to external shocks. We noticed this at the beginning of the pandemic, especially in the supply chains. As a central banker, how do you assess risks from geopolitical tensions?
Both increasing rivalries between economic areas and the pandemic could well encourage tendencies to roll back globalization. During the first lockdown, international supply chains broke in some cases; some production lines came to a standstill. For this reason, there are calls for greater reliance on domestic production and thus less dependence on supplies from abroad. But this would make the economy more vulnerable to disruptions at home. You don't increase the resilience of an economy by switching from one cluster risk to another. Ultimately, diversified production structures help to cope with disruptions or crises such as we are currently experiencing. Partitioning deprives economies of the benefits of the international division of labour while making them less robust than some would hope.
In addition to all these issues, there is another pressing one these days: the e-euro. ECB President Christine Lagarde has been talking for quite some time about a possible digital currency that could be adopted by the ECB as legal tender alongside cash. This could be understood as a reaction to the developments surrounding the DLT economy - and the idea that value chains and business processes could be handled in parts via the blockchain in the future - and thus be organized in a more decentralized manner. What is your perspective on this?
If a central bank issues a different form of money, that's not decentralization to begin with. The Eurosystem would remain the central player in the case of a digital euro, or even gain more influence. For the Bundesbank, the first priority in these considerations is: What do citizens want? What do companies need? How can payments be made conveniently, cost-effectively and at the same time online-compatible and secure? In my view, that is sometimes neglected in this discussion.
How do you think digital payments could be improved?
In the online world, speed and low transaction costs are the trump cards. But instant payments are already possible, i.e. payments that can be made securely, immediately and definitively. In addition, there is increasing interest in programmable payments, for example, so that the e-car pays for the refueled electricity automatically at the charging station.
This could probably be achieved by further developing existing systems. But consumers should have a choice. And digital central bank money could have the potential to facilitate innovation. That is why we are working intensively on digital central bank money, but we should not lose sight of other solutions. The interface to customers should definitely be the financial and banking system, as it has been up to now. It is important that the central banks provide the backbone for payment transactions. But the private sector must provide the services for consumers.
But couldn't the e-euro still be a good complement to the commercial banks' paper money - simply because the ECB enjoys so much trust as an intermediary?
After all, citizens already trust that the money in their bank accounts is safe - and rightly so. This is also ensured by banking supervision and deposit insurance. And they can already pay digitally with this money today, for example via card or smartphone. What we are discussing is giving citizens the option of paying with central bank money in a digital environment as well. But we have to design a digital euro in such a way that it delivers added value and the side effects and risks of this very fundamental step remain limited. This is because it could have an impact on the structure of the financial system and its stability, among other things. Therefore, restrictions are being discussed, such as a cap on the amount that anyone or everyone can hold.
There is also sometimes discussion among observers about the extent to which the e-euro could be used to issue programmable money - which, if programmed with a purpose, would be used only for that purpose.
The idea of programming money in such a way that it could no longer be used to buy cigarettes, for example, seems absurd to me. Digital central bank money must be a universal means of payment like cash. And one thing is clear: the whole discussion is not about abolishing cash. Cash remains an attractive means of payment in many situations, and the Eurosystem will continue to make it available.
The interview was conducted by Katharina Brienne and Michael Maier.