06 June 2012

Bundesbank/Dombret: "The recent proposals of a so-called banking union appear to be premature"

In his speech at the Bank of America Merrill Lynch Global Macro Conference, Dombret talked about three conditions that he said had to be met to achieve a lasting solution to the current crisis, and to prevent future crises.

The first of these conditions is the rigorous implementation of budgetary consolidation and growth-enhancing structural reforms in the Member States of European Monetary Union. The second is a reform of the framework of the European Monetary Union that takes recent experience into account. The third condition is further progress in financial regulation.

A crucial question with regard to public finances in European Monetary Union is whether the right cure is to prescribe frontloaded consolidation for all euro area countries. I suggest that dragging out fiscal adjustment would have major negative effects. Of course, it is correct to say that, in normal times, consolidation dampens economic growth. Current circumstances, however, are anything but normal, and it is an illusion to believe that backloading consolidation would help to restore confidence. The current crisis is essentially one of confidence. On the other hand, one should not exaggerate the risks of a more restrictive fiscal policy stance, all the more so as the rescue packages and the extremely accommodative monetary policy stance do help to cushion the adjustment. The long-term benefits of frontloaded consolidation, I am convinced, will significantly exceed the short-run negative effects.

I am confident that, once the implementation of structural reforms has started, investors will return even before the effects of these reforms have fully unfolded. Those who are currently short in European sovereign debt and the euro will have to decide when the right time has come to go long again.

The second requirement for a lasting solution to the current crisis and the prevention of future crises is the much needed strengthening of European Monetary Union’s institutional framework. For me, right now, it has become evident that the European Monetary Union’s constitutional setting is far from being sustainable. To make European Monetary Union sustainable two paths can be followed that I will briefly discuss subsequently: truly improving the Maastricht Treaty or building the foundations of a fiscal union.

While the fiscal compact is certainly a major step in the right direction, it is far from being the cornerstone of a “fiscal union” in the euro area. The fiscal compact aims at strengthening the current framework, but its success will hinge crucially on the Member States’ willingness to implement and apply the rules. European authorities are not equipped with a supranational right to intervene in national budgets when Member States do not apply the rules properly. Therefore, the fiscal compact – which has not been ratified by all Member States yet – does not justify calls for monetary policymakers to further extend central banks’ balance sheets. Nor does it substantiate any extensive joint liability.

Against this background the recent proposals of a so called banking union appear to be premature. Such a banking union, potentially comprising a euro area deposit-guarantee system, a euro area resolution fund and common euro area supervision for the largest and systemically important banking groups could very well represent a sensible step forward. Yet it has to follow a deeper fiscal union as it would imply significantly increased risk sharing amongst countries. Introducing a banking union without having established a genuine, democratically legitimated fiscal union would risk undermining the no bail-out clause and the disciplining effects of financial markets on fiscal policy. From a formal perspective it necessitates amending the EU Treaty – meaning it is very unlikely to be a short-term fix to the current challenges mainly related to recapitalisation needs in some banking systems, to political risks and to contagion effects within the euro area.

The same is true regarding the proposed introduction of eurobonds. This is where I respectfully disagree with Olivier Blanchard, the IMF chief economist, who was quoted as saying: “… the Germans had good reason to reject bearing the brunt of irresponsible policies by other states. But now we have a fiscal treaty.” And he concluded: “The Germans should accept that the eurozone is going by way of eurobonds.” Under the current framework, the issuance of commonly guaranteed sovereign bonds would actually increase the existing mismatch between liability and control. I think, that, at least for the time being, euro area governments have been reluctant to surrender their fiscal autonomy to a European authority.

The decisions taken up to now do not yet indicate which direction Europe will take. However, there is absolutely no doubt as to the political will to ensure the continuity of European Monetary Union. Especially to observers from outside the euro area, and given the often slow decision-making processes, the strength of this commitment is underestimated.

We in the euro area believe in the continuity of the euro. And if the euro area embarks on the necessary reforms that I have outlined today, it will emerge from the crisis stronger than ever.

Full speech

© Deutsche Bundesbank