13 February 2013

Bundesbank/Weidmann: Crisis management and regulatory policy

Weidmann highlighted two challenges for central economic policy: 1) give the principle of liability renewed heft, both in the financial system and in monetary union as a whole; 2) preserve and protect the role of central banks as independent, clearly focused guarantors of monetary stability.

Strengthen the principle of liability

One of the crucial questions is: how can competition and the price system be protected if the principle of liability is undermined by the problem of systemic importance?... The decisive question is thus how to give the principle of liability more heft – in the financial markets and among governments.

There are a number of approaches that could be taken at the level of the financial markets.

Higher capital requirements for banks are one such approach. They enable banks to shoulder greater losses by themselves and thus shift the risk back to the owner. Government bonds, in particular, should be adequately backed by capital in future.

Plans to ringfence certain risky banking business by creating independent trading units within banks are another such approach – they reduce internal cross-subsidising of risky trading business, thereby giving depositors better protection from the risks of such business.

The banking union is yet another. It shifts banking supervision to the European level and can thus ensure a better equilibrium with regard to liability and control between investors, national taxpayers and euro area Member States. For this to succeed, the banking union needs not only a central supervisor but also resolution regimes which can help systemically important financial institutions, too, to file for bankruptcy without causing damage to the system while, at the same time, creditors participate in the costs of the institution’s failure.

In order to strengthen the principle of liability at the level of sovereign states, the framework of monetary union needs to be improved. Even with regard to government finances, liability and control must be in equilibrium. In the Maastricht framework, both liability and control were, essentially, located at national level. During the crisis, however, we moved away from this: control remained national, whereas liability has been increasingly transferred to the European level. While national governments take independent decisions on debt, the community is liable for the consequences.

This set-up is a breeding ground for renewed unsound developments. I therefore see only two convincing options.

Either we shift control and intervention rights to the European level as part of a fiscal union; or, in the sense of a return to the Maastricht framework, we strengthen the liability and independent responsibility of member states. Taken to its logical conclusion, this also means that we cannot – and must not – rule out the possibility of sovereign defaults.

As things now stand, however, it is not quite clear which of these two directions policymakers are leaning towards; they seem to be performing a balancing act, with one foot in the Maastricht world and the other in a fiscal union. In the long run, such a balancing act is painful and unhealthy.

The role of central banks

While policymakers vacillate, expectations of central banks increase. The Eurosystem is being cast as the only actor on the European stage with any ability to take any meaningful action. Accordingly, there are ever-increasing calls for the Eurosystem to do even more to resolve the crisis.

I consider this a bad idea, for two reasons.

First, the Eurosystem cannot resolve the crisis. The causes of the crisis are structural, and are to be found at the individual Member State and the European level... Only policymakers can solve these problems; central banks cannot. To that extent, the discussion surrounding an allegedly overvalued euro is just a red herring to divert from the real challenges. Quite apart from the fact that the relevant indicators are not pointing to major overvaluation, even despite the euro’s recent appreciation, policymakers should adhere to the tried and tested assignment of roles...

The second reason why the Eurosystem should not do even more is that the Eurosystem has already done much to contain the crisis. It has cut interest rates; it is supplying virtually unlimited liquidity to banks; and it has intervened in the bond markets. With these measures, the Eurosystem – like other central banks round the world – has taken considerable risks, and it has stretched its mandate considerably...

At all events, this creeping or even open politicisation of central banks is causing me concern. The value of independent central banks is borne out not only by theoretical considerations but also by historical experience. I have already mentioned Italy as an example; England and France have seen similar experience, too...

It must be recognised that the aim of a stronger rules-based policy framework is to prevent the primary objective of monetary stability from being watered down. Central banks use these rules to tie their own hands in order to avoid being co-opted by fiscal policy. The price central banks have to pay for this, however, is that monetary policy also surrenders its flexibility. And it is precisely the decisive contribution made by central banks to stabilisation at the height of the crisis in the autumn and winter of 2008 which showed, in my opinion, just how important and useful such flexibility can be if it is firmly anchored in a clear commitment to the primary objective of price stability. However, the risks of such a policy are likewise becoming increasingly apparent.

Yet it is not only the benefits of independent central banks which are being questioned. On the heels of the crisis, changes to the monetary policy framework are being proposed which are designed to give monetary policy more policy options in times of crisis...

[Walter] Eucken emphasised time and again, and I agree, that monetary stability is the basis for functioning competition, for a market economy and for general prosperity. However, I am also convinced that monetary stability is possible only with independent central banks whose mandate is focused on preserving price stability.

At all events, I am convinced that the crisis does not justify discarding this framework, which has proved its worth in theory and through practical experience.

Full speech

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