Bundesbank Speaks 'Greece's Future in the Euro Lies With Politicians'

Jens Weidmann, president of Germany's central bank, the Bundesbank, talked to Handelsblatt about the European Central Bank's monetary policy, his beef with quantitative easing and the Greek debt crisis.
Mario Draghi's chief critic makes his points to Handelsblatt.

He’s known for being calm and collected. But in an interview with Handelsblatt at the Bundesbank’s regional office in Düsseldorf, editors saw a different side to the German central bank’s president, Jens Weidmann. Asked whether he could or should be responsible for Greece leaving the 19-nation euro zone, Mr. Weidmann took his time answering – and at times got quite emotional.

Handelsblatt: Mr. Weidmann, the Greek crisis has been underway for five years now. Even after the latest round of negotiations, there is no agreement in sight between Athens and its euro zone partners. In your opinion, can the country be kept in the euro zone?

Jens Weidmann: The situation has clearly escalated in recent weeks, and the country's fiscal emergency is apparently still increasing. Only the Greek government itself knows how much longer its fiscal reserves will last. The decision over Greece's future in the monetary union clearly lies with politicians. But it is also clear that it didn't have to come this far. Unfortunately, a lot of time has been wasted since the new Greek government came into office.

No one in the world is still lending money to Greek banks, because everyone knows the banks would immediately declare bankruptcy if the state defaulted on its own debts. The European Central Bank is providing the banks with emergency loans, even though it is in fact only allowed to provide such loans to solvent banks. Why is the ECB still behaving as if this problem didn’t exist?

The ECB governing council is certainly aware of the problem of the unhealthy interdependence of banks and the government in Greece, as evidenced by its regular meetings on extending the emergency loans. In light of the [ECB’s] ban on monetary state financing, I don’t think it's right that banks are being granted loans that are then used to finance bonds from their own state, which itself has no market access.

Is the Greek central bank demanding enough collateral from banks in exchange for the emergency loans?

As [ECB President] Mario Draghi pointed out recently, the ECB Council is now engaging in a discussion – and one that is absolutely necessary – over whether the haircuts on the collateral required by the Bank of Greece are high enough. Even the value of the collateral is strongly linked to the solvency of the Greek state.

Would you be willing to assume responsibility for the ECB shutting off the liquidity faucet, thereby forcing Greece to leave the euro zone?

I think the premise behind your question is problematic. It implies that central banks are responsible for the composition of the monetary union or the granting of aid payments. This responsibility does not lie with the Eurosystem [the network of European central banks] but with the euro countries. At the moment, the latter are saying that they will no longer approve any further emergency loans for Greece. Do you expect the central bank in turn to circumvent this political decision and provide financing?

But hasn't the ECB allowed itself to be forced into this role? After all, the Greek government understood all too well that it was grasping at final straws from Frankfurt.

That is precisely my concern. The more the impression is created that we are stretching our own rules and playing a political role, the more difficult it becomes to adhere to our mandate.

But perhaps it is the central banks' duty to clarify this issue to lawmakers.

And that's why I'm talking about it.

The book on Greece's finances isn't as thick as Mr. Weidmann would like.

 

If you were the German chancellor, would you advise against pushing another aid package for Greece through the parliament, the Bundestag?

Well, the ball is now clearly in the Greek government's court. It needs to commit its country to fundamental reforms. Additional financial resources could buy it time, but that would certainly not correct the problem of a lack of competitiveness or creating a viable administrative infrastructure.

Does the Greek government still have enough credibility to take the necessary steps?

A great deal of trust has certainly been destroyed in recent weeks and months. And it's much more difficult to build trust than to destroy it. The question of whether sufficient credibility exists must ultimately be decided by those responsible for the negotiations with Greece.

It was always argued in the past that a “Grexit” would cause too much political damage to the euro zone which after all is still young. But isn't it at least equally harmful to repeatedly help a country that keeps refusing to take the necessary steps?

It is clear that the euro zone is more resilient today than at the height of the crisis. And the markets have also understood that Greece's problems within the euro zone are unique and of its own making. In this regard, the risk of contagion would be manageable. However, in the scenario you mentioned, the irreversibility of the monetary union would be called into question, which would fundamentally change its character. This needs to be weighed against the risk that others will follow Greece's example and the monetary union will transform into a transfer union.

And what would be so bad about that?

An economically successful monetary union, accepted by the population and with a stable currency, could not be guaranteed on that basis. But, once again, the best option is for the government in Athens to live up to its responsibility for sustainable economic development in Greece, as well as its responsibility to the monetary union. That's why the Greek government must now promptly submit convincing reform proposals. The Eurogroup also made this point recently.

If the chancellor reads this part of the interview, she'll wonder what she should do next and think, Mr. Weidmann is telling me that dealing with the Greeks is difficult, but it still isn’t clear to me whether we should allow them to withdraw from the monetary union.

She should know where I stand by now.

But doesn't this have to be said directly?

The issue is that we cannot satisfactorily do our job as a central bank in a transfer union in the long term. That's why we, as a central bank, must depend on the individual countries getting their economic problems under control. Wasn't that sufficiently direct?

 

013 - Neu 2015-03-17-01

 

By transfer union, you mean permanently providing support to a country?

It became clear pretty quickly that the aid to Greece could not be judged by the standards of a normal aid program. But that still isn't the same thing as a monetary union in which countries cannot stand on their own feet in the long term, economically and financially, and are financed by others.

So the long-term risk of a transfer union is higher than the short-term risk of a Lehman-style financial shock for Europe?

The best thing is if neither of the two risks occurs. It is worthwhile to preserve this currency and not speak so flippantly about any scenarios of disintegration.

You are one of the sharpest critics of the ECB's creative monetary policy. How is your relationship with the ECB President, Mr. Draghi?

I have a good working relationship with Mario Draghi. Besides, this isn't about personal conflicts, which don’t exist, anyway. It's about having a substantive discussion. All of the members of the ECB council share the goal of wanting to fulfill our mandate. But we are discussing what the right path should be. As a citizen, I would be more concerned if there were no substantial discussions and if – in light of the difficult decisions that are taking the central bank into uncharted territory – there were no differences of opinion.

Does it worry you that the central banks have become all-powerful?

We are not omnipotent. I am concerned, however, about the growing politicization of central banks as much as I am about the constantly growing expectations we face. This creates the risk of central banks become dangerously overloaded, not just in terms of our democratic legitimization, but also because we wouldn't even be capable of solving Europe's problems. We can increase economic growth in the short term, but this would be nothing but a flash in the pan without the necessary structural reforms. If the impression is created in politics that the central bank is always ready to step into the breach, it creates the risk that these reforms will not happen, along with the risk that monetary policy will fall into the wake of other areas of politics and lose sight of its mandate.

Most recently, the ECB’s purchase of government bonds, or quantitative easing (QE), has helped ease the euro zone’s crisis. At the same time, yields on government bonds with short-term and medium-term maturities have fallen into negative territory. For investors, this means that abstaining from consumption is no longer rewarded, but in fact punished with a financial loss. How much longer do we have to live in this contorted world of interest rates?

Interest rates are in fact very low, even though they have risen considerably in the capital markets of late. However, low interest rates are also politically desirable at the moment, because the rate of inflation in the euro zone is significantly below the ECB council's target rate and will stay that way for the foreseeable future. At the same time, today's low inflation also means that interest rates are not unusually low in real terms, that is, in light of actual purchasing power. There have been times, here and there, when real interest rates on safe investments in Germany were negative, such as in the 1970s and 80s.

There are already banks today, in Spain, for example, that are offering property loans with negative interest.

Those are isolated cases. I think it's unlikely that borrowers across the board will soon be paid to borrow money.

But Germany’s KfW bank is already discussing those kinds of scenarios…

KfW is a development bank with a public mandate. It is 100-percent owned by the federal government and can borrow money on the capital market at low rates similar to those available to the government. Commercial banks use a different basis of calculation.

 

078 - Neu 2015-03-19-01

 

It sounds as if you didn’t believe that the contorted world of interest rates were that problematic…

Far from it. Of course there are risks that arise from consistently low interest rates. And those risks also increase with the duration of the low interest-rate period. Interest is the price of capital. In principle, therefore, it's a price like any other. And if something is available for almost nothing, this can lead to faulty allocations: Capital can be used incorrectly, because unsustainable business models can appear worthwhile. Besides, the pressure on governments to reform can subside, as can their enthusiasm for consolidation. In addition, the risk of financial market excesses grows, as does the pressure on life insurance companies and company retirement pensions.

Has the strong reaction of capital markets surprised you? And how much of that is attributable to the ECB, which has been buying up government bonds since early March?

The markets had already priced in the QE program to a large extent. Nevertheless, there was a surprisingly sharp decline in interest rates once the purchases began, which some interpreted as recognition of its decisive implementation. The fact that longer-term interest rates have declined in the meantime certainly had something to do with the structuring of the program. For instance, the circumstance that we are not buying any bonds with yields below minus 0.2 percent was interpreted to mean that we are prioritizing longer-term bonds. But in the meantime, capital market rates have again moved significantly away from their lows and, in the case of 10-year bonds, are even above levels that existed at the time of the QE decision.

Apparently there have already been discussions over whether this negative 0.2-percent-limit should be abandoned, as the supply of bonds on the market is already getting tight today. Is that true?

There is a decision by the ECB council on the program and its configuration, and it is being implemented accordingly. So far, the Bundesbank has not had any trouble acquiring the planned volumes.

Did the Bundesbank push for this limit in the ECB council?

We didn't have to. It is in the interest of the ECB council as a whole not to generate ongoing losses with this type of program unless absolutely necessary. These losses would be incurred if the acquired bonds generated lower yields than the opposing items on the liabilities side of our balance sheets.

Despite the recent move upwards, do you expect the yield on German 10-year government bonds to drop below zero in the foreseeable future?

I assume that the economy in the euro zone will recover and that inflation will increase again accordingly – partly because the effects of the oil price on inflation are diminishing. This should lead to a rise in long-term interest rates, even in Germany. At any rate, I see the risk of deflation, which until a few weeks ago was still being vigorously discussed, as being lower than ever.

 

Video: Jens Weidmann has long been an advocate of structural reforms and getting Europe's government debts under control.

 

Does this mean that the many European and U.S. economists who had warned against the risk of deflation in the euro zone were wrong?

Lower energy prices were the primary reason for the very low rates of inflation we have seen recently. The decline in market-based inflation expectations, in particular, could have been at least partly a result of the constant talk of supposed deflation. If you spend a lot of time talking about the risk of deflation, this will eventually be reflected in market prices.

Inflation expectations are not the only thing on the rise. Credit markets in southern Europe recovered recently, and the euro had been falling sharply until recently. Don’t you have to admit that QE is working the way ECB Chairman Draghi had expected it to?

No one, including me, disputes that the central bank, the player with the deepest pockets, can influence the financial markets and the economy with massive bond purchases. But this still leaves us with the question of whether the QE program was absolutely necessary, in light of our primary goal of price stability, and of how we should appraise the risks and side effects this type of program inevitably creates. This consideration was at the center of the QE decision, and in that sense, the assessments within the ECB council still vary.

In your view, what are the greatest risks?

The QE program turns the central banks within the Eurosystem into the countries' biggest creditors, further accelerating the fusion of monetary and fiscal policy. This can lead to an increase in political pressure on central banks when future monetary policy decisions are made, especially as the robustness of reforms in the member states is further weakened.

What can the central bank do about risks to financial stability?

Macroprudential instruments represent the first line of defense. They include, for example, the condition that banks apply higher standards to a borrower's creditworthiness and performance when approving real estate loans.

Does this mean that classic tools of monetary policy, such as the benchmark interest rate, should not be used to fight financial market bubbles, as the Bank for International Settlements (BIS) has proposed?

This is a complex and very important issue, which the Bundesbank addressed at length in one of its most recent monthly reports. At any rate, we should not go so far as to impose several equivalent goals on monetary policy – price stability on one side and financial stability on the other. This can quickly turn into a random monetary policy, which would harm its credibility and reduce its effectiveness.

But isn’t the benchmark rate a far more effective way of fighting exaggerations in the financial markets?

Perhaps. But regulatory instruments can be likened to a scalpel. They can intervene in precise ways in certain markets. The benchmark rate is more like a sledgehammer that should be used if exaggerations in the financial markets become more pronounced and eventually threaten price stability. In other words, monetary policy should not simply stand on the sidelines and look on as bubbles form. The point is that its actions must be dictated by the goal of price stability. That's also the way I understand the BIS.

(L-R) Handelsblatt editor-in-chief Sven Afhüppe, Bundesbank President Jens Weidmann, Handelsblatt finance head Daniel Schäfer and monetary policy editor Jens Münchrath.

 

In which financial market sector do you see the greatest risks of a bubbles developing? Italy, with a national debt of 120 percent of its GDP, is refinancing itself in the bond markets at interest rates near or in some cases even below zero.

The current low interest-rate environment can generally lead to a hunt for yield, so that investors take greater risks and premiums shrink in return. This can also lead to poor budget practices no longer being suitably penalized and good practices no longer being rewarded.

Is the biggest problem, therefore, that the zero interest-rate policy ultimately curbs political and institutional reforms in Europe?

In fact, the pace of reform has noticeably weakened in the last two years, even in the program countries [those euro-zone countries that have been bailed out by their European partners]. But monetary policy cannot conjure up the lasting growth the euro zone needs. It is vital that governments create the necessary basic conditions.

Would you argue that QE should be stopped earlier than planned?

Regardless of my skeptical position toward QE, I don't think it’s helpful for the credibility of the ECB council that its decisions are repeatedly questioned once they have been made.

Was it necessary to define this program, from the very beginning, for such a long period of 19 months, without tying it to the development of certain indicators?

As I said, I was against this program and the underlying logic of a balance-sheet goal. You can’t exactly ask me, at this point, whether the volume was appropriate. My choice would have been zero.

But wouldn't nine months be better than 19?

Certain expectations were raised in advance, and they played a role in determining the structure of the program.

Are you referring to the goal of increasing the ECB’s balance sheet by a trillion euro, which Mr. Draghi already mentioned last fall?

Yes, for example.

Did you feel overlooked when Mr. Draghi laid out such a balance-sheet goal without a council decision and without any discussion in public?

Of course, the ECB president has an accentuated role. At the same time, to achieve an effective, shared monetary policy in the euro zone that is broadly accepted, it is important that monetary policy decisions are preceded by open and transparent discussions in the ECB council. This allows their entire expertise to be included and the justification for decisions to become clear.

Does this mean that we can assume that you were not particularly amused by Mr. Draghi's remark?

I was always skeptical about a balance-sheet goal, because the quantitative relationship between the central bank's total assets and our price stability goal is completely unclear.

Still, the Bundesbank has ensured that QE was implemented in such a way that each national central bank is liable for its own risks in connection with the bond purchases. But this means the Bundesbank is more likely to lose money under the QE program, while the other central banks are reaping profits.

The general abandonment of a risk-sharing prevents us from introducing Eurobonds through the back door – and that's a good thing. Incidentally, the potentially higher interest income for other central banks is also offset by higher risks, for which profit-minimizing reserves have had to be formed. On the whole, however, looking at central bank profits is too shortsighted. After all, earning profits is not the goal of our monetary policy. Our mandate is price stability, even if this may be associated with losses.

Will a return to a normal monetary policy occur during your term in office?

My current term ends in 2019. There should be more than enough time to return to calmer waters when it comes to monetary policy.

Mr. Weidmann, thank you for the interview.

 

The interview was carried out in German. It was translated into English by Handelsblatt Global Edition staff. The Bundesbank will be issuing its own official translation in the coming days.

The interview was conducted by Sven Afhüppe, Handelsblatt’s editor-in-chief, Jens Münchrath, who leads monetary policy coverage, and Daniel Schäfer, who heads Handelsblatt’s finance section. To contact the authors: [email protected], [email protected] and [email protected]