Bundesbank President Jens Weidmann called on monetary policy makers to take into account the effects of financial imbalances on price stability as part of their existing mandate. "However, financial stability should not be placed on a par with price stability as an objective of monetary policy", he said before an audience of 500 at an event co-hosted by the ifo institute and the German daily Süddeutsche Zeitung newspaper at the Ludwig Maximilians University of Munich, adding that financial stability should primarily be secured via macroprudential policy. The objective of macroprudential policy is to safeguard the stability of the financial system as a whole using regulatory and supervisory instruments.

However, according to Weidmann, as financial stability risks probably cannot be eliminated through macroprudential instruments alone, monetary policy should, in his view, extend its time horizon and take into account the longer-term effects of financial imbalances on price trends in order to ensure price stability in the long term. He noted that "if monetary policy makers are aware of the effects of monetary policy on financial stability and the resulting feedback effects on price stability, monetary policy will tend to be tighter in upturn periods than would be required by short-term inflation alone."

"Alarmism is uncalled for"

The Bundesbank's president warned that, with respect to the Eurosystem's current ultra-loose monetary policy, the attendant risks to financial stability should not be ignored, stating that "In my view, monetary policy makers should not be allowed to simply shrug their shoulders if there are signs of speculative exaggerations on the asset markets." The substantial and in some cases rapid rise in prices on European equity and bond markets in previous weeks and months points, in Weidmann's view, to a highly increased risk appetite, which central banks have to watch carefully. Weidmann also pointed out that, at the same time, the risks to financial stability from the protracted low-interest-rate environment might not be limited to asset markets alone. "Because this low-interest-rate environment depresses the earnings situation of banks and insurance companies, it increases the risk of instability the longer it continues", he noted. It was therefore all the more important that financial institutions continue to improve their capitalisation and critically scrutinise their business models.

Weidmann saw no sign of a speculative price bubble in the German real estate market. Although residential real estate prices had risen considerably in Germany in the past few years, these increases were focused in large cities. "Vigilance is certainly appropriate, but alarmism is uncalled for", Weidmann said.

Ban on monetary financing of governments

In the subsequent discussion, Hans-Werner Sinn, President of the ifo institute, asked whether or not flawed policies in the Eurosystem had promoted the growth of bubbles in southern European countries, noting that the prospect of financial institutions receiving emergency loans from national central banks had made a major contribution to this situation by lulling investors into a false sense of security and subsequently enabling capital flight from the crisis countries.

Bundesbank President Weidmann reminded the audience that the real estate price bubble in southern Europe had already developed in the early 2000s. Emergency liquidity assistance (ELA) was at the time probably not a factor behind investors' decisions. Weidmann noted that ELA could be granted only under clear rules, ie only temporarily and only to solvent institutions. Looking to the Greek situation, he noted that ELA to individual Greek banks did raise concerns regarding the ban on monetary financing of governments.