© Alice Schnür-Wala

Bundesbank President Jens Weidmann believes that the increasingly robust economic recovery in the euro area is creating scope to move away from an ultra-loose monetary policy stance. "The ongoing economic recovery is now opening up the prospect of a normalisation of monetary policy," he said at the start of a discussion with his Austrian counterpart Ewald Nowotny at an event hosted by the Austrian Society for European Politics in Vienna. Mr Weidmann stressed that it is not a question of slamming on the brakes, but of easing off the accelerator a little. "Both the timing and the pace of monetary policy normalisation depend on the extent to which price pressures are sustainable and self-sustaining," he remarked.

Price pressures set to pick up over time

With oil prices leaning somewhat to the downside of late, Mr Weidmann expects euro-area inflation rates to return to a slightly lower level at year-end, noting that domestic price pressures are still relatively subdued. The Governing Council also agrees unanimously "that domestic price pressures in the euro area will likewise pick up over time – not least as labour market conditions continue to improve," said the Bundesbank President.

Mr Weidmann argued that, for now, an accommodative monetary policy stance is the right calibration for bolstering economic recovery and thus for strengthening inflationary pressures in the euro area. However, he continued, there are different opinions in the ECB Governing Council over the degree of monetary policy accommodation and what instruments to use in this regard. Mr Weidmann reiterated his criticism of government bond purchases, which for him are solely an instrument of last resort to be used notably to fend off deflation. "But I’ve said in the past that the fears of deflation are overblown," he said, adding that, since then, they have become even less of an issue.

Structural reforms would bolster forces of growth

Mr Weidmann also used his speech to underline the importance of pursuing smart fiscal and economic policy such as structural reforms in order to strengthen the forces of growth. He observed that willingness to embrace reform has dwindled quite substantially since the sovereign debt crisis came to a head, however. "Germany is facing major challenges," he reminded his audience, explaining that the country needs to ready its social security systems to withstand the challenges posed by demographic trends, push labour force participation higher still, step up investment in education and expand its digital infrastructure.

Mr Weidmann also pointed to the wealth of growth potential that still has not been harnessed at the European level, highlighting the importance of switching the single market wholesale to digital goods and of completing the single European market for services. Above and beyond that, he explained, a capital markets union would allow businesses to reap rewards from broader funding opportunities.

He expressed his concern that the start of the exit negotiations between the EU and the UK would leave little room for other major projects. "This makes it all the more important for the member states to embrace reform with renewed vigour," he stressed, welcoming the announcements made by the new French president.

Packaging risks doesn’t make them disappear

Mr Weidmann's speech in Vienna also addressed the proposed introduction of "European Safe Bonds," admitting that he was sceptical as to how successful they would be in increasing the range of particularly safe assets in the euro area. In the model, based on the work of economist Markus Brunnermeier, two tranches of a new type of securities are issued and collateralised with sovereign bonds of all the euro-area countries. Losses from the sovereign bonds used as collateral would initially accrue in the junior tranche. This would make the senior tranche especially safe, which is why instruments in this tranche are also referred to as "European Safe Bonds".

"Sovereign default risks cannot be eradicated by packaging sovereign bonds of different countries or by splitting up bonds into safe and less safe tranches," Mr Weidmann emphasised. "Safe opportunities for investment can only be created by the member states themselves by ensuring sound public budgets. This is best achieved by consistently implementing the liability principle," he concluded.