Bundesbank President Jens Weidmann has again warned of the risks posed by loose monetary policy in the euro area. Inflation is still subdued at present, he noted. "But in light of the ongoing economic recovery and a consensus inflation rate forecast of just under 2 % for 2019, it is certainly legitimate to ask when the ECB Governing Council should set its sights on normalising monetary policy," Mr Weidmann remarked at the Deutsche Bundesbank's second Capital City Reception.

The President of the Bundesbank primarily voiced criticism of the non-standard monetary policy instruments, specifically the Eurosystem's purchases of government bonds, which he argues blur the important boundary between monetary and fiscal policy. "Hence my view that government bond purchases are an instrument of last resort - one which should mainly be used to fend off deflation," he stated. 

After-effects of crisis still being felt

That domestic price pressures are still relatively muted at present can be attributed mainly to the fact that multiple countries are still feeling the after-effects of the crisis, said Mr Weidmann. Many banks are still showing restraint when it comes to lending, he continued, and a large number of enterprises and households in the euro area are still busy scaling back what are, in some cases, high levels of debt.

Retrenchment efforts by general government, on the other hand, have waned perceptibly since 2013, the Bundesbank President noted, pointing out that the large member states of France, Italy and Spain were precisely the ones which spent every last bit of what they saved in interest payments thanks to the low interest rates over the past few years, instead of using it to pay off their debts. With that in mind, Mr Weidmann praised the commitment made by the new French president, Emmanuel Macron, to comply with the fiscal rules and strengthen economic reforms.

Monetary union remains vulnerable

The Bundesbank President's speech also touched on the architecture of monetary union and current reform proposals. He warned that the mutual liability introduced in the context of the European Stability Mechanism (ESM) further increases the euro-area countries' incentive to run up debt. "If action is taken at the national level but responsibility is taken at the European level, the euro area will never achieve long-term stability. Instead, it could lose its footing because policymakers rely on safeguards at the European level," Mr Weidmann cautioned. 

Deeper integration can only make the euro area stronger if each level assumes responsibility for the debts it incurs, he stated. In this connection, he reiterated a Bundesbank proposal which envisages that all bonds issued by a government which has applied for ESM assistance have their maturity automatically extended by three years. Mr Weidmann argued that this would continue to provide incentives for private creditors to lend cautiously, and would also significantly reduce the need for financial aid under the rescue mechanism, thus broadening its scope. 

European capital markets union

A common budget can also reduce the risk of the monetary union drifting apart, according to Mr Weidmann, who believes it could help cushion shocks to a certain extent and thus synchronise the economic performance of the individual countries to a larger degree. "But this effect would not be as major as some might hope," he warned, pointing to the United States as an example. Integrated capital markets are more effective, he argued, when a business's shareholder base is spread across different states, which is why the Bundesbank is supporting the European Commission in its efforts to establish a European capital markets union. "Taking these steps to make the euro area more robust is a chance that should not go to waste," Mr Weidmann stated.

Second reception in the capital city

Mr Weidmann made these remarks at the Bundesbank's Capital City Reception. The event aims to further strengthen dialogue about central bank issues in the capital and provides a networking opportunity for individuals from the political arena in Berlin. Around 200 guests attended, among them members of the Bundestag's Financial and Budget Committees as well as representatives of various ministries, academic institutions, and associations.