European Central Bank Governing Council member Jens Weidmann comments on exchange rates, monetary policy and Ireland’s promissory note swap.
He made the remarks in an interview in Frankfurt on Feb. 13.
“The G-7 communiqué is in line with the Bundesbank position, making clear that foreign exchange rates are to be determined by the markets. That’s the main line of the communiqué.”
In earlier reported comments “I was referring to the strained relationship between the government and the Bank of Japan, which I found worrisome, and I argued that the central bank and the exchange rate shouldn’t be politicized. That was my starting point in the debate. We have to disentangle two issues. One is the effect of policies geared toward domestic monetary policy needs, the other is about influencing the exchange rate to gain a competitive edge. The communiqué made clear that the latter approach to the exchange rate is clearly not what the G-7 wants.
“I fear a politicization of the exchange rate, and I saw indications of that in Japan, but you could as well refer to recent statements by European politicians not too far from here. We should make clear that the exchange rate enters our policy-making through the effect on the inflation outlook, but we will abstain from manipulating or directly targeting the exchange rate.
“I don’t want to discuss the appropriateness of specific domestic monetary policies, even if they might have debatable externalities on other countries. What we are discussing here are policies geared toward the exchange rate. Sometimes the intentions aren’t even disguised. If we’re asked to steer the exchange rate, it’s a clear case for the latter.”
On the euro exchange rate:
“I believe that the exchange rate of the euro is broadly in line with fundamentals. You cannot really say that the euro is seriously overvalued. I never said there is a currency war, but there is a danger of competitive devaluation that we have to guard against.
“The exchange rate enters our data set relevant for decision making as far as it influences price developments, but it isn’t a policy target.
“I don’t think that Mario Draghi was trying to talk the euro up or down. What Mario did was to lay out how the exchange rate enters our policy deliberations.
“If the appreciation of the exchange rate reflects a regained confidence in the euro area and an improved growth outlook, then this is fully in line with fundamentals.
“If all central banks unambiguously target price stability, this will go a long way toward reducing exchange-rate volatility. At least in the case of the Eurosystem, the target is clearly price stability.
“The exchange rate is one factor among many in determining future inflation rates. We will certainly not justify any monetary policy decision with one single factor.
“The Governing Council just met last week and the press statement referred to broadly balanced risks for price stability. I don’t see there is any major change between then and now.
“I wouldn’t get too excited about exchange rate movements. The whole debate underlines the importance of getting your competitiveness right. It’s in the interest of those countries to increase competitiveness and implement the structural reforms that have been agreed or announced.”
On the role of currencies at the G-20 meeting:
“I don’t think it’s the main topic. Our agenda is pretty broad. We will discuss a wide range of issues, of which the exchange rate is one. The G-7 declaration has already channeled this debate. We have a lot of other issues on our agenda like commitment to fiscal sustainability and financial regulation.
“I consider these summits part of a gradual process. One step at a time. This focus on the outcome of one summit misses the broader picture.
“I don’t think there is a currency war. But we have to beware of countries embarking on competitive devaluation. I welcome the G-7 statement, which is going to be discussed at the G-20 summit as an element to fend off this potential risk. We are in a situation where there is a lot of pressure, especially on monetary policy. This is an ongoing debate which we will have to face for a longer period of time, because the adjustment processes in different countries will go on for a while and the temptation to look for a quick fix is always there.”
On Ireland’s promissory note swap:
“It’s important that we draw a clear line between monetary and fiscal issues. The transaction in Ireland demonstrates how difficult it is for monetary policy to free itself from the embrace of fiscal policy once you’re engaged. The Irish government in its very own statements underscored the fiscal elements in this transaction.
“I’m rather strict when it comes to the definition of monetary financing. It’s important to draw a clear dividing line and accept the limitations of Article 123 for our actions. It’s not difficult from that to guess what my position is.
“The Irish government liquidated the IBRC. That has repercussions on net financial assets and has to be assessed against the background of Article 123. Of course the Eurosystem has to make sure that its actions are in conformity with its rules and statutes.
“I’m not passing a legal judgment on a particular transaction, but I think it is clear from what I said that I’m very concerned about monetary policy being too closely intertwined with fiscal policy and crossing the line to monetary financing. That’s why I was very skeptical about some of the decisions in the past, and you can be sure that I apply the same benchmark to this transaction.
“Once you cross a certain line, setting a precedent, it’s very difficult to come back and argue against the next similar transaction. That’s why it is important to define our mandate narrowly, so we’re not drawn into fiscal policy matters. There is a reputational issue, there’s a credibility issue. It might make it more difficult to focus on our main objective credibly. If governments had wanted to provide additional funding to Ireland, they could have tapped the ESM.
“We took note of this issue in the Governing Council. Our deliberations aren’t public. Apart from that, the transaction is out there, it’s known, it’s very transparent. Everybody has his own judgment on this -- I have mine.
“The transaction as such is technically a bit complex but it has a fiscal nature as stated by the Irish government. That’s clear enough.”
On the economic outlook:
“The confidence indicators are in line with our projections, in which we see a gradual recovery taking place in the second half of the year. I see it as a confirmation of our projections.
“The situation in the euro area is quite heterogeneous. Take the German labor market which is in quite a robust shape, whereas unemployment in Spain is above 25 percent. It depends on the country you’re looking at.
“Our forecast, which I think is still in line with what we’ve seen so far, is one of a gradual recovery in the second half of this year, lagging the upswing of the world economy. I have no reason to doubt this baseline or to speculate about scenarios, and the recent figures for GDP in Germany and the euro area came as no surprise.
“One of the major risk factors that we debate every time is of course the development of the European debt crisis. This partly has to do with political uncertainties about the continuation of the reform process in some member countries and at the EU level.”
“Governments defined two preconditions for financial assistance under the ESM. One is systemic relevance and the other is public debt sustainability. Cyprus is the first case where these new rules have to be applied. I guess my definition of systemic effects would be a narrow one in that it is not enough that we might see an effect on another country, but on the system as a whole. Whether we have these effects depends a lot on how the adjustment in Cyprus is framed, which then in turn will of course affect debt sustainability in Cyprus. To meet the debt sustainability criteria a potential program will certainly need a substantial bail-in component. Besides, there are other issues that I would say are more political, like money-laundering and so on.
“Whether a program upsets markets and creates contagion will depend on its design, specifically how a bail-in is spelled out, but I don’t want to speculate about this. There might be an issue - either regarding the systemic effects of the program or debt sustainability. I am confident that finding a balanced approach is the heart of the current debates with Cyprus.”
On further debt relief for Greece:
“I don’t see that.”
On LTRO repayment:
“It’s a sign of the eased tensions on financial markets, especially when it comes to the refinancing of banks and the interbank market. So I would take it as it is. It’s a sign of increased confidence. And banks know that we are still in full allotment mode, so there is no reason to worry about liquidity shortage.
“Banks can get back to us at any time. We are in full allotment mode, the interest rates are very low. The banks aren’t risking much by partially repaying the LTRO. They’ve reduced liquidity they didn’t need anymore. This is a good sign. That’s the story.
“We are still operating in an environment of abundant liquidity despite the partial repayment of the LTRO. I don’t think that the next repayment is going to change this fundamentally. So in that sense, higher market rates aren’t my major concern at this juncture.”
On the ECB’s bond-purchase program:
“My criticism was never related to the fact that I doubted a positive market reaction. I don’t find the market reaction surprising. But the market reaction shouldn’t be the relevant benchmark in judging this decision. The decision has been taken and now we have to limit the risks that emanate from this program. That’s a view that we all share. Conditionality is a very important element of the OMT, but for it to be credible we must avoid being drawn into fiscal policy matters. Otherwise, it’s difficult to argue credibly that we enforce conditionality.
“Monetary policy has very powerful tools but that doesn’t mean that each one of them is always appropriate. The same effect on markets could have been achieved by the Eurogroup announcing euro bonds from tomorrow on: whether or not this would have been a sensible decision for the long-term stability of the EMU, it would have also calmed markets because what counts for them in the end is that risk is seen to be shared. The finance ministers would have had the political legitimation to do it. But they didn’t. So we’re back to the question of who is legitimized to do what, and where are the limits of monetary policy. We all agree in the Governing Council that central banks cannot solve the euro-area crisis. There is unanimous agreement that only structural reforms and fiscal consolidation can solve the euro-area crisis.
“I hope we don’t have to buy bonds under the OMT. However, experience with similar announcements is that it is quite likely that someday you will be asked to show your hand.
“The program has to be seen in the broader context of monetary policy decisions. It leads to a blurring of the line between fiscal and monetary policy, with repercussions on decisions-making in other cases.
“Fiscal policy has the means to react. The question for me is: Do central bank actions alleviate the pressure on fiscal policy to act or compensate for a lack of fiscal policy action? You have numerous examples from the recent history of the crisis where this is the case. Once such a pattern emerges, it should not come as a surprise if fiscal policy is very reluctant to act. And that has to do with the reluctance to tap the ESM, which is there to fulfil this task.”
On Berlusconi’s election promises:
“It’s a very illustrative point of my concerns. If policy makers refuse to implement the necessary reforms, can you then expect the central bank to fight against the market reaction to this deviation from the reform course? That’s why credible conditionality is of key importance. The way in which the necessity of reforms is questioned in the Italian electoral campaign is a good illustration of this risk.”
On the single supervisory mechanism:
“Only a change in the Treaties would allow an unambiguous separation between monetary policy and the supervisory functions, but that has not been decided. So we have to work with what we have and try to separate the two functions as much as this is possible under the current Treaty, which leads to complicated constructions.
“There is a reputational risk. Supervisors will make mistakes. We have to minimize them and minimize their consequences, but the possibility can’t be ruled out that a supervisor will make a mistake. So there is a reputational risk that could also impact on our capacity as monetary policy makers. So we have to minimize these risks through efficient structures, and the quality of the staff for instance. The decision has been taken, so we have to proceed from there. We can only minimize the risks. There are potential conflicts of interest. That’s why I believe that a system with a very clear separation is ultimately better for monetary policy. At the very least we have to ensure that there are strong Chinese walls between the two areas.
“I would find it reassuring to set up the supervisory mechanism with the ultimate objective to separate it from the central bank or at least build much more reliable Chinese walls between monetary policy and supervisory decisions. Thus we would act as an incubator. I think this is a view shared by others.
“The very tight schedule is a challenge but I’m not questioning the timetable.
“We are playing our part to make the SSM work. At the Bundesbank we have staff who are up to the task. We as the Eurosystem have to perform this task efficiently, and there will be a division of labor between the national central bank and the ECB.
“The SSM is a key issue for us, but it’s only half of the story. At least as important is a European resolution scheme. If the two of them aren’t put in place together, you have a system difficult to work in.”
On the role of central banks:
“The recent discussion about the role of central banks is really a cause for concern. We have a wide-ranging debate and when I listen to some commentators who applaud the Japanese government for -- they say -- having domesticized their central bank, this is of course for me a worrisome development.
“We are reliving a debate about the role of the central bank that we have already had in the past. The independence of central banks is being questioned more and more, academically and politically. I think that’s a serious mistake -- not because I’m sticking to principles but because it’s a key lesson learnt from history. Independent central banks focused on the primary goal of price stability are best suited to deliver on that without jeopardizing growth.
“To tinker with this proven framework could well be a self-defeating exercise, as it would hamper the effectiveness of monetary policy: it would risk undermining the credibility of central banks and unanchoring inflation expectations.”
On rumors about his resignation:
“You shouldn’t believe all the rumors. It’s clear, I’ve made the point numerous times, I deliberately came to the Bundesbank in a difficult time, I know what there was to expect here. I get a lot of pleasure from serving here at the top of the Bundesbank, it’s a very sensible task, and in that sense don’t believe the rumors you are hearing.”