This is a translation of the original German article published in FAZ on February 6, 2014.
European Central Bank President Draghi has played down German fears about high inflation and urged Germany not to ignore the positive impact of European monetary policy. Bundesbank president Weidmann has also recently stressed that there are no reasons for German concern about inflation. The public debate about European monetary policy, however, has become more heated in Germany. This debate is harmful; it seems that the criticism is often based on the experience of the Bundesbank’s failure to recognise the different conditions of monetary policy in a monetary union, but it is also wrong to think the European crisis is over. We need a more balanced debate, which discusses these risks openly and critically.
At the heart of the German debate is the ECB’s Outright Monetary Transactions (OMT) purchasing programme for government bonds, and now also its low interest rate policy. On OMT, there is a concern that the ECB is setting the wrong incentives for both banks and governments. In fact, by the mere announcement of the OMT programme, the ECB has helped crisis countries reduce their financing costs. In summer 2012, many capital markets were dominated by the bet against the euro and against individual countries. This was reflected in the interest rates required on government bonds of crisis countries, as calculations by the Germany Council of Economic Advisors show. The OMT announcement corrected these exaggerations and made capital markets more confident about crisis countries. There has been no more to it so far since the ECB has not bought a single government bond through the OMT programme.
ECB policy is also criticised in Germany on the basis that interest rates are too low for the German economy, leading to a risk of overheating. This argument is however flawed or partial at best. It cannot be the task of the ECB to align monetary policy to a single country; monetary policy has to be implemented for the euro area as a whole. Of course, if a rate cut were to be justified only with regard to the situation in the southern periphery of the euro area, it would not be a sufficient justification. A justification for low interest rates for the whole euro area needs to be given. The justification put forward is that we might get into a period of deflation, in which falling prices solidify and lasting damage is done to the economy.
The current inflation rate of 0.7 percent in the euro area is far below the ECB’s inflation target of just below 2 percent in the medium term. In these circumstances, the deflation fear is quite real: the euro-area economy is still very weak and production is far below potential. This also applies partly to the German economy. In addition, we need relative price adjustments in Europe’s crisis countries. This means that the prices in these countries have to fall over a longer period relative to Germany. These are the reasons for the ECB to take the risk of a deflationary spiral very seriously.
In Germany, concerns are articulated that the low interest rate policy will harm savers. It is certainly true that it is increasingly difficult for savers to feel confident about their pension provisions in a low interest rate environment. The low interest rate phase, however, is not an isolated result of European monetary policy, but a reflection of the financial crisis as a global phenomenon. Long -term interest rates in Germany are so low because much capital has come in this safe haven. And this has great advantages for businesses and borrowers, such as the German state, which can access finance at a much cheaper rate. It also helps employees and supports German taxpayers. Alternative forms of investment, such as German stocks, have paid off handsomely in recent years. This means that the big problem is not the low interest rates, but rather the way Germans save. Only 20 percent of Germans hold stocks, compared to more than 60 percent in the US.
In principle, a debate on the correct monetary policy cannot be centred on savers. Each monetary policy measure has always and everywhere distributional effects. This applies to periods of financial crisis as well as to normal times. The legitimacy of a monetary policy decision is not based on distributional issues but on the mandate of the ECB. The German debate on ECB monetary policy should therefore not be based on the past experience of the Bundesbank (which, incidentally does not exclude the purchase of government bonds, as events in 1975 showed). Instead it should focus on the future and discuss what monetary policy in the currency union should do in the coming years in order to fulfil the ECB mandate. Dramatically falling inflation rates since 2011 show that the ECB has more leeway. In particular, the EU Treaty obliges the ECB, in line with Article 127 (1), to support the EU’s general objectives, if the price stability target is met. Article 3 of the Treaty defines as a general objective, among other things, that social and economic cohesion be strengthened.
This also shows that the criticism of the low interest rate policy, as for instance formulated by Paul Kirchhof in the FAZ with a dubious distinction between good (savings) and bad (stocks) ownership, is based on a misunderstanding of the operation of monetary policy. A central bank can only achieve its primary mandate of price stability in an environment of financial and economic stability. It is therefore its duty to use all instruments available within the legal mandate to support the necessary conditions for price stability. This includes also a possible contribution to securing the currency – as with the announcement of the OMT.
What can the ECB do now? It is certain that the ECB cannot exit its expansionary monetary policy and that it must consider new monetary policy measures. A combination of measures will be necessary. Forward guidance should not only include commitments about the duration of the low interest rate policy, but the ECB should explain better to the financial markets under which conditions monetary policy is going to be reactive. In addition, to repair the transmission mechanism it will be necessary to align monetary policy primarily to those market segments that are not functioning adequately. Conditional lending to banks with the requirement to grant loans to companies in certain sectors is a possibility, though not an easy step.
One of the biggest challenges for the ECB will be to reduce the risk of deflation. On this issue there are very different opinions. Some consider the purchase of government bonds or private bonds in the secondary markets, as practised by the US Fed, as the best solution. Such a decision should not be made on the basis of ideological positions, but be based on empirical evidence. Bond purchases belong, in principle, to the set of instruments of a modern central bank. Their effectiveness is recognised if they have the goal to reintegrate fragmented markets. Poorly thought-through use of these tools, however, can certainly have negative side effects.
With its common banking supervision role, the ECB obtains an additional task in 2014. It will have to make sure that this new task of financial and banking stability does not interfere with its monetary policy mandate. This requires a clear institutional separation between monetary policy and supervision. It also requires that the ECB establishes itself as a tough and credible regulatory body that ensures that banks in the euro area are adequately capitalised.
Above all, the ECB must maintain its credibility. Especially in Germany there has been much unwarranted criticism that has lost the sight of the European mandate of the ECB. The public debate in Germany needs to be more focused on what the mandate of the ECB is, and why the ECB’s policy is also in the interests of Germany. This requires clarification that a pluralism of opinions about future monetary policy is helpful and not harmful. What is perceived as a conflict between the ECB and the Bundesbank reflects the diversity of viewpoints about the optimal path for future European monetary policy.
The ECB must achieve price stability in the euro area and contribute to the general economic objectives of the Union, if its price stability mandate allows. At the same time it is also clear that governments continue to bear responsibility. Resolution of insolvent banks, far-reaching structural reforms and improving the business environment for new and innovative sectors, not least in Germany, are government tasks, which the ECB cannot and should not carry out.
The European crisis is far from over and will continue to influence economic policy in Europe. The ECB’s monetary policy will continue to play a central role, because there are still major monetary policy challenges and divergences in the euro area. These problems, mainly the concern about deflation and financial fragmentation in the euro area, have continued to increase in recent months. There is no easy solution to these problems. But a balanced open debate in Germany is an important contribution to accompany the future path of monetary policy.