Ex European Central Bank Chief Economist: What Kind of Euro ???
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Otmar Issing, Former Chief Economist, European Central Bank
Credit: INSM
30 March 2011.
Otmar Issing, Former Chief Economist, European Central Bank
Credit: INSM
30 March 2011.
Otmar Issing, 74, was chief economist of the European Central Bank from 1998 to 2006.
Prior to his position at the ECB, Issing worked as a senior economics advisor to German Chancellor Helmut Kohl
before taking a senior management position at Deutsche Bank, where he ultimately became chief economist.
Q: Mr. Issing, at the most recent summit, European Union member states agreed on a package to rescue the euro that includes, among other things, augmenting the crisis fund.
Will this safeguard the common currency?
Issing: The euro is now on stronger footing.
In that sense, things could have been worse.
But the resolutions are still a far cry from what the monetary union needs.
The fundamental problem hasn’t been solved.
Q: What’s the obstacle?
Issing: Before the euro was introduced, former Chancellor Helmut Kohl said:
The monetary union will not function without a political union.
But a political union of Europe doesn’t exist, and it won’t happen in the foreseeable future.
That’s why we need mechanisms that force the member states to pursue solid financial policies.
These mechanisms are missing, and even the most recent decisions reached in Brussels can do little to change this.
Q: The EU heads of state want to significantly tighten the Stability Pact so that debt crises can be prevented before they begin.
Why isn’t this enough?
Issing: My confidence in the sustainability of such resolutions has always been limited.
But it was completely shaken when Germany and France mutually killed the pact in 2003.
At the time, several European finance ministers said to me:
How are we to convince our citizens to support a stability pact if not even Germany wants to abide by it?
Q: But now the European Commission in Brussels is receiving additional tools to monitor national budget policy.
Isn’t that a big improvement?
Issing: Ultimately, the European Commission cannot impose any effective sanctions,
because the national governments make all key decisions,
so we have potential violators passing judgment on current violators.
The jury is biased. In addition to political control, another, incorruptible authority is needed.
Q: And who exactly should that be?
Issing: The market.
The decisions of investors in the financial markets constitute an additional control mechanism.
A country that behaves correctly pays low interest rates, while one that lives beyond its means pays higher interest.
Q: With all due respect to your confidence in the markets,
isn’t it rather naïve, given the fact that investors have also lent money to ailing governments in the past without hesitation?
Issing: I have never been one of those people who trusted the market completely.
The most important thing is how the government sets the underlying conditions.
And this is where the euro has its greatest shortcomings.
Under the Maastricht Treaty, EU members agreed that they would not be liable for each other’s sovereign debt.
But the markets never trusted this pledge and, as it turned out, they were right.
This is the key starting point for a reform.
It has to be clear to investors that they are partly liable when a country can no longer service its debt.
Q: But this is precisely what is happening at the moment.
The German government has made sure that private creditors will be involved on a case-by-case basis when a country can no longer service its debt.
That’s progress, isn’t it?
Issing: Case-by-case means that the issue is ultimately resolved politically.
However, I doubt that politicians will administer such bitter medicine when push comes to shove.
That’s why the involvement of private creditors must occur automatically and in accordance with set rules.
This is what I envision:
As soon as public money is spent, private investors must also be involved
and relinquish portions of their claims or agree to extending maturity dates.
It is part of the market economy that those who buy securities and collect higher interest rates for doing so
should carry part of the risk when something goes wrong.
Taxpayers shouldn’t always be footing the bill.
Q: The question is whether this is even feasible.
When the German government was thinking about the involvement of private creditors several months ago,
investors, fearing losses, sold off their Greek and Portuguese bonds en masse.
It’s like trying to extinguish a fire by pouring on more fuel.
Can that be a permanent solution?
Issing: At the time, the German government didn’t make it sufficiently clear that the involvement of private creditors was only intended for the future.
The investors feared losses on their existing investments and were anxious as a result.
But this doesn’t have to happen if the government makes its plans sufficiently transparent.
Q: EU leaders want to augment the bailout fund so that it can mobilize €440 billion ($620 billion).
The eventual permanent bailout fund is to have more than €500 billion at its disposal.
Are these dimensions necessary?
Issing: In my view, the dimensions are not the key issue.
More important are the conditions under which the fund distributes its money.
It would be fatal, however, if the sheer size of the bailout fund tempted those in charge of it to dole out the money, thinking:
Now we have so much money available, so we should use it.
The fund has to be big enough to impress the markets, but it should also be used sparingly.
Q: Responding to a German initiative, the euro countries want to make a pact to improve their competitiveness.
Do you think this is a good idea?
Issing: The pact stems from the realization that the success of a monetary union depends on each individual member.
Not all euro countries have to march in step, but at least they should be moving in the same direction.
But it would be problematic to demand, in the name of such a pact, that the Irish increase their corporate taxes, for example.
Q: But that’s a legitimate concern.
The EU gives the Irish money, and they use it to fund low corporate tax rates.
Is that a good model for a future-oriented European fiscal policy?
Issing: The Irish will point out, with some justification, that
the EU forcing them to raise tax rates undermines their prospects for growth.
This cannot be in the interest of the other countries.
Q: Do you expect that Portugal and Spain will have to resort to the bailout fund?
Issing: I would rule it out for Spain.
The country is finally on the road to reform.
For example, it is cleaning up rigidity in the labor market stemming from the days of the Franco dictatorship.
Portugal still stands a chance of making do without assistance.
Q: Even more pressing is the question of Greek debt.
Do you believe Athens will be able to raise money on its own once the assistance runs out?
Issing: It was important to help Greece in its acute crisis to prevent it from spreading to other countries.
But as soon as the other countries are out of danger, the Greek government debt will have to be restructured.
This can be done by cutting that debt or by extending the terms of the loans,
but there is no getting around a debt restructuring, no matter how you calculate it.
Q: Can banks and insurance companies cope with such a measure?
Issing: Lengthening loan periods would be more palatable than a haircut.
It will not force the banks to write off their claims.
They’ll get their money back; it’ll just take longer.
Q: Even should its debt be restructured, Greece would still struggle for years to pay off its loans.
Wouldn’t it be better to simply exclude the country from the monetary union?
Issing: Such debates are superfluous because they ignore reality.
You need to amend agreements to eject a country.
This can only be done unanimously.
No “candidate” would agree to it.
It’s a complete waste of time to even think about it.
Q: And what if a country wants to leave the monetary union of its own accord?
Issing: I think that would be political and economic suicide.
Q: Does that also apply to Germany?
Issing: It also applies to Germany, but in a different sense.
Q: That also, of course, means that Germany is chained to the euro, for better or worse.
Does that not mean that a transfer union becomes inevitable?
Issing: It depends what you mean by the term.
At a joint panel discussion last summer, former Foreign Minister Joschka Fischer claimed:
Anyone who denies that we have been living in a transfer union for a long time is an idiot.
Q: How did you respond?
Issing: I told him that I am one of those idiots.
Of course, there are already many European financial transfers today: agricultural subsidies, structural aid, the cohesion fund.
But these tools are earmarked and limited with respect to amount.
In this case, however, we are talking about possible transfers for which there are practically no upper limits.
It’s a completely different dimension.
Q: But their purpose is to save the euro.
Isn’t helping member states in trouble part of European solidarity?
Issing: No. In fact, the notion of the strong helping the weak is not the issue here.
This is about those who abide by the rules paying for those who break the rules.
This isn’t solidarity, but a perversion of it.
Q: How so?
Issing: It’s simple: A country like Germany, which behaves in accordance with the rules, has to support the Irish.
Meanwhile, per capita income in Dublin is higher than it is in Berlin.
Is that fair?
If we take this approach in the long term, we will end up with a German population with the kinds of anti-European sentiments I would find horrifying.
The German population’s identification with Europe is already declining to a disconcerting extent.
Q: What does this mean for the euro?
Issing: It certainly doesn’t mean that it will be dissolved.
It’s a good bet that the euro will continue to exist for a long time to come.
The question is not whether the euro will survive, but which euro will survive.
If everyone is liable for everyone else, even in the case of bad policies,
it will become more and more difficult for the European Central Bank to defend the stability of the euro.
Q: Will we see higher inflation?
Issing: History has taught us that solid public finances and stable money belong together.
However, I don’t believe that there will be significantly higher inflation.
The ECB has a clear mandate and is sufficiently independent to keep this from happening.
But tensions would rise considerably within the monetary union.
Q: To help highly indebted countries, the future bailout fund is to be permitted to buy up the bonds of at-risk countries.
How do you feel about that?
Issing: It’s a completely wrong approach.
Bond purchases
- tie up a great deal of money,
- provide little relief and
- are difficult to reconcile with the democratic principles of our constitution.
The most important right granted to parliament is to decide on the government’s finances.
This right is undermined when key decisions are made in European institutions that lack adequate democratic legitimacy.
Q: Does this mean that you wouldn’t help needy countries at all in the future?
Issing: Not at all, but the basic principle must be that assistance only be provided under certain conditions.
Q: On the other hand, as an experienced central banker, you ought to be pleased that the ECB has been relieved of a burden now that it no longer has to buy up bonds.
Issing: I don’t want a situation in which you have to choose between the plague and cholera.
Q: Was it a mistake for the ECB to have purchased bonds?
Issing: I swore to myself that I would never comment on and certainly would not criticize the institution for which I worked so long.
But no one will deny that this case is extremely problematic and borders on the impermissible.
In the final analysis, the ECB was the only institution capable of taking action.
That’s why the expansion of such a crisis mechanism, which also unburdens the central bank, makes fundamental sense.
Q: Bundesbank President Axel Weber has clearly spoken out against this decision.
He resigned because he refuses to support the ECB’s policy.
Was that the right step?
Issing: If someone is convinced that such positions are inconsistent with his conscience,
he must be prepared to bear the consequences.
David Caploe PhD
EconomyWatch.com
