European Central Bank Governing Council member Jens Weidmann said Thursday that purchases of sovereign bonds by central banks come with risks even if monetary authorities often rely on such actions.
In a dinner speech on the occasion of the 20th Dubrovnik Economic Conference, Weidmann, who heads the German Bundesbank, said, “While sovereign bond purchases are a widely used monetary policy tool, they are not without risks.”
“They bring monetary policy very close to monetary financing of governments, which could undermine the central bank’s ability to maintain its mandate of price stability,” he said.
Moreover, he argued, “monetary policy may face the danger of being dragged and driven by fiscal policy, and find it very difficult to free itself.”
Governments can become more and more attached to the welcome effects of such actions and face a “rude awakening” when these cease or undergo reduction, he observed.
Also, he said, the redistribution of risks among taxpayers of different countries is a decision that should only be taken by democratically elected representatives of the people.
“The rallying markets are also being sustained by exceptionally easy monetary policy conditions the world over,” Weidmann affirmed. “Nevertheless, there is a risk that market valuations may be running ahead of the adjustment processes.”
The fact that many European sovereign bonds’ long-term yield has already priced in the necessary adjustment implies the potential for a setback, he said.
“It is therefore all the more important that policymakers ensure that the necessary economic progress is actually achieved,” he affirmed.
With interest rates very low, “the current environment necessitates an even stronger political will,” according to Weidmann.
Even if the crisis no longer occupies the forefront of people’s attention, “it is too early to claim victory over the crisis in the euro area,” he said. Even though financial markets might suggest otherwise, the crisis is far from over.”
Weidmann prodded France and Italy to implement structural reforms to make up for losses in competitiveness “and thereby act as a role model for the crisis countries as well as for all other EU countries.”
He warned that “if France for example were allowed, for the third time, to postpone the correction of its excessive deficit, this would severely undermine the credibility of the new Stability and Growth Pact.”