NEW YORK (MNI) – ECB Governing Council member Jens Weidmann on
Monday suggested the central bank would tighten monetary policy once
inflation risks in the Eurozone increase, even if this could hurt
peripheral countries.

“After all, monetary policy must not lose sight of its primary
objective: to maintain price stability in the euro area as a whole,” the
president of the Bundesbank said in a speech to be delivered at the
Economic Club of New York.

“Let us say that monetary policy becomes too expansionary for
Germany, for instance. If this happens, Germany has to deal with this
using other, national instruments,” the central banker elaborated.

“But by the same token, we could say this: even if we are concerned
about the impact on the peripheral countries, monetary policy-makers
must do what is necessary once upside risks for euro area inflation
increase,” he stressed.

“Delivering on its primary goal of maintaining price stability is
essential for safeguarding the most precious resource a central bank can
command: credibility,” Weidmann said.

The Governing Council member warned that inflation in advanced
economies could rise faster than the 1.9% and 1.7% forecast by the IMF
for this year and next.

“We have to be careful that inflation expectations remain well
anchored and consistent with price stability,” Weidmann said.

The sovereign debt crisis is still weighing on
Eurozone economic prospects, Weidmann said. “The sovereign debt
crisis has not yet been resolved. The renewed
tensions over the past two weeks are a case in point.”

While markets might have underestimated sovereign bond risks for a
long time, they are now overestimating it, Weidmann reckoned.

The central banker rejected calls that firewalls and ex ante
risk-sharing in the Eurozone be extended, consolidation of public debt
be stretched and monetary policy play an even bigger role in crisis
management.

“The proposed measures would buy us time, but they would not buy us
a lasting solution,” Weidmann argued. And the longer they are applied,
the greater the possible negative side effects will be, he warned.

“In the end, monetary policy is not a panacea and central bank
‘firepower’ is not unlimited, especially not in monetary union,” he
cautioned.

“In my view, the risks of front-loading consolidation are being
exaggerated,” the central banker said. “You cannot
borrow your way out of debt; cut your way out is the only promising
approach.”

Weidmann noted that the central banks of the Eurosystem have
already done a lot to contain the crisis. “Now we have to make sure that
by solving one crisis, we are not preparing the ground for the next
one.”

Research has found that risk-taking becomes more aggressive when
central banks apply unconditional monetary accommodation in order to
counter a correction of financial exaggeration, especially if monetary
policy does not react symmetrically to the build-up of financial
imbalances, he pointed out.

“In the end, putting too much weight on countering immediate risks
to financial stability will create even greater risks to financial
stability and price stability in the future,” Weidmann warned.

“Moreover, extensive and protracted funding of banks by the
Eurosystem replaces or displaces private investors,” the Governing
Council member reckoned. “This breeds the risk that some banks will not
reform unviable business models. So far, progress in this regard has
been very limited in a number of euro area countries.”

–Berlin bureau: +49-30-22 62 05 80; email: twidder@marketnews.com

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