FRANKFURT (Reuters) - As recently as last November, Jens Weidmann steadfastly opposed any move by the European Central Bank to print money to buy assets and buoy the euro zone economy. No longer.
The Bundesbank chief, known for his hardline stances at the ECB and as head of the German central bank, is now ready to support such quantitative easing (QE) if he and his ECB colleagues deem it necessary.
What has changed is that “the situation has changed”, according to one person familiar with the German’s thinking, speaking on condition of anonymity.
Euro zone inflation has slowed to 0.5 percent from 0.9 percent in November, falling far below the ECB’s target of just under 2 percent and stoking fears the bloc could become stuck in a prolonged period of so-called “low-flation”, or even sink into outright deflation.
Such a scenario risks undermining the efforts of crisis-hit countries on the euro zone periphery to shape up their economies, and could ultimately hit growth across the board if households defer purchases in anticipation of lower prices in the future.
Seeking to head off such a drop in inflation expectations, the ECB’s governing council said earlier this month it was unanimous in its commitment to use unconventional tools - central bank-speak for things like QE - to counter a protracted period of low inflation.
The unanimity meant Weidmann was on board. This matters because as leader of the hawkish faction on the 24-member council, he can shape debates and restrict policy moves. Last May, for example, he prevailed in limiting the size of an interest rate cut.
At the height of the euro zone crisis in 2012, Weidmann was alone in opposing a new, as-yet-unused ECB bond-buy plan, dubbed Outright Monetary Transactions (OMT), that targets specific euro zone countries in trouble and comes with reform strings.
Some council members still lament that episode of isolation and would like to avoid a repetition.
With the straightforward QE debate, Weidmann has softened his tone. Late last month, he said such a program was not out of the question.
On the face of it, this might look like an about-turn from his opposition to the OMT. But underpinning Weidmann’s position is a firm logic based both on principles and pragmatism.
For the Bundesbank chief, the OMT bond-buy plan agreed in September 2012 represented a clear move into the fiscal arena as it required economic policy commitments from governments as a condition for ECB market intervention.
Attaching such strings to monetary policy is anathema to the Bundesbank, which is deeply attached to “Ordnungspolitik” - the idea that the role of a totally independent central bank is solely to ensure stable prices, not to promote economic growth and employment or to help governments with fiscal problems.
With the OMT, Weidmann was worried about the ECB effectively financing governments. QE, free of any conditions on countries’ economic policies, would be solely for monetary policy purposes.
“I actually think Weidmann is quite pragmatic, as long as he is convinced the bank is absolutely focusing on monetary policy and not pursuing objectives of government financing,” said Clemens Fuest, head of Germany’s ZEW economic institute.
“That was his concern with the OMT program. But I think QE is another story,” added Fuest, who also advises the government in Berlin. “Of course, drawing the line is not easy. But with quantitative easing, drawing the line is not impossible either.”
After digging in his heels as a matter of principle over the OMT, Weidmann’s more pragmatic side extends to the idea of showing qualified support for QE before low inflation becomes entrenched.
Waiting too long before showing a readiness for resolute policy action would risk inflation expectations drifting lower - an outcome that would require more drastic ECB action.
By acting pre-emptively, even just by talking about QE at this stage, “the action itself doesn’t need to be as large”, said Berenberg bank’s Christian Schulz, a former ECB economist.
Weidmann, a past economics adviser to German Chancellor Angela Merkel, can also point to a Bundesbank precedent. In the 1970s, the German central bank bought government bonds to bring down interest rates, after its standard tools stopped working.
Despite the precedent, Weidmann’s predecessor, Axel Weber, resigned in 2011 in protest at a previous ECB bond-buying plan - the Securities Markets Programme (SMP), which he saw as financing governments. Juergen Stark, who had acted as Bundesbank president in 2004, followed Weber and quit as ECB chief economist later in 2011 - also in opposition to the SMP.
The resignations achieved little but showed the Germans’ frustration that the ECB was morphing out of the Bundesbank cast in which it was forged: a mould based on ‘Ordnungspolitik’.
With Berlin having pledged billions of euros in taxpayers’ money to bail out debt-ridden euro zone countries, German voters expect the Bundesbank to act as their economic rock.
Weidmann - softly-spoken and, at 45, far younger than his predecessors - is trying to play that “stability anchor” role.
By remaining “in the room”, he can try to influence the details of an asset-purchase plan should the ECB prepare to launch one.
Such details could include setting standards such that the ECB only buys high-grade debt, and ensuring it claims seniority status so as to minimize the risks to its balance sheet.
Already Weidmann’s influence shone through in the council’s commitment this month to using unconventional measures “within our mandate” - a clear nod to the Bundesbank, which regularly stresses a legal prohibition on the ECB funding governments.
“This is a kinder, gentler Bundesbank that he is displaying,” said David Marsh, author of ‘The Euro: The Politics of the New Global Currency’ and chairman of think tank OMFIF.
“He is thinking about his role on the governing council and his ability to get his way on other, more substantive issues,” Marsh said. “Not ruling out QE is sensible. He can’t oppose everything just for the sake of it.”
As well as potentially posing a risk to economic growth, very low inflation or even deflation aggravates the adjustment process of debt-saddled countries on the euro zone periphery, which the Bundesbank has been pressing to shape up.
Low inflation across the euro zone gives the countries on the periphery less scope for relative price adjustment against more competitive economies like Germany, and also makes it harder for them to reduce their debt piles.
Greece is already running a negative inflation rate.
But the problem is perhaps biggest for Italy, the euro zone’s third-largest economy, which is saddled with 2 trillion euros ($2.76 trillion) of public debt and is struggling with the competing need both to cut costs and spark growth.
The European Commission expects Italy’s debt to hit 134 percent of gross domestic product (GDP) this year.
Even with a solid recovery and higher inflation, Italy will take years to cut its debt to 100 percent of GDP, let alone reach an EU target of 60 percent.
Against this backdrop, pressure is mounting on the ECB, in particular from the International Monetary Fund, to do more to stave off the threat of deflation in the euro zone.
For Weidmann, it is essential that countries “don’t regard it (QE) as some kind of panacea that will exonerate the governments from having to make economic reforms,” said Marsh.
The ECB was hurt by an experience in 2011 of buying Italian bonds only for Italy’s then-prime minister, Silvio Berlusconi, to renege on reform promises he had made to get it to step in.
The upshot is that Weidmann, and the conservative voices in Germany who press him to steer a hawkish course, are eager not to let governments off the hook with free and easy ECB action.
Ex-ECBer Stark, one such conservative voice who is still active in German media, told Reuters the ECB would have to act decisively if a significant risk of outright deflation were to materialize.
“But in my view we are not in such a scenario,” Stark said.
“We are in a period of benign disinflation and price stability rather than entering a period of bad deflation. Assuming the ECB does at present not have other information, it would be wrong to give in to the calls for action,” he added. ($1 = 0.7234 Euros)
Additional reporting by Eva Taylor and Andreas Framke Editing by Jeremy Gaunt