1. Monetary Policy and Fiscal Soundness: Do we Have a German Problem?
Charles Wyplosz
The Graduate Institute, Geneva and CEPR
57th Annual Conference of the Italian Economic Association Milan, 22nd October 2016

2. The immediate concern May Eurozone countries have not recovered
The ECB is fighting below-target inflation and high unemployment
Fiscal policies are pro-cyclical
Germany has recovered

3. Output gaps (% potential GDP)
Lost ouptut:
17% of GDP

4. Germany and the Eurozone
Stability Pact
“in abbeyance”
Highly correlated
Highly uncorrelated
Source: European Commission

5. The problem One size does not fit all
ECB cannot please all
Useless appeals to Courts
This is when fiscal policy must be used
But “fiscal space” is limited where gaps are large
We need think how the Eurozone can/should function

6. Possible answers Germany does not need a fiscal expansion
True, no reason to raise public indebtedness
Countries in difficulty have only themselves to blame
True: lack of reforms, perennial fiscal indiscipline
But fixing these will make things worse in the short run
Time to play by existing rules
The moral hazard view
What if rules are bad? Time to review them

7. The money/fiscal connection
The German fear
ECB will never exit because of existing debts
Inflation
The German solution
Wait until output gaps close
Meanwhile: reform and reduce deficits and debts
Can we do better?

8. Can we do better? Some principles
ECB cares about Eurozone as a whole
Monetary policy to remain expansionary
Exit when needed
Governments must prepare and deal with excessive debts
Many solutions (ESBies, blue/red bonds, PADRE)
Adapt policy mix to national conditions
Germany: easy money/tight fiscal
Large-gap countries: easy money/easy fiscal
Stability and Growth Pact in abbeyance
Deal with moral hazard: reinstate no-bailout

9. The underlying issue Monetary policy has fiscal characteristics
Open market operations absorb public debts
Interest rates affect budgets (and redistribute incomes)
Ultimately, money backed by taxpayers
The asset side of central banks
The answer – monetary dominance – can never be absolute
Fiscal policy mismanagement forces central banks to act
Banks need a lender of last resort, states too
These issues are ignored

10. Conclusion: a reminder
Inflation in Germany
3.1%
1,4%
Source: OECD