— May Increase Pressure For Loose Monetary Policy

FRANKFURT (MNI) – Plans for a European rescue fund that allows bond
buys of Eurozone member states not under a bailout program weaken the
principles of monetary union and may encourage fiscal recklessness, the
Bundesbank warned Monday.

There should be no further weakening of the no-bailout principles
of EMU, the German central bank said in a thinly veiled rejection of
eurobonds.

The decisions taken by EU leaders in July would result in a pooling
of risks and “weaken the principles of fiscal self-responsibility and
discipline fostered by capital markets on which monetary union is
based,” the Bundesbank said in its Monthly Report.

Fiscal policy decisions would still be taken by democratically
legitimized national parliaments, but risks would have to be borne by
all EMU members, who lack concrete powers to intervene in national
policies.

“As a result there is a risk that Eurozone countries’ inclination
to indebtedness will increase and that the common monetary policy will
be under increasing pressure to be accommodative,” the report said.

Bundesbank President Jens Weidmann had previously cautioned that
the Eurozone had taken “a large step towards the collectivization of
risks” that will make it “even more difficult to maintain the incentives
for solid financial policies.”

“Without a regime change that sees fiscal sovereignty diminished
greatly” there must be no further weakening of the no-bailout principles
and the Maastricht rules but instead a reinforcement, the Bundesbank
said.

Reform efforts to prevent the build-up of excessive debt level and
economic imbalances in the Eurozone are welcome but are not ambitious
enough, particularly as regards the Stability and Growth Pact, the
bank added.

“For instance, it is not clear how an improved sanction mechanism
of the Stability and Growth Pact can prevent unsound national fiscal
policies, if the continued disregard of rules leads to protection from
capitals markets on very advantageous conditions,” the report noted.

“So long as government bonds of countries not under bailout
programs are bought on the secondary market, it is not clear how strict
compliance with consolidation and reform requirements can be enforced,”
it said.

Germany must lead by example in reducing its deficit, particularly
in light of the European debate about introducing German-style balanced
budget principles in other countries, the central bank said.

A significant reduction in Germany’s public deficit ratio to the
government’s latest target of 1.5% of GDP this year appears “achievable”
so long as no additional costs from the financial and sovereign debt
crisis emerge, the report noted. For 2012 a continued albeit slower debt
reduction is in the cards.

Given high debt level and demographic changes that will pose
additional challenges in the years ahead, Germany must aim to reach a
balanced budget as quickly as possible and generate surpluses when the
economy is going well.

In this context, tax cuts without equivalent spending cuts are not
warranted, as they would may delay meeting deficit targets, the central
bank said.

–Frankfurt bureau tel.: +49-69-720142. Email: jtreeck@marketnews.com

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