German central bank governor Jens Weidmann warned parliament today that new measures taken by the euro zone do not encourage countries to get their budgets in order.
He said further steps towards liability sharing without weaker states having to surrender some of their economic decision-making set the wrong incentives.
"The decisions (from July 21st) mark a large step in the direction of joint liability and lower disciplinary action by capital markets, without in turn noticeably strengthening control and influence on national fiscal policies," Mr Weidmann said in a speech prepared for the German budget committee.
Leaders of the region agreed on July 21 to extend the powers of the European Financial Stability Facility (EFSF), to include giving precautionary loans to countries under attack in the markets and buying sovereign bonds to prop up struggling states.
The changes will have to be approved by national parliaments. The German parliamentary budget committee is canvassing the opinions of experts - also including Bundesbank chief Jens Weidmann - on the draft law before a vote scheduled for September 29th.
The European Central Bank is filling in until the new powers are implemented and has started buying distressed euro zone debt. Mr Weidmann, like his predecessor Axel Weber and former ECB policy maker Juergen Stark, opposed the ECB's decision to reactivate its controversial bond buying programme after a 19-week pause, saying it blurs the lines between fiscal and monetary policy and threatens the ECB's independence.
Speaking at a parliamentary budget committee hearing on the EFSF, Mr Weidmann said the bailout fund should focus on more efficient instruments than bond purchases.
"There are more efficient means than secondary market purchases of bonds, for example credit programmes that allow the financing of financial institutes or precautionary credit programmes," Mr Weidmann said.
The Bundesbank president also said it should be discussed whether banks should hold extra capital when purchasing sovereign bonds, something that is not foreseen in the current Basel III regulatory framework.
"The question is, when it is the right time to implement this discussion," he said.
Under Basel accounting rules, sovereign debt held in a bank's own currency is still given a risk weighting of zero. Critics of the rule say this encourages banks to buy debt without having to build a capital cushion, and provides an incentive for governments not to address their deficit levels as they are still able to borrow.
ECB governing council member Erkki Liikanen said today the bond-buying programme was a temporary one.
The July 21st agreements also eased credit conditions for struggling member states and extended maturities.
Mr Weidmann said it was particularly serious that "that the new credit conditions minimise incentives for countries in the aid programme to return as soon as possible to solid public (finances) and to the capital markets through economic and financial reforms."
The changes to the EFSF, and to the tools to prevent crisis, risk increasingly weakening the institutional framework, Mr Weidmann said.
But, he added, "overall it is neither planned nor necessary to change the existing principles on which the currency union is founded; they remain adequate and necessary for a stability-oriented currency union."
A power shift from a state to European level was a possible consequence of the crisis, Mr Weidmann said, but added that "there was no sign on a political level of a common European fiscal policy, or a political union with democratically legitimised authority on a central level versus public budgets."
Reuters
