ECB's Weidmann warns against central bank overreach

Germany's federal reserve Bundesbank President Jens Weidmann poses in his office in the Bundesbank headquarters during a photo shoot with Reuters in Frankfurt May 17, 2013. REUTERS/Kai Pfaffenbach

CAMBRIDGE, Massachusetts (Reuters) - To restore a robust financial system, central banks should concentrate on ensuring stable prices instead of taking on new tasks, European Central Bank Governing Council member Jens Weidmann said on Monday.

Weidmann, who also heads the German Bundesbank, said that if central banks guarantee government solvency, governments could well end up becoming less responsible with their finances.

"By piling more and more stabilisation tasks on to monetary policy, stability will prove ever more elusive," Weidmann said in a speech at Harvard University

"If governments can expect to be bailed out by central banks, chances are that they will adjust their behaviour accordingly."

Were central bank to buy government debt or keep interest low for longer than afforded by inflation, it risks fiscal policy dominating central banks, he added.

"Then, traditional roles are reversed: monetary policy stabilises real government debt while inflation is determined by the needs of fiscal policy," Weidmann said.

ECB Vice-President Vitor Constancio and Executive Board member Peter Praet have said asset buying - or quantitative easing (QE) - is an option after years in which the bank's policymakers have ruled it out.

Constancio and Praet have, however, not said, were the ECB to start buying bonds, whether they favour it buying government bonds, or only private-sector assets.

But the more conservative minority at the bank, including Weidmann, who voted against this month's surprise interest rate cut, still seem dead set against any such move.

Turning to banking regulation, Weidmann argued that the spillovers between banks and governments should be reduced by, on the one hand, letting banks fail without taxpayers bailing them out, and on the other, by ending preferential treatment of government bonds in bank balance sheets.

"Rather than for monetary policy to waltz with fiscal and financial policy, we need to erect walls between banks and sovereigns," Weidmann said.

"Sovereign bonds should be adequately risk-weighted, and exposure to individual sovereign debt should be capped, as is already the case for private debt."

Weidmann also said that banking supervision should not remain the ECB's task in the long run to avoid potential conflicts of interest which could emerge when the central bank is burdened with tasks beyond ensuring stable inflation.

(Reporting by Richard Valdmanis, writing by Sakari Suoninen; editing by Ron Askew)