“In this crisis we have paid great attention to avoid the risks of default” given concerns about contagion to other eurozone states, said Weidmann, an advocate of conservative fiscal and monetary policies.
However, the risk of default should exist, he said. “In the long term, we should ensure that as a last resort a state could default” as such a possibility “is a key element” to keep markets disciplined.
Economists and officials have long worried about the so-called moral hazard of putting in place a bailout system. While it can calm markets, it also gives borrowers and lenders an incentive to take more risk as they expect to be bailed
Moral hazard is a basic principle of central banking to contain risk, meaning that those who lend should know from experience that if they make misjudgements they will pay a high price.
“That is why we working to separate the states and the banking systems,” said Weidman, who also sits on the European Central Bank’s committee which decides monetary policy.
Weak banks pushed several eurozone states to rescue their lenders, adding to the financial burden of sovereigns. Such a scenario pushed Ireland into a bailout and nearly tipped Spain into one as well.
The eurozone is currently working on creating the first elements of a banking union, which is key to the eurozone bailout fund directly recapitalising banks.