Ladies and gentleman,
First of all, let me extend my thanks to David Marsh and OMFIF for
inviting me to this symposium today. There are many themes on the
relationship between China and Europe that we could fruitfully discuss
but I would like to focus my remarks today on the euro area and the
evolution of the sovereign debt crisis. In particular, I would like to
review the key lessons from the experience of the last 5 years – and how
these lessons have been incorporated into Europe’s response to the
crisis.
1. Lessons of the crisis
Let me begin with that first question: what have we learned about the
euro area in the past 5 years? In my view, there are three main
lessons.
First, the financial crisis demonstrated - quite compellingly - that
financial contagion is the flip side of European financial market
integration. We have learned that deep financial integration, without a
commensurate deeper integration of financial stability policies is
unstable.
This potential vulnerability has been characterized by Dirk
Schoenmaker as a “financial trilemma”: the three objectives of european
financial integration, european financial stability and national
supervision of banks cannot be achieved at the same time.
The existence of this trilemma was confirmed in the euro area
experience. Indeed, as it happened, enormous capital inflows channelled
by banks of core countries to banks in the periphery allowed for large
financial imbalances in the public and private sectors of recipient
countries. When these flows turned into outflows as the economic
environment deteriorated after 2008, these imbalances not only led to
problems for the countries concerned but also produced contagion to
other parts of the euro area.
Financial stability - we have seen - is a common good and as such
requires shared responsibility for its preservation. A single mechanism
for financial supervision and a common authority with strong tools for
bank resolution – could have more easily dealt with the situation.
Second, we have learned that shock absorbers at the national level
are insufficient in the face of a major financial and economic crisis.
Hence the European level has an important role to play.
The design of the euro area assumed that stabilisation would take
place at the national level and to a large extent automatically.
Stabilisation would be provided by national fiscal policies that would
respond to idiosyncratic national conditions. Accordingly, a fiscal
brake at the EU level, codified in the Stability and Growth Pact, was
designed to prevent fiscal profligacy, preserve fiscal space and hence
allow automatic stabilisers to play out in full during downturns.
Moreover, country-specific shocks were expected to become ever less
important as the euro would spur market integration and the flexible
single market to allow an easy and fast rebalancing after such shocks.
However, the scale of the shock after the 2008 financial crisis was
unprecedented in a number of countries and it far exceeded their
national shock absorption capacity. The euro area had no mechanisms to
provide financial support for countries in difficulty and stave off
cross-border contagion; there were no area-level institutions to prevent
governments from being pulled down by their domestic banking systems.
This underscored the pitfalls of a design that relies exclusively on the
national level to fulfil the stabilization function.
Third, we have learned that governance of economic policies at the EU
level has to be broader and deeper than anticipated prior to the
crisis.
Besides fiscal surveillance, which essentially focused on public deficits,
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there was believed to be no need to closely monitor macroeconomic
imbalances and disequilibria on the labour, product or financial
markets. Disequilibria originating from the private sector were supposed
to be only short-lived and eliminated by market forces.
The data clearly show that this was insufficient. Between 1999 and
2007, the ratio of public debt to GDP in EMU declined on average by 5.6
percentage points. The improvement was by large the result of favourable
economic conditions rather than concrete fiscal consolidation measures
which should have aimed at approaching the reference value of a 60% GDP
to debt ratio at a satisfactory pace, as the Treaty prescribes it. In
some countries – as we all know - the sovereign debt dynamics were much
less favourable than the euro area average. Nevertheless, the
accumulated private sector imbalances seem to have far exceeded those in
the public sector.
In the same period - between 1999 and 2007 - the ratio of private
sector debt to GDP increased by 26.8 percentage points. Also for the
same period, in the stressed countries, the cumulative increase in the
private debt ratio to GDP versus the public debt ratio, amounted
respectively, to 49 and 24 per cent for Portugal, 75 and minus 35 per
cent for Spain, 101 and minus 10 per cent for Ireland, 217 and 4 per
cent for Greece. In 2007, at the beginning of the crisis, the public
debt ratio was just 62.7% in Portugal, 46.4% in Spain and 26.6% in
Ireland, in all cases well below the euro area average.
Nevertheless, the increase in total debt, both public and private,
was associated with various destabilizing developments, ranging from
rising asset prices to losses of wage and price competitiveness.
Clearly, the euro area needed a framework to monitor macroeconomic
imbalances and suffered from its absence.
2. Responses to the crisis
So how has Europe incorporated these lessons into its policy responses to the crisis?
It is useful to conceive of the European response in two phases. First, Europe has had to respond to what might be called the
acute challenges, by which I mean the shifts in investor
sentiment and market psychology that have led to market panic and
cross-border contagion. These had to be addressed to manage the on-going
crisis.
Second, it has had to respond to the
systemic aspects of the crisis, by which I mean the underlying
economic and institutional weaknesses that have led these acute effects
to appear. These have to be addressed to find a sustainable solution to
the crisis and prevent a re-emergence.
a. Acute challenges
The acute challenges have been addressed, first and foremost, by
establishing crisis management tools at the European level. This
included the temporary European Financial Stability Facility and
Mechanism in May 2010 and more recently the permanent European Stability
Mechanism. Their significance cannot be overstated. Financial support
can now be given swiftly and efficiently, conditional on strong
macroeconomic adjustment. This arrangement maintains the core principle
that Member States are responsible for their economic policies, while at
the same time removing the tail risk of a self-fulfilling
liquidity/solvency crisis. This partly remedies the lack of a ‘federal’
shock absorber, while not altering the fundamental balance of
competencies within the euro area, which would require fundamental
Treaty changes. The capacity of these arrangements also ensures
sufficient scope for support. The ESM is a permanent institution that
can raise up to 500 billion euros in financial markets – actually, one
of the world’s largest and most flexible international financial
institutions.
b. Systemic challenges
As regards the systemic aspects of the crisis – the underlying
economic and institutional challenges that lie at the heart of Europe’s
current difficulties – reforms have taken place on two main levels.
First, Member States have undertaken major internal and external
adjustments to reduce fiscal and macroeconomic imbalances.
Encouragingly, it is those Member States with the deepest
vulnerabilities that have undertaken the most far-reaching adjustments.
For instance, on the fiscal side, Greece has closed its structural
primary budget deficit by around 13 percentage points of GDP since 2009,
Portugal by almost 7.5 pp, Ireland by around 6.5 pp, and Spain by more
than 4.5 pp. This compares with an average reduction in the structural
primary deficit of 2.6 pp for the euro area.
The competitiveness losses these countries accumulated over the first
decade of EMU are also being tackled. From October 2008 to Jun 2012,
unit labour costs decreased in Ireland relative to the euro area average
by around 19%, around 12% in Greece, 10% in Spain, and by around 6% in
Portugal. The internal rebalancing within the euro area is underway.
Current account positions have also improved. The three countries
under full EU-IMF programmes have current account deficits that are on
average around 8 percentage points of GDP lower than they were in 2008
and are approaching full balance or even in surplus as in the case of
Ireland. This rebalancing is not just the results of declining imports
associate with a recessionary period but are the consequence of a great
increase in exports that in the case of Portugal and Spain exceeded the
European average since 2009. The second level on which fundamental
reforms have taken place to address underlying weaknesses is the
strengthening of the institutional architecture of the euro area.
Fiscal governance has been strengthened on several occasions. Very
recently, 25 EU countries signed up to the Treaty on Stability,
Coordination and Governance, known as the European Fiscal Compact, and
which entered into force in the beginning of this year. Member States
commit to run structurally balanced budgets and introduce a respective
fiscal rule into their national primary legislation. Additional
regulations have strengthened the European fiscal governance framework,
of which the final pieces – the so-called “two-pack” – will
significantly add to the fiscal rule book for euro area countries. It
will be important to have the new rules fully implemented and complied
with. This should give credibility to fiscal policies, hence reducing
investor concerns about fiscal sustainability.
The absence of any oversight framework for macroeconomic policies has
been redressed through the creation of a dedicated procedure for the
monitoring of macroeconomic imbalances such as excessive credit growth
or exuberant house price increases. In addition, a new idea of “reform
contracts” will be explored further next year, by which Member States
would commit to specific measures to boost competitiveness and receive
targeted financial support from the euro area in return.
c. Towards a Banking Union
However, the most significant governance development has been the
commitment to create a real banking union in the euro area – to resolve
the “financial trilemma” I referred to at the beginning of my remarks.
Its first component is the elevation of supervisory responsibilities to
the European level.
In mid-December last year, the Finance Ministers of the EU Member
States unanimously reached an agreement on the legislative framework for
a Single Supervisory Mechanism (SSM) through the attribution of banking
supervision tasks to the ECB. This legislative framework is expected to
be enacted in the course of the first quarter of this year.
The agreement on the SSM is a milestone in European integration, with
no precedent in monetary union historical experiences. Member States
have agreed to assign to the European level a full and complete set of
banking supervision powers over all banks of the euro area Member States
and also over the banks of the EU countries wishing to join the SSM.
The supervisory powers range from authorisation, Pillar 1 and Pillar 2
tasks to early intervention and sanctioning powers. Furthermore, the SSM
will also have responsibilities regarding macro-prudential supervision
of the euro area financial system as a whole also of individual
countries, which is a necessary complement for both central banking and
banking supervisory policy, as the crisis has taught us.
The establishment of the SSM is essential for the functioning of
Monetary Union. The independent supranational supervision by the SSM
will help to restore confidence in the banking sector. This should
reverse the trend towards financial fragmentation, prevent flows of
deposits due to the lack of confidence, and help restart a
well-functioning interbank market.
It is also a major step for the single financial market. The SSM will
simplify supervision and support the development of a single rulebook
by the European Banking Authority, while helping to better address
systemic risks in Europe.
The Single Supervisory Mechanism, although very important, is only
the first step towards a banking union. The next step is the
establishment of a Single Resolution Mechanism – a necessary complement
to the SSM. Building on a strong legislative framework on bank recovery
and resolution (which is under preparation) such a Single Resolution
Mechanism, with a Single Resolution Authority at its centre, is
essential to enable timely and impartial resolution decisions focused on
the European dimension and to minimise resolution costs. It will
contribute to breaking the vicious bank-sovereign nexus and minimize the
risk of supervisory forbearance in the absence of workable resolution
options. The European Commission will present a proposal in the course
of the year.
As you can see Europe has responded decisively to the challenges.
Member states have progressed individually in rebalancing their
economies and in common in strengthening the union’s institutions.
Notwithstanding the achievements made, no time should be wasted in
complacency. Continued policy actions are necessary to sustain
confidence and revive the growth potential of euro area countries. The
imperative is to further reduce fiscal and structural imbalances as well
as to advance with financial sector restructuring and with European
institution building. Additional progress on those reform fronts will
send a strong signal to markets.
d. The monetary policy response
Let me also briefly touch upon the response of monetary policy. As
you know, our primary objective is to maintain price stability in the
euro area. Neither our mandate nor our resolve to deliver on it has
changed in the face of the crisis.
However, the range of instruments we use to achieve price stability
had to be widened. The crisis severely damaged the transmission
mechanism of monetary policy and thus changes in the ECB’s key interest
rates could not be transmitted uniformly across the euro area. Moreover,
the sources of disruption in the transmission varied over time. Hence,
we used different types of non-standard measures as the crisis evolved:
we provided liquidity in fixed-rate, full allotment mode, considerably
extended the maturity of central bank credit, widened the eligible
collateral set, bought government and covered bonds outright and reduced
reserve requirements.
This is also the case for the last measure we announced: the Outright
Monetary Transactions – OMTs. The OMTs are designed to tackle unfounded
fears of the reversibility of the euro that distorted the sovereign
bond markets in the euro area. The perceived redenomination risk had led
to a fragmentation of financial markets along national borders and
jeopardised the singleness of our monetary policy. Thus, the OMTs were
designed as a credible backstop to self-reinforcing negative market
expectations and has been successful in alleviating some of the acute
crisis challenges I have alluded to before.
Yet, they were also designed to preserve incentives for prudent
economic policies. The ECB will only intervene in government bond
markets for countries that are subject to effective conditionality of
certain ESM programmes – thereby re-enforcing also the resolution of the
systemic challenges I mentioned before. The credibility in the eyes of
the market of the OMT as a backstop certainly underpins the significant
improvement of sovereign bonds’ yields and spreads since the beginning
of August, when the ECB’s Governing Council took the decision to create
the programme.
3. Conclusion
The global financial crisis – more than 5 years on now – exposed
several structural deficiencies in the institutional set-up of the euro
area. However, the lessons learned now translate into policy action.
The Euro area has been making progress in all domains of the necessary
response to the crisis: countries have been successfully applying
adjustment programs; financial backstops have been created; monetary
policy has delivered in its role of liquidity provision to the banking
sector and Member States have started an ambitious programme of
institutional reforms that is deepening European integration and
improving the framework for monetary union.
Once again we can see the wisdom of one of the founding fathers of
the European project, Jean Monnet, when he wrote: “Men only act in a
state of necessity and usually only recognise necessity in a situation
of crisis”.
Once again, European countries have shown their resolve in making the
euro a success and reaffirmed the deep political commitment to work
together towards a stronger union.