Jean-Claude Trichet: The financial crisis and the role of central banks -
the experience of the ECB
Keynote address by Mr Jean-Claude Trichet, President of the European Central Bank, at the
international symposium marking the 50th anniversary of Bank Al-Maghrib, Marrakech,
29 May 2009.
* * *
Dear Governor Jouahri,
Dear Governors,
Ladies and gentlemen,
It is an honour and a great pleasure for me to be a speaker at this celebration marking the
50th anniversary of the Bank Al-Maghrib. I would like to congratulate Governor Jouahri on
this occasion, and wish him and the staff of the central bank all the best for the future.
The Eurosystem has a well-established framework for dialogue with the Bank Al-Maghrib, the
Euro-Mediterranean Seminar. This forum regularly brings together the governors of
Eurosystem central banks with those of the "Barcelona Process: Union for the
Mediterranean". The Euro-Mediterranean Seminar has, since its first meeting in 2004 in
Naples, strengthened our dialogue by addressing various topics relevant to central banks
around the Mediterranean. The Bank Al-Maghrib and Governor Jouahri have contributed to
this fruitful exchange of views and will no doubt do so at the next meeting in March 2010 in
Cyprus. In addition, the Bank Al-Maghrib has close bilateral relations with some of the central
banks in the Eurosystem and in particular with the Banque de France on various aspects of
technical assistance.
We are living in a very challenging time. Morocco, like all countries worldwide, has been hit
by the global crisis. The business cycles of Morocco and the EU are largely synchronised
and the existence of various economic transmission channels such as trade, tourism, and
remittances, explain why both the European and Moroccan economies are going through a
challenging period in the present global context.
My speech today will focus on the global financial crisis and its roots, on the ECB's response
to the crisis and on the role of emerging market economies in the world economy.
The global financial crisis and its roots
Let me start by briefly highlighting the origins and evolution of the current crisis. Imagine a
neutral observer who looked at the financial sector about a decade ago and then didn't look
at it again until the eve of the current financial crisis. He would have found a completely
different financial industry, one which over the past decade has undergone a dramatic shift of
focus. He would have discovered a financial system that had moved away from its traditional
role of supporting trade and real investment. He would have found a financial system in
which speculation and financial gambling had run rife. He would have encountered a system
transformed - a system no longer managing genuine economic risks but one actually
creating and assuming financial risks - risks resulting from arbitrage and intentional
exposure to asset price changes.
That same observer would have realised that financial liberalisation and innovation had
made our economies more productive. The securitisation of assets, for example, had great
potential to diversify economic risks and to manage them efficiently. But it also meant that
financial institutions were able to sell loans or take them off the balance sheet, which
weakened lenders' incentives to conduct prudent screening and constant monitoring of credit
risk. So underwriting standards and lending oversight declined, and contributed to the
excessive credit growth in the second half of the 1990s.
In sum, the observer would have concluded that the factors that fuelled the credit and asset
price boom of the past decade also created the conditions for a bust.
In mid-2007 we started to see the backlash. The start of the financial turmoil was sudden but
not unexpected. The financial system as it worked over the past decade - with its flawed
incentives and its overly complex products and with global imbalances as its macroeconomic
backdrop - was no longer sustainable. The asset cycle turned, the weaknesses were
exposed and investors suddenly lost confidence. After years of exceptional risk appetite and
high profits, the pendulum swung in the opposite direction, as markets became extremely
sensitive to financial risk.
In September last year, the crisis escalated sharply. In particular, a major financial player
collapsed, which was directly involved in about 30 large payment and settlement systems
worldwide and had a balance sheet of USD 600 billion. Its failure turned a large-scale crisis
of confidence into a global financial panic. Financial intermediaries restored liquidity buffers,
tried to economise on capital and to scale down their balance sheets. They sold assets and
tightened lending conditions. Banks and other financial institutions drastically reduced their
exposure to the risks that they had imprudently accumulated during the phase of financial
euphoria. Financial intermediation and loans to companies were curtailed in the wake of a
forceful process of "deleveraging".
This was the point when important spillovers of the financial crisis set in. We saw the almost
immediate spillover from the financial sector to the real economy. The credit squeeze and
loss of confidence started to take a toll on the real economy, and a negative feedback loop
developed between the financial sector and the real economy, and has since become a
major feature of economic and financial developments. Almost simultaneously, the crisis that
originated in the advanced economies spilled over to the emerging market economies. Since
the fourth quarter of 2008, virtually all economies - both those of the industrialised countries
and the emerging markets - have faced synchronised business cycles. Since half a year, we
are facing a highly synchronised global economic downturn.
The ECB's response to the financial crisis
Turning to the ECB's response to the crisis, let me first insist that none of my remarks should
be interpreted in terms of the future course of monetary policy. I stick rigorously to what I
have said during my last press conference. We are indeed in the one-week "purdah period"
before the next meeting of the Governing Council.
Since the start of the financial turmoil, central banks around the globe face unprecedented
challenges. We at the ECB and other central banks have reacted swiftly, flexibly and
decisively. The ECB took the lead with some exceptional decisions as early as 9 August
2007. We have, since then, modified our operational framework and used an exceptional set
of non-standard policy tools. These tools, combined with the bold action taken by euro area
governments over recent months, have played an essential role in preventing a collapse of
the financial system and in bolstering confidence.
I would like to emphasise that despite this upheaval and our exceptional measures, our
objective remains unchanged: to preserve price stability over the medium term, and that's
what guides our policy. In so doing, we support the conditions for financial and economic
stability. The crisis has not changed this objective.
Interest rates
As regards interest rates, the ECB's Governing Council has reacted promptly and decisively
to the intensification and broadening of the global financial turbulence. We have lowered our
key interest rate by 325 basis points since October 2008. This is the largest cut ever decided
over such a short period in Europe. These moves were fully in line with our strategy. The
upside risks to price stability have indeed receded considerably over that period due to the
sharp fall in oil and other commodity prices, and the abrupt slowdown in economic activity.
As price stability is the needle in our compass, we took account of the easing of inflationary
pressures and lowered interest rates.
In this context, I would like to underline that since the introduction of the euro in 1999, the
ECB's quantitative definition of price stability - an inflation rate of below, but close to, 2% in
the euro area, over the medium term - has proved to be an invaluable asset. It has guarded
against undesirably high inflation and against deflation. Long-term inflation expectations in
the euro area, whether based on surveys or extracted from financial indicators, have been
and continue to be firmly anchored at levels consistent with our definition of price stability.
Inflation expectations have been exceptionally resistant to sudden upward short-term price
changes, and we have ensured that is also the case with sharply falling inflation.
Non-standard measures
In addition to reducing interest rates, we have taken exceptional policy actions in response to
the crisis - "non-standard" measures related to liquidity management. At the very start of the
money market stress in August 2007, the ECB reacted within a few hours and temporarily
provided additional liquidity to banks with immediate liquidity needs. We were in fact the first
central bank to take non-standard measures.
When in mid-September 2008 the crisis intensified and interbank trading came to a virtual
halt, the ECB engaged in a new mode of liquidity provision. We started to provide refinancing
well above the levels that banks had absorbed to fulfil their reserve requirements in normal
times. Our approach comprises three main "building blocks".
•
We significantly adapted our regular refinancing operations. We now follow a "fixed
rate full allotment" tender procedure and have significantly expanded the maturity of
our operations. Banks have been granted access to essentially unlimited liquidity at
our policy interest rate at maturities of, initially, up to six months. This is an
exceptional mode of operation. In normal times we auction a given amount of central
bank credit and let competition between the bidders determine the interest rate. This
unusual mode of operation implies that we currently act as a surrogate for the market
in terms of both liquidity allocation and price-setting.
•
Our second building block is the long list of assets that we take as collateral. This list
was already very long before the crisis, but we have extended it even further and now
accept an even wider range of securities as collateral.
•
The first two building blocks offer unlimited refinancing against a very wide range of
collateral. But they can only reach the financial system if they are coupled with the
third building block, namely the very large number of counterparties that have always
been able to take part in our refinancing operations. Even before the financial crisis,
this number was higher than for the other major central banks. Following the changes
to our operational framework in October last year, this number rose further.
All these non-standard measures have now been supplemented by further exceptional steps
that the ECB's Governing Council decided to take at its last meeting on 7 May.
•
We will conduct liquidity-providing longer-term refinancing operations with a maturity
of 12 months. This will further lengthen the maturity at which we provide banks with
liquidity at fixed rates and full allotment. This move is consistent with the operations
we have undertaken since October 2008 and it recognises the central role played by
the banking system in the euro area economy.
•
The European Investment Bank (EIB) will become an eligible counterparty in the
Eurosystem's monetary policy operations. Access to the Eurosystem's liquidity is a
natural complement to the EIB's financing initiatives and it will facilitate the
accommodation by the EIB of additional demand for its lending programme.
• Furthermore, the Governing Council decided in principle that the Eurosystem will
purchase euro-denominated covered bonds issued in the euro area. We expect to
engage in a programme of around €60 billion that targets an important segment of the
private securities market, which has been particularly affected by the financial market
turbulence.
Our primary concern when taking these decisions in recent months was to maintain the
availability of credit for households and companies at accessible rates. I have described that
as "enhanced credit support". Furthermore, our very flexible liquidity management ensured
that solvent banks did not get into difficulties because of liquidity constraints.
Our response to the crisis has been carefully calibrated to the financial and economic
structures of the euro area. In particular, we needed to bear in mind that the euro area's
financial system is predominantly bank-based. Take the structures of private credit
outstanding as an example: recourse to banks makes up more than 70% of non-equity
external finance in the euro area. By comparison, in the US the equivalent proportion is only
around 30%. This reflects the fact that the US financial system is primarily market-based. In
the euro area, guaranteeing steady access to credit for households and companies largely
means preserving the viability of the banking system. Banks play such a dominant role in our
economy that it was appropriate to focus our non-standard measures on the banking sector.
This profound contrast in financial and economic structures explains the different responses
by central banks to the crisis as exemplified by the approaches of the ECB and the Federal
Reserve System of the US. We rely on different channels as regards the transmission of our
policy action. But these variations do not reflect conflicting views on fundamental principles
or objectives. On the contrary: given the different structures, the approaches need to be
different to achieve the same objective. Thus, I would strongly argue that central banks
around the world are united in purpose.
As I indicated before, the remarks I just made on the ECB's response to the crisis did not
contain any message concerning future monetary policy, and should not be interpreted as
containing any such message.
Emerging markets and Mediterranean economies in the global economy
Today we are celebrating the 50th anniversary of Bank Al-Maghrib. This is also an occasion
to reflect on the role of the Mediterranean region, and on the role of emerging market
economies in general in the global economy.
The growing importance of these economies, including those in this area, has profound
implications for the euro area and the rest of the world. I would like to share my thoughts with
you on this phenomenon.
The growing role of emerging market economies
The global financial crisis is slowing the growth of the emerging market economies. Only a
year ago, some observers were still saying that these economies were likely to decouple
from the downturn stemming from the advanced economies. Today it is obvious that this has
not happened. Most emerging markets are affected by the crisis through real or financial
channels. Many sectors have been severely hit by the global turmoil, for instance, the
automotive, textile, building and tourist industries. In addition, remittances which, for many
emerging markets, are an important source of revenue, are vulnerable to the downturn in
host countries, even though they tend to be a relatively stable source of income. It is too
early to say when emerging market economies will bottom out of the global financial crisis,
but some recent data, particularly for Asia, are somewhat encouraging. According to the
latest IMF forecasts, world output will shrink by 1.3% and the advanced economies by no
less than 3.8%. However, GDP in emerging markets, though lower than in previous years,
will still grow by 1.6%.
Despite the crisis, the long-run prospects for emerging market economies remain bright.
Projections for long-term growth, based on demographic trends and models of capital
accumulation and productivity, suggest that the emerging markets are likely to gain in global
importance. A number of studies found startling results regarding the growth prospects for
emerging markets. According to one study, Brazil, Russia, India and China (the so-called
BRIC economies) could account for over half the size of today's six largest industrialised
economies from 2025 onwards.1 We have to prepare for a very profound structural
rebalancing of world output during the next years.
The world economy is changing profoundly, as so should its governance. The creation and
the recent reinforcement of the G20 and the enlargement to the G20 of the Financial Stability
Board are milestones in this respect. The rise of the emerging economies will also be
reflected in the reforms of the international financial institutions.
What are the specific implications of the growing role of emerging markets for the euro area?
The euro area has close links with emerging market economies. In trade terms, the euro
area is actually more open than other major economies. Our exports and imports of goods
and services account for more than 40% of GDP, significantly more than in the United States
or in Japan. Emerging markets are important in trade: nine of 20 euro area's main trading
partners are emerging economies, with a share of more than 18% of exports and around
31% of imports in 2008. The BRICs alone accounted for more than 12% of extra-euro area
exports and more than 22% of extra-euro area imports in 2008.
The growing role of Mediterranean economies
In the present context, which is very challenging, the Mediterranean region is one of the few
in the world that will continue to grow this year. The countries in this area have an
increasingly important place among the world's emerging markets. Moreover, the
Mediterranean economies, and particularly the Maghreb countries, have close links to the
euro area. For example, more than 50% of Morocco's imports and exports are with the euro
area.
Within the Mediterranean region, labour and product markets have become more flexible, the
financial sector is now on a more solid footing and the economy has become more
businessfriendly. A continuation of these reforms will help to increase the long-run growth potential of
the region. A continued implementation of such reforms would lay the foundation for an
increase in the long-run growth potential in the region. Central banks and monetary policy
frameworks are frontrunners in this reform process. In that respect, Morocco is an excellent
example. Important progress has been made towards introducing an inflation targeting
framework, which is the medium-term objective of Bank Al-Maghrib. The bank's new statutes
promulgated in February 2006 confirmed its independence in the conduct of monetary policy
and enshrined price stability as its primary objective mandate.
As you know, the Eurosystem attaches greatest importance to cooperating with central
banks of emerging market economies, including those in the Mediterranean region. The
ECB, as the central bank of the world's second largest integrated economy, very closely
monitors economic developments in regions nearby, notably the Mediterranean.
As I said earlier, we have been working more closely in recent years by holding regular
EuroMediterranean Seminars for central banks. And further east, we have established a similar
seminar with the governors of the Gulf Cooperation Council. The group's first meeting was
held in Germany last year.
Conclusion
To conclude, I would like to call your attention to the following points.
To start with, we are, for the first time, putting to the test the soundness and resilience of the
globalised economy, which has become increasingly integrated over the past fifteen years.
We now have to draw, systematically and without complacency, the lessons of the global
crisis that we are fighting against.
Secondly, we have a duty. Our duty is to considerably reinforce the resilience of the global
financial system and the soundness of the real global economy. We should not allow that, a
few years from now, a new crisis would emerge that would be similar to the current one. That
would be unforgivable.
Thirdly, the international community has engaged in drawing all lessons from the crisis. We
agree on the method, on the role of the G20, on the role of the Financial Stability Board, and
on the role of international financial institutions, in particular the crucial role of the
International Monetary Fund, and also of the Bank for International Settlements, which during
the past years has shown remarkable lucidity in its analysis. As regards the global financial
sector, we agree on the broad orientations to follow: to reduce procyclicality, to fight
shorttermism, and to impose transparency.
Fourthly, we are still today in a very difficult and very unpredictable environment. We
permanently need to remain alert, and there is no place for complacency. I would have two
main messages in that regard. As concerns direct government support to the financial sector,
today's priority is "rapidity of execution." Decisions that have already been taken should be
implemented swiftly. This holds true, in particular, for recapitalisation, as currently only 55%
of funds earmarked for recapitalisation have been used in the euro area. In crisis times, rapid
implementation is crucial. As concerns global governance, I insist on the absolute necessity
to reinforce macroeconomic policy surveillance of systematically important countries and
economies. The IMF has to play a fundamental role in such monitoring, coupled with
responsible and active peer surveillance.
Finally, central banks have a fundamental role in ensuring monetary and financial stability
from a long-term perspective. Morocco knows that it can count on the crucial contribution of
Bank Al-Maghrib, whose fiftieth anniversary we are celebrating today. The world economy
can count on central banks to continue to act as anchors of stability, which are more needed
than ever. The European Central Bank, for its part, will continue to be an anchor of stability
and confidence. And I am pleased to note the recent proposals by the European
Commission, in line with the recommendations of the de Larosière report, to establish a
European Systemic Risk Council under the auspices of the ECB.
Thank you for your attention.