Christian Noyer: Euro area's situation - analysis, challenges and
solutions
Lunch-debate by Mr Christian Noyer, Governor of the Bank of France and Chairman of the
Board of Directors of the Bank for International Settlements, at the Montreal conference:
"Demographic shifts - threats or opportunities?", Montreal, 11 June 2012.
* * *
Prime Minister,
Governor,
Mr Chairman,
Ladies and Gentlemen,
It is a great pleasure and honour to participate in this lunch-debate with you today. I would
especially like to thank the International Economic Forum of the Americas and its Chairman
for organising this Montreal Conference, which for the past 18 years has been a major
international economic event.
I would also like to take this opportunity to share my analysis of the euro area's situation, the
challenges we face and the solutions available to us.
Before doing so, I think that it would be useful to say a few words about the international
economic situation.
At the global level, growth is expected to slow down slightly in 2012 compared with 2011,
notably due to a moderation in growth in Europe and a little bit also in emerging countries, in
particular China. The United States is recovering relatively rapidly, but faces a number of
challenges, especially with regard to its fiscal situation and the housing market.
Overall, - and this is one of the things that the crisis has clearly highlighted since 2008 - the
world's economic areas are closely interlinked and problems end up being shared.
Consequently, some solutions can only be applied at the international level. This is why the
G20 has grown in significance since 2008.
We need to make further progress in international cooperation, in particular to identify the
sources of global financial imbalances and reduce them via the "framework for strong,
sustainable and balanced growth" and to improve international financial regulation. As
regards the latter, we must always bear in mind our twofold objective: enhancing financial
stability while ensuring the financing of the economy.
I would now like to turn to the situation in the euro area.
As you know, in 2011, the sovereign debt crisis in the euro area was particularly ferocious,
spilling over to countries with sound economic fundamentals.
The first three months of 2012 had shown a few signs of improvement, in particular thanks to
the Eurosystem initiatives and positive political impulses: pressure on sovereign debt eased
slightly, and bank financing and money markets recovered somewhat.
But since April, sovereign debt and banking systems have come under renewed pressure.
The two main driving factors behind this deterioration are the fiscal problems and difficulties
in the banking sector in Spain - but the plan adopted over the weekend should respond
effectively - and, above all, the major political uncertainty in Greece.
Therefore, there is a tremendous amount of work to do on a number of fronts if Europe is to
find a durable solution to the crisis.
The challenge for most individual euro area countries is obviously to achieve strong
fiscal consolidation while ensuring long-term growth. Clearly for me, there is no
contradiction between these two objectives. On the contrary, they are complementary.
The efforts already made on the fiscal front by the euro area are already bearing fruit: not
only is the absolute level of the euro area's deficit half that of elsewhere, but also the pace of
fiscal consolidation is actually much greater. It is clearly an asset for us today and an
element of confidence both for the markets and economic agents, which needs to be further
enhanced. But, by the same token, countries need to create the conditions for a strong and
sustainable growth through strong structural reforms. Here as well, the progress already
made in many countries is important but more needs to be done, notably with regard to the
labour and goods and services markets.
Beyond these national efforts, I believe that what the euro area really needs today is to
make progress towards a more coherent and integrated economic and financial union.
Indeed, the crisis has clearly brought to the fore a number of weaknesses in the functioning
of the euro area and has thus fuelled concerns.
First, the fiscal discipline mechanism through peer pressure as established by the Stability
and Growth Pact proved to be weak. Second, the euro area did not equip itself at the outset
with an instrument for monitoring competitiveness.
Third, the euro area had not put in place a resolution mechanism before the beginning of the
crisis.
I believe that important decisions have been taken on these three points, which should bring
significant improvements if they are fully implemented:
- Europe has considerably enhanced its fiscal discipline framework. The legislative
package (the so-called "Six Pack") entered into force in December and considerably
reinforces the Stability and Growth Pact: the surveillance powers of the European
Commission over national budgets have been enhanced, sanctions have become
quasi-automatic, the criteria for public debt and public spending are being more
closely scrutinised and a new framework for the surveillance of macroeconomic and
competitiveness imbalances has been put in place. In addition, 25 European Heads
of State or government signed the Treaty on Stability, Coordination and Governance
which establishes a comprehensive new "fiscal compact" including a requirement for
national structural deficit not to exceed 0.5% of GDP. These new rules must now be
fully implemented by each country.
- Besides, Europe has equipped itself with an instrument to combat crises. At the last
European Council meetings, it was decided to bring forward the creation of the
permanent European Stability Mechanism (ESM) to July 2012, and to make it more
powerful, increasing the lending capacity of the ESM to USD 1 trillion. It is absolutely
necessary that this strong tool becomes fully operational as soon as possible.
I believe that there is another very important reason why the euro area has been so badly hit
by the crisis; it is because we are a very highly integrated economic area but do not have the
appropriate institutional mechanisms for this integration. In particular, this explains the
contagion effects and the negative feedback loops between banks and States, which have
made matters much worse in the area.
Obviously, a good and coherent functioning of the banking sector is absolutely vital for an
overall solution to the euro area crisis. This conviction is based on two fundamental
observations:
- Appropriate financing is essential for our economies to achieve strong and
sustainable growth. In Europe, the banking system is the main source of financing,
and hence its strength is of crucial importance. However, financial markets naturally
also play a key role and they should focus on serving the economy.
- Secondly, is critical not just for creating the right conditions for
financial stability
the appropriate financing of the economy. It is also an extremely valuable asset in
fostering confidence, which has been severely lacking in recent years and is another
key condition for growth. It is also a vital condition for the effectiveness of monetary
policy as it allows the normal functioning of transmission mechanisms. In addition,
given the feedback loop between banks and sovereigns and the potential impact of
a financial crisis on a country's fiscal position, financial stability makes a major
contribution to fiscal stability.
A smooth functioning of the banking sector is therefore clearly an essential element in the
resolution of Europe's problems. As a central banker and supervisor, I see three major tools
which can help to ensure appropriate financing of the economy and financial stability - both
of which are essential financial conditions for sustainable growth.
1. Financial regulation and supervision must be tailored to the two objectives of
strengthening the financial sector while ensuring an appropriate financing of the economy. Of
course, after the 2008 financial crisis, the most urgent priority was to re-establish financial
stability and bolster resilience to financial shocks. But in the implementation process of the
new Basel 3 rules, we need to pay the utmost attention to their potential consequences for
the financing of the economy, especially in view of the much shorter agenda. In particular,
the new liquidity rules need to be adjusted. In addition, much more progress is now needed
in the area of "shadow banking".
2. Since the beginning of the crisis, the Eurosystem has constantly provided all possible
support within the scope of its mandate to help the banking system overcome its difficulties.
For instance, the idea of the two LTROs was to remove funding pressures in order to allow a
smoother adaptation to the new rules and difficult environment. Simultaneously, this aimed to
prevent a major credit crunch that would compromise both the financing of the economy and
the maintenance of price stability in the area. We will continue to pursue these goals, with no
concessions to our primary mandate and our independence.
3. Beyond this action of the Eurosystem entrenched in the Treaty, the euro area needs a
new and concrete It is true that we have
leap towards stronger financial integration.
made enormous progress for more regulation and created new tools, but the different
episodes of the crisis have demonstrated that a monetary union can be stronger if it relies on
a financial system whose health is not ultimately dependent on national mechanisms:
- the homogeneous health of the financial system is key for the proper transmission of
a single euro area monetary policy;
- as long as the euro area's financial health is vulnerable to problems in one country,
negative feedback loops between sovereign and banking risks can materialise - this
is precisely what happened in the euro area;
- in a monetary union, capital is free to move very quickly from one country to
another, thereby augmenting the potential incidence of "bank runs" if no
supranational deposit guarantee mechanism is in place.
Therefore, we have to build a truly federal authority in the Euro zone, a structure combining
the US FDIC's functions with the ones of the US Federal Reserve System would be a major
advantage for the future of the euro area. It should have three main powers:
- banking supervision (possibly the same kind of structure as the Eurosystem with
one "head" and decentralised implementation);
- deposit guarantee, with massive firepower, provided that it could collect a tax on
every euro area bank and could borrow on the markets with a supranational
guarantee;
- banking resolution (crisis management).
Of course, such a leap will require numerous steps and the elimination of a large number of
substantial obstacles. But what it requires most is an unfailing political will from all euro area
members to progress towards a stronger and more coherent economic and monetary union.
After all, the greatest advances in the European project have always come in reaction to
crises. And we should remember the prediction of Jean Monnet: "Europe was born out of
crises and will be the solution to these crises."