Christian Noyer: The euro area is getting stronger
Speech 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 Paris Europlace International
Financial Forum, "Post-crisis growth and investment opportunities in Europe", New York,
22 April 2013.
* * *
Mr Chairman,
Ladies and Gentlemen,
I am very pleased to have this opportunity to speak to you here in New York.
I'd like to offer you some views about the euro area from both a short- and long-term
perspective.
I'll start with Cyprus. This was certainly a traumatic episode. Obviously, the decision process
was not optimal. And the adjustment effort requested from the country, while absolutely
necessary, was totally unexpected by the population. As a result, many observers have
interpreted the Cyprus crisis as a sign of fragility and uncertainty about the euro.
In fact, it's quite the opposite. Imagine if the situation in Cyprus had occurred nine months
ago. Most likely it would have resulted in a new wave of turbulence in euro sovereign
markets, with interest rate increases and strong capital flows out of the periphery. This was
not the case. There was no contagion, and no spill-over effects from Cyprus to other euro
area countries. During the first quarter of 2013, when the Cyprus crisis developed, long-term
interest rates in Greece, Portugal and Ireland actually declined by around 270, 120 and
130 bps, respectively. In the case of Spain, yields decreased by 70 bps, while in Italy, they
decreased by 30 bps.
This is the first time in three years that a major crisis in one euro area country has not
affected others. This sends an important message. The euro area is more robust today than
it was a year ago. While challenges remain, the actions taken have increased our resilience
to internal and external shocks.
Before I move on to other areas of progress, I would like to say a few more words on Cyprus.
First, the financial support provided by the euro area countries and the IMF was very
substantial, up to EUR 10, 000 for every Cypriot citizen. This should put to rest the claims
that the country was unfairly treated and discriminated against. Second, the commitment to
protect insured depositors has been maintained in the euro area and, in fact, is strengthened
as a result of recent events. Last but not least: Cyprus is a unique case. This was an extreme
situation of moral hazard with big depositors looking for abnormal yields in the domestic
banking system. And it justified an exceptional treatment. Cyprus is neither a precedent nor a
template for future crisis management. It is also important to state that such a banking model
has no place in the euro area. And such a situation would not have existed had the banking
union been in place.
This brings me to some broader issues and the progress made in restoring the euro area's
robustness and integrity.
Nine months ago we had reached a degree of market fragmentation that was threatening the
integrity of the euro area. Spreads on peripheral sovereigns were at an all-time high; private
capital flows from core to periphery countries had all dried up, financial conditions were
increasingly diverging. The same borrower was faced with very different conditions across
countries.
As everybody knows, the introduction of the OMT, following President Draghi's remarks in
July 2012, marked a major change. The measures taken have restored confidence,
eliminated the tail risks of convertibility and reversed the dynamics of market fragmentation.
The process of repair of financial intermediation is making significant progress. In recent
weeks, non-euro area investors have returned to debt and equity markets in stressed
countries. Deposits flows have also reversed from core to periphery where repatriation by
domestic households has been significant. Target 2 balances, which measure the degree to
which financial intermediation compensates for insufficient private capital flows, have
receded by 20% since last summer.
The second transformational change has been the Banking Union. Never in its history, has
the EU been able to agree upon and implement a major reform so quickly. A year ago, the
issue was not even on the table. Then, last June, leaders made a decisive step. Through
days and night of hard work and negotiations, a detailed agreement was finally reached in
December.
It is hard to overstate the benefits that banking union will bring. It will break the link between
sovereigns and their banks. It will stop those negative feedback loops that have such
perverse effects in times of stress. It will ensure that credit conditions in the euro area will not
depend on where you are but on who you are, which is what should be expected of an
efficient financial market.
The governance structure we have adopted will guarantee that, while the Governing Council
will keep the decision power, there will be no conflict of interest between monetary policy and
banking supervision. On the contrary, more consistent supervision across the euro area
should allow for the early detection of potential risks and imbalances and, ultimately, improve
the transmission of monetary policy.
Today the first pillar of the banking union is being constructed: the Single Supervisory
Mechanism. This is a fundamental first step and its rapid implementation is a major success
for the euro area.
But alone it cannot achieve all the objectives of a banking union. That is why we must rapidly
construct its two other pillars: a supranational bank resolution authority (the European
Commission is due to deliver a draft text on this topic before the summer) and a unified
deposit insurance system.
Naturally, in the current situation, there are some dark spots. One major concern is the
stagnation of bank credit, which especially affects SMEs. Overall, the improvement in banks'
funding situation, has not led to increased lending to the non-financial private sector, which
has declined in recent months. Admittedly, part of this weakness is due to low demand
factors. And here also, some fragmentation can be observed. Among countries: credit
distribution is more active in Germany or France than in Italy or Spain. And among
borrowers: big corporates can issue at very favourable rates while at the same time, too
many SMEs are deprived of necessary financing. This divergence is a source of concern,
especially since, in our economies, SMEs play a dominant role in fostering innovation and
employment.
This situation may not reflect a weakness specific to the euro area. In all advanced
economies, banks are engaged in a process of balance sheet repair and deleveraging.
Recent numbers show major advances for European banks in their efforts to strengthen their
capital base, in line with Basel III requirements and, in particular for big international banks,
quite comparable to capital strengthening in US banks (when differences in accounting
standards are neutralized). To put it simply, in the euro area, banks are responsible for 80%
of total financial intermediation, twice as much as in the US. Consequently, the impact is
much stronger on the real economy.
What can central banks do? Our actions are guided by the following elements. Inflation is
firmly under control. Policy rates are very low. In practice, most central banks today are
operating close to the zero lower bound. Therefore, their actions are focused, in all advanced
economies, on making sure that the impact of their decisions is felt in all parts of the
economy. In other words, they aim to ensure that the monetary policy transmission
mechanism is working.
Let us now turn to fiscal policy. In all advanced countries, and primarily in the US, the fiscal
stance is being hotly debated. As we all know since Musgrave has introduced his famous
distinction, fiscal policy has three dimensions: stabilization, allocation and distribution. In a
post crisis environment, governments are struggling to find the right mix.
Today, what constitutes a "growth-friendly" fiscal policy? Discussion has sometimes focused
on the stabilization aspect, and more specifically, on one important, but limited feature: the
so-called "fiscal multipliers" which are set out to measure the impact of a change in the fiscal
balance on GDP. This narrow standpoint focuses on the negative impacts of fiscal
consolidation, especially when the output gap is significantly negative, as is now the case.
However, we need to take a broader perspective and take into account the effects of fiscal
policy on consumer and investment confidence as well as on the efficient allocation of
resources. Where could the gains come from? To answer this question, it is important to
consider the interactions between the fiscal stance and debt markets. Surely, a
growthfriendly strategy is one that minimizes the risks of major financial disruptions in the future,
that does not impede the smooth functioning of financial intermediation and that does not
block the transmission of monetary policy. In several countries of the euro area, sovereign
spreads are still at penalizing levels. In so-called "core" countries, including France, the
situation is different with historically low interest rates. While, in some cases, this reflects the
consolidation achieved in fiscal accounts, there are also other temporary factors at work. Low
interest rates are the product of low growth expectations in the short run; and they also result
from exceptionally accommodative global monetary and liquidity conditions. This
environment offers a unique window of opportunity to consolidate and bring public debt to a
more appropriate level.
Ultimately, growth in the euro area will depend on the ability to undertake the necessary
structural reforms and enhance competitiveness. The euro area, like all advanced economies
is facing a double challenge. First, it must absorb the consequences of the crisis, resorb
financial imbalances, eliminate excessive indebtedness and restore the normal functioning of
capital markets. And second, it must adjust to the deep changes taking place in the world
economy. Looking past current difficulties, it is clear that the euro area is well equipped to
confront the challenges of the 21st century. With 370 million consumers and high purchasing
power, it remains the biggest market in the world. It is also the most economically integrated
area, with highly qualified manpower and very good infrastructures. Too often, however, euro
area countries are prevented from reaping the benefits of their position by the rigidities that
have accumulated over time, during the periods of easy growth. Now, the international
environment is more challenging: new and powerful competitors have emerged and
comparative advantages are shifting. There is no alternative to adjustment.
Already, the crisis has produced significant reforms in many countries, with the downsizing of
the public sector, changes in labour regulation and more competition in goods markets. We
have seen a significant improvement in cost competitiveness as measured by unit labor
costs (ULC): between 2008 and 2012, in the three program countries (Greece, Portugal and
Ireland) cumulated ULC growth stood about 12 percentage points below the euro area
average, thanks either to wage cuts, to productivity gains, or to both. The current account
balances as well clearly show a strong correction. In the three program countries the current
account balances in percent of GDP improved by more than 9 percentage points between
2008 and 2012. In Spain the current account deficit improved by more than 7 percentage
points over the same period. Part of the adjustment has been driven by a contraction in
domestic demand. However, in Ireland, Spain and Portugal export performance has been
very strong compared with the pre-crisis period. In total, the euro area generated a trade
surplus of more than 1% of its GDP in 2012 compared with around zero in previous years.
We expect this surplus to continue in the coming years.
In France, successive governments have reformed pension regimes, introduced measures to
reduce labour costs (the competitiveness pact) and increased flexibility in the labour market.
These are first steps in an ongoing effort to restore competitiveness and rebuild an export
base. These measures must be pursued and amplified.
Let me conclude. The last three years have been the most difficult for Europe since the
creation of the European Union. It is certainly too soon to say that the crisis is over. Current
trends, however, are positive and the euro area looks today much stronger than it did a year
ago. Current projections point to a return to positive growth in the second half of 2013 and in
2014. There are numerous signs that efforts undertaken in the last two years are bearing
fruit. Significant changes have been made to euro area governance, both by strengthening
fiscal frameworks and improving crisis management mechanisms. Much remains to be done.
But if we keep on the right track, we will emerge from the crisis better equipped to take
advantage of the opportunities offered by our common currency.