Lucas Papademos: Opening address at the Fifth ECB Central Banking
Conference
Speech by Mr Lucas Papademos, Vice President of the European Central Bank, at the Fifth
ECB Central Banking Conference "The Euro at Ten: Lessons and Challenges", Frankfurt am
Main, 13 November 2008.
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I. Introduction
On behalf of the Executive Board, I would like to welcome you to the Fifth ECB Central
Banking Conference, taking place in the tenth year of the ECB's establishment. We are
delighted that this year's conference has attracted many distinguished participants from
academia, central banks, governments, international institutions and the financial sector.
Your contributions will ensure that this conference will provide insightful and
thoughtprovoking analysis and generate debate on many policy issues of relevance to central
banking.
As we will be celebrating the 10th anniversary of the introduction of the single European
currency in a few weeks' time, the theme of this conference is, of course, focused on "The
Euro at ten: lessons and challenges". The introduction of the euro was a historic milestone in
the process of European monetary, economic and political integration, with wide-ranging
implications for the European and global economies. Accordingly, this conference will
concentrate on several issues of relevance to the performance of the euro area economy
and financial system and on the challenges for the conduct of monetary policy and the
performance of other central banking tasks in an increasingly integrated global economy.
II. The euro: economic performance and policy challenges
The first session will examine the macroeconomic performance of Economic and Monetary
Union, its achievements and challenges, over the past ten years. There are several key
questions to be addressed. First, has the euro and the single monetary policy established a
zone of monetary stability as envisaged, with all the direct and indirect benefits this entails for
the 320 million citizens of the euro area? The evidence unambiguously provides a positive
answer. The euro has been a resounding success: it has established itself as a stable and
credible currency, which has become the second most important currency in the world after
the US dollar. A deeper analysis, however, should reveal the contribution of monetary policy,
and of other factors, to this achievement and the challenges that lie ahead and must be
effectively addressed in order to ensure the preservation of price stability in the years to
come.
A second key question is whether - or to what extent - the euro has contributed to boosting
the trend growth of the euro area economy by strengthening competition, enhancing market
efficiency, raising productivity growth and increasing labour utilisation. The answer to this
question if less straightforward and the evidence seems, at first sight, to be rather mixed. On
the one hand, average annual economic growth in the euro area has remained virtually the
same (2.18%) over the ten years following the introduction of the euro (1999-2007) as in the
two preceding decades (2.14% (1990-1999) and 2.27% (1980-1989)). On the other hand,
employment grew impressively, namely by 18.67 million, or 1.36% per annum, over the past
ten years, compared with 5.99 million, or 0.49% per annum, in the previous decade. A
deeper analysis could reveal how the euro has contributed to strengthening the performance
of the real economy, but also how other factors constrained and partly offset its positive
impact, and it will also point to important challenges ahead, parts of which stem from the
divergences in the performance in terms of growth and competitiveness across the member
countries in the euro area. We are looking forward to the paper by Wyplosz and Mongelli,
and to the discussion that will follow, for answers to these and other relevant questions.
Another important set of issues, which will be addressed in the second session, concerns the
role of the euro in fostering the integration of financial markets in Europe and in promoting
the efficiency and stability of the European financial system - and through it - of the broader
economy in the euro area. Assessing the impact of the euro on the integration, efficiency and
stability of the European financial system requires careful analysis in order to disentangle its
contribution from the influence of other factors that have simultaneously affected the
development and functioning of the financial system.
Indeed, the globalisation of financial markets and institutions, which was fostered by financial
innovation and technological advances, has played a key role in shaping the overall
environment and influencing the processes that determine financial market efficiency and
stability. Moreover, the increasing interconnectedness and interdependence of our
economies and financial systems have important implications both for the conduct of
monetary policy and for the performance of the central banking task of safeguarding financial
stability. These implications - and there are many - will be examined and assessed in the
third session on the basis of the paper by Kashyap, Rajan and Stein and in the concluding
policy panel. And, in between, two other panels will address - from both an analytic and a
policy point of view - other important challenges confronting the euro area, in particular those
stemming from its future enlargement and its evolution towards an optimal currency area.
III. The ongoing financial crisis: lessons and challenges for central banks
Over the past ten years, the ECB has performed its tasks in an often difficult economic and
financial environment that was adversely affected by sizeable and persistent shocks; and it
has had to face some extraordinary challenges. The first was the unique, historically
unprecedented challenge of conducting the single monetary policy successfully so as to
preserve price stability in a newly established monetary union of politically independent,
though economically well-integrated, member countries. The other major and exceptional
challenge is the one we are still facing today: the preservation of price stability and the
safeguarding of financial stability in the euro area during the worst financial crisis in decades.
The ongoing financial crisis which is, in many respects, unprecedented in intensity, scope
and complexity has highlighted the role of the ECB in safeguarding financial stability. The
events of the past year allow us to draw a number of conclusions concerning the
responsibilities and actions of central banks in general, and of the ECB in particular, in
contributing to preserving price stability through both crisis management and crisis
prevention. And they have also shown how the conduct of a monetary policy aimed at the
preservation of price stability and the performance of tasks aimed at safeguarding financial
stability require the appropriate use of available policy instruments. Let me briefly elaborate
on a number of pertinent lessons learnt and on the challenges to be faced.
It is by now widely accepted that a main underlying cause of the current global financial crisis
was the same one that had fuelled similar episodes in earlier times: the excessive growth of
credit globally over a long period of time and the associated high leverage in the financial
system and in the non-financial sectors of some countries. Central banks, through their
monitoring and analysis of monetary and credit developments, can provide early warning
signals about the building-up of financial imbalances that may lead to excesses in the
financial markets - through various channels involving an under-pricing of risk and an
increase in market liquidity that can fuel asset price bubbles which will eventually be followed
by market corrections. And such corrections will be the more severe, the higher the degree of
leverage and the more prolonged the period of excessive credit growth. There is substantial
empirical evidence across countries and over different periods in support of this proposition.
The ECB's monetary policy strategy, which includes a comprehensive analysis of
developments in money and credit, is well-suited to provide useful information about
monetary risks to financial stability that can have longer-term implications for price stability
and output volatility.
A second related policy issue is whether - or to what extent - central banks should "lean
against the wind" of financial market excesses that can be expected to turn into a financial
storm and whether they can do this both in a manner that is consistent with the preservation
of price stability and by effectively using the single policy instrument at their disposal, the
interest rate. In principle, this can be done, and should be done, under certain
circumstances. This would require the monetary policy stance to be tightened in periods of
booming financial markets, so as to contain the risk of instability to the price level over a
longer-term horizon (when the boom could turn into a bust); in other words, in order to buy
insurance against the risk of a financial crisis in which financial intermediation could grind to
a halt. Such a policy could also help address the problem of moral hazard that may be
created by policies that aim only to mitigate the impact of adverse shocks to financial
stability, and thus treat asset booms and busts asymmetrically. In practice, however, a policy
of "leaning against the wind" is not always feasible; it may by itself not be an effective means
to contain unsustainable asset price bubbles in the presence of exuberant expectations and
it may not be compatible with the maintenance of price stability over the medium term.1
Consequently, the single instrument of monetary policy - the central bank interest rate -
cannot always be used, cannot be used systematically, to simultaneously achieve the price
stability objective (over the medium and longer term) and effectively safeguard financial
stability. Clearly, additional tools must be employed to this end. Central banks can further
strengthen their analytical tools and methodologies that can help identify risks and
vulnerabilities in the financial system and provide early warning signals of emerging
imbalances and potential instabilities. And central banks - via their financial stability reviews
and other means - have done so fairly successfully. But the recent experience has also
shown that, despite the communication of such early warnings, the financial markets did not
hear, or did not want to hear them for several reasons, including the influence of
inappropriate incentive structures at different stages of the financial intermediation and
securitisation chain. What is, therefore, needed is a more effective use of regulatory policy
instruments by supervisory authorities that can help contain procyclicality in risk assessment
and the increase in leverage that is characteristic of asset market booms. Pre-provisioning
measures during the upswing phase of the cycle and more effective and longer-term oriented
risk management can contribute to this end.
More generally, and this a third important lesson learnt from the ongoing financial crisis, the
effective safeguarding of financial stability - both in preventing and in managing a financial
crisis - requires parallel and complementary action by central banks and supervisors, and an
enhanced cooperation and exchange of information between them. It is evident that this can
be achieved most effectively and efficiently when central banks are responsible for banking
supervision, or are actively involved in the performance of supervisory tasks - as well as
have access to pertinent information - in collaboration with a separate supervisory authority.
However, irrespective of the organisational structure and the institutional responsibility,
effectively reducing the likelihood of a recurrence of financial crises affecting markets and
institutions requires the fruitful cooperation of the central banks and supervisory functions.
Let me now conclude by briefly pointing to two other important lessons and associated
challenges that have been highlighted by the ongoing financial crisis: the first concerns the
role and actions of central banks in mitigating the impact of financial turbulence on the
financial system and the broader economy; the second is related to the need to strengthen
the cross-border financial stability arrangements globally and in Europe.
The recent experience has demonstrated the crucial role of central banks in crisis
management through the provision and management of liquidity in the money markets and,
in exceptional cases, by providing emergency liquidity assistance to individual institutions.
Since the eruption of the market turmoil, central banks in advanced economies have used
various policy instruments to limit its effects. The ECB's operations in the money markets
have been based on a fundamental principle: the separation of the monetary policy stance
from liquidity management. The monetary policy stance is defined by the level of the key
ECB interest rates and is determined with a view to achieving the primary objective of
preserving price stability over the medium term. Liquidity management aims at ensuring the
orderly functioning of money markets and at mitigating financial stability risks.
The provision and management of liquidity by central banks has alleviated pressures in the
money markets and has kept spill-over effects on the credit markets and the real economy
contained. In particular, the provision of unlimited liquidity by the ECB to the euro area
banking system against an expanded list of eligible collateral since mid-October should
effectively eliminate concerns about liquidity risk and further reduce pressures in the term
money market. Central banks, however, cannot address some of the underlying causes of
money market tensions, such as concerns about counterparty credit risk and the continuing
uncertainty regarding banks' other funding sources and capital positions. The measures
being taken by governments should address these problems over time.
The separation principle that guides the conduct of monetary policy and the management of
liquidity during a financial market correction implies that the policy interest rate is not
employed to alleviate stresses in the financial system if upside risks to price stability prevail.
Only if the preservation of price stability is secured over the medium term, and will not be
jeopardised by a change in the monetary policy stance, can the policy interest rate be
employed to mitigate the impact of financial market stresses in the economy, including their
potential effects on medium-term price developments.
Finally, I would like to stress that the financial crisis has underscored the importance of
international cooperation and concerted action in addressing the liquidity needs of
crossborder financial institutions and ensuring the efficient distribution of liquidity at a global level.
In particular, the Federal Reserve, the ECB and other major central banks cooperated
closely and their concerted liquidity provision enhanced the effectiveness of liquidity
management globally. There is an emerging consensus on the need to strengthen
cooperation between the supervisory authorities responsible for major cross-border
institutions and to promote a more convergent and consistent application of regulations. In
the European Union, the implementation of measures to improve supervisory cooperation,
and to accelerate the convergence of supervisory rules and practices, has gained
momentum. And there is a growing understanding of the need to strengthen the
panEuropean character of financial stability arrangements for crisis prevention and crisis
management. Regardless of the institutional framework that may be adopted, what is
essential is to ensure the effective cooperation and the sharing of relevant information
between central banks and supervisors in a timely and efficient manner.
IV. Concluding remarks
Over the past ten years, the euro has established itself as a stable and credible currency and
the single European monetary policy has preserved price stability, and thus the purchasing
power of the euro, in the euro area. In addition, the euro has played an important role in
insulating euro countries from other adverse effects that the financial crisis could have had
on their economies, via the foreign exchange markets and other channels, if the euro had not
existed. And some Member States that have not yet adopted the euro as their currency have
indeed experienced such effects. Therefore, the euro and the liquidity management of the
ECB have also played an important role in safeguarding financial stability in the euro area.
With these thoughts on some lessons that could be learnt from our experience with the euro,
from the ongoing financial crisis and from the contribution of the ECB and central banks to
the preservation of financial stability, I wish us all a fruitful and enriching conference.
Thank you for your attention.