Fabrizio Saccomanni: The European Union and the global crisis -
the implications for banks, finance and economic policy
Remarks by Mr Fabrizio Saccomanni, Director General of the Bank of Italy, at the Federal
Ministry of Finance, Berlin, 8 February 2011.
* * *
1. Introduction
Since the crisis that disrupted the world economy in 2007, financial tensions have affected
the eurozone as well. Last year saw moments of crisis in the sovereign debt markets for
eurozone countries that threatened to compromise the monetary policy transmission
mechanisms. In the international and especially the British and American press, economists
and financial analysts hypothesized or predicted sovereign defaults, some countries' exit
from the monetary union, and an end to the euro. Even my old friend Otmar Issing, one of
the founding fathers of the euro, in an article in the Frankfurter Allgemeine Zeitung last
November that had echoes across the globe, warned governments in the eurozone that the
very survival of the currency was at risk. How have we got to this point? Are the risks for the
euro really so serious? Can they be mitigated and managed? These are the issues I would
like to address today. First, I will recount the phases in the crisis, showing how, after
originating in the United States, its repercussions spread to the European Union. I will also
describe the situation in Italy, which differs from the other "peripheral" countries in terms of
the structure of its economy, the solidity of its banking system and the outlook for the public
finances. Second, I will examine why Europe came unprepared to manage a global crisis,
lacking the necessary tools and procedures. As has often happened in the history of
European integration, the crisis has spurred the EU to adopt a series of measures to
strengthen economic governance and crisis management. I conclude by sketching out what I
consider to be the crucial items on the European agenda if we are to come through the crisis
and promote sustainable growth in the European Union.
2. The global crisis and its impact on the European Union
The developments of the financial crisis that struck the world economy in August 2007 are
familiar enough, so I will just summarize what to my mind are the main repercussions on the
European Union. I will argue that the crisis had three distinct phases, each with distinct
implications for the various EU countries.
Phase one. The first phase - that of financial "toxic securities" - began in the United States
and spread to Europe through the banking systems in which these high-yield, high-risk
financial instruments accounted for a large share of financial intermediation. The network of
"vehicles" created especially to market these products proved a particularly important
channel. Over time, this network had become a veritable "shadow banking system",
operating outside all supervisory control. As was widely reported, during this phase many
banking crises required government support measures. Italy was one of the least affected
countries, and no Italian bank was placed under public control. The Bank of Italy prevented
the creation of any "shadow banking system" in Italy, and banks' liquidity positions were
monitored daily. London's much vaunted "light touch" approach to supervision was never
adopted in our country. Government financial support to banks was a mere 1.3 per cent of
2009 GDP in Italy, as against 51.9 per cent in the UK, 32.2 per cent in Spain, 20.6 per cent in
Germany, and 18.4 per cent in France. Italian banks' recourse to ECB refinancing was
extremely modest, even at times of acute liquidity shortages in interbank markets. No Italian
bank is featured in the ECB's list of "persistent bidders". A number of lessons for regulation
and supervision in Europe can be drawn from this phase of the crisis. First, the rules and
procedures of banking and financial oversight need to be harmonized in order to avoid
disparities in treatment among institutions operating in different countries. Second, we cannot
permit substantial volumes of banking and financial business to escape all prudential
supervision through recourse to off-balance-sheet transactions and vehicles. Finally,
experience has demonstrated the greater efficiency of systems in which banking supervision
is entrusted to the central bank. Central banks, in fact, are well placed to detect crises early,
because they are in direct daily contact with the money markets and the payments system.
Phase two. The second phase of the crisis was marked by the sharp slump in economic
activity in 2009. To combat the recession, the ECB adopted a highly expansionary monetary
policy, and fiscal stimulus was introduced in almost all EU countries. During this period, the
Italian economy was among those hardest hit. GDP fell by 5 per cent in Italy, as against
4.7 per cent in Germany, 2.5 per cent in France, 3.7 per cent in Spain and 4.9 per cent in the
UK. The recession was especially hard on the small- and medium-sized enterprises that are
the backbone of Italy's industrial sector, with immediate effects on output and employment.
However, the high public debt prevented us from adopting the sort of economic stimulus
measures that other countries did. The only available option was to increase the support to
unemployed workers. Even so, unemployment in Italy held at about the level recorded in
Germany and in France, and well below that in Spain. The lesson of this second phase is the
extraordinary success of the economic policies adopted, which effectively limited both the
depth and the length of the recession. There were none of the disastrous consequences
seen in the Depression of the 1930s, and the recession lasted for just one year. Already in
2010 the whole of the EU saw a sharp upturn. But it was also plain to see that the recovery
differed from country to country. Countries with public finances in order and debt at tolerable
levels were able to react more quickly and effectively to the recessionary trends triggered by
the crisis. Countries like Italy, with a large debt burden, had to limit fiscal stimulus to the
utmost and accept a slower pace of recovery. Differences in factor productivity, export
competitiveness and labour market flexibility also weighed in. Finally, it was seen how in a
globalized system the financial markets have little "patience" for expansionary fiscal policies
that are not accompanied by a specific, credible plan to bring deficit and debt down to levels
deemed sustainable in the medium term. This kind of "market discipline" does have validity,
even if excesses were not lacking. The financial operators, analysts and rating agencies that
in 2008 had clamoured for massive monetary and fiscal stimulus to combat the crisis, by
2009 were already voicing worries over the growth in the public debt and calling for an exit
strategy, warning of serious repercussions on the markets in the event of delay or hesitancy.
The third phase of the crisis, in which the EU still finds itself, began with the
Phase three.
"discovery" of the critical state of the public finances in Greece in early 2010 and the rapid
contagion of most of the European sovereign debt market. Despite the vigorous measures
taken by the ECB, the Eurogroup countries and the EU, there were recurrent tensions
throughout the year, fuelled by financial speculation and rumours of default by this or that
sovereign debtor, the demise of the euro, or the break up of the EU. Again, the impact of the
crisis was not uniform. The interest rates on government securities fell in Germany, at times
to just over 2 per cent, but rose to record levels in Greece, Portugal and Ireland. Interest
rates also increased in Spain and Italy, though less sharply. Italy's spread, which before April
2010 had been higher than Spain's, has remained consistently lower since then, confirming
the market's positive assessment of Italy's public finance management in this phase of the
crisis. In absolute terms, since the beginning of monetary union the rate on ten-year Italian
government bonds has kept constantly between 4 and 5 per cent, an entirely natural and
sustainable level for long-term securities. The market's assessment also reflects the low level
of private debt in Italy, the soundness of the banking system, the high level of households'
real and financial wealth and, finally, the size and diversification of our manufacturing
industry, active in all the main sectors. Finally, it takes account of the fact that, based on the
multi-year financial stability plan already approved by Parliament, the deficit/GDP ratio
should drop below 3 per cent in 2012 and draw close to 2 per cent in 2013, on the way to
achieving a balanced budget in the subsequent years. It would appear, in short, that the
market considers Italy capable of addressing its structural problems.
It is undoubtedly too soon to draw definitive lessons from this phase of the crisis, which is not
yet over. But some preliminary observations can still be made. First, the public finances are
in better shape in the euro area as a whole than in the other major economies, the US and
Japan. The deficit/GDP ratio for the euro area was 6.3 per cent in 2009 and is forecast to fall
to 3.9 per cent in 2012. The corresponding figures for the US are 12.9 and 6.7 per cent; for
Japan, 10.2 and 8.1 per cent. In 2012 public debt in the eurozone is forecast to reach 88 per
cent of GDP, compared with 103 per cent in the United States and 239 per cent in Japan. So
we can say that the euro area as a whole does not have the problem of fiscal imbalance.
Further, the European balance of payments is in equilibrium and the euro, albeit with some
volatility, has held strong against the other main currencies throughout the crisis. However, it
must be acknowledged that some euro-area countries do have excessive levels of debt and
deficit, which if not properly dealt with could pose risks to the stability of the euro area and
the euro. However, the experience of the crisis demonstrated that the EU lacked the
instruments either to prevent or to manage problems of this kind. The eurozone could count
on the monetary policy of the ECB and the Stability and Growth Pact. The ECB has ensured
price stability in the medium term and supplied economies with the liquidity needed for the
functioning of the banking and financial systems, but it cannot shoulder the burden of solving
problems of public finance without betraying its constitutional mandate. And the Stability and
Growth Pact had already been violated before the crisis precisely by the large countries,
Germany, France and Italy, which instead should have set the example for the rest. Quite
possibly it is unrealistic to expect the EU to handle the risks of financial globalization armed
only with a "policy" - strong and efficient, but of limited scope - and a "rule" - clear and
simple, but which each country is free to interpret as it sees fit. If we want to preserve our
European currency, then, we must expand the European Union's economic policy arsenal
and adapt it to the reality of the global economy and finance. All the eurozone countries must
take part in this effort, because the creation of the euro has brought benefits to each.
Germany gained a large domestic market free from restrictions and competitive devaluations.
In 2009, 61 per cent of Germany's trade surplus came from trade with the rest of the
eurozone; and adding the other member countries, the EU provided fully 87 per cent of the
German surplus. When the euro was created, Germany had an external current account
deficit equal to 1.4 per cent of GDP; today it has a surplus of 5 per cent. Meanwhile,
Germany's partners benefited from the monetary stability ensured by the euro and lowered
their interest rates very close to German levels. The "founding pact" underpinning Economic
and Monetary Union has therefore been respected by all; so if imbalances in
competitiveness, productivity and the public finances persist, it is up to the European Union
to equip itself with the instruments and procedures to induce its member states to eliminate
them.
Before turning to the possible remedies for the Union's inadequacies, I would like to sketch
the reasons why the EU was caught unprepared to face the global crisis.
3. European construction: forever unfinished?
It may well be asked whether the founding fathers of the European Community and then of
Economic and Monetary Union deliberately planned to leave the European construction
halffinished, with an ambitious and absorbing mission but without the means to accomplish it.
Based on the historical record, my answer is no. From the time of Jean Monnet, Konrad
Adenauer and Alcide De Gasperi, but also later, with Helmut Kohl, François Mitterrand and
Altiero Spinelli, European construction was always conceived as a gradual and pragmatic
process aimed at eventually achieving that "ever-closer union among the peoples of Europe"
envisaged since the Treaty of Rome of 1957. And this vision was shared by the authors of
the Delors Report, all the governors of the European central banks among them, which in
1989 set out the stages for realizing the Economic and Monetary Union. On the occasion of
the European Council meeting in Dublin in the spring of 1990, Helmut Kohl and François
Mitterrand wrote a letter to their colleagues arguing the need to proceed with political union.
In November 1991, in a speech to the Bundestag, Chancellor Kohl said: "Political union is the
indispensable counterpart to economic and monetary union. Recent history, and not just that
of Germany, teaches us that the idea of sustaining economic and monetary union over time
without political union is a fallacy". In May 2000 Foreign Minister Joschka Fischer, speaking
here in Berlin, at Humboldt University, albeit in a personal capacity, lucidly underscored the
need to give the EU the effective ability to act by creating a European Federation, with a
government endowed with executive power and a parliament wielding legislative power. And
I could cite other European leaders.
European construction was conceived, then, as a gradual process open to all countries that
share its objectives and satisfy certain political, institutional and economic conditions.
There was a wide political consensus in Europe on the unwritten principle that the two
processes - strengthening the institutions of the Community and enlarging it to new
members - had to proceed in step. And the two processes did develop in parallel, in a
balanced and harmonious manner, at least until the changeover to the single currency, even
though every phase of enlargement was accompanied by a period of intense debate on the
Union's internal rules. This drew European governments' attention away from the outside
world, preventing the EU from playing a significant role on the global political and economic
scene. But after the break-up of the Soviet bloc and the creation of the euro, this parallel
progress came to an end. Top priority was assigned to enlargement, with no fewer than
10 countries, mostly central and eastern European, included all at once in 2004. The
decision had found broad support among governments throughout the EU, albeit not always
for the same reasons, but it caused anxiety and concern in the population. Politically, the
enlargement meant the end of the historical division of Europe wrought by the Iron Curtain,
and in this light it was viewed with great favour, especially in Germany but generally in all the
countries. In addition, enlargement meant an expansion of the internal market and,
potentially, a "dilution" of the influence of the eurozone continental bloc of countries, a
prospect that certainly did not displease the United Kingdom. For the population, instead, the
prospect of an open-ended Europe that might include all the Balkans and even Turkey
fuelled fear of mounting immigration that would have shattering effects on the labour market
and on ethnic and social equilibria. In this context, the effort to strengthen the enlarged EU's
capacity for action did not find political support even in founder countries such as France and
the Netherlands. The outcome, in 2005, was the failure of the draft Constitutional Treaty
around which a broad consensus had formed in the European Convention. The more modest
Treaty of Lisbon, approved by the governments of the Union at the end of 2007, when the
global crisis had already begun, did not enter into force until the end of 2009, when the crisis
had already unleashed its devastating effects, after a long and difficult process of ratification
by parliamentary vote and referenda.
An outside observer might find it incomprehensible that the European Union, for fear of the
impact of enlargement, deliberately deprived itself of the instruments that would have served
to manage the problem better. Actually, as so many times in the history of European
integration, the crisis obliged the governments to reopen the "building site" of European
construction. In a brief span of time major reform projects have been completed and new
initiatives launched that can greatly strengthen the EU's economic governance. This is not
the place to go into the details of what is being done in the "building site". But I would like to
convey the importance of the changes to the institutional framework. Before the crisis, the
eurozone's sole instruments were, as I said, monetary policy and a weak rule, the old
Stability and Growth Pact. With the reforms already decided or at an advanced stage of
discussion, the EU and the eurozone have adopted instruments for intervention in three
important areas: banking and financial supervision, economic and budgetary policy
coordination, and crisis management mechanisms and procedures. The first two reforms
should improve the ability of the EU to prevent the build-up of unsustainable financial
imbalances, and hence the emergence of crisis situations. The third reform will enable crises
to be managed in an orderly manner by facilitating the adjustment of disequilibria. Let us
briefly see what is involved.
The reform of the supervisory architecture. Three new independent authorities have been
instituted, responsible for the microprudential supervision respectively of banking, insurance
and the financial markets. They began operating on 1 January of this year. Their main task is
to make the supervisory rules uniform in the respective sectors and to harmonize the
supervisory practices of the national authorities, for the coordinated pursuit of their objectives
of intermediaries' stability, capital adequacy and liquidity. Specifically, the European Banking
Authority will also be charged with preparing and conducting a new stress-test of European
banks after the exercise conducted last July, which was severely criticized by analysts and
market participants for its leniency and lack of transparency. It is absolutely essential that the
new test adhere to internationally accepted standards and methods, and that markets be
promptly informed of the results; and it is necessary that any bank that fails to pass take
adequate measures to strengthen its capital. Alongside the microprudential supervisory
authorities, a macroprudential supervisory body will operate at the ECB to monitor systemic
risk. The European Systemic Risk Board will analyse the evolution of the credit and financial
aggregates to determine whether unsustainable imbalances with systemic implications are
being created. The Board will be empowered to recommend to the competent authorities that
they take the measures necessary to prevent "speculative bubbles" in the financial and
property markets.
Economic policy coordination. The changes in this area, designed by the task force under
President Van Rompuy, envisage a significant strengthening of budget discipline through a
reform of the Stability and Growth Pact and a new mechanism of surveillance on
macroeconomic disequilibria and vulnerabilities. The new Stability Pact will stress
mediumterm fiscal sustainability and trends in the public debt, imparting operational and quantitative
content to the Treaty's debt criterion. Budgetary coordination will begin each year with the
so-called "European semester", a simultaneous assessment of both the budgetary measures
and the structural reforms proposed by the individual member states. The Pact will have both
a preventive and a corrective "arm", plus a broad spectrum of measures and sanctions to
apply progressively in each. The new surveillance procedure will stress macroeconomic
imbalances and suggest the economic policy measures needed to deal with them; in cases
of recurrent non-compliance, sanctions may be imposed. The legislative acts for the
institution of these new instruments are still under discussion. It is important, while retaining
the objectives, to accord greater operational importance to prevention than to inevitably tardy
corrective measures. In any case, it is important that the Commission's power to issue
warnings and recommendations to divergent countries be applied uniformly and not subject
to the approval of the Ecofin Council.
Crisis management. Under the pressure of global markets, in 2010 the European Union
created the machinery for financial assistance to member states in difficulty. At the same
time, the ECB introduced a plan of market purchases of government securities to ensure the
proper functioning of the mechanisms of monetary policy transmission. After bilateral
interventions for Greece, the European Financial Stability Facility and the European Financial
Stabilization Mechanism became fully operational, with overall nominal capacity of
€500 billion. Naturally, these are mechanisms for conditional support tied to severe
adjustment plans agreed with IMF, EU, and ECB. The Stability Facility has already made a
highly successful international bond issue to raise funds to support Ireland. These
instruments will remain in being until 2013, when a new, permanent mechanism is slated for
creation through a Treaty amendment. The new mechanism will be activated by a procedure
to determine whether the applicant country is insolvent. If it is, it must negotiate a
restructuring of its debt with private creditors and becomes eligible for financial assistance
only if the debtor position has been made sustainable. These changes move in the right
direction, but so far financial analysts have remained sceptical. They maintain that the
Stability Facility does not have the "firepower" for peak needs, if the sovereign debt crisis
should spread to major countries like Spain or Italy. I myself consider this scenario most
improbable, but I do think it would be good to increase the Facility's effective size, which is
certainly smaller than the nominal amount, and above all to enhance its operational potential.
4. Conclusion
The global crisis, with its repercussions on the European Union, is not yet over. There are
still strains in the banking systems and the public finances of a number of member states.
Uncertainty and volatility continue to beset the financial markets. Economic activity is
expanding this year, but growth is expected to slow in 2012 in both Germany and the United
States. There is no denying that the prime responsibility for putting their public finances and
banking systems in order rests on the single countries. Italy is fully aware of this necessity
and will do its part, as it always has. It is just as obvious, however, that countries with a
common currency are under a moral obligation to cooperate for the adjustment of the
imbalances and to prevent contagion that would destabilize the currency. The measures
taken in this regard have significantly enhanced the EU's capability for effective economic
governance even in times of crisis. But the unique European construction is still hard for
outsiders to fathom, even those who invest in our financial markets and our currency. So we
must make a special effort to communicate better, to make our institutions and procedures
more transparent, and to put an end to destabilizing speculative attacks. We need
institutional arrangements that are adequate to the economic and financial challenges that
the EU and the eurozone will face and that do not require periodic reinterpretation or
amendment of the Treaty. Every time the Union reopens Treaty talks, as at present, our
partners and the markets wonder whether we are about to take a step forward or a step
back. The time for clarity on the economic governance of the European Union is now.
Yet the Union cannot solve its structural problems by fiscal consolidation alone.
Consolidation is necessary to stabilize the financial markets and to leave more room for
private investment. But we must also undertake a strategy of structural reform to increase the
European economy's growth potential, to reduce unemployment, especially among young
people and women, and to correct the disparities within the euro area in productivity and
competitiveness. These are reforms that can and must be undertaken by all the countries of
the Union. This is not the place to set out the details of this plan, which for that matter is
specified both in official EU documents, such as the 2020 strategy, and in private writings.1
In brief, the need is to complete the internal market through further liberalization in services
such as mass retailing, transportation, construction, finance and the professions, where the
EU lags behind its main competitors. Action is needed for the full integration of energy
markets, which are still fragmented at national level and dominated by local monopolies that
impose high costs on firms and households. And as the Monti Report notes, we must
reinforce the physical infrastructures needed to underpin a huge internal market: the
transport and telecommunications networks, the energy grid and the water supply system.
Experience shows that these processes of liberalization and integration stimulate research
and innovation, which are the prerequisites for new investment and productivity gains. This
agenda is ambitious, and in some respects will be unpopular in the short run. It therefore
requires strong leadership by the main European players. We have already missed a number
of good opportunities - Maastricht, Amsterdam, Nice, and lastly Lisbon - to rise to this
difficult challenge.
Let me conclude these remarks with the words of a dear friend of mine and an unwavering
champion of European integration - Tommaso Padoa-Schioppa, who passed away
prematurely in December. In a bitter reflection in 2006, after the failure to ratify the European
Constitutional Treaty, Tommaso called on Europe to exercise "active patience", admonishing
us that "completing the construction of a united Europe requires truth and clarity on the basic
questions, the rejection of ambiguity, convincing arguments why Europe is necessary both to
the prosperity and security of our member countries and to peace and order in the world."2
This admonition has lost none of its relevance.