Jean-Claude Trichet: Recovery, reform and renewal - Europe's economic
challenge
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the
conference "The ECB and Its Watchers" XII, Frankfurt am Main, 9 July 2010.
* * *
Ladies and Gentlemen,
It is a pleasure to be with you in this 12th edition of the ECB Watchers' Conference. Today, I
would like to consider where we are in the financial crisis and the economic recovery; to
describe the emerging contours of the post-crisis order both in Europe and the wider world;
and to reflect on what has been achieved by the global policy response to the crisis and what
remains to be done.
1. Where do we currently stand in the crisis?
We are now almost three years into the crisis. The development of the crisis was marked by
a progressive collapse of confidence: a seizing up of markets, dramatic financial events
impacting the global financial system, a sharp decline in trade and a freefall in economic
activity in the industrial world. We can all feel relief that the collective international efforts to
avert catastrophe in the winter of 2008/09 have been successful.
But events over the past few months have made clear that it is still too early to declare the
crisis over. And, just as they have done throughout the crisis, governments and central banks
in Europe and around the globe continue to respond to shifting economic and financial
circumstances with swift, decisive and effective action.
In early May 2010, the gravity of the situation was such that public authorities in Europe had
to step in, with unprecedented actions in terms of quantity and quality, to restore a sense of
direction and renew confidence.
Over the past three years much has been achieved; but much remains to be done. Restoring
confidence and a clear sense of direction does not mean going back to business as usual -
the crisis has shown that we need to make fundamental changes to the way we manage our
financial systems, our public budgets and the interactions between the national and
international institutions that oversee the world economy.
There is a very strong unity of purpose among the world's policy-makers: to eliminate the
fragilities of the global financial system and the global economy in order to achieve strong,
balanced and sustainable economic growth.
We are now at a stage in which we have to finalise new rules and regulations that will help to
make our economies more resilient in the future. This means that we are now in the time of
implementation of decisions already taken and in the ultimate preparation of the new rules
and regulations. It is a very important phase and it requires our full attention.
I see three areas at the core of efforts that will contribute to shaping the contours of the
postcrisis order:
First, institutions. As the Nobel laureate Douglass North said 20 years ago, "Institutions
exist to reduce uncertainty in the world." That message remains true today. We need strong
institutions with clear responsibilities and which offer a framework for dialogue and formal
agreement.
This is all the more important at the global level. The scope of international cooperation is
broadening significantly as our economies become increasingly connected. This is reflected
in current efforts to strengthen the mandates and governance structures of existing
international institutions. At the same time, existing informal fora are being adjusted and new
fora developed.
Examples are manifold. The G-20 has emerged as the prime group for global economic
governance. The Global Economy Meeting of central bankers acts as the main forum for
central bank cooperation. And the Financial Stability Board now represents all systemically
important emerging market economies, and its mandate has been enhanced to strengthen
the international financial architecture. These are encouraging developments and we must
continue to pursue this path.
The second area at the core of our efforts concerns reforms of the financial sector.
This is also an area where further progress is needed. The extent of the financial crisis
leaves no doubt that tighter regulations and supervision are required to overhaul the financial
system. We know that the crisis originated mainly in institutions that had moved away from
traditional banking and which increasingly relied on non-interest sources of income and
nondeposit-funding.
Reforms should be designed in a way that internalises the social responsibility that financial
institutions bear for savers and society as a whole. How can this be achieved? The answer
can be summed up in four dimensions: more transparency, better regulation, less
procyclicality and less short-termism:
1. More transparency is needed to ensure that financial market participants return to
their prime mission of assessing the quality of investment. Securitisation lessened
lenders' incentives for prudent screening and steady monitoring. Risk could be
bundled, sliced and re-bundled for further sale. Risk management became difficult
because information was unavailable to investors, buried in financial structures that
were not transparent. Reform must ensure that sellers of securitised products
disclose all information about the underlying loan structures so that both investors
and rating agencies can correctly price the risks embedded in these products.
2. Better - that is, more effective - regulation will ensure that no financial product and
no financial market participant can escape the eyes of supervising authorities. Many
financial players with high leverage have gone unchecked by our regulatory system.
Better regulation will expose the risks inherent in the financial system and make the
system more stable. Needless to say, highly leveraged institutions should be part
and parcel of this process.
3. Less pro-cyclicality of the financial system will reduce market volatility. Regulation
should attempt to limit the risks that banks assume by imposing higher,
countercyclical capital requirements, thus limiting leverage. Financial institutions will
be asked to raise the quality and quantity of their capital base to ensure they have
adequate buffers against future market disruptions.
4. Less short termism: the promise of significant returns in the short term was often
linked to a misjudgement of underlying risk. At the level of individual institutions,
compensation schemes must be adjusted to avoid encouraging excessive
risktaking on the basis of relatively small amounts of capital. Instead, the incentive
structure should encourage profitability over the medium to longer term. At the same
time, on Wednesday, the European Parliament approved significant curbs on bank
bonuses as part of wider efforts to reform the financial sector. EU finance ministers
are set to endorse the law next Tuesday with the curbs taking effect from the start of
next year. At the level of the financial system as a whole, we need to improve
decisively the prevention of build-up of risks, including systemic risk.
Macroprudential oversight will help to prevent the building up of imbalances.
The third area of work concerns fiscal consolidation. This affects all industrial
economies. Governments must send a clear message to markets - a message of
determination and commitment to sound macroeconomic policies. There is no doubt that
bold government actions including large capital injections in support of the financial sector
helped to cushion the impact of the financial crisis. These measures were courageous and
important in avoiding an even worse economic downturn.
But many countries in the industrial world have reached the limits of fiscal expansion. Rising
debt levels and large fiscal deficits have raised concerns among financial market participants
about the longer-term sustainability of public finances.
Just like consumers and countries, governments cannot live beyond their means forever.
Fiscal authorities need to look beyond the current cyclical upturn. There is no alternative to
that. Let me remind you of an often forgotten remark by John Maynard Keynes from 1937, in
the aftermath of the Great Depression, when he said: "Just as it was advisable for the
government to incur debt during the slump, so for the same reasons it is now advisable that
they should incline to the opposite policy".1
Fiscal consolidation and growth are not mutually exclusive. I disagree with the view that
reducing public expenditures will hinder economic growth. On the contrary, prudent fiscal
management provides the basis for balanced and sustainable growth. Stability-orientated
fiscal policies will foster confidence among households, entrepreneurs and investors, which
will ultimately increase our welfare by creating new jobs.
2. How should we address European modalities of today's global challenges?
I have outlined three key areas for efforts to shape the contours of the post-crisis world
- reform of the institutions of global governance, reform of the financial system and reform of
public finances.
These are global challenges affecting in particular the industrial economies. I would now like
to explain how Europe specifically is responding to these challenges. An ambitious agenda
lies before the continent. It is not only a visionary agenda: it has to be pursued with
determination right now. We have to demonstrate the same spirit with which the European
Union was progressively developed over the past half-century: setting objectives, agreeing
deadlines and mobilising the necessary political will within Parliaments.
Europe's governments are committed to pursue fiscal consolidation. Those within the euro
area have formally declared that they will take "all measures needed to meet fiscal targets
this year and the years ahead in line with excessive deficit procedures" (Euro area heads of
state or government declaration of 7 May 2010). Some of them have made precise additional
commitments to accelerate fiscal consolidation and ensure the sustainability of their public
finances.
Fiscal consolidation is being put in place at the same time as we strengthen the resilience of
the European banking sector. Publication of the detailed results of a harmonised
panEuropean stress test is an important step in the right direction. These tests will increase
transparency and enhance investors' confidence in Europe's banking sector. They will also
contribute to restoring the important intermediation role of the interbank market in channelling
funds within Europe.
3. Where next?
So where do we go from here? As I have indicated, collectively as European and global
policy-makers, we need to ensure economic recovery and renewed confidence, while
reducing fiscal deficits and remaking the financial system into one that supports the real
economy. This needs to be our clear sense of direction.
Sound public finances and a stronger and more resilient banking sector will strengthen the
fundamentals of the European economy. Already prior to the crisis, the euro area was among
the least volatile economies in the world. Volatility of both inflation and output growth were
significantly lower than in other industrial countries and inflationary expectations remained
remarkably stable.
Once enacted and implemented fully, the new measures of fiscal consolidation and financial
reform will help foster these sound fundamentals and turn the current cyclical upturn into
sustained growth.
The latest signs that we are receiving from the economy are encouraging. Exports are
recovering at a steady pace. Industrial production is rising and employment is stabilising.
This fundamentally distinguishes the current situation from the situation that we faced last
year.
But as I have said, the crisis is not yet over. For the ECB's role as the guardian of the euro,
this means, first of all, to remain faithful to its primary mandate of delivering price stability in
the medium term, in line with its definition.
In the exceptional financial market circumstances that we are experiencing since 2007 we
have decided some non-standard measures to help restoring a more appropriate market
functioning and a better transmission of our monetary policy. But our monetary policy stance
has always been to deliver price stability and be credible in this delivery with a solid
anchoring of inflation expectations. The Securities Markets Programme is fully in line with
this approach. The Governing Council is constantly and carefully monitoring all
developments and stands ready to do all that is necessary to maintain price stability.
Later today, Jürgen Stark will present the outcome of our enhanced monetary analysis that
enlarges our toolkit to pursue this aim.
Beyond our role as guardians of the euro, we also have to deliver on our responsibilities as
part of European and global economic governance. In this context, I would like to touch on
the work programme of the Van Rompuy Task Force, which was established by the
European Council in March 2010 and in which I am participating. Vítor Constâncio and
Lorenzo Bini Smaghi will go into greater detail, and I will highlight a few elements of the task
ahead.
First, national fiscal reforms - to which I alluded before - need to find an anchor and a
collective guarantee in renewed and strengthened institutions for multilateral budgetary
surveillance. National fiscal frameworks will receive a blueprint of good practice, which will
ensure that commitments to fiscal prudence are internalised first and foremost in the national
Parliaments. A new code for statistical reporting will support the legislatures in enforcing their
fiscal plans. This will be the first line of defence against the accumulation of fiscal
imbalances.
We will have a second line of defence at the level of the EU27, and in particular within the
euro area. Here, a more stringent implementation of rules and procedures to check and
correct excessive deficits and debts will be essential, among other things by increasing the
automaticity and speed of procedural steps. Ultimately, the process needs also to comprise
non-pecuniary forms of deterrence. In the most severe cases of persistent non-compliance, a
limitation or suspension of voting rights should be considered.
The second area of institutional reform tackles one further aspect of the crisis: the fact that
seemingly sound public budgets can sometimes reflect an overheated economy. When rising
asset prices boost revenues from financial and housing market transactions, the budget
looks sound; but when asset prices fall, the budget can go into profound distress.
So for all its critical importance, reinforced fiscal surveillance is not enough. We need
reinforced macroeconomic surveillance. There is one indicator that can reveal underlying
weaknesses as they are forming: losses of competitiveness. Within a monetary union, the
relative competitiveness of economies measures the sustainability of national price and cost
developments, the compatibility of national nominal trends with those that are likely and
appropriate for the union as a whole.
The third area of institutional reform will be a crisis management framework. This framework
has to respect strict conditionality and minimise moral hazard. It is an issue that has not yet
been addressed in the task force itself.
We have a great deal of work to do on these three issues in the months ahead, and I am
confident that when bold reforms in these areas are undertaken, we will have achieved the
necessary quantum leap in euro area governance.
Thank you for your attention.