Jean-Claude Trichet: Global governance today
Keynote address by Mr Jean-Claude Trichet, President of the European Central Bank, at the
Council on Foreign Relations, New York, 26 April 2010.
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Ladies and Gentlemen,
It is a real pleasure to be back here at the Council on Foreign Relations.
You will all be familiar with the well-worn French expression "plus ça change, plus c'est la
même chose" - and its New York equivalent "same old, same old" - to imply a world-weary
feeling that despite the appearance of change, things remain the same.
Well, since my last visit three years ago, I think we will all agree that there have been the
most dramatic changes in the world economy. And these are changes that suggest that
things will not and should not remain the same.
Back in April 2007, I noted that the ever-closer integration of national economies and the rise
in capital mobility had made the international system more vulnerable to changes in investor
sentiment. I added that it was vital to strengthen the ability of the global economic system to
absorb shocks to preserve global financial stability.
But few then could have imagined the magnitude of what eventually came to pass, starting
with the subprime crisis in the summer of 2007, turning into a full-blown global financial crisis
in the autumn of the following year with the collapse of Lehman Brothers, and culminating in
a devastating impact on trade, production and jobs.
These are not entirely new phenomena - but we have to go a long way back in the history
books for a suitable comparison. According to economic historians Barry Eichengreen and
Kevin O'Rourke, the initial decline in global production between mid-2008 and mid-2009 was
broadly comparable with that at the beginning of the Great Depression. The corresponding
correction in global equity prices and the fall in global trade volumes were even larger.
The good news is that the global economy has now turned the corner, largely thanks to the
unprecedented support measures taken by both central banks and governments, which have
helped to restore confidence. Yet the recovery remains somewhat fragile and not yet
sufficiently supported by private demand; therefore, it is not the time for complacency.
I should add that the recovery should be measured in much broader terms than focusing on
a resumption of GDP growth. A full recovery also implies a return to sustainable fiscal
positions. It means a full restoration of trust in some of our financial institutions. And it
requires a healing of the scars that the irresponsible behaviour of some financial players has
inflicted on our societies and on the real economy.
In my introductory remarks today, I would like to explore some of the lessons for
policy-makers around the world that can be drawn from the extraordinary events of the past
three years.
I will first elaborate on why we need a set of rules, institutions, informal groupings and
cooperation mechanisms that we call "global governance".
Second, I will analyse how, in hindsight, the existing system of global governance has fared
during the crisis.
Third, I will examine the evolution of the system in response to the crisis, in particular the rise
of new key players in the world economy, such as the G20, the Global Economy Meeting of
central bank governors and the Financial Stability Board.
1. Why we need global governance
There are numerous definitions of global governance. In the economic and financial sphere I
will propose that global governance comprehends not only the constellation of supranational
institutions - including the international financial institutions - but also the informal groupings
that have progressively emerged at the global level. Those informal forums (G7, G10, G20,
etc.) are key in improving global coordination in all the areas where decision making
processes remain national - whether in helping to work out agreed prudential standards and
codes or to facilitate where appropriate, the coordination of economic macro-policies.
No market can survive without a set of rules. This is particularly true at the international level,
where natural barriers to transactions are formidable. One of the global governance's primary
aims should be that of facilitating the proper functioning of cross-border markets and thereby
of reducing transaction costs.
The process of doing so is evolutionary and demands a pragmatic approach with respect to
what arrangements may and may not work, depending on the circumstances. But the more
complex the goods and services exchanged are, the greater the need for a sound
institutional infrastructure. In this respect, finance stands out as an arena in which global
rules may be particularly beneficial.
More generally, the crisis has weakened the arguments of those who think that deregulation
is always conducive to better functioning markets. We have learned once again that markets
cannot function properly without an effective regulatory and supervisory infrastructure.
Governments, central banks, international institutions and globally agreed prudential
standards and codes are the means by which we collectively seek to avail ourselves of the
global public good of global economic stability.
Of course, there are limits to what internationally agreed rules can and should seek to
achieve.
First, the principle of subsidiarity is essential. This principle, which is a key feature underlying
of European Union legislative framework, says that no rule should be imposed at a global or
supra-national level that cannot be more or equally effectively set at the national or local
level. This principle might also be read as implying that the "burden of proof" should rest on
those who want to establish global, as opposed to local, rules and institutions.
Second, it is not straightforward to set common rules in complex and innovative fields such
as finance. While financial liberalisation, deregulation and innovation all have the potential to
make our economies more productive and more resilient, the financial sector must not forget
that its purpose is to serve the real economy, not the other way around. We have painfully
witnessed the fallout from excessive complexity of financial instruments in the current crisis.
Finally, there is a risk that common rules are not optimal and in particular that they are too
limited, since they have to be the minimum standards across many constituencies. This risk
is very real in the area of finance because of significant differences across countries in
financial structures, financial instruments and preferences for financial regulation.
Overall, the global financial crisis has shattered previously held convictions that "keeping
one's house in order" is the right principle to ensure global welfare. We have certainly
become more aware of the negative externalities that financial innovation and financial
globalisation can create. Finance in its current form has become a double-edged sword for
the real economy.
2. How global governance has fared during the global crisis
Let me now turn to how our institutions of global governance in the financial sphere have
fared during the crisis.
Central bank cooperation
One dimension of international cooperation that I consider to have worked particularly well
during the financial crisis has been that among central banks - both bilaterally and
channelled through the various Basel-based committees. This institutionalised cooperation
has ensured an unprecedented degree of collaboration in, for instance, the provision of
cross-border liquidity - the network of temporary currency swaps or repos set up bilaterally
by major central banks such as the Fed and the European Central Bank.
The Bank of International Settlement (BIS) itself has been "ahead of the curve" in terms of
identifying unsustainable trends in the financial sector and more generally in the global
economy - such as the under-appreciation of risk and excessive credit growth - which
eventually led to the crisis. It could do so based on a high degree of analytical depth and
information sharing at a global level that the central banks' global cooperation has been able
to develop over time.
These analytical contributions assisted in driving the strong and coordinated policy response
when the crisis erupted. We have now scaled back our cross-border operations as markets
have recovered, but the spirit of cooperation and the readiness to work together is stronger
than ever.
Regulatory arbitrage
But as much as some aspects of global governance appear to have passed the severe test
of the global crisis, we should remember the significant shortcomings that may have
contributed to creating the conditions for the crisis to happen in the first place.
One is the lack of coordination in financial regulation that was pervasive before the crisis and
which encouraged financial institutions to engage in a large degree of regulatory arbitrage.
This was the unavoidable result of the fact that while financial players were becoming
increasingly global, and despite the remarkable efforts of the Basel Committee in respect of
the banking sector, financial regulation remained largely national, with only relatively weak
coordination at the international level.
The dramatic under-supply of the global public good of international financial stability is an
area where reform is essential.
Global imbalances
Another shortcoming that needs to be addressed for the future was the insufficient
orientation
of macroeconomic policies towards medium-term stability and sustainability. This
led to the build-up of unsustainable external imbalances between deficit and surplus
economies prior to the crisis.
Although warnings had been voiced, including by the IMF, about the risks of a disorderly
adjustment, there was no effective mechanism to influence macroeconomic and structural
policies in key countries where those policies appeared unsustainable from the standpoint of
global economic and financial stability. This must change - and it requires both the work of
international institutions and the cooperation of national authorities.
3. The evolution of global governance
Let me turn to the question of how global governance is evolving after the crisis.
The scope of international cooperation has been significantly broadened. After an initially
hesitant response, governments implemented broadly coordinated policies, both within the
EU as well as at the global level under the aegis of the G20. And central banks were able to
take quick, decisive and coordinated action at short notice.
But the crisis also showed that gaps in the system of global governance - in terms of both
efficiency and legitimacy - have to be filled. This can be done - indeed, it is being done - by
strengthening the mandate of existing international institutions and adjusting existing or
developing new informal forums.
Overall, the system is moving decisively towards genuine global governance that is much
more inclusive, encompassing key emerging economies as well as industrialised countries.
The significant transformation of global governance that we are engineering today is
illustrated by three examples.
First, the emergence of the G20 as the prime group for global economic governance at the
level of ministers, governors and heads of state or government. Second, the establishment of
the Global Economy Meeting of central bank governors under the auspices of the BIS as the
prime group for the governance of central bank cooperation. And third, the extension of
Financial Stability Board membership to include all the systemic emerging market
economies.
Let me touch on each of these.
The breakthrough of the G20
One distinctive feature of this crisis has been that it erupted at the centre of the system.
Although emerging countries have been severely affected, taken as a group, they have
rapidly become a source of strength for the world economy. It is therefore not surprising that
the crisis has led to a clear recognition of their increased economic importance and to their
full integration into the institutions of global governance, notably with the breakthrough of the
G20.
The G20 has been effective in addressing the global crisis. We are now at the stage where
this forum is making the transition from acting in a crisis resolution mode to contributing to
crisis prevention. This is, in particular, the purposes of the G20 framework for strong,
sustainable and balanced growth. The primary goal of this framework is to collectively
implement coherent and medium-term policy framework to attain a mutually beneficial growth
path.
For this purpose a Mutual Assessment Process (MAP) has been set up that will allow to
assess whether policies of individual members are collectively consistent with sustainable
and balanced growth trajectories. The first steps in this MAP have been presented by the
IMF to the G20 Ministers and Governors last week during our spring Washington meetings.
Guidance has been given to the IMF on the next steps in the process that will lead to policy
recommendations on how to best meet the common goal of strong, sustainable and
balanced growth.
Since this process is fully owned by the G20 members, and given that it involves them not
only at the level of Ministers and Governors but also at the level of Heads of State and
Government, it is confirming the strong commitment at the global level to more multilaterism
in economic decision making.
Further strengthening of central bank cooperation
In the area of central bank cooperation, the main forum is the Global Economy Meeting
(GEM), which gathers at the BIS headquarter in Basel. Over the past few years, this forum
has included 31 governors as permanent members plus a number of other governors
attending on a rotating basis. The GEM, in which all systemic emerging economies' Central
Bank governors are fully participating, has become the prime group for global governance
among central banks.
The GEM has become a very important forum for assessing global economic and financial
conditions, for analysing economic and financial policy issues of common interest to central
banks. I have the privilege of chairing the GEM presently, and must say that I find the candid
exchange of views of our bi-monthly meetings of enormous value.
Strengthening institutions
Among the new and strengthened forums, I would like to highlight the expansion of the
membership in the Financial Stability Board (FSB), whose membership is now largely
overlapping that of the G20. The FSB has received an enhanced mandate to strengthen the
international financial architecture and global financial stability.
Collaborative efforts between the IMF and the FSB in this context are currently underway,
including a joint early warning exercise for the identification of risks to the global economy.
The IMF itself has overhauled its lending framework and introduced new instruments to
assist countries in financial need, a first step in the broader discussion of its future mandate
and internal governance. The meeting of the IMFC, two days ago in Washington, showed a
confirmed determination to move ahead in this field.
The crisis has also pointed to the need to enhance the framework for cooperation in financial
regulation and supervision in Europe. As a result, micro-prudential supervision will be
reinforced with the creation of a European System of Financial Supervisors, including three
new European supervisory authorities in banking, insurance and securities.
Moreover, micro-prudential supervision will be complemented by macro-prudential
supervision, focusing on the prevention of systemic risk. The financial crisis has been
revealing in many respects. It has revealed the scale of the potential fallout from the failure of
large financial institutions. It has revealed the fragility of the financial system to features and
trends that cut across institutions, markets and infrastructures. And it has illustrated the
magnitude of the consequences of adverse feedback loop between the financial system and
the real economy.
All three elements I have just described are key features of systemic risk: first, contagion;
second, the build-up of financial imbalances and unsustainable trends within and across the
various components of the financial system; and third, the close links with the real economy
and the potential for strong feedback effects.
In short, the crisis has revealed the fundamental importance of systemic risk. The purpose of
macro-prudential supervision is to identify sources of systemic risk and recommend remedial
action. In the EU, this will be the task of the European Systemic Risk Board (ESRB). The
members of the ECB's General Council will be voting members of the ESRB, together with
the three heads of the envisaged European supervisory authorities and a member of the
Commission. Moreover, the body will comprise all national supervisory authorities. The ECB,
as an institution of the European Union as a whole, as an institution of the 27 EU Member
States, has been invited to provide support to the ESRB. The Ecofin Council concluded that
the ECB should provide analytical, statistical, administrative and logistical support, in close
cooperation with all the national central banks from the 27 states. The ECB is prepared to
bring to the benefit of the ESRB, with the participation of all the members of the ECB's
General Council, the macroeconomic, financial and monetary expertise of all EU central
banks.
The legislative proposals are currently being reviewed by the European Parliament for a
decision later this year. I am confident that the ESRB can make a very important contribution
for the overall stability and functioning of the EU's financial system.
Conclusions
In conclusion I would like to stress four points.
First, global governance is of the essence to improve decisively the resilience of the global
financial system. We avoided a major depression but it was a close call. Governments had to
support the financial sector by putting at risk taxpayers' money for the equivalent of around
25 % of GDP on both sides of the Atlantic. This as unprecedented. I am convinced that, if we
do not reinforce significantly the resilience of the financial system, our democracies will not
accept for a second time such a very large scale of rescue operation.
Second, a characteristic of the recent turbulences is not only that they displayed a high level
of unpredictability but also an extreme rapidity in the succession of events characterising the
unfolding of the crisis. Global governance today must demonstrate a capacity to coordinate
with agility and, where necessary, to decide extremely swiftly. This is also unprecedented.
Third, the crisis has had some paradoxical effects: on the one hand it has unleashed a
tendency to reengage in financial nationalism if not mercantilism; on the other hand it had
contributed to the recognition that a very high degree of interdependencies between
economies called for a much higher level of cooperation. These two opposing forces are
presently competing. It is imperative that effective global governance preserve the level
playing field which is indispensable to foster global stability and prosperity. It is a major
challenge. Both sides of the Atlantic have a very important responsibility in this respect in
many domains, in particular in prudential and accounting rules.
And fourth, as we have seen the crisis has driven an historic change in the framework of
global governance. In my view this transformation was overdue. But there are two immediate
reasons for this change. One is positive: the emerging economies are now economically and
financially so important and systemically so influential that they must have a full and proper
ownership of global governance. But the second reason is negative: the industrialised
countries have proven particularly clumsy in their handling of global finance before the crisis
at the time when their responsibility in global governance was obviously overwhelming.
There was therefore no reason to confirm their exclusive prime responsibility. This calls for
the industrialised countries to be now particularly irreproachable in the delivery of their
present and future contribution to the stability and prosperity of the global economy within the
new, more inclusive framework.
Thank you for your attention.