Mario Draghi: Strengthening the foundations of the euro area and
maintaining price stability
Speech by Mr Mario Draghi, President of the European Central Bank, at the Wirtschaftstag
2012 "Kapitalismus in der Krise? Die Zukunft der Marktwirtschaft" der Volksbanken
Raiffeisenbanken, organised by Genossenschaftsverband e.V., Frankfurt am Main,
7 November 2012.
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Sehr geehrte Damen und Herren,
Es ist mir eine große Freude, heute hier bei Ihnen zu sein.
I am very pleased to have the opportunity to speak to you today. Small- and medium-sized
enterprises - and the banks that finance them - are the backbone of the German economy.
Your continued success is vitally important - not only for Germany, but also as a key driver
of growth and employment in the euro area as a whole.
For this reason, you are a very important constituency for the European Central Bank (ECB).
We pay close attention to your experiences and your views of the future. For example,
through surveys that we conduct twice a year, we are able to gather valuable information on
the access to finance of smaller companies in the euro area.
The most recent survey was released only last Friday and relates to the period from April to
September 2012. It contains information from about 7,000 small and medium-size firms
throughout the euro area, of which around 1,000 are from Germany.
The findings are encouraging for firms in Germany. Banks remain willing to provide them with
loans. But the situation for SMEs in the euro area overall is more difficult. Many are reporting
a deteriorating financing situation. The availability of bank loans for SMEs across countries
has become increasingly divergent.
These developments reflect the fact that the economic and financial situation in the euro area
remains challenging. I would like to use my address today to discuss that situation and to
share with you the ECB's views. I will focus on two themes in particular.
My first theme will be the important steps being taken by governments to put the euro area
on the path back to stability. Individually, they are addressing their deep-rooted economic
challenges. Collectively, they are working to strengthen the foundations of the euro area.
My second theme will be the measures taken by the ECB to maintain price stability and to
remove unfounded fears about the euro area. These measures are essential to ensure that
our low interest rates are passed through to the real economy.
The current economic situation
Let me begin with the current situation in the euro area.
Unemployment is deplorably high. Overall economic activity is weak and it is expected to
remain weak in the near term. And the growth of money and credit are subdued.
In this context, inflation is well contained. We expect it to fall below 2% next year.
Germany has so far been largely insulated from some of the difficulties elsewhere in the euro
area. But the latest data suggest that these developments are now starting to affect the
German economy. This is also evident in the KfW-ifo-Mittelstandsbarometer.
Germany is an open and integrated economy, so it is not surprising that a slowdown in the
rest of the euro area has an impact here. Intra-euro area trade amounts to around 40% of
German GDP. And around 65% of foreign direct investment in Germany comes from other
euro area countries.
But it is less often noted how problems in the wider euro area affect the financial situation
in Germany. It is the weak euro area economy that is keeping interest rates here at very low
levels. And it is the crisis of confidence in some euro area countries that is causing
safehaven flows of money into Germany, depressing interest rates even further.
This highlights the fact that countries in a single currency area are connected like
communicating vessels. A change in one vessel creates an equal change in all the others.
As interest rates rise in countries in difficulty, they fall in strong countries like Germany. As
TARGET2 liabilities increase in some countries due to capital outflows, TARGET2 claims
increase in Germany due to capital inflows.
Financial developments in Germany are the mirror-image of financial developments in the
rest of the euro area. And this means that measures to ensure the stability of the euro area
as a whole will also be to the benefit of Germany.
So let me now turn to the actions being taken by governments to achieve that goal of
stability.
Actions by governments to restore stability
Across the whole euro area, governments are making determined efforts to reverse
economic imbalances. They are implementing reforms to redress the misguided policies of
the past and to create sustainable long-term growth. It is a difficult road and there is still a
long way to go. But the early signs are encouraging.
Fiscal consolidation is progressing well in most countries. The International Monetary Fund
(IMF) forecasts that the euro area's primary budget will be almost in balance this year. By
comparison, Japan will have a primary deficit of 9% of GDP, the United States 6.5% and the
UK more than 5%.
We are also seeing some noteworthy improvements in competitiveness. Price
competitiveness has improved significantly in several euro area countries. And current
account deficits are falling.
For example, the countries under full EU-IMF programmes have seen their unit labour costs
improve by more than 10% since 2008, relative to the euro area average. Their current
accounts have improved by around 8% of GDP since then.
Governments have also taken measures to strengthen the rules and institutions that guide
economic policies in the euro area. This is important to ensure that the positive
developments do not simply reverse when economic conditions improve and markets
stabilise.
One notable example is the new fiscal compact, which will provide a strong tool for keeping
budgets close to balance in the future. Governments have also set up a new framework to
prevent and correct unsustainable developments in the private sector.
In short, some hard work has been done in the euro area to unwind imbalances and to
reinforce governance. But there is still a lot more hard work to do. Maintaining the current
momentum of reform is essential for putting the euro area on the path back to stability.
Fragmentation in monetary policy transmission
Let me now turn to the measures being taken by the ECB.
The confidence crisis and the process of adjustment across the euro area has weighed on
short-term growth and dampened inflationary pressures. To maintain price stability, the ECB
has lowered its interest rates to historically low levels.
But before August this year, our low interest rates were not reaching companies and
households evenly across the euro area. In some countries, interest rate reductions were
being fully passed on. In others, lending rates barely declined. And in a few countries, they
had actually risen.
This divergence happened because banks in some countries had found it increasingly
expensive to obtain funding from market sources. They therefore could not pass on the lower
interest rates to their customers.
This meant that monetary policy was unable to support the real economy in these countries.
Smaller companies were affected the most, as was clear from our surveys of SMEs. And as
companies in the euro area are very dependent on bank loans for financing, some
economies were being forced into a damaging cycle.
Economic activity was weakening. Public finances were deteriorating. Banks and
governments were being forced to pay even higher interest rates. And credit and economic
growth were then falling further, leading to rising unemployment and reduced consumption
and investment.
This situation posed serious risks not only for the countries concerned, but for the whole euro
area. It was hindering the overall economic recovery. It was even damaging the single
market, as healthy companies were being curtailed in financing solely because of their
location.
If this situation had been left unaddressed, it could have created a risk of deflation and
threatened the ECB's ability to ensure price stability. That is why we decided that action was
essential.
Understanding the ECB's response
How did the ECB respond to this situation?
In our analysis, a key reason why our low interest rates were not being passed on was that,
earlier this year, some investors had become influenced by imagined scenarios of disaster.
They were therefore charging very high interest rates to governments and private borrowers
in countries they perceived to be most vulnerable.
These interest rates went beyond levels warranted by economic fundamentals and justifiable
risk premia. Interest rates do not have to be identical across the euro area. But it is
unacceptable if the reason for large differences is the fragmentation of capital markets
caused by fears of a euro area break-up.
It was clear to us that governments could not address these break-up fears alone. The only
way to restore market confidence and the proper transmission of our monetary policy was a
fully credible backstop against disaster scenarios.
Our new programme of Outright Monetary Transactions provides this backstop by allowing
for unlimited interventions in government bond markets. This commitment has generated a
lot of debate. But we have to understand how markets work. Our actions have to send a
clear signal to markets that their fears about the euro area are baseless.
It is important to stress that "unlimited" does not mean uncontrolled. Most importantly, to
qualify for interventions, countries must have agreed a European Stability Mechanism (ESM)
programme with strict conditionality and IMF involvement. The ECB will only intervene if the
policy conditions under that programme continue to be met.
Conditionality is very important. It ensures that countries continue to reform while the ECB is
active. It provides a clear basis for us to terminate our operations if the programme is not
complied with in full. And it also protects the ECB's independence, as we will not be forced to
substitute for a lack of actions by governments.
Consequences of the ECB's actions
So what can citizens expect will be the consequences of the new programme? Let me
emphasise three key points.
First, our actions will not lead to disguised financing of governments.
Interventions will take place solely on the secondary market, where bonds already issued are
traded. This is fully consistent with the Treaty's prohibition on monetary financing. And since
we will only purchase bonds with a remaining maturity of between one and three years, there
will still be ample room for market discipline on governments at longer maturities.
Second, our actions will not lead to inflation.
The weak overall economic situation, combined with slow money growth, means that the
risks of inflation are currently very low over the medium term. Our interventions will not
change this outlook. In fact, for every euro we inject with our interventions, we will withdraw a
euro. So they will not affect monetary conditions.
Furthermore, we see no signs that our announcement has affected inflation expectations.
They are firmly anchored because we have always delivered price stability. And citizens can
trust that we will continue to do so: price stability remains our mandate and our sole
objective.
Third, our actions will not lead to greater risks for taxpayers in Germany.
Taxpayers are protected by the fact that our interventions will take place only in countries
with sound economic and fiscal policies. Their continued commitment to these policies will be
ensured by the ESM programme. And the ECB will assess compliance with this programme
in full independence.
Moreover, by normalising conditions in financial markets, our actions will help reverse the
capital flows into Germany that are creating some distortions here. This should ultimately
support the savers, pension funds and insurance companies that depend on interest income.
And it should reduce TARGET2 imbalances.
In other words, ECB actions that support market confidence are of benefit not only to
countries in difficulty, but also to the euro area as a whole. Our measures ensure the proper
transmission of monetary policy, which means neither excessively high interest rates nor
excessively low interest rates. The measures enable the ECB to continue to maintain price
stability for the benefit of all citizens of the euro area.
The announcement on OMTs has already triggered positive effects. Sentiment in financial
markets has improved significantly. Excessive government bond spreads have gone down, a
number of banks in stressed countries have been able to regain access to markets and
Target2 balances have broadly stabilised.
The way forward
Let me draw to a close.
Actions by the ECB can build confidence in the euro area in the near term. But only actions
by governments can secure confidence in the euro area over the longer term. In particular,
governments need to work together to establish a stronger institutional structure for the euro
area.
This process began in June this year with what has been called the "Four Presidents'
Report". That report - of which I am a co-author - identified four key pillars on which a stable
and prosperous monetary union should be built. These pillars are financial union, fiscal
union, economic union and political union.
In the near term, the most important pillar is financial union. Financial union is essential in a
single currency area where cross-border capital flows can lead to credit booms and other
imbalances - and where the negative effects of a bust can spread rapidly to other members.
One essential part of financial union is a single banking supervisor. As you know, the
European Commission has recently proposed that the new supervisor should be based at
the ECB. This is important to ensure consistency across the euro area and to prevent
regulatory capture. Day-to-day tasks, however, would remain with national supervisors who
have the competence and resources to implement them.
But financial union does not have to imply the pooling of deposit guarantee schemes, an
issue that I know is of concern in this country. Organising and funding deposit guarantee
schemes can remain a national responsibility, with comparable effectiveness.
In the longer term, all four pillars are equally important. They are the bedrock for the
enormous potential of the single currency for Europe's citizens.
Completing economic and monetary union would give citizens greater security against any
future crisis. It would create the foundations for sustainable growth and employment. For all
citizens of the euro area, it is therefore essential that Europe's leaders stay on course.
Thank you for your attention.