Mario Draghi: Building the bridge to a stable European economy
Speech by Mr Mario Draghi, President of the European Central Bank, at the annual event
"Day of the German Industries", organised by the Federation of German Industries, Berlin,
25 September 2012.
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Ladies and gentlemen,
Bundesverband der Deutschen Industrie
It is a privilege to be invited to address the this
afternoon.
The BDI in many ways mirrors the strengths of the German economy. It simultaneously
represents global multinationals and family-owned small businesses. It is this combination of
small, medium and large firms that gives German industry its uniqueness and resilience. And
this has been rewarded in recent years through strong growth and high employment.
The euro area as a whole has been facing challenging times. Financial markets are
fragmented. Economic growth has been broadly flat for the first half of 2012. Growth also
remains highly uneven, with some parts of the euro area economy expanding at a solid pace,
while others are still in a phase of adjustment.
But my central message to you today is that, provided that all policy-makers persevere with
the necessary reforms, we have a number of reasons to be positive about where the euro
area is heading. We are seeing signs of improved sentiment in financial markets and we
expect the economy to return to growth next year. At the same time, considerable progress is
being made on all fronts to strengthen the foundations of the euro area.
Above all, the Member States of the euro area are undertaking determined measures to
address the root causes of our current challenges. Individually, governments are
implementing the fiscal and structural reforms essential for growth. Collectively, they are
reforming the governance of the euro area so as to guarantee sound policies for the future.
We at the European Central Bank (ECB) are continuing to maintain price stability, which is
the foundation of growth and job creation. We have introduced new measures to ensure
price stability by removing unfounded fears about the euro area. These measures are
supporting financial market sentiment while deeper reforms are implemented across the euro
area.
However, our measures can only build a bridge towards a more stable future. It must be
completed with decisive measures by governments to address fundamental challenges and
complete the euro area's institutional architecture. They are currently making progress in this
direction. The key challenge going forward is to ensure that the immediate upturn
strengthens rather than weakens this commitment.
Actions by the Member States to strengthen the euro area's foundations
Let me begin with the actions being taken by the Member States to strengthen the euro
area's foundations.
Across the euro area, strong budgetary consolidation is taking place. The International
Monetary Fund (IMF) forecasts that the euro area's primary budgetary position will be almost
in balance this year. This means that, apart from debt service, all other expenditures are
covered by current revenues.
This is quite an achievement in an international context: Japan, for example, will have a
9% of GDP primary deficit this year, the U.S. 6% and U.K. more than 5%. And the euro area
is not only performing well on average: each individual country will have a primary budget
deficit lower than these three countries. It is those countries most in need that are making the
largest adjustments.
Important improvements are also taking place in competitiveness. For example, the countries
under full EU-IMF programmes have seen unit labour costs improve by around 10% since
2008, relative to the euro area average. This has translated into current account deficits that
are on average more than five percentage points of GDP lower than they were then. And this
is not only due to lower imports, but also rising exports induced by higher competitiveness.
At the same time, the Member States are taking significant steps to improve euro area
governance. Governance of fiscal policies has been decisively strengthened with the fiscal
compact. This agreement is a powerful tool for keeping fiscal policies in balance and
reducing debt to sustainable levels.
Governance of financial policies is also now being given proper attention. The European
Commission has recently proposed a single supervisor for euro area banks. Single
supervision is particularly important in a single currency area where countries are more
immediately affected by instability originating from other member countries. Such single
supervision should ultimately lead to a more stable financial system.
Taken together, these actions show that clear progress is being made towards addressing
the fundamental causes of our current challenges. Deficits are being reduced. Rebalancing is
happening. And governance is being reformed.
Actions by the ECB to ensure price stability
Let me turn to the ECB's recent actions. We have played a role in improving overall
confidence by removing unfounded fears about the euro area that were affecting our ability to
ensure price stability - notably through our recent announcement of Outright Monetary
Transactions, or OMTs. Let me briefly explain the rationale for this decision.
The euro area has experienced a very severe fragmentation in its financial markets. In recent
months, we have seen highly divergent borrowing costs for the real economy in different
parts of the euro area. In our analysis, these differences were larger than justified by
individual credit risk. They reflected, to a considerable extent, unfounded fears about the
future of the euro area.
For example, a loan to a family in Germany for a house purchase with a five- to-ten-year
maturity had an interest rate of 3%; the rate for a comparable borrower in Spain was 7.5%.
At the same time, the average firm in Germany paid around 3% for a new loan over five
years, while the average firm in Italy paid above 5.5%.
In these circumstances, monetary policy cannot work properly. This is because a key
channel through which the ECB ensures price stability is through the cost of credit, in
particular bank credit. Bank credit accounts for about 70% of external financing of euro area
firms, and that ratio is even higher for smaller enterprises.
But if we are unable to influence borrowing costs in some parts of the euro area, this channel
is disrupted. Firms and households have less access to financing, economic growth stalls
and these regions are faced with a risk of deflation. In other words, our ability to ensure price
stability for the whole euro area is compromised.
The ECB's Governing Council therefore faced a choice: to accept this situation and allow the
singleness of its monetary policy to be undermined; or to take actions within its mandate to
restore the normal transmission of monetary policy across all parts of the euro area. We
decided in favour of the latter.
Our actions aim to repair monetary policy transmission through providing a credible backstop
in government bond markets that removes unfounded fears and tail risks from the euro area.
Insofar as this supports investor confidence, it will help stabilise conditions in other markets,
such as those for corporate and bank bonds. This ultimately feeds into more even borrowing
costs for the real economy across the euro area.
Early signs suggest a positive effect. Since the beginning of this month, euro area banks
issued about 27 billion euros of new debt - the most since March of this year. Some of these
banks had not been able to access the market for almost six months previously.
Non-financial corporations have also issued around 43 billion euros of new bonds, the
highest figure for five of the last six months.
It is too early to tell the full impact of our measures on borrowing conditions for firms and
households. It will take time for the effects of our actions to feed through systematically.
But the fact that we have seen positive signs so quickly is revealing. It shows that investors
are fundamentally confident in the overall trajectory of the euro area. They are ready to
re-invest at the first signs of stabilisation. This underscores my central message today: the
euro area is making progress - and investors are recognising that progress.
The benefits of stability for the euro area as a whole
I have described how the measures taken by both the Member States and the ECB are
beginning to improve confidence. This will ultimately lead to greater overall stability. The
benefits of this do not accrue only to countries in difficulty. They accrue to the euro area as a
whole.
This is particularly true for an open and outward-looking country like Germany. German
industry is a sector deeply embedded in the wider European economy. The stability of the
euro area is key to its sustained prosperity. For this reason, ECB actions to maintain price
stability for the whole euro area are directly in its interests.
As has long been recognised in this country, low inflation and stable exchange rates ensure
a level playing field on which German firms can prosper. They can compete based on their
sophistication and innovativeness, without unfair distortions. At the same time, being part of
a large and stable currency area provides a buffer against external shocks. This will only
become more essential in an ever globalising world.
These factors have led to real economic benefits for Germany. Its intra-euro area trade
increased from around 25% of GDP in 1999 to almost 40% of GDP in 2010, while its
extra-euro area trade increase by more than 20 percentage points in the same period.
Almost 65% of foreign direct investment in Germany now comes from the euro area - and
more than one and a half million jobs depend on that investment.
In other words, a stable euro area supports a strong German economy. And a stable euro
area is the objective of the all the measures that I have just described.
Moreover, measures that support investor confidence also support the proper functioning of
the financial system. For instance, TARGET2 data suggests that balances have now fallen
slightly from their peak in August. This highlights the fact that if investors are confident that
adverse scenarios will not materialise, they will be more prepared to make cross-border
loans. This supports demand across the euro area and the smooth functioning of the Single
Market.
I understand that some observers in this country have concerns about the medium-term
implications of this policy. So let me be clear: we always have a medium-term orientation.
We are steadfastly committed to our mandate to maintain price stability. And the measures
we have announced fully support this commitment.
First of all, our actions are for the sole purpose of ensuring the proper transmission of
monetary policy. They do not aim to finance governments, and nor would they if they were
activated. Our operations would only take place in the secondary market, which ensures that
money would pass to investors holding sovereign bonds, not to governments.
Moreover, we have been explicit that our measures can be only successful if they are
accompanied by reforms from governments that address deep-rooted issues. The Governing
Council has made a strong commitment to such reforms a pre-requisite to be considered for
our operations. This ensures that governments will continue to take essential measures.
Euro area citizens can be certain that we remain alert to any risk to price stability. We have
always delivered price stability in the past - indeed, the average rate of inflation in Germany
since the launch of the euro has been the lowest since the 1950s. And we will continue to
deliver price stability in the future.
The credibility of our commitment is clear. Indicators of inflation expectations show that
citizens and financial markets expect inflation to remain low in line with our mandate. We
take very seriously the trust that citizens put in us to meet their expectations. We will not let
them down.
Building a bridge to the long term
I have discussed the actions that the ECB has taken to ensure price stability and the positive
early impact they are having. Of course the current improvement in sentiment does not mean
that everything is solved. The ECB's actions can only build a bridge to the future. The project
must be completed through decisive actions by governments - both individually and
collectively - to address the underlying causes of our current challenges.
This requires further efforts by governments to restore fiscal sustainability across the euro
area. It requires deep structural reforms to achieve long-term competitiveness and growth.
Governments must remain firmly committed to their current reform efforts, and not seek to
relax them as economic conditions start to improve.
To secure long-term stability also requires a second level of actions. For citizens and
investors to fully regain confidence in the euro area, they need to be convinced that its
design flaws have been permanently fixed. A concerted effort from governments to complete
our economic and monetary union is therefore essential.
This does not require a choice between extreme options. Some observers have argued that
long-term stability requires a return to the original Maastricht framework. Others have
suggested that we need a full federation, a United States of Europe. In my view, neither
approach is necessary.
We can ensure future stability by elevating to the European level only those policies that are
essential for our union to function effectively. I have been asked to work on identifying these
policies under the lead of the President of the European Council and together with the
Presidents of the Commission and the Eurogroup. In our view, a stable and prosperous
union must be built on four pillars.
The first pillar is a financial union that can maintain a stable and integrated financial market.
This implies a single supervisor to control risk-taking by banks and reduce regulatory capture
- and a single resolution system to ensure that banks can fail without dragging down their
sovereigns.
As regards the Commission proposal for a single supervisor that I mentioned earlier, I am
confident that governments will find agreement on the appropriate perimeter of supervisory
responsibilities, as well as issues related to democratic accountability. For our part, we will
guarantee the firm separation of monetary policy from supervisory tasks. We will also ensure
close cooperation with national supervisors who have the competence and resources to
implement supervision.
fiscal union
The second pillar is a that can effectively prevent and correct unsustainable
budgets. The consequences of misguided fiscal policies in a monetary union are too severe
to remain self-policed. So a stable EMU would ultimately require the establishment of true
budgetary oversight at the European level.
The third pillar is an economic union that can guarantee the highest standards for
competitiveness. Countries must be able to generate growth and high employment without
excessive imbalances. This implies that there must be minimum standards for key economic
policies and incentives for continued structural reform.
The fourth pillar is a political union that can engage euro area citizens more deeply and make
the other pillars legitimate. This is essential to ensure that where sovereignty in selected
policy fields is pooled, democratic participation is deepened in parallel.
A firm commitment from governments to complete economic and monetary union is the best
complement to the ECB's actions.
It ensures that, by supporting immediate confidence, we will build the bridge to a more stable
and prosperous euro area. And it sends a clear signal to investors that the euro area has a
vision for a sustainable future.
Conclusion
Let me draw to a close.
In exceptional times, regaining stability sometimes requires exceptional measures. We
cannot always look to the past for answers. We may need to take new steps to achieve
longstanding goals.
That is the situation we have been facing.
For the Member States, new steps have been needed to restore competitiveness. A
sustained commitment to reform efforts is required and a rethinking of the institutional
architecture of the euro area.
For the ECB, new steps have been needed to maintain price stability in the face of
fragmented financial markets. These new steps are not a departure from our mandate.
Indeed, they are the only way to ensure that we continue to fulfil our mandate.
All the measures I have described today are fundamentally about ensuring stability. In the
current circumstances, the greatest risk to stability is not action, but inaction. This is why the
ECB has acted.
The euro supports the strong industrial sector on which Germany depends. It supports
openness, growth and prosperity. And ultimately, it supports peace and stability.
This is why the euro is irreversible.
Thank you for your attention.