Christian Noyer: Challenging times for finance and banking in Europe
Keynote address by Mr Christian Noyer, Governor of the Bank of France and Chairman of
the Board of Directors of the Bank for International Settlements, at the Paris Europlace
International Financial Forum, Paris, 8 July 2014.
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Ladies and gentlemen, dear Arnaud,
I am pleased to be able to give this keynote address today for our Paris Europlace
International Financial Forum, before the round tables begin. These are challenging times for
economic policy-makers, central bankers and professionals working in the field of finance
and banking in Europe
I will address three questions: is the euro crisis over? Does Europe face the prospect of a
lost decade? What short-term policy challenges are we facing today? And I will finally say a
few words about recent changes in our communication strategy.
I. Is the euro crisis over?
Less than two years ago, the euro area was fighting for its existence. Euro pessimists were
questioning its ability to survive. Not anymore. Analysts may be questioning Europe's ability
to grow. But the challenges that we are facing are different. They are macroeconomic, not
existential or systemic.
Thanks, mainly, to the Eurosystem's actions, financial conditions are normalising. Spreads in
peripheral countries have been dramatically reduced. Soon, budgets will be reasonably
balanced and there will be no more fiscal drag on the economy. Households and corporates
have strong balance sheets. Recent forecasts put German growth at more than 2%, Italy in
positive territory, and the outlook for France has improved markedly. Growth of business
activity in the euro area in April was the highest in the past three years.
But the crisis has left an important legacy:
 Money and financial markets remain excessively segmented. The monetary
transmission mechanism is severely impaired and credit conditions are still very
different across countries and sectors.
 Deleveraging in the banking sector still acts as an impediment to recovery and
growth. Bank credit remains flat in the euro area as a whole, and SMEs' financing is
a major concern, especially in stressed countries, where the percentage of
financially constrained but viable borrowers is estimated at 25% vs 1% in "core"
countries.
We are very aware that balance sheet repair is a prerequisite for credit to resume and for
monetary policy to be efficient. So, we are addressing the problem as a priority.
1. We are building a safer and more robust system of financial intermediation. A major
step has been the creation of a banking union that, as you all know, will delink bank
and sovereign risks and ensure a harmonised and tough financial supervision. It is
easy to underestimate this achievement. The idea was adopted less than two years
ago. The Single Supervisory Mechanism is now up and running. There is no
example in contemporary European history when so much has been achieved in so
little time.
2. We have launched a tough and comprehensive AQR and subsequent stress tests
that should be completed by the end of this year. For the first time, these exercises
will be conducted in a fully integrated way - under the aegis of the SSM -with full
accountability of the results. Completion should mark a turning point where there will
be no more doubts about the sustainability of our banks and credit should resume at
a normal pace.
3. In the longer run, a major policy challenge for the euro area is to "reinvent" a new
and robust financial integration model. We need sound cross-border capital flows,
because we do not want the Eurosystem to intermediate permanently between
borrowers and lenders from different countries. Developing a safe securitisation
process should be a priority, despite the major technical difficulties.
II. Is Europe facing the prospect of a lost decade?
Questions about long-term growth are not limited to Europe. What we hear about our
continent reflects a more general concern: the possibility of "secular stagnation" in advanced
economies.
Secular stagnation rests on the assumption that the natural interest rate is negative. This
may happen for two reasons:
 In the short run, we may have a downward shock on demand and an increase in
savings resulting from the deleveraging process. I have just explained how we are
currently addressing this issue ;
 In the longer run, ageing and slower innovation may push up saving rates and bring
down the return on capital. Therefore, the ultimate response to the risk of secular
stagnation is to improve the return on investment, thus pushing the natural interest
rate back into positive territory. Again, this is not only a European problem. But we
do have difficulties in this regard. Structural reforms are not easy.
Many, however, are currently being implemented. France, although at too slow a pace, is
reducing taxes on labour and has somewhat improved labour market flexibility.
Adjustments efforts conducted by several countries, especially in Southern Europe, are
starting to pay off. Competitiveness gaps between Northern and Southern Member States
have been reduced, notably through real wages decreases in countries like Spain or
Portugal, which are exporting more and more. This builds the way for a healthy growth in
peripheral countries, which are experiencing a trade surplus of 2% of their GDP on average,
and a moderate public deficit, taken down to 3%.
III. Short-term policy challenges and responses
The main challenge, of course, is low and declining inflation, with inflation expectations in the
euro area drifting downward at short to medium-term horizons. This prevents adjustments in
relative prices, - an important mechanism to eliminate gaps in competitiveness - and
increases the risk of outright deflation, should a negative shock occur in the future.
Strangely, in the euro area, growth and inflation are moving in opposite directions. As growth
accelerates, inflation keeps going down. This "disconnect" in the Philips curve is puzzling.
We must look, then, at the broader picture. Euro area economies have attracted strong
capital inflows over the recent months, with two opposite effects on financial conditions: first,
easing through lower long-term interest rates. And, second, an appreciation of the euro
exchange rate.
It's not clear whether the overall effect is positive. While nominal conditions are more
accommodating in euro area than in the US, real indicators point to a more restrictive stance.
We may see a perverse feedback loop develop, with low inflation, increasing real rates,
capital inflows and exchange rate appreciation mutually fuelling each other. The financial
economy may be heading towards a bad equilibrium that would threaten the real economic
recovery.
The situation called for an appropriate policy response and, as you know, the Governing
Council has agreed last month on a strong package of four significant measures.
First the refinancing and deposit rates have both been reduced - bringing the deposit rate
into negative territory for the first time. Second, the ordinary regime of unlimited liquidity
provision has been extended to the end of 2016. Third, the Eurosystem will conduct a new
set of targeted longer-term refinancing operations. This exceptional liquidity will be provided
at long maturity (up to four years) and a guaranteed fixed rate, a clear sign that monetary
accommodation should persist for a very long time. Finally, the Eurosystem is actively
preparing to buy asset based securities that will help channel monetary accommodation and
ease financial conditions to private non financial borrowers, especially SMEs.
IV. New communication strategy
As you know, two important decisions were made at the last Governing Council: the
frequency of monetary policy meetings will change to a six-week cycle; and starting in
January 2015, the ECB intends to publish accounts of its monetary policy discussions.
Why these decisions and why now? The starting point is that monetary policy is becoming
more complex. This is true for all major central banks. Monetary policy does not only consist
anymore in moving interest rates, but also comprises many other non-conventional
measures. This makes it more difficult for markets and economic agents to understand the
economic rationale behind these complicated sets of decisions. Still it remains crucial for
central banks to be able to influence expectations. Indeed, one form of non conventional
policy, namely, forward guidance, depends entirely on managing expectations about future
interest rates.
There are, therefore, important challenges in implementing monetary policy in the post-crisis
environment. The response is to place more emphasis on enhanced communication.
As you know, the Eurosystem has always put a priority on transparency. We were the first to
systematically organise press conferences after our policy meetings. However, we need to
go further and ensure that markets understand the reasoning behind the Governing Council's
decisions. To that purpose, we should give a sense of the discussion and the main
arguments. In the jargon, the aim is to clarify the Central bank's "reaction function" and allow
financial markets and the public to form reasonable expectations about the future policy. This
in turn gives us the capacity to influence interest rates at longer maturities and steer broader
financial and economic conditions.
It is too early to tell exactly how those "accounts" will take shape. The Governing Council and
the Executive Board of the ECB will be testing different possibilities. Many issues have to be
considered. We need to preserve the collegiality of the Governing Council's deliberations,
and the ability of each and every member to freely express and exchange views, in order to
let them be influenced by the course of discussions. This is essential for the effectiveness of
our collegiate decision-making. Like any committee, the Governing Council benefits from the
diversity of views and perspectives that are brought to the table. As you all know, members
sit and express their views in a personal capacity; they must consider the situation of the
euro area as a whole and are forbidden by the Treaty to take any instruction from any
Government. We need to take proper account of the specific institutional setting of the euro
area and the unique communication challenges in a multi-country monetary union.
Once the decision is taken to publish accounts, it is natural to change the frequency of
monetary policy meetings to six-week. This will give space for producing the accounts and
yet not create confusion with regards to following meeting and any action that might be
taken.
Conclusion
While many uncertainties remain, actions taken during the last two months show that the
Eurosystem is flexible, responsive, and, as we have said many times, ready to take any
actions that may prove necessary should downside risks further materialise.