George Provopoulos: Key challenges for South East Europe inlight of
the crisis
Opening address by Mr George Provopoulos, Governor of the Bank of Greece, at the
Conference of Bank of Greece & Oxford University: "Challenges and Prospects of South
East European Economies in the Wake of the Financial Crisis", Athens, 16 October 2009.
* * *
I am very pleased to welcome you to the Bank of Greece for this conference, co-sponsored
by the Bank of Greece and the University of Oxford through the latter's program on South
East European Studies. The focus of this conference is the policy responses to the most
severe economic and financial crisis that the world has faced since the Great Depression
and the key challenges that lie ahead for South East Europe in light of the crisis.
This morning, I would like to share with you some thoughts about policy responses to the
crisis. I will also provide some observations on the challenges that lie ahead. I will have more
to say about the major challenges facing the economies of South East Europe during this
afternoon's panel discussion. My remarks about policy will deal with three broad issues: first,
the response of the Governing Council of the European Central Bank to the crisis; second,
the pace at which the extraordinary monetary and fiscal stimuli now being provided should be
withdrawn; and, third, the need to develop a macro-prudential approach to financial
regulation.
Monetary policy
Exceptional times call for exceptional measures. The policy response of the ECB to the crisis
has been rapid, bold and frequently unconventional.
With the intensification and broadening of the crisis, beginning in October 2008 the ECB
Governing Council reduced its key policy rate from 4.25 per cent to 1.00 per cent in a period
of only seven months. This was an extraordinary response for a central bank that had, until
that time, moved at a measured pace in changing rates, abiding by the principle that a
certain degree of persistence in policy-rate changes increases the effectiveness of rate
adjustments.1
Interest-rate reductions may not be very effective, however, during times of extreme stress
when conventional channels of monetary-policy transmission are blocked or impaired. In the
aftermath of the collapse of Lehman Brothers, financial markets froze and credit
intermediation collapsed. Uncertainty pervaded the markets, counterparties were viewed with
suspicion, and the flow of credit all-but halted. In these circumstances, the ECB undertook a
number of non-standard measures to enhance the flow of credit and support the functioning
of the money market. Our approach consists of five broad elements.
• First, the full accommodation of banks' liquidity needs at a fixed rate.
•
Second, the expansion of the list of assets used as collateral.
•
Third, the lengthening of the maturities of long-term refinancing operations.
•
Fourth, the provision of liquidity in foreign currencies.
•
Fifth, purchases of covered bonds in order to stimulate a market that has been
traditionally an important source of funding for banks.
In addition to this exceptional support to domestic financial markets, the ECB has also
provided assistance to non-euro-area financial markets. For, example, we have entered into
either swap or repo arrangements with Denmark, Sweden, Hungary, and Poland. Moreover,
E.U. countries have strongly supported recent measures to increase IMF resources through,
among other vehicles, bilateral loans to the Fund, an SDR allocation, IMF gold sales, and a
quota increase. In turn, the Fund has responded to the crisis with a record lending
commitment, which includes programs to Belarus, Bosnia-Herzegovina, Hungary, Iceland,
Latvia, Poland, Romania, Serbia, and the Ukraine.
In addition to the foregoing actions by the ECB, euro-area governments launched major
fiscal-stimulus programs while supporting banks with guarantees and capital injections.
Together, these measures reduced uncertainty and increased confidence, contributing to an
improvement in economic and financial conditions.
Exit strategy
With the recovery in the euro area in its initial stages, and with economic activity still far
below pre-crisis levels, it is too soon to begin a withdrawal of the stimulus measures.
Nevertheless, the development of a medium-term macroeconomic framework for the
postcrisis period will be crucial. It will help facilitate the achievement and maintenance of a sound
fiscal position and the ability of the monetary authorities to deliver price stability. It will also
help foster financial stability. The challenge will be to choose the correct timing of the
withdrawal so as to avoid: first, a premature unwinding of public interventions; second,
jeopardizing the achievements in stabilizing economic and financial conditions; third, letting
these measures continue for too long, with risks of distorting incentives and damaging public
balance sheets. Among the factors that will shape the ECB's approach to exiting the
nonstandard measures are the following:
•
First, we will act with the aim of securing price stability in the medium-term. By
implication, any non-standard measure that may pose a threat to price stability will
be promptly withdrawn. If no such risk exists, a measure can be maintained in case
of significant financial-market tensions.
•
Second, we have built a degree of phasing out into the exit process through the
design of our measures. In the absence of new policy decisions, several of these
measures will unwind naturally, for example, through pre-determined termination
dates.
• Third, the ECB's operational framework comprises a broad set of instruments so
that the exit strategy can be formulated in a flexible way. For example, the
interestrate corridor allows short-term interest rates to be changed while keeping some
nonstandard measures in place should the need arise. Therefore, the Governing
Council can choose the way in which interest-rate action is combined with the
unwinding of the non-standard measures.
Let me turn to the issue of the exit from expansionary fiscal policies. In my view, an important
medium-term risk to sustained recovery revolves around deteriorating fiscal positions. The
large increases in fiscal deficits and public debt incurred to provide stimulus to the economy
have already raised concerns in financial markets, as suggested by the widening sovereign
spreads relative to pre-crisis levels, for economies with large fiscal burdens. If the recovery
were to stall, followed by a prolonged period of very-low growth, deficits and debt could swell
to difficult-to-sustain levels. Governments will, therefore, need to start addressing mounting
long-run fiscal challenges by committing to large reductions in deficits once the recovery is
on a solid footing and advancing reforms that will put public finances on a more sustainable
path. I need to add that Greece is among the euro-area countries for which the challenge of
medium-term fiscal viability is especially urgent.
Financial sector regulation
The best way to manage a crisis is to prevent it happening. At the root of the market failure
that led to the crisis was optimism bred by a long period of high growth, low real interest
rates, and policy failures. One such failure was that financial regulation was not equipped to
address the risk concentrations and distorted incentives underlying the financial innovations.
This circumstance raises another medium-run challenge. The present crisis has revealed
that macro-prudential factors play an important role in determining the size, nature, and
propagation of systemic risk. Therefore, it is essential to establish an effective framework for
macro-prudential supervision that will ensure a systematic analysis of risks, as well as the
formulation of policies to address such risks.
Let me say a few words about the framework for macro-prudential supervision envisaged for
the E.U. Following the publication of the Report of the de Larosiére Group in February 2009,
the Commission issued a package of draft legislation in late September with the aim of
creating a European Systemic Risk Board - or ESRB. The main task of the ESRB will be to
identify and assess risks to the stability of the EU financial system and issue risk warnings
when the identified risks appear significant. Several features of the proposed framework are
important.
• First, the European System of Central Banks will play a key role in the functioning of
the ESRB. The voting members of the ESRB's General Board will include the 27
governors of the EU's national central banks and the President and Vice President
of the ECB.
•
Second, the ECB will be assigned the task of ensuring sufficient human and
financial resources for the ESRB's Secretariat.
•
Third, the ESRB will not be responsible for the implementation of macro-prudential
policies. That responsibility will remain with national authorities and national
supervisors.
•
Fourth, since the ESRB will not implement macro-prudential policies, the effective
monitoring of the follow-up to its warnings and recommendations and the consistent
and timely implementation of the recommendations will be crucial for the
performance and the credibility of the new macro-prudential supervisory framework.
The creation of the ESRB will, in my view, constitute a historic step forward, putting in place
an important building bloc of an EU financial-stability framework that is consistent with the
objectives of creating a single market.
Challenges for Southeastern Europe
Some of the policy challenges facing the euro area also need to be addressed by the
countries in Southeastern Europe. Moreover, many of the countries in Southeastern Europe
are confronted by additional challenges. Let me mention some of these challenges, as well
as some questions that we may wish to consider during the course of this conference.
•
First, prior to the crisis many countries in the region ran large current-account
deficits underpinned by capital inflows. As the crisis demonstrated, however, capital
flows can be subject to abrupt and sharp reversals. What policy measures can be
used to deal with surges of capital inflows and their sudden reversals?
•
Second, much of lending in the economies concerned has been denominated in
foreign currencies. This situation can lead to corrosive feedback loops between
banking crises and foreign-exchange crises, compounding the effects of each. What
policies can be taken to safeguard domestic banking systems from exposure to
foreign-currency borrowing?
•
Third, some banking systems of euro-area countries have relatively-high exposures
in the countries of South East Europe. In addition to the measures, including
bilateral MOUs among some national central banks, that have already been taken,
what other actions would help minimize the risks that may arise from strong financial
linkages?
•
Fourth, many of the economies in Southeastern Europe tend to be relatively closed.
Moreover, the trade linkages among the countries of Southeastern Europe
themselves are quite limited. In other words, the shares of the exports of each
country in Southeastern Europe to the rest of the region tend to be relatively small,
given the geographical proximity of our countries. These shares are typically in the
range of 15 per cent to 30 per cent. What accounts for this circumstance and how
can we boost both the level of trade in goods and services, and intra-regional trade
among our economies, thus helping to generate a virtuous cycle of growth?
These are some of the issues that perhaps can be addressed.
I look forward to a lively discussion.
Thank you for your attention.