Jean-Claude Trichet: Preventing spillovers on the global economy
Speech by Mr Jean-Claude Trichet, President of the European Central Bank, at the Bretton
Woods Committee, International Council Meeting 2011, Washington DC, 23 September
2011.
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Ladies and Gentlemen,
It is now four years after the outbreak of the global financial crisis, and three years after the
collapse of Lehman Brothers, which were stark reminders of how much financial integration
and globalisation made all economies interdependent.
This interdependence creates benefits but also adverse spillovers which may arise in all
domains, from inadequate macro policy choices to private market imperfections. I will focus
today on two key areas of policy interest to address spillovers in the global economy:
(1) reforming global finance, and (2) strengthening policy discipline at the domestic and
global level, before turning to how the euro area can contribute to global stability.
1. Reforming global finance
At the Pittsburgh Summit in 2009, G20 leaders agreed "to do everything needed to repair our
financial system and to maintain the global flow of capital". The November 2011 G20 Cannes
summit will take stock of where we stand in terms of implementation of this important reform
agenda.
In a number of areas, important decision have already been taken, notably as regards the
improvement of bank capital with the agreement on Basel III, and the development of
macroprudential frameworks. In other areas, we are close to concluding our work, in particular as
regards a new global framework on systemically important financial institutions (SIFIs).
In those areas where decisions have already been taken by the international community,
implementation is now key. The G20 yesterday committed to full implementation of Basel III
along the agreed timelines. The EU has already started this process early with the European
Commission putting its proposals on the table for the so-called Capital Requirements
Directive IV, which will translate Basel III into the legal framework of the EU Member States.
In terms of macro-prudential framework, the European Systemic Risk Board has started its
operation this year. All jurisdictions must ensure timely implementation so that we can ensure
that we have done everything to make a difference as regards the resilience of the global,
regional and national financial systems.
Let me briefly highlight three key areas on which we need to stay committed and where swift
progress is of the essence.
The first challenge may come from the shadow banking sector. The introduction of more
stringent capital requirements may provide incentives for banks to shift part of their activities
outside the regulatory realm. It is therefore decisive that we continue our work to improve our
capacity to identify and assess the potential risks stemming from the shadow banking
system. This includes regulatory reform of money market funds, securitisation and the
interaction with the banking sector.
The second challenge is how to keep pace with financial innovation. Improving the OTC and
commodity derivatives markets is a key part of this agenda, It is a complex matter and one in
which alignment of details is essential to avoid regulatory arbitrage.
The third challenge is to enhance transparency across the board: with regards to markets,
institutions, and products. Insufficient information contributes to mispricing of risks, mistrust
among market participants, which can result into downturns and crises. At our October
meeting of G20 Finance Ministers and Central Banks Governors we will be discussing
IOSCO "recommendations to promote markets' integrity and efficiency to mitigate the risks
posed to the financial system by the latest technological developments".
2. Improving policy discipline globally
Aside from a more resilient global financial system, we need to have more disciplined macro
policies as the lack of discipline in macroeconomic policies in several countries led to the
build-up of unsustainable external imbalances before the financial crisis.
There is still a gap between the degree of economic integration and the willingness of policy
makers to take into account interdependence and spillovers.
Keeping one's house in order is no longer sufficient in an integrated world. Spillovers from
the rest of the world can influence economies considerably. Multilateral surveillance is now
being enhanced along two tracks. The informal G20 track and the formal IMF track.
The G20 Framework for Strong, Sustainable and Balanced Growth, incorporates a first
systematic multilateral assessment of global imbalances. It comes at an appropriate time
because four years after the crisis, global imbalances remain unsustainably high. The sum of
the current account balance (in absolute terms) of the major economies are projected to
remain close to 2.5% of world GDP in the next few years. This is less than their pre-crisis
peak (over 3% of world GDP), but still twice as high as in the early 1990s, before the
acceleration in financial and real globalization.
It is now of foremost importance to implement the Framework effectively, and to fully live up
to the expectations that the G20 process raised internationally. The G20 Cannes Summit will
provide a litmus test.
Multilateral surveillance of domestic policies of systemic countries to ensure their orientation
towards medium term stability and sustainability is being strengthened in the IMF as well.
The recently conducted first round of IMF spillover reports, the Consolidated Multilateral
Surveillance Report to the IMFC and the current triennial review of IMF surveillance can be
seen as useful steps towards a broader and more comprehensive framework.
3. Strengthening governance in the euro area
The need to strengthen discipline is understood strongly on our side of the Atlantic, so that
the euro area can do its part in contributing to global stability.
The earlier economic governance framework has proved to be insufficiently binding while
lacking appropriate comprehensiveness.
The requirements for a very significant reinforcement of the fiscal surveillance of the Stability
and Growth Pact and for the creation of a new surveillance of competitive indicators and
macroeconomic policy have been discussed widely and in much detail by euro area
authorities. We have embarked on a deep and comprehensive reform of its economic
governance to reinforce economic policy coordination.
The Governing Council of the ECB has called for a "quantum leap" in the economic
governance of the euro area. This includes in particular (i) greater automaticity of sanctioning
mechanisms, particularly in the Stability and Growth Pact (ii) as well as truly independent
fiscal and economic analyses of macroeconomic imbalances.
The recent conclusion of the negotiations between the European Parliament and the EU
Council on the economic governance reform package are welcome. Fiscal surveillance will
become stronger and more coherent with the reinforcement of the Stability and Growth Pact.
While falling short of the quantum leap that the ECB was advocating, this agreement
strengthens the initial Commission proposals in many ways and is thus a step in the right
direction.
The EU budgetary frameworks will also be strengthened, including through the introduction
of fiscal rules at the national level. The so-called "European Semester" can be expected to
provide ex-ante and integrated guidance to the Member States for the formulation of national
budgets and structural reforms for the following year.
This will be complemented by the introduction of a macroeconomic surveillance procedure,
which closes an important gap in the economic governance framework. It is key for this
framework to be rigorously applied, including in terms of the indicators used, in order to
consolidate the effectiveness of this new procedure to assess in particular euro area Member
States experiencing sustained losses of competitiveness and large current account deficits.
The focus needs to be on the prevention of situations creating risks to economic, budgetary
and financial stability in the euro area. In addition, this macroeconomic surveillance
procedure should rely on transparent and effective trigger mechanisms.
Conclusions
Let me conclude with three key messages to policy makers - in advanced and emerging
market economies alike - who all have a role to play to address the challenges that are
ahead of us.
First, what has already been decided has to be implemented expeditiously, comprehensively
and fully. This requires resolve and fortitude on the part of the public authorities, but also
lucidity on the part of the private sector.
Second, there can be no complacency as regards the unfinished part of our reform agenda
for a stronger international financial architecture. And I cannot help saying that on top of what
is clearly identified by the international community as the urgent issues under discussion in
the Financial Stability Board and the G20, we are far from understanding the potential global
systemic instability that is associated today with the sheer size of the non-banking sector
which experienced an exponential growth over the last 20 years.
Third, as regards the euro area and the sovereign debt crisis, of which the euro area is
currently the epicentre, the euro area central banks, and the ECB in particular, have been
permanently calling for sound economic policy management, in particular in the fiscal
domain, for structural reforms and for reinforced economic governance. As independent
institutions that are devoted to stability and that are medium- to long-term oriented, we are an
anchor of stability and confidence. This is especially valuable in the turbulent market
environment that we are witnessing and that is characterised by acute tensions of some
sovereign signatures which are causing negative spillovers on others.
Only a few weeks ago, the central bankers were all meeting in the BIS headquarters in Basel
in our Global Economy Meeting. Reporting to the press afterwards, I stressed that we were
all very closely "united in purpose": each of us in our own economy, with its different features
and challenges, striving to solidly anchor inflation expectations, preserve stability and
consolidate confidence. Meeting here in Washington, authorities have the opportunity to
display the same unity in purpose to address their economic challenges at home, prevent
negative spillovers for the global economy and consolidate confidence in the world recovery.
Now, at the end of this exposition, it might be useful for me to tell you what is the assessment
that the European Systemic Risk Board has expressed after its last meeting only two days
ago:
Since its previous meeting on 22 June 2011, risks to the stability of the EU financial system
have increased considerably. Key risks stem from potential further adverse feedback effects
between sovereign risks, funding vulnerabilities with the EU banking sector, and a weakening
growth outlook both at the global and the EU level. Over the past few months, sovereign
stress had moved from smaller economies to some of the larger EU countries. Signs of
stress are evident in many European government bond markets, while the high volatility in
equity markets indicates that tensions have spread across capital markets around the world.
The situation has been aggravated by the progressive drying-up of bank funding markets,
and availability of US dollar funding to EU banks had also decreased significantly. In that
context, central banks have decided on coordinated US dollar liquidity-providing operations
with longer maturities. The high interconnectedness in the EU financial system has led to a
rapidly rising risk of significant contagion. This is threatening financial stability in the EU as a
whole and adversely impacts the real economy in Europe and beyond.
Looking ahead, decisive and swift action is required from all authorities. In the immediate
future this includes: (1) implementing, fully and rapidly, the measures agreed upon at the
21 July meeting of the Heads of State or Government of the euro area; (2) adopting
sustainable fiscal policies and growth-enhancing structural measures so as to achieve or
maintain credibility of sovereign signatures in global markets; and (3) enhancing the
coordination and consistency of communication.
Authorities must act in unison with a total commitment to safeguard financial stability.
Supervisors should coordinate efforts to strengthen bank capital, including having recourse
to backstop facilities, taking benefit from the possibility of the European Financial Stability
Facility to lend to governments in order to recapitalise banks, including in non-programme
countries.
I thank you for your attention.