Jürgen Stark: In the aftermath of the global economic crisis - What next?
Speech by Mr Jürgen Stark, Member of the Executive Board of the European Central Bank,
at the ECONOMIST conference - 15th Roundtable with the Government of Greece, Attica,
18 May 2011.
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Introduction
It is a pleasure to be here today. In my introductory remarks I would like to discuss briefly the
main underlying causes for the current problems of some euro area countries. Such an
understanding of the causes is essential in order to develop strategies for "Restoring
Confidence in the European Economy", the main topic of this session of the conference. In
the remainder of my initial remarks I will then outline the key policy elements of such a
strategy, both at the national and at the European level.
The majority of EMU member states is about to overcome the economic consequences of
the global financial crisis. The economic recovery in the euro area has been sustained and
has become more broadly based. The economy no longer needs the degree of economic or
monetary stimulus as adopted during the height of the crisis in late 2008 and early 2009.
Economic growth in the first quarter of 2011 has turned out significantly stronger than
expected. Germany, in particular, is experiencing high growth rates, falling unemployment
and a declining government deficit. To a great extent these positive developments are
attributable to economic reforms adopted in the past which are now taking effect. Some
countries, at the euro area's periphery, Greece, Ireland and Portugal, find themselves in a
critical economic situation.
The origins of the current crisis
The current problems in these countries have a number of root causes which have led to
significant macroeconomic imbalances and vulnerabilities. In the years prior to the recent
crisis, price and costs developments diverged noticeably within the euro area over extended
periods of time. The cumulative impact of those differences has meant the gradual but
significant erosion of the competitiveness positions in a number of euro area countries.
The mechanisms underlying these developments have varied between countries but mostly
have been linked with strong growth in domestic demand, relative to the supply capacity of
the economy. Demand pressures were often related to overly optimistic expectations about
future incomes and profits. That triggered high spending, reduced saving and excessive
indebtedness by the private sector and often increased risk-taking by the financial sector.
This process was often exacerbated by low real interest rates and an insufficiently tight fiscal
stance. Even where headline fiscal numbers such as the deficit or the debt ratio still
suggested a healthy fiscal situation, the underlying reality was that government finances
were often buoyed artificially by cyclically sensitive revenues. With the deterioration of the
economic situation the structural weaknesses in the underlying fiscal position became
evident culminating in the current sovereign debt crisis in some euro area countries.
These developments highlight important shortcomings not only at the level of national
policymaking but also with respect to the institutional framework at the European level. The
Stability and Growth Pact (SGP) was watered down in 2005 and has been ineffective in
preventing the build-up of significant fiscal imbalances. Peer pressure has not worked and
the changes in the fiscal rules in 2005 have led to excessive political interference and the
lack of effective implementation. Moreover, the institutional framework so far lacks any
effective tools for macroeconomic surveillance which could prevent the emergence of
macroeconomic imbalances. The Broad Economic Policy Guidelines have proven not to be
an effective tool.
Before turning to the necessary policy responses I would like to stress that the fiscal and
macroeconomic policy challenges are not problems which some euro area countries face in
isolation but are also evident in many other advanced economies outside the euro area.
Government deficit and debt levels have reached historically high levels. Concerns about the
soundness of fiscal policies are a broader phenomenon, as, for example, discussed in IMF
research and highlighted by the recent lowering of the outlook for the U.S. sovereign debt
rating. Also issues of competitiveness and external imbalances are global in nature and not
specific to the euro area. But this is not an excuse for the Europeans not to bring their house
in order.
What has to be done?
A number of policy implications for the euro area follow from this analysis. The main
objective has to be a smooth functioning of EMU which implies that countries follow a path of
sustainable and balanced growth. The strategy to achieve this consists of two key elements:
first, to unwind the imbalances that had arisen during the first decade of EMU; and second,
to ensure an adequate institutional framework and sufficient structural flexibility of individual
Member States so that the risk of such imbalances occurring again is minimised.
The first challenge is to restore price and cost competitiveness. In a monetary union such as
the euro area, with a single currency and a single monetary policy, the main adjustment
mechanism is the competitiveness channel which works via an adjustment in relative prices
and costs. Over the next few years, the restoration of competitiveness will require significant
further adjustments in a number of countries which have seen an erosion of competitiveness.
The second key challenge at the current juncture is that governments need to return to
sustainable fiscal positions. Even in the short-term fiscal consolidation will help to regain
confidence and thus have a positive impact on economic activity. This should be
underpinned by structural reforms to enhance the growth potential. For some countries
returning to sustainable fiscal positions requires significant further fiscal consolidation efforts,
especially in countries with large external deficits and high levels of indebtedness. But this
call for fiscal discipline applies more widely - in all countries the implementation of strong
fiscal consolidation efforts is required and effective rules need to be adopted that anchor
fiscal prudence in overall budgetary decisions in the future.
Third, both competitiveness and fiscal sustainability should be supported by higher
productivity growth. That implies that structural reforms should be targeted to remove
remaining rigidities in the labour and product markets. In recent years, the progress with
respect to structural reforms in euro area countries has overall clearly been disappointing
and not commensurate with the requirements of participating in a common currency area.
The Europe 2020 Strategy for jobs and smart, sustainable and inclusive growth may provide
the institutional framework at the European level for ambitious progress with respect to
structural reforms.
These policy requirements gain particular urgency for those countries currently receiving
EU/IMF financial assistance. The policy conditionality associated with these programmes has
been designed to address the main imbalances and vulnerabilities, taking into account the
specificities of the individual countries. Full compliance with the policy conditionality of the
assistance programmes is absolutely essential to unwind existing imbalances and restore
market confidence.
Turning to the necessary policy response at the European level, the reinforcement of the
fiscal rules and the introduction of a new surveillance framework for macroeconomic
imbalances are necessary elements in strengthening overall economic governance in the
euro area. The current proposals are a step in the right direction but so far fail to constitute
the necessary quantum leap for euro area countries. As to macroeconomic surveillance, it is
of paramount importance that the procedure has a clear focus on those countries which pose
the most serious threat to the smooth functioning of EMU. These are - as the present
experience shows - countries with large and persistent current account deficits, significant
accumulated losses of competitiveness and high levels of private and public sector
indebtedness. Moreover, the procedures should be quasi-automatic, limiting excessive
political interference in the process. Furthermore, it would be useful to have a more gradual
application of financial sanctions to provide clear incentives for appropriate macroeconomic
policies.
Concluding remarks
Policy-makers in individual euro area countries have to come to terms with the realities of
being part of a monetary union and adjust policies accordingly. This means pursuing sound
and sustainable fiscal policies, preventing the build-up of macroeconomic imbalances and
ensuring that the economy has the necessary shock-absorption capacity - and in particular
flexibility - to ensure a smooth adjustment to country-specific developments. In that respect,
ambitious and front-loaded structural reforms are essential. The EU 2020 Strategy can play a
useful role in that respect. Of course, the ultimate responsibility for effective reform lies with
national governments who have to ensure the economic flexibility and growth potential
necessary to reap the full benefits of being a member of the euro area. Some loss of
sovereignty is part of the reality of sharing and benefiting from a common currency. If this is
not acknowledged in time, it may imply an even larger loss of sovereignty at a later stage.
The ECB considers it fundamental to set up an effective surveillance mechanism in the euro
area in order to prevent challenges similar to those experienced currently by some euro area
countries from re-emerging in the future. It is equally important that markets can play their
disciplinary role in an efficient manner. This requires transparency in the surveillance process
and the realisation of markets that the no-bail out clause does indeed constitute one of the
binding constraints of EMU.
As in the past, the ECB will continue to deliver on its mandate and ensure price stability for
the euro area over the medium term. This will provide an important anchor of stability to each
individual euro area country, an anchor which is particularly valuable for those countries
undergoing a difficult adjustment process. Individual Member States will benefit from this
stability. At the same time, they have the responsibility to ensure the smooth functioning of
the common currency area. This requires further efforts in all euro area countries to make
sure that, in terms of monetary policy, one size does indeed fit all.