Peter Praet: The state of the global economy
Speech by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at
the 4th World Policy Conference, Vienna, 9 December 2011.
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I would like to thank for John Hutchinson and Arnaud Mehl for their contributions in the preparation of this speech.
Ladies and Gentlemen,
It is a real pleasure to be here in Vienna to exchange views on the future of global
governance. Vienna is certainly a city with a long tradition of discussing issues with a global
dimension. Following my invitation to speak at this conference, I remembered that, almost
200 years ago, it was here that the famous Congress of Vienna attempted to forge what
came to be known as the "Concert of Europe". This marked the creation of a new global
order and a major turning point in world history.
The global economy today is also at a turning point. What we have been observing since the
unprecedented financial market tensions in mid-2007, is not merely the unfolding of a global
financial and economic crisis. We have been observing the emergence of a new global order,
which is occurring at a faster pace than was anticipated prior to the crisis.
The exact form this new world will take is unclear. But the need for sound global governance,
which we will discuss today and tomorrow, is becoming ever more apparent. On the
economic front, several important changes have already occurred. The G20 has replaced the
G7 as prime forum for international economic cooperation. The Financial Stability Board has
been established to address vulnerabilities and develop regulatory and supervisory policies
conducive to global financial stability. Bodies based at the Bank for International Settlements
in Basel, which are of keen interest to the central banking community, have also been
reformed and their membership enlarged to relevant emerging market players.
In assessing the state of the global economy today, I would like to emphasise that we are at
a crossroads. In this respect, I would like to make three specific points. Firstly, I will describe
the outlook and risks for the global economy and euro area. I will then discuss the interplay
between the current prospects and key policy challenges: namely global real and financial
imbalances as well as liquidity and capital flow volatility. Finally, I will briefly comment on
major governance challenges in the Eurozone.
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Let me commence by depicting how I see the outlook and key risks for the global economy
and euro area at this juncture. Against a background of heightened uncertainty and rising
stresses in financial markets, global sentiment has further deteriorated in recent months. It
now appears that some of the downside risks which had been previously identified have
materialised. Looking ahead, short-term indicators as well as the latest survey data suggest
that global growth is expected to remain sluggish.
However, looking at the global economy as a whole masks the considerable degree of
heterogeneity which prevails. Indeed, a key characteristic of the global economy relates to
the divergence in global growth patterns not only between advanced and emerging
economies but also within these country groupings. In advanced economies, growth sapping
headwinds persist with annual GDP growth expected below potential. In particular, these
headwinds relate to the continued need for public and private sector deleveraging as well as
the persistent weaknesses in labour and housing markets in some advanced economies.
These factors, combined with the ongoing tensions in financial markets, are expected to
restrain global growth over the medium term.
Conversely, in emerging economies, growth has remained relatively robust. While growth
has recently experienced some moderation, largely on account of weaker external demand.,
this should assist in alleviating some of the overheating pressures. The resilience of
emerging economies throughout the crisis has been impressive. However, emerging
economies are not immune to developments in other parts of the globe.
More than four years after the beginning of the financial crisis, uncertainty continues to
remain high, with substantial downside risk to the economic outlook notably for the euro
area. Downside risks in particular relate to a further intensification of tensions in euro area
financial markets and their potential spillover into the real economy. Additional downside
risks also relate to the global economy, which may turn out to be weaker than expected, as
well as protectionist pressures and the possibility of a disorderly correction of global
imbalances.
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I would like to focus now on key global policy challenges confronting the global economy.
The first of these challenges is the persistence of large real and financial imbalances at the
global level, which is a key source of vulnerability in the medium term. A few figures are
worth recalling. Combined together, the current account deficits and surpluses of the main
systemic economies are projected to stand at roughly 2% of world GDP over the next five
years. This is less than before the crisis (3% of world GDP in 2007), but twice as much as in
the late 1990s. A large share of the adjustment in external imbalances since the crisis has
been cyclical, not structural According to the IMF, the US current account deficit is projected
to reach about 3% of GDP in 2011, against surpluses of roughly 5% and 9% of GDP for
China and oil exporters respectively. They are a source of tensions that could ultimately lead
to protectionist pressures. However, the euro area as a whole has a balanced current
account position.
Global fiscal imbalances remain significant, with a marked degree of heterogeneity between
advanced and emerging economies. Consolidation efforts required to bring public finances to
a sustainable path are a key priority for advanced countries.
Efforts made to adjust these imbalances remain clearly insufficient. This raises the risk,
which I referred to earlier, of a disorderly unwinding down the line, with significant potential
fallouts for global financial markets and the global economy.
At their Cannes Summit on 3-4 November 2011, G20 Leaders agreed on an Action Plan to
lay the foundations for strong, sustainable and balanced global growth in the medium-term.
This is welcomed. All G20 members made commitments, but they are sometimes imprecise.
It is often unclear as to how these commitments can genuinely contribute to a rebalancing of
global demand patterns. For instance, only a few of the G20 members explicitly reaffirmed
their support to the solemn pledge by their Leaders in Toronto last year to halve fiscal deficits
by 2013 and stabilise public debt ratios by 2016. Large emerging markets have announced
that they would enhance the flexibility of their exchange rate regime, but without indicating a
specific time-frame when this would occur. Europe is doing its share in committing to
accelerate and further deepen the Single Market.
More decisive policy measures to rebalance global demand patterns are still required, in
particular to raise savings in deficit economies and increase domestic demand in surplus
economies. All systemic economies could benefit from effective multilateral surveillance
along with their international responsibilities. Now is not the time to lose sight of the need to
correct imbalances globally although our attention is - for good reasons - more focused on
immediate challenges!
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The second and related key global policy challenge relates to how best to address global
liquidity conditions and volatile capital flow constellations. Ample global liquidity conditions
have the potential to push volatile capital flows into emerging economies. If they respond by
accumulating reserves to cap exchange rate appreciation, this widens global imbalances.
While this is an issue which was already discussed before the crisis, some argue it might
have been exacerbated as a result of policy responses to the crisis.
Indeed, some of the policy responses have been sub-optimal from a global vantage point.
Many countries have continued to accumulate large reserve holdings to limit currency
appreciation. For instance, China's reserve holdings now exceed USD 3 trillion; those of
Russia USD 400 billion; those of Brazil, Korea or Taiwan USD 300 billion. Others have
adopted capital flow management measures, including higher reserve requirements and
- sometimes - outright controls on capital inflows. Some observers have claimed that
"currency wars" might break out.
This is why the efforts from the international community to better understand global liquidity
developments, as well as how to deal with global liquidity shortages, in particular during
crises, by the G20, the IMF and by the central banking community at the Bank for
International Settlements in Basel are valuable undertakings. The agreement by G20
Leaders on actions and principles that could help reaffirm the benefits from financial
integration and increase resilience against volatile capital flows is commendable. This
agreement provides coherent conclusions to guide countries in the management of capital
flows.
The first line of defence against excessive capital flow volatility should comprise sound
domestic macroeconomic policy frameworks and institutions as well as appropriate exchange
rate regimes, financial regulation and supervision. Capital control measures should be
temporary in nature and only used as a last resort, given that they may delay the necessary
domestic policy implementation and distort the distribution of capital flows across countries.
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Ladies and gentlemen,
When delegates to the Congress of Vienna first met in 1814, the new world that was about to
emerge and which would last for almost another century was only barely discernible. The
outbreak of the global economic and financial crisis is putting us in a similar situation today.
Throughout the world, citizens call upon policy-makers to act decisively to resolve the crisis
and help the global economy turn a corner. All relevant authorities have to take their
responsibilities.
To ensure that this crisis can be fully addressed will require an ambitious strengthening of
economic governance. Significant reforms in this direction are taking place in Europe. The
EU Council and European Parliament have agreed on a legislative package that significantly
limits the discretion of national authorities. This includes a framework for monitoring a wide
range of macroeconomic imbalances, also backed by sanctions. Countries are expected to
anchor fiscal prudence in national rules. All these measures were unthinkable four years ago.
Today, Euro area Heads of States or Government agreed in Brussels to move towards a
stronger economic union. This implies measures in two directions, namely: a new fiscal
compact and strengthened economic policy coordination and the development of the euro
area stabilisation tools to face short term challenges. In the view of the ECB's Governing
Council, a new fiscal compact comprising a fundamental restatement of the fiscal rules,
together with the fiscal commitments that euro area governments have made, is the most
important precondition for restoring the normal functioning of financial markets. To
accompany fiscal consolidation, bold and ambitious structural reforms are essential. They
should be immediately carried out to help the euro area countries improve competitiveness,
increase the flexibility of their economies and enhance their longer-term growth potential.
We at the ECB take our responsibilities. Monetary policy in the euro area will remain
dedicated to our mandate, which is to maintain price stability over the medium term. The
policy measures taken by the ECB have resulted in the Governing Council's outstanding
record during the past 13 years in terms of price stability and anchoring of inflation
expectations.
The ECB will continue to remain an anchor of confidence and stability, in a global economy
characterised by marked uncertainties. This is the central contribution we can make to foster
sustainable growth, job creation and financial stability in the euro area as whole.
Thank you for your attention and I wish you all a fruitful and enriching conference.