Jörg Asmussen: Key issues about the crisis and the European response
Intervention by Mr Jörg Asmussen, Member of the Executive Board of the European Central
Bank, at the Center for Strategic and International Studies, Washington DC, 20 April 2012.
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It is a pleasure to be here today at the Center for Strategic and International Studies and I
would like to thank Karl-Theodor zu Guttenberg for his kind invitation. In recent years a
common theme in U.S. foreign policy discussions was whether to disengage from Europe
and focus on the Pacific. Today it seems that people in Washington are more interested than
ever in European affairs. Unfortunately, it is for entirely the wrong reasons. How nice it would
be to go back to those days of being irrelevant!
I would like to set the stage for our discussion today by addressing some of the key issues
about the crisis and the European response to it. These issues get to the heart of the major
debates in the U.S. and Europe at the moment. They are complex and they require us to
think long-term and avoid simplifications. Ultimately, they are about what kind of Europe we
want for the future.
In particular, I will focus my intervention on three questions:
Is the worst of the crisis over?
Is the European response to the crisis killing growth?
Is the ECB's response to the crisis swamping the world with liquidity?
Is the worst of the crisis over?
Policy-makers are often asked if the worst of the crisis is over. It is a difficult question to
answer. If we are optimistic we are accused of cheerleading. If we are pessimistic we risk
panicking the markets and setting off self-fulfilling cycles. So we have to go by what the data
are telling us. And the data show a clear stabilisation in the global economy since last year.
The U.S. is showing signs of a sustained recovery. Data releases have consistently surprised
on the upside throughout the first quarter of this year, although April was more mixed. Survey
data point to a moderate expansion in economic activity in early 2012. Unemployment is now
at the lowest level since January 2009.
In the euro area, survey data confirm a stabilisation in economic activity at a low level in early
2012. We continue to expect the euro area economy to recover gradually in the course of the
year. The outlook is supported by strong export growth to the U.S. and emerging markets.
Downside risks remain, however, related to a possible worsening of the sovereign debt crisis.
Financial markets are also now generally less volatile - although we must closely monitor the
situation in the Spanish government bond market. Certainly the doomsday predictions from
the fourth quarter of last year seem to have been avoided.
We should not forget that, only five months ago, der Spiegel, the leading German weekly
magazine ran an article entitled "A continent stares into the abyss", which declared that the
end-game for the euro had begun. The front cover of The Economist magazine in the same
week asked "Is this really the end?", set against an image of a burning 1 euro coin hurtling
towards oblivion. What changed in this time? In my view, the explanation is actions taken at
three levels.
First, Member States recognised the seriousness of the situation and implemented major
reforms. Spain has begun addressing its competitiveness problem with the most significant
labour market reform in a generation. It is also improving central control over regional
spending. Italy is increasing competition and modernising its public administration to increase
its potential growth. The debt exchange in Greece was successful, which gives the country a
fresh start to address its fiscal and competitiveness issues. Ireland and Portugal have
continued to implement their EU-IMF programmes, which are both on track.
Second, Europe has strengthened its economic governance. Fiscal rules have been
reinforced through the agreement on the fiscal compact, which obliges all euro area
countries to run a structural balanced budget. It also shifts the onus for enforcement away
from Brussels and onto national institutions, encouraging greater ownership.
Monitoring of economic policies will go deeper through the new "enhanced surveillance"
legislation. It allows the Commission to send missions to countries experiencing or
threatened with financial difficulties and recommend policy changes. This gives the
Commission the power to demand some reforms that the U.S. federal government could not
demand of a U.S. state.
Euro area firewalls have been strengthened by the decision to increase the total resources to
around I trillion US dollars. Altogether, this presents a convincing package for markets: a
tough new set of rules, a strong regime for monitoring those rules, and a credible safety net
to back it up.
Third, the ECB has played its part by preventing a funding crisis in the banking sector. The
two 3-year LTROs launched in December and February have eased bank funding pressures
and stopped further deleveraging. This should over time support lending to firms and
households across the euro area.
These actions have pulled the euro area back from the very dangerous situation we faced
last year. But the crisis of public and private debt in some countries is clearly not over. The
recent rise in Spanish yields is evidence of this. This is no longer a problem that can be
addressed through bigger firewalls or a more active ECB. It can only be addressed through
consistent and determined reform, even if it is painful in the short term.
In the Spanish case the shift in market sentiment is a result of poor communication on deficit
targets and delays in announcing the budget. In other words, Spain currently has a credibility
problem with the markets. But this can be fixed by taking measures to regain credibility.
Overall, we should not wait for a "silver bullet" to end the crisis. It does not exist. The end of
the crisis will come only after a series of comprehensive steps taken over a number of years.
This means all Member States and EU institutions playing their part.
Let me stress that we are greatly helped in this task by excellent transatlantic cooperation,
not least between the ECB and the Federal Reserve. Among other things, the provision of
dollar swaps lines has been a key weapon in fighting the crisis since 2007. So the U.S. is
also playing an important role in supporting the European recovery.
Is the European response to the crisis killing growth?
This leads into my second question: is the response I just described - fiscal consolidation
and structural reforms - killing growth in Europe? It is important to understand that we see
things differently in Europe and the U.S. In our view, strong public finances are a
pre-condition for sustainable growth. We see fiscal consolidation as supporting growth,
because it creates confidence effects that will support consumption and investment in the
future.
Certainly, the short term effects of consolidation can be negative. We recognise this. That is
why we always recommend that consolidation is accompanied by productivity-enhancing
structural reforms. This means inter alia opening up closed professions, increasing the
efficiency of public administration and improving judicial systems. These are reforms that will
ultimately benefit the majority of people, by increasing the growth-potential of these
economies.
Take the example of Spain. The labour market reforms I mentioned are essential to increase
employment. The Spanish labour market has for too long been organised in a way that
protects insiders. This is what lies behind the very high rate of youth unemployment.
It may be the case that these reforms will not return some of the current problem countries to
pre-crisis growth rates. So there will inevitably be calls for more stimulus. But we should keep
in mind that the last ten years were not representative: it was a boom period, built on credit,
creating ever larger imbalances.
That party is now over. We need to learn the lessons from it. And the lesson from the
bursting of a debt bubble cannot be to load up on more debt. These countries need reforms
that undo previous excesses and re-build their economies on a more sustainable basis. This
is the direction in which Europe is currently heading. And there is really no alternative.
There is one area, however, where I fear we are not learning the right lessons in Europe.
Several European countries face a vicious circle where weak domestic banks cause fiscal
difficulties for governments, which in turn undermines public debt sustainability and further
damages banks' balance sheets.
In the U.S., such a feedback loop does not exist, because federal institutions act as shock
absorbers. They prevent local crises from becoming systemic: for example, banks can be
recapitalised through the U.S. Treasury and resolved through the Federal Deposit Insurance
Corporation. In Europe we need to look to the U.S. for inspiration in this area. This is why I
have called for a European bank resolution authority.
Is the ECB's response to the crisis swamping the world with liquidity?
Let me turn now in more detail to the recent actions by the ECB - in particular, the question
whether the 3-year Long Term Refinancing Operations (LTROs) have swamped the world
with liquidity. Behind this question is the implication that increasing central bank liquidity
always leads to distortions, be it inflation or currency volatility. But this misunderstands what
central bank liquidity is.
ECB liquidity is a very specific form of money. It can be used only to make payments
between banks with accounts at the ECB and to meet reserve requirements. There is no
automatic mechanism which converts this liquidity into loans or asset purchases. Banks take
such decisions based on factors like their financial strength, their risk aversion and the
demand for credit by non-financial corporations and private households.
So we should not make simplistic assertions about one factor leading to another. We should
ask: what are we seeing in the data? Looking at credit growth in the euro area, we see few
signs of distortions. The LTROs have certainly prevented an abrupt deleveraging. But loans
to the euro area private sector increased by only 1.1% in February, compared with an
average of around 7% since the start of the euro.
Looking at capital flows to other parts of the world, we see a broadly balanced picture. The
euro has in fact appreciated in effective terms since we conducted the first LTRO in
December 2011. There have been significant capital inflows due to renewed interest and
confidence by foreign investors.
The strongest effect of the LTROs has been on bank funding. Euro area banks issued EUR
55 billion in senior unsecured bank debt in the first two months of this year, more than the
whole amount in the second half of last year. This is exactly what the LTROs were intended
to achieve: to prevent a bank funding crisis. Over time we expect this to feed into higher
credit for firms and households.
When this happens, we will be constantly alert to any threats of inflation. Our commitment to
price stability is steadfast and credible. And observers recognise this. Following the two
3 year LTROs market indicators of inflation expectations - that is, investors risking their own
money - show no signs of inflation above our medium-term objective.
So to conclude, the euro area still has a lot of work to do to put itself back on a sustainable
footing. This work is difficult because it goes to the root of our economic problems. But it is
also essential. Solutions that would paper over these problems by creating more debt are not
in Europe's long-term interest. They would solve this crisis by creating the conditions for the
next one.
But we also need to be patient. The euro area is made up of 17 different democracies. And
as you know very well in Washington, democracy is sometimes messy. Events may not play
out as an economist would determine in his or her model. We may not take the most direct
route to our destination. But important thing is that, in the end, we get there. I am confident
that in Europe we are heading slowly but surely down the right track.
Thank you for your attention.