Vítor Constâncio: ECB Annual Report 2010
Introductory statement by Mr Vítor Constâncio, Vice-President of the European Central Bank,
at the presentation of the ECB Annual Report 2010, to the Committee on Economic and
Monetary Affairs of the European Parliament, Brussels, 2 May 2011.
* * *
Madam Chair,
Honourable members of the Committee on Economic and Monetary Affairs,
It is a great pleasure to present to you the European Central Bank's Annual Report for 2010
which forms a core part of our accountability towards the European Parliament. It is the first
time for me to appear before your Committee in my capacity as the Vice-President of the
ECB and I am looking forward to an enriching exchange of views.
I will first briefly review the economic and monetary developments over the past year, explain
our monetary policy decisions, and summarise our current assessment of the
macroeconomic outlook. I ask for your understanding that my remarks on the outlook should
not be construed as providing indications on the prospective monetary policy stance, as we
are in the so-called purdah period, where the members of the Governing Council refrain from
comments on the current outlook for monetary policy. I will also briefly touch upon the current
fiscal challenges in the euro area and issues related to financial stability and regulation.
Before concluding, I would like to address the EU economic governance framework,
following in particular the reports adopted by this Committee and the start of the trialogue
discussions.
Economic and monetary developments and outlook
Monetary policy in 2010 and in early 2011 continued to operate in a very complex and
challenging environment. Renewed tensions in some financial market segments in May 2010
posed new challenges for the conduct of monetary policy.
Since early 2010, the economic recovery in the euro area has gained momentum. This has
been mainly driven by continued strong external demand. At the same time, domestic
demand strengthened during the review period. Overall, following the 4.1% decline in 2009,
euro area real GDP increased by 1.8% in 2010. This outcome was much more favourable
than expected one year ago.
Looking forward, we expect the euro area economy to further benefit from the ongoing
recovery in the world economy. At the same time, private sector domestic demand should
increasingly contribute to economic growth, benefiting from the accommodative monetary
policy stance and the measures adopted to improve the functioning of the financial system.
The Governing Council assesses the risks to this outlook to be broadly balanced in a context
of elevated uncertainty.
As regards price developments in the euro area, inflation has been on an upward trend since
early 2010, mainly reflecting rises in global commodity prices. The average annual inflation
rate rose to 1.6% in 2010, and continued increasing in early 2011, reaching 2.7% in March
and according to Eurostat flash estimate 2.8% in April. While domestic price pressures are
still moderate, risks to the inflation outlook have moved to the upside. These relate mainly to
higher than expected energy prices. In addition, increases in indirect taxes and administered
prices may be greater than expected, owing to the need for fiscal consolidation in the coming
years. Finally, the ongoing recovery in economic activity could result in stronger than
expected domestic price pressures. While our monetary analysis indicates that the
underlying pace of monetary expansion is still moderate and money based medium term
forecasts show inflation subdued, monetary liquidity may facilitate the accommodation of
price pressures stemming from other factors.
Under these conditions, the Governing Council of the ECB, at its meeting of 7 April 2011,
decided to increase the key ECB interest rates by 25 basis points, after maintaining them
unchanged for almost two years at historically low levels. This step was warranted to adjust
the very accommodative monetary policy stance in the light of upside risks to price stability.
Indeed, it is essential that recent price developments do not give rise to broad-based
inflationary pressures over the medium term through second round effects. Our decision to
raise rates will contribute to keeping inflation expectations in the euro area firmly anchored in
line with the Governing Council's aim of maintaining inflation rates below but close to 2%,
over the medium term. Such anchoring is a prerequisite for monetary policy to contribute to
economic growth. Historically, interest rates remain low across the maturity spectrum. Thus,
our current monetary policy stance remains accommodative, supporting economic activity
and job creation.
In view of the ongoing financial tensions, the ECB kept several of its non-standard monetary
policy measures in place in 2010 and early 2011, notably the full allotment of liquidity at a
fixed interest rate in most refinancing operations. In addition, in May 2010, the ECB decided
to launch the Securities Markets Programme, enabling the Eurosystem to purchase private
and government bonds, with the aim of supporting the transmission of monetary policy.
Liquidity effects stemming from these purchases have been fully neutralised by
liquidityabsorbing operations. All the non-standard measures taken during the period of acute
financial tensions are, by construction, temporary in nature and will be adjusted when
appropriate.
Fiscal policies and bond markets
Turning to fiscal policies, fiscal deficit and debt ratios had deteriorated substantially in 2008
and 2009. In 2010 the euro area deficit to GDP ratio only broadly stabilised at a very high
level, while the debt ratio continued to increase.1 Individual countries experienced extremely
high deficit rates.
Taking a broader view, the economic recession amplified imbalances in fiscal policies that
had built up gradually long before the crisis. In particular, many countries failed to implement
sound fiscal policies during good economic times. Temporary revenue windfalls were used to
finance permanent expenditure increases and some countries failed to achieve structurally
sound fiscal positions despite a long period of strong economic growth. On the institutional
side, the EU fiscal framework (which had been revised in 2005) was too weak and not
implemented with sufficient rigour.
Reflecting large fiscal imbalances and a loss of investor confidence, government bond
spreads increased drastically for some euro area countries and became very volatile in 2010.
The willingness of investors to support government financing needs declined. Greece and
Ireland in 2010 required financial support by means of joint EU/IMF programs. Portugal also
asked for assistance in April.
Looking ahead it is essential that these three countries undertake drastic reforms. Greece
and Ireland have to fully implement the agreed programmes and for Portugal the approval of
a convincing adjustment programme is now of the essence.
More generally, all euro area governments need to achieve the consolidation targets for
2011. For the following years, consolidation targets need to be underpinned by concrete
consolidation measures. The deadlines to correct excessive deficits agreed in the ECOFIN
Council need to be respected. Estonia and Luxembourg are the only euro area countries
currently not subject to an excessive deficit procedure. In view of very high expenditure ratios
in the euro area, consolidation plans need to focus on expenditure reduction. Strengthening
confidence in the sustainability of public finances is key, as this will reduce interest rate risk
premia and improve the conditions for sound and sustainable growth.
Moreover, it is key to strengthen incentives for sound economic policies, notably in good
economic times. I will turn to efforts in this area shortly.
Financial stability
I would now like to touch briefly on financial stability issues. The start of the preparatory work
for the European Systemic Risk Board (ESRB) - the body in charge of macro-prudential
oversight in the EU - allowed its smooth establishment in 2011, together with the European
Supervisory Authorities. The ESRB is now fully operational, with its General Board having
already met twice and its advisory committees in place.
The ECB has been entrusted with the provision of analytical, statistical, logistical and
administrative support to the ESRB. Hence, the ECB is making the utmost effort to enhance
its capabilities and analytical tools for conducting systemic risk analysis.
In the context of the Basel III framework, the ECB fully supports the European Commission's
work on the Capital Requirements Directive (CRD) IV. The Commission's proposal by
mid2011, as envisaged, would provide the European Parliament and the Council with sufficient
time to put the new framework in place by the end of 2012.
The ECB Annual Report highlights our support to the Commission's initiative regarding a
crisis management and resolution framework for EU financial institutions. The EU clearly
needs better tools with well designed triggers to tackle problems in the banking sector more
effectively. National regimes should be harmonised as much as possible and arrangements
for better coordination between Member States in crisis situations need to be devised.
The ECB shares the overriding policy objective of the new EU regime to provide a framework
within which financial institutions can fail, while at the same time safeguarding the stability of
the EU financial system as a whole and minimising public costs and economic disruption.
From this perspective, a credible resolution framework that disciplines large and cross-border
financial institutions, in particular, is essential. In this context, the setting up of a network of
national resolution funds that could evolve, in the medium to long term, to a European
Resolution Fund, is undoubtedly very important. The ECB is also actively contributing to the
discussions in the FSB and the G20 to putting in place arrangements that will reduce the
systemic risk emanating from so-called global systemically important financial institutions.
As regards the new round of the EU-wide stress test, which will be conducted under the
aegis of the newly established European Banking Authority (EBA), it is designed as a
sufficiently severe and rigorous exercise to be credible. It is expected to reduce uncertainty
among market participants concerning the health of European banks.
Let me just mention some of the enhanced features. First, the assumed macroeconomic
shock is stronger than in the previous exercise. In addition, the EBA has provided more
rigorous guidance to banks on the cost of funding and static balance sheet assumptions.
Second, the capital metrics is now Core Tier I capital ratio instead of the broader concept of
Tier I capital used previously. Third, a stricter peer review will be performed, with enhanced
disclosure of results. Finally, Member States have committed to specific and ambitious
strategies for the reinforcement of vulnerable institutions. In this context, it is important that
appropriate backstops be in place for those banks which do not pass the test.
Economic governance
Let me finally congratulate your Committee on its recent vote on the economic governance
package. ECON has undoubtedly taken an important step towards the much needed
strengthening of economic and budgetary surveillance in the EU and the euro area.
In particular, I very much welcome the fact that the automaticity of procedures has been
stepped up by extending the use of reversed qualified majority voting. The room for halting or
suspending procedures against those Member States breaking the rules must be reduced.
The strengthening of the Commission's role in the procedures that the approved reports
propose in this context are therefore welcome. Moreover, the political and reputational
measures that you are proposing are necessary to foster early compliance with the
surveillance framework. An earlier and more gradual application of financial sanctions within
the macroeconomic surveillance framework goes in the same direction. Your support in the
same framework for a clear distinction between Member States belonging or not to the euro
area is also positive. The requirements of avoiding negative imbalances must be more
demanding for members of the monetary union. This type of distinction, making full use of
the Treaty's new Article 136, has to be to be applied in different domains, drawing the
appropriate lessons of the crisis for the functioning of the monetary union. Finally,
compliance by Member States with the obligations under the Stability and Growth Pact is
facilitated by the strong national budgetary frameworks that you want to establish within the
euro area by proposing several concrete mandatory features. The proposal of a financial
sanction for the manipulation of data is also to be welcomed, as well as the institutional
provisions for reliable, timely and accurate statistical information.
At the same time, there are certain aspects of the Committee's position, on which we have
concerns. Most importantly, the Stability and Growth Pact should not be softened by
introducing further exceptions and a longer list of "relevant factors" (including cyclical
developments to some public investments or state aid measures for the financial sector), that
can be invoked in the assessment of compliance with the deficit and debt criteria. This could
create further room for unwarranted discretionary decisions and may open the door to lax
fiscal policies at a time of much needed fiscal consolidation.
As regards macroeconomic surveillance, we have often emphasised that, in order to be
effective, it should have a clear focus on a restricted number of indicators capturing
macroeconomic imbalances per se. This procedure is specifically targeted at macroeconomic
imbalances, meaning extreme and persistent divergences from a sustainable trend that
threaten the proper functioning of monetary union. It is not about achieving higher growth
potential which is of course highly desirable and is the goal of the EU 2020 strategy. This
does not imply that I do not recognise the need to co-ordinate all the dimensions of economic
policy under the umbrella of the European Semester.
Overall, the Reports approved by your Committee are a positive contribution for the trialogue
that follows and that, I hope, can be successfully finalised so that the economic governance
package can be adopted and implemented as soon as possible.
Conclusion
Madam Chair, honourable Members,
The lessons of the financial crisis for Europe are responsible for the vast programme of
reforms that we have been implementing. Last year, focused in the euro area, the crisis
highlighted the interplay between the sovereign debt problems and the financial sector, since
they represent two faces of the same crisis. Weak financial sector can have an adverse
impact on public finances, while deficient fiscal policies and macro imbalances can have
negative repercussions on the financial sector. Resolving both problems will put the euro
area on a track of renewed sustainable growth, leaving this crisis behind us. This requires
the implementation of effective economic governance that can ensure fiscal sustainability,
competitiveness and growth, the completion of the permanent European Stability Mechanism
and the efficient functioning of the new European System of Financial Supervision. In all
these endeavours, the European Parliament and the ECB share common values and goals
and will, I am sure, continue to collaborate in order to ensure the success of Europe.
Thank you for your attention.