Peter Praet: The role of the central bank and euro area governments in times of crisis Speech by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at the German Federal Ministry of Finance, Berlin, 19 April 2012. *  *  *  I would like to thank Maximilian Freier and Gianluigi Ferrucci for their contribution in the preparation of this speech. Introduction Since 2007, we have constantly been confronted with exceptionally tense financial and economic conditions. When the tensions in the financial markets first emerged in the summer of 2007, they were perceived as a liquidity shock. However, the collapse of Lehman Brothers in September 2008 – the first climax of the crisis – revealed more fundamental fragilities in the global financial system. The accumulated credit excesses, paired with the complex cross-country linkages in the financial markets, quickly exacerbated the financial market tensions on the other side of the Atlantic, transforming them into a crisis of global dimensions. The resulting Great Recession of 2009 affected virtually all industrialised countries and caused other weaknesses in the economic and financial system to be crystallised. Specifically, the severe economic contraction worsened the fiscal positions in many countries around the world, particularly in those that already had sustained public or private debt imbalances before the crisis. The subsequent tensions in some sovereign debt markets have spilled back into the financial markets. As safe assets, sovereign bonds play a key role in financial systems.

Even small deviations from the targets can quickly jeopardise the progress made and undermine confidence. To address imbalances, countries also need to take structural measures and deal with market rigidities. Suitable structural reforms can have a positive impact on growth and employment already in the relatively short term, and can thus also help to mitigate the negative effects of consolidation. Structural adjustment nevertheless remains difficult, but not impossible. This is proved by the experience in the Federal Republic of Germany over the past years. Losses in competitiveness after the reunification boom in the early 1990s were effectively addressed by means of moderate wage growth over extended periods of time. At the same time, the German experience shows how well-targeted structural reforms strengthen potential growth and boost employment. The labour and welfare reforms contributed significantly to positive economic developments in Germany over past years. In the remaining time, let me also briefly address the other two challenges faced by euro area governments, namely the instability of the financial markets and the remaining deficiencies in the European economic governance framework. Banks should continue to strengthen their balance sheets. The financial system has to return to fulfilling its primary task of providing credit to the real economy. But, as I have said before, euro area governments also have to do their part. Sound fiscal positions across the euro area will contribute significantly to strengthening confidence in a banking sector that relies heavily on government bonds as safe assets and for use as collateral.