miguel fernandez ordonez : recent developments in the spanish economy testimony by mr miguel fernandez ordonez, governor of the bank of spain, before the senate budgetary committee, madrid, 23 november 2009. * * * ladies and gentlemen, i appear before this committee as part of the parliamentary discussion of the state budget for 2010, at a time when the deep international financial and economic crisis is giving way to a recovery, albeit one that is expected to be slow and not free from uncertainty. following the successive downward revisions to growth projections during the summer of 2007, the outlook has begun to improve in recent months. indeed, many countries are posting positive growth rates for the third quarter of 2009. yet we must acknowledge that this improvement is largely the outcome of the extraordinary large - scale measures adopted globally to boost demand and support the financial system. we still do not know whether the incipient world recovery is sufficiently self - sustaining for the exceptional stimuli to begin to be withdrawn without the risk of economic activity falling again. in the case of the spanish economy, the situation is more complex. while there has been a similar or even lesser decline in output than in other developed countries. however, the effects in terms of employment and public finances have been sharper. hence the role economic policies must play to consolidate the recovery is essential. we are thus at a crossroads where it is vital to make the right diagnosis and select the right economic policy tools. as my appearance is part of the parliamentary discussion of the budget, i shall be analysing the spanish fiscal policy situation. allow me, however, to refer also to other policies i consider essential to resume the path of budgetary stability and to emerge from this crisis in the best possible condition. first, though, i would like to briefly assess the international setting and the economic outlook for the euro area which, as is well known, determines monetary policy. projections from various international institutions ( such as the imf and, more recently, the european commission and the oecd ) suggest we will resume positive growth rates in most countries in 2010 and 2011. but they constantly stress that these estimates are shrouded in greater - than - usual uncertainty, since the take - off of productive activity needs a sound financial basis, which in turn requires that the normal functioning of intermediaries and financial markets be fully restored. in these circumstances, one of the main difficulties governments and central banks face is to identify the right time to disengage the extraordinary measures adopted in

the loan originator, thus shifting the associated risks. and a new class of asset in the shape of collateralised debt obligations ( cdos ) was created, which facilitated a further layer of restructuring and redistribution of the risks in an asset - backed security. the extent to which loans were moved off balance sheet through these means is shown in fig. 2 ( left - hand panel ). finally, we saw a veritable explosion in the issuance of credit default swaps ( cdss ), which allowed investors to hedge themselves against a wider range of default risks ( righthand panel ). the picture that emerges from this is one of a more complex process of financial intermediation, but one in which the innovation in contracts apparently allowed specific types of risks to be split out, traded and redistributed towards those in a better position to bear them. we thus seemed to be moving ever closer to an idealised arrow - debreu world of a full set of state - contingent securities. moreover, it seemed natural to think that the increased dispersion of risk would make the financial system more, rather than less, stable, a view that was certainly held by the former chairman of the us federal reserve, alan greenspan : “ these increasingly complex financial instruments have been especial contributors, particularly over the past couple of stressful years, to the development of a far more flexible, efficient, and resilient financial system than existed just a quarter - century ago. ” ( greenspan, 2002 ). accompanying this expansion in credit, there was also a rise in certain asset prices, particularly that of housing, in those countries where credit rose most sharply ( see fig. 3 ). but significantly, that explosion in credit was not associated with a marked expansion either in the demand for goods and services, or in consumer price inflation. it is also notable that the run - up in house prices in the united states was less marked than in the other anglophone countries and spain. in part, that may reflect a more elastic response in the construction of new houses in the united states. the point to stress is that there was nothing self - evidently wrong with this expansion in balance sheets and the associated rise in asset prices. there is some evidence from developing economies that suggests that increased development in financial markets helps to foster growth and catch - up. and if financial innovation allows households to gain access to mortgage finance where they were previously unable to, one should expect that to lead to a