jose manuel gonzalez - paramo : fiscal policy and the financial crisis – the need for an effective exit strategy speech by mr jose manuel gonzalez - paramo, member of the executive board of the european central bank, at the cfs conference “ the ecb and its watchers xi ”, frankfurt am main, 4 september 2009. * * * introduction the economic and financial landscape has changed dramatically since the last ecb watchers conference. until a year ago, the front line in the fight against the financial market turmoil had been manned largely by central banks. then, in the space of a month : • fannie mae and freddie mac were taken into public ownership ; • merrill lynch was taken over by bank of america ; • the federal reserve extended an extraordinary loan to aig in return for a majority stake ; • and lehman brothers filed for bankruptcy. the financial turmoil became a financial crisis. the us treasury unveiled a proposal to buy up to 700 billion us dollars of illiquid mortgage - based assets. and on this side of the atlantic, a wave of government interventions to stabilise the financial system and support the broader economy was set in motion. the need for policy actions in september 2008, money markets around the world had come to a standstill. banks had stopped lending to each other. central banks had become the main source of refinancing for the banking system. given the situation, the top priority was to restore more orderly market conditions as soon as possible in order to limit the damage to the real economy. to this end, in addition to the unconventional measures taken by central banks, vast public funds have been made available to guarantee bank lending, to recapitalise troubled banks and to purchase impaired assets. to what extent have these actions been successful? a useful measure of money market tensions is the spread between unsecured and secured money market rates. in the euro area, for the three - month maturity, this spread rose from below 10 basis points before the onset of the turmoil to 180 basis points at the height of the crisis in autumn 2008. since then, it has declined to around 40 basis points. this is still an elevated level, but nonetheless indicates significant progress towards restoring stable money market conditions. and while credit conditions in the euro area have weakened significantly over the past 12 months, there has been no collapse in bank lending to the non - financial private sector. even so, economic activity has contracted more sharply than at any time since the second world war. in the

institutional framework, has not proceeded with the same speed and there continue to be clear differences according to the activity type. banking consolidation also raises sensitive moral hazard and crisis management questions, as painfully illustrated by the crisis. the securities markets showed strong growth in the years before the crisis and clear signs of integration, though not to the same extent as observed in the euro money markets. with the crisis, bond price indictors showed signs of more dispersion across countries in europe, but the question is whether this points to more segmented markets or rather increased risk awareness on the part of investors. very topical in this respect is also the cds market and its interaction with the underlying ( sovereign ) bond market. finally, the integration of a securities market depends to a large extent on the integration of the supporting market infrastructure. this is an area where the eurosystem and the european commission have taken significant measures, but integration continues to be affected by legal, fiscal and technical issues. an important set of issues on which the panellist may want to comment relate to the regulatory reform process, where the g20 provides the strategic impetus, the financial stability board ( fsb ) plays an important role in policy coordination, and the committees and working groups ( such as the basel committee on banking supervision, which is the emblematic global committee ) the review of specific international standards. important regulatory reforms are underway in europe, as well as in the united states, and i want to elaborate on them because they have important implications for the ecb. as you know, the proposed reform for the financial supervisory framework in the eu will be based on two pillars. the micro - prudential pillar, the european system of financial supervisors ( esfs ), will be composed of the national supervisors and three european supervisory authorities ( esas ). the european systemic risk board ( esrb ) will form the macro - prudential pillar. under the proposals of the european commission, the esas will carry out a range of activities, including the issuance of binding and non - binding rules which will provide the basis of a so - called “ single eu rulebook ”. the esas will further promote a consistent application of eu legislation and of a common supervisory culture, and provide for mediation in the case of disagreements between national supervisors. all this should lead to a more harmonised regulation and supervision across countries, and as a result also foster financial integration. for central bankers, the part of the reform which directly concerns them is the establishment