jose manuel gonzalez - paramo : monetary and fiscal policy interactions during the financial crisis speech by mr jose manuel gonzalez - paramo, member of the executive board of the european central bank, at a conference, madrid, 26 february 2010. * * * introduction it is a great pleasure for me to be here today in madrid to deliver the closing remarks at this important conference on the interactions between monetary and fiscal policies. before starting my intervention, let me recall that we are presently in the purdah period, i. e. within the one - week period before the next decision meeting of the governing council. thus, nothing that i will say today is intended to have implications on our future monetary policy decisions, nor should it be interpreted as such. undoubtedly, this conference has addressed a very timely topic. because of the financial crisis, substantial policy challenges have emerged for which we need to find answers. and i am not sure whether it gives me much comfort that these challenges are not only faced by policymakers, but, in a deeper sense, by the economics profession as a whole. i think that for all of us much remains to be done until we will be able to say that we have “ understood ” the lessons from the financial crisis. the range of topics that have been covered over the past two days is impressive. i will not try to comment on all the papers. this would be too much for a single speech. in any case, at the end of an intensive conference this would probably not be in line with your preferences. instead, i will focus my remarks today on the monetary and fiscal reaction of the euro area to the financial crisis. but before doing so let me start by making a few short, inevitably selective remarks on some of the papers. one paper which i found particularly relevant is the one by eric leeper, because i very much agree that the current crisis is a period in which uncertainty over future policy regimes poses particular challenges. as government debt reaches unprecedented levels in peacetime and ageing populations will significantly add to the fiscal burden in many industrialised countries in the coming years, the notion of a “ fiscal limit ” that might be reached at some point in the future is immensely important. and this limit matters already today because of forward - looking expectations. another interesting point which came out of the presentations by wieland, corsetti, lane, faia and others, is that the current environment has been conducive to a renewed and very rich debate about the deter

the theoretical example you cite underlines the problem i just mentioned of the borderline between monetary and fiscal policy. we are already supporting investment in the euro area through our monetary policy. we have brought down the entire yield curve and we are buying securities of public entities such as the eib as part of our asset purchase programme. but it is absolutely not our role to decide which investment should go ahead, which bridge should be repaired or which school built, nor whether the investment should be private or public. ben bernanke, in his memoirs, suggests that if the united states and europe took different paths out of the crisis, that is partly because europe ’ s monetary policy in the first years was too tight, and its fiscal policy too strict at the wrong moment … i ’ m not for rewriting history, but the ecb and governments reacted with the tools they had at the time. they went through three crises – the subprime crisis in 2007, the 2009 global economic slowdown and the euro crisis from 2010 on – without a common fiscal backstop ( that only came in 2010 with the european financial stability facility ) and without the foundations of a banking union. if we were to draw lessons from the experience, i would rather insist on the fact that the euro area was too late and too timid in cleaning up and shoring up its banking system, i. e. stress testing the banks, raising capital and shedding bad loans. that partly explains why our recovery is lagging behind that of the united states. in banking matters, forbearance doesn ’ t serve a purpose. you can ’ t buy time. we ’ re catching up now, but we still have some way to go, and the banking union isn ’ t complete. some countries, such as germany, insist that there should be a limit on euro area banks ’ sovereign exposure. do you agree? there are three dimensions in my view. there is the question of sovereign risk for banks. but we must also consider the consequences for government financing, and the functioning of financial markets, which need risk - free assets as liquidity instruments. if you focus on one aspect of the problem and ignore the others, you run the risk of shifting risk around instead of reducing it. the ecb ’ s policy is increasingly unpopular in germany. do you foresee a moment when it might become an obstacle to your own action? europe nowadays is a source of irritation for many. not only its monetary policy, and not