vitor constancio : the macroeconomic and the financial landscape in the aftermath of the 2007 crisis – new challenges and perspectives speech by mr vitor constancio, vice - president of the european central bank, at the high level policy seminar, european university institute, florence, 7 june 2011. * * * ladies and gentlemen, thank you very much for the invitation to join you today at the european university institute for this high level policy seminar. it is an apposite time to take stock of the lessons of the recent crisis ; the actions that have been taken in response ; and the measures that are needed for the future. i believe that the recent financial and economic crisis has revealed some fundamental lessons about the functioning of the euro area – lessons which policymakers have been obliged to learn and act upon to build tomorrow ’ s european structure. we learned that preventing future crises requires action across a range of policy areas encompassing fiscal, economic and financial policies. on the other hand, we learned that these policy areas are interconnected – fiscal imbalances can undermine the financial sector ; financial sector imbalances can weigh on the credibility of the sovereign ; both can spillover into the real sector, and vice versa. responding to these lessons requires a holistic encompassing concept of economic governance. this implies a high degree of institutional coherence and co - ordination which is not easy to achieve – even unitary states like the u. s. have struggled to put in place such a comprehensive approach. in the euro area, it requires establishing a comprehensive set of rules and institutions to guide economic policies towards mutually beneficial outcomes. in the absence of a central political authority, such rules and institutions are essential to overcome collective action problems and prevent free riding – to maximise the common good as opposed to private utility. the key to effective rules and institutions is as follows : their scope must be commensurate with the scope and degree of economic and financial integration in the euro area. otherwise, authority lags behind integration and crises cannot be efficiently forestalled. in general, policymakers have recognised that fundamental changes to economic governance are needed after the crisis. but my main contention today is that the reforms put forward in response, whilst very important, do not yet meet sufficiently the criterion for effectiveness. if we truly recognise the lessons of the crisis for the euro area, economic governance must be more ambitious. let me begin by recalling these lessons and their implications for economic governance. lessons from the crisis by now we know all

stability and growth pact. in this respect, let me say that the current crisis has taught us an important lesson about the importance of preserving the public ’ s trust in the soundness of public finances. at the current juncture, euro area governments must make credible commitments to return to sound fiscal policies. doing so in full compliance with the stability and growth pact is the most credible exit strategy. this requires, first, a full reversal of the fiscal stimulus measures taken so far. this is necessary to ensure an efficient allocation of resources by minimising distortions in the incentives of economic agents and by avoiding a permanent increase in the size of the public sector. second, governments must live up to their commitment to maintain fiscal discipline. this means that credible fiscal consolidation plans have to be implemented as early as possible, including a consolidation effort of at least 1 % of gdp per annum where necessary. if euro area countries do not practise fiscal restraint seriously, the debt dynamics will be in danger of spiralling out of control. the current crisis has shown how important it is for countries to consolidate during good economic times and to build a “ fiscal reservoir ” from which they can draw in periods of “ drought ”. many euro area countries failed to do so. they suddenly found themselves in this turbulent environment burdened by high fiscal deficits and debt ratios. their room for fiscal manoeuvre was very limited, as was their capacity to adopt effective counter - cyclical measures when they were most needed. in addition, the developments in government bond yield spreads since last autumn have shown that, in uncertain times, financial markets increasingly discriminate between countries on the basis of their creditworthiness, including fiscal fundamentals. we are seeing the first, timid signs of an economic recovery ; investors are regaining their appetite for risk. it is critical that euro area governments boost confidence in the soundness of public finances as an element to support both the recovery and long - term economic growth. as regards monetary policy, it is equally important to draw up a strategy for withdrawing in due course the extraordinary measures that have been implemented or announced. the ecb obviously cannot maintain the current degree of support indefinitely. we are providing substantial short - term support to the financial system and the real economy, and thereby ultimately maintaining price stability. but what if macroeconomic conditions warrant a removal of monetary stimulus? in fact, we are prepared to take appropriate actions once the macroeconomic environment improves. we will ensure that the measures taken can be