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Joaquín Almunia

European Commissioner for Economic and Monetary Policy

A recipe for recovery: the European response to the financial crisis

2nd Brussels' International Economic Forum
Brussels, 11 November 2008

Ladies and Gentlemen,

I would like to thank Gerhard Stahl and Professor Sinn for inviting me to address the Brussels International Economic Forum for the second year running.

When I spoke here in June last year, the economy was buoyant and the sub prime crisis was yet to hit our financial markets. Unfortunately, we meet today in much gloomier circumstances.

The financial turmoil, which started in August 2007, reached crisis point at the beginning of this autumn. The collapse of Lehman Brothers, on September the 15th, sent a shockwave through the financial system and undermined what was left of investor confidence.

The impact on the broader economy has become more evident by the day. Any optimism that the global economy might avoid a severe slowdown has now evaporated. It is clear that 2009 and even 2010 will be difficult years.

Against this background, I will structure my comments this morning in two parts. First, I will outline the EU response to the financial crisis. Second, I will talk about the implications for the broader EU economy, and the policies we need for a sustainable recovery.

I. Financial crisis and the European response

Let me start with the financial crisis. I won't give a blow by blow account of the turmoil, as I think we are all quite familiar with the events of the last two months.

Save to say, that after the period of excess and risk accumulation in the financial sector, we are now living through a painful market correction. The financial system is enduring a phase of severe deleveraging, characterised by dysfunctional credit markets, unprecedented write-downs in asset valuations, generalised risk aversion, and threats to the stability of the banking sector.

Although the banking sector has been at the centre of the crisis since the beginning, problems have spilled into other parts of the financial system - to the enormous credit default swaps market, insurance companies and hedge funds.

And the impact is being felt not only in markets but in countries too. In Europe, Hungary has experienced severe funding problems and had to seek external assistance from the IMF and the EU, despite the progress made over the last two years to correct its imbalances.

From the outset, Europe has taken decisive action to manage this crisis. Governments, the Commission and the ECB have been working closely together to contain the turmoil, protect savings and maintain a flow for credit for businesses and households.

The European Central Bank has injected huge amounts of liquidity into markets to prevent a severe credit crunch. In the last four weeks it has cut the interest rate twice, by a total amount of 100 basis points.

And the October agreement by Member States on an EU rescue package for banks was an unprecedented act of coordination, allowing us to synchronise national responses within a common European framework.

Initial market reactions to these rescue packages have been positive. There has been a modest improvement in the functioning of interbank markets in the past weeks. Yet conditions remain precarious.

It's clear that we must do everything in our power to return markets to normal functioning so that they can continue their job of financing households and businesses and supporting growth.

The Commission has called for rescue packages to be put in place rapidly and consistently to help restore confidence. We are monitoring their implementation closely. We are also prepared to use competition rules to ensure that a level playing field is maintained between beneficiaries and non-beneficiaries of state aid and to prevent distortions in the Internal Market.

For those Member States experiencing balance of payment pressures or serious financial stability risks, the EU stands ready to provide financial assistance. Hungary will receive 6.5 billion euros in aid from the EU –as part of a total package of 20 billion euros agreed together with the IMF and the World Bank- and last week European Finance Ministers agreed to raise the ceiling for Community balance of payments aid from 12 to 25 billion euros. This solidarity will be vital to prevent the crisis from spreading further.

Even as we deal with the immediate crisis, we have to think further ahead. The last months have exposed the weaknesses in our financial systems. We must act to ensure sure that a crisis of this scale does not and can not happen again.

With this in mind, the Commission has accelerated work on a package of precise measures that tackle shortcomings in our financial sector. We have already proposed reforms to capital requirements, deposit guarantees and accountancy rules.

Tomorrow we will come forward with measures to tighten up the regulation of credit rating agencies, followed by an initiative on executive pay. We are also working on regulating derivatives, hedge funds and private equity. And a high level group chaired by Jacques de Larosière has been set up to assess cross border supervision in Europe and will present its first results to the European Council in the spring.

This is part of a major effort to reform the supervisory and regulatory model on which our financial markets are based.

But clearly, given the international nature of financial markets, this cannot be a purely European exercise. It should be a global one. Hence the international summit in Washington this weekend – the first of a series - will be crucial: first to establish consensus among the key international partners on what needs to be done to prevent a repeat of the current situation, and then to pave the way for effective, concrete reforms.

The scope of these discussions should be wide. We need to tackle not just the lax financial regulation but also strengthen international crisis management capacities and address the global current account imbalances that lie at the root of today's crisis.

We are realistic. We know that success will not come easily or quickly. The current framework for global governance makes it particularly difficult to generate the ownership and legitimacy for real change. Which is why we must grasp this opportunity to drive forward a restructuring of global governance – including the Bretton Woods institutions – so that they reflect the geo-political realities of the 21st century.

We are determined that this weekend's summit paves the way for real change in the international financial system. So during last Friday's European Council meeting EU leaders agreed a set of common lines to take to Washington.

These include a commitment to new, common standards of oversight, transparency and risk assessment and proposals to strengthen international crisis management. We propose a period of 100 days following the Summit to draw up and begin implementing new measures.

II. Implications for the EU economy

So far I have concentrated on the financial sector. Yet it is clear the financial turmoil is having a considerable fallout for the real economy.

The crisis has caused confidence to fall significantly. It is aggravating the housing market corrections in some advanced economies. With the US and some European countries in recession, and the outlook darkening for emerging economies too, the global economy is slowing and external demand is falling rapidly.

What does all this mean for the EU economy? The economic forecasts that I presented last week indicate a bleak outlook.

In our central scenario, growth in 2008 would be 1.4% in the EU and 1.2% in the euro area – half what it was in 2007. In 2009 the EU economy is expected to grind to a stand-still at 0.2% [0.1% in the euro area] before recovering to 1.1% [0.9% in the euro area] in 2010.

While all Member States will experience a downturn, it will be more pronounced and protracted in those countries with greater exposure to shocks.

Employment is set to increase only marginally in 2009 and 2010 compared to the 6 million new jobs created over the last two years. After being at its lowest for more than a decade, we expect unemployment to rise by about 1 percentage point.

There is one piece of good news– the downturn is helping to ease inflation as oil prices fall. We now forecast inflation at 2.4% in the EU for 2009.

The outlook is not only bleak, it is also highly uncertain. There is a real risk that if the financial stress intensifies or lasts longer, it may have a greater effect on the economy and could fuel the negative feedback loop between the economy and the financial sector. In fact, last Friday the IMF updated its own forecasts published one month before, with even gloomier figures.

Faced with the most difficult economic situation in decades, we need to mobilise a concerted and coordinated policy response as we have done in the financial sector. This means using all the policy instruments we have available to limit the slowdown, protect jobs and lay the ground for a sound recovery.

The first tool is monetary policy. The recent fall in inflation has opened the way to interest rate reductions to help sustain consumption and investment. The European Central Bank has already demonstrated its readiness to act with two cuts in the last weeks.

Second, within the rules of the Stability and Growth Pact there is scope for budgetary policy to cushion the slowdown.

We don't underestimate the challenges ahead for fiscal policy. The slowdown will inevitably take its toll on budgetary positions. And emergency measures to support the banking sector are already having an effect on government debts.

But the revised Pact is designed to handle such crisis situations. Since 2005 it has the inbuilt flexibility to manage the deterioration in public finances.

We invite Member States to draw fully on the flexibility of the Pact.

However, this cannot be a license to increase the burden for future generations.

Fiscal policy should remain on a sustainable course.

It should take into account the different situations in different Member States. The recent sharp increase in spreads on sovereign debt in a number of Member States is a reminder that the scope to use fiscal policy to support the economy varies across countries.

The Pact provides for specific treatment when "exceptional circumstances" exist. A deviation above the 3% ceiling, if it is temporary and the deficit remains close to the reference value, does not trigger the opening of an Excessive Deficit Procedure.

If the EDP is open, but the economic situation is what the Pact defines as "special circumstances", the deadlines for the correction of an excessive deficit can deviate from the general rule and be extended to more than one year. And if this situation continues at the end of that period, new recommendations can be issued without advancing to the next steps in the procedure.

These recommendations will take into account the existence of national fiscal rules and medium term budgetary frameworks that will help fulfil the engagements assumed by the member state concerned by the EDP.

They should also encourage reforms that will make European economies more resilient in the long run and stimulate innovation and investment.

This brings me to the third element for economic recovery.

We can mitigate the impact on the real economy if we fast track certain structural reforms, especially those which boost demand and help reduce inflationary pressures, supporting household purchasing power.

Immediate priority should be given to measures which enhance productivity. So we must step up investments in research and technology and in innovation. Pressing ahead with measures in low carbon technologies and energy efficiency would both support European competitiveness while tackling climate change.

Accelerating implementation of the Services Directive should also be a high priority, given the key role services play in creating jobs and reducing inflationary pressures.

As unemployment is set to increase, we will also need measures that ease the hardship of job losses and lay the ground for renewed employment growth. This means strengthening 'flexicurity' in our labour markets policies, making sure that income support is available to vulnerable households and investing in education and skills.

Finally, we must take immediate steps to improve access to financing for businesses, especially SMEs. Part of this can be done through the European Investment Bank, which has already increased its loan package for SMEs to 30 billion euro. We will propose reinforcing the capital base of the EIB so that the bank can continue to support businesses as well as accelerate financing of climate change, energy security and infrastructure projects.

I have outlined just a few key measures. However, as with policies in the financial sector, success of our European strategy will depend on whether we can coordinate our action at the European level.

And, building on a common European approach, if we can generate an international response to the slowdown.

The downturn has a global nature, and international partners need to take coordinated measures to boost world demand, particularly those countries or regions with large current account surpluses. This would both help support global growth and facilitate the unwinding of large global imbalances.

We also need to work together to prevent protectionism from taking hold. In developed and developing countries alike, economic nationalism is on the rise and the benefits of globalisation are being questioned following the crisis. This is understandable. But history tells us that it is a dangerous tendency, one that can turn a downturn into a protracted and more severe problem.

It is vital that we in Europe reaffirm our commitment to the principle of openness and lead by example. We must uphold the competition rules that underpin the Single Market and come out strongly against trade barriers.


Ladies and gentlemen, let me conclude.

Faced with the most daunting economic situation in decades, we have to act on three fronts: to stabilize and reform the financial system; to limit the impact on economic growth and prepare the ground for recovery; and to mobilise a coordinated, global response to the macro-financial risks that threaten the stability of the world economy.

The European Commission is now preparing a comprehensive recovery plan based on each of these areas that we will present on the 26th November. With it, we aim to drive forward a coordinated response to the crisis, one that instils confidence in our economic and financial systems and safeguards prosperity for citizens and businesses.

The EU has the means and the will to drive forward real change and this is the message we will be taking to Washington this weekend.

Thank you for your attention.

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