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European Commissioner for Economic and Monetary
John Hopkins School of Advanced International Studies
Ladies and gentlemen,
It gives me great pleasure to be here at the School of Advanced International Studies in Washington and I'd like to thank Dan Hamilton for inviting me back to this distinguished institution to speak about the European response to the global financial crisis.
When I was last here in October 2007, we were grappling with the immediate fallout of the crisis in the sub-prime mortgage market. Back then we knew we were in unchartered territory – that the outlook for the economy and the course of the financial turbulence was highly uncertain. But few of us imagined that a year later the turmoil would intensify into a full scale financial crisis, pushing the banking systems on both sides of the Atlantic to the brink of collapse and triggering an economic hurricane that would sweep the world.
All G7 economies are now in recession and we are set to see the sharpest contraction in global growth since World War Two. Some recent survey data in both Europe and in the US has provided grounds for optimism. But it is too early to tell whether these indicators represent a bottoming out of the economic decline. One thing we can be sure of; 2009 will be difficult and painful for economies worldwide.
So a year and a half on – what lessons are we learning from the worst financial crisis in a generation? And what are we doing in Europe to rein in this crisis and return the global economy to a path of stability and growth?
In my view, there are two particularly important lessons that emerge from the current crisis and which must be factored into the global efforts for recovery.
The first lesson is that confidence is key. When Lehman Brothers collapsed on the 15th September 2008, the global economy was hit by an abrupt and unparalleled loss of confidence. The speed and the scale by which this loss of confidence spread through financial actors and economic agents worldwide is unprecedented. Stock markets collapsed, banks stopped lending to one another and public trust in financial markets was shattered. It has quickly become clear that restoring confidence is a prerequisite for a stabilisation of the financial system and a recovery of the global economy.
Second, we are learning a powerful lesson about the interdependence of our economies. Where in past downturns countries would have looked to the United States alone to kick start global growth, today this is not a viable option.
The US, alongside the EU and all advanced economies is experiencing a sharp drop in GDP and unemployment is rising rapidly. Likewise emerging and developing countries have been seriously hit by the combined effect of declining capital inflows, commodity prices and exports. Global trade has become one of the primary transmission mechanisms of this crisis and global factors are driving this downturn.
What does all this mean? It means that solving the crisis with domestic policy instruments alone will simply not work. The case for global coordination to counter the worldwide downturn is overwhelming.
Which is why the stakes were so high ahead of the G20 summit that took place in London at the beginning of this month. And why the success of this meeting represents such an important step forward in the international community's response to the crisis.
In my view, the summit produced three particularly important results:
The task for the global community now is to translate promising words into concrete actions.
In Europe we have been working hard to do just that – in a manner both consistent with our international partners, and based on close coordination between our 27 EU Members. In fact a common European approach has been central to our response.
For the highly integrated economies of the European Union, coordination is vital to maximise the impact of our actions. But it is also necessary to safeguard the fruits of more than 50 years of European cooperation, common assets which form the cornerstones of our economies and provide a valuable platform for recovery. This includes the European Single Market, which is a vital driver of trade and prosperity in the EU.
And our single currency, the euro, which celebrates its 10th anniversary this year. For a decade the Economic and Monetary Union – EMU - has anchored macro-economic stability in the EU and shielded its members from external shocks and turbulence. Today, the euro is facing the first recession in its history and there is no question this year will be a stress test for the European single currency.
And yet those who predicted the euro would break apart at the first sign of economic crisis were very much mistaken. On the contrary, in these difficult times EMU continues to provide a stabilising anchor for its members. Critics have pointed to widening spreads between euro area member countries, speculating on the possibility of a break up. Yet without the credibility that EMU brings, these spreads would be even higher.
The euro has eliminated the possibility of volatile exchange rates that in past crises hit trade and investment and generated political tensions. EMU is shielding those smaller and more vulnerable economies that would otherwise have seen speculative attacks on their currencies by markets.
For those EU countries outside of the euro-area, in Central and Eastern Europe, some of them that are most acutely affected by the crisis are now stepping up preparations to join the single currency so that they may share in the stability offered by the world's second most important currency. The euro area has already expanded from 11 to 16 members since its introduction and we are looking forward to seeing the borders of EMU expand further in the next years.
The point I want to stress here is that European countries have shared interests and a strong incentive to work together to counter the economic downturn. And this cooperation has been evident throughout our response to the crisis.
Let me outline the wide ranging actions we have taken in Europe.
Our approach has been, first, to stabilise financial markets and prevent a collapse of the banking sector.
We have injected nearly €300 billion euro worth of recapitalisations and €2.5 trillion euro worth of guarantees into the financial system. These actions have delivered some successes. We have managed to avoid a Lehman Brothers occurring in the Europe. Despite the fact that the sector on the whole remains fragile, financial markets have gradually stabilised and we are seeing notable improvement in some areas such as interbank lending.
As you are doing here in the US, we are now addressing the 'impaired assets' on bank balance sheets that pose a major obstacle to rebuilding trust in the financial system and a serious risk to prospects for a swift recovery.
So far several European countries – have provided relief on impaired assets totalling more than 580 billion euros and further action is being planned by other Member States. Measures have been taken according to common guidelines set down by the European Commission. I am pleased by the close convergence between these European guidelines and the framework endorsed by the G20. This is a complex issue and coordination worldwide is vital for the effectiveness of interventions.
Second, we are making major progress to strengthen the system of regulation and supervision in financial markets. This forms a major strand of our response, not only because such steps will create a more resilient financial system, one that will support economic growth and prevent a crisis on this scale from happening again. But in the short term, effective and targeted financial reforms can also provide a much needed boost to investor confidence. They are vital to restore public trust in the financial system.
To this end we have brought forward proposals on credit rating agencies, on capital requirements and accounting. And in the coming months we will announce a second wave of initiatives to strengthen financial regulation in the EU: [in just a few days time] we will announce legislation on hedge funds and private equity to address the systemic risk posed by these investment vehicles.
We will also tackle the derivatives and the other complex structured products that played a part in amplifying the current crisis. This isn't about stifling the innovation of our financial sector. But in future we cannot allow any part of our financial system to operate in the shadows.
In parallel, we are working on a revamped system of supervision better adapted to oversee the extensive cross-border operations that take place in Europe's financial markets. By detecting risks to financial stability at an early stage and triggering effective corrective action, it will form a key component of the beefed up system of macro-financial surveillance proposed for the global economy.
The third strand of our response is a massive direct stimulus to the real economy to boost demand and kick start growth.
A 3% cut in interest rates by the European Central Bank since last October has contributed to the worldwide monetary stimulus.
On the fiscal side, EU countries have launched an unprecedented budgetary stimulus of between 3 and 4% of GDP. That's €400 billion channelled into initiatives to help industry and businesses, to support public investment projects and to give a direct boost to household purchasing power.
I should add that this fiscal support also reflects the operation of automatic stabilisers – the increases in social welfare payments and the declines in tax revenues that occur as growth slows and unemployment rises. We must not forget that these stabilisers play a large role in Europe as a result of our strong social welfare systems and will play an even larger role if the downturn deepens.
On this note, let me just say that much has been made of the relative sizes of fiscal spending. Yet this is an artificial debate when measures already announced are still in the implementation phase. Moreover, it would be foolish to categorically rule out the possibility of another fiscal stimulus in the future. But the key task we face right now is to implement current measures as quickly as possible, ensuring a good level of coordination between international partners, so that the first results begin to take hold.
We must also bear in mind the importance of medium and long-term fiscal sustainability. I know that sustainability is a concern shared by the current US administration.
In Europe too, budget deficit and debt levels have risen sharply over the last months. We are determined not to let today's crisis response sow the seeds for tomorrow's problems. I have called on European countries to already now set out credible strategies for reversing the fiscal expansion. We are drawing on our framework of fiscal rules – known as the Stability and Growth Pact – to help countries plan a credible path back to healthy public finances once growth returns.
This is imperative for two reasons: in the short term, to maintain public confidence in governments' ability to manage the crisis and its fallout; in the longer term, to safeguard the sustainability of public finances. The challenge of population ageing looms large, and the impact will be particularly acute in Europe, where fertility rates are decreasing faster than the US. We cannot let our actions today place an unbearable burden on citizens tomorrow.
This brings me to the last, but crucial point I want to make before I finish.
Most of the focus right now is on doing everything necessary to generate global recovery. It's on learning past lessons and repairing the damage brought by this crisis.
But we must also be forward looking: we must devise adequate exit strategies from the crisis – withdrawing the fiscal and monetary stimulus and unwinding public support for the financial sector will be complex tasks that we need to start planning for today.
Moreover, we must prepare now for the challenges of a post-crisis world. The financial sector will not be the engine of growth it has been over the last decade. Reduced leverage and less dynamic financial markets mean that we will have to look to the real economy to find new sources of dynamism.
This need will only be compounded by long running challenges such as globalisation, climate change and ageing which have not diminished with the current crisis
What does this mean? It means that sustainability must be the foundation of our crisis response. All of the actions we take today to stimulate recovery in the short term must be consistent with our long term goals to build a more prosperous, equitable and greener world for tomorrow.
There are several pre-requisites if we want to achieve this vision:
First, a fair and open multilateral trading system and free flows of cross border investment is essential. A surge in protectionism now would do lasting damage to global economic growth and to prospects for development. G20 leaders have pledged to avoid economic nationalism at all costs and to pursue Doha negotiations. Their actions must match their words.
Second, we need a renewed emphasis on structural reforms to strengthen resilience and boost productivity. In Europe we know that there is much we can do to boost the dynamism of our economies. Increased investment in research and innovation, more flexible markets and a better environment for business are some of our key priorities – all will lead to better performance and productivity that will leave us well placed to seize the opportunities of globalisation and to manage population ageing. The re-vamp of the EU's reform strategy – the Lisbon strategy - is currently underway, and this plus the crisis provide a powerful window for action. There is no better opportunity to take this process forward.
And third, a transition to a low carbon economy should be at the heart of Europe's reform process. Carbon reduction is an environmental imperative; but green growth also offers innumerable economic benefits for business and industry. The EU is currently a world leader in terms of targets for carbon reduction and renewable energies and we have put new investments in energy infrastructure, in energy efficiency and in cleaner technologies at the core of our response to the crisis. We are determined to ensure that December's climate change conference in Copenhagen yields a global step change towards a low carbon future.
Ladies and gentlemen, let me conclude.
The international community has set down a clear agenda to tackle the crisis in our economies and financial systems. The challenge now is to focus on implementing each aspect of that agenda in a coordinated and resolute manner. Europe is rising to this challenge. We have launched fiscal actions to resuscitate our economies, we are pushing through a roadmap of targeted measures in financial markets and we are at the core of efforts to shape the world that will emerge from this global crisis.
In all of these endeavours, international coordination is key. Testing times make strong partnerships across the Atlantic especially important. But good working relationships throughout the global community will deliver results. The G20 process is evidence of that. Let's use this opportunity to forge a new global leadership based on cooperation and an engagement of all partners to build a stronger, fairer economy for the future.