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European Commissioner for Economic and Monetary Affairs
"Debt, Governance and Growth: A Euro Area Perspective"
Council on Foreign Relations
Brussels, 1 June 2011
Ladies and Gentlemen,
Thank you for your kind invitation to give a talk at the Council on Foreign Relations. It is a great pleasure to be here and share with you some views on the European economy and its governance.
Before turning to the challenges of the euro area, let me begin with a positive note: the economic recovery in Europe is maintaining its momentum and becoming increasingly self-sustaining, despite some financial turmoil and external turbulence. However, developments remain uneven and tensions in the sovereign debt market continue.
It has been clear already for a long time that the current stage of the crisis is a severely intertwined combination of a sovereign debt crisis and banking sector fragilities. It is equally clear that we cannot solve one without solving the other. We need to resolve both, in parallel.
So what have we done to this end? When working on our crisis response, I have greatly appreciated the pertinent advice given by the legendary Bill Rhodes in his recent memoirs on international financial affairs:
"When facing an economic crisis, the clock is always running against policymakers, so they must act rapidly to implement the necessary reforms and programs to avoid further deterioration. Experience has taught that the time is the enemy."
While we may have not been all the time ahead of the curve, we have nevertheless been able to put together a comprehensive crisis response, which has been partly implemented, and is partly still being worked out.
The first essential element of the comprehensive response is to complete the financial repair in Europe. This is why we are currently conducting a new round of bank stress tests, which is carried out across the EU and managed by the recently established European Banking Authority.
The tests will identify pockets of vulnerability in the banking system, and once identified, vulnerable banks must be either restructured and/or recapitalized. EU Member States have committed to put remedial plans in place to that effect prior to the publication of the results.
The other dimension of the crisis is the still cumulating sovereign debt. Even if public debt as a share of GDP is on average lower in Europe than in the US, we are convinced that putting the debt-to-GDP ratios on a downward path is a pressing priority for all EU Members States.
For some EU member states, like Greece, there has simply been no choice to fiscal consolidation. If you are shut out from the private debt market, you need to put your fiscal house in order to regain access to market financing. For other member states, it is obvious – and in fact confirmed by economic modeling exercises – that fiscal prudence is positive for growth and employment in the medium to long run.
The impact of debt on growth can also be looked from another angle. Carmen Reinhart and Kenneth Rogoff have coined the "90% rule", that is, countries with public debt exceeding 90% of annual economic output grow more slowly. High debt levels can crowd out economic activity and entrepreneurial dynamism, and thus hamper growth. This conclusion is particularly relevant at a time when debt levels in Europe are now approaching the 90% threshold, which the US has already passed.
Ladies and Gentlemen,
In Europe we have been forced to take unprecedented and, I dare say, decisive action to contain the crisis and protect the ongoing recovery. It has been a comprehensive policy response combining both short-term firefighting measures and long-term construction of new architecture.
To prevent Greece from defaulting, a loan package with strong conditionality was put in place a year ago. In parallel, we created effective financial backstops to manage potential further problems in sovereign financing that could threaten financial stability in Europe. These mechanisms were put into action for Ireland and Portugal.
We have also decided on the principles of a permanent stability mechanism, which will replace the temporary mechanisms in 2013.
By containing the sovereign debt crisis into the most vulnerable countries, these backstops have helped to prevent the crisis from spreading to a Europe-wide financial turmoil, and thus protected the ongoing recovery.
But the firefighters' job is not over yet. Despite significant achievements in reducing the fiscal deficit since spring last year, Greece is not likely to be able to gain access to market financing by early next year, as foreseen in the EU-IMF program. This calls for difficult decisions still in June.
The Commission, together with the ECB and the IMF, is currently carrying out the fourth quarterly review of the Greek program. Good progress has been made in the ongoing talks in Athens, especially on the two most pressing issues: measures to close the fiscal gap of 2011 and to launch the 50 bn€ privatization program. I am confident that the review can be concluded in the coming days. Once the review is concluded positively, the EU with the IMF will move on to prepare next steps in order to safeguard financial stability and to continue economic reform in Greece.
Ladies and Gentlemen,
I have been asked what has been the main lesson we have learned from the crisis. It is a simple but fundamental lesson: prevention is always better than correction – not to speak of being forced to crisis management.
The financial crisis revealed certain systemic weaknesses in the EU's economic and monetary union. Many countries in the euro area did not use the opportunity of good times in the first decade of the euro to put their fiscal houses in order. When the crisis hit, it exposed those countries where imbalances were large and/or public finances were in a bad shape.
In response, we are undertaking a fundamental reform of EU economic governance. The legislative package proposed by the Commission last fall should be adopted by the Council and the European Parliament in June. It consists of three building blocks:
1. strengthening the Stability and Growth Pact to prevent unsustainable fiscal positions, and correcting such positions promptly, if they nevertheless emerge,
2. introducing a broadened surveillance of macroeconomic imbalances and divergences in competitiveness, with corrective actions recommended if excessive imbalances are identified, and
3. creating a more effective enforcement mechanism, with earlier and more automatic sanctions in the case of violation of the rules.
Some think that EMU stands for 'European Monetary Union'. In fact it stands for 'Economic and Monetary Union'. Now we are to strengthen its economic pillar and thus finally bringing a real dose of E into the EMU.
Ladies and Gentlemen,
To conclude, with our comprehensive crisis response we have managed to prevent a financial meltdown and contained the sovereign debt crisis into three countries now covered by the EU-IMF programs. But of course we can not declare any victory yet. The work must go on.
June is a critical month in overcoming the crisis. This calls for bold decisions on completing the financial repair, reinforcing economic governance and keeping Greece on the reform track.
We may not be fully in the endgame yet, but we can make the coming weeks the beginning of the end of the crisis.
Thank you for your attention.