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European Commission

Olli REHN

Vice-President of the European Commission and member of the Commission responsible for Economic and Monetary Affairs and the Euro

Keynote speech by Olli Rehn at the Brussels Economic Forum

Brussels Economic Forum 2013

19 June 2013

Distinguished speakers, Ladies and Gentlemen,

Let me welcome you to the 2013 edition of the Brussels Economic Forum. I am delighted about the large participation in this forum that focuses on the future of our Economic and Monetary Union. But before I turn to the future of EMU, let me say a few words on its current condition.

When we met here last year, there were serious concerns that the euro could disintegrate. A tail risk, perhaps, but certainly something that was in many people's minds, or at least in the minds of the market forces.

One year later, that tail risk has disappeared. I can see three reasons for this.

First, financial stability is now credibly anchored. The European Stability Mechanism is operational, and with the ECB's announcement on Outright Monetary Transactions, it has helped to stabilise the financial and bond markets.

Second, the rebalancing of the European economy is underway. Current account imbalances of the euro area have been significantly reduced. The EU's policy mix is focused on sustainable growth and job creation. Monetary policy is accommodative and will remain so. In fiscal policy, consistent consolidation of public finances will continue, though with a slower pace in the current economic context, while ensuring the medium-term sustainability of public finances.

Third, serious steps of deeper integration have been taken, from the reinforcement of economic governance to the Single Supervisory Mechanism of euro area banks. And more is to come.

And in six months' time, far from having fewer members, the euro area will have more members. I am referring to Latvia, a former programme country, which has shown an impressive economic turnaround over the last two years.

At the same time, we are of course not yet out of troubled waters. Stress in financial markets has been significantly reduced, but this has not yet transmitted much into the real economy.

Europe is only gradually emerging from the crisis, with growth slowly picking up in the second half of this year. Moreover, the divergences in the euro area remain large, and unemployment is at record highs in many countries, as we are painfully aware.

When designing economic policy today and for tomorrow, we must take into account the lessons learnt from the early to middle period of the present crisis. At the outset of the crisis in 2008 to 2009, fiscal stimulus to increase aggregate demand was a central pillar of the crisis response in Europe and elsewhere. It did mitigate the ramifications of the crisis, but could not prevent a rapid rise in public debt. In the European Union the level of public debt increased from the pre-crisis average of 60% five years ago to around 90% of GDP today, both because of the impact of the crisis itself and because of the fiscal stimulus.

In the United States, most economists assume that the Federal Reserve's decisive monetary policy action and the Treasury's rapid and robust resolution of the vulnerabilities in the banking system played a more important role than fiscal policy in containing the crisis and restoring confidence, especially as the main impact of fiscal stimulus was felt from 2010 onwards.

Compared to Europe, the United States also succeeded better in undertaking a relatively immediate and massive repair of its banking sector and financial system. In Europe we have done a lot, but we still have much work to be finished in order to complete the financial repair and restore confidence.

How about the Japanese experience then? Does a balance sheet recession automatically lead to a Japanese scenario of two lost decades? I believe there is no uniform interpretation of the Japanese experience. One view is that the private debt overhang should be countered by massive stimulus. The contrasting view is that Japan failed to restructure the banking sector – and to restructure the corporate sector.

This leads to the question for European policymakers: where do we stand with the completion of the financial repair and structural change in the real economy in Europe?

The protracted recession is, in a number of European countries, a balance sheet recession at the end of a very long credit cycle. Economic growth will not fully resume before debt – both public and private debt – has been reduced in the overall economy. In turn, the necessary economic rebalancing and structural change is hindered by the vulnerabilities in the banking sector and by the deep distortions in the credit channel.

It has become clear that this is no ordinary cyclical downswing. Instead, we face profound structural problems in Europe, largely stemming from the misallocation of resources as a consequence of the large and unsustainable macroeconomic imbalances in the previous decade: the credit booms, the debt-fuelled real estate bubbles and the public sector overexpansion in many Member States.

Tackling these structural problems and the erosion of economic competitiveness is at the core of the policy recommendations the Commission gave to the member states on 29 May.

The breathing space provided by the slower pace of fiscal consolidation, which we recommend to several countries, should be used effectively for economic reforms that can unleash Europe's growth potential and capacity to create jobs. This is crucial for France, Italy, Spain, Belgium and many other Member States. Giving more time for certain Member States to meet their agreed objectives in fiscal policy should enable them to accelerate efforts to carry out overdue reforms.

Ladies and Gentlemen,

Against this background, we will discuss the future of Economic and Monetary Union from three angles today: the real economy, the financial sector, and the public sector. All three have played a role in generating the current crisis. In all three areas, further policy action is necessary over the coming years to achieve a strong EMU 2.0 that will help generate growth and jobs for our citizens. Let me address each in turn.

The capacity for real economic adjustment, the main theme of the first session, is fundamentally important in a monetary union. This is by no means a new insight, but it was not given sufficient weight when EMU was launched, which now has a very high cost in both economic and social terms.

In the first decade of EMU, the financial market integrated rapidly with the euro and with the loose credit conditions in the global financial industry. But the imbalances that were built up during that time were in non-tradable sectors. And because goods, services and labour markets were less integrated than financial markets, price developments could diverge substantially, which became one of the origins of the present crisis in Europe.

These large divergences of unit labour cost were not sustainable, and when credit risk suddenly changed in the wake of the financial crisis, immense pressures arose to restore the lost competitiveness and to rebalance the current account, especially in the deficit countries.

It has been argued that this economic rebalancing could be engineered in a symmetrical way between surplus and deficit countries. However, the reality is more complex.

Why so? Mainly because Europe is not a large closed economy, but a large open economy. To give one example, Germany's current account surplus is nowadays largely determined by trade with non-euro area countries, especially emerging economies in Asia or Latin America. Similarly, our extensive study on current account surpluses last December found that increases in Germany’s domestic demand would not necessarily benefit all the euro-area countries to the same extent: the positive impact on growth would mostly be felt in its neighbouring countries rather than in the euro area periphery.

This reflects structural shifts in global trade in the past two decades: with the enlargement of the European Union, countries with a well-educated labour force but significantly lower labour costs became part of the single market. This change opened up opportunities and increased competition. Similar pressures for EU industry arose from the liberalisation of world trade, in particular following China's accession to the WTO in 2001.

These global shifts affected the euro area in an asymmetric way. The product mix and industrial structures in euro area countries have reacted differently to the rise of the emerging market economies. Moreover, the central and eastern European economies have been integrated into the value chain of Europe's economic engine, Germany, clearly more deeply than the economies of southern Europe have done, even though there are significant regional differences in these countries.

Consequently, it is evident that Europe has to pursue its structural change by capitalising on the global economy. It is not least the challenge – but even more the opportunities – from trade and global competition that calls for economic reforms and puts pressure on rent-seeking societies. That the trade negotiations with the US can now be opened is of paramount importance from this standpoint.

I am therefore particularly delighted that Pascal Lamy has agreed to deliver the key lecture of today. Martin Jahn, who will open the first panel, will bring his experience to the discussion about the success of the central and eastern European countries, but also the hard choices they had to make.

Moreover, structural change has to be financed. This is why today's second session focuses on the banking sector, on which Europe still depends – too much, one could say. While sovereign risk has receded, the monetary transmission mechanism remains impaired and credit conditions suffer from financial fragmentation.

We are now building the regulatory architecture for Europe’s integrated financial market. In less than a year after the idea was put on the table, the single supervisory mechanism was agreed.

Now the focus is on the second pillar, the single resolution mechanism, which is the natural complement to the SSM. It should consist of a single resolution authority and common resolution fund, financed through levies on the sector itself.

The banking union is essential to reverse the process of financial fragmentation in Europe and, thus, to preserve the integrity of the single market in the EU for financial services.

The possibility for direct recapitalisation of banks by the European Stability Mechanism is another important feature of the banking union that we are building. I expect the Eurogroup to agree on the principles and rules of a direct recapitalisation instrument for the ESM tomorrow.

The banking union will not be completed overnight. That's why we are taking action to bridge the current weaknesses of the banking sector, for example with the capital increase for the European Investment Bank, which is now effective. But these weaknesses must be addressed directly as well, if the financial sector is to resume its functions and to channel savings to the most productive uses to support adjustment and recovery.

And that's why, on 29 May, we recommended to the euro area that it ensure that the single supervisory mechanism and the European Banking Authority conduct asset quality reviews and stress tests. Rigorous reviews and credible tests, as planned for early next year, are crucial for a successful outcome.

The banking union is not about bailing out bankers, it is about getting a banking system that serves the real economy. In this regard, the Commission is further pursuing the proposals on structural separation made by the high level group chaired by Governor Liikanen. I am very pleased that he could join us today and he will introduce the subject and recommendations in the second panel.

Today's forum will close with a third session on fiscal union. Over the last years, the Stability and Growth Pact has been put on a much sounder foundation.

The rules are applied so as to take country-specific differences into account, as we have done on 29 May at the close of the third European Semester, with the focus on structural sustainability of public finances over the medium-term.

With the recent reforms, the options for further fiscal integration have been by and large exhausted under the current Treaty.

The Commission's Blueprint towards a genuine Economic and Monetary Union, published last November, sketched out further elements, timelines and conditions. In our view, the essential guiding principle must be that any step towards increased solidarity and mutualisation of economic risk be combined with increased responsibility and fiscal rigour: that is, with further sharing of sovereignty and deeper integration of decision-making within the eurozone.

Against this backdrop, it is not uncommon for the Commission to, on the one hand, face calls for greater economic and fiscal integration but, on the other hand, be criticised for our well-grounded recommendations on fiscal policy and structural reforms.

This, once again, teaches us that a deep fiscal union will not emerge overnight. We will lose our citizens unless this is done through a profoundly democratic process – and even the best economic ideas must pass this test before they can be realised.

In other words, the first-best world of economic science is not always at our disposal in the second-best world of political reality. That said, there is no need to fall back into the third-best world of intergovernmentalism. The Community method is and will remain the backbone of any steps to further integration, so that it is both effective and inclusive, also keeping on board the smaller Member States. I am sure that Sharon Bowles, who introduces the third panel, will agree with this.

Ladies and Gentlemen,

Behind the Community method stand dedicated Europeans. I would like to warmly thank the staff of the Directorate General for Economic and Financial Affairs for their tireless work for the European Semester. The depth and quality of the analysis is outstanding, and it is a crucial contribution for reforming Europe and creating the foundations for sustainable growth and job creation.

I will soon have to leave for the Commission meeting, which just started and where we will propose to the European Council how to facilitate new lending to productive and innovative SMEs, and we will finalise our Youth Employment Initiative.

This SME initiative should involve a combined use of structural funds from the EU budget and the balance sheet of EIB/EIF, in order to create incentives for new private lending to SMEs. I trust that the European Council will endorse this initiative and thus help redress the financing trap of SMEs, which is currently acting as a major bottleneck of investment and growth.

Before handing over now to Marco Buti, Director General for Economic and Financial Affairs, to introduce Pascal Lamy, let me make some concluding remarks.

Ladies and Gentlemen,

Europe is no longer in intensive care, even though our patient will need surveillance and medication still for some time to come. Our challenge today is to finally beat the crisis and see through the rebalancing and reforms in the European economies.

We need to focus on the competitiveness of our economy, which leans on innovation and skills, embraces the opportunities offered by expanding world trade and boosts productive investment and access to finance, so that our SMEs and industrial base can create jobs and prosperity.

It means staying the course of fiscal consolidation, and it means rebuilding our Economic and Monetary Union.

In fact, this is all about reforming the European economic and social model. Not nostalgically clinging to the status quo, because that would mean a permanent decline. Not dismantling the European model, because we believe in the combination of entrepreneurial drive and social justice. But instead, genuinely reforming and modernising the European model of social market economy. I count this Brussels Economic Forum to give a major input for that work.

Thank you.


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