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Vice-President of the European Commission and member of the Commission responsible for Economic and Monetary Affairs and the Euro
Moving Europe out of the crisis
Initiative Neue Soziale Marktwirtschaft (INSM): Symposium and farewell ceremony in honour of Professor Hans Tietmeyer: "Social Market Economy for Europe"
Frankfurt, 1 July, 2013
Sehr geehrter Herr Professor Dr. Tietmeyer, sehr geehrter Herr Kannegiesser, meine Damen und Herren,
Herzlichen Dank für die Einladung zu diesem hochrangigen und wichtigen Symposium. Es hat für mich eine besondere Bedeutung, den Tag zu Ehren von Professor Hans Tietmeyer beginnen zu dürfen.
As former President of the Deutsche Bundesbank, he is one of the most esteemed experts on international finance and monetary policy.
My first meeting with Professor Tietmeyer was 20 years ago, although I don’t expect him to remember that, as I was part of a larger delegation. At the time, I was a member of the Finnish Parliament and Prime Minister’s policy advisor. While preparing our country's accession negotiations, the analysis Professor Tietmeyer gave us on the EMU was both intellectually rigorous and policy-wise realistic, even sober.
Ladies and Gentlemen,
I would like to begin with an expression, which I believe has been coined by the Bundesbank, and that is the word Stabilitätskultur, stability culture.
Initially, this term was confined to describing the broad social acceptance of delegating monetary policy away from political powers to an independent central bank. In full respect of the independence of the ECB and in my view as an economist, monetary policy has lived up to this culture. Price stability is firmly anchored, as results and forecasts show.
Of course, monetary policy is not done in a vacuum, but rather it is a reflection of the values and experiences of a nation. Let me here recall the words of Joseph Schumpeter: "Der Zustand des Geldwesens eines Volkes ist ein Symptom aller seiner Zustände." ["The condition of the monetary system of a nation is a symptom of all its conditions."]
I would paraphrase Schumpeter by saying that what goes for a nation, goes today as well for Europe, with our Economic and Monetary Union. What, then, is the condition of Europe’s monetary system, and more broadly, its economy and economic policy?
We have different time-spans in different policy dimensions. In the short term, we have needed the stabilisation of financial markets to avoid the immediate freefall of our economy. In the medium term, the rebalancing of the eurozone economy is on its way and economic reforms are being pursued to restore foundations for sustainable growth and job creation. For the long term, the architecture of EMU is being re-built.
Let me touch these in turn, starting with the short-term stabilisation. The ECB's announcement on Outright Monetary Transactions, together with the European Stability Mechanism, which is now operational, has greatly helped to anchor financial stability and to reduce the risk of extreme events in the European economy. Compare this to last year, when there were concerns in financial markets that the euro could disintegrate. Thankfully, such fears have now been dispelled.
It has to be underlined that that the OMTs would come with clear policy conditions, such as a credible fiscal strategy and growth-enhancing reforms. These stand at the beginning of the causality chain, which may facilitate the use of OMTs, if they were needed.
Yet, the stabilisation of financial markets, though welcome, is not enough alone. Even if stress in financial markets has been significantly reduced, the impact has not yet been felt in the real economy. There are still major divergences in growth the euro area, and there is an unemployment crisis in many EU member states, as we are painfully aware. Growth in Europe will only slowly pick up in the second half of this year.
But this is no ordinary downswing. In a number of European countries, the protracted recession is 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 – has been reduced in the overall economy.
In the first decade of the Economic and Monetary Union, the financial markets integrated rapidly with the euro and with the easy credit conditions in the global financial industries. However, in some Member States, this was associated with mounting macroeconomic imbalances, growing financial risks and, ultimately, asset price bubbles.
When credit risk suddenly changed in the wake of the financial crisis, immense pressures arose to restore the loss in competitiveness and to rebalance the current account – especially in the deficit countries.
In other words, this is no ordinary cyclical downswing precisely due to the massive misallocation of resources in the previous decade, and this is why we now face profound structural problems in Europe.
And this relates to the requirements for adjustment capacity within a monetary union. What we have learnt, if we did not know it before, is that price stability and output stabilisation alone are not enough to guarantee sustained macroeconomic stability. What is crucial in a monetary union is the capacity for real economic adjustment, a point that many forgot during the first decade of EMU. This now costs dearly in both economic and social terms. Professor Tietmeyer warned of this early on.
Therefore, the EU has constructed the macroeconomic imbalances procedure as a second building block of the reinforced economic governance, side-by-side with the fiscal policy surveillance. We have done in-depth reviews of economic imbalances of over dozen member states, which formed the backdrop of our policy recommendations we presented in the end of May. I will return to this shortly.
Before that, let me focus on the question of symmetry of economic adjustment. It has been argued that the necessary economic rebalancing could be engineered in a symmetrical way between current account surplus and deficit countries. However, the reality is more complex.
The main reason for this is that the eurozone is not a large closed economy, but a large open economy. To give you a familiar example, Germany's current account surplus is by now largely determined by trade with non-euro area countries, especially emerging economies.
A Commission study 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.
This reflects the structural shifts in global trade in the past two decades: with the enlargement of the EU, 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 European industry arose from trade liberalisation, in particular China's accession to the World Trade Organisation in 2001.
These global shifts affected the euro area in an asymmetric way. The central and eastern European countries have been integrated into the value chain of Europe's economic engine, Germany more than southern European economies, although there are regional differences.
Consequently, Europe has to pursue its structural change by capitalising on the global economy. In this respect, I very much welcome the launch of negotiations for a Trade and Investment Partnership with the US.
It is true that current account surpluses can be a sign of competitiveness. But there is another side of the coin as well: they also mean that domestic savings are invested abroad.
Our study I referred to earlier shows that Germany suffered large valuation losses on its foreign assets in recent years. Last week's study by the economic research institute DIW Berlin draws similar conclusions. The DIW study shows that if the investment rate in Germany had been as high as the euro average in the last 15 years, growth in per capita income would have been 1 pp higher annually.
In the same vein, the recommendations we made to Germany on 29 May include sustaining the conditions that enable wage growth to support domestic demand. This calls for making better use of its labour force, including enhancing women’s participation in work, continuing efforts to speed up the expansion of the national and cross-border electricity and gas networks, and stimulating competition in the services sectors, including professional services, to boost domestic sources of growth.
Ladies and Gentlemen,
The future of the Economic and Monetary Union relies on further policy action continuing over the coming years to build a strong EMU 2.0 that will help generate growth and create jobs for our citizens. Emerging from the crisis calls for action on at least three fronts: the real economy, the financial industry and the public sector.
First, resolving the crisis requires structural solutions. Tackling the capacity for real economic adjustment, the structural problems and the erosion of economic competitiveness is at the core of the policy recommendations the Commission gave to Members States on 29 May, and which EU leaders endorsed last Friday.
The breathing space provided by the slower pace of fiscal consolidation, which we recommend to several countries, should be used effectively for economic reforms e.g. in product and labour markets 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.
Accordingly, the two largest eurozone economies, Germany and France, hold the keys in their hands towards a smoother and more effective rebalancing of the European economy. In a nutshell, this calls for competitiveness-supporting economic reforms in the labour market, entrepreneurial conditions and pension system in France, and meanwhile structural measures to further reinforce domestic demand in Germany. This is in fact what the Commission has just recommended to these countries. If Germany and France together can together achieve this, they do a great service for the entire eurozone by providing stronger growth, creating more jobs and reducing social tensions.
I am of course fully aware that the necessary reforms often require persuasion and perseverance from the policy makers. The courage and foresight that helped Ludwig Erhard to produce the German economic miracle based on the free market will be needed in today's Europe.
Let's recall when Ludwig Erhard was confronted by General Lucius Clay, who had been warned by his advisors that Mr. Erhard’s decisions on economic reforms were a terrible mistake. “Pay no attention to them”, Erhard responded, “my advisors tell me the same thing”. Perhaps we may yet to see the same kind of conviction and leadership in Europe!
By the way, we do have pertinent recent European examples of economic reforms paying off. Apart from Ireland, Latvia is a case in point.
You may recall that this time last year, the talk of the town and among the market forces was a potential break-up of the euro. There were wild rumours about a “Grexit” and even wilder ones about a “Fixit”.
True, on the 1st of January next year, the euro will not have 17 members any more – it will have more members, not less. I am referring to Latvia, which will become the 18th member of the euro following its impressive economic turnaround that has been achieved through the determination in economic reforms and fiscal rigour, and the country has moved on from receiving financial assistance to achieving sound rates of sustainable growth.
My second point is that the necessary structural change has to be financed. Economic rebalancing is still being held back by vulnerabilities in the banking sector and by deep distortions in the credit channel. While the sovereign risk has to a large extent receded, the monetary transmission mechanism remains impaired in Europe and the credit conditions suffer from financial fragmentation.
We are building the regulatory architecture for Europe's integrated financial market. Let's not forget the progress we have already made. The single supervisory mechanism was agreed less than a year after the idea was put on the table. The Commission will shortly make a legislative proposal for a single resolution mechanism as its natural complement. This will consist of a single resolution authority and common resolution fund, which will be financed through levies of the sector itself.
Another important feature of the banking union is the possibility to directly recapitalise banks through the European Stability Mechanism. Two weeks ago, the Eurogroup agreed on the principles and rules for a direct recap instrument, and the ECOFIN Council reached broad agreement on the tools for the resolution of failing banks.
The banking union is essential to reverse the process of financial fragmentation in Europe, thereby preserving the integrity of the single market, and ensuring proper financing of structural change.
Clearly, the banking union will not be completed overnight. That's why we are taking action to bridge current weaknesses of the banking sector, so as to ensure that the financial sector will be able to resume its proper function and thus channel savings to the most productive uses to support adjustment and recovery in the real economy.
Compared to Europe – and to Japan – the United States managed to undertake a relatively immediate and massive repair of its banking sector and financial system, which most economists assume played a more important role than fiscal policy in containing the crisis and restoring confidence. In Europe we have done a lot, but we still have much work ahead of us to complete the financial repair.
That's why, on 29 May, we recommended to the euro area to ensure that the single supervisory mechanism and the European Banking Authority carry out rigorous asset-quality reviews and stress tests in the next 6-12 months. It is crucial to complete the repair of the credit channel – as the European economy is bank-based – but it is equally essential that the lending is channelled to the most productive uses.
Another example is the €10 billion capital increase of the European Investment Bank, which is now effective. Consequently, the EIB’s lending mandate for 2013-15 is 40%, which is mostly directed towards the SME finance, innovation, infrastructure and green growth.
This brings me to my third point, public finances. The public and private excesses of the last decade mean that public debt in the euro area has reached a level above 90% of GDP. But a fact that is easily forgotten is that the fiscal deficit in the euro area has been reduced from over 6% of GDP in 2010 to below 3% this year. Fiscal policy now has a credible framework and consistent consolidation needs to continue, with the focus on structural sustainability of public finances over the medium-term.
The reinforced economic governance is now being implemented. With these important reforms, the options for further fiscal integration have been exhausted under the current Treaty on European Union.
Last November, the European Commission published its Blueprint towards a deep and genuine Economic and Monetary Union, which sketched out further elements, timelines and conditions for further economic and fiscal integration. 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 in economic and fiscal policy.
Ladies and Gentlemen,
All in all, the economic and financial crisis has clearly taught us that the stability culture has to go beyond monetary policy and beyond fiscal policy. I am particularly referring to a sound micro- and macro-prudential policy for the financial sector, as well as to the prevention of harmful macroeconomic imbalances and to the pursuit of structural reforms as enabling policies for a stable monetary union. In the end of the day, having a set of stability rules is not the same and does not yet amount to as having a stability culture. This is more than simply a semantic remark.
A culture of stability means not only having a framework of norms and rules that contribute to fiscal and financial stability. Culture also means that we all make the rules our own. Of course, the sinners among the euro area countries are well known but, in this regard, it is healthy to remind ourselves of the German-French episode soon a decade ago.
Even today, it is perplexing for the Commission to, on the one hand, hear 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 embedded in a stability culture will not emerge overnight.
I welcome the fact that the European Council has just confirmed that the EU Institutions will remain the backbone of any steps towards further integration, so that it is both effective and inclusive to all member states.
At the same time, progress cannot be achieved unless it is done through a profoundly democratic process, both at national and at European level. Our citizens expect – and accept – nothing less.
Ladies and Gentlemen,
This brings us to the origins of the European economic model and the need for a renewed social market economy. The EU’s common economic strategy is all about reforming the European economic and social model.
Not somehow nostalgically clinging to the status quo, since that would only lead to a permanent economic decline of Europe.
Not dismantling the European model, because we believe in the combination of stability culture, entrepreneurial drive and social justice.
But, instead, genuinely reforming and modernising the social market economy, for the sake of sustainable growth and job creation.
I count on today’s conference giving a valuable contribution to that goal. I am especially looking forward to Professor Tietmeyer’s insight as this subject has been close to his heart over the decades. I wish him all the best for his future.