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14 November 2011

Christian Noyer: Europe - a financial crisis, not a monetary one


Mr Noyer recalled the crisis to date and the solutions that have been implemented. He mentioned that the past months have witnessed a succession of serious and complex events, and it is therefore logical that feelings of confusion and uncertainty have developed in society.

Mr Noyer, Governor of the Bank of France and Chairman of the Board of Directors of the Bank for International Settlements, gave a speech entitled 'Challenges and outlook for the global economy' at a press conference in Saint-Denis, Reunion.

How did the first crisis transform into the euro area crisis that has been raging for the past two years? In two words, the answer is public debt. Indeed, the financial crisis of 2008 had far-reaching consequences on the public finances of most countries: tax revenues fell due to declining activity; welfare spending rose due to higher unemployment; stimulus plans had to be implemented and, in many countries with the notable exception of France, the cost of rescuing the financial system was huge. Government deficits in numerous countries increased and their debt exploded. As an indication, the ratio of government debt to GDP of most industrialised countries rose by over 20 points between end-2007 and today, which is very significant.

If the fiscal positions of these countries had been sound before 2007, the situation would be very different today. But most countries had large deficits and high debt levels before the crisis. Creditors started to question the ability of some countries to meet their commitments. Doubts emerged as to the “sustainability” of their public debt, despite the fact that, for decades, markets had considered government bonds to be risk-free or the safest type of asset.

For the past two years, the epicentre of this second episode of the crisis has been in Europe because the first doubts about the sustainability of an OECD country’s public debt focused on a euro area country: Greece.

The financing conditions of a number of other euro area countries have been extremely tight for the past few months, but they have not required bail outs. This is particularly the case of Spain and Italy. Here too, certain economic or political weaknesses along with deteriorated public finances are stoking fears in financial markets, which – I should say in passing – have the unfortunate habit of lumping all players together and always expecting the worst. I would like to stress one point: the current crisis is not a crisis of the euro but a sovereign debt crisis. Moreover, we can see that all the turmoil that has been affecting the economy for the past few years is ultimately due to indebtedness: first, US household indebtedness and then sovereign indebtedness.

Nevertheless, since end-2009, the crisis has revealed major shortcomings in the implementation of fiscal discipline and, more generally, in the economic governance of the euro area. The founders of the single currency had put in place the Stability and Growth Pact because they knew that a monetary union could not work without a common fiscal discipline. Its principles were sound, aiming to achieve a long-term balanced budget. But its implementation was greatly lacking.

I believe that two major mistakes were made:

  • First, countries – including France and Germany – weakened the Pact by failing to comply with the provisions of its preventive arm (they were not in balance over the cycle but permanently close to the 3 per cent deficit ceiling), or those of the corrective arm (they never abided by the sanctions).
  • Second, the euro area did not equip itself at the outset with an instrument for monitoring competitiveness. The basic premise is important and simple: when joining a monetary area whose goal is to achieve a rate of inflation of just below 2 per cent, changes in its unit production costs must be in line with this central bank objective. In all the countries that did not abide by this calculation and this discipline, year after year, there was a loss of competitiveness.

The crux of the matter is that as soon as countries were approved for euro area membership, they considered that they were protected simply because they belonged to a single currency area: as their fiscal or competitiveness gaps were no longer penalised by the markets that indiscriminately lent to all euro area Member States at the same rate. When doubts started to emerge, the markets reacted rapidly, violently and often excessively, although it must be said that real underlying problems existed.

Full speech



© BIS - Bank for International Settlements


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