20 April 2012

Jörg Asmussen: Key issues about the crisis and the European response

Intervention by Mr Jörg Asmussen, Member of the Executive Board of the European Central Bank, at the Centre for Strategic and International Studies, in which he addressed some of the key issues about the crisis and the European response to it.

Is the worst of the crisis over?

In the euro area, survey data confirm a stabilisation in economic activity at a low level in early 2012. We continue to expect the euro area economy to recover gradually in the course of the year. The outlook is supported by strong export growth to the US and emerging markets. Downside risks remain, however, related to a possible worsening of the sovereign debt crisis.

What changed in this time? In my view, the explanation is actions taken at three levels. First, Member States recognised the seriousness of the situation and implemented major reforms. Spain has begun addressing its competitiveness problem with the most significant labour market reform in a generation. It is also improving central control over regional spending. Italy is increasing competition and modernising its public administration to increase its potential growth. The debt exchange in Greece was successful, which gives the country a fresh start to address its fiscal and competitiveness issues. Ireland and Portugal have continued to implement their EU-IMF programmes, which are both on track. Second, Europe  has strengthened its economic governance. Fiscal rules have been reinforced through the agreement on the fiscal compact, which obliges all euro area countries to run a structural balanced budget. It also shifts the onus for enforcement away from Brussels and onto national institutions, encouraging greater ownership. Third, the ECB has played its part by preventing a funding crisis in the banking sector. The two three-year LTROs launched in December and February have eased bank funding pressures and stopped further deleveraging. This should over time support lending to firms and households across the euro area.

These actions have pulled the euro area back from the very dangerous situation we faced last year. But the crisis of public and private debt in some countries is clearly not over. The recent rise in Spanish yields is evidence of this. This is no longer a problem that can be addressed through bigger firewalls or a more active ECB. It can only be addressed through consistent and determined reform, even if it is painful in the short term.

Is the European response to the crisis killing growth?

Certainly, the short-term effects of consolidation can be negative. We recognise this. That is why we always recommend that consolidation is accompanied by productivity-enhancing structural reforms. This means inter alia opening up closed professions, increasing the efficiency of public administration and improving judicial systems. These are reforms that will ultimately benefit the majority of people, by increasing the growth-potential of these economies.

There is one area, however, where I fear we are not learning the right lessons in Europe. Several European countries face a vicious circle where weak domestic banks cause fiscal difficulties for governments, which in turn undermines public debt sustainability and further damages banks’ balance sheets. In the US, such a feedback loop does not exist, because federal institutions act as shock absorbers. They prevent local crises from becoming systemic: for example, banks can be recapitalised through the US Treasury and resolved through the Federal Deposit Insurance Corporation. In Europe we need to look to the US for inspiration in this area. This is why I have called for a European bank resolution authority.

Is the ECB’s response to the crisis swamping the world with liquidity?

ECB liquidity is a very specific form of money. It can be used only to make payments between banks with accounts at the ECB and to meet reserve requirements. There is no automatic mechanism which converts this liquidity into loans or asset purchases. Banks take such decisions based on factors like their financial strength, their risk aversion and the demand for credit by non-financial corporations and private households.

The strongest effect of the LTROs has been on bank funding. Euro area banks issued €55 billion in senior unsecured bank debt in the first two months of this year, more than the whole amount in the second half of last year. This is exactly what the LTROs were intended to achieve: to prevent a bank funding crisis. Over time we expect this to feed into higher credit for firms and households.

So to conclude, the euro area still has a lot of work to do to put itself back on a sustainable footing. This work is difficult because it goes to the root of our economic problems. But it is also essential. Solutions that would paper over these problems by creating more debt are not in Europe’s long-term interest. They would solve this crisis by creating the conditions for the next one.

Full speech

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