10 October 2012

Christian Noyer: Remaining challenges facing the euro area

Bank of France Governor Noyer said that the main challenge facing the euro area is to pursue the efforts underway to return to balanced budgets, regain competitiveness and growth, and strengthen economic and monetary union.

I will now explain how the euro area is dealing with the three fundamental causes of the crisis it is facing.

First, the efforts already made on the fiscal front by euro area countries are already bearing fruit: the primary position of the euro area should be close to balance by the end of 2012, which is a remarkable achievement compared to the other major economic areas (Japan, the United States and the United Kingdom will all run deficits of around 9 per cent, 6 per cent and 5 per cent respectively). At the current juncture, this is clearly an asset for us and an element of confidence both for the markets and economic agents, and needs to be further enhanced. In addition to these efforts at the national level, a stronger framework for common discipline has been put in place, which represents a major step forward towards a more integrated economic union.

The legislative package (known as the “six-pack”) which came into force last December considerably reinforces the Stability and Growth Pact: the surveillance powers of the European Commission regarding national budgets have been enhanced, sanctions have become quasi-automatic and the public debt and public spending criteria are being more closely monitored. In addition, the Treaty on Stability, Coordination and Governance puts in place a new “fiscal compact”, notably including the requirement that the annual structural government deficit does not exceed 0.5 per cent of GDP.

Lastly, the institutions that underpin the euro area are in the process of being strengthened extremely rapidly as a result of the crisis.

• I have already mentioned the substantially reinforced fiscal and macro-economic discipline  framework: it needs to be recognised that this is a very important step given the transfers of sovereignty that it represents – we are moving towards a stronger economic union;
• The European Stability Mechanism, whose implementation has been bolstered by the go-ahead given by Germany’s constitutional court and which held its first Board meeting, has a firepower of €500 billion of new money to directly buy government bonds, provide collateral or lend funds. It will also be able to directly lend money to banks in difficulty without increasing the debt of their home countries as soon as the single supervisory mechanism will be in place. It is a powerful crisis resolution tool that Europe has equipped itself with; added to already disbursed bilateral and EFSF loans and to the existing EU facility, the total firepower will near 1,000 billion of USD;
• The work on the establishment of the banking union is moving forward rapidly too.

The Commission’s report that was submitted a few weeks ago sets out a clear framework: all banks in the euro area will quickly become subject to a single supervisory mechanism under the authority of the ECB. Day-to-day supervision will be performed by the national supervisors, in accordance with the principle of decentralisation that has already proved its effectiveness in the implementation of the single monetary policy within the Eurosystem. The principle underlying this single supervisory mechanism is that the severity of the crisis in the euro area has largely been due to the vicious circle that developed between banking and sovereign risk. To break this link, we need to have a genuine institutionalised banking union that ensures not only the same supervision throughout the euro area, but also identical rules, an integrated bank crisis resolution mechanism, and a common deposit guarantee scheme. We are moving towards the banking and financial union that was missing from monetary union.

It is clear that the ultimate responsibility for exiting the crisis lies with governments, at national level – implementing reforms, consolidating public finances and restoring competitiveness – and at the collective level – agreeing on and implementing a more coherent and comprehensive institutional framework around monetary union. These reforms are obviously – and fortunately – the fruit of a democratic process and can only be that. But the corollary to this is that these necessary reforms cannot be immediate: they take time, first to be implemented and then to yield their effects. And the time of the markets is not that of democracy, as you know. Doubts and delays create nervousness, volatility and worry in financial markets, which often leads to sharp rises in interest rates for countries deemed to be vulnerable.

The Eurosystem has decided to take firm action when it considers that these interest rates do not reflect a genuine credit risk differential, but rather unfounded fears about the reversibility of the euro. Because at that point, the effectiveness of the single monetary policy is clearly jeopardised: the key interest rates that we set no longer feed through to the real economy in the same way in all countries via the bank lending channel – which is a crucial channel in the euro area given the predominance of intermediated financing. In order to fulfil our mandate of maintaining price stability, our monetary policy impulses need to be transmitted homogeneously across the whole area. This is why we decided to create a new instrument: Outright Monetary Transactions. The idea is to have a credible backstop to counter unjustified increases in sovereign yields. This backstop must naturally be accompanied by strict conditionality to guarantee that the country concerned makes effective progress towards a more robust economic situation.

By means of this new tool, as with all of the other tools that we have deployed since the start of the crisis – in particular the measures to support bank liquidity – the Eurosystem is endeavouring to relieve the pressure from the markets which may undermine the ability of countries to implement the reforms embarked on, and which may eventually jeopardise price stability. We shall continue to take all of the necessary action to fulfil our mandate and contribute, within this framework, to the success of this tricky but necessary period.

Full speech

© BIS - Bank for International Settlements