23 June 2013

ECB/Asmussen: The global crisis - Lessons for international policy cooperation

"As the sense of urgency imposed by the crisis vanishes, the risk is that complacency slows down reforms, while the road that lies in front of us is still long. But the decision to complete the global reform agenda through enhanced international cooperation is entirely in our hands."

Does the crisis call for a substantial change in the approach to international policy cooperation? My answer is yes, for the following three reasons:

First, the world has become more interconnected and shocks are transmitted more rapidly across countries. Consider the following figures on global financial integration:  Total foreign assets and liabilities of advanced economies rose from 68 per cent of GDP in 1980 to almost 450 per cent of GDP in 2010. The synchronisation of a severe economic and financial downturn, after the failures of major financial institutions in 2008, is a stark reminder of the significant interdependence of our economies. In 2009, 40 out of the 50 largest economies in the world experienced severe recessions.

Second, we need a new approach to international cooperation because the potential sources of shocks have multiplied. Alongside domestic shocks, countries are now more exposed than in the past to external financial shocks and global shocks to confidence. Keeping one’s “house in order” is no longer sufficient to fully insulate domestic economies from these shocks.

Third, we need a new approach to international cooperation because the crisis has unveiled structural vulnerabilities in the global economy. In particular, our current institutions were designed for the economic system of the 20th century. They are not suitable for the global challenges of the 21st century. Global economic cooperation is needed to design better institutions.

For these three reasons, we have to take the crisis as a serious opportunity to tune global policy-making to today’s interconnected world.  Let me first identify past mistakes by considering the main vulnerabilities unveiled by the crisis, both at the global and European level. On the global front, the crisis mainly revealed the existence of global economic governance failures and weak surveillance mechanisms.

Global imbalances led to the accumulation of fragilities in the global financial system and to unsustainable global macroeconomic outcomes. While financial sectors became increasingly international, supervision and regulation remained largely national in scope and only loosely coordinated at the international level. This encouraged regulatory arbitrage, the creation of large, complex financial intermediaries, and poor risk management practises.

Several of these features also characterised our European continent. The crisis revealed fragilities in the governance, surveillance frameworks and financial architecture of the euro area.

The rules and governance framework associated with the Stability and Growth Pact were not sufficiently enforced and, therefore, respected. Efforts to promote structural reforms, for example under the Lisbon Agenda, were weak. As we know now too well, macroeconomic imbalances within the euro area grew unabated. Competitiveness developments across Member States diverged to an unsustainable extent.

For instance, a harmonised indicator of price competitiveness shows that between 2000 and 2008 Germany became almost 20 per cent more competitive in real terms vis-à-vis the rest of the euro area average. Over the same period, price competitiveness decreased by around 10 per cent in Italy and Spain vis-à-vis the euro area average.

In addition, despite the unprecedented level of financial integration in the euro area, banking supervision remained domestic. Cross-border resolution frameworks, in turn, did not reflect the increasing complexity and interconnectedness of the European banking system.

Overall, inappropriate policies in one country in the euro area could create negative externalities for other euro area countries, and possibly destabilise the monetary union as a whole. The crisis hence revealed that the euro area needs much stronger mechanisms to correct inappropriate domestic policies. It also revealed that the euro area’s ability to absorb shocks, especially asymmetric ones, and its frameworks for crisis management and resolution need to be significantly strengthened.

An essential lesson from the crisis is that the Economic and Monetary Union is an incomplete project. The “Four Presidents'” Report outlined the necessary steps to move towards a genuine monetary union, which I strongly support.

First, we need to complete with great urgency the banking union. We need a clear and transparent assessment of the conditions of the banking system (“asset review”) before the Single Supervisory Mechanism takes over. We also need a strong commitment towards an effective Single Resolution Mechanism (SRM) which is an indispensable element of the banking union and a necessary complement to the SSM. The SRM would allow for a smooth winding down of banks, especially those with large cross-border activities. It needs to entail both a strong Single Resolution Authority (SRA) as well as a Single Resolution Fund (SRF). The latter should be financed with ex-ante risk based levies on the banking sector. These arrangements would enhance the credibility of the system and ultimately break the link between banks and sovereigns.

Second, we need to further strengthen and integrate our economic governance frameworks to make our economies more competitive and resilient to asymmetric shocks. One front on which European governance can greatly improve relates to structural reforms. Ultimately, structural reforms benefit the many at the expense of the few. A recent OECD Report called this the “Double Dividend” of structural reforms: they increase growth, and if implemented properly, decrease inequality.

One way to create incentives for Member States to engage in structural reforms could be the provision of temporary financial assistance to alleviate the short-term costs of reforms, in exchange of a contractual agreement to complete them. The contract would entail clear goals in line with EU policies and measurable targets. These contracts could be useful in several instances, especially in the presence of “reform and bailout fatigue”, and constrained public finances.

Third, the increasing level of integration within Europe calls for a new institutional design to ensure legitimation, accountability and democratic control. On the one hand, Governments should ensure that national parliaments are appropriately informed and involved in decision processes. On the other hand, national parliaments are often not in the best position to incorporate the EU common interest in their decisions. Therefore, European institutions should be strengthened, in particular the European Parliament which could maybe also convene in a euro area format. This would ensure that the level of accountability matches the level at which decisions are taken.

Full speech

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