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10 July 2011

Lorenzo Bini Smaghi: European democracies and decision-making in times of crisis


Bini Smaghi argued that in today's sophisticated financial markets, deferring decisions creates uncertainty, entails substantial costs and may undermine the political cohesion of the European Union.

Bini Smaghi presented the following key issues:

• First, it increases uncertainty in financial markets about the course that will ultimately be followed. This explains why spreads have systematically increased when decisions were postponed, even when clear deadlines were set.

• Second, the longer a decision is delayed, the more unpalatable it ultimately becomes, as the action required to calm the markets and to restore stability has to be even stronger. This applies not only to the measures which are needed to correct the budgetary imbalance but also to the size of the financial package required to support the country which no longer has market access. An example: if Greece, and the Eurogroup had not waited until May 2010 to address the crisis but had done so several months earlier, the fiscal adjustment would probably have been milder, market access would not have been so impaired and the size of the financial support by the other countries would have been smaller.

• Third, by putting off difficult decisions until the very last moment, interim or partial solutions tend to be adopted instead of more lasting ones. Crises then drag out as one quick fix gives way to another without the underlying weakness being addressed. An example: last year's less-than-stringent stress tests in certain euro area countries failed to take account of concerns about the robustness of the financial sector, so the exercise is being repeated this year.

• Fourth, as the sequence of quick fixes proves to be ineffective in getting to the root of the problem, reform fatigue starts to spread and people become less willing to accept increasingly unpalatable measures. The result is a blurring of the difference between the negative but short-term impact of the necessary adjustment on the one hand, and the disaster which would result from inaction on the other. This in turn increases the risk of taking the wrong – irrational – decision. The narrow vote in favour of the adjustment programme in Greece at the end of June 2011, amid widespread protests and with strong opposition in parliament, illustrates this risk.

• Fifth, if people do not realise how close they are to the abyss, and thus do not support the adoption of the unpalatable decisions, policy-makers have to make them aware of the risks by appealing directly to them, which may in turn frighten and unsettle the markets. For example, in May 2010 the claim that the euro was at risk, which was made in countries like Germany to justify the creation of the European Financial Stability Facility, added to market turbulence and may, over time, cause citizens to lose confidence in their currency.

Full speech


© ECB - European Central Bank


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