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15 December 2011

Mario Draghi: The euro, monetary policy and the design of a fiscal compact


Mr Draghi elaborated on the motivation for the monetary policy measures that the ECB announced last week, and he shared some views on the last European Council summit's decisions which he said brought important new elements to the economic and monetary union.

Banks in the euro area have recently come under pressure both as regards their capital bases and their funding conditions. The plan to strengthen their capital bases is an attempt to reinforce their standing in financial markets, but this is not an easy process. There are essentially three options for banks to pursue to raise their capital ratios as demanded by the European Banking Authority: they can raise their capital levels, sell assets or reduce their provision of credit to the real economy.

The first option is much better than the second, and the second option is much better than the third. But raising capital levels is expensive in a depressed market and faces resistance from shareholders. Selling assets is less preferable and curtailing credit to the real economy is even worse. Therefore, public authorities ought to cushion the impact on the real economy and banks should consider restraining dividends and ad hoc compensation to strengthen buffers.

Foundations for a stable economic and monetary union

We have now begun the process of re-designing Europe’s fiscal framework on three fronts.

The first lies with the countries concerned: they have to put their policies back on a sound footing. I believe that they are now on the right track and they are right in implementing budgetary consolidation resolutely. The unavoidable short-term contraction may be mitigated by the return of confidence. But in the medium term, sustainable growth can be achieved only by undertaking deep structural reforms that have been procrastinated for too long. The  second pillar of a response to the crisis consists of a re-design of the fiscal governance in the  euro area, what I called the fiscal compact. The fiscal compact is a fundamental restatement of the rules to which national budgetary policies ought to be subject so as to gain credibility beyond doubt.

Last week’s summit committed to enshrine these rules in the primary legislation. They will foresee that the annual structural deficit should not exceed 0.5 per cent of nominal GDP. Euro area Member States will implement such a rule in their national legal frameworks at a constitutional level, so that it is possible to avoid excessive deficits before they arise, rather than trying to control them after they have emerged.

Rules will also foresee an automatic correction mechanism in case of deviation. Moreover, the leaders agreed on a numerical benchmark for annual debt reduction to bring down debt levels. They also agreed to sanctions that will apply automatically to euro area Member States in breach of the 3 per cent reference value for deficits.

The European Court of Justice may be asked to verify the implementation of these rules at national level. Taken together, I believe that these decisions are capable of making public finances in the euro area credibly robust.

Full speech



© BIS - Bank for International Settlements


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