21 February 2012

Bank of Spain Governor, Miguel Fernández Ordonez: Facing the crisis in Europe

Mr Ordonez said that exiting the crisis will not be possible unless a stronger European governance framework is accompanied by a far-reaching revision of national economic policies, enabling them to be fully adapted to the conditions under which a monetary union can operate.

The diagnosis of the relative role played by national economic policies in the unfolding of the euro crisis is still subject to some controversy. But it would be reasonable to say that the lack of fiscal discipline has been a central factor, given the leading role the debt markets have played in the origin and transmission of tensions. As we learned, the fiscal discipline rules of the Stability and Growth Pact were insufficient to ensure the budgetary rigour needed for the normal functioning of a monetary union without fiscal union, and accorded governments an excessive degree of discretionality. Hence, there was a failure during the expansion years to adopt fiscal measures that would have provided greater room for manoeuvre to face the crisis.

The crisis also highlighted the interrelatedness which, at times of tension, arises between the three sides of the triangle comprising sovereign risk, banking risk and the economic fragility stemming from the build-up of macro-economic imbalances. Once one of these factors is activated, there is a serious danger that feedback loops will be set in train that only exacerbate and deepen the crisis. From this standpoint, the current strains are also attributable to the excessive complacency with which high levels of private debt were run up in several countries during the boom years and which, without the counterweight of sufficiently strict fiscal policies, ultimately led to a series of burgeoning current account deficits.

The relative passivity shown by all economic agents in the face of the build-up of imbalances is also due to excess confidence in the adjustment mechanisms that were assumed to be inherent in the functioning of the euro. For instance, it was assumed that relative price and wage rises and the changes in competitive positions, induced by the demand and spending excesses in those countries showing signs of overheating, would prompt the necessary adjustments to move demand back onto a more sustainable path and to redress the differences in competitiveness.

We now have proof that the effectiveness of this adjustment channel depends on the flexibility of price- and wage-setting processes. Regrettably, virtually no progress was made during the expansion in eliminating the frictions and structural rigidities that distort the operation of labour and product markets in many countries. This lack of reforming ambition has inhibited the functioning of this adjustment channel, leading to the divergences in competitiveness not being promptly corrected.

The list of structural weaknesses in the area’s governance framework would not be complete without mentioning the failure to design any crisis management mechanism capable of making a rapid and forceful response in the initial stages of tensions, preventing the problems from becoming protracted and untreatable.

On the fiscal front, reforms to date have translated into a significant strengthening of the Stability and Growth Pact. Key factors in this reinforcement have been the greater attention to debt ceilings and the establishment of greater automaticity in the procedures to evaluate potential non-compliance and to activate the necessary corrective mechanisms, along with the requirement to revise national legal frameworks.

Elsewhere, the new framework for the prevention and correction of domestic and external macro-economic imbalances has also been designed. This so-called Excessive Imbalance Procedure uses an early warning mechanism based on a broad set of indicators which, together with timely economic analysis, should help detect sufficiently in advance those situations of vulnerability that may endanger financial stability in the euro area and give form to the measures needed to correct them.

Full speech

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