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17 July 2012

Luis M Linde: Assessment of Spain’s economic situation


Testimony by Mr Luis M Linde, Governor of the Bank of Spain, before the Parliamentary Committee on Economic Affairs and Competitiveness where he spoke about the situation of, and outlook for, the Spanish economy, as well as the forthcoming reforms.

The Spanish crisis has a home-grown component, whose origins lie in the expansionary phase that followed the 1992–1993 crisis and which ran until the outbreak of the current crisis in the summer of 2008. During this expansion, severe macro-economic and financial imbalances built up, essentially a marked deterioration in competitiveness and excessive debt. Heavy corporate and household debt (routed through Spanish credit institutions which, in turn, had to resort to external borrowing to obtain the funds needed) left the Spanish economy potentially exposed to the global financial instability and to the instability of the euro area.

Our public finances benefited during this stage from exceptional revenue growth, which detracted from the effort to contain domestic demand. This all took place, moreover, in very accommodative financial conditions, i.e. with very low or indeed negative real interest rates at times, owing to the policy then pursued both by the US Federal Reserve and by the European Central Bank. This growth in public revenue would ultimately prove unsustainable, meaning that the recession resulted in a serious fiscal crisis, precisely when events in Europe would lead analysts and the markets to focus on the sustainability of public finances.

The Report stresses that this situation requires an economic policy that redresses the financial position of all sectors – households, firms, general government and financial institutions – and corrects the malfunctioning of certain institutions which hamper adjustments and affect competitiveness.

The three pillars that should underpin this economic policy strategy are an ambitious process of fiscal consolidation and public saving; the pushing through of reforms to enhance efficiency and competition in the sectors least exposed thereto; and, of course, the restructuring and reform of our banking system and its regulations.

The “Institutional Protection System” mechanism, the so-called “cold mergers”, a means of integration which sought to avoid or circumvent the political difficulties posed by regional governments, and other difficulties posed by the banks themselves, in the face of savings bank merger and integration processes that were deemed advisable. “Cold mergers” were accepted with the aim of promoting certain processes that could allow the sector to be rationalised and improve the efficiency of specific savings banks; clearly, however, their final effect was not very positive and contributed rather to delaying decisions and adjustments. Another example lies in countercyclical provisioning, which the Banco de España was obliged to abandon, if not in full, at least in part. The Banco de España was, indisputably, a pioneer in the introduction of this measure which would be classified today as a macro-prudential policy tool. At the time, the measure was criticised by the international financial community because it was not readily compatible, it was said, with accounting rules, and because it ran counter to the separation of macro and regulatory policies then advocated. And it was also criticised, we should recall, by Spanish banks, since it was understood that it damaged or could damage their competitive position.

From today’s standpoint, many would agree that the main shortcoming of that regulation was its timidity and its insufficiency to rein in excessive credit growth, and that we would all have come out winning had it been maintained and applied across the board, as the Banco de España had argued at the start of the new millennium, and had it been made even more demanding. In sum, the Banco de España was considered to be unorthodox at the time. But today we know that it should have been even more unorthodox in using its regulatory and supervisory powers to mitigate the vulnerability of our financial system.

Full speech



© BIS - Bank for International Settlements


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