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The policy response of the Eurosystem
The primary explanation for the improvement in sentiment over the last few months has been the measures taken by the Eurosystem – that is, we at the European Central Bank (ECB) and our colleagues at the national central banks of the 17 countries that share the euro. As you know, since December last year the Eurosystem has launched two long-term refinancing operations – LTROs – with a maturity of three years. While the total liquidity requested by banks in these operations amounted to around €1 trillion, the net liquidity injection by the Eurosystem has been around €0.5 trillion euro because the other half has been shifted over from other operations.
Let me be clear about why we implemented the three-year LTROs. It was not to support sovereign debt markets. It was also not to bolster bank profits. The LTROs were specifically designed to prevent a credit crunch that could compromise the maintenance of price stability in the euro area. With funding markets closed, banks needed liquidity assurance over the medium term to avoid pre-emptive deleveraging and to continue lending.
To understand why these operations were necessary requires a euro area wide perspective. It would be misleading to judge the urgency for action – or the necessary responses – based on the situation in any one country or groups of countries. The Eurosystem acts in the interests of the euro area as a whole with 330 million citizens. This is the perspective that always informs our decisions.
Some have expressed that the Eurosystem is exposing itself to excessive risks. Critics point in particular to the differentiated collateral framework adopted by some national central banks to allow banks to participate in the three-year LTROs. Let me underscore that high haircuts are applied to the additional credit claims so as to ensure risk equivalence between this collateral and the regular framework. Moreover, the main elements of the risk management framework applied are common: the eligibility criteria and risk control measures were approved by the Governing Council, and the Council will monitor the effectiveness of the risk control framework on an ongoing basis. Hence, there is only limited national discretion. I should also emphasise that the Eurosystem has a long experience in the acceptance of credit claims in its collateral framework.
Moreover, the Eurosystem is being very careful to manage any risks that may ensue from our current operations. We employ a conservative risk management framework. On the additional collateral presented so far, the average haircut is 53 per cent. This means that on a nominal value of €100 we provide €47 of liquidity. This shows you how prudently such collateral is accepted.
Target2
It is important that this debate is framed correctly – in particular, by distinguishing between symptoms and causes. Target2 is a payment system that reflects the flow of funds within the euro area. Imbalances within Target2 are a symptom of real and financial imbalances between euro area countries. Restoring normality within Target2 requires not that we address the symptom – the payment system – but that we address the cause: the underlying imbalances.
This is not the task of monetary policy. It is the task of the national authorities and EU institutions that are responsible for fiscal, economic and financial policies. Important progress has been made in recent months to strengthen the credibility of these policies – and this has been recognised by financial markets.
Policy responses at the national and EU level
The signature at the last European Council of the International Treaty, including the fiscal compact, is an important signal of commitment to reducing deficit and debt levels. Enshrining balanced budget rules in national legislation creates a new “first line of defence” against fiscal imbalances. Like the Schuldenbremse in this country, this legislation shifts the onus for enforcement away from Brussels and onto national institutions. Prevention is better than cure – and that is the spirit of the compact.
Member States have also taken important steps to strengthen euro area and global firewalls. The entry into force of the European Stability Mechanism has been advanced and the paying-in of capital will be accelerated to reach full lending capacity sooner than originally planned. On top of this, euro area countries have committed to providing an additional €150 billion to the IMF.
Seen together, these measures represent a coherent strategy to strengthen euro area economic governance. The focus is not, as some commentators claim, skewed towards fiscal consolidation. Stronger fiscal rules are one – albeit essential – element in a larger package that addresses real and financial imbalances and provides a safety net for countries in financial difficulties.
But stronger governance cannot be effective without individual Member States also fulfilling their responsibilities. Here too we have witnessed a number of positive developments in recent months.
It is important that observers recognise that these reforms at the national level will take time. They are addressing deep-rooted obstacles to competitiveness and growth, and the positive effects may not be visible immediately. But once realised, they will put employment and growth on a new and more sustainable track.
The example of Germany shows the need for patience. The structural reforms passed many years ago did not immediately feed through into higher growth and employment. But now they have, and Germany is reaping the benefits and leading the way in Europe.
With a new governance framework in place and strong commitments from national governments, there are solid grounds for trusting that reforms will be implemented across the euro area as a whole.
Conclusion
The turnaround we have witnessed since November is the result of every institution of the euro area fulfilling its responsibilities. No single institution can carry the burden of addressing a set of challenges that are simultaneously economic, financial and fiscal. Everyone has played their part.
But let me emphasise that the current stabilisation should not make us pause in our responses to these challenges. Indeed, this is a time for continued action.
The present situation provides a window of opportunity for governments to accelerate efforts to consolidate budgets, to boost employment and to enhance competitiveness – and to do so with confidence.
It also creates a benign environment for banks to strengthen their resilience further – including by retaining earnings and cutting dividends and bonuses.
Decisive policy measures brought about the stabilisation since last November. Now, further decisive policy measures are required to strengthen fiscal positions and competitiveness.
These measures will lay the foundations for future sustainable and balanced growth in the euro area.