Breakfast Policy Briefing, European Policy Center (EPC), remarks by Angel Gurría, OECD Secretary-General
Brussels, 12 November 2008
Good morning Ladies and Gentlemen:
It is an honour to be at the European Policy Centre to talk about the current financial crisis, its economic impact and the contributions that OECD can make to the post-crisis global financial architecture.
Resolving the crisis represents one of the greatest challenges in recent decades. While the US and many European countries are already experiencing serious downturns (with many now slipping into recession), they will experience flat or negative growth during 2009. And there is considerable uncertainty about the timing and strength of an eventual recovery.
But what is most worrying now is that the spill over from the financial sector to the real economy is already translating into growing unemployment. The shock on the productive side of the economy is now hurting the lives of millions of families. And this has to be the central priority for governments and politicians throughout the world, along with restoring confidence and stability to the financial system.
1. Building better financial markets: policy responses
First and foremost, it is imperative to restore confidence in the global financial system. To relieve the extreme stress in financial markets and restore normal credit market conditions, governments have announced extensive policy interventions, including massive liquidity injections, deposit and bank lending guarantees, the purchase of troubled assets to remove them from banks’ balance sheets and bank re-capitalisation.
When implementing these measures, it is essential that existing shareholders bear most of the pain of bad decision-making by management, so that the cost for taxpayers is kept to a minimum. Also extreme care has to be observed so that the different approaches to supporting financial institutions and depositors will not lead to distortions in competition and cause runs on financial institutions not covered by the support schemes.
Policy makers should thus continue to improve cross-border cooperation on the way packages are implemented, while ensuring that competition level-playing fields are maintained in their own countries. Detailed consideration must be given to how governments exit from their involvement when the turmoil eventually dissipates and normality returns.
In addressing financial markets’ vulnerabilities, governments must also be careful not to sow the seeds of future problems. Relaxing mark-to-market rules for asset prices is perhaps necessary in illiquid and volatile markets, where genuine systemic risks are present and when markets fail to provide adequate price signals. If used as a last resort, it should be for a limited period to avoid unnecessary solvency and deleveraging problems. A rapid return to transparent balance sheets is essential as the systemic risk passes to ensure sound information flows and efficient markets in the future.
Addressing regulatory and supervisory deficiencies is definitely a cornerstone of any solution.
A key lesson from the crisis is that the efficient functioning of financial markets is critical to maintaining the stability of the real economy, and that efficiency relies not just on competition but also on effective regulation and supervision.
And this is not about the “end of capitalism” or “the failure of market economy”. Open markets have produced many benefits, innovations, social progress, where regulation was strong, and supervision updated. However, the reaffirmation of the principle of open markets requires also the existence of a strong regulatory framework. As a Mexican economist recently put it: “Governments should not act because open markets don’t work; governments should act so that open markets do work!”
The financial crisis has brought into sharp focus the weaknesses of regulatory and supervisory systems in both the US and Europe. But it also presents an opportunity to address these weaknesses and reduce the probability of future crises.
The financial industry itself has been active in identifying measures that it can take to address issues that contributed to the crisis. Both the Institute of International Finance (IIF) and the Counterparty Risk Management Policy Group III have made interesting proposals.
The official policy responses and the work by international standard-setting bodies like the OECD, the IMF, the IOSCO or the Financial Stability Forum (in which the OECD also participates) are crucial. These reforms will address pertinent problems such as oversight of capital, liquidity and risk management; transparency and valuation; changes in the role and use of credit ratings; strengthening the responsiveness of authorities to risks; and improving arrangements to deal with stress in the financial system.
The rapid integration and deepening of European financial markets during the past decade also represents a challenge to policymakers. Supervisory and regulatory practices will have to keep pace with deeper cross-border integration. The European single capital market is heavily reliant on cooperation between national regulators and supervisors that have different responsibilities, instruments and powers.
Two potentially good options are either establishing a single EU financial supervisor, or developing a European system of supervisors that involves a central agency working together with national supervisors. A European system would be easier to integrate with the existing framework. But, if it proved to be impossible to balance the interests of all countries within such a system, a single supervisor should not be ruled out.
For its part, the OECD will focus on the longer-term structural reforms of the financial system. And we will do it from a plural perspective, taking into account the strong inter-relationships between regulations on capital, deposit insurance, tax provisions, corporate governance frameworks, competition policy, accounting rules, executive compensation, etc.
A piecemeal approach will not alter the business strategies that were at the heart of the crisis. This is also why we cannot wait until we fix the financial markets to deal with the economic downturn. We must act simultaneously. And we must act now!
2. Macroeconomic policy choices: restarting the engines
Well-judged macroeconomic policies can help to alleviate the effects of the economic downturn. Central banks across the globe are rapidly easing their monetary policy stance. The European Central Bank has participated actively in these actions, reducing policy rates by 100 basis points since July, while the Bank of England cut the policy rate by 150 basis points in a single step last week. The Federal Reserve’s key short-term interest rate is now at its lowest rate ever, at 1%.
Headline inflation is now rapidly receding, thanks to falling commodity prices. With inflation expectations well-anchored and substantial economic slack likely to develop, there remains scope for further reductions in policy rates.
Governments can also make significant contributions to reducing the combined effects of the financial turmoil and economic weakness. The automatic fiscal stabilisers are already helping to cushion the downturn, especially in Europe.
But more needs to be done, especially if continued uncertainty in financial markets delays the impact of monetary policy easing. Thus, discretionary fiscal easing remains an important near-term policy option. However countries differ both in their need for fiscal stimulus and in the budgetary scope they have for it.
The United States and Japan have weak fiscal automatic stabilisers and interest rates that are already very low; therefore, they have stronger needs for discretionary stimulus. But an already large fiscal deficit in the US and high public debt in Japan put limits on how much they can do.
European countries typically have stronger fiscal stabilisers and interest rates can still move further down. But this does not exclude discretionary action, especially in those European countries that used the previous upturn to consolidate their public finances. Whatever the exact situation, it is important that any fiscal stimulus is timely, temporary and targeted. China, which has just announced a sizeable fiscal stimulus package, is in a situation of its own, with considerable room for manoeuvre.
And let’s not forget the importance of social policy in times of crisis. It will certainly be needed to reduce hardship. While social safety nets are in place in OECD countries, there will be a need to step up re-training efforts for those who have become unemployed. There may also be more pressure to help those who are in danger of losing their homes.
All these necessary measures, all these initiatives for regulatory improvement, all the financial resources being pumped into the banking systems and all the macroeconomic and monetary adjustments, together, constitute an unprecedented package to reactivate confidence, growth and stability. Will they be enough to produce a better scenario than the one which got us here? Have we really addressed the fundamental causes of this unprecedented crisis?
3. The need for a broader approach
Building a better global economy is a much broader question. It is a challenge that goes beyond short term monetary and fiscal adjustments.
We are facing an unprecedented crisis in a new era, and we cannot solve it with “more of the same” policies. We need new approaches and new institutional mechanisms that allow us to generate truly global and multidisciplinary responses. As John Maynard Keynes recognised in other times of turbulence: "When the facts change, I change my mind. What do you do, sir?"
One of the big differences between this crisis and previous ones is the intensity of its global dimension. It caught us in times of extraordinary interdependence. We all know that this problem originated within the geographical area of the G7, but we also know that its consequences and its solutions have to be global. This is why the coming meeting of the G20 has special relevance.
The causes and consequences of this crisis are rooted in a wide set of inter-related policy areas and therefore can only be addressed through integrated responses; from financial regulation to corporate governance, from fiscal policy to competition, from innovation to financial education, employment, insurance and pensions; to mention a few.
The OECD is currently working on a comprehensive policy Action Plan to help address the crisis and use the opportunity to build a better world economy. It is basically organised around two pillars: First, align regulations and incentives in the financial sector so that market operators act in a tighter oversight and risk management environment; Second, review and upgrade national policies and improve policy coordination at the international level to restore the conditions for economic growth.
Ladies and Gentlemen:
I would like to conclude by stressing a final point in which I am sure we all agree. The current economic crisis demands tough decisions now, but it must not distract our attention from the other grave structural challenges that we confront. It is crucial that in the middle of the storm we don’t lose our sense of direction; that we don’t weaken our efforts to address the perils of poverty, inequality and climate change; that we keep our commitments to scale-up development aid, to keep global trade and investments open, to develop cleaner energy to protect our environment.
This crisis is teaching us a great deal about our vulnerability and interdependence, but it is also showing that we do have an extraordinary capacity to co-operate and find common understandings and shared solutions among nations.
Thank you very much.