Remarks by Angel Gurría, OECD Secretary-General
OECD Conference Centre, 14 January 2009
Good morning, ladies and gentlemen,
It is a pleasure to launch the 2009 OECD Economic Survey of the euro area. I would like to thank both the European Commission and the European Central Bank, with whom we collaborated closely during the preparation of the Survey.
The Survey is being published at critical moment. The OECD economies, including the euro area, are now in recession and are likely to stay there for some time, amidst the worst financial crisis since the Depression. The crisis has spread to emerging economies and global trade growth is slowing markedly, with further deceleration in prospect.
These events present new and complex challenges for European policymakers.The ECB has to maintain price stability at a time when the normal transmission channels have become less effective and inflation is falling sharply. Alongside financial regulators and supervisors, the ECB and the European Commission are having to take steps to ease the current crisis, as well as undertaking reforms to make future crises less likely. The fiscal authorities are taking a more active role in stimulating demand, while at the same time having to ensure that fiscal policies are well targeted and do not undermine longer term fiscal sustainability.
The euro area economy is in recession and will be weak for some time
The near-term outlook for the euro area economy is bleak. The euro area slipped into recession before the financial crisis intensified in October, and incoming data since the OECD Economic Outlook was finalised in November suggests that the downside risks to economic activity highlighted then are now materialising. A deep and protracted slowdown appears increasingly likely.
Financial conditions remain very tight despite government initiatives to ease the strains in financial markets. Credit growth remains positive, but is clearly slowing. Housing markets continue to contract with investment and house prices falling in a number of countries. Declining wealth and rising unemployment are encouraging households to rein in spending. The rapid slowing of the global economy has dramatically reduced the demand for European exports. Business and consumer confidence has plummeted.
The one positive element is that the outlook for inflation has altered radically. After peaking at 4% in July, headline inflation is already down to 1.6%. Further falls in inflation are likely over the coming months. Although core inflation is more persistent, that too should drift down this year as the labour market deteriorates and downstream price pressures fall away.
The recession, combined with government actions taken to restore confidence in financial markets, brings substantial fiscal costs. Last November, in our Economic Outlook we projected the area-wide government budget deficit to rise by 0.8% of GDP in 2008 and 2009, from 1.4% to 2.2%, reversing the improvement since 2006. Since then, the prospect of much weaker economic growth means the actual deterioration in fiscal positions will be significantly larger.
European governments have acted firmly to prevent the financial system from collapsing
A priority for all euro area member states is to find effective responses to the financial crisis and ensure their swift implementation. In reacting to these developments, policy actions that would undermine longer term objectives should be avoided.
Following the intensification of the financial crisis last autumn European governments organised a coordinated response to bolster the stability of their financial systems. Bank funding was improved by guaranteeing new medium-term debt issuance, direct recapitalisation and higher ceilings for deposit guarantee schemes.
These measures have helped to prevent a systemic financial collapse in European financial markets, though markets remain strained. There is also doubt about whether the funds set aside for recapitalisation are sufficient or being used quickly enough. It is essential that national differences in implementation, do not lead to distortions in competition and that consideration be given to how governments exit from their commitments when the turmoil eventually dissipates. In addressing financial markets’ vulnerabilities, governments must be careful not to sow the seeds of future problems.
The official policy responses and the work by international standard-setting bodies, including the OECD, will address pertinent problems such as liquidity and risk management; transparency and valuation; the role of credit ratings; strengthening the responsiveness of authorities to risks; and improving arrangements to deal with stress in the financial system. The European Commission is working closely in international fora on all of these issues and should continue to do so. The OECD will focus on longer-term structural reforms to the financial system, based on a comprehensive “Strategic Response” to the financial and economic crisis which is meant as a contribution to the global efforts such as the work by the G-20.
Monetary and fiscal policy can both help to cushion the downturn
The fragile state of the euro area economy and the sharp easing of inflation pressures mean that there is ample scope for the ECB to further relax monetary policy and for governments to make greater use of discretionary fiscal policy.
The ECB has already lowered policy rates by 175 basis points since early October, though current financial market tensions have slowed the speed of pass-through into money market and retail interest rates. The ECB has also made necessary changes to its refinancing schemes to help alleviate liquidity shortages in financial markets. We expect the ECB to cut rates further, and view such cuts as both prudent and consistent with its price stability objective.
However, with the monetary policy transmission mechanism impaired, fiscal policy is shouldering more of the burden of stimulating demand to help cushion the slowdown.
The European Economic Recovery Plan and related fiscal initiatives by national governments are welcome, but need to be implemented effectively and may need to be strengthened should downside risks materialise. Of course, as fiscal positions deteriorate and public debt increases, the scope for action will become increasingly limited by the reactions of capital markets reflecting longer term stability concerns.
The effectiveness of any discretionary fiscal stimulus depends on the extent to which it can meet a number of conditions:
In particular, discretionary easing needs to be timely, stimulating aggregate demand when private demand is at its weakest, rather than come too late when an expansion is already underway.
Moreover, because medium-term fiscal consolidation is essential for the good of the European economy, it is vital that such actions are temporary. Expansionary fiscal measures must be reversed once the economic cycle turns up, and fiscal credibility must be improved so that the benefits of fiscal expansion are maximised and the dangers minimised. Countries should implement strong and transparent medium-term fiscal frameworks and revise their medium-term objectives to better reflect underlying debt positions.
Finally, fiscal stimulus packages should be targeted where they will have the greatest effect in stimulating economic activity. Rapid implementation of well-focussed public spending, tax cuts or spending vouchers would seem likely to have the most immediate demand effect, particularly if they are targeted at liquidity constrained households. Measures such as tax reform and support for infrastructure investment could also support medium-term growth prospects, although they may not be the most effective means of providing a timely demand stimulus. Any additional support for firms and industries should be targeted at instances of clear market failure and at sectors of systemic importance to the wider economy, notably the financial sector itself.
The European financial architecture must be reformed to prevent future financial instability
The rapid integration and deepening of European financial markets during the past decade represents a particularly important challenge to policymakers. Supervisory and regulatory practices need to keep pace with deeper cross-border integration.
Inconsistent regulation and supervision between countries could lead to regulatory arbitrage and distort the European single market in capital services. It could also make it harder to resolve a crisis stemming from the failure of a large, systemically important cross-border institution.
Although progress has been made to improve the supervision of such institutions by establishing colleges of supervisors for all banking groups operating in multiple EU countries, managing cross-border risks requires a more centralised and integrated approach.
Two potentially good options are either establishing a single EU financial supervisor or alternatively developing a European supervisory system that involves a central agency working together with national supervisors. Either option would improve the monitoring and containment of systemic risks within the European financial market. The second option, i.e. a European supervisory system would seem easier to integrate with the existing framework. But, if it proved impossible to balance the interests of all countries within such a system, a single supervisor should not be ruled out.
Ladies and Gentlemen:
In conclusion, we should recognise that the first decade of Economic and Monetary Union has been a great success. The ECB, the European Commission and member governments should be congratulated for making this possible.
Although the current crisis represents a grave challenge to euro area economies, and to the world as a whole, it also represents a vital opportunity to implement long-lasting reforms. In responding to the current crisis, it is essential that European governments not lose sight of the long-term policy challenges highlighted in the Lisbon agenda of strengthening the single market, bolstering innovation and skills, managing the transition to a low-carbon economy and further integrating the European economy with the rest of the world. For its part, the OECD will examine what can be done to further this agenda in our upcoming Survey of the European Union.
If the euro area can demonstrate its capacity to emerge soundly from the current downturn, while still implementing the reforms that are needed to deliver long-term growth it will send a strong message to the international community of the very real advantages of integration and of a cooperative approach to policy challenges. A message that is now more important than ever before.
Thank you very much.