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A consistent strategy for a sustained recovery
Lecture by Mario Draghi, President of the ECB,
at Sciences Po,
Paris, 25 March 2014
The crisis is not over but the turning point has passed, ECB President Mario Draghi said in a speech in Paris. In the summer of 2012 Europe’s policymakers shifted from “real-time” crisis fighting to a consistent strategy that outlines the path to recovery. Before that point, policy measures, often commendable in themselves, were taken under the pressure of events and often in the wrong order. Combined with the euro area’s institutional set-up this delayed the recovery.
The early phase of the “Great Recession” that came after the global financial crisis followed roughly the same pattern across advanced economies. A retrenchment in investment, trade and hiring sent government budgets into large deficits as they sought to offset the shock to nominal spending. Nonetheless by mid-2010 most advanced economies were showing signs of a gradual return to growth.
The euro area however suffered a second recession lasting until the second quarter of 2013. With hindsight, we can see that one reason for this was the policy response, which was the reverse of the ideal sequence: the Deauville agreement on private sector involvement in 2010 and Greek debt restructuring in 2011 took place while an effective backstop for solvent governments was still being constructed. The stress testing of banks and capital raising took place without a clear backstop for solvent banks.
This created market pressure on banks and governments, exacerbated by the euro area’s incomplete financial integration and a fiscal framework that was not strictly enforced. A number of governments did not have the fiscal space to absorb the shock presented to them or were unable to maintain the trust of the market while doing so. Instead of providing a counter-cyclical buffer, these countries had to convince investors of their debt sustainability, making it unavoidable that fiscal consolidation was front-loaded.
The turning point came when European policymakers acknowledged the need to complete the euro area’s institutional architecture, with banking union as a first step. This marked the beginning of a consistent strategy towards sustained recovery.
While the ECB’s Outright Monetary Transactions removed unfounded redenomination fears that put price stability at risk, banking union was needed to bring together fragmented national banking systems. The single supervisory mechanism (SSM), the single resolution mechanism and single resolution fund are important conditions for the reintegration of the single financial market.
The SSM now provides a catalyst for cleaning up the banking system in a way that promotes “good deleveraging,” avoids creating “zombie banks” and sets the stage for economic recovery.
The unavoidable consolidation of public finances has placed a larger burden on monetary policy to achieve price stability by managing aggregate demand. This has led to record low interest rates and forward guidance. The ECB’s accommodative stance will support a gradual closing of the output gap in coming years.
Meanwhile potential growth must be raised, although this is not a task for monetary policy. Structural policies to increase productivity and attract investment need to be put in place – the latter can be supported by a healthier banking sector, but regulation, tax and education also play important roles. Moreover, those who have experienced the crisis, or the economic volatility of the 1970s and early 1980s, know that recovery also stems from joint action. By making policies consistent across borders we have achieved positive results
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