1 00:00:01,510 --> 00:00:10,870 Know. All right. 2 00:00:10,960 --> 00:00:20,080 Let me just stand up for a moment to welcome you all here. This is the second seminar of the PFI Michaelmas term series. 3 00:00:20,440 --> 00:00:25,690 It's also the birthday of the financial market program because it was signed on the 17th of October. 4 00:00:26,050 --> 00:00:30,360 So happy birthday to the program. Welcome to Klaus Wrangling. 5 00:00:30,940 --> 00:00:33,790 You've probably seen from the poster his curriculum vitae. 6 00:00:34,000 --> 00:00:43,090 But just for any who haven't before, he became managing director of the ESM and CEO of its predecessor, the FSF. 7 00:00:44,560 --> 00:00:53,680 Klaus had held a number of public positions and he was at the European Commission as director general of economics and finance. 8 00:00:54,730 --> 00:00:59,950 He was in Germany as a very senior level in the Ministry of Finance, 9 00:00:59,950 --> 00:01:06,220 where I think it's fair to say he was one of I was going to say the midwives, perhaps I should say the godfathers of the euro project. 10 00:01:07,870 --> 00:01:13,000 And he was before that he was at the International Monetary Fund. 11 00:01:13,300 --> 00:01:18,459 And there was a time 25 years ago, in 1988, when when 2000, 12 00:01:18,460 --> 00:01:26,160 Russell Kincaid and I were travelling around Europe to try to discuss balance of payments imbalances and the role of financial markets. 13 00:01:26,220 --> 00:01:31,690 I recall this very well and I went back and looked at this document. I found the issues haven't changed very much. 14 00:01:31,810 --> 00:01:37,120 Certainly the market participants haven't changed very much, and I'm not sure the governments have changed very much. 15 00:01:37,130 --> 00:01:41,800 But so he has a long track record. He also was in the private sector. 16 00:01:41,800 --> 00:01:44,860 He was a managing director of the hedge fund, more capital. 17 00:01:45,310 --> 00:01:51,640 And this may account for the fact that his first bond issue at the ESM was, I think, three times oversubscribed. 18 00:01:52,030 --> 00:01:55,790 And it is the birthday also of the of the two. 19 00:01:56,170 --> 00:02:00,610 Two weeks ago. Over two weeks ago. So welcome. And Klaus, it's your second time here. 20 00:02:00,620 --> 00:02:06,760 You were here three years ago, just as Ireland was beginning to look for your help at the time. 21 00:02:07,570 --> 00:02:12,760 In fact, we thought we might not have a seminar due to this. It's a real pleasure to have you again. 22 00:02:13,420 --> 00:02:22,900 Russell Kincaid spent his career at the International Monetary Fund, and he recently left the fund and came here for a year to Oxford. 23 00:02:23,650 --> 00:02:32,950 He was he worked on Asia, the Middle East, and on Europe being in charge of the division handling Germany, being mission chief for Bulgaria, 24 00:02:33,280 --> 00:02:40,120 and later was deputy director of policy at the IMF and then was the director for risk management and Audit of the IMF. 25 00:02:41,470 --> 00:02:43,600 So it's Kraus, Klaus. 26 00:02:43,600 --> 00:02:50,320 His job is to solve crises, and Russell's job was to warn the fund not to lend to countries that could anyway pose difficulties, I think. 27 00:02:50,350 --> 00:02:53,560 So this was a fine, fine prospect. 28 00:02:53,980 --> 00:03:00,100 Now, just a quick word of housekeeping. As you can see, this is being podcast. 29 00:03:00,490 --> 00:03:06,010 And that means that you can't unfortunately ask questions during Klaus's presentation. 30 00:03:06,010 --> 00:03:12,819 You can't interrupt him. You really shouldn't heckle him because you have not you are not consenting adults. 31 00:03:12,820 --> 00:03:20,020 You have not signed the consent form for the podcast. The podcast will be cut off too, after Klaus has spoken. 32 00:03:20,380 --> 00:03:24,940 And that means that Russell's Russell's questions and Klaus his answers will be under 33 00:03:24,940 --> 00:03:28,480 the Chatham House Rule and the discussion will be under the shadow mouth rule. 34 00:03:28,780 --> 00:03:31,300 So that's when everybody can let their hair down, so to speak. 35 00:03:32,470 --> 00:03:39,160 Can I just also say it is not yet confirmed whether there will be a seminar next Monday evening 36 00:03:39,430 --> 00:03:44,799 because there is a remaining question mark when Paul Tucker will fly to spend his year at Harvard. 37 00:03:44,800 --> 00:03:48,400 And judging by this morning, the flight, the flight have not yet been settled. 38 00:03:48,850 --> 00:03:53,500 And so we will send out a notice in due course saying whether there'll be a seminar next Monday. 39 00:03:53,770 --> 00:03:59,710 If not, then we will resume into week's time with the seminar with a speaker from the European Central Bank. 40 00:04:01,360 --> 00:04:04,450 With that, I'll hand over to Clowes. Okay. 41 00:04:04,450 --> 00:04:09,250 Thank you very much, Max. First, congratulations on the first anniversary of the program. 42 00:04:09,640 --> 00:04:13,930 Um, nice to be here and nice to be your second time. 43 00:04:14,110 --> 00:04:22,720 Thanks for inviting me. Particularly nice to sit here with Max and Russell because as Max said, we have a common past. 44 00:04:22,840 --> 00:04:31,150 He was too modest. Of course he was the boss. When I arrived in that division in 1985, Russell was his deputy, so I had to catch up. 45 00:04:31,540 --> 00:04:35,919 Um, a few years later, and Russell moved to the IMF and I could take his position. 46 00:04:35,920 --> 00:04:41,050 So but we had very three and a half, very intensive years together. 47 00:04:41,650 --> 00:04:44,950 People forget that those were the days of the Latin American debt crisis. 48 00:04:45,280 --> 00:04:48,969 Um, and, um, we had to work on that. 49 00:04:48,970 --> 00:04:54,400 That was the task of the division. And sometimes it's useful to think back of what happened then. 50 00:04:54,910 --> 00:05:01,300 What were the solutions? It's probably a sign that we are getting to, oh, it's that many of the actors today don't remember. 51 00:05:02,110 --> 00:05:08,110 Maybe I shouldn't have said that because it's online, so. Okay. 52 00:05:08,140 --> 00:05:15,790 Um, let me go from. My presentation. And I'm sorry that Max didn't allow you to interrupt me, but you can do it all afterwards. 53 00:05:16,840 --> 00:05:23,260 Um, yes. And I hope everybody can read this also in the back. 54 00:05:23,850 --> 00:05:32,160 So obviously, policymakers today who deal with the European crisis and European issues have two, two issues to deal with. 55 00:05:34,090 --> 00:05:41,770 They have to stabilise and stabilise the current situation and they have to think about the future, 56 00:05:41,770 --> 00:05:46,509 how to complete monetary union, how to make sure that either there is no crisis. 57 00:05:46,510 --> 00:05:50,680 Although one should be very careful with such a statement, we know there will always be a crisis somewhere. 58 00:05:51,160 --> 00:05:56,049 It's part of our economic system, but that crisis doesn't happen too quickly. 59 00:05:56,050 --> 00:05:59,600 The next one. And that's not too serious. Um. 60 00:06:00,640 --> 00:06:02,050 We are working on that. 61 00:06:02,200 --> 00:06:11,020 I know the impression around the world, inside Europe and outside Europe, I'm sure also in Oxford is that we have not done a very good job, 62 00:06:11,170 --> 00:06:16,990 that things are very much ad hoc, no comprehensive strategy, often acting too late. 63 00:06:17,500 --> 00:06:28,480 I think that is the predominant perception. Some of that is true, but still looking backwards, what happens the last three years or so? 64 00:06:29,380 --> 00:06:34,420 One can discover that there is a consistent, comprehensive strategy, 65 00:06:35,410 --> 00:06:39,340 and I admit it's not easy to discover, but that's why I want to guide you through that a little bit. 66 00:06:41,440 --> 00:06:45,820 Several things have contributed to the current stabilisation in the euro area. 67 00:06:46,030 --> 00:06:49,840 It's not only monetary policy, as the Financial Times writes every week. 68 00:06:50,080 --> 00:06:58,150 It's not only OMT, although it has. That played a very important role to switch expectations of markets in August last year. 69 00:06:59,350 --> 00:07:06,190 But for me, there are four inter-related developments, four elements of our crisis strategy, 70 00:07:06,190 --> 00:07:14,560 where we have made progress in parallel on each one of them. That explains quite easily why the situation today is better than 18 months ago. 71 00:07:15,190 --> 00:07:23,210 And you find some here on the screen the. No, this was I'm jumping ahead to the next slide. 72 00:07:23,220 --> 00:07:27,710 I think this was just still talking about the origins of the crisis. 73 00:07:28,040 --> 00:07:37,969 But I think I would skip that and I would go to these elements of our strategy, um, for elements first. 74 00:07:37,970 --> 00:07:46,070 And for me, the most important one is what's happening at the national level in the periphery, in the countries that had a problem. 75 00:07:46,970 --> 00:07:51,410 And I will show you in a moment that there is substantial adjustment. 76 00:07:51,650 --> 00:07:56,570 I think it's widely accepted now also in markets, but it's good to look at some of the facts. 77 00:07:56,810 --> 00:08:07,250 For me, that is the key thing, because only if the countries that need to adjust actually do adjust, we will be able to see an end of the crisis. 78 00:08:07,580 --> 00:08:11,569 But the second point is also important better economic policy coordination. 79 00:08:11,570 --> 00:08:17,570 The euro area, as you know, many academics, particularly in this country, in the US, 80 00:08:18,080 --> 00:08:24,770 have often said monetary union cannot work because there's a centralised monetary policy and you 81 00:08:24,770 --> 00:08:30,590 do fiscal policy and structural reform in a decentralised way at the national level doesn't work. 82 00:08:30,680 --> 00:08:34,820 And some, Martin Feldstein, Krugman, others still say it doesn't work. 83 00:08:35,570 --> 00:08:40,190 I think it can work, but of course, it can only work if there are rules to coordinate policies. 84 00:08:40,460 --> 00:08:44,420 And these rules are not good enough in the past and we have to change that. 85 00:08:44,420 --> 00:08:53,660 I will also explain that a little bit. The third point is that we closed institutional gaps in the initial design of monetary union. 86 00:08:54,830 --> 00:09:04,670 When monetary union was prepared in the late eighties and then throughout the nineties, there was no plan to have financial backstops. 87 00:09:05,000 --> 00:09:15,050 Um, we thought and I include myself that it wouldn't be needed, that the, that capital flows inside EMU would always evened out. 88 00:09:15,640 --> 00:09:20,270 Um, we did not foresee a crisis like the one we have seen in the last four years. 89 00:09:21,260 --> 00:09:25,370 Um, so that was a mistake. We have closed that institution, that gap. 90 00:09:25,370 --> 00:09:28,819 We created the EFSF and ESM as financial backstops. 91 00:09:28,820 --> 00:09:38,660 And here I would also add, um, all the things the ECB does today, which were also not foreseen in the initial design of monetary union like OMT. 92 00:09:39,410 --> 00:09:48,050 So that's the institutional side. And then the last point, and I will spend a bit more time on that, given the focus of the, the seminar program, 93 00:09:48,530 --> 00:09:54,500 is what's happening to the banking system because that's there is a fourth element in this strategy, 94 00:09:54,950 --> 00:09:59,690 which I therefore call a comprehensive strategy to stabilise the euro area. 95 00:10:00,480 --> 00:10:05,180 Um, first of all, national adjustment and second better quality policy coordination. 96 00:10:05,180 --> 00:10:09,800 Third, closing institutional gaps. And fourth is to strengthen the banking system. 97 00:10:11,110 --> 00:10:14,810 We know economies don't work well when the banking system doesn't work. 98 00:10:14,830 --> 00:10:21,490 The crisis has led to a renationalisation of European banking market and fragmentation 99 00:10:21,970 --> 00:10:26,830 with high costs for the countries in southern Europe and the periphery. 100 00:10:27,640 --> 00:10:31,300 We are trying to fix that by moving to the banking union. 101 00:10:31,540 --> 00:10:34,780 So that's the fourth point in in the strategy. 102 00:10:35,200 --> 00:10:41,349 And for me, that all together explains quite well why is the situation in Europe, 103 00:10:41,350 --> 00:10:47,410 in the euro area is better today than last time I came here three years ago. 104 00:10:48,280 --> 00:10:53,140 So let's look at each of these four points a bit. And in particular, that's the last one. 105 00:10:53,380 --> 00:11:00,100 That's the banking union. So first point adjustment, that's the national level. 106 00:11:01,030 --> 00:11:05,500 Here you'll see, um, what's happening on the fiscal side. 107 00:11:06,280 --> 00:11:11,679 Fiscal deficits are coming down rapidly. There's always a debate whether it's too fast, too slow. 108 00:11:11,680 --> 00:11:14,260 But but the direction is very clear. 109 00:11:14,950 --> 00:11:25,150 I also don't think it's particularly fruitful to talk much about fiscal multipliers when you have a fiscal deficit of 15.6% like in Greece in 2009. 110 00:11:26,020 --> 00:11:34,180 Whatever the fiscal multipliers are, one has to act when that happens and you have to bring it into line with some financing possibilities. 111 00:11:35,170 --> 00:11:40,390 Every EU country has a plan how to bring down the deficits. 112 00:11:41,320 --> 00:11:50,200 We look at now it's a structured effort. So we we take out the the problems that come from the cycle so the nominal targets can be postponed. 113 00:11:50,200 --> 00:11:53,890 But in structured terms, the plans are being followed. 114 00:11:54,570 --> 00:11:56,280 Overall, it's actually quite good. 115 00:11:56,290 --> 00:12:05,440 You see on the right hand side that in the aggregate the deficit of the euro area is only about half what you see in the UK, US and Japan. 116 00:12:06,100 --> 00:12:11,270 So it's working, it's moving in the right direction. Competitiveness. 117 00:12:11,450 --> 00:12:19,489 The other big macroeconomic problems that you saw in the euro area accumulating during the first decade of monetary union there, 118 00:12:19,490 --> 00:12:29,870 we also see significant progress. You see on the left hand side how the unit labour costs developed in southern European countries and in Ireland. 119 00:12:30,500 --> 00:12:36,680 They moved up strongly since 2000 or 1999, the beginning of monetary union. 120 00:12:37,040 --> 00:12:40,580 The bottom lines are thick blue line. That's Germany, just as a reference point. 121 00:12:41,270 --> 00:12:43,850 And so you could also say northern Europe. 122 00:12:44,150 --> 00:12:53,960 And you see that in the peak in in the nine in 1998, the gap between southern Europe and northern Europe was 45%. 123 00:12:55,210 --> 00:13:01,570 That was a result cumulative of the first decade of monetary union that was not sustainable. 124 00:13:02,830 --> 00:13:14,740 You saw the result. When you look at the right hand side, the current account deficits, they reached them in some cases, ten, 15, 18% of GDP. 125 00:13:15,130 --> 00:13:19,150 Again, not sustainable. Had to change. Interesting. 126 00:13:19,150 --> 00:13:24,100 The turning point came in the first quarter of 2008 in southern countries. 127 00:13:24,760 --> 00:13:37,030 Um, so well before Lehman. And that was a result of work from the bodies that are in charge of supervising, monitoring the economies, the commission. 128 00:13:38,500 --> 00:13:46,190 But also IMF and OECD. Um. Max was at that time with me in the commission, and we saw this happening. 129 00:13:46,190 --> 00:13:48,080 Of course, we were not totally blind. 130 00:13:49,000 --> 00:13:57,850 But it was the time of the Great Moderation and some of our famous colleagues thought cycles had disappeared from economics and all these things. 131 00:13:57,850 --> 00:14:01,030 So it's all a bit weird today, but those were the days. 132 00:14:01,570 --> 00:14:06,430 Um, so the turning point was there already in 2008. 133 00:14:06,430 --> 00:14:07,870 And since then there's a lot of progress. 134 00:14:08,440 --> 00:14:17,410 Not only today, by the way, which is the yellow line, but clearly the countries that borrow from EFSF and ESM are making progress. 135 00:14:17,440 --> 00:14:23,079 Conditionality works. People who come from the IMF and there are several here, knows that very well. 136 00:14:23,080 --> 00:14:28,810 Conditionality works. Um, um. It takes a while to see it, but it always works. 137 00:14:29,260 --> 00:14:34,210 And you see it certainly now in Greece, Portugal, Ireland, Spain. 138 00:14:35,210 --> 00:14:42,950 And we will also see it in Cyprus soon. Very clearly here on the competitiveness side, improving, card account, deficits disappearing. 139 00:14:44,060 --> 00:14:51,920 Several countries are back in surplus also for cyclical reasons, obviously, because imports are collapsing, but exports are also growing. 140 00:14:52,580 --> 00:14:56,300 Like Spain, exports are up 11% year over year. 141 00:14:56,720 --> 00:15:04,790 So these economies are rebalancing. So we see a rebalancing inside each country towards the external side, and that's the only way. 142 00:15:05,270 --> 00:15:10,580 And we see a rebalancing inside monetary union. So the problems are disappearing slowly. 143 00:15:12,250 --> 00:15:19,060 Also these programs in Greece, Portugal, Ireland have not only the macroeconomic component of cutting deficits, 144 00:15:19,990 --> 00:15:26,980 they have very strong structural components. Very painful also for people who have to give up privileges. 145 00:15:27,610 --> 00:15:34,390 And it's always easy to say people should give up privileges and and rents should or should not be there. 146 00:15:34,400 --> 00:15:44,290 But if you talk to a Greek truck driver who bought the license to be allowed to drive a truck two years ago for €200,000, 147 00:15:44,770 --> 00:15:49,030 because the number of licenses for truck driving in Greece had not increased for 20 years. 148 00:15:49,540 --> 00:15:53,049 Um, that's why it's very expensive for the economy. 149 00:15:53,050 --> 00:15:58,060 It was cheaper to fly something from Frankfurt to Athens than trucking it from southern Turkey to Athens. 150 00:15:58,690 --> 00:16:02,860 So the truck driver who bought this was in the old system. He put all his savings in there. 151 00:16:03,220 --> 00:16:08,860 And if you tell that truck driver today, no, no, there are no more licenses, the guy will not be happy. 152 00:16:09,370 --> 00:16:15,639 So structural reforms are painful, just like fiscal adjustment is painful. 153 00:16:15,640 --> 00:16:21,250 But it means that civil servants and pensioners have to give up 30 or 40% of their income. 154 00:16:22,260 --> 00:16:26,520 But it is working. It's painful, but it's working. So that was the first part. 155 00:16:27,180 --> 00:16:30,870 Markets, of course, have discovered it was a time that gets all this. 156 00:16:31,080 --> 00:16:35,380 Markets had a time to act before they discovered the problems. 157 00:16:35,450 --> 00:16:39,060 They also there was a time to act before they saw the progress. 158 00:16:39,090 --> 00:16:49,320 Now they see it fully. Interest rates on ten year government bonds for Ireland and Spain are only half what they were 18 months ago. 159 00:16:49,840 --> 00:16:56,790 Also, Portugal, Ireland, Spain have been able the last few months to issue ten year government bonds again. 160 00:16:57,660 --> 00:17:04,560 They were not able to do that for the preceding two years. So things are getting a lot better. 161 00:17:05,310 --> 00:17:09,240 Not yet in Greece. That's the most difficult case and Cyprus is the most recent case. 162 00:17:09,630 --> 00:17:15,540 But in the other cases, there is a lot of progress. So let's move to the second part of the strategy. 163 00:17:16,500 --> 00:17:22,300 Better call policy coordination. And that's a key point also in the long run. 164 00:17:22,570 --> 00:17:26,620 Um, because in the past we focussed on fiscal coordination, 165 00:17:27,430 --> 00:17:37,300 not totally wrong because in the monetary union I think the scope and the potential for spill-overs coming from the fiscal side are very large. 166 00:17:38,050 --> 00:17:40,630 Um, and therefore it was important to focus on that. 167 00:17:41,110 --> 00:17:51,520 But first, not every country followed strict rules, including big countries like Germany and France in 2003 when they ignored the rules. 168 00:17:52,690 --> 00:17:55,960 And secondly, it was too narrow, too narrowly defined. 169 00:17:56,560 --> 00:18:04,210 So what has happened now during the last two years is that the roots of the stability pact have been tightened. 170 00:18:04,630 --> 00:18:08,200 They have been made stricter. They have also been put into different formats. 171 00:18:08,770 --> 00:18:12,730 And I will not go into all the details, because that would take too much time. 172 00:18:13,600 --> 00:18:17,730 But they are clearly stricter. There is much less room for political interference. 173 00:18:18,780 --> 00:18:27,780 And that's important to realise that the modalities for voting on in this process of the Stability and Growth Pact, 174 00:18:28,290 --> 00:18:33,870 the voting modalities were turned around in the past, like always in the EU. 175 00:18:34,620 --> 00:18:38,609 The proposal from the Commission needs the qualified majority in the Council to 176 00:18:38,610 --> 00:18:43,080 become European law in the future for the different steps of the Stability Pact. 177 00:18:43,590 --> 00:18:48,810 It's sufficient that of all European Commission proposals to become law. 178 00:18:50,040 --> 00:18:55,650 That will happen unless there is a qualified majority in the Council against the Commission proposal, 179 00:18:56,340 --> 00:19:02,130 and that's a complete change and strengthens the role of the position of the Commission very much 180 00:19:03,120 --> 00:19:08,130 makes the Commission much stronger and most of the time the commission has been on the right side. 181 00:19:08,460 --> 00:19:15,510 When we think about the proposals in the context of the Stability and Growth Pact and and fiscal adjustment, 182 00:19:15,870 --> 00:19:18,270 so much tighter rules, less room for interference. 183 00:19:18,780 --> 00:19:26,610 But also these fiscal rules are now in the context of the fiscal compact introduced into national legislation, 184 00:19:27,240 --> 00:19:35,430 which means that if a country in the future were to violate the European rule on on budgetary conduct, 185 00:19:36,030 --> 00:19:42,240 the country would also violate its own national legislation. So it's another hurdle in order to prevent that. 186 00:19:43,850 --> 00:19:52,610 There's earlier coordination with the European Semester where countries notify the Commission in the first half of the year about the intentions. 187 00:19:53,360 --> 00:20:02,270 Then there is an analysis and the Commission discussions are council and the country gets recommendations from its partners. 188 00:20:03,500 --> 00:20:13,570 Complaints, maybe. But the country's national parliament remains in charge of taking the final decision on the national budgets. 189 00:20:13,580 --> 00:20:21,650 So they remain responsible. But they take the decision knowing what the partners think about what they are about to vote on. 190 00:20:22,820 --> 00:20:37,490 And now we have since this month, the two pack in place where the commission checks before a national parliament takes the final decision on a budget. 191 00:20:37,820 --> 00:20:42,830 Whether this budget is really consistent with all the rules that have been adopted the last two or three years. 192 00:20:43,550 --> 00:20:51,300 And you will read a lot more about that in the newspapers the next few days because the process is unfolding the first time we will see how it goes. 193 00:20:51,320 --> 00:20:55,370 I'm sure some governments will not like it when the commission speaks out. 194 00:20:55,940 --> 00:20:59,060 I hope and I expect the commission will speak out. Its their role. 195 00:20:59,420 --> 00:21:04,010 They were given this task. So a lot is happening in this fiscal side. 196 00:21:05,330 --> 00:21:12,320 Then in addition, also important as one of the lessons from the crisis, surveillance has been broadened significantly. 197 00:21:13,010 --> 00:21:19,760 That's now something called the Excessive Imbalance Procedure. 198 00:21:20,540 --> 00:21:27,440 Sounds terrible for most people, but it describes pretty well what it's meant avoiding excessive imbalances. 199 00:21:28,650 --> 00:21:30,990 There will always be imbalances in the monetary union. 200 00:21:31,320 --> 00:21:36,270 You also have imbalances between the regions and the US, so the not to speak of regions of China. 201 00:21:36,960 --> 00:21:41,300 Um, but they shouldn't become excessive. Um, um. 202 00:21:41,460 --> 00:21:52,290 And this procedure. Now very systematically the commission, the ECB, the ministers, finance ministers will look at other areas beyond fiscal. 203 00:21:52,530 --> 00:21:57,750 Um that can also lead to problems if they get out of control like credit bubbles. 204 00:21:57,990 --> 00:22:02,790 Real estate bubbles. Excessive deviations in competitiveness. 205 00:22:03,560 --> 00:22:06,660 Um. Com. Account imbalances and all these things. 206 00:22:06,670 --> 00:22:14,100 Um. So much more systematic way of these broader macroeconomic variables are being monitored. 207 00:22:15,560 --> 00:22:19,010 Then the commission, if necessary, can make recommendations to the council. 208 00:22:19,250 --> 00:22:23,270 So the Council has to vote on that. Give it to the country concerned. 209 00:22:23,930 --> 00:22:30,560 And if repeatedly, a country does not follow the recommendations, that can be sanctions. 210 00:22:31,370 --> 00:22:35,760 So let me stop here, because one can talk forever about this and this improved framework. 211 00:22:36,140 --> 00:22:42,410 But it isn't the important second element of the response to the euro euro crisis. 212 00:22:43,160 --> 00:22:47,900 The third one, as I already mentioned, is closing institutional gaps. 213 00:22:49,370 --> 00:22:54,140 Um. There was nothing like CEO was Evans e Azam when the crisis broke. 214 00:22:54,710 --> 00:23:04,550 What we have done now, we have imported the approaches that the IMF has used successfully the last few decades globally into Europe. 215 00:23:05,800 --> 00:23:09,260 Um, many people don't realise that, particularly my own country, 216 00:23:09,260 --> 00:23:14,470 when I talk about these things, this is completely new and we are giving money away and um, 217 00:23:14,600 --> 00:23:23,420 forgets that the IMF has done very similar operations and in all continents during the last 4050 years, quite successfully. 218 00:23:23,630 --> 00:23:29,690 Never lost money. Um, so we have imported many of those approaches. 219 00:23:30,870 --> 00:23:36,990 So as a mentor, Sophia was there for years and is to finance macroeconomic adjustment programs. 220 00:23:37,710 --> 00:23:41,220 We can also, like the IMF, support precautionary arrangements. 221 00:23:41,250 --> 00:23:46,890 We haven't done it yet, but we have the instruments. Then we can do things that the IMF cannot do. 222 00:23:47,730 --> 00:23:55,020 We can do in direct bank recapitalisation. The IMF cannot support specific sectors of the economy. 223 00:23:55,440 --> 00:23:58,710 We could also intervene in the primary and secondary bond market. 224 00:23:59,180 --> 00:24:05,580 Um, we haven't done it, but we have the instrument and it's particularly important in the context of the ECB's OMT. 225 00:24:06,650 --> 00:24:11,230 Um, the instruments available. So it goes beyond what the IMF can do. 226 00:24:11,240 --> 00:24:18,950 But the core business and most of our programs are very much like IMF programs where we provide the financing. 227 00:24:19,340 --> 00:24:26,060 The conditionality, as you know, is negotiated by the troika, which includes the European Commission, the ECB and the IMF. 228 00:24:27,180 --> 00:24:30,899 Where we also different from the IMF and that's why we are clearly not a European 229 00:24:30,900 --> 00:24:35,610 Monetary Fund is that we have to organise the money first before we can lend. 230 00:24:36,520 --> 00:24:43,700 The IMF when when they agree on a program, they push the button and gets the money automatically from the member states. 231 00:24:43,720 --> 00:24:49,720 So they have a very quiet job compared to the MSF and the Azem. We have to go to the market, raise the funds. 232 00:24:50,110 --> 00:24:54,970 That's why Max talked about bond issues, which have been quite successful so far. 233 00:24:55,630 --> 00:25:03,790 And on the next slide, you can see what MSF and DSM have done during the last two and a half years. 234 00:25:04,830 --> 00:25:11,460 Um, we have, uh, lending capacity together of €700 billion. 235 00:25:12,750 --> 00:25:16,170 Um. We have used so far. Um. 236 00:25:17,370 --> 00:25:24,269 Less than a third of that. We have committed to more than 36 billion of which to run it, and it changes every week. 237 00:25:24,270 --> 00:25:28,680 So I have to look at the numbers. We have disbursed €215 billion. 238 00:25:29,190 --> 00:25:33,899 All this happened during the last two and a half years. So 250 billion, 15 billion. 239 00:25:33,900 --> 00:25:37,410 That's about 280 billion USD. 240 00:25:38,070 --> 00:25:46,530 The IMF has told the claims outstanding of about 240 billion USD are only half of what we have done and two and a half years. 241 00:25:47,010 --> 00:25:50,610 So much for the criticisms that we often heard in Europe that we are not doing enough. 242 00:25:51,660 --> 00:25:58,650 I think we have done quite a bit. The good news is also that fallen €50 billion uncommitted. 243 00:25:59,850 --> 00:26:06,940 Most of the firepower of the US is not committed, is available for future cases. 244 00:26:06,960 --> 00:26:12,240 Hopefully they don't come, but it's good to have this available in case of need. 245 00:26:13,220 --> 00:26:18,900 Um, so the 215 billion that we have lent went to five countries. 246 00:26:19,320 --> 00:26:27,629 Ireland, Portugal and Greece are financed by the EFSF, which was the first temporary institution which will take no new programs. 247 00:26:27,630 --> 00:26:33,090 But they continue to finance these three countries and they are still about 15 billion in the pipeline. 248 00:26:33,510 --> 00:26:43,680 Why is the ESM is doing all the new programs that started with the Spanish bank restructuring and the Cypriot program earlier this year? 249 00:26:45,070 --> 00:26:49,240 That also means that both institutions. I have to say that for the market people, 250 00:26:49,810 --> 00:26:57,130 those institutions will be in the market for the next 25 years because we have EFSF bonds outstanding was 25 maturity. 251 00:26:57,790 --> 00:27:06,489 That's the longest one. All the others are shorter and the EFSF will exist as long as it takes to unwind all these operations. 252 00:27:06,490 --> 00:27:11,170 Then the others have closed down. ESM is the permanent institution. 253 00:27:11,410 --> 00:27:18,540 You may ask, why are the two institutions? The reason is that the EFSF was had to be put together very quickly. 254 00:27:18,550 --> 00:27:29,020 There was nothing. We had to start from scratch and therefore one had to use some strange legal vehicle operates on the Luxembourg law. 255 00:27:30,130 --> 00:27:34,810 ESM as a real international financial institution, operates under international law. 256 00:27:35,350 --> 00:27:42,700 But to do that, it takes some time to create international law, have it ratified, and all member states took a while. 257 00:27:42,820 --> 00:27:44,500 That's why we have these two institutions. 258 00:27:44,500 --> 00:27:53,380 But the division of labour is now very clear as F continues to finance the first three countries, either in Greece and Portugal. 259 00:27:53,740 --> 00:28:05,920 ESM does everything else. Um, so last point, looking at these institutional innovations that happened in the last few years is the role of the ECB. 260 00:28:07,010 --> 00:28:15,630 Particular OMT. Um, which has already said was very important to switch the perception on the market last August. 261 00:28:16,170 --> 00:28:17,430 It's important to have it. 262 00:28:17,440 --> 00:28:27,840 I think it's a very efficient use of of the two institutions and the efficient cooperation between us at the ESM and the ECB, 263 00:28:28,350 --> 00:28:32,670 because it provides, on the one hand, the conditionalities that the ECB cannot provide. 264 00:28:33,000 --> 00:28:41,910 We can provided with ESM programmes, and we can combine it then with the unlimited firepower that only a central bank can provide. 265 00:28:42,630 --> 00:28:46,890 Our firepower is not unlimited. So it's a very efficient combination. 266 00:28:47,700 --> 00:28:52,770 We know exactly what to do. I signed an IOU with Mario Draghi. 267 00:28:52,780 --> 00:28:56,519 So if it's activated, we know who does what. It is available. 268 00:28:56,520 --> 00:29:05,370 It can be activated quickly, but ideally it will never be used like our remaining firepower. 269 00:29:05,400 --> 00:29:09,600 Best is to have its people know about it and not use it. 270 00:29:10,230 --> 00:29:20,010 So that was the third element of the comprehensive crisis response, national adjustment, better policy coordination, the new institutions. 271 00:29:20,430 --> 00:29:25,530 Let's move to the fourth element of the crisis response. 272 00:29:26,120 --> 00:29:30,120 Um, strengthening and helping the banking sector. 273 00:29:31,530 --> 00:29:36,210 And here, of course, dramatic things happened during the last four or five years. 274 00:29:36,960 --> 00:29:47,280 This may be a bit dense, but on the left hand side, you see how in the earlier years, in 2006, 2007, it's a light blue. 275 00:29:48,150 --> 00:29:51,720 Private flows financed all the deficits. 276 00:29:51,750 --> 00:29:55,450 And in the countries of the periphery. Um. 277 00:29:57,540 --> 00:30:02,519 Those were the easy days before the crisis. Financial flows. 278 00:30:02,520 --> 00:30:09,120 No problem. Financing current account deficits, fiscal deficits, deficits of the private sector. 279 00:30:10,020 --> 00:30:16,560 All of that was financed by this light blue. Then starting in 2008 with the global crisis. 280 00:30:17,660 --> 00:30:20,900 Although I prefer to say it was really the moment when the. 281 00:30:22,130 --> 00:30:29,660 Homemade problems of a mule which had accumulated the first decade of a mule, came together with the global financial crisis. 282 00:30:29,660 --> 00:30:36,800 It's this combination that made it so difficult. So when that happened in 2008 with Lehman, you see the blue block. 283 00:30:37,160 --> 00:30:41,870 It's still positive. There was still private flow to these countries. 284 00:30:42,440 --> 00:30:51,800 Um, but it was already, um, supported by Eurosystem flows, which includes the target balances. 285 00:30:52,190 --> 00:30:56,420 So more and more money was channelled through, through the ECB. 286 00:30:57,410 --> 00:31:04,430 Then the blue shrank in 2009 and became negative in 2010, 11 and 12. 287 00:31:04,790 --> 00:31:14,780 So withdrawal of private capital from these economies substituted it, and there was no other way to substitute it in the short run by public money. 288 00:31:14,810 --> 00:31:21,380 IMF money was F ESM and ECB money and that took over. 289 00:31:21,560 --> 00:31:25,129 Otherwise there would have been a total collapse. Unfortunately, 290 00:31:25,130 --> 00:31:32,930 we only have numbers at the moment up to the third quarter of last year and will be very interesting to see the 2013 numbers when they come out. 291 00:31:34,130 --> 00:31:38,780 I think it will indicate a slow normalisation of the situation. 292 00:31:39,290 --> 00:31:47,420 Um, and then we will move back to normal. Although my view is the new normal will not look like 2006 and 2007. 293 00:31:47,900 --> 00:31:53,960 Um, those flows were too big. They financed the huge current account deficits in these countries. 294 00:31:54,440 --> 00:31:57,710 The deficits will be much smaller in the future. They should be smaller. 295 00:31:58,250 --> 00:32:06,800 Um. So the normalisation will mean that there's no net new inflow coming from ESM and the IMF. 296 00:32:07,490 --> 00:32:14,629 Target balances are dropping anyway now. There will be a healthy, sustainable amount of private capital flow. 297 00:32:14,630 --> 00:32:21,830 Again, that will be the new normal. The right hand side shows that the banking sector of all is not back to normal yet. 298 00:32:22,580 --> 00:32:28,070 It shows the ease the use of the ECB deposits facility. 299 00:32:28,850 --> 00:32:34,610 We have, as you probably know, the situation that banks borrow a lot from the ECB and then they put at the end of the day, 300 00:32:34,610 --> 00:32:36,290 a lot of money back to the ECB. 301 00:32:37,070 --> 00:32:49,250 Um, the balance of that was hugely, um, was huge up to €900 billion, um, in October 2011, um, until the summer of last year. 302 00:32:49,430 --> 00:32:54,110 Since August last year, it's dropping, but it's still around €350 billion. 303 00:32:54,470 --> 00:33:01,670 Um, so that's an indication that the situation is better, much better than a year ago, but it's far from normal. 304 00:33:01,970 --> 00:33:04,190 Um, because that should really be known that balance, 305 00:33:04,960 --> 00:33:13,070 it should go back at these where it was in January 2008 when it was 200 billion and maybe even less than that. 306 00:33:13,460 --> 00:33:21,530 So there is a problem. Another way to look at it is that the interest rates for private borrowers in 307 00:33:21,620 --> 00:33:26,480 the periphery are substantially higher than in northern European countries. 308 00:33:27,050 --> 00:33:31,220 These are ECB interest rates. Um. Um. 309 00:33:32,540 --> 00:33:35,570 On loans to non-financial private sector borrowers. 310 00:33:36,630 --> 00:33:43,050 And you see a difference of three or four percentage points, um, which is very painful of course, 311 00:33:43,050 --> 00:33:51,540 for these countries because these are the countries that are going through adjustment any way they have to improve competitiveness, 312 00:33:51,720 --> 00:34:01,520 given that they cannot move the exchange rate. They do it by cutting wages, cutting income, um, more in Greece and Ireland than in Italy and Spain. 313 00:34:01,530 --> 00:34:05,640 But it's happening everywhere. Um, that's painful. 314 00:34:06,810 --> 00:34:16,680 If now certain corporates, um, have capital costs that are significantly higher than the capital costs that their competitors have. 315 00:34:17,100 --> 00:34:21,180 A few kilometres on my it's further north because there's a border in between. 316 00:34:21,870 --> 00:34:27,030 Then what can they squeeze? They have to squeeze again labour costs on top of what they are already doing. 317 00:34:27,600 --> 00:34:34,380 So that's not nice for the people who want to earn a decent living, but it's also bad for domestic consumption and domestic demand. 318 00:34:34,890 --> 00:34:38,700 So that's a risk that GDP drops further. So this is not healthy. 319 00:34:39,420 --> 00:34:48,480 Um, there can be some differentiation, but it should be based on creditworthiness, not on geographical location. 320 00:34:50,660 --> 00:34:59,120 So this when you look at these two charts, that describes a problem that's more or less what politicians also discovered. 321 00:34:59,420 --> 00:35:06,790 So some of last year. The first two and a half years of the crisis, they had focussed on the fiscal side, on debt levels, 322 00:35:06,790 --> 00:35:13,240 on competitiveness and current accounts, and they saw to some of last year that all these things were moving in the right direction. 323 00:35:13,570 --> 00:35:16,660 It was not over, but it was moving in the right direction. 324 00:35:16,960 --> 00:35:22,690 Why here on the banking side, financial markets and looking at interest rates, 325 00:35:22,690 --> 00:35:28,720 looking at how much money was channelled through the ECB, the problem was getting worse. 326 00:35:30,240 --> 00:35:34,260 And that's why, to the surprise of some in the summer of last year, 327 00:35:34,260 --> 00:35:39,660 all of a sudden the word banking union appeared in the communique of euro area summits. 328 00:35:40,040 --> 00:35:48,590 Um, I can tell you it was not so easy to explain all this to top politicians because normally this is beyond their radar screen. 329 00:35:49,990 --> 00:35:56,200 But they realised that there was a problem and that's why banking union is now on the top of the agenda. 330 00:35:56,650 --> 00:36:00,910 It was again be there the end of the week when the next summit in Brussels. 331 00:36:01,720 --> 00:36:09,730 And banking union has three objectives. First, to limit this fragmentation in the financial markets to the minimum possible. 332 00:36:10,360 --> 00:36:13,630 Second, to break the sovereign bank link. 333 00:36:13,660 --> 00:36:16,690 And third, to protect taxpayers. 334 00:36:19,490 --> 00:36:22,950 So. What has happened in this area. 335 00:36:23,550 --> 00:36:31,770 We have always, for some time, has stepped up additional new institutions for support for financial markets, 336 00:36:31,770 --> 00:36:36,390 supervision for banks, insurance companies, securities markets. 337 00:36:36,420 --> 00:36:43,140 We also created the ECB, European Systemic Risk Board, which is really an interesting. 338 00:36:44,480 --> 00:36:50,240 Um, institutions not well known in the broad public, but you probably all know about it. 339 00:36:50,960 --> 00:37:01,430 Other countries also drew the conclusion from the crisis that macroprudential risks have been ignored or not not monitored appropriately. 340 00:37:01,850 --> 00:37:08,720 Max and and Russell have written the paper on that. Um, so now people have woken up. 341 00:37:09,200 --> 00:37:12,290 They know that this is potentially very important to prevent the crisis. 342 00:37:13,100 --> 00:37:19,850 ECB Does it in the euro area, and I think for the euro area is even more important than for a country. 343 00:37:20,780 --> 00:37:31,220 The US has created a similar body in the UK. But in the monetary union where monetary policy is not available in any country specific way, um, 344 00:37:31,580 --> 00:37:41,210 supervisory tools can be particularly helpful because supervisory tools in a monetary union remain available at the national level. 345 00:37:41,840 --> 00:37:44,970 They can be used to address to address national problems. 346 00:37:44,990 --> 00:37:50,210 For example, five years ago when the Irish real estate bubble was getting bigger and bigger. 347 00:37:51,280 --> 00:37:55,059 The Irish supervisors could have intervened if they had the instruments. 348 00:37:55,060 --> 00:38:00,700 They could have said the loan value ratio should be no higher, no more than 80. 349 00:38:01,360 --> 00:38:09,910 Typically in Ireland, like in this country, in the US banks financed under 10% of the purchase price of of a real estate project. 350 00:38:10,420 --> 00:38:15,100 So the Irish supervisors could have used that and could have stopped that. They didn't do it. 351 00:38:15,580 --> 00:38:22,720 But there was also nobody in Europe who told them to do that. And that's my expectation that the US upheaval will play that role. 352 00:38:23,920 --> 00:38:28,960 We also, of course, Europe is part of what's happening globally in Basel. 353 00:38:29,590 --> 00:38:33,470 The G20 or Basel three is being implemented. Um. 354 00:38:34,610 --> 00:38:39,200 Um. In preparation of that, banks are increasing their capital. 355 00:38:39,590 --> 00:38:44,290 Last year alone, European banks increased their capital by €250 billion. 356 00:38:45,240 --> 00:38:52,350 Um, and doing that and some deleveraging the core tier one capital ratios or move to 9% or higher. 357 00:38:52,860 --> 00:38:56,740 So a lot of progress with the European banks. Um. 358 00:38:58,140 --> 00:39:09,360 And we continue with our regulatory framework in the European Union on the different capital adequacy directives we are discussing B, 359 00:39:09,360 --> 00:39:15,660 our D, which stands. But I get to that. On the next slide, I explain a bit what all these these acronyms mean. 360 00:39:16,320 --> 00:39:22,530 Um, and we are moving towards banking union, which has these different components. 361 00:39:23,130 --> 00:39:26,230 Um. Banking union. 362 00:39:26,230 --> 00:39:28,630 As you know, the first part has been agreed. 363 00:39:29,260 --> 00:39:36,400 The Single Supervisory Mechanism as a sum will be taken over by the ECB and will be operational in about a year. 364 00:39:37,330 --> 00:39:42,760 The single resolution mechanism is still under debate on the first debate, actually. 365 00:39:43,150 --> 00:39:48,730 Different views on this. Not surprising when you have 17 countries on the commission and that different views. 366 00:39:50,170 --> 00:39:53,170 I'm sure there will be a solution found in the next few months. 367 00:39:53,170 --> 00:39:54,970 But I cannot tell you tonight which one. 368 00:39:55,870 --> 00:40:04,959 Um, direct bank recap instrument is something that's directly linked to my institutions because he has the idea that on top of the instruments, 369 00:40:04,960 --> 00:40:09,310 we already have ESM. I showed them on the audio slide. 370 00:40:09,730 --> 00:40:16,630 We would also be authorised to give capital equity directly to just one bank. 371 00:40:17,930 --> 00:40:20,719 Which would be in addition to our normal work, 372 00:40:20,720 --> 00:40:27,620 I have to recruit different staff who was able to supervise and restructure banks sit on the board of a bank. 373 00:40:28,160 --> 00:40:33,320 Um, but this is broadly agreed by the euro area finance ministers. 374 00:40:33,950 --> 00:40:37,730 Um, however, we knows that in some countries it's hotly disputed. 375 00:40:38,510 --> 00:40:48,770 Um, particular in Germany, it may well become subject of the coalition agreement between the two parties that may form the grand coalition in Germany. 376 00:40:49,250 --> 00:40:55,610 And we have to see what happens there. But it is one of the elements of the, of the banking union. 377 00:40:56,150 --> 00:41:06,800 Um, as you know, as part of the banking union and the ECB taking over as single supervisor, there will be asset quality reviews. 378 00:41:07,310 --> 00:41:11,990 Um, and spring of next year, there will be stress tests from EBA. 379 00:41:12,650 --> 00:41:20,959 Um, at the end of that, one has to know if there are gaps, who will fill those gaps as again the fierce debate ongoing. 380 00:41:20,960 --> 00:41:31,250 How to do that. Um, some people think that the ESM should be authorised to act as a financial backstop in this context, 381 00:41:31,580 --> 00:41:40,430 not only through direct bank recapitalisation, but also as a backstop to the single resolution mechanism and single resolution fund. 382 00:41:41,150 --> 00:41:45,560 Um, all of that are in the debate and not over. Um, we will see where it goes. 383 00:41:46,130 --> 00:41:53,750 What we could already do today is use the instruments that we applied in the case of Spain to help the bank 384 00:41:53,750 --> 00:41:59,780 restructuring by giving a loan to the government where the money is clearly earmarked for the banking sector. 385 00:42:01,110 --> 00:42:06,180 That doesn't cut the link between sovereign and banks. Um, but it provides the financing. 386 00:42:06,420 --> 00:42:10,410 Um, so this is available, um, and would be used again. 387 00:42:12,180 --> 00:42:15,950 So that's where we are on banking union. I'm sure you will have many questions. 388 00:42:15,960 --> 00:42:23,250 I better stop here. But let me repeat. Apart from banking union, where we all are working very actively right now, 389 00:42:23,760 --> 00:42:31,970 my main message is there are these four good reasons why the euro area is stabilising, why the market situation has stabilised. 390 00:42:31,980 --> 00:42:39,150 It's not by coincidence. It's not because markets now focus on U.S. debt ceilings and emerging market exchange rates. 391 00:42:40,380 --> 00:42:44,340 We have made good progress at the national level. The adjustment is really there. 392 00:42:44,670 --> 00:42:52,050 It's not over. It must continue. But it's really the the policy coordination that's much stricter and much broader today than ever before. 393 00:42:52,560 --> 00:42:59,549 Thirdly, we have new institutions that are available to react to a crisis, and we are working. 394 00:42:59,550 --> 00:43:07,410 Fourthly, on the banking union, which I think is an important part and compliment to economic and monetary union. 395 00:43:07,650 --> 00:43:10,410 Thank you. Thank you very much.