We will phase out these measures once the underlying rationale fades away and the situation returns to normal. The crisis is not yet over, and the time to exit has not come. But when it comes, we are ready to take the appropriate action. We will act to ensure that the measures taken are phased out in a timely fashion, and that the liquidity provided is absorbed so as to counter effectively any threat to price stability over the medium to longer term. Of course, this phasing out is not a linear, straightforward process. Many aspects need to be considered, and the ECB has the operational flexibility and institutional independence to implement the desirable course of action in a determined manner whenever the need arises.
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Overall, we are well-placed to do so as the feasibility of a timely exit was one of our guiding principles when designing the non-standard measures. Apart from the outright purchases of covered bonds, all measures taken have finite lifetimes and allow for the return of monetary policy to the pre-crisis mode when required. Let me now turn to the response of European governments to the financial crisis. This consisted of measures to support the financial system and measures to reduce the effects of the financial crisis on the rest of the economy.
After the collapse of Lehman Brothers in September , most European governments swiftly adopted measures to support the financial system in a coordinated action. These included increasing deposit insurance ceilings, guarantees for bank liabilities and bank recapitalisations. The extent and design of the commitments vary widely between countries, reflecting the specific characteristics of national financial systems and the presence of large and systemically important institutions.
Our assessment of the effectiveness of the support measures is overall positive. The measures were needed for averting a further escalation of the crisis in late Here it seems that capital injections have been effective as well as debt guarantees and asset purchases. The three-month euro and dollar Libor spreads over market overnight interest rates, a measure of credit risk, have recently fallen to their lowest levels since the collapse of Lehman Brothers. Besides these measures to support the financial sector, the government response to the crisis also includes the fiscal reaction to reduce the fall-out of the financial crisis on the rest of the economy.
This is a combination of the operation of so-called automatic stabilisers the automatic reduction in tax receipts and the rise in government welfare payments as economic activity declines and specific discretionary fiscal measures, such as additional public investment, tax relief and subsidies for part-time employment. The size and timing of the stimulus measures, of course, differed considerably between countries. For the whole euro area, however, the European Commission estimates the stimulus measures to amount to 1 percent of GDP over the years The variety of stimulus measures and their dependence on the expectations and reactions of households and businesses make it difficult to assess precisely how effective they are.
But measures such as car scrapping schemes have helped to sustain private consumption and, on the whole, the recent bout of fiscal activism in the euro area seems to be reasonably well co-ordinated, well timed and well targeted.
In the euro area, GDP contracted by 0. While still negative, this was better than most had forecasted. All in all, the government response has been effective and we have welcomed it. But it comes at a cost as well. The fiscal loosening should be only temporary and we need to make sure that it is abandoned as soon as the underlying rationale fades away and the economic environment improves. The governments should ensure that fiscal consolidation does not start later than the economic recovery when private demand can substitute the public demand.
Only a part of the fiscal consolidation will occur through the automatic stabilisers and the temporary nature of some fiscal stimulus measures. Additional and more ambitious fiscal adjustment will be needed as well. Fiscal policy can only be a successful macroeconomic tool if it is sustainable in the long term.
The crisis has reminded us that monetary and fiscal policies are not sufficient to stabilize the economic situation. We also need to ensure the stability of our financial system. For this we need proper regulation and macroprudential supervision of systemic risk. Let me first focus on the first issue. In discussing monetary and fiscal policy, I have focused on the European response to the crisis. Now as I turn to the regulatory reform, I necessarily will speak about the global response.
Many of the issues can only be truly tackled at the global level. Indeed, under the aegis of the Group of Twenty, authorities worldwide have agreed on a common agenda for regulatory reform. Let me briefly recall the progress made thus far and highlight the measures that are of great importance to us. I will focus on three topics on the regulatory reform agenda that in my opinion are key: First, the prudential framework: Counter-cyclical capital buffers will be built up in good times to be drawn down in times of stress.
A leverage ratio will be introduced as a supplementary measure to the Basel II framework to curb excessive balance sheet growth, and a liquidity requirement will be established, obliging banks to hold sufficient high-quality liquid assets. These measures, to be issued by year-end, will significantly increase the ability of financial institutions to withstand shocks and therefore the resilience of the financial system. Let me highlight, however, that these measures will be phased-in as the economy recovers, to ensure they do not hamper the credit flow to the economy.
Second, the scope of regulation: Credit rating agencies will be subject to mandatory registration and oversight, with the aim of making them more transparent and reducing the potential for conflicts of interest related to the rating process.
Hedge fund managers will also be subject to registration and disclosure requirements. This sector, which is highly connected with other parts of the financial system, needs to be included in the effort to achieve greater transparency. In the European Union, legislation on Credit Rating Agencies was approved while work on alternative investment fund managers, including managers of hedge funds, is on its way.
The European response to the financial crisis
Legislative proposals have also been tabled in the US for both sectors. Moreover, there is a consensus on the need to extend regulation to the over-the-counter derivative markets, which should be subject to greater transparency and reduced counterparty risk. In this context, support on both sides of the Atlantic has been given to the establishment of central counterparties.
Authorities at the international level have worked closely together, with the result that central facilities have now been introduced in both the US and Europe to clear a considerable share of credit default swap transactions. Third, systemically important financial institutions: Action in this area is crucial.
The second key pillar in ensuring financial stability is related to the concerns of systemic risk and the supervisory architecture, in particular the macro-prudential approach to supervision. Measures are also being taken at the international level, but I would now like to return my focus to the European response.
Economic crisis in Europe: Cause, consequences, and responses | VOX, CEPR Policy Portal
The new body will be responsible for macro-prudential oversight in the European Union. It will identify and assess risks to financial stability, and issue risk warnings and policy recommendations. First, the ESRB needs to have good cooperation and extensive information exchange with the microprudential European Supervisory Authorities to ensure a proper monitoring and analysis of systemic risk. Second, effective mechanisms for the monitoring of the recommendations that the ESRB will issue are needed.
And third, the global dimension of macroprudential supervision is key. We need to ensure international coordination and good cooperation with the International Monetary Fund, the Financial Stability Board and other country counterparts that can contribute towards a better assessment and earlier detection of risks that originate from outside the European Union.
Finally, let me say that while institutional setups are needed to safeguard financial stability, trust in the stability of the financial system cannot be achieved solely by regulation alone. Individual financial institutions also need to contribute their share. In this context, let me briefly touch on the issue of business models.
The countries have, however, made rather different choices about spending. France, Italy and Spain refrained from cutting welfare benefits, in stark contrast to Ireland and the UK where cuts to benefit payments for working age adults played a major role. France and the UK have both chosen to afford relative protection to spending on health and education, while Italy and Spain have chosen to cut these services more deeply than other service areas.
Countries have also made divergent choices about which households should bear the brunt.
In Italy households with children have lost less from tax and benefit reforms than pensioner households; the reverse is true in Ireland and the UK. With France, Ireland, Italy, Spain and the UK implementing large fiscal adjustments since the onset of the Great Recession, we might hope that policymakers would have used this moment to improve the efficiency of the tax system and public spending in their countries.
Or, at the very least, we would hope that they did not exacerbate existing inefficiencies. Unfortunately, in many cases, the fiscal response to the crisis has been a missed opportunity. In Ireland, reforms have unnecessarily created uncertainty and distortions. This creates distortions in the economy: Therefore, the increase in the main rate of VAT will have come at the cost of increasing these distortions. The UK income tax schedule has also been made considerably more complicated; take the introduction of a transferable tax allowance for married couples, and the tapering away of child benefit from high income parents.
However, the lesson from the reforms made so far is that we perhaps ought not to be too optimistic. We may have to settle for reforms that do not add to existing deficiencies. European Union flags fly outside the European Commission headquarters in Brussels. The views expressed in this article are those of the author alone and not the World Economic Forum.
More on the agenda. Explore the latest strategic trends, research and analysis. Fiscal response There have been some very different solutions aimed at dealing with the fiscal problems faced. Similar on tax, different on spending Each country has raised tax to some degree, and the nature of the tax increases implemented shows up some interesting similarities. Making the most of it? Publication does not imply endorsement of views by the World Economic Forum.