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The 2007 financial crisis, the most severe recession since the 1930s.

Euro area: the way forward Boris KISSELEVSKY, Financial Councellor to the Embassy of France in Moscow Bank of Russia, 17 May 2013. The 2007 financial crisis, the most severe recession since the 1930s. A sovereign debt crisis during the summer of 2011, with its epicentre in the euro area.

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The 2007 financial crisis, the most severe recession since the 1930s.

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  1. Euro area: the way forwardBoris KISSELEVSKY,Financial Councellor to the Embassy of France in MoscowBank of Russia, 17 May 2013

  2. The 2007 financial crisis, the most severe recession since the 1930s. A sovereign debt crisis during the summer of 2011, with its epicentre in the euro area. Yet, public finances in the euro area are in better shape than in most other large advanced countries: How did we get there? What has been the policy reaction? What reforms to ensure the success of the euro area? Introduction

  3. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Policy answers to deal with the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  4. 1. The Sovereign debt crisis, third phase of the financial crisis

  5. The Sovereign debt crisis, third phase of the financial crisis 1st phase: a financial crisis Interbank Risk premium (in basis points) Risk aversion Risk aversion common factor

  6. The Sovereign debt crisis, third phase of the financial crisis 2nd phase: a deep and global economic crisis

  7. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  8. The rise in public debt after the financial crisis Strong use of fiscal policy 8 Lyon – 18 Octobre 2011

  9. The rise in public debt Public Debt (in GDP % ) 1800 - 2012 260 240 220 200 180 160 140 120 100 80 60 40 20 0 1800 1820 1840 1860 1880 1900 1920 1940 1960 1980 2000 United States Italy France United Kingdom - Unis - Uni A high level of public debt in peace time 9 Lyon – 18 Octobre 2011

  10. The rise in public debt A better fiscal position for the euro area Fiscal balance 2011 estimates

  11. The rise in public debt A better fiscal position for the euro area Public Debt – 2011 estimates

  12. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  13. The euro area at the epicentre of the sovereign debt crisis

  14. The euro area at the epicentre of the sovereign debt crisis Refinancing needs for Euro area countries (Bns Euros)

  15. The euro area at the epicentre of the sovereign debt crisis Low compliance with the Stability and Growth Pact 15 Lyon – 18 Octobre 2011

  16. The euro area at the epicentre of the sovereign debt crisis Protracted external imbalances 16 Lyon – 18 Octobre 2011

  17. The euro area at the epicentre of the sovereign debt crisis Strong divergences within the euro area Industrial production (2005=100, sa-wda)

  18. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  19. Risks of adverse feedback loops Lower growth Worsen fiscal balance Less bank lending Lower bank asset quality Automatic stabilisers held back Higher guarantees Fiscal situation Financial sector Sovereign risks increase 19 Lyon – 18 Octobre 2011

  20. Risks of adverse feedback loops Spillover from sovereign risk to the banking sector CDS average premium: Sovereign vs banks (in basis points)

  21. Risk of a credit crunch? 21 Lyon – 18 Octobre 2011

  22. 2. Economic policy answers: the acute phase of the crisis

  23. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  24. Germany Greece 1.5 8.0 1.0 6.0 0.5 0.0 4.0 - 0.5 2.0 - 1.0 - 1.5 0.0 - 2.0 - 2.0 - 2.5 2010 2011 2012 2013 2010 2011 2012 2013 automne 2010 printemps 2011 automne 2011 automne 2010 printemps 2011 automne 2011 Spain Italy 3.0 2.0 2.5 1.5 2.0 1.5 1.0 1.0 0.5 0.5 0.0 0.0 - 0.5 2010 2011 2012 2013 2010 2011 2012 2013 automne 2010 printemps 2011 automne 2011 automne 2010 printemps 2011 automne 2011 Fiscal consolidation Structural effort (% GDP) Source: European Commission Lecture: les tableaux ci-dessous dressent, pour un échantillon de pays de la zone euro, les évolutions de prévision d’efforts structurels. Pour 2012 (dans une moindre mesure pour 2011) l’effort structurel prévu est plus important lors de la dernière prévision, signe que la consolidation est bien engagée.

  25. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  26. A strong monetary policy reaction 26 Lyon – 18 Octobre 2011

  27. Non conventional monetary policy measures • Measuresaiming the bankingsector, which finance ¾ of the euro area economy: • Fixed rate full allotment • Up to 3-yearmaturity • Extension of collateralrequirement • Direct marketpurchases to insure a correct transmission of monetarypolicy: • SMP: Governmentsecurities • CBPP: Covered bonds • OMT: Outrightmonetary transactions

  28. Eurosystem Response to the Crisis 1/5 • STANDARD MONETARY POLICY MEASURES: • Interest rate cuts to historical minimum of 0.75% • but insufficient since markets do not transmit price signals • NON-STANDARD MEASURES: • Temporary and extraordinary • Complement (not replace) standard measures • Objective: Restore the monetary policy transmission mechanism • by providing liquidity to the banking system through relevant markets: • Interbank money markets • Covered bond markets (CBPP1& 2) • Debt markets(SMP and OMT)

  29. Eurosystem Response to the Crisis 2/5 • Measures addressed to the INTERBANK MARKET: • ECB replaces the missing intermediation role of the market • 1. Full allotment policy (since 15 October 2008) • Counterparties have their bids fully satisfied (against collateral) • ensures banks’ continued access to liquidity • 2. Lengthening of the refinancing operations • 6-month, 12-month and 3-year operations (LTROs) • reduce funding risk of banking system over a longer horizon • 3. Lower reserve requirement (reserve ratio: from 2% to 1%) • brings down the liquidity needs of banks around EUR100bn

  30. Summarising…

  31. Looking ahead… The flexibility of the monetary policy operational framework has allowed the Eurosystem to provide the necessary liquidity during the crisis while maintaining the primary objective of price stability Non-standard measures are not the lasting solution to the crisis but “buy time” for the needed structural reforms (fiscal consolidation, orderly deleveraging of banks…) Phasing-out of non-standard measures? Gradual Post-crisis operational framework? Possibly: core features maintained refined with lessons learnt

  32. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  33. A successful stabilisation Decrease in sovereign yields

  34. A successful stabilisation Contrasted situation for countries under programme

  35. A successful stabilisation A decrease in banking risk

  36. Impact on credit to be confirmed 12-months change (%) (gross; not corrected for securitisation for housing loans) Non financial corporations Housing loans

  37. 3. Long termreforms

  38. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  39. European Governance overhaul A strengthening of European Governance • 1/ A strengthening of the Stability and Growth Pact • 2/ Economic imbalances surveillance • 3/ A framework for the crisis management

  40. European Governance overhaul A strengthening of the Stability and Growth Pact • A strengthening of ex ante surveillance : • The European semestre • The golden rule • Structural deficit below 0.5% of GDP • Debt reduction:1/20th a year above 60% of GDP • More automatic sanctions ex post: • Reverse qualified majority at all stages of the excessive deficit procedure • Infra-annual surveillance • Progressive sanctions up to 0.5% GDP fine

  41. European Governance overhaul Surveillance of economic imbalances • A yearly scoreboard prepared by the Commission: • External imbalances: • Balance of payment • Net investment position •  export market shares •  unit labour costs •  effective exchange rates • Internal imbalances: • Public and private indebtedness • Housing prices • Unemployment • European Council Recommandation in case of excessive imbalances • The Member-State presents a corrective action plan • Sanctions in case of insufficient action plan

  42. European Governance overhaul Surveillance of economic imbalances • For France, 2 surveillance points: •  export market shares: -19 points in 5 years/ 6% threshold • Public Debt: 82% / 60% threshold • In-Depth study for 12 Member-States, among which France • 4 Member-States under programme (Ireland, Portugal, Greece and Romania) already under strengthened surveillance.

  43. European Governance overhaul A permanent framework for the crisis management • A credible stabilisation mechanism « firewall »: • European Financial Stability Fund (EFSF - June 2010): 440 Mds € • 192 Mds for Greece, Ireland and Portugal • 109 Mds additional for Greece • Leverage? • European Stability Mechanism (ESM – july 2012): 500 Mds € • Conditionality • Interest rates close to EFSF funding costs • Prevent spillovers and insure financial stability

  44. Outline • The Sovereign debt crisis, third phase of the financial crisis • The rise in public debt after the financial crisis • The euro area at the epicentre of the sovereign debt crisis • Risks of adverse feedback loops • Economic policy answers: the acute phase of the crisis • Fiscal consolidations plans… • …and a strong monetary policy reaction… • …achieved stabilisation of the acute phase of the crisis • Long term reforms to make the euro area a success • A new Governance for Europe • Financial regulation reform • Increasing long-term growth

  45. Financial regulationreform A global reform of banking regulation… • Increase capital requirement for market operations • Increase the quality and quantity of capital • Reinforce and harmonise liquidity regulation • Regulate bonuses • BANKING UNION

  46. Financial regulationreform …a reform to be extended to the financial system • Regulation of Systemic Financial Institutions: • Enhanced loss absorption capacity (G SIB) • Restructuration mechanism and enhanced supervision • Extending G SIB to all systemic institutions • Market risks: • Standardisation of complex financial products • Compensation by regulated central conterparts • Better supervision of shadow banking, in particular hedge funds

  47. Financial regulationreform A new macroprudential surveillance • Macro-prudential surveillance : • Complement microprudential supervision • Take into account interconnexion between institutions, markets, instruments and risks accumulation. • For example: preventing housing bubbles • A new institutional framework: • Financial stability board and IMF at a global level • In the US, Financial Stability Oversight Committee (FSOC) • In Europe, European Systemic Risk Board (ESRB) • In France, creation of the « Autorité de Contrôle prudentiel » under the aegis of Banque de France and of the COREFRIS

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