Ladies and gentlemen,
“I am still learning.” When Tommaso Padoa Schioppa left the European Central Bank he gave his colleagues a souvenir with this motto. It was well chosen. It shows his approach towards the world: Towards the single currency, towards fiscal policy, and towards European unification.
Tommaso Padoa Schioppa believed in Europe. He believed in the European Union. And he believed that – in the process of European integration – the Euro was not only a milestone but ‑ more importantly ‑ its catalyst.
So do I. There is one basic principle which directed – and still directs – European integration: The principle that economic unity precedes political unity, but is intended to lead to political unity. Applying this principle European Monetary Union was not accompanied by a political union. Each country continued to determine its own budgetary, fiscal and social policy to a large extent.
But we are still learning. I presume that most of us never imagined that a sovereign debt crisis in a relatively small country could affect the entire Eurozone. Yet the fact is that the Greek crisis, just like the crisis in Ireland, weakened confidence in the Eurozone as a whole. It is for this systemic risk, the risk that one country’s debt crisis will prove contagious for other Eurozone members and for the Eurozone as a whole, that the Stability and Growth Pact failed to function as an adequate provision.
Currently, nervous capital markets are testing Europe’s resolve to apply the lessons of the past years. Jean-Claude Juncker’s prediction on the eve of the Euro’s introduction on 1 January 2002has been fulfilled. He said: “The Euro, one day, will be perceived as the father of all things European. The Euro compels us to engage with European issues at an existential level, to steer them into the right channels.”
Ladies and gentlemen, that is the very point we have reached now. We must now attend to the most important European question: What is the way forward for political integration, particularly in the areas of economic and fiscal policy?
And of course, we must frame this debate, including its economic and fiscal-policy dimensions, in the context of constitutional law and constitutional politics. On the one hand, the nation-state has indisputably lost its monopoly on regulation. On the other hand no-one wants a European super-state. A European super-state would basically just be an attempt to transfer the monopoly on regulation characteristic of the outdated nation-state to a larger unit. That would not be new. Nor would it be worthwhile. And that is why we need something unique – sui generis – as the German Constitutional Court said. Although we lawyers have something to confess to the non-lawyers among us: When lawyers can’t get something to fit neatly into existing categories, they fall back on their Latin and say ‘sui generis’.
However, I do not want to go into the issues of constitutional law, because I am here as Germany’s Minister of Finance. Instead I would like to make a few points which – in my opinion – are significant when discussing how we can stabilise European Monetary Union on a lasting basis. How an enhanced cooperation of economic and financial policy in Europeand the Eurozone should look like.
The first point I want to make is that, at the heart of the matter, we are not experiencing a crisis of the Euro, but various crises in individual countries that belong to the Euro area. These crises were caused by the individual countries’ erroneous economic and fiscal policies, as in the case of Greece, or were caused by a banking system going off the rails, as in Ireland.
Let me repeat that: We are faced with sovereign debt crises in individual countries, and not with a currency crisis. This is demonstrated by the simple fact that the external and internal value of Europe’s common currency – despite all the turbulences – has remained impressively stable.
The European Central Bank is fulfilling its mandate, and there is no doubt whatsoever that it will continue to do so in future. And that it will thus further strengthen confidence in the Euro. We have delivered price stability, which is exactly what not only the German but the European people expected – and were entitled to expect.
My second point is that reducing the deficit burden does not hinder growth in the long term. Today, there can no longer be an argument that credibly reducing excessive government debt does not starve growth, but nurtures sustainable growth. German figures confirm that.
My third point is that it is the Euro, which protects us from excessive exchange rate fluctuations. This is something we need to repeat again and again. Take the banking crisis from 2008 onwards. We would have seen large distortions in the system of currencies, particularly in Europe. Exchange rates would have risen and fallen abruptly. And the result would have been terrible damage to most of our economies.
The fourth point I want to make: We used to believe that the different rates of interest paid by the single currency’s members would be a sufficient incentive for prudent fiscal policies by countries within the Eurozone. If you do not manage your economy well, you pay higher interest. And if you manage your economy well, you pay lower interest. In principle, that remains true.
But when the Stability and Growth Pact was drawn up, back when European Monetary Union was founded, the belief in rational markets was less a scientific fact than a religious faith. Their limits became visible during the financial and banking crisis in 2008. The truth is that markets work well, but they do not always act rationally since human beings do not always act rationally. Human beings and therefore markets cannot responsibly deal with unlimited freedom. We know that is true for people, we had to learn that it is true for markets as well. Clearly it was a mistake to deregulate financial markets as much as possible. Markets aggregate the decisions and acts of human beings. Like human beings they need institutions, need rules and boundaries to act responsibly.
Markets are not perfect. There was no way it could have been foreseen, that they underprice or overprice risk to the extent we witnessed in previous years. The advances that have been made in communications technology did not help in that regard. When we created European Monetary Union, when we drafted the Stability and Growth pact, the advances in communications technology were in its infancy. No one foresaw – no one could foresee – that these advances would change financial markets for good – but not always for the better. Instantaneous communication has lead to instantaneous execution. That has lead to volatility beyond anything we could have foreseen.
Financial markets today are a world apart from financial markets in the past. Today, financial markets can and do react in seconds to new information, but they frequently no longer reflect and analyze the information properly.
That is one reason, why the threat of interest rate differentials did not and can no longer fully protect the Eurozone from the risk of contagion arising from a loss of confidence in a few Eurozone countries.
But we must not simply abandon interest rates as a disciplinary mechanism. Governments need the markets. Markets tell governments things that governments don’t want to hear. And they force governments to do the right thing, although too often too late and too suddenly. For this reason, I am convinced that we cannot do away with the threat of higher interest rates for spendthrift states. If we did, it would shut down the premise by which the Stability and Growth Pact operates. Besides, I firmly believe that it would be a disastrous signal to send to the financial markets. They would immediately interpret it as meaning the Euro would now cease to be a stable currency. For this reason, I am convinced that we cannot do away with the threat of higher interest rates for profligate states.
Putting all the blame for what went wrong on financial markets would be convenient, but far too easy. Because it is also true that the financial crisis of 2008 and the ensuing recession can only go so far in explaining the high levels of indebtedness of some Eurozone countries. The inconvenient truth is that a number of European countries lived well beyond their means over the past decades.
The added debt burden of the past years is only the final straw – albeit a rather heavy one – breaking the back of Europa’s bull. For too long, and even in good times, governments spent more than they earned. Perhaps worse, some also spent more than they could easily repay, given their economies’ declining long-term growth potential due to aging populations.
Excessive government spending has led to levels of debt that will become unsustainable if we do not begin reducing them now. Not doing so would compromise our ability to shape our future and prevent our children and grandchildren from shaping their own.
Recent studies – most prominently Rogoff’s and Reinhardt’s book “This Time Is Different” -, have shown that once government debt burdens reach thresholds perceived to be unsustainable more debt will stunt rather than stimulate growth. The recent turmoil within the Eurozone suggests that this finding holds true for growth in Eurozone countries as well. Greece’s debt crisis and the crises it generated offer a clear warning to European policymakers not to allow public debt to pile up indefinitely. It graphically demonstrated how markets can suddenly withdraw their support to governments when deficits and debt reach levels investors consider unsustainable. It would be grossly negligent of European policymakers to ignore these warnings, as markets would permanently lose confidence in Eurozone countries’ ability to service their debts, leading to citizens losing their confidence.
The financial, economic, social and political consequences of such a debt crisis would be dramatic and difficult to contain. It was therefore right to react swiftly and decisively to secure the stability of the Euro by providing short-term assistance to Greece, Ireland and now, Portugal. However, even though the EFSF is a necessary step towards stabilising the current situation, the crisis in Greece has revealed structural weaknesses of the European Monetary Union’s fiscal policy framework which cannot and should not be fixed by routinely throwing other countries’ money at the problem.
No, throwing other countries money at the problem is not the answer. We have to repair public finances, and we have to do so in a way that rather encourages than hinders future growth. All Eurozone governments need not only convincingly demonstrate their commitment to fiscal consolidation but also to increasing competitiveness to restore confidence of markets as well as their citizens. But it is not only countries that need incentives to restore competitiveness and to borrow responsibly. Investors too need incentives to lend responsibly.That is why wemust provide for private-sector participation in the resolution of sovereign-debt crises.
We are learning from experience. EMU’s rules were insufficient to increase competitiveness, impose fiscal discipline and to prevent crises within the Eurozone. And the EU was ill-equipped to deal with sovereign liquidity and solvency crises when they did occur.
- Clearly EMU’s precautionary measures against excessive indebtedness are insufficient.
- Clearly EMU’s political-economic coordination is insufficient.
- Clearly EMU lacked a crisis resolution mechanism in case of emergency.
In brief: The Eurozone’s economic and fiscal governance lacked bite in both substance and form.
So now we have come to the heart of the matter:
Only calling for more budgetary discipline has proven to be insufficient. We have to make sure that this discipline is actually in place. It is vital, that we look at more than just government budgets, debt and deficit figures. We must consider an individual members’ economic performance too and better co-ordinate economic policy.
Yes, we have to avoid overly large imbalances between member States. But no, this cannot take the form of successful countries voluntarily limiting their competitiveness.
Yes, recent events have shown that a common currency cannot survive without solidarity between its members. But such solidarity can only prevent an individual country’s crisis from turning into a Eurozone crisis. A Member State has to be willing to deal with the root causes of its problems itself.
The only workable course is for those countries in the Eurozone who are somewhat weaker, to become stronger. We can help them, but we cannot do their job. Besides, one does not resolve one’s own problems of competitiveness by asking others to become less competitive and one cannot permanently close the gap between expenditure and income by asking others for more money.
We have learned these lessons the hard way: The European Heads of States and Governments have drawn the right conclusions from last years’ crisis and have developed a comprehensive strategy to improve competitiveness and reform the fiscal policy framework within the European Economic and Monetary Union.
The surveillance of budgetary policies will considerably be strengthened with revised, stronger fiscal rules within the framework of the Stability and Growth Pact which shall commit Euro countries to sound fiscal policy:
- Sanctions will apply if Euro states do not bring fiscal positions close to balance in the medium term
- Sanctions will also apply if Euro states do not follow the debt reduction target of 60 percent of GDP in the medium term
- Sanctions will apply on a quasi-automatic basis if Euro states will not abide by the rules.
The crisis has demonstrated that compliance with the Stability and Growth Pact is simply not enough – the Eurozone has to put additional emphasis on strengthening the competitiveness of all its members. Consumption developments, bubbles in housing markets and the accumulation of external and internal debt in some Member States deepened the impact of the crisis and constrained the capacity to respond. This is why a new procedure for detecting and correcting economic imbalances will be introduced. This procedure will concentrate on curing the root causes of macroeconomic deficits by forcing Member States to ensure a high level of competitiveness.
The Heads of State and Government of the EU have developed a growth strategy called “Europe 2020” to turn the European Union’s economy into a intelligent, sustainable and integrative economy which is characterised by a high level of employment and productivity and by distinctive social cohesion.
A pact for competitiveness, the “Euro-Plus-Pact” has been agreed upon. Its goal is to foster and improve competitiveness of EU Member States and the EU as a whole by creating a system of benchmarking against the best. All countries joining the Pact will commit to common yearly targets and have to implement concrete national reform measures in order to reach the targets. The Pact shall not only strengthen the competitiveness of Europe, but also the sustainability of its public finances in the long term. Examples of possible reform measures are the adjustment of pension systems to national demographic situations or the limitation of early retirement regulations.
By means of the “European Semester” Member States’ budgetary and structural policies will be examined more closely to detect inconsistencies and emerging imbalances.
The above mentioned package of reforms will ensure that we will detect problematic developments early enough and will be able to correct them.
But for the very unlikely event that a strengthened Economic and Monetary Union will not be able to prevent a Member Statefrom liquidity or solvency crisis in the future, we are establishing a robust and permanent crisis resolution mechanism.
The European Council in March has agreed on a permanent European Stability Mechanism (ESM) that will fill the institutional gap of the architecture of the European Economic and Monetary Union as a new emergency pillar for financial crises.
Again, the ESM only comes into play when crisis prevention and other measures have failed and its activation is subject to firm rules on the basis of strict conditionality. That is why the ESM can only provide financial assistance if a Member Stateis unable to access the market and if the financial stability of the whole Eurozone is at risk. That is is what is meant by the “Ultima Ratio” principle.
Secondly, the ESM can only provide financial assistance subject to a rigorous debt sustainability analysis conducted by the European Commission and the IMF, in liaison with the European Central Bank (ECB). It can only provide financial assistance subject to strict conditionality under a macro-economic adjustment and reform programme by the Member Statein need, which is commonly prepared by the European Commission, the ECB and the IMF.
It is also not without importance – believe me – that the ESM can only provide financial assistance if activation is unanimously agreed by the voting members of the ESM Board of Governors, consisting of the Ministers of Finance of the Euro Area Member States.
Last but not least the ESM will provide for private sector involvement. This is of very high priority to the German government. And for good reason: We have to deal with the problem of moral hazard. Risks and rewards should not be separated from each other. Investors – and that includes European bond holders – ultimately have to bear the rewards as well as the risks of their decisions. But during the previous crises it was almost exclusively European taxpayers that ultimately bore the risks of investors’ decisions.
That is inadmissible. Sure, it was right to stop financial markets from disintegrating in the past, but it would be wrong to cushion their losses in the future. In the long run a division between risks undermines the foundations of capitalism – which needs risks and rewards to be inseparably – to function properly. Perhaps even worse it erodes the legitimacy of our democratic societies as citizens trust in the basic fairness if the system crumbles, when they see their governments and parliaments, their representatives, bailing out investors time and time again. Sustaining such a policy would be driving a permanent rift between the electorate and the elected and alienate voters from the democratic process, as they see their representatives as beholden to special – not voters’ – interests.
The rift between Europeand its citizens is already there. Europeno longer registers well with many Europeans. That is for a number of reasons. But being in Brusselslet me name just one: Europeno longer registers because of the disconnect between the European institutions and its citizens. It is not sufficient to set up an information booth in every European capital, one has to reach the people. That is not happening. Europe’s institutions and its representatives are perceived as distant and technocratic, immersed in their own world, speaking their own language. When there is a debate about Europethan only with the initiated for the initiated.
This will not do. Ultimately Europestands and falls with the support of its citizens. That means we have to convince our citizens that Europeis good for them, that it is an idea worthy their support – and their votes. We have to do that in a language they can understand, not in bureaucratic “Brusselspeak”. And we have to put our money where our mouth is. Or more precisely: their money.
That leads me back to the ESM: The thorough planning and composition of the ESM has made it possible to agree on clear and reliable rules for the involvement of investors and tax payers: the nature and the extent of private sector involvement depend on the outcome of the debt sustainability analysis and potential implications for Euro area financial stability. If debt sustainability cannot be confirmed for a Member Statein crisis, private sector involvement becomes compulsory.
With adequate private sector involvement we strengthen the crucial principle of a market economy: the inseparability of risk and accountability. Strong Member States will not provide an automatic safety net for weak Member States. They will not automatically account for risks taken by private creditors.
In order to facilitate private sector involvement, standardized collective action clauses will be included in the terms and conditions of all new Euro area government securities with a maturity in excess of one year issued from July 2013 onwards. These clauses are intended to enable creditors to adopt a qualified majority decision agreeing to a legally binding change to the terms of payment in the event that a debtor Member Stateis unable to meet its payment obligations. There are those who think that including rules for the involvement of the private Sector in the ESM would drive spreads sky high and increase volatility manifold. I have listened carefully to those arguments and I am not convinced. I think markets – to a large extent – have already discounted and accepted the fact that there will be rules for private sector involvement in the ESM.
Ladies and gentlemen,
Every now and then, one has to take a stand and deliver. Now is the time. This is not the time to muddle through.
There are some who say we are doing just that. That is utter nonsense. True, we have bought time for Greece, Ireland and Portugal but only for these countries to take the necessary steps to lower their deficits and strengthen their economies. And to develop a rules based approach to improve competitiveness and strengthen fiscal policy within the Eurozone.
There is no disagreement about the fact that Europe, and above all the Eurozone, must improve the links between its countries’ national fiscal and economic policies. It is essential that European Monetary Union’s institutional structures are indeed capable of obliging Euro members to adopt a fiscal and budgetary policy that reflects their responsibility for the common currency.
For those who think that the framework I have outlined is objectionable, it is worth remembering that the European Monetary Union was not intended to be a quick fix for Eurozone members or ‑ for that matter ‑ a get-rich scheme for financial speculators. It was not meant to be a system of redistribution from richer to poorer countries via cheaper borrowing for governments by means of common Eurobonds or outright fiscal transfers. European Monetary Union won’t succeed if a number of countries persistently run deficits and weaken their competitiveness at the expense of the Euro’s stability.
In fact, EMU was designed to encourage structural reforms: profligate members were supposed to be forced to live within their means and to strengthen their competitiveness by the rules of the Stability and Growth Pact, as well as by their peers.
The approach I have outlined may sound disappointing at first to all those who are now calling for the supposed structural faults in European Monetary Union to be corrected once and for all by building up the political union. But it is an approach that – in my view – echoes the genesis of European integration. Europe is, and will remain, complex and complicated. Europe moves forward one step at a time. But ladies and gentlemen, despite or perhaps because of all the complications, all the struggles, we can ultimately say: “Yet it moves” or in Italian “Eppur si muove”. I am sure Tommasso Padoa Schioppa would have liked that. Thank you very much.