Transcript The European Economic Recovery Plan

The Global Crisis: a
European Perspective
Vitor Gaspar, Director General of BEPA (Bureau of
European Policy Advisers)
RTD Debate – 17 March 2009
The views expressed are my own and do not necessarily reflect those of the European Commission.
BOTTOM LINE
1. The crisis has spread globally through strong economic
and financial linkages. The crisis is global in character.
2. Experience of Great Depression shows unilateral
national approaches lead to negative spillovers and
retaliation deepening and prolonging the crisis. It is
necessary to engage multilaterally to preserve open
trade.
3. Europe is the largest economic entity in the world and
the most integrated. Nowhere else is coordinated action
so justified to explore synergies and to avoid negative
spillovers.
BOTTOM LINE
The European Economic Recovery Plan is based on the
judgment according to which the current financial and
economic crisis is a unique, unprecedented, historical
event that justifies exceptional responses.
Outline
1.
2.
3.
4.
5.
Factors contributing to the current global
crisis.
Events in economic and financial
markets after October 2008.
Policy responses to the global crisis.
The European Economic Recovery Plan.
Conclusion.
Outline
1.
2.
3.
4.
5.
Factors contributing to the current global
crisis.
Events in economic and financial
markets after October 2008.
Policy responses to the global crisis.
The European Economic Recovery Plan.
Conclusion.
1. Factors contributing to the
current global crisis



There have been several elements that led to the
financial turmoil that started in August 2007:
Macroeconomic factors - The great moderation : low
volatility of macroeconomic aggregates, low inflation,
housing market bubbles, widening and unsustainable
international imbalances
Microeconomic factors - Financial innovation: new
financial instruments of unprecedented complexity,
development of the “originate and distribute”
complementing the “originate and hold” model of bank
operations, excessive risk taking not always by those
who could best bear risk, poor risk management,
inadequate regulatory and supervisory surveillance.
Outline
1.
2.
3.
4.
5.
Factors contributing to the current global
crisis.
Events in economic and financial
markets after October 2008.
Policy responses to the global crisis.
The European Economic Recovery Plan.
Conclusion.
2. Events in economic and financial
markets after October 2008

The economic outlook deteriorated sharply as the global
crisis intensified last autumn :
 The Commission interim forecasts 2009-2010
published on January 19 and updating the autumn 2008
forecast project world GDP growth to slow down to 0.5%
in 2009 from 3.3% in 2008.
 For the EU, GDP is forecast to contract by 1.8% in 2009
before recovering to 0.5% in 2010.
 In the euro area, the respective estimates are -1.9% and
0.4%.
 The Commission forecasts are in line with the IMF's
January 2009 ad-hoc update of the November 2008
World Economic Outlook.
2. Events in economic and financial
markets after October 2008
Table 1: Real GDP growth forecasts, EU-27 and euro area (annual average % change)
2010
2009
Commission
Euro area
Euro area EU
Euro area EU
1,8
1,5
1,8
1,7
1,3
0,9
1,1
0,1
0,2
1,2
0,4
0,5
-1,9
-1,8
0,9
IMF
1,2
1,7
1,4
1,2
1,7
0,2
0,6
1,3
-0,5
-0,2
1,2
0,2
0,5
-2,0
-1,8
1,0
OECD - euro area
1,4
1,7
1,3
1,7
1,2
-0,6
1,0
2008
EU
February 2008 interim
Spring 2008
September 2008 interim
Autumn 2008
January 2009 interim
2,0
2,0
1,4
1,4
1,0
Spring 2008
July 2008 update
October 2008
November 2008 update
January 2009
1,8
1,7
1,5
1,3
June 2008
September 2008 update
November 2008 update
-
Source: Commission, IMF and OECD forecasts, various issues as indicated
2. Events in economic and financial
markets after October 2008

Financial systemic-risk pressures have abated
since September-October 2008 as the result of
unprecedented and continuing government
financial support.
 Nevertheless, markets have not yet returned to
normalcy and risk-perceptions—as reflected in
interest-rate spreads—are still well above earlycrisis and especially pre-crisis levels.
2. Events in economic and financial
markets after October 2008
Figure 1. Average Libor interest rate in Euro Area, UK, US - as of Mar 4, 2009
2. Events in economic and financial
markets after October 2008
Figure 2. 3-month Libor spreads to Overnight Index Swaps – as of Mar 4, 2009
2. Events in economic and financial
markets after October 2008
Figure 3. 3-mo US TED Spread: T-bill vs. Libor - as of Mar 3, 2009
2. Events in economic and financial
markets after October 2008
However,
pressures are still strongly present in the credit markets that directly finance
the real economy.
Figure 4. Commercial MBS spreads as of Mar 3, 2009
2. Events in economic and financial
markets after October 2008
Figure 5. Spreads in consumer finance sectors as of Jan 12, 2009
2. Events in economic and financial
markets after October 2008
Figure 6. CDS spreads for US and European corporates as of Mar 3, 2009
Outline
1.
2.
3.
4.
5.
Factors contributing to the current global
crisis.
Events in economic and financial
markets after October 2008.
Policy responses to the global crisis.
The European Economic Recovery Plan.
Conclusion.
3. Policy responses to the global
crisis



In today’s conditions of financial turmoil the
transmission mechanism cannot be relied to operate
as in normal circumstances; hence the responsibility
for stabilization shifts towards budgetary policy. Fiscal
policy initiatives are needed to complement monetary
policy action.
The spillovers across nations can be very significant
in the present circumstances – hence the steps to
strengthen international policy coordination.
Inter-linkages and interdependence are particularly
strong in the EU and, in particular, in the euro area.
3. Policy responses to the global
crisis
Member States are faced with a common disturbance,
experience strong spillovers in their policy actions and
share central common interests:
•
The Single Market and the Single Currency.
•
Structural Adjustment and Sustainable Growth.
•
Financial Stability and overall Macroeconomic
Stability.
•
Multilateral governance for the global economy.
3. Policy responses to the global
crisis
•Central bank’s liquidity provision and
aggressive lowering of interest rates;
•Extension of guarantees on banks’ liabilities.
•Capital injections and (in some cases) statecontrol
•Treatment of impaired assets.
•Discretionary fiscal stimulus.
•A review of the regulatory and supervisory
framework in Europe
3. Policy responses to the global
crisis

Monetary easing in a concerted joint policy
action on October 8, 2008.
 EU leaders agreed on the principles for an
unprecedented concerted action in the EU.
 The European Economic Recovery Plan (EERP)
adopted on November 29 is the cornerstone of
the policy response.
 The Commission has presented on January 28
proposals to invest €5 billion in key energy and
internet broadband infrastructure projects in
2009-2010.
Outline
1.
2.
3.
4.
5.
Factors contributing to the current global
crisis.
Events in economic and financial
markets after October 2008.
Policy responses to the global crisis.
The European Economic Recovery Plan.
Conclusion.
4. The European Economic
Recovery Plan
EERP rests on two pillars:
I.
Discretionary fiscal stimulus
II.
Priority areas for Lisbon strategy
Fiscal stimulus should be in line with the following criteria:
coordinated;
timely;
targeted;
temporary.
4. The European Economic
Recovery Plan
Policy action to respect the rules of the Single Market and
the Stability and Growth Pact.
Policy action should follow the priorities of the Lisbon
Agenda and the urgency of structural reform.
Crisis are moments of opportunity. Hard questions are
posed and traditional forms of operation are
challenged.
The EERP leads us not only from crisis to recovery but
from crisis to long run sustainable prosperity.
Outline
1.
2.
3.
4.
5.
Factors contributing to the current global
crisis.
Events in economic and financial
markets after October 2008.
Policy responses to the global crisis.
The European Economic Recovery Plan.
Conclusion.
5. Conclusion

Existing EU State-aid rules & ex-ante guidance of the
EC have played a major role in ensuring a minimum
degree of consistency between the measures taken
by Member States and therefore contribute to stay
close to a co-ordinated, co-operative outcome (Single
Market).

Key characteristic of intervention: Reconciliation of
short-term and longer-term perspectives of public
intervention is crucial to reach a sustainable and
competitive banking sector and hence financial sector
basis for the real economy.


Reconcialiation between the short and long run
perspectives is also present in fiscal policy.
Discretionary expansion must be
(co-ordinated)
timely, targeted, and temporary (SGP).
5. Conclusion

Building the ground for sustainable recovery requires
(as a necessary, albeit not sufficient condition) the
restoration of financial stability.

But to prevent and manage future crises, further
progress in the area of regulation, coordinated
supervision and crisis management procedures (as
put forward in the ESRC & the ESFS
recommendations) is essential.

The same applies in the global context (G20). The de
Larosière Report is also a EU contribution to the G20.
The Global Crisis: a
European Perspective
Vitor Gaspar, Director General of BEPA (Bureau of
European Policy Advisers)
RTD Debate – 17 March 2009
The views expressed are my own and do not necessarily reflect those of the European Commission.
EU as a Framework for National
Governments’ Intervention
Vitor Gaspar
(with Joep Konings)
Bureau of Economic Policy Advisers,
European Commission
Workshop on The Future Face of Europe’s Financial System,
Bruegel, 23 – 24 March 2009
Disclaimer
The views expressed are my own and
do not necessarily reflect those of the
European Commission
Introduction and Motivation
 Global






crisis and many policy responses:
Central bank’s liquidity provision and
aggressive lowering of interest rates;
Extension of guarantees on banks’ liabilities.
Capital injections and (in some cases) statecontrol
Treatment of impaired assets.
Discretionary fiscal stimulus.
A review of the regulatory and supervisory
framework in Europe
In this presentation I concentrate on:
 Global

crisis and many policy responses:
Central bank’s liquidity provision and aggressive lowering of
interest rates;

Extension of guarantees on banks’
liabilities.
Capital injections and (in some cases)
state-control
Treatment of impaired assets.

Discretionary fiscal stimulus.

Regulatory & Supervisory Framework.


Outline

A/ Common framework for public intervention: linking
gains of co-operation to spillovers

B/ Single Market: Functioning of competition and State
Aid Rules


Example: Using the banking crisis to illustrate the risk of
negative spillovers and the need for co-ordinated action in the
context of the internal market
C/ A new EU framework for crisis prevention and crisis
management
A/ Common framework for public intervention:
linking gains of co-operation to spillovers
(Berrigan, Gaspar, Pearson, 2008)

Coase Theorem as a benchmark to identify the gains from cooperation:
In an environment with perfect information, well-defined property
rights an costly bargaining:
-
Private provision of public goods is not pareto efficient in case of
non-cooperative interactions (Nash).
inefficient as individuals do not take into account the externality
to other economic agents
Pareto-improved outcomes can be achieved through collective
action (bargaining; co-ordination)
-Let the units of public good that individual i contibutes to the provision
of the public good be denoted by q i , i  1,2
- Individuals have preferences for the public good and one private good
Relevance of this framework in the EU
context

Across the border spillovers as a result of public intervention are
much clearer when they materialize in the areas in which the
European Union has core competence, such as aspects related to
the working of the internal market, including regulation and
supervision.

In times of crises conditions of the Coase theorem are not met (e.g.
costless bargaining, symmetric information,…) and therefore there is
increased pressure for decentralised and uncoordinated actions.

Legal framework of the internal market is therefore a very powerful
tool: Member States have delegated authority to the European
Commission to have legally binding procedures governing the
working of the internal market.

These legal and binding procedures have fostered the working of
the internal market to the benefit of market integration, which in turn
has forced further political integration.
B/ Single Market: Functioning of competition
and State Aid Rules – key features
 Internalising negative spillovers
State aids rules are designed to prevent un-coordinated government
interventions to interfere with the functioning of the Single Market and
also to improve the effectiveness of public intervention.
 Proportionality,non-discriminatory and conditionality of the
measures
The EU framework guarantees that measures taken by Member States
comply with the key principles in state aid rules
 Reconciling short term imperatives with longer term
considerations
Design of the intervention of the intervention should reconcile short
term imperatives (safeguarding financial stability, underpinning bank
lending) with longer term considerations (avoiding fragmentation of
the Single Market, distortion of competition, emergence of a structurally
weak banking sector, unsustainable public finances)
Example: The Banking Sector

EC provided (ex-ante) guidelines on the application of State aid
rules to measures taken in relation to financial institutions in the
context of the current global crisis.

Guidelines on six classes of measures since the start of the crisis
(Com 2008/C 270/02):

Guarantees covering the liabilities of financial institutions
Recapitalisation of financial institutions
Controlled winding-up of financial institutions
Provision of other forms of liquidity assistance
Rapid treatment of state investigations
Treatment of impaired assets





Key features of guidelines common across
measures (background)
-
Non discriminatory coverage (to avoid undue distortive effects on
neighbouring markets and the internal market as a whole)
-
Minimum private sector contribution (fees charged for the
provision of the scheme should come as close as possilbe to that
could be considered a market price)
-
Temporal scope
-
Behavioural commitments to avoid distortions of competition
(including compulsory restructuring plans)
Background: Communication (2008/C 270/02) :
The application of State aid rules to measures taken in
relation to financial institutions in the context of the current
global crisis


Article 87(3)(b) of the Treaty the Commission may allow State aid "to
remedy a serious disturbance in the economy of a Member State".
In the present circumstances: legal basis for aid measures
undertaken to address this systemic crisis.
general support measures have to be:
- well-targeted in order to be able to achieve effectively the objective
of remedying a serious disturbance in the economy,
- proportionate to the challenge faced, not going beyond what is
required to attain this effect, and
- designed in such a way as to minimize negative spill-over effects
on competitors, other sectors and other Member States.
Background: Communication (2008/C 270/02), contd.
Guarantees covering the liabilities of financial
institutions





eligibility: non-discriminatory so as to avoid undue distortive effects on
neighbouring markets and the internal market as a whole
types of liabilities covered: mainly depositors’ guarantees to avoid
bank runs and contamination
Temporal scope of guarantee scheme
Aid limited to minimum-private sector contribution: fees charged for
the provision of the scheme should come as close as possilbe to that
could be considered a market price.
Avoidance of distortions of competition: negative effects on nonbeneficiary banks must be avoided by:
- behavioural constraints
- restrictions on commercial conduct (e.g. advertising using guarantee
status)
- prohibitions of conduct incompatable with the purpose of the
guarantee scheme (e.g. new stock options for management)
Background: Communication (2008/C 270/02), contd.
Recapitalisation of Financial Institutions



Used to support financial institutions that are fundamentally sound
but may experience distress because of extreme conditions in
financial markets  strengthen capital base to avoid negative
systemic spillovers.
considerations in relation to general guarantee schemes apply,
mutatis mutandis, also to recapitalisation schemes.
The particular nature of a recapitalisation measure gives rise to the
following considerations:
- objective criteria, to avoid unjustified discriminatory treatment
- minimal capital injection and must include private participation
- Member State concerned should, in principle, receive rights, the
value of which corresponds to their contribution to the
recapitalisation + consider claw back mechanisms or better fortunes
clauses
Background: Communication (2008/C 270/02), contd.
Controlled winding up of financial institutions


-
-
-
considerations in relation to general guarantee schemes apply,
mutatis mutandis
Other considerations:
Minimise moral hazard, notably by excluding shareholders and
possibly certain types of creditors from receiving the benefit of any
aid
Liquidation phase should be limited to the period strictly necessary
for the orderly winding-up to avoid competitive distortions
Sales process should be open and non-discriminatory
Sale should take place on market terms
Maximise sales price for the assets and liabilities involved
Background: Communication (2008/C 270/02), contd.
Provision of other forms of liquidity assistance

Provision of central banks’ funds to finanicial institutions are not
considered as aid when:
-
The financial institutions is solvent at the moment of the liquidity
provision
Fully secured by collateral
Central bank charges a penal interest rate to the beneficiary
Measure is taken by the central bank’s own initiative
-
Most member states appealed to the revised guidelines on
timely and coordinated state aid in the financial sector
since last September
Total number of cases of state aid for the financial sector, by
country
10
9
8
7
6
5
4
3
2
1
0
DE
BE
PT
DK
F
UK
FI
AS
IT LV NL
HU IR
Total per country
SW
SI ES
The Irish banking crisis triggered the awareness among the member
states to have a co-ordinated response across Europe, given the
potentially large negative spillovers undermining the working of the
internal market
Total number of cases of state aid for the financial
sector
ua
ry
20
09
20
09
Fe
br
Ja
nu
ar
y
r2
00
8
8
em
be
r2
00
D
ec
em
be
20
08
N
ov
ob
er
ct
O
Se
p
te
m
be
r2
00
8
8
t2
00
us
Au
g
ly
Ju
Ju
ne
20
20
08
08
16
14
12
10
8
6
4
2
0
month that the Commission adopted the decision
 Economic Rational for Co-ordinated
Intervention: Internalising negative spillovers
1.
Guarantees covering the liabilities of financial institutions:
In volatile markets, need to reassure depositors that they will not
suffer losses and therefore to avoid bank runs.
Potential negative spillovers:
- Bank run can cause contamination of healthy banks
- If decentralised and uncoordinated national measures are
taken, increased risk of a disturbing impact on deposit shifting
from non- beneficiary banks to beneficiary banks (e.g. Irish
case). Deposit shifting has the effect of contaminating healthy
banks in neigbouring countries
2.
Recapitalisation of Financial Institutions
Financial sound institutions may experience distress because of
extreme conditions in financial markets (falling asset prices,
deposit runs, etc.)
Potential negative spillovers:
- When the compensation scheme does not reflect market
prices, banks in other member countries not benefiting from
the capital injection are put at a disadvantage.
- Irreversible nature of capital injections can trigger in a later
stage expansion of the beneficiary bank at the expense of nonbeneficiary banks in the same or other countries
3.
Treatment of impaired assets
Reducing uncertainty about exposure of banks to financial losses
is key to restoring investor confidence (resolving the information
problem!)

Impaired asset relief is required to get credit markets functioning
again
Potential negative spillover:
Introducing asset relief measures by a first-mover Member State
results in pressure on other member states to follow suit, risking a
subsidy race between Member States
C/ Towards a new EU framework for crisis
prevention and crisis management

To have an efficient internal market in financial markets, there is a
need for further procedural agreement between the Member States

de Larosière group formulates recommendations towards (i) a new
regulatory agenda, (ii) stronger coordinated supervision and (iii)
effective crisis management procedures
In particular:
 European System of Financial Supervision (ESFS)

create a network of EU financial supervisors, based on the principle of
partnership, cooperation and strong coordination at the centre
 European Systemic Risk Council (ESRC)
decide on macro-prudential policy, provide early risk warnings to EU
supervisors, compare observations on macro-economic and prudential
developments and give direction on these issues.
 Important Role for the EU in achieving global solutions





Solutions at the European level can only have full effect if they are
part of a global effort to improve stability
Benefits of openness, non-protectionism and the internal market
have been clear in the past
Financial system is global, so the EU must work also with third
countries to foster global co-ordination and to obtain the best
regulatory framework.
G20 initiative is essential to enhance regulatory and supervisory
standards
It is therefore important that the Commission is a permanent
member of the G20 & the Financial Stability Forum to properly
represent EU interests
Conclusions

Coase theorem is a useful framework for analysing public
intervention

Existing EU State-aid rules & ex-ante guidance of the EC have
played a major role in ensuring a minimum degree of consistency
between the measures taken by Member States and therefore to
minimise non-cooperative outcomes.

Key characteristic of intervention: Reconciliation of short-term and
longer-term perspectives of public intervention is crucial to reach a
sustainable and competitive banking sector and hence financial
sector basis for the real economy.

But to prevent and manage future crises, further progress in the
area of regulation, coordinated supervision and crisis management
procedures (as put forward in the ESRC & the ESFS
recommendations) is essential, within a global context (G20)
THANK YOU FOR YOUR
ATTENTION!
 You
can find more details at:
 http://ec.europa.eu/competition/sectors/fin
ancial_services/financial_crisis_news_en.
html
EU as a Framework for National
Governments’ Intervention
Vitor Gaspar
(with Joep Konings)
Bureau of Economic Policy Advisers,
European Commission
Workshop on The Future Face of Europe’s Financial System,
Bruegel, 23 – 24 March 2009