Fiscal and Financial Stability in Europe: Recent Experience and Challenges Ahead

Friday, February 21

Thomas Wieser, President of the Euro Working Group

On February 21, Thomas Wieser, the
President of the Euro Working Group, gave a public lecture at the Joint Vienna Institute on “Fiscal and Financial Stability in Europe: Recent Experience and Challenges Ahead.”

Overall, Mr. Wieser called for better and stronger coordination between EU countries to deal with the present crisis and to prevent such crises in the future. In his presentation, Mr. Wieser explained the roots of various crises, starting from the global financial crisis to the euro area debt crisis, and outlined desirable policies going forward. He stressed that weak financial regulation and supervision had contributed to the unfolding financial crisis. He strongly supported a banking union within the euro area, open to other EU countries, to strengthen coordinated financial surveillance.

Mr. Wieser argued that the recent crisis was not only a euro area crisis but could be traced to the acceleration in globalization processes. It started in advanced economies, then transmitted to emerging markets. More competition had caused unemployment and inequality to increase in mature industrialised economies around the world. Mr. Wieser suggested that most developed countries felt reluctant to accept these facts and initiated policies that led to mounting debt levels. Mostly, policies that increased public debt/GDP became steadily more important, but in some economies incentives  to encourage borrowing by private households in order to keep up consumption were more important. But the end results were more or less the same: Over the years, this policy led to the accumulation of private and public debt in advanced economies.

In the euro area, Mr. Wieser explained, the lack of constraints on the current account and the inability to adjust the exchange rate allowed competitiveness to rapidly decline, and . external imbalances increased steadily. Interest rate convergence and ineffective banking oversight led to excessive lending in certain sectors and countries. Insufficient global monetary policy action to deal with financial bubbles, and poor banking regulation and supervision contributed to the global financial crisis in 2008, and the crisis quickly transmitted to Europe. The financial system distress in the EU was followed by the debt crisis in some of the euro area members.

Mr. Wieser noted that while fiscal policy had to play an important role, the existing fiscal rules did not work adequately and the degree of accountability of governments had declined. He pointed to a clear policy disconnect between Brussels and national governments.

As an antidote, Mr. Wieser supported further strengthening of policy coordination within Europe. He argued that stronger financial integration in Europe requires a single supervisor and a single resolution mechanism. In his view, had closer financial integration existed during the crisis, the EU would have forced banks to clean up their balance sheets more vigorously and to restructure already in 2009-2010. A more rigorous clean-up of banks’ balance sheets actually happened in the U.S., and as the economic situation improved in 2011, the U.S. banks were again in a position to provide new credit to the real economy, unlike in Europe.

To ensure financial stability in the future, a banking union is currently being established with the ECB assuming the role of the single supervisor, and a new model of bank resolution is to come into effect in 2016. A single resolution fund of €55 billion will contribute to paying the resolution cost of banks. Mr. Wieser explained that another important aspect - for the future - was creating a fiscal union to move closer to joint fiscal policy making. Achieving a common fiscal policy would however take a longer time.

Finally, Mr. Wieser shared his views on the EU’s prospects for the coming years. He said that external and internal imbalances would start unwinding although it might take some time. In his opinion, reviving economic growth in Europe in the context of a strong competitive environment and deleveraging would require massive structural reforms. At the same time, governments would need to reconsider the structure of their spending to support growth-enhancing areas, such as human capital and innovations.

The lecture was followed by a lively Q&A session. The audience was interested in the prospects of the banking union as well as the fiscal union. Some questioners were skeptical as to whether a single resolution fund would have enough capacity to deal with a Europe-wide banking crisis, while others asked how a single fiscal policy would deal with different economic realities across countries. Mr. Wieser agreed that building a banking union and a fiscal union would not be easy. He emphasized, however, that closer policy coordination across European countries and the outside world would ultimately be essential and would need to be pursued despite those difficulties.

Asel Isakova, Junior Economist, JVI

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