Tokyo, 12 October 2012†
Asian Development Bank Institute and Reinventing Bretton Woods Committee
Ousmène Jacques Mandeng, Public Sector Group
The conference focused on the likely permanent effects of the Eurozone crisis discussing the consequences for international financial cooperation and pending institutional deepening in the Eurozone. The Eurozone made significant advances in establishing a financial safety net with the European Stability Mechanism (ESM) but at the same time raising concerns about the relationship between regional and multilateral financial cooperation possibly undermining international economic integration. Increasing reliance on regional financial safety nets contrasts with earlier considerable opposition to establish an Asian Monetary Fund (AMF) during the Asian crisis.
Eurozone advances: Outlook is more favourable amid recent ECB measures to signal reduction of denomination risk, fiscal consolidation, improvements in competitiveness and actual and targeted institutional reforms in particular establishment of a banking union. Flexibility on political side has been shown and needs to be expanded while importance to maintain economic policy discipline. Significant advances in political union amid monetary union, banking union and greater coordination of fiscal policies. Crisis is being used to advance unprecedentedly ambitious but needed reforms. Confidence in EUR has been maintained. Reform outcome may produce a reformed and strengthened Eurozone in particular relative to lagging reform efforts in the rest of the world.
Eurozone challenges: Recent measures and reform efforts have only very partially mitigated Eurozone distress that continues to dominate generalised market sentiment. Persistent unsustainable divergence between income and debt as prospects of a break-up of the Eurozone remain acute. Considerable uncertainty about taken measures remain and greater clarity and efficacy in communicating the measures are needed. ECB measures are meant to buy time only to allow for more orderly adjustment. Spanish downgrade by credit rating agency Standard and Poor’s was a reminder that key crisis resolution objectives have not been met. Window is closing fast on implementation of new measures and Spain remains critical test case for new framework. Not enough emphasis on economic growth amid lack of economic union and risk of rising political risk and social tensions. Eurozone risks suffering a lost decade. Unemployment and credit growth have been seen as key indicators for stabilisation. Programme design errors have led to suboptimal adjustment path amid underestimation of the economy-wide effect of fiscal consolidation. Institutional reforms may lack anchor amid uncertainty on final objective for European integration. Measures taken may also not be radical enough to restore stability.
Multilateralism and regionalism: Approach to crisis resolution may have relied unduly on national and regional efforts. Concerns about distortions from measures and negative implications for the rest of the world remain. Negative externalities are mitigated amid established coordination mechanism through Troika though fundamental disquiet about efficiency of Troika approach continues. Asymmetry is pronounced between financial markets integration and national sovereign rescue operations. Increasing regionalism will require additional safeguards to mitigate risks of undermining multilateralism and globalisation. Increasing threats of competitive devaluations and protectionism linger amid flagging multilateralism.
Asian integration: Eurozone integration difficulties raised bar for the path and prospects for integration in Asia. Important lessons include that monetary integration is not sufficient for economic convergence.
The Panel Discussion 1 focused on the relationship between regional and multilateral sovereign crisis resolution mechanisms. The panel’s introductory remarks highlighted that the inauguration of the ESM on 8 October marked a milestone for financial stability in the Eurozone. At the same time, it was seen as an important reminder that the international economy risks moving away from the fundamental notion of multilateralism to some form of regionalism. Similar trends can be observed in Asia with the establishment of the Chiang Mai Initiative Multilateralisation (CMIM) and in Latin America with considerations to strengthening the Fondo Latino Americano de Reservas (FLAR). While during the Asian crisis, the International Monetary Fund (IMF) and others have discouraged strongly the creation of an Asian Monetary Fund (AMF) as advanced by Japan in 1997, it was highlighted that the ESM is for all practical purposes a European Monetary Fund (EMF).
The introductory remarks noted that not long ago consensus existed that the international economy to prosper needs to rely on multilateralism. The IMF was established to support countries to avoid those taking measures that would be “destructive of national or international prosperity.” The question therefore is could the seeming fragmentation of stability mechanisms undermine multilateralism, the internal dimension of providing regional support against the external dimension arising from possibly negative externalities of such support, that is, unintended consequences from regional facilities for globalisation.
Panellists expressed differences in their assessment on reform advances in the Eurozone. One panellist stressed that there is room for optimism for the Eurozone as important adjustments are taking place including on competitiveness with changes in relative unit labour costs, fiscal consolidation and as new institutions are being established in particular for the financial sector. The panellist emphasised that the latest analysis by the IMF about the Eurozone was too negative. One panellist highlighted that the policy debate in the Eurozone has changed fundamentally and that the zone is no longer in denial. The ECB has strongly signalled that there cannot be denomination risk in the Eurozone with the adoption of the Outright Monetary Transactions (OMT). At the same time, the ECB measures are meant to buy time to avoid disorderly adjustments, e.g. fire sales of distressed assets, and allow institutional adjustments to take place while admitting that the risk of moral hazard remains high. The panellist stressed that the measures imply that there is mutualisation of obligations that is giving rising to political tensions amid a fundamental conflict between creditor and debtor nations.
Several panellists noted concerns about the strength of recent Eurozone measures. One panellist stressed that the unsustainable divergence between income and debt required radical actions either based on inflation or reforms. The panellist highlighted that the crisis has already affected fundamentally investor behaviour and changed the notion of risk-free assets that could considerably reduce capital markets support for government refinancing operations. Another panellist stressed that there had not been enough progress on the fiscal front in the Eurozone amid the need for less fiscal consolidation in the short term while deploying rules to anchor expectations on fiscal consolidation over the medium term. The panellist outlined that the measures are not radical enough with reference to measures undertaken by U.S. President Roosevelt in 1933 of forced gold sellings to the governments as a measure that fundamentally shifted public expectations about policies. The panellist argued that while the U.S. Federal Reserve has adopted measures akin to Roosevelt, the ECB’s OMTs are too constrained by the conditionality framework; the lack of radicalism in measures risks being a recipe for a lost decade for the Eurozone. Several panellists noted though that the Eurozone is advancing reforms that would otherwise not have been possible to ensure that the decade will not have been lost.
Spain was seen by several panellists as a benchmark for reform efforts of the Eurozone. One panellist stressed that Spain was an important test case for the ECB. Another panellist argued, that the ECB with the OMT has created a window of opportunity but due to Spain’s refusal to incur an ESM programme risks not being ceased. Market confidence now rests only on the assumption that Spain will seek an ESM arrangement arguing that a Spanish request was inevitable and that further procrastination can only deteriorate the situation. Another panellist underscored that the OMT rests on the assumption that the IMF will set the conditionality framework. Views differed on the Troika approach amid one panellist stressing that the Troika was an independent process, another outlined that the Troika has undermined the technocratic nature of IMF involvement and risks unduly politicising the support arrangements. The ESM conditionality framework remains uncertain. One panellist argued that while any conditionality for Spain needs to be realistic, the support institutions will have to accept the consequences of conditionality targets being missed.
The views on possible adverse externalities from regional financial safety nets have been mixed. The focus on regional safety nets risks undermining scope for coordination and may threaten the foundations of multilateralism. Some panellists saw the risk that measures taken for the Eurozone may have negative spillovers for the rest of the world, that is measures that produce outcomes that appear optimal locally but suboptimal for the rest of the world. One panellist stressed that national central bank policies produce global outcomes. The appreciation of the yen was a case in point. High correlation between key advanced government securities yields also increased probability of synchronised shocks in the vent of a change in sentiment. The panellist also outlined the inherent asymmetry between financial market integration and national and regional safety nets as national banks are affected by the mere fact that they form part of global financial markets. Another panellist indicated that Eurozone policies have caused significant adverse spillovers for Switzerland with the considerable appreciating pressure on the franc which can also be seen as a sign of the eroding confidence in the euro. Another panellist highlighted that as policy makers are accountable to their local constituencies taking into account adverse externalities is significantly constrained.
The notion that the ESM could be regarded as an EMF was broadly shared but one panellist stressed that the ESM differs as it does not negotiate conditionality and as such is less than the IMF while it offers a broader range of instruments and intervention possibilities, e.g. by being able to provide resources directly for recapitalising banks, and as such is more than the IMF.
The Panel Discussion 2 reviewed institutional reforms in the Eurozone with a focus on a pending banking union, direction of further integration and critical elements for stability. Panellists stressed the need for more efforts to restore conditions for sustainable economic growth, highlighted the need to clarify next steps towards further integration in the Eurozone and the need to restore credibility and trust of economic adjustments in the Eurozone. The panel also discussed the likely repercussions of the Eurozone crisis for economic integration efforts in Asia.
Panellists noted concern about the economic outlook for the Eurozone. The recession in the Eurozone is deepening argued one panellist. Emphasis needs to shift towards an economic union amid the need to restore adequate conditions for economic growth. The panellist argued that the euro is too strong and that all indicators of aggregate demand are falling or stagnant highlighting that debt stabilisation will be illusive amid a stagnant economy. Another panellist emphasised that the main indicator for progress in the Eurozone is the level of unemployment as the “acid test” for the union. Stress in the Eurozone will be insurmountable if unemployment reaches 30 percent in Greece and Spain. The panellist also stressed that convergence between Italy and Germany many be a necessary condition for the union to work. One panellist outlined that the effect of fiscal consolidation on the real economy had been underestimated and criticised that some adjustment programmes had not been realistic from the beginning undermining the credibility of the adjustment framework. The panellist underscored that the development of credit is key including for monetary stability.
Panellists agreed to the need to establishing a banking union. There was recognition that only several months ago a banking union was not even envisaged and that the measure is of significant importance. One panellist argued that there was backtracking on the different components of a banking union and that risk sharing constituted a necessary condition for the establishment of such union. Lack of clarity remained on the outlines for supervision on the scope of bank coverage. One panellist stressed that the ECB is the only institution in a position to assume bank supervision for the Eurozone, that bank supervision should be conducted on a consolidated basis but that the quality of supervision is essential hinting that more time may be needed to finalise the supervisory framework. Another panellist emphasised that supervision to be effective has to cover all banks. The panellist argued that the bank resolution regime would have to be fully funded to be credible and that specific provisions for bailing-in unsecured creditors need to be specified. Several panellists stressed that a fiscal or transfer union may be necessary for effective bank resolution and a deposit insurance regime.
Panellists had mixed views on progress towards a fiscal and political union. One panellist stressed that there had been significant progress towards greater fiscal coordination. The panellist highlighted that key elements of a political union are already in place with regard to monetary union and a pending banking union. Another panellist emphasised that further steps towards closer integration must be anchored in the final objective of integration. Countries may be reluctant to participate in e.g. a banking union if it is seen only as a quick fix to mutualise European debt but if it is one element of a longer-term project support may be substantially higher. The panellist hinted that the lack of clarity of the final destination of European integration makes it difficult to gain consensus on the measures needed to reach the destination.
Panellists reflected on the effect of the Eurozone crisis for considerations for further economic integration in Asia. One panellist concluded that convergence for integration is critical but that monetary integration is not sufficient to achieve convergence. Asia was looking towards Europe to guide its integration efforts the panellist argued but that Asia is now reviewing its own integration efforts and that prospects for further integration have been dampened. Despite the high cost of self-insurance, one panellist argued that the developments in Europe regarding the establishment of the ESM as a proxy for an EMF could lead now in Asia to efforts to establishing a fully fledged AMF.
† Panel discussions and opening remarks with: Marek Belka, Luigi Buttiglione, Barry Eichengreen, Philip Hildebrand, Haruhiko Kuroda, Jong Wha Lee, Ousmène Mandeng, José Antonio Meade, Ewald Nowotny, Peter Praet, Klaus Regling, Nouriel Roubini, Sayuri Shirai, Marc Uzan.