May 04, 2015
With Greece on the brink of insolvency – fanning fears of an exit from the Eurozone – the European Union is scrambling to find a solution to avoid a “Grexit” as debt payments loom. To analyze the roots of the current crisis and look ahead to the EU’s next steps, Knowledge@Wharton sat down recently with Banque de France Governor Christian Noyer. He is also a member of the Governing Council and General Council of the European Central Bank, chairman of the Bank for International Settlements and alternate governor at the International Monetary Fund.
Noyer argues that the current Greek crisis is unique within the European Union, while admitting that surveillance for such eventualities was initially insufficient and not comprehensive. He also says that the euro’s decline against the dollar is a result of market forces and the ECB is not trying to push the currency to any given level.
An edited transcript of the conversation follows.
Knowledge@Wharton: How did Greece find itself in this situation?
Christian Noyer: The Greek debt crisis was led by a combination of the international financial crisis of 2008 and a long-lasting, inappropriate fiscal management in Greece before 2008.
The 2007-2008 credit crunch exposed many European and especially Greek banks to great losses. The credit crunch also caused a reduction in bank lending and investment and generated a recession. In addition to an already high level of debt for domestic reasons, Greece’s debt further increased as the recession caused deterioration in public finances.
The Greek public debt, which was already the highest in Europe, rose to 126.8% of GDP in 2009 and its public deficit reached 15.2% of GDP. Greece’s economy was not competitive enough to cope with that shock and its growing trade deficit made its external, public and private debts rise to non-sustainable levels, as it also happened in other European countries such as Hungary, Latvia and Romania in 2008 to 2009, leading all these countries to request external financial assistance from the EU and IMF.
Undeniably, Greece was a specific case among these countries. Before the crisis, the exceptional combination of a lax fiscal policy, an oversized, poorly managed public sector, inadequate reactions to mounting imbalances, structural weaknesses, and statistical misreporting led to an unprecedented sovereign-debt crisis in Greece. Greece’s underlying public finance situation was brutally revealed to the financial markets in October 2009, following years of data misreporting.
“Greece’s underlying public finance situation was brutally revealed to the financial markets … following years of data misreporting.”
Knowledge@Wharton: What could the European partners have done differently?
Noyer: Clearly, the European framework for surveillance of member states’ imbalances was insufficiently effective and not comprehensive enough until 2009 to 2010. This is the reason why the economic surveillance has been improved and the economic governance of the euro area strengthened in response to the crisis, through the so-called “six-pack,” “two-pack” and “Fiscal Compact.”
The euro area also implemented “financial safety nets,” first on a temporary basis with the EFSF [European Financial Stability Facility], then on a permanent basis with the ESM [European Stability Mechanism]. These financial safety nets have been used to support other euro area countries when the sovereign-debt crisis in Greece spread to other euro-area countries, such as Spain, Portugal and Ireland. In these countries, financial assistance programs have been successfully implemented.
The case of the Greek program has been specific from the beginning. It is possible that the initial program proposed by the IMF, the EU Commission and the ECB was not shaped ideally for Greece. Some parameters may have to be altered and several Greek demands may perfectly be heard within the existing framework. However, the current and previous Greek authorities must take responsibility for not being able to collect their own taxes.
Our common priority today is to revive growth and make sure that Greece is solvent in the long run Twitter . To do so, there is a need for implementing those reforms that have already been agreed upon by Greece. Greece needs to recover its competitiveness. We need to continue with the labor market reforms and encourage firms to hire again. There is a need to improve the payment culture in the country. It is also important for Greece that its European partners support it in its path to implement appropriate reforms and restore the sustainability of its public finances.
Knowledge@Wharton: What is the way forward now?
Noyer: In the short run, no additional financial aid is scheduled for Greece. I understand that the list of reforms sent by the Greek government is not yet [as of 23 April] considered as being fully satisfactory according to the ECB, the Commission, and the IMF.
The European partners have recalled many times that they are open to use the existing flexibilities of the program in order to enable the new government to honor some electoral commitments and address the “humanitarian crisis” that Greece faces. But, as creditors, they would never accept unilateral measures that undermine the sustainability of public finances in the long run.
I hope that an agreement can be found rapidly on a final list of reforms that will need to be comprehensive and sufficiently detailed so that it could be approved by the international creditors.
Regarding public debt, thanks notably to measures decided in 2012, Greece has been granted a grace period until 2020. As [ECB President] Mario Draghi said during the press conference following the Governing Council of 15 April, [he will not] consider a Greek default, but debt restructuring remains a possibility.
Knowledge@Wharton: Which other European countries are facing a “Greece-like” risk?
Noyer: From the beginning in 2009, Greece has always been a specific case within the Eurozone and no other country in the Eurozone is today in the same situation as Greece.
Knowledge@Wharton: What can and should they do?
Noyer: Other Eurozone countries such as Ireland, Portugal and Spain used to be under heavy pressure, but European aid combined with important structural reforms have enabled these to regain growth and financial stability.
All Eurozone member states should pursue the reforms they have committed themselves to implement, in a coordinated manner with their European partners.
For every member state, it is crucial to follow the rules of the European macroeconomic surveillance and to implement corrective measures and structural reforms where needed. It is also absolutely essential that member states comply with the Stability and Growth Pact (SGP).
“Our common priority today is to revive growth and make sure that Greece is solvent in the long run.”
Knowledge@Wharton: What can the EU do to avoid these situations?
Noyer: The EU has made great steps in order to avoid such crises in the future.
On the sovereigns’ side, the euro area has broadened its economic surveillance. The Stability and Growth Pact has been reinforced by a new legislative package: the “six pack” and the “two pack.” The “six pack,” adopted in 2012, reinforces both the preventive and the corrective arm of the Pact and introduced a new procedure in the area of macroeconomic imbalances, while the “two pack” adopted in 2013 strengthened the fiscal frameworks of euro area member states and upgraded the scope and quality of national annual budgeting and medium-term fiscal planning.
On the banking side, the Banking Union is a major breakthrough for the financial stability of the Eurozone. Of course, one cannot see all the benefits of the banking union since it has only been in place for a few months — the ECB was established as a banking supervisor in November last year — but now the Eurozone is much better equipped to cope with banking crises.
Knowledge@Wharton: What roles can – and should – the European Central Bank play now and in the future to help avoid such situations?
Noyer: First of all, I would like to recall that the prevention of and the solution to sovereigns’ financial problems do not rely on the European Central Bank or on the Eurosystem, but are within the remits of the Eurogroup and of the European Commission. By implementing effectively the new framework for surveillance of fiscal and macroeconomic imbalances, the Eurogroup and the European Commission will prevent any Eurozone sovereign from being again in a situation of financial distress.
As it already happened in the past … the ECB Governing Council will remind member states of their commitments should they become complacent in implementing the rules that they have designed and agreed to abide by.
As regards the direct responsibility of the ECB/Eurosystem, the main tool to prevent future banking crises is the effective implementation of the Single Supervisory Mechanism — i.e., the new framework for banking supervision that combines the ECB and the National Supervisory Authorities of the Eurozone, which has been in place since November 2014. The SSM should ensure that future banking problems are detected sufficiently early and addressed promptly and without political interferences.
If necessary, those banking problems may be addressed through the use of financial resources provided by the financial sector itself, and no longer by public funding.
This new framework should provide that, in the future, banking problems do not put at risk the public finances of a Eurozone sovereign, as was the case in the past with the banking problems in Ireland and Spain.
Knowledge@Wharton: Some experts say that the decline in the euro against the dollar is a result of market forces and the European Central Bank is not trying to push the currency to any given level. Do you agree or disagree?
Noyer: I strongly agree with this view. It is clear that the decline in the [euro vs. the U.S. dollar] results from market forces which are driven by the relative divergence of economic situations and monetary policies between the U.S. and Europe. The U.S. has enjoyed a relatively strong growth and a significant decline in unemployment. By contrast, in the euro area, the ECB had to face a slower growth and had to use a wide range of conventional and unconventional measures in a context of slow growth and low inflation.
“We look at exchange rates because it is important for growth and for inflation, but targeting a level would be inefficient and inconsistent with our mandate.”
As a result, interest rates in the U.S. are higher than in the euro area, and therefore fixed income markets are more attractive to international investors. What we are witnessing primarily results from the fact that the U.S. and the euro area are in different positions in the economic cycle. All these differences logically contribute to a decline in the euro-to-dollar parity.
Moreover, the ECB does not target any specific exchange rate: Our mandate is focused on inflation. We look at exchange rates because it is important for growth and for inflation, but targeting a level would be inefficient and inconsistent with our mandate.
Yet of course, the exchange rate is also a transmission channel of our monetary policy. The various measures that we implemented contribute to abundant euro liquidity and lower interest rates, which are important determinants for exchange rate levels.
Knowledge@Wharton: The ECB has recently embarked on large-scale asset purchases at the rate of 60 billion euros a month. What is the strategy behind this move?
Noyer: The strategy behind the decision to embark on large scale quantitative easing is based on our mandate, which is to maintain price stability.
We have been faced with a situation characterized by weak growth and a rapid fall in inflation figures and, more importantly, in inflation expectations. These developments had to be addressed swiftly to fulfill our primary objective — i.e., to maintain inflation rates at levels below, but close to, 2% over the medium term. Keep in mind that our mandate is symmetrical and we are expected to fight against low inflation with the same determination as too-high inflation, and this is precisely what we are doing.
Inflation expectations were at risk of becoming disanchored. Conventional measures such as a reduction in the policy rate become less effective at the zero lower bound. New measures such as the Targeted Long Term Refinancing Operations (TLTRO) or forward guidance helped to some extent, but our assessment was finally that these also were not enough. The decision to embark on large-scale asset purchases, and in particular the public sector purchase program, was therefore necessary. Let me emphasize that this purchase program is both the logical prolongation of measures implemented over the previous months, and a reinforcement of these measures. The purchase program can be seen as an extension along the yield curve of the forward guidance on policy rates.
After nearly two months of implementation of the public sector program, I am confident that the range of measures enacted by the Eurosystem since September 2014 will help bring inflation back to levels in line with our objective. So far, the implementation has been very smooth and the impact on financial markets and financial conditions are in line with our expectations. There is evidence that the program had an impact on bond yields, both sovereign and corporate, which reduces the cost of financing for firms and boosts investment.
Knowledge@Wharton: In some instances, interest rates are being pushed further into negative territory, from the current deposit rate of -0.1%. What impact might this have on different economies in Europe?
Noyer: The deposit facility rate in the euro area was actually lowered to -0.2% in September 2014. This further move into negative territory was simultaneous to the decrease in the main refinancing rate down to 5 basis points.
These measures were part of our accommodative monetary policy to prevent a prolonged period of too low inflation. The expected impact of low interest rates is an increase in lending activity and a boost in demand, which should ultimately push inflation back to a level consistent with our target — close to, but below 2%.
More specifically, the negative deposit rate has several main purposes. First, it complements other measures designed to flatten the yield curve with the aim to better convey the accommodative stance of our monetary policy. Second, it is a tool that allows reviving the interbank market within the euro area. Negative rates discourage each individual bank to accumulate reserves for precautionary motives and provide them with an incentive to lend their excess liquidity. Third, with negative rate, banks are expected to search to compensate for the losses incurred on the deposit of reserves at the central bank by lending to the economy.
“I am confident that the range of measures enacted by the Eurosystem since September 2014 will help bring inflation back to levels in line with our objective.”
While there have been concerns about the consequences of negative interest rates, we observe that money markets have been functioning for six months now with negative interest rates, with some reduction in volumes but no major difficulties. Current negative yields in some segments of the bond markets also reflect an adequate transmission of current monetary policy measures.
As regards the possibility that the deposit facility rate could fall below the current level of -20 basis points in the euro area, the view of the Governing Council is that the current level should be regarded as the effective lower bound.
Knowledge@Wharton: You recently said that the aggregate size of central banks’ balance sheets over the world has tripled and that their balance sheets have grown from 10% to 20% of GDP. What are the drivers behind this? What impact can – and does – this action have on advanced economies? On emerging economies?
Noyer: Central banks’ balance sheets have indeed risen in a spectacular fashion since the onset of the crisis. This reflects central banks’ ability to expand their balance sheets considerably thanks to their power to create money. The rise in the asset side of the central bank’s balance sheet is mechanically financed by the issuance of central bank reserves. The only limit to this mechanism is public confidence in the money issued by the central banks — banknotes, notably. In the Eurosystem, we consider that confidence is best anchored when the central bank maintains an inflation rate close to, but below, 2%.
Broadly speaking, the expansion of their balance sheets has compensated for the deleveraging process of private agents — banks, firms, households — and the reduced financial intermediation triggered by the crisis. Through the increase in the size of their balance sheets, central banks have cushioned the fall in money market activity, eased financial conditions, and stimulated credit to the real economy. Without those actions, the financial and economic consequences of the crisis would have been much more painful.
As regards the Eurosystem, let me say that all monetary policy actions were designed and implemented fully in line with our mandate, that is to say price stability. After various other non-standard measures initiated last year, we have recently launched an Expanded Asset Purchase Program [EAPP], covering both public and private securities. Following the repayment of our 3-year, Very Long Term Refinancing Operations (VLTRO) by banks over the past year or so, the Eurosystem had regained important room to manoeuver on its balance sheet.
The implementation of the EAPP will therefore push the size of our balance sheets towards a high, but not unprecedented, level. However, while we recognize that the balance sheet of the central bank is a powerful tool, there is no “fetishism” of the balance sheet in our view: There is no magic number with regard to the size of the balance sheet, but a rational use of this tool.
And finally, to answer your last question, there is no direct impact of central bank balance sheet expansion on emerging economies. The goal of unconventional policies is to reignite economic growth in advanced economies, which should be beneficial for advanced and emerging economies alike.
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