Keynote
address by Mr Jean-Claude Trichet, President of the European Central Bank, at
the Council on Foreign Relations, New York, 26 April 2010.
Ladies
and Gentlemen,
It
is a real pleasure to be back here at the Council on Foreign Relations.
You
will all be familiar with the well-worn French expression “plus ça change, plus
c’est la même chose” – and its New York equivalent “same old, same old” – to
imply a world-weary feeling that despite the appearance of change, things
remain the same.
Well,
since my last visit three years ago, I think we will all agree that there have
been the most dramatic changes in the world economy. And these are changes that
suggest that things will not and should not remain the same.
Back
in April 2007, I noted that the ever-closer integration of national economies
and the rise in capital mobility had made the international system more
vulnerable to changes in investor sentiment. I added that it was vital to
strengthen the ability of the global economic system to absorb shocks to
preserve global financial stability.
But
few then could have imagined the magnitude of what eventually came to pass,
starting with the subprime crisis in the summer of 2007, turning into a
full-blown global financial crisis in the autumn of the following year with the
collapse of Lehman Brothers, and culminating in a devastating impact on trade,
production and jobs.
These
are not entirely new phenomena – but we have to go a long way back in the
history books for a suitable comparison. According to economic historians Barry
Eichengreen and Kevin O’Rourke, the initial decline in global production
between mid-2008 and mid-2009 was broadly comparable with that at the beginning
of the Great Depression. The corresponding correction in global equity prices
and the fall in global trade volumes were even larger.
The
good news is that the global economy has now turned the corner, largely thanks
to the unprecedented support measures taken by both central banks and
governments, which have helped to restore confidence. Yet the recovery remains
somewhat fragile and not yet sufficiently supported by private demand;
therefore, it is not the time for complacency.
I
should add that the recovery should be measured in much broader terms than
focusing on a resumption of GDP growth. A full recovery also implies a return
to sustainable fiscal positions. It means a full restoration of trust in some
of our financial institutions. And it requires a healing of the scars that the
irresponsible behaviour of some financial players has inflicted on our
societies and on the real economy.
In
my introductory remarks today, I would like to explore some of the lessons for policy-makers
around the world that can be drawn from the extraordinary events of the past three
years.
I
will first elaborate on why we need a set of rules, institutions, informal
groupings and cooperation mechanisms that we call “global governance”.
Second,
I will analyse how, in hindsight, the existing system of global governance has
fared during the crisis.
Third,
I will examine the evolution of the system in response to the crisis, in
particular the rise of new key players in the world economy, such as the G20,
the Global Economy Meeting of central bank governors and the Financial
Stability Board.
1. Why we need global
governance
There
are numerous definitions of global governance. In the economic and financial
sphere I will propose that global governance comprehends not only the
constellation of supranational institutions – including the international
financial institutions – but also the informal groupings that have
progressively emerged at the global level. Those informal forums (G7, G10, G20,
etc.) are key in improving global coordination in all the areas where decision making
processes remain national – whether in helping to work out agreed prudential standards
and codes or to facilitate where appropriate, the coordination of economic macro-policies.
No
market can survive without a set of rules. This is particularly true at the
international level, where natural barriers to transactions are formidable. One
of the global governance’s primary aims should be that of facilitating the
proper functioning of cross-border markets and thereby of reducing transaction
costs.
The
process of doing so is evolutionary and demands a pragmatic approach with
respect to what arrangements may and may not work, depending on the
circumstances. But the more complex the goods and services exchanged are, the
greater the need for a sound institutional infrastructure. In this respect,
finance stands out as an arena in which global rules may be particularly
beneficial.
More
generally, the crisis has weakened the arguments of those who think that
deregulation is always conducive to better functioning markets. We have learned
once again that markets cannot function properly without an effective
regulatory and supervisory infrastructure.
Governments,
central banks, international institutions and globally agreed prudential standards
and codes are the means by which we collectively seek to avail ourselves of the
global public good of global economic stability.
Of
course, there are limits to what internationally agreed rules can and should
seek to achieve.
First,
the principle of subsidiarity is essential. This principle, which is a key
feature underlying of European Union legislative framework, says that no rule
should be imposed at a global or supra-national level that cannot be more or
equally effectively set at the national or local level. This principle might
also be read as implying that the “burden of proof” should rest on those who
want to establish global, as opposed to local, rules and institutions.
Second,
it is not straightforward to set common rules in complex and innovative fields
such as finance. While financial liberalisation, deregulation and innovation
all have the potential to make our economies more productive and more
resilient, the financial sector must not forget that its purpose is to serve
the real economy, not the other way around. We have painfully witnessed the
fallout from excessive complexity of financial instruments in the current
crisis.
Finally,
there is a risk that common rules are not optimal and in particular that they
are too limited, since they have to be the minimum standards across many
constituencies. This risk is very real in the area of finance because of
significant differences across countries in financial structures, financial
instruments and preferences for financial regulation.
Overall,
the global financial crisis has shattered previously held convictions that
“keeping one’s house in order” is the right principle to ensure global welfare.
We have certainly become more aware of the negative externalities that
financial innovation and financial globalisation can create. Finance in its
current form has become a double-edged sword for the real economy.
2. How global
governance has fared during the global crisis
Let
me now turn to how our institutions of global governance in the financial
sphere have fared during the crisis.
Central bank
cooperation
One
dimension of international cooperation that I consider to have worked
particularly well during the financial crisis has been that among central banks
– both bilaterally and channelled through the various Basel-based committees.
This institutionalised cooperation has ensured an unprecedented degree of
collaboration in, for instance, the provision of cross-border liquidity – the
network of temporary currency swaps or repos set up bilaterally by major
central banks such as the Fed and the European Central Bank.
The
Bank of International Settlement (BIS) itself has been “ahead of the curve” in
terms of identifying unsustainable trends in the financial sector and more
generally in the global economy – such as the under-appreciation of risk and
excessive credit growth – which eventually led to the crisis. It could do so
based on a high degree of analytical depth and information sharing at a global
level that the central banks’ global cooperation has been able to develop over
time.
These
analytical contributions assisted in driving the strong and coordinated policy
response when the crisis erupted. We have now scaled back our cross-border
operations as markets have recovered, but the spirit of cooperation and the
readiness to work together is stronger than ever.
Regulatory arbitrage
But
as much as some aspects of global governance appear to have passed the severe
test of the global crisis, we should remember the significant shortcomings that
may have contributed to creating the conditions for the crisis to happen in the
first place.
One
is the lack of coordination in financial regulation that was pervasive before
the crisis and which encouraged financial institutions to engage in a large
degree of regulatory arbitrage.
This
was the unavoidable result of the fact that while financial players were
becoming increasingly global, and despite the remarkable efforts of the Basel
Committee in respect of the banking sector, financial regulation remained
largely national, with only relatively weak coordination at the international
level.
The
dramatic under-supply of the global public good of international financial
stability is an area where reform is essential.
Global imbalances
Another
shortcoming that needs to be addressed for the future was the insufficient orientation
of macroeconomic policies towards medium-term stability and sustainability. This led to the build-up of unsustainable
external imbalances between deficit and surplus economies prior to the crisis.
Although
warnings had been voiced, including by the IMF, about the risks of a disorderly
adjustment, there was no effective mechanism to influence macroeconomic and
structural policies in key countries where those policies appeared
unsustainable from the standpoint of global economic and financial stability.
This must change – and it requires both the work of international institutions
and the cooperation of national authorities.
3. The evolution of
global governance
Let
me turn to the question of how global governance is evolving after the crisis.
The
scope of international cooperation has been significantly broadened. After an
initially hesitant response, governments implemented broadly coordinated
policies, both within the EU as well as at the global level under the aegis of
the G20. And central banks were able to take quick, decisive and coordinated
action at short notice.
But
the crisis also showed that gaps in the system of global governance – in terms
of both efficiency and legitimacy – have to be filled. This can be done –
indeed, it is being done – by strengthening the mandate of existing
international institutions and adjusting existing or developing new informal
forums.
Overall,
the system is moving decisively towards genuine global governance that is much more
inclusive, encompassing key emerging economies as well as industrialised
countries.
The
significant transformation of global governance that we are engineering today
is illustrated by three examples.
First,
the emergence of the G20 as the prime group for global economic governance at
the level of ministers, governors and heads of state or government. Second, the establishment of the Global
Economy Meeting of central bank governors under the auspices of the BIS as the
prime group for the governance of central bank cooperation. And third, the
extension of Financial Stability Board membership to include all the systemic
emerging market economies.
Let
me touch on each of these.
The breakthrough of
the G20
One
distinctive feature of this crisis has been that it erupted at the centre of
the system. Although emerging countries have been severely affected, taken as a
group, they have rapidly become a source of strength for the world economy. It
is therefore not surprising that the crisis has led to a clear recognition of
their increased economic importance and to their full integration into the
institutions of global governance, notably with the breakthrough of the G20.
The
G20 has been effective in addressing the global crisis. We are now at the stage
where this forum is making the transition from acting in a crisis resolution
mode to contributing to crisis prevention. This is, in particular, the purposes
of the G20 framework for strong, sustainable and balanced growth. The primary
goal of this framework is to collectively implement coherent and medium-term
policy framework to attain a mutually beneficial growth path.
For
this purpose a Mutual Assessment Process (MAP) has been set up that will allow
to assess whether policies of individual members are collectively consistent
with sustainable and balanced growth trajectories. The first steps in this MAP
have been presented by the IMF to the G20 Ministers and Governors last week
during our spring Washington meetings.
Guidance
has been given to the IMF on the next steps in the process that will lead to
policy recommendations on how to best meet the common goal of strong,
sustainable and balanced growth.
Since
this process is fully owned by the G20 members, and given that it involves them
not only at the level of Ministers and Governors but also at the level of Heads
of State and Government, it is confirming the strong commitment at the global
level to more multilaterism in economic decision making.
Further strengthening
of central bank cooperation
In the area of central bank cooperation, the main forum is the Global Economy
Meeting (GEM), which gathers at the BIS headquarter in Basel. Over the past few
years, this forum has included 31 governors as permanent members plus a number
of other governors attending on a rotating basis. The GEM, in which all
systemic emerging economies’ Central Bank governors are fully participating,
has become the prime group for global governance among central banks.
The
GEM has become a very important forum for assessing global economic and
financial conditions, for analysing economic and financial policy issues of
common interest to central banks. I have the privilege of chairing the GEM
presently, and must say that I find the candid exchange of views of our
bi-monthly meetings of enormous value.
Strengthening
institutions
Among
the new and strengthened forums, I would like to highlight the expansion of the
membership in the Financial Stability Board (FSB), whose membership is now
largely overlapping that of the G20. The FSB has received an enhanced mandate
to strengthen the international financial architecture and global financial
stability.
Collaborative
efforts between the IMF and the FSB in this context are currently underway, including
a joint early warning exercise for the identification of risks to the global
economy.
The
IMF itself has overhauled its lending framework and introduced new instruments
to assist countries in financial need, a first step in the broader discussion
of its future mandate and internal governance. The meeting of the IMFC, two
days ago in Washington, showed a confirmed determination to move ahead in this
field.
The
crisis has also pointed to the need to enhance the framework for cooperation in
financial regulation and supervision in Europe. As a result, micro-prudential
supervision will be reinforced with the creation of a European System of
Financial Supervisors, including three new European supervisory authorities in
banking, insurance and securities.
Moreover,
micro-prudential supervision will be complemented by macro-prudential supervision,
focusing on the prevention of systemic risk. The financial crisis has been revealing
in many respects. It has revealed the scale of the potential fallout from the
failure of large financial institutions. It has revealed the fragility of the
financial system to features and trends that cut across institutions, markets
and infrastructures. And it has illustrated the magnitude of the consequences
of adverse feedback loop between the financial system and the real economy.
All
three elements I have just described are key features of systemic risk: first,
contagion; second, the build-up of financial imbalances and unsustainable
trends within and across the various components of the financial system; and
third, the close links with the real economy and the potential for strong
feedback effects.
In
short, the crisis has revealed the fundamental importance of systemic risk. The
purpose of macro-prudential supervision is to identify sources of systemic risk
and recommend remedial action. In the EU, this will be the task of the European
Systemic Risk Board (ESRB). The members of the ECB’s General Council will be
voting members of the ESRB, together with the three heads of the envisaged
European supervisory authorities and a member of the Commission. Moreover, the
body will comprise all national supervisory authorities. The ECB, as an
institution of the European Union as a whole, as an institution of the 27 EU
Member States, has been invited to provide support to the ESRB. The Ecofin Council
concluded that the ECB should provide analytical, statistical, administrative and
logistical support, in close cooperation with all the national central banks
from the 27 states.
The
ECB is prepared to bring to the benefit of the ESRB, with the participation of
all the members of the ECB’s General Council, the macroeconomic, financial and
monetary expertise of all EU central banks.
The
legislative proposals are currently being reviewed by the European Parliament
for a decision later this year. I am confident that the ESRB can make a very
important contribution for the overall stability and functioning of the EU’s
financial system.
Conclusions
In
conclusion I would like to stress four points.
First,
global governance is of the essence to improve decisively the resilience of the
global financial system. We avoided a major depression but it was a close call.
Governments had to support the financial sector by putting at risk taxpayers’
money for the equivalent of around 25 % of GDP on both sides of the Atlantic.
This as unprecedented. I am convinced that, if we do not reinforce significantly
the resilience of the financial system, our democracies will not accept for a
second time such a very large scale of rescue operation.
Second,
a characteristic of the recent turbulences is not only that they displayed a
high level of unpredictability but also an extreme rapidity in the succession
of events characterising the unfolding of the crisis. Global governance today
must demonstrate a capacity to coordinate with agility and, where necessary, to
decide extremely swiftly. This is also
unprecedented.
Third,
the crisis has had some paradoxical effects: on the one hand it has unleashed a
tendency to reengage in financial nationalism if not mercantilism; on the other
hand it had contributed to the recognition that a very high degree of
interdependencies between economies called for a much higher level of
cooperation. These two opposing forces are presently competing. It is
imperative that effective global governance preserve the level playing field
which is indispensable to foster global stability and prosperity. It is a major
challenge. Both sides of the Atlantic have a very important responsibility in
this respect in many domains, in particular in prudential and accounting rules.
And
fourth, as we have seen the crisis has driven an historic change in the
framework of global governance. In my view this transformation was overdue. But
there are two immediate reasons for this change. One is positive: the emerging
economies are now economically and financially so important and systemically so
influential that they must have a full and proper ownership of global
governance. But the second reason is negative: the industrialised countries
have proven particularly clumsy in their handling of global finance before the
crisis at the time when their responsibility in global governance was obviously
overwhelming.
There
was therefore no reason to confirm their exclusive prime responsibility. This
calls for the industrialised countries to be now particularly irreproachable in
the delivery of their present and future contribution to the stability and
prosperity of the global economy within the new, more inclusive framework.
Thank
you for your attention.
