The Debt Crisis Requires a Comprehensive Solution

Andres Lipstok
 Governor of Eesti Pank and member of the Governing Council of the ECB

According to Andres Lipstok, Governor of Eesti Pank and member of the Governing Council of the ECB, the national central banks of the euro area have limited possibilities to tackle the debt crisis, since there are problems with confidence in the economic policy of several Member States.

The debt crisis that has aggravated over the past months has affected the financial sector of the entire euro area. The lack of confidence in the euro area's banking sector has been on the rise since this summer and has damaged the banks' ability to obtain funds from financial markets. Tensions in the euro area's banking sector are also detrimental to economic growth outlooks.

In view of these developments, at the last meeting of the Governing Council of the European Central Bank we decided to broaden the range of the so-called non-standard monetary policy measures and keep the central bank's key interest rate at 1.5%.

The most important change in the non-standard measures was the extension of the maturities of refinancing operations to a year, which means that commercial banks can obtain loans for a longer period. Secondly, we decided to start purchasing covered bonds. These measures are essential to securing sufficient liquidity in the euro-area banking sector.

Extraordinary measures were expanded primarily to help the monetary policy decisions of the Eurosystem - the central banks of the euro area - reach borrowers more clearly. In other words, when money is appreciating or depreciating, it should affect borrowers more directly. However, as the euro area's banking problems have grown worse, changing the central banks' interest rates might not have a significant influence on the financing conditions of companies and individuals. All the same, it is crucial that changes in monetary policy interest rates also shape the financing of the real economy.

We did not change the key monetary policy interest rate at this meeting. This mainly stemmed from the medium-term assessment on inflationary developments. At present, the inflation acceleration and deceleration risks remain in balance. The potential deceleration of inflation is mainly related to shrinking economic activity. The lower the demand, the weaker is the pressure to raise prices. However, in the forthcoming years the inflation of many euro area countries may be boosted by budget balance improvements, which will partially be achieved through indirect taxes and the administrative regulation of prices rises.

The currently employed non-standard measures, including the Eurosystem's purchases in the bond markets, are clearly temporary. As woes are mainly caused by the lack of confidence in the economic policies of several euro area countries and the resulting potential impact on the solvency of euro area banks, the options of the single monetary policy in solving the debt crisis are relatively limited. The purchases of government bonds and the massive provision of liquidity to euro area banks in order to keep monetary policy functional only help to alleviate the symptoms of the crisis, but do not tackle the core of the difficulties. Instead, there is a danger that the active contribution of central banks might reduce the stimulus of governments to solve the situation.

The solution of the euro area's crisis and the prevention of future crises must proceed from the elementary principle that decision-making and accountability are inseparable. Although even according to the current rules, within the Stability and Growth Pact all euro area countries must safeguard the sustainability of the fiscal policies of other countries, the primary decision-making right and responsibility still falls on individual Member States. On a broader scale, it would be extremely hazardous for the stability of the euro-area economy if decisions regarding expenditure were made on the level of Member States, while the expenses were paid jointly.

Secondly, when solving the euro area crisis it must be remembered that the disciplinary effects of the financial markets and the Stability and Growth Pact have been insufficient to guarantee responsible fiscal policies. Thus, with any implemented measure it is important to increase the countries' interest in pursuing sustainable fiscal policies. To begin with, it is imperative for everyone to keep their promises, for instance those given in the memoranda of economic and financial policies summarising the conditions of the provision of international aid.

Unfortunately, the misconception that one simply needs a lot of money to break out of the vicious circle of distrust is quite widespread. It is believed that money would help to patch up the mistakes made in fiscal policy. However, in that case we would only amplify one of the key reasons for the current problems - lack of accountability - and would thus soon face an even greater crisis.

Thirdly, experience from the few last years has pointed out the importance of buffers in both the financial and government sector. It is unfortunate that the concern for the solvency of Greece is causing systemic problems for the financial sector of the entire euro area. The plans to increase the equity capital of the banking sector of the euro area countries are the best option to strengthen the euro area's financial sector. This step will reduce the possibility that troubles in one country could spread to other euro area countries.

Fourthly, the experience of various countries proves the importance of the endlessly repeated principle of economic flexibility and of sufficient growth capacity in the single currency area.

Fifthly, it is clear that despite the strong convergence of the economies of euro area countries, their economic growth and development cycles are and will remain different in the future. The common monetary policy of the euro area must guarantee the inflationary goal in the single currency area as a whole. Differences in the economic structure and long-term growth outlooks of the euro area countries mean that, if necessary, countries must also use various other economic policy measures to maintain economic stability.

In conclusion, the solution for the crisis in the euro area must be comprehensive and include all the above principles. It is often stressed that in a crisis the fire should be extinguished first and that we will have time to tackle the long-term problems after the crisis. However, now the price of extinguishing the fire has become so great that we no longer have the right to ignore the long-term perspective.

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