Prof. Dr. Hans Geeroms*

1. How the European institutions organised and are organising the fight against the economic and financial crisis7 September 2009HIVA-Leuven • Prof. Dr. Hans Geeroms* * Professor at VLGMS, Collège d’Europe, HUB and University of Warschau, adviser for European and International Economics of the Belgian Prime Minister. The views expressed are my own and do not constitute any official position of the Belgian Government.

2. Overview of exposé • Introduction: financial crisis • Impact on real economy • Answers of the European Union: • How to prevent a new financial crisis? • How to remedy the economic crisis? • Monetary Policy • Coordinated fiscal policy • Employment Summit

3. 1. Origins of International Financial crises • Combination of: • Subprime crisis • Securitisation of bank debts • Aggravated by: • Search for yield; increasing leverage • Incentives structure • Risk management (‘liquidity risks’) • Supervisory deficiencies • Role of rating agencies • Global imbalances

4. Bankruptcy of Lehman Brothers triggers financial crises

5. Massive write-downs Write-downs estimates by origin of assets All financial institutions. Total (past + forthcoming) USD bn and EUR bn Ratio of write-downs estimates over total assets by origin of assets All financial institutions. Total (past + forthcoming) Source: IMF

6. EU Policy Response to financial crisis • Government financial rescue packages (+ central bank actions) • Towards a new financial architecture (EU/Global)

7. Financial rescue packages • i. Guarantee schemes • ii. Capital injections • iii. Impaired asset purchases • iv. Nationalisations • Other measures to support financial stability • i. Increased depositor protection • ii. Restrictions on short selling of equities • iii. Changes in accounting rules

10. Effective write-downs and capital injections All financial institutions (EUR bn.) Cumulative Evolution (2009 Q2 incomplete) Source: IMF

11. Capital injections (% of GDP) Source: European Commission

12. Guarantees on bank liabilities (% of GDP) Source: European Commission, DK: 253% and IE= 225.2%

13. Financial rescue packages • Preliminary assessment: • Member States have implemented sizeable support measures • Measures have been effective in stabilising markets • Banking sector remains under stress • Need to deal with impaired assets and clean banks’ balance sheets

14. Towards a new EU financial architecture (1) • Ensuring reinforced regulation • i. Increasing transparency, incl. clear and timely disclosure • ii. Enhancing and enforcing independent risk control mechanisms • iii. Promoting proper risk-management incentives regarding securitisation • iv. Strengthening capital adequacy rules • v. Extending regulatory framework (derivatives markets, hedge funds) • vi. Reducing pro-cyclicality – Basel II, valuation • Ensuring adequate supervision • i. Reinforcing prudential framework • ii. Developing early warning system • iii. Designing early intervention scheme • iv. Establishing integrated EU system of supervision (Larosière Report-Lamfalussy Report)

15. Towards a new EU financial architecture (2) • Building on the recommendations of the de Larosière Group, the EU builds a new Supervisory framework • On macro-prudential supervision: • Establishment of a European Systemic Risk Council (ESRC) that will: • collect and analyse all information relevant for monitoring and assessing potential threats to financial stability that arise from macro-economic developments and developments within the financial system as a whole; • identify and prioritise such risks; • issue risk warnings where risks appear to be significant; • where necessary give recommendations on the measures to be taken in reaction to the risks identified; • monitor the required follow-up to warnings and recommendations, and • liaise effectively with the IMF, the FSB and third country counterparts.

16. Towards a new EU financial architecture (3) On micro-prudential supervision: • Establishment of a European System of Financial Supervisors (ESFS) that will: • ensure a single set of harmonised rules • ensure consistent application of EU rules • ensure a common supervisory culture and consistent supervisory practices • ensure a coordinated response in crisis situations (not impeding on fiscal sovereignty) • collect micro-prudential information • undertake an international role • it will be given the responsibility for the authorisation and supervision of certain entities with pan-European reach, e.g., credit rating agencies and EU central counterparty clearing houses

17. Towards a new EU financial architecture (4)

18. Towards a new global financial governance • Strengthening international consistency and quality of regulatory standards • Strengthening cross-border co-operation among financial supervisors (creation of the Financial Stability Board) • Reinforcing IMF’s multilateral and bilateral surveillance and crisis prevention functions • Strengthening global crisis management and resolution capacities

19. Impact of the crisis on the real economy

20. Tighter lending conditions Net percentage of banks indicating that "over the past three months, they have tightened credit standards as applied to the approval of loans or credit lines Source: ECB Bank Lending Survey, April 20009

21. Sharp deceleration of private sector credit growth Source: ECB, last value: April 2009

22. Contraction of consumption Source: European Commission

23. Contraction of Investment Source: European Commission,

24. Industrial production collapsed Source:European Commission, last value: 2008Q4

25. Economic growth (percentage change in real GDP) Source: IMF, World Economic Outlook, Spring 2008

26. Economic growth (percentage change in real GDP) Source: IMF, World Economic Outlook, November 2008

27. Economic growth (percentage change in real GDP) Source: IMF, World Economic Outlook, July 2009

28. Main macro-economic data: euro-area Source: European Commission, May 2009

29. EU’s reaction to the economic crisis • Monetary policy • Fiscal Policy (budget policy)

30. Central Bank actions • Conventional tools: • Cut interest rates • Unconventional tools: • Unlimited liquidity supply (at fixed rate) • Loosening of collateral standards • Lengthening of the ECB’s balance sheet (introduction of additional longer term refinancing operations) • Foreign exchange swaps (provision of US dollar liquidity to the ECB’s counterparties) • Covered bond purchases (‘credit easing’)

31. Policy rates cut to historic lows Source: Ecowin, last value: 26 May 2009

32. "Quantitative easing" leads to expansion of CB’s balance sheets

33. Fiscal policy or “Keynesian” policy: • Government Balance = Revenue – Spending • Revenue = direct taxes (on personal income, company profits) + indirect taxes (VAT, excise, other consumption taxes) + social contributions (of employer and employee) + non-tax revenue + others • Spending • Keynesian policy: reduce revenues and/or increase spending = increase the deficit. • Is it effective?? “Ricardian” equivalence (people anticipate future tax rises and start saving more, thereby neutralising government actions)

34. The European Economic Recovery Plan • Timely, temporary, targeted, coordinated stimulus • Overall size: 1.5 % of GDP (200 bn euro) • At Member State level: Size determined by fiscal space • Targeting: ST (stabilisation); LT: (growth; job creation; social protection; green economy) • Credible commitment to medium-term fiscal adjustment and sustainability • Structural reforms that support demand and enhance resilience in the short run • Structural reforms to boost growth potential in the long run

35. The EU fiscal stimulus package Source: European Commission

36. The European Economic Recovery PlanTotal budgetary support to economic activity Source: European Commission

37. Sharply deteriorating public finances Source: European Commission

38. Sovereign bond yields diverging Source: Ecowin, Last value 3 June

39. The EERP and the SGP The reformed SGP is flexible enough to allow corrective action to be implemented in timeframes consistent with the recovery of the economy: • Rapid fiscal consolidation is only called for in cases of immediate sustainability risk • Possibility of revising EDP recommendations, including an extension of the deadline for correction, in case of adverse economic developments with major unfavourable consequences for public finances • Hence when opening EDPs special attention needs to be paid to the overall economic situation and the underlying causes of the deteriorations in government deficits and debt • In particular, consideration should be given to the budgetary effects of the measures taken in the context of the EERP and whether those measures conform to the general criteria ("3Ts": temporary, timely, targeted)

41. Unemployement rate (% of active population)

42. EU’s action plan on unemployment: Prague employment summit • Maintain as many people as possible in jobs, with temporary adjustment of working hours combined with retraining and supported by public funding (including from the European Social Fund). • Encourage entrepreneurship and job creation, e.g. by lowering non-wage labour costs and flexicurity; • Improve the efficiency of national employment services by providing intensive counselling, training and job search in the first weeks of unemployment, especially for the young unemployed. • Increase significantly the number of high quality apprenticeships and traineeships by the end of 2009. • Promote more inclusive labour markets by ensuring work incentives, effective active labour market policies and modernisation of social protection systems that also lead to a better integration of disadvantaged groups including the disabled, the low-skilled and migrants. • Upgrade skills at all levels with lifelong learning, in particular giving all school leavers the necessary skills to find a job. • Use labour mobility to match supply and demand of labour to best effect. • Identify job opportunities and skills requirements, and improve skills forecasting to get the training offer right. • Assist the unemployed and young people in starting their own business, e.g. by providing business support training and starting capital, or by lowering or eliminating taxation on start-ups. • Anticipate and manage restructuring through mutual learning and exchange of good practice.

43. A look at the (bleak) future

44. Current recession set to be the deepest for decades Source: European Commission

45. Road to recovery may be long Source: IMF, World Economic Outlook

46. Lower potential economic growth rate 46

47. Lower potential growth ratedue to ageing of population 47 Source: EPC, 2009 Ageing report

48. Crisis scenarios 48 Source: EPC, 2009 Ageing report

49. Total cost of ageing 2007-2060 49

50. Besides the cost due to an ageing population, we also start the coming decade with a much higher governent debt, due to: • sharply increased deficits in 2008-2010; • state guarantees and direct support for bank rescue operations.