Europe’s response to the financial crisis – some success, but much more to do

The Malta Independent - Saturday, 13th February 2010

My first Rapporteurship as an MEP drew closer to success this week following the committee vote on my report on the performance of the European Central Bank (ECB) in 2008 and 2009, as the ECB, EU and Member States battled to limit the damage caused by the financial crisis. The result, with the draft report approved by 35 votes and just 2 against, demonstrates, I hope, that a good balance was found. Of course, while the political negotiations in the Economic and Monetary Affairs committee have been concluded, they will resume again in February when my report is debated with President Trichet and then voted in Parliament. The work is far from over. I have found the experience as a Rapporteur to be a complex and multi-faceted role. Writing the report is the easy bit! The real challenge is the lengthy negotiation with colleagues from the other political groups, with President Trichet and other high-ranking ECB officials, and with fellow colleagues in my Socialist and Democrat party group, all of whom have political ‘red-lines’ and their own ideas. Reconciling these competing positions while still retaining the integrity and coherence of the text is a fine balancing act. The report itself, needless to say, focuses on the crisis that has engulfed European countries over the past two years. The financial and economic crisis has seen the worst global economic decline since the 1930s and the most rigorous test of the ECB since its inception. After a relatively benign period of economic growth enjoyed across most of Europe for over a decade most Member States have had their economy ‘stress-tested’, not through a simulated model but in real time and with painfully real consequences. In 2008, GDP growth across the euro area was just 0.7% and, by the time my report is voted in plenary, we will have the frightening statistics of a significant economic contraction together with a forecast of a very sluggish return to growth in 2010 and 2011. Most Member States are experiencing rising budgetary deficits and soaring government debt. The Commission’s economic forecasts in May 2009 predicted average budget deficits across the eurozone of 5.3% and average government debt of 77.7%, figures which, in turn, are both expected to increase in 2010. It may take many years for these deficits, brought about by the financial crisis, to return to the levels of 2006 and 2007. On balance, the ECB deserves qualified praise for its response to the crisis. The primary function of the ECB, according to the EU treaties, is to maintain “price stability” and, although inflation was far above the ECB’s self-imposed ceiling of 2% when it peaked at 4% in June and July 2008, inflation rates have since tumbled and are now at negative rates. The ECB has also steadily cut interest rates, from a peak of 4.25% in June 2008 down to 2% by January 2009 and the current rate of 1% in May, in a bid to re-invigorate lending and to kick-start the European economy. However, the ECB’s main role during the crisis has been to expand liquidity provisions in the form of a variety of loans amounting to over €500bn to effectively bail-out financial institutions. Without such financial life-support, many institutions holding our savings and pensions would undoubtedly have collapsed. But, this praise must be tempered. The ECB’s interest rate cuts were not as prompt as those taken by the likes of the US Federal Reserve and the Bank of England. Similarly, while the ECB’s massive cash injections have kept many institutions from collapse, the reality is that many banks have not passed on this liquidity to customers, particularly to the detriment of the small and medium sized businesses on whom economic recovery will rest. Instead, many banks have used the liquidity to buttress their own position - covering losses and, to justified public revulsion, bonus payments. However, the report is also about looking to Europe’s economic future. We need to put in place a planned ‘exit strategy’, with Member States gradually winding down their stimulus packages and the ECB drawing back the liquidity that it has provided to banks. My report concludes that such an ‘exit strategy’ in the monetary and fiscal fields should take place only after we can see a sustainable economic recovery, and calls for co-ordination on the timing of these exit strategies between Member States. Moreover, the European Commission should allow Member States to continue with their stimulus packages without forcing them to reverse this process through an over-enthusiastic early enforcement of the Stability and Growth Pact. Above all, the crisis has demonstrated that markets do not always self-correct and are prone to systemic risk. In this, I support the root-and-branch reforms to the financial architecture in the EU and, in particular, the establishment of a European Systemic Risk Board (ESRB) - a body designed to act as a ‘watch dog’ giving an early warning of any systemic risks or imbalances in the financial markets. In this regard the most immediate priority is to provide a qualitative definition of ‘systemic risk’ - it stands to reason that you cannot identify a problem if you lack a clear definition of what it is you are looking for! Creating such models must be an urgent priority for the ECB. Above all, lessons have to be learnt from the crisis, by the ECB and other central banks, financial institutions, regulators and politicians. We must restore public confidence in financial institutions through measures which include greater transparency and better risk management. We need to ensure that a crisis of this magnitude does not repeat itself again. Prof. Edward Scicluna is a Labour MEP