–Expanding Sov Debt Crisis Must Be Halted To Avoid Macro, Fin Disaster

NEW YORK(MNI) – Following is the third part of the text of a speech
by European Central Bank Executive Board member Juergen Stark Friday at
the Forecaster Club of New York:

Fiscal policy

Let me now turn to the fiscal situation in the euro area in more
detail. The severe imbalances that came to the forefront in the wake of
the financial and economic crisis – to a significant extent – are
related to past policy mistakes. In this context, one needs to bear in
mind that the euro area neither constitutes a fully-fledged federation
nor a political or fiscal union. While monetary policy is centralised,
budgetary sovereignty remains to a large extent at the Member State
level. The Stability and Growth Pact has been put in place to ensure a
sufficient degree of fiscal coordination. However, this rules-based
framework, which is built on peer-pressure, was not sufficient to ensure
a smooth functioning of the monetary union. This calls for a more
pronounced transfer of sovereignty to the European level and the move
towards a fiscal union.

Countries have joined the euro area and benefited from its
advantages but some have failed to live up to the responsibilities that
are inherent in being part of a monetary union. In particular, many euro
area countries failed to achieve sufficiently sound fiscal positions in
line with the rules of the European Fiscal Framework in previous
economic good times. This was the consequence of a lax enforcement of
the provisions of the Stability and Growth Pact, notably due to a
deficient governance framework at the European level. As a result, many
countries already entered the crisis with weak fiscal positions which
amplified the fiscal deterioration.

In 2010, the aggregate fiscal balance of the euro area stood at
more than 6% of GDP up from an almost balanced budget in 2000; euro area
debt amounted to more than 85% of GDP in 2010. Moreover, 14 out of 17
euro area countries are currently facing an excessive deficit procedure
related to a budgetary deficit above the 3% of GDP reference value of
the Treaty. Particularly high deficits exist in the countries subject to
EU/IMF programmes, i.e. in Ireland, Greece and Portugal, but also in
some large euro area countries, notably Spain and France. As
consequence, sizeable and persistent structural adjustment will be
necessary in most euro area countries to put debt back on a declining
path and reduce it to a sustainable level, in line with the 60% of GDP
debt criterion of the Stability and Growth Pact.

However, most advanced economies face substantial fiscal
consolidation requirements. Notably, for the US, the IMF estimates that
general government gross debt will reach 100% of GDP in 2011 and that it
will continue to rise through the year 2016. At the same time, the
general government deficit is expected to remain close to 10% of GDP in
2011 [Slide 12]

As you can see from the slide, significant aggregate structural
adjustment of 1 percentage-point of GDP per year will be necessary in
the euro area to reduce the debt ratio to below 60% of GDP by 2030. For
the US, even such a relatively ambitious adjustment path would keep the
debt-to-GDP at around 75% of GDP by 2030. These scenarios highlight the
significant fiscal challenges we are facing on both sides of the
Atlantic in the aftermath of the financial and economic crisis.

In European countries, the correction of excessive deficits is on
its way. The pace of fiscal adjustment has been set by the European
Council in a way that reflects country-specific imbalances. Most
countries will have to reduce their deficit ratio to below 3% of GDP by
2013 at the latest. Accordingly, euro area Member States have presented
medium-term consolidation strategies in their Stability Programmes which
point to a strongly expenditure-based adjustment. Such an approach is
warranted in view of strong increases in government spending during the
crisis in most countries. Moreover, past experience suggests that
successful consolidations typically have a strong expenditure component.

In addition, case study evidence from previous consolidation
episodes indicates that ambitious expenditure reform was typically
carried out in the context of a broader economic reform programmes,
comprising structural reforms to promote potential growth and
institutional reform, e.g. to strengthen the budgetary framework. In
fact, many euro area countries, notably the ones subject to EU/IMF
programmes, are following such a strategy which I would like to call the
European approach to fiscal adjustment.

If effectively implemented, such reform programmes would enable
countries to address their sustainability risks and, at the same time,
limit potential short-term costs of fiscal tightening through
growth-enhancing structural reform. Especially in the current
environment of heightened market sensitivity, ambitious reform efforts
should quickly trigger positive confidence effects and be conducive to
macroeconomic stabilisation.

It is, therefore, of the utmost importance that European
governments implement the announced fiscal consolidation and reform
measures and ensure – by all means – the delivery of agreed fiscal
targets. This will be crucial to regain market confidence, notably in
countries with very high and strongly rising debt ratios and pronounced
risks related to the expected ageing-related fiscal burden. For these
countries, with a view to ensuring a sufficiently swift return to sound
and sustainable fiscal positions, it appears to be advisable to
implement fiscal adjustment beyond what is required to correct excessive
deficits and converge towards the medium-term budgetary objective,
typically a balanced budget.

Only if national governments strictly adhere to ambitious fiscal
consolidation and reform does it make sense to seek ways to buy some
time to implement the planned measures. The European Financial Stability
Facility is the appropriate vehicle for that but before coming
operational European governments need to deliver on their commitment to
leverage funds available to this facility. Public programmes should be
based on strong conditionality, as otherwise incentives to take the
necessary national measures would be weakened. In addition, surveillance
mechanisms at the European level need to be strengthened to monitor
progress and avoid major derailments in the future.

Decision-making in crisis times is different in our democratic
systems. In the US, a medium-term fiscal exit strategy has yet to be
clearly specified. The bipartisan congressional committee on deficit
reduction did not reach an agreement on measures to reduce the public
deficit. At the same time, the recent downgrade of US long-term
government debt and rising sovereign CDS spreads signal that no advanced
economy is immune to a loss of market confidence in its public finances.
It is therefore essential for the US to formulate a credible fiscal
consolidation programme that returns its government debt to a declining
path towards sustainable levels.

(3 of 4)

** Market News International New York Newsroom: 212-669-6430 **

[TOPICS: M$X$$$,MGX$$$,M$$CR$,M$$EC$]