The future of economic governance in the the EU - European Union Committee Contents

Examination of witnesses (Question Numbers 127-145)

Dr Thomas Mayer and Dr Marco Annuziata

16 NOVEMBER 2010

  Q127  The Chairman: Good morning, everybody, and welcome to our third witness session on the report on economic governance. We are honoured today to have two supreme experts on the subject. We are very grateful, gentlemen, that you have managed to find time to come and see us. I have to issue my normal caution to everyone: these are lofty rooms and sound gets lost awfully quickly, so please use the microphones or declaim as did our 19th-century forebears. I remind my colleagues to state if they have a declaration of interest, although I think that most have made a declaration by now. I say to the witnesses that we will send a transcript of this session to you and we would be most grateful if you could check to assure us that you know that what has been set down is right, proper and correct. Some supplementary points might occur to you—so often, when you leave the room, you wish you had said this or that. We would be most grateful if you would put those down on paper and send them to us, because we are anxious to get as much information and evidence as we can collect. Would one or both of you like to make an opening statement? In so doing, would you be kind enough to say who you are and where you come from? If not, I will start with the first question. Does anyone want to make an opening statement?

  Dr Thomas Mayer: No, I would be quite happy to react to the questions.

  Dr Marco Annunziata: Likewise.

  Q128  The Chairman: Thanks very much. Dr Annunziata in particular stated in his written evidence that the recent fiscal crisis in Europe has exposed a number of flaws in the existing system of economic governance. The most simple and fundamental is that the smooth functioning of monetary union requires a much greater degree of centralisation and co-ordination in macroeconomic decision-making, especially as regards fiscal policy. To what extent is closer fiscal union necessary for the eurozone to succeed? What does centralisation and closer co-operation actually mean? Is it Brussels directing to member states or simply some sort of bargaining process about respective national positions? Dr Annunziata, would you like to make a start?

  Dr Marco Annunziata: Certainly. What is happening in the eurozone right now is the following. The introduction of a common monetary policy and common currency has been followed by a massive degree of integration of the financial sector and of the banking sector, evidenced, for example, by the distribution of the holdings of sovereign debt of each individual country across other member countries. Part of the concern that we have about the current situation in Ireland, Greece and Portugal is that sovereign debt issued by these countries is being held in significant amounts by banks in other member countries—in the eurozone, as in Italy and France, but also outside the eurozone, as in the UK. This implies that shocks and instability in one member country can no longer be isolated and contained to that country; they spill over. This we have seen in the case of Greece; once instability in Greece became manifest and triggered concerns in the market as to whether Greece would be able to solve its debt, it was ultimately necessary for the European Union to step in and to organise, together with the IMF, a rescue mechanism to prevent the spilling over of the instability to the rest of the area. That has one clear implication, in my view, which is that, if one country deviates in its fiscal policy from the prudent path, it has a negative spillover effect on other countries. This is why, in my mind, it is necessary to have a closer degree of fiscal co-ordination and fiscal centralisation. If the consequences of one country's fiscal policy are so quickly and so dramatically transmitted to the rest of the area, then the rest of the area must have some say—some influence—on the way each country's fiscal policy is run. The most thorny question is how to organise this. Unlike monetary policy, fiscal policy lies at the heart of the exercise of sovereign power; decisions on taxation and spending should lie with the elected representatives. This is where the issues become especially complicated—hence your question as to what closer co-ordination actually means. The simplest solution, which is, however, the most extreme and dramatic, would be full fiscal integration, where a central authority in Brussels would to a large extent run fiscal policy for the whole of the euro area, in a system similar to that of the US. That, of course, is not feasible unless it goes hand in hand with political union, because we cannot have fiscal policy being run by a policy institution that does not reflect the will of the people. Alternatively, mechanisms and rules have to be set in place. The stability and growth pact was supposed to provide exactly this mechanism, by setting guidelines and limits, not on the details of the composition of taxation spending but at least on the fiscal deficit and the fiscal debt; the result is fiscal policy which has implications at the macro level. The problem that we have seen with the stability and growth pact is that it has been impossible to enforce. There are in theory sanctions, but sanctions have proven to be unenforceable. The underlying problem is that to enforce sanctions you need somehow to override the sovereignty of individual states, which is why I am also sceptical about the strengthening of the stability pact and, frankly, somewhat sceptical even of the idea of quasi-automatic rules. The best and most pragmatic way to proceed would be if eurozone countries agreed on what fiscal rules should be followed. These fiscal rules could then be incorporated into national legislation—viz. the German example of constitutional rules on debt. These mechanisms, made legally binding within each country according to popular will, and therefore by legally elected representatives, would be one way in which to ensure a sufficient degree of fiscal co-ordination without going so far as a full centralisation of fiscal policy.

  Q129  The Chairman: That is very attractive, but I put it to you that in the single market legislation, if it is incorporated at national level, we quite often find that regulation varies from country to country. Do you think that it would be possible to arrive at an ideal set of regulations that could be applied nationally?

  Dr Marco Annunziata: I think that in this case it would be, because it would start from a recognition of the fact that what needs to be limited is the extent of the deficit in public finances and the extent and the level of public debt. Limits would be imposed on these macroeconomic variables that are easily identified and reasonably easily measured. Then, some flexibility could be left to each country as to what correction mechanism would kick in. Another example in the European Union is Poland, which has constitutional limits on the debt to GDP ratio with provisions that limit the flexibility in the budget. If the debt to GDP ratio limit of 55% is breached, there are safeguards limiting the level of expenditure. The details of these mechanisms could vary from country to country as long as they are set in stone in the legislation giving reasonable assurances that they will guarantee an automatic correction of fiscal policy if certain limits are breached. It should be possible to have a set of rules that are in principle generally accepted and where the thrust of the rule is the same across countries, whereas some of the details of the implementation could vary from country to country.

  Q130  The Chairman: Dr Mayer, would you like to respond to that first question? In addition, are we really saying that fiscal policy and monetary policy are now for ever related to each other? Is it not very difficult now, as has been the case, to separate those two sets of policies?

  Dr Thomas Mayer: On the first part of your question, why we are discussing the issue now, I would like to make a brief historical analogy. European monetary union is often compared to the gold standard and, in a way, it is somewhat similar. We have seen that in the 1920s, at the time of the gold standard, very big imbalances in the global economy built up. When the downturn came in the wake of the 1929 stock market crash, it led to countries defaulting. At the time, it was Germany that was the borrower and the Americans who were the lenders. Germany defaulting was a serious threat to bank and financial stability and there was an ensuing depression. There was a lack of a credit mechanism at the time to manage the situation in a better way. This was also, historically, at least one element that led to the creation of the International Monetary Fund post-World War II. What history tells us is that when such big imbalances have built up and have led to threats to the financial system and when these imbalances are then viciously corrected by the market and the financial system suffers, the central bank cannot alone ensure financial stability. If you let the central bank ensure financial stability on its own, it can do so only by printing money. You then have a need for co-operation between the fiscal authorities and the monetary authorities to ensure financial stability. We have seen this through the financial crisis in the United States, where there was fairly close co-operation between the Federal Reserve and the Treasury. To some extent we have seen it in the UK, where we have had closer co-operation between the central bank and the fiscal authorities. If you transfer this analysis to the euro area, I would at least argue that the ECB needs to have some help from the fiscal side. Otherwise it is thrown back on dealing with the problem of financial stability through purely monetary means, which is not what you want. We all know from Walter Bagehot that you address liquidity issues through monetary policy, but you should not address insolvency issues in the banking sectors through monetary policy. Therefore, I think that there is a case for a fiscal agent that supplements the monetary agent—the ECB. I fully agree with what Dr Annunziata said. We should of course have precautionary elements in economic policy to avoid coming to such a dangerous situation—to a crisis—but we cannot be sure that with precaution alone we can avoid a crisis.

  Q131  The Chairman: What form would this fiscal agent take?

  Dr Thomas Mayer: There is a big debate going on at this moment, today and tomorrow, at ECOFIN, about what has been called a permanent crisis management mechanism. Such a permanent crisis management mechanism would in my view have two key functions. Function number one is that it would perform for EMU what the IMF did in the gold standard post-World War II. The function was to give, in times of emergency and financial distress, emergency financial assistance coupled to adjustment programmes. The second function would be to make a default of a sovereign possible without this causing a systemic shock. That is obviously a very tall order, but if there was the possibility of a sovereign default in EMU, we would have a very strong disciplinary element for Governments that would reinforce the points that Dr Annunziata made in introducing disciplinary elements in national fiscal policies.

  The Chairman: I am going to ask Lord Hamilton to ask a question, which I know he is very interested in.

  Q132  Lord Hamilton of Epsom: I am absolutely fascinated by the concept of sovereign default without systemic failure. How does this actually happen? Does the country that defaults remain within the eurozone or does it fall out of the eurozone and revert to its previous currency?

  Dr Thomas Mayer: The discussions that have taken place since the beginning of the year, when this came to the fore, have basically concluded that evicting a country out of the eurozone is impossible. We have put the legal framework together and that was not foreseen; we cannot change it and we cannot find a majority to introduce such an exit clause. At the same time, a voluntary exit by a country in difficulties is also very unlikely, given that the euro has provided, in times of financial stress, some shelter to these countries and allows them to go about their affairs in better ways than otherwise. If you want a practical example, compare the fate of Iceland, which was not backed by the Community, with the labours that Ireland is going through. So exit is not possible. The task for the European Community is to find a mechanism by which one can deal with an over-indebted country and in certain circumstances provide some debt relief to it with the participation of the private sector, so that over time the country can be restored to financial health.

  Q133  Lord Hamilton of Epsom: Does that include the banks taking what is known as a "haircut"?

  Dr Thomas Mayer: I am speaking not pro domo when I say that this would be unavoidable. I do not think that politically it would be acceptable to the financially stronger countries to solve such a problem solely on the back of the taxpayer. I do not think that the taxpayer would accept that, when they are called on to make a contribution to resolve such an issue, the lenders, who in the past have benefited from elevated returns by lending money to the country, would be entirely spared.

  Q134  The Chairman: Dr Annunziata, would you care to contribute to the debate that has been started by Lord Hamilton and Dr Mayer?

  Dr Marco Annunziata: Yes. I completely agree with the points that Dr Mayer made, but I would add the following. I also feel strongly that some form of private sector participation in the pain of haircuts is necessary and healthy. In some ways, the reason why we find ourselves in the current predicament is that we have had private investors in the first 10 years of the eurozone buying up the debt of various eurozone countries as if they carried the same risk. Therefore, the private sector has exercised no role in assessing whether or not different fiscal policies and different parts of productivity and economic strength carry different implications for the tradeworthiness of the sovereign. This can be addressed only if the private sector knows that, in the case of crisis, it will suffer haircuts. Therefore, it will be more careful in assessing the situation and will require a higher-risk premium when it sees fiscal policy veering off track. The question that you were posing is whether this can be done without a systemic disruption to the financial system. This is the most difficult question. It is easier to agree that, going forward, haircuts should be included on new debts. So, for example, as we have seen in the declaration of European Finance Ministers in Seoul, it seems easy to agree that we should have a mechanism in place such that new debt, issued after a certain date, will be subject to haircuts. In a way, we are sidestepping the problem. The problem that we are facing today is that a number of European countries are saddled with substantial amounts of public debt. The question that you are posing is whether the current problem can be addressed by, for example, imposing haircuts on the holders of the debts of Greece, Ireland or Portugal, should they require help from the IMF and the EFSF, without creating a systemic crisis in the eurozone. That is a very difficult question to answer. I can tell you what I think that we should be looking for. Normally we would be looking for what is driving the behaviour of private investors. What would drive private investors to cause contagion? If they face haircuts on Greek and Irish debt, what will lead them to sell off Portuguese and Spanish debt on the market? Part of it is the investor's ability to discriminate between the situations of the different countries. Here, some progress has been made compared to April and May, when investors looked at the eurozone as one homogeneous country in terms of public debt. I think that investors are now much better able to discriminate between the weaker countries, which are currently identified as Ireland, Greece and Portugal, and countries that are in a somewhat more resilient position, such as Spain and Italy. I say "somewhat more resilient" and not strong in absolute terms. The other issue is the transmission channel. The fact that private investors can discriminate a bit more gives us a bit more confidence that systemic contagion can be avoided. The other element to watch out for is the transmission of the shock through the financial system. One concern that markets will have is that, if losses are imposed on banks, they will be located not just in the countries suffering a debt crisis but across the European Union. Would these losses be of a size that is disruptive and constitute a threat to the stability of the system? Can the Governments involved step in to help to stabilise the financial sector with, for example, capital injections? These are the issues on which one should focus to understand whether or not systemic contagion can be avoided. I believe that we are moving towards a situation where systemic contagion can be avoided, but these, I believe, are the crucial issues in this regard.

  Q135  The Chairman: Dr Annunziata and Dr Mayer, do Ireland and Portugal today represent a systemic risk?

  Dr Marco Annunziata: I think that they definitely represent a contagion risk in the sense that, as we are already seeing, instability in Ireland is spilling over into significant concern and therefore the risk of widening of sovereign debt spreads for Portugal but also, to some extent, for Spain and Italy. There is definitely a contagion effect at work. I would also say that a lot of the concern that we see in the markets right now is driven by uncertainty over what will happen in terms of a possible debt restructuring mechanism going forward. It strikes me that the market does not have any uncertainty over whether Ireland will be helped. There is not the uncertainty that we had at the beginning of the year with Greece, when there was genuine uncertainty over whether it would be helped. Now we have statements of commitment from the European Union and the EFSF is operational. The markets know that the IMF and the EFSF will step in but they do not know what the implications will be in terms of a discussion on that restructuring. In my mind, this is what makes the current situation in Ireland so disruptive in terms of the wider effect of instability and spread across the other countries.

  Dr Thomas Mayer: If we did not have the euro area safety net that was constructed, I would answer, "Yes, Ireland does pose a systemic threat". Since we have the euro area safety net, we have now the possibility of taking care of Ireland or any other country—as long as they are not too big, I have to say as a small caveat—to carry them on. However, as Dr Annunziata has said, it is presently very difficult to connect the situation now with the past, when investors were buying euro area sovereign debt indiscriminately and assuming that there was no risk and that this was a risk-free asset. In fact, that behaviour was at least also indirectly encouraged by the authorities, as there was no equity set aside required for banks for euro area sovereign debt. It was treated by almost all sides as risk free. We need to connect this regime to a regime where we have to say that there are associated default risks. It is a very difficult task, but there is a silver lining on the horizon that I believe makes it eventually doable. When I personally as an economist do my analysis, I would come out and argue that there may be cases of sovereign insolvency in the GIP group of countries—Greece, Ireland and Portugal—but I think that we can say with considerable confidence that the rest of the euro area is solvent.

  Q136  The Chairman: So a permanent mechanism is urgently needed.

  Dr Thomas Mayer: It is needed, yes. The legacy of the past is fortunately not so big that we could not do some preparation—we have until the middle of 2013, which is for how long the euro area safety net exists—to take care of any events that may happen with these countries.

  Q137  Lord Jordan: As the present crisis develops, why is Ireland refusing help? What does it have to gain?

  Dr Marco Annunziata: It is gaining some time. Ireland is refusing help for the time being because at the government level it is fully funded for another six or seven months. In order to finance its budget deficit, it does not need to access the markets until the middle of next year. The Irish feel, I believe, that they have already made a tremendous effort in terms of fiscal austerity plans and in terms of beginning to address the problems in the banking system. Therefore, if they have a little bit of good luck or good news in the growth outlook either in Ireland or in the global picture, especially the US and UK, with which Ireland has substantial trade links, that might be enough to restore market confidence before they need to access external financing. I think that this is why they are trying to buy time, thereby avoiding a situation in which they would instead be subject to negotiations with the IMF and the European Union before perhaps imposing further constraints.

  The Chairman: I am going to ask Lord Marlesford to ask his question now, but would you incorporate the relevance of the question that we had assigned about the United Kingdom interest?

  Q138  Lord Marlesford: It is relevant. What I am unclear about, from both of you, is whether you see the problem as a eurozone problem, an EU problem or a world problem. Dr Mayer started telling us the history, quite rightly and interestingly, but that was a world problem that had no connection with a sort of eurozone equivalent—everyone was using different currencies. I want to ask about the relevance of the currency. Does the currency matter or is it merely a matter of who has a problem in paying back debts to whom?

  Dr Thomas Mayer: It is first and foremost a eurozone problem, because in a figurative way it is a quasi-recreation of the gold standard, where such things can happen. This could not happen in the UK, where the Bank of England can step in and provide liquidity to the Government if needed. So it is a eurozone problem, but the external, spillover effects of the eurozone problem turn it into an EU and a global problem. If we have a major default of a sovereign in the eurozone, I think that this would have global ripple effects. Remember that what triggered the 1931 global banking crisis was the default of the Austrian Creditanstalt. This was a smallish bank in a smallish country that introduced a second leg to the depression. So I would say that this is a eurozone problem but with global effects.

  The Chairman: With great apologies to Baroness Maddock, we have to move on. Because we have a flow of discussion and debate, I will ask Lord Moser whether he would intervene at this point.

  Q139  Lord Moser: Dr Mayer, you made an optimistic point a few moments ago about how troubled countries could be helped. Then you said, I think, "as long as the problem is not too big". That leads me to ask a question that I was going to ask a bit later. In some of your briefing papers, you propose a European monetary fund as a solution. Could you say a word about that?

  Dr Thomas Mayer: Yes. In essence, this idea of a European monetary fund was inspired by two historical precedents. On the one hand, there were the deficiencies of the gold standard and the answer from the architects of the post-World War II financial system in the creation of the International Monetary Fund. That is one element where we can learn from historical experience and that we can use to fortify the euro area. The other historical element was the way in which countries eventually dealt with the Latin American debt crisis of the late 1970s and the early 1980s. You might recall that, when Mexico was threatening to default, we had a standstill agreement initiated by the IMF under the leadership of Jacques de Larosie"re that meant that we would not have a situation where the banks had immediately to write off the debt of the defaulting countries. After several years, we then had an almost orderly default, which was managed by the issuance of so-called Brady bonds. The principle of the Brady bonds was that investors could exchange an impaired, unsafe asset against a safe asset at a discount. If you held a Latin American debt paper that was promising to pay you back at 100% but this promise was not very credible at the time, you could switch it over and obtain a payment backed by the US Government guaranteeing you a repayment of 100—X percent—the X, I have to say, differed from country to country. If you put these two elements together, you arrive at what I called earlier a European monetary fund, which has the ability to manage the adjustment process in a fixed exchange rate system where you cannot move the exchange rate any more. If that adjustment process fails, you have a mechanism that would allow an orderly burden sharing among all the stakeholders in the system. The stakeholders in the system are the population of the affected country—they would of course have to make a contribution to adjustment through austerity—the taxpayers in the other countries of the European monetary union, who probably will have to make a contribution as well to safeguard financial stability, and the creditors, who would also have to make a contribution to a resolution of the problem.

  Q140  Lord Moser: But will there be a sort of European IMF?

  Dr Thomas Mayer: A European IMF-plus.

Lord Moser: What is the plus?

  Dr Thomas Mayer: The plus is the ability to restructure the debt of an insolvent country that cannot be restored to normal operations because it is over-indebted. This was an element that the IMF lacked. In 2002, the IMF tried to build a debt restructuring mechanism for severance. At the time it was pushed forward by the IMF's deputy director, Anne Krueger. This effort failed because people could not agree on a move of sovereignty from the national to the supranational level. There would have to be some authority guiding the process, but the shareholders of the IMF were not willing to accept that. This time around, the situation is different in so far as members of the euro area have already shifted a significant degree of their sovereignty to the supranational level. So the situation is not directly comparable to the discussion that we had in 2002 in the IMF context, where the creation of such a debt restructuring mechanism failed because the countries were not under a pre-existing umbrella of a supranational regime.

  Q141  The Chairman: Dr Annunziata, I think that I may have cut off your earlier contribution. Would you tie that in with this question: if we did create an EMF, would that in effect sideline the IMF?

  Dr Marco Annunziata: That is a very appropriate question. We have to ask ourselves what we want to add to the existing framework that would actually be useful. The IMF, in terms of the design of the adjustment policies, needs to go hand in hand with any external financing and debt restructuring mechanism. The IMF has an enormous and unparalleled degree of expertise—hopefully, no European institution will ever be in a position to accumulate the same degree of expertise going through another crisis. Therefore, the involvement of the IMF would remain extremely precious and essential to help us to guarantee a greater degree of external monitoring. That is why, in the end, the current arrangement that we have in place implies the intervention of the IMF, side by side with European financing via the EFSF. The IMF not only has greater expertise but is also more of an outsider and therefore a more objective monitoring and enforcement mechanism. The European equivalent of this mechanism, as Dr Mayer was saying, should combine the two crucial aspects of providing guided assistance to external financing—guiding the crisis and helping a country through the crisis—together with some mechanism that imposes the cost on the creditors. It is essential that we combine these two components and that we do not shy away from the problem of existing debt, as it is the existing stock of debt in a number of countries that constitutes the problem and the source of instability. It is not a debt that will be issued in the future. As for how broad-ranging these arrangements should be, I support what Dr Mayer was saying in response to Lord Marlesford. This is a eurozone problem. The source of the problem is the common currency, so the rules that come into place in terms of limits on fiscal policy and the mutual support mechanism should be there for eurozone members. They are essential for eurozone members. There is no automatic argument as to why they should be extended to EU members that do not belong to the eurozone. There is an issue, as Dr Mayer was pointing out, of spillover effects coming from whatever happens in the eurozone to neighbouring countries. Here, the UK has a clear vested interest. From the UK's perspective, the issue is more strategic, if you will. What is the best way to influence the process in a way that is beneficial to the UK? Is it easier to do it through voluntary participation in these arrangements or via an outside influence while staying outside? But the problem is born of the adoption of a common currency, so the eurozone is the natural arena and range of countries where the new rules absolutely need to be applied.

  The Chairman: Thank you. Baroness Maddock, take us in a fresh direction, please.

  Q142  Baroness Maddock: I wanted to ask about the stability and growth pact. First, what economic indicators should be monitored under the stability and growth pact? Dr Annunziata, I know that the Italian Government insisted that aggregate debt included private as well as public debt as part of the budget criteria of the stability and growth pact. Do you believe that this view has any merit? Would it help to detect excessive credit expansions such as the housing bubbles that we have seen? Would it help to detect those in advance? Do you think that this approach is closer to the way in which the markets look at the financial stability of countries?

  Dr Marco Annunziata: It is not surprising that my Government, the Italian Government, are pushing for an approach that would consider private debt as well as public debt given that Italian household private debt, at this point in time, is relatively low. But that approach is correct from a theoretical standpoint. While public debt has sustainability issues of its own, from the point of view of the systemic stability of a country it is the sum of public and private debt that matters. This is the way in which markets tend to look at it. In fact, something that we have observed even since 2008-09, since the earlier phases of the crisis—and by crisis, here, I refer to the subprime crisis—is that the widening sovereign debt spreads were more significant for countries that had large current account deficits, reflecting a public and private sector debt, and relatively more muted, for example, in the case of Italy, because Italy had a smaller private sector debt and a smaller current account deficit debt, even though the Italian public debt reissue was the highest of the countries being considered. So it is a sensible step towards enlarging the stability pact to a broader set of variables. The suggestions coming from the European Commission are to look at the current account deficit and indicators of competitive and central activity. They are all going in the right direction of looking at sustainability from the point of view of a country and not just the Government. Looking at current accounts and the private sector would help as an early warning signal to monitor what is happening. For example, are asset or housing bubbles being created? Is there excessive credit growth in the economy? It would be a helpful way to monitor them. The tricky question will then be how you address them. This is something that Dr Mayer referred to at the beginning. Some of these distortions might be born of monetary policy but cannot necessarily be addressed by monetary policy—for example, in countries such as Spain or Ireland, where we saw an excess of credit growth over the last several years before the crisis. That is, in some part, to be attributed to the single monetary policy, which, being a common monetary policy for the whole of the eurozone, necessarily cannot be appropriate for each single individual country. So it might be the source of excess credit or imbalances in individual countries. The question then becomes how you address those. Should you, for example, impose stricter rules on fiscal policy to counterbalance the impact that the common monetary policy is having? This is a difficult question. Should a country that is running a balanced budget—but, because interest rates are relatively low, given its level of growth, credit growth accelerates—be asked to run a budget surplus of 3 or 5 per cent of GDP to counteract the monetary policy and therefore offset the imbalance in the private sector? It is another very difficult question that would arise. But definitely, in terms of extending the range of indicators, this will go in the right direction.

  Q143  Baroness Maddock: Dr Mayer, do you have anything to add to that?

  Dr Thomas Mayer: One small comment. The pact wants to foster stability and growth. For stability and growth, we need fiscal stability, financial stability and international competitiveness. But, in the past, we have only really intensely monitored fiscal policy.

  The Chairman: We are pressed for time and we have our third witness with us. With the indulgence of Sir Martin Jacomb, perhaps I can ask Baroness Hooper and Lord Vallance to telescope their questions. I am going to give you an opportunity, gentlemen, to make any final points that you are anxious to make before us today, after which I intend to close this session.

  Q144  Baroness Hooper: Do you consider that the new European Systemic Risk Board has a useful role and how will that role develop in terms of macroeconomic events and procedures?

  The Chairman: While you are thinking about that, perhaps Lord Vallance could ask his question.

  Q145  Lord Vallance of Tummel: My question opens up quite a wide debate. Our witnesses may want to consider whether they might want to write in rather than answer now, but let me ask it. The debate that we have been having this morning centres on reinforcing financial and fiscal disciplines and one form of crisis management or another. However, in your written evidence, Dr Annunziata, you emphasise the equal importance of, I think your phrase was, "fostering convergence in competitiveness". I wondered if you might expand a little as to what you mean by competitiveness in this context. Presumably, it goes beyond relative wage levels. How in practical terms would you see convergence being fostered?

  Dr Marco Annunziata: I start with one comment on the Systemic Risk Board. The European Systemic Risk Board can play an extremely important role, which should be complementary to the monitoring being implemented under the stability and growth pact. Before the summer, we discussed increasing the range of macroeconomic variables that could be included under the stability pact but, to understand whether or not systemic risks are being created, we need to go beyond that. We need to look not only at the increase in public and private debt in individual countries but also at trends in individual financial sectors, how the risk is being located within the sector and to what extent the interlinkages across the banking sector in Italy, France, Spain and Greece create the risk of transmission of imbalances. This is where the European Systemic Risk Board would come in. It would have an enormous amount of work to do in terms of just gathering information to put us in a better position to assess how significant the systemic risk is. We have discussed it before with reference to Ireland. Now we both feel that we are in a better situation to assess the systemic risk and feel that it is limited. There is some progress compared to the beginning of the crisis, but there is still an enormous amount of work to do. In that respect, the Systemic Risk Board will be extremely precious. In terms of competitiveness, what I meant is that—this goes hand in hand with what Dr Mayer said a moment ago—in the eurozone we have been focusing on the criterion of fiscal prudence, but the problem is that, at the same time, we have allowed countries to move in completely different directions as regards productivity growth and competitiveness. This has created a situation where some countries have been running enormous levels of private debt, not just because households or corporations were borrowing a lot more given a lower level of interest rates, but also because these countries had seen a deterioration in the external competitiveness of their industrial systems. That meant that they were no longer able to export on the external market, either within or outside the euro area. These issues need to be monitored because otherwise they will continue creating enormous imbalances between surplus countries and deficit countries. This goes to the heart of a debate that goes beyond the eurozone. What should be the burden of adjustment between countries running current account surpluses and countries running current account deficits? What I meant in my remarks is that there should be a strong emphasis on structural reforms, pushing countries to liberalise their markets and to improve their education system and research and development efforts to try to make the entire eurozone more competitive on the global market.

  The Chairman: Dr Mayer.

  Dr Thomas Mayer: Very quickly on the European Systemic Risk Board, I think that this is an integral part of the monitoring of financial stability, as seen as part of the whole. On the question of international competitiveness, what we need is more cost discipline. The countries that have accumulated the large external deficits did so because there was no pressure for cost discipline. As credit was easily available, these deficiencies did not show up. Like Dr Annunziata, I think that the best means to achieve cost discipline is competition. If you have more intense competition in the single market, this would be a big leap forward in ensuring cost discipline and, therefore, a restoration of international competitiveness.

  The Chairman: Colleagues, I apologise to those of you who have been unable to ask a question today. We are enormously grateful to Dr Annunziata and Dr Mayer for the answers to the questions that we have been able to put. If there are further points or, indeed, points that you feel you have not had the opportunity to reply to, we would be most grateful if you could write them down. The point on competitiveness that Lord Vallance was asking about was extremely important and interesting, as were so many others.

  Lord Trefgarne: I was going to ask whether we could have a note on the question that I would have asked about the eurozone bond.

  The Chairman: Yes. It would be good if we could give you some guidance about those questions that we were not able to turn to, as Lord Trefgarne has pointed out. In the mean time, we will send you the transcripts. Please correct them and let us know if you have further ideas. Take away our enormous thanks for this morning's session.

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