Staying Focused on the Big Picture in Times of Turbulence

When the unexpected happens, such as the ongoing financial turbulence around the world, losing sight of the big picture is not uncommon. Surprise and uncertainty often bring this about. Clearly, dealing with the turbulence is the first order of business. It is one which, in the very short-term, calls on central banks to restore functioning money and credit markets. That imperative, however, must be twinned with policies—including financial sector regulatory policies—focused on preserving Europe's longer-term economic performance.

In its inaugural Regional Economic Outlook for Europe, the IMF highlights a number of key challenges for policymakers. The first step in preserving the region's longer-term economic performance is to upgrade private and public prudential arrangements so Europe's economy can continue to benefit from financial innovation without incurring excessive risks. Another is to stay focused on advancing fiscal consolidation and structural reforms, including the strengthening of financial systems, for a more robust outlook.

The current turbulence is the most pressing threat to growth, and this is why addressing it has to be a priority. While the IMF, among others, had warned that the risks were building, the scale of the turbulence shows how difficult it is to identify precisely the risks from financial innovation. And yet, financial innovation and integration in Europe have, over time, yielded large benefits, perhaps most apparent in the rapid income convergence enjoyed by many countries in emerging Europe.

The response to the crisis, therefore, needs to be a balanced one. Private and public prudential frameworks must do more to keep up with financial innovation. Risk assessment models and market and liquidity risk management, for example, need to be improved. There is also a need to restore trust among investors, a step that will require considerably greater transparency than is the case now about their financial situations. In addition, financial safety nets and crisis resolution mechanisms will need to become more effective and their cross-border dimension incorporated.

But, while the financial turmoil has adversely affected Europe, the bigger picture shows that many, if not most, European economies have yet to reap the full benefits of financial innovation.

Perhaps the primary challenge is to overcome visceral habits of not just inaction but of wrong action when times are good, by giving away cyclical fiscal windfalls. Such gifts are generally unaffordable. And, in Europe's emerging economies, fiscal consolidation is essential to mitigate convergence-related demand pressures and external risks.

In addition to the healthy diet of fiscal consolidation, European economies need the protein provided by structural reforms to make them stronger and help them grow faster. Despite recent progress, Europe's structural rigidities remain its Achilles' heel, inhibiting economic growth and making adjustment to shocks protracted and difficult.

The impact of the US subprime mortgage crisis and and the global credit crunch on Macedonia has been limited, with foreign bank participation lower than in other countries in emerging Europe. Credit to the private sector continues to expand at a robust pace, and prudential indicators give evidence of a sound financial system. The IMF and the World Bank Group are assisting the Macedonian authorities in upgrading banking supervision by implementing a Supervisory Development Plan, which emphasizes risk-based (rather than compliance-based) supervision. Fiscal policy continues to provide a solid basis for macroeconomic stability in Macedonia, with the central government budget showing a surplus in the year to date. Going forward, Macedonia's key challenge is to maintain macroeconomic stability, while accelerating structural reforms, aiming to make financial and labor markets work better. This should be conducive to higher economic growth, more job creation, and improved integration in the world economy.

The author is Director of the International Monetary Fund's European Department