”The first blow from the crisis came from the trade channel and it did not discriminate against individual countries” (photo: Mihai Barbu/Reuters)
EUROPE IN 2010
As 2009 draws to a close, Belka says that what is striking about Europe is how differently countries fared during the global crisis. How hard countries were hit by the decline in trade and capital flows was determined by the openness of the economy and quality of policies and institutions rather than by the East-West geographical divide. These different points of departure will also make for a multispeed recovery, Belka argues in this interview with IMF Survey online.
IMF Survey online: 2009 has been a tough year for Europe. What will 2010 be like?
Belka: The crisis that hit Europe in late 2008 was unprecedented. All we can say for certain about the near future is that 2010 is not going to be anything like 2009.
We are now in the middle of a recovery but it is not very robust, although clearly the situation is improving. I find it interesting that the markets are much more upbeat about Europe’s near-term prospect than we are. Here at the IMF, we look at the structure of the recovery, and we see both the forces that will drive the recovery and the forces that may hold it back. So it’s going to be an interesting year, with much riding on the choice of economic policies.
The year 2010 will be dominated by the challenge of how to strike a balance between continuing to support the economy and gradually phasing out unconventional measures. Here, I’m thinking about unconventional financial and monetary measures rather than fiscal stimulus.
In Europe, the banking sector is not yet in as good shape as we would like it to be. However, now is the time to switch from extraordinary, meltdown-preventing measures (like blanket guarantees) to institution-specific measures. We know the problems are concentrated in a limited number of institutions, so policymakers should concentrate on them. National authorities need to ensure that banks keep capital up to deal with the loan losses ahead and be in a position to extend credit. Weak banks should be required to raise capital and restructure or face resolution.
IMF Survey online: When will the situation improve for the many people who have lost their jobs?
Belka: Unemployment, as we all know, is a lagging indicator. The turnaround in the labor market will only happen after business activity has recovered. In the most general terms, this means we can probably expect the labor market to start improving late in 2010 and into 2011.
That said, the situation is very different in different countries, and I don’t simply mean between western and eastern Europe. When you look at advanced Europe, the unemployment rate has barely moved in countries such as Germany and the Netherlands whereas in other parts of Europe, including Spain, Ireland, and a number of countries in emerging Europe, unemployment has spiked.
So the situation is very uneven, partly because of the policy response to the crisis, partly due to the structure of the economy. For the hardest hit countries, the situation will stabilize but the improvement will be gradual during 2010 and beyond. In those countries that didn’t experience a marked increase in unemployment, we will probably see a marginal increase.
IMF Survey online: What is your advice to policymakers as they start unwinding the policies that were put in place to fight the crisis?
Belka: Keep the overall supporting stance of policies for the time being because we’re not sure how robust this recovery is. As and when the situation permits, 2011 is the year to start fiscal consolidation, and here we fully support the approach of the European Commission. Some countries, of course, have to act faster. Greece, Ireland, and Spain for instance can’t afford to wait, but most of them are already doing what is necessary. Several countries in the east—Serbia, Ukraine, Romania, and Hungary—have already started the process of consolidation.
As far as the financial sector is concerned, I have already mentioned it is time to switch from systemwide measures to institution-specific measures.
When it comes to monetary policy, the European Central Bank (ECB) is being cautious, as always. It is not signaling any withdrawal from monetary easing anytime soon, and that is as it should be. But we should expect some withdrawal of unconventional monetary measures when the economy allows for it.
"It may seem as if regulation is a burden. But if it helps avoid a crisis, then it’s a burden worth taking on."
All these policies are pinned down by very low inflation. There is no sign of a pickup of inflation even close to the 2 percent that is described by the ECB as price stability. We believe inflation will stay close to 1 percent in the near future, not least because inflation expectations are well anchored.
So, to sum up, our advice is: Support economic activity for now. Plan for a careful exit. And finally, deal with impaired financial institutions more forcefully than is being done now.
IMF Survey online: Countries in emerging Europe have weathered the crisis very differently, ranging from your native country, Poland, which escaped recession altogether, to Ukraine and the three Baltic countries, Romania, and Hungary, which suffered deep downturns. What factors determined whether countries ended up in one camp or the other?
Belka: I would name four factors: structural features of the economy, the quality of macroeconomic policies, the quality of institutions, and the exchange rate regime.
In a crisis, it’s good to be a relatively big economy with a diversified production base. Poland comes to mind. It not only has a relatively big domestic market but also a diversified export industry. In fact, Poland’s economy alone constitutes 40 percent of the region. If you add two other countries that have remained relatively stable—the Czech Republic and Slovakia—you have 65 percent of the region’s GDP. So looking at how Poland has weathered the crisis may give you a better picture of how emerging Europe has handled the crisis rather than looking at, say, Latvia.
Those countries that had unsustainable fiscal policies, such as Hungary or Romania, fell into crisis first. And those that had managed their policies well, including Poland but even more so the Czech Republic, remained relatively stable. And even though the crisis delivered a pretty severe blow, we have seen a clear rebound quite early in the crisis and no sign of destabilization in the banking sector in these two countries.
The quality of institutions played a role. One of the key institutions is financial sector supervision. Those countries that had strong supervisory regimes in place, such as the Czech Republic, managed to avoid excessive currency mismatches. Low interest rates also played a part because there was no incentive to engage in carry trade. The same was true, but to a lesser degree, of Poland.
Fixed exchange rate regimes have been a pillar of economic stability for the three Baltic states and Bulgaria. But they also encouraged excessive capital inflows. And now, with the crisis, these fixed regimes have radically limited the policy options for these four countries. That said, the exchange rate regime is only one factor. Some of the hardest hit countries, including Ukraine, Hungary, and Romania had floating, rather than fixed rates. So I’m far from saying the most important factor in the crisis is the exchange rate regime. The other three factors I have mentioned probably played a bigger role.
IMF Survey online: There have also been big differences within advanced Europe, with countries such as Ireland, Britain, and Greece struggling to regain their footing, while other advanced countries are already growing again. Again, what policy lessons can we draw from their experience?
Belka: Well, the first blow from the crisis came from the trade channel and it did not discriminate against individual countries. On the contrary, we saw a situation in which Germany’s GDP fell more than that of other countries that we sometimes think of as poor performers. So the numbers do not really reflect the complexity of the situation. Germany’s economy is at the crossroads of the global economy and that’s why it suffered first when trade imploded. This was a hard blow, but in Germany’s case, it is temporary.
You also have two other categories of countries. First, countries with homemade imbalances—mainly real estate and asset price bubbles. When the crisis hit, these bubbles suddenly burst and the economies were hit not only by declining trade but also by sinking housing markets. Ireland and Spain are two good examples.
As it happens, both these countries started with relatively low levels of public debt, so they were able to react to the crisis by using the fiscal space that they had accumulated in good times. Now, of course, both countries have been forced to start fiscal consolidation. In a monetary union, depreciating your economy out of the crisis is not an option. So countries must rebuild their competitiveness through factory price adjustment, which often means, unfortunately, cutting wages. This is currently going in many countries.
The third category of countries includes Greece as the most prominent example. The country had a difficult fiscal situation leading up to the crisis but was not hit so badly in terms of growth. Whereas Germany experienced a decline in GDP of almost 5 percent in 2009, Greece’s corresponding number was just under 1.5 percent, making the country seem initially like an oasis of stability.
Well, needless to say, these numbers don’t tell the entire story. Greece now has to undertake a very painful fiscal adjustment, but it’s not really because of the crisis. The crisis just brought problems to the fore which had been accumulating for decades. We may see similar problems show up in other parts of Europe.
IMF Survey online: When it comes to regulating the financial sector, how do you strike the right balance between making sure another crisis doesn’t happen anytime soon and not stifling competition?
Belka: This is a frequent call that we hear: do the right thing but not yet! We don’t want to micromanage what needs to happen in the financial sector, and the markets play an important role. But basically, banks need to increase their capital base, and they should probably do it sooner rather than later because capital is cheap right now. The future may be less benign for them.
"Keep the overall supporting stance of policies for the time being because we’re not sure how robust this recovery is."
We are in a situation where the banks are using the unprecedented monetary easing that has taken place as a massive subsidy provided to them by society. But let’s be clear: It’s the taxpayer who is rebuilding the financial system. Current high profitability will not last forever.
I am often asked whether new regulation will strangle the banks and slow down the growth of the global economy. My answer is that almost all crises bring about a permanent drop in wealth which is never regained: the output is lost forever. Economies may be able to return to their pre-crisis growth path, but it’s been very rare that an economy has made up for the loss of wealth not created during a crisis.
Now, if good regulation and tough supervision can prevent or at least soften the impact of crises, isn’t it, on balance, better for our long-term standard of living? Avoiding crises is probably the best way to stimulate the long-term growth rate. So, yes, it may seem as if regulation is a burden. But if it helps avoid a crisis, then it’s a burden worth taking on. Having said this, we are not advocating a “regulate everything” approach. The new regulatory framework should precisely address the vulnerabilities that have become evident in the crisis.
IMF Survey online: Now that the panic is behind us, what main lessons do you take away from this crisis?
Belka: Good policies begin in good times. Unfortunately, good times are usually seen as something to enjoy while they last, not only by politicians, but also by the people who elect them. And then the crisis hits and makes us realize good times don’t go on forever.
Therefore, good times are also times to make provisions for a rainy day. Making provisions is not only about accumulating reserves. It is also about building institutions that are able to resist the onslaught of a crisis, including in the financial sector.
We have drawn many lessons from the crisis when it comes to the shortcomings and imperfections of the financial markets. It is only legitimate to use the situation to bolster the regulatory framework and supervision. I worry that some lessons may not be learned. Policymakers were so effective in preventing a real catastrophe that some people may now simply forget what really happened.
