## Beyond the Growth Versus Austerity Debate: Three Smart Things To Do Together

_IMF News, September 27, 2012_

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## Bibliographic details
- Authors: José Viñals
- Published: September 27, 2012

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### Overview
- Speech by José Viñals, Financial Counsellor and Director of the Monetary and Capital Markets Department, International Monetary Fund.
- Delivered at The Eurofi Financial Forum, Brussels, September 27, 2012.
- Central thesis: the debate framed as “austerity versus growth” is a false dichotomy; Europe must pursue stabilization, integration, and growth together through coordinated, smart policies.

### Diagnosis: two interlocking vicious cycles
- Economic vicious cycle:
  - Driven by three mutually dependent forces: weak sovereigns, weak banks, and poor economic growth.
  - Interaction: bank weakness → weaker growth → sovereign support → sovereign weakness → bank strain → weaker growth.
  - Example: Ireland public debt was 25 percent of GDP before the crisis; in early 2012, it was almost 110 percent.
- Political vicious cycle:
  - Escalating market tensions → euro-area level policy reactions → market relief → complacency or political fragmentation → renewed larger market tensions.
- Current conditions highlighted:
  - Euro area overall unemployment standing at 11.3 percent on average.
  - In Greece and Spain, one out of four are unemployed.

### Fiscal policy: “Fiscal adjustment needs to be smart”
- Core points:
  - Many countries have legacy high public debt; sovereign debt has lost its traditional risk-free character in some cases.
  - Fiscal stimulus is not an option; fiscal consolidation is essential to restore sovereign safety and support banks and growth.
  - Fiscal consolidation should be paced appropriately: neither too fast nor too slow.
  - If growth is worse than expected, prioritize fiscal measures over fiscal targets to avoid undue procyclicality.

### Structural policies: “Structural policies need to be smart”
- Priority areas:
  - Broad reforms in labor and product markets to unlock investment and improve supply capacity.
  - Delivering on ambitious structural reform agendas is politically difficult but essential, especially in Southern Europe where competitiveness problems are acute.
- Quantified IMF estimate:
  - Internal IMF studies indicate in-depth product, labor market and pension reform could lift growth in the euro area by 4.5% over five years.
- Financial sector reforms:
  - Clean up remaining excesses; build higher quality capital and truly liquid assets.
  - Restart securitization on safer grounds than pre-crisis.
  - Design a financial system that is lean, fit, fair, accessible, and supportive of growth.

### Financial regulation, supervision, and incentives
- Regulatory advances and remaining needs:
  - Agreement on new capital frameworks and movement by some institutions toward new requirements.
  - Need for rigorous and internationally consistent implementation of the new regulatory framework.
  - Better understanding of the shadow banking system; counterparty risk reduction in derivatives markets; effective national and cross-border resolution regimes required.
- Supervisory enforcement:
  - Enforcement needs strengthening; banking union initiative designed to remedy weaknesses in supervision within the euro area.
- Incentive alignment:
  - As institutions become safer, shareholders and bondholders may accept lower returns; compensation should align with lower risk profiles.
  - Shift appropriate burden from taxpayers to other stakeholders.

### Financing growth: three priority actions for the financial sector
- Repair:
  - Focus on problem areas and act fast to clean up banks and prevent emergence of “Zombie banks,” which are detrimental to growth.
  - Highlight vulnerability of banks dependent on wholesale funding; even deposit-rich banks are not completely safe.
- Build buffers:
  - Banks must continue to build capital and liquidity buffers steadily and consistently in line with Basel III requirements.
  - IMF finding: reasonably higher capital and liquidity buffers contribute to lower financial stress and to higher and more stable growth, particularly when buffers are high quality and more liquid.
- Integration and risk-sharing:
  - Understand implications of globalized financial systems; solutions to a global crisis must be global.
  - Response to contagion should be better institutional integration and cooperation, not fragmentation.
  - Strong support for establishing a banking union to reverse fragmentation, end financial repression, and enable efficient cross-border resource allocation within the common currency area.

### Conclusions and policy message
- The real choice is not between austerity and growth or stability and growth, but between:
  - Making tough political decisions to address root causes decisively now; and
  - Postponing necessary measures with the false hope that time is on our side.
- Recommended policy package:
  - Smart demand management, structural change, and regulatory reform together to foster confidence, restore stability, and support growth.
  - Reboot the financial system onto a safer path so it can channel resources to stronger and more stable growth.
- Call for leadership:
  - Turn intention into reality; decisive leadership is required so “this time it must be different.”

*By José Viñals, Financial Counsellor and Director of the Monetary and Capital Markets Department, International Monetary Fund, The Eurofi Financial Forum, Brussels, September 27, 2012.*

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## References

- [Greece and the IMF](http://www.imf.org/external/country/GRC/index.htm)
- [Ireland and the IMF](http://www.imf.org/external/country/IRL/index.htm)
- [Spain and the IMF](http://www.imf.org/external/country/ESP/index.htm)
- [Speeches](https://www.imf.org/en/news/searchnews)
- [José Viñals](https://www.imf.org/external/np/bio/eng/jv.htm)
- [PRESS CENTER](http://presscenter.imf.org/)
- [https://www.imf.org/en/home](https://www.imf.org/en/home)

_Source: https://www.imf.org/en/news/articles/2015/09/28/04/53/sp092712_