WASHINGTON - Chairman Issa,
Ranking Member Cummings, and members of the Committee, thank you for the
opportunity to testify today on developments in Europe. Europe is a key strategic and economic
partner of the United States, and we have an enormous stake in the success of
European efforts to restore financial stability and secure growth. The U.S. recovery is getting stronger, but the
strength of our recovery will depend in part on events beyond our shores, as we
saw last year when U.S. growth was buffeted by headwinds from Europe.
time, European leaders have taken a series of steps to address the crisis and we
are encouraged by the progress to date. We hope Europe will build on that progress
with additional actions to calm the financial tensions that have been so
damaging to global economic growth and put in place a stronger framework of
policies and institutions to make the European Monetary Union viable over the
longer term and help the member countries to strengthen economic growth.
The European Policy Response
With our encouragement and the support of the IMF, Europe’s
leaders have put in place a comprehensive strategy to address the crisis. This strategy has the following key elements:
- Economic reforms in the member states to restore fiscal
sustainability, restructure the banking systems, and improve competitiveness
and growth prospects;
- Institutional reforms, including the “Fiscal Compact,” that
establish stronger disciplines on the fiscal policies of the member states to
limit future deficits and debt as a share of GDP;
- A coordinated strategy to recapitalize the European
financial system, with government guarantees of funding; and
- A “firewall” of funds to provide financial support to
governments that are undertaking reforms to help assure access to financing on
These efforts by governments have been reinforced by a
substantial amount of support from the European Central Bank.
The European economies at the center of the crisis have made
very significant progress.
The causes of the crisis were years in the making and were
very different across the continent.
establishment of monetary union in 2000, interest rates across the union fell significantly,
with rates converging toward Germany’s.
This was accompanied by a substantial rise in borrowing. In Greece, government spending and borrowing rose
dramatically. In Portugal, Spain, and
Ireland, private debt expanded. And in
all these countries, as well as Italy, the competiveness of the private sector
eroded significantly, relative to Germany.
exception of Greece, fiscal profligacy was not the primary cause of the crisis.
and Spain, the governments actually ran fiscal surpluses, while the private
sector borrowed too heavily, inflating a housing bubble. Italy’s large public debt is a legacy of a
different era. By the early 1990s, the
country embarked on serious fiscal consolidation, maintaining primary surpluses
(i.e., the government’s total revenues exceeded total expenditures, excluding
interest payments on debt) between 1992 and 2008.
crisis intensified, however, public deficits expanded everywhere, and fears of
cascading defaults by government, the collapse of the financial system, or the
unraveling of the euro itself caused a broader financial panic across much of
the continent, with the governments of many countries losing the ability to
borrow at sustainable interest rates without support.
course of the last eighteen months, the countries in crisis have put in place
very tough and far-reaching reforms to address the underlying causes of the
Greece has reduced
its structural budget deficit, which measures the underlying deficit adjusted
for the effects of recession on revenues and expenditures, by nearly 12 percentage
points of GDP since 2009, according to the IMF.
Ireland, Portugal, and Spain have reduced their structural deficits by between
4.5 and 5 percentage points over the same period. In Italy, where the structural deficit
expanded by much less, the government has shaved off 1¼ percentage points of
GDP. Each of these governments has further
plans in place to move closer to a sustainable fiscal position over the medium
reforms are only part of the solution.
The harder challenge is to address the erosion in competitiveness and
restore reasonable rates of economic growth, a challenge made more difficult by
the fact that in a monetary union, the member states do not have their own
monetary policies or currencies that can adjust, and in Europe today, there is
no mechanism for fiscal transfers to help cushion economic shocks.
countries at the center of the crisis are also putting in place measures to
restore competitiveness. The Italian
government has begun to implement reforms to improve the business environment,
and developed plans to reform the country’s labor laws. Spain has introduced reforms to increase the
dynamism of its private sector. Greece,
Portugal, and Ireland have also introduced a range of competitiveness-enhancing
reforms, including plans for privatization, and labor market reforms and
countries are also acting to restructure and repair their banking systems. Spain is restructuring its financial sector, reducing
the number of savings banks from 45 to 15.
In Ireland, bank recapitalization of €70 billion is now complete and the
deleveraging of the system – which aims to reduce banks’ loan-to-deposit ratios
by almost 20 percent over three years – is proceeding as planned.
economic reforms to work, policymakers in the Euro Area will have to be careful
to calibrate the mix of financial support and the pace of fiscal
consolidation. The reforms will take
time and they will not work without financial support that enables governments
to borrow at affordable rates and keeps the overall rates of interest across
the economy at levels that won’t kill growth.
growth is likely to be weak for some time.
The path of fiscal consolidation should be gradual with a multiyear
phase-in of reforms. If every time
economic growth disappoints governments are forced to cut spending or raise
taxes immediately to make up for the impact of weaker growth on deficits, this would
risk a self-reinforcing negative spiral of growth-killing austerity.
economic reforms have been aided by actions by the ECB, which has lowered
interest rates, undertaken purchases of sovereign debt in secondary markets,
and provided critical funding and liquidity support for the European banking
system. Last December, the ECB
introduced the three-year Long-Term Refinancing Operation (LTRO) and broadened
eligible collateral. Through its two
lending operations in December and February, the LTRO has allotted over €1.0
trillion to hundreds of banks.
the European Banking Authority (EBA) has conducted a series of stress tests
with new disclosure requirements for the banking systems of the entire Euro Area
and required banks to raise capital and take other steps to build stronger
financial cushions against the economic downturn and to reflect the higher
risks of the assets they hold. European
banks have raised more capital, but they have also been selling assets and
cutting bank lending to help meet the new capital requirements, which is adding
to the financial headwinds now slowing growth.
leaders have worked with private bondholders and the IMF to restructure and
reduce Greece’s government debt. Fears
of a disorderly Greek default played a significant role in fueling the fires of
the crisis across Europe over the past two years, and Europe’s leaders have, as
a result, worked to contain the risk of contagion from Greece and to insulate
the rest of Europe from the impact of the solutions necessary in Greece.
This mix of
economic reform and financial measures has helped calm financial tensions. The cost of borrowing has fallen sharply for
Italy and Spain. Concerns about bank
funding problems have eased. But Europe
is still only at the initial stages of what will be a long and difficult path
The most important
unfinished piece of the broader financial strategy is to build a stronger European
firewall to provide a backstop for the governments undertaking reforms. The existing €440 billion European Financial Stability
Facility (EFSF) has made commitments totaling €192 billion. Europe’s leaders have decided to establish
another fund called the European Stabilization Mechanism (ESM) to succeed the
EFSF starting in July 2012. They are in
the process of reviewing options for expanding the combined financial capacity
of these funds so that they can make clear to financial markets that they have
the financial resources available on a scale that is commensurate with future
needs in the event the crisis were to intensify.
financial crisis has already caused significant damage to economic growth in
the United States and around the world, and we have a strong interest in a
successful resolution of the crisis.
The Euro Area
accounts for about 18 percent of global GDP.
It is a major source of financing for many emerging economies. It accounts for about 15 percent of U.S. exports
of goods and services, but a larger portion of exports of many of our trading
partners. When growth slows in Europe,
it affects growth around the world. And
when the fears of a broader European crisis have been most acute, as they were
in the summer and fall of 2011 and during the spring and summer of 2010,
financial markets fell around the world, damaging confidence and slowing the
momentum of the global recovery.
financial system has relatively little exposure to the five European economies
at the heart of the crisis, but we have significant financial and economic ties
to Germany and France and the continent as a whole.
worked very closely with Europe’s leaders over the past two years, and with the
members of the IMF, to help support a stronger European response to the
Reserve’s dollar swap lines with the ECB, the Bank of Canada, the Bank of
England, the Bank of Japan, and the Swiss National Bank have played a critical
role alongside the ECB’s direct efforts.
European banks borrowed heavily in dollars before the crisis, and many
lost the ability to borrow in dollars as the crisis intensified. The Fed’s swaps made it possible for Europe’s
banks to borrow dollars from their central banks, which has helped avoid a more
rapid deleveraging, reducing the impact on financial conditions in many
countries where European banks had lent heavily.
The IMF has
also played an important role in Europe. The IMF has provided advice on the design of
reforms, a framework for public monitoring of progress, and support for
programs in Greece, Ireland, and Portugal in partnership with Europe, which has
assumed the majority of the burden. These actions have helped limit the damage
from the crisis to the United States and to economies around the world.
It is in the
interest of the United States that the IMF is able to continue to play a
constructive role in Europe. IMF
resources cannot substitute for a strong and credible European firewall and
response, but they can help supplement the resources Europe mobilized on its
The IMF has
substantial financial resources available today, and it has the ability, as it
has demonstrated in the past, to mobilize temporary resources if that were
necessary to help contain the damage from a further intensification of the
crisis in Europe. For these reasons, we
have no intention to seek additional U.S. resources for the IMF. The IMF has played a critical role in every major
post-war financial crisis, while consistently returning to the United States
and other IMF members any resources – with interest – that it has temporarily
encouraged by the progress that our European colleagues have made over the last
few months. We hope they are able to
build on these efforts in the coming weeks and months to put in place a more
durable foundation for financial stability and economic growth. We do not want to see Europe weakened by a
protracted crisis. We will continue to
work closely with them, and with the IMF, to facilitate further progress.