The document summarizes responses to the euro area crisis from monetary, fiscal and structural policy perspectives. It discusses short-term measures taken as well as long-term solutions needed, including fully-fledged fiscal and economic institutions and structural reforms. The crisis originated from excessive indebtedness and imbalances in both public and private sectors. Monetary policy played an essential role in fighting the crisis through liquidity provision and unconventional measures. Fiscal initiatives aim to impose budget controls and enable cross-country financial solidarity.

1. Responses to the euro area crisis
Benoît Cœuré
Member of the Executive Board
European Central Bank
The Interactive Museum of Economics
Mexico City, 20 July 2012

2. In a nutshell
• The crisis has been generated by excessive indebtedness
and imbalances, whether in the public or private sector
• Depending on countries, excessive indebtedness has been
compounded with
• real estate and housing bubbles
• divergent developments in competitiveness
• financial / banking fragilities
• Rising country risk has resulted in market fragmentation,
undermining some of the benefits of the monetary union
The crisis
2

3. Short and long-term solutions
• Fiscal and monetary policy authorities in the euro area have
taken a number of short-term measures to fight the crisis,
which, although essential, are by their nature temporary
• Monetary union came with a strong and independent
central bank, but without fully-fledged institutions in charge
of economic, fiscal and financial policies
• Progress has been made towards improving governance and
incentives, but long-term solutions require the creation of
such fully-fledged institutions, based on a democratic
process, and the fixing of fundamentals via structural
reforms
Solutions
3

4. The responses from monetary
policy
4

5. Policy-controlled interest rates
Credit supply,
bank interest rates
Inflationary
expectations
Long-term interest rates,
asset prices
Exchange rates
Import prices
Interest rate channel
Supply and demand in goods and labour marketsWage and price setting
Price developments
Liquidity channel
Monetary policy transmission channels
5

6. Inflation volatility falls despite larger energy price volatility
Larger energy price volatility boosts inflation volatility
-0.20
0.00
0.20
0.40
0.60
0.80
1.00
1991-2010 1991-1998 1999-2010
Cov(core,energy) Var(core)
Cov(food,core) Var(food)
Cov(energy,food) Var(energy)
Headline HICP
-0.20
0.00
0.20
0.40
0.60
0.80
1.00
1991-2010 1991-1998 1999-2010
Cov(core,energy) Var(core)
Cov(food,core) Var(food)
Cov(energy,food) Var(energy)
Headline PCE
Energy price shocks and inflation volatility
US: Decomposition of InflationVolatilityEuro Area: Decomposition of InflationVolatility
Price stability has been delivered
6

7. A stable macro-economic environment
Source: OECD and ECB calculations.
Note: Observations refer to the average annual output growth and inflation between 1999 and 2011.
7
UKUSA
Japan
Australia
Switzerland
Norway
0.0
1.0
2.0
3.0
4.0
5.0
0.0 1.0 2.0 3.0 4.0 5.0
Standarddeviationofinflation
Standard deviation of output
Euro area
Hungary
Island
Mexico
Brasil
China
Poland
Chile
Israel
Cezch rep.
Sweden
Korea

8. Stable inflation expectations
Point expectations and risk premium
Source: García, J.A. and T. Werner (2010), “Inflation risks and Inflation risk premia”, ECB Working Paper No 1162.
Note: Inflation expectations are BEIR. Last observation: October 2010.
0
1
2
3
4
5
6
7
8
1995 1996 1997 1998 1999 2000 2001 2002 2003 2004 2005 2006 2007 2008 2009 2010 2011
0
1
2
3
4
5
6
7
8
10-year Inflation expectations 10-year Inflation risk premium
10-year real bond yield 10-year nominal bond yield
8

9. Sources: BEA, Eurostat. Notes: 1999Q1 =100. Last observation: 2012Q1.
GDP per capita growth
Stability in euro area achieved with comparable average per-capita growth performance to the US
9
Strong growth performance
85
90
95
100
105
110
115
120
95 96 97 98 99 00 01 02 03 04 05 06 07 08 09 10 11 12
Euro area US

10. Policy-controlled interest rates
Credit supply,
bank interest rates
Inflationary
expectations
Long-term interest rates,
asset prices
Exchange rates
Import prices
Interest rate channel
Supply and demand in goods and labour marketsWage and price setting
Price developments
The crisis:Transmission impairments
Liquidity channel
10

11. 11
Money market segmentation
Cross-country standard deviation
of unsecured interbank lending rates
Source: ECB Financial Integration Report April 2012, page 16
3-m EURIBOR and EONIA/OIS
(in percentage points)
Sources: ECB, Bloomberg
0.0
0.5
1.0
1.5
2.0
2.5
3.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
2004 2005 2006 2007 2008 2009 2010 2011 2012
Euribor/OIS spread (RHS)
Euribor 3-months
OIS 3-months
0
5
10
15
20
25
30
0
5
10
15
20
25
30
2004 2005 2006 2007 2008 2009 2010 2011 2012
overnight
1-month maturity
12-month maturity
61-day moving average, basis points

12. Note: data in percent. The lower and the upper bound are the deposit facility and the marginal lending facility rate respectively.
Last observation: 11 July 2012.
Monetary policy response post-Lehman
Monetary policy in the first phase of the crisis
12
0.0
1.0
2.0
3.0
4.0
5.0
6.0
0.0
1.0
2.0
3.0
4.0
5.0
6.0
Jan07 Jul07 Jan08 Jul08 Jan09 Jul09 Jan10 Jul10 Jan11 Jul11 Jan12 Jul12
deposit rate
EONIA
main refinancing rate/
minimum bid rate
MRO rates
(marginal/fixed)
marginal lending rate
9 Aug 2007 15 Sept 2008 7 May 2010

13. Policy-controlled interest rates
Credit supply,
bank interest rates
Inflationary
expectations
Long-term interest rates,
asset prices
Exchange rates
Import prices
Interest rate channel
Supply and demand in goods and labour marketsWage and price setting
Price developments
Liquidity channel
Transmission plumbing
13

14. First phase of the crisis:
• Full accommodation of liquidity needs at a fixed rate
• Extended range of collateral for open market operations with
stringent risk control
• Extended range of maturities for open market operations up to 1
year
• Provision of foreign currency denominated liquidity
• Outright purchases of covered bonds
Monetary policy measures in the euro area
14

15. 15
External financing for non-financial corporations
0
20
40
60
80
100
Euro Area United States
0
20
40
60
80
100
Banks
Non-Bank
Non-Bank
Banks
Source: ECB Monthly Bulletin April 2009
Note: Breakdown of the sources of external financing of non-financial corporations, in percent,
average 2004 – 2008
Euro area United States

16. Source: ECB. Last observations: 1 July 2012.
The Eurosystem balance sheet
Monetary policy in the first phase of the crisis
16
-1200
-1000
-800
-600
-400
-200
0
200
400
600
800
1000
1200
1400
1600
-1200
-1000
-800
-600
-400
-200
0
200
400
600
800
1000
1200
1400
1600
Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12
EUR bn
main refinancing operation marginal lending facility
1-maintenance period refinancing operation 3-month longer-term refinancing operation
6-month longer-term refinancing operation 1-year longer-term refinancing operation
3-years longer-term refinancing operation covered bond purchase programme and securities markets programme
fine-tuning providing operation fine-tuning absorbing operation
deposit facility liquidity needs
9 Aug 2007
15 Sep 2008 3 Dec 2009 7 May 2010
Intensification of the
financial turbulence
Initiation of gradual
phasing out
Start of the sovereign
debt crisis
Beginning of the
financial turbulence
Introduction of
3-yr LTROs
22 Dec 2011

17. Sovereign bond spreads
Sources: Thomson Reuters Datastream and ECB calculations. Note: bond yield spreads are vis-à-vis the German 10-year
government bond, end-of-day data (last value 11 Jul 2012, 17:00 CET).
Second phase of the crisis: credit risk shocks
17
-
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
-
500
1,000
1,500
2,000
2,500
3,000
3,500
4,000
4,500
5,000
Jan08 Jul08 Jan09 Jul09 Jan10 Jul10 Jan11 Jul11 Jan12 Jul12
Greece
Portugal
Ireland
Spain
Italy
France

18. Sovereign credit risk and bank CDS
18
Annual change in individual bank CDS in 2011
and exposure to stressed sovereigns
(in b.p.; portfolio share)
-150
100
350
600
850
1100
1350
0 0.2 0.4 0.6 0.8 1
Source: EBA (8 December), Datastream, ECB
calculations. – Notes: Annual changes in banks’ CDS
(x-axis) vs. proportion of banks’ sovereign exposure to
countries under stress relative to their overall direct
sovereign exposures (y -axis). – 4 3 EU banks from
Dec’11 EBA sample (correlation 66%).
Banks Lending Standards (Net Percentage)
Source: BLS
-40
-20
0
20
40
60
80
2003 2004 2005 2006 2007 2008 2009 2010 2011 2012
Loans to enterprises
Loans for house purchase
Consumer credit
Transmission with credit risk shocks

19. First phase of the crisis:
• Full accommodation of liquidity needs at a fixed rate
• Extended range of collateral for open market operations with
stringent risk control
• Extended range of maturities for open market operations up to 1
year
• Provision of foreign currency denominated liquidity
• Outright purchases of covered bonds
Monetary policy measures in the euro area
Second phase of the crisis:
• Securities Markets Programme: Intervention in dysfunctional
segments of the securities debt market
• Lower minimum reserve requirements
• Further extension of collateral for open market operations with
stringent risk control
• Refinancing operations (“LTROs”) with a maturity of 3 years
19

20. Source: ECB. Last observations: 1 July 2012.
The Eurosystem balance sheet
Monetary policy in the second phase of the crisis
20
-1200
-1000
-800
-600
-400
-200
0
200
400
600
800
1000
1200
1400
1600
-1200
-1000
-800
-600
-400
-200
0
200
400
600
800
1000
1200
1400
1600
Jan 07 Apr 07 Jul 07 Oct 07 Jan 08 Apr 08 Jul 08 Oct 08 Jan 09 Apr 09 Jul 09 Oct 09 Jan 10 Apr 10 Jul 10 Oct 10 Jan 11 Apr 11 Jul 11 Oct 11 Jan 12 Apr 12 Jul 12
EUR bn
main refinancing operation marginal lending facility
1-maintenance period refinancing operation 3-month longer-term refinancing operation
6-month longer-term refinancing operation 1-year longer-term refinancing operation
3-years longer-term refinancing operation covered bond purchase programme and securities markets programme
fine-tuning providing operation fine-tuning absorbing operation
deposit facility liquidity needs
9 Aug 2007
15 Sep 2008 3 Dec 2009 7 May 2010
Intensification of the
financial turbulence
Initiation of gradual
phasing out
Start of the sovereign
debt crisis
Beginning of the
financial turbulence
Introduction of
3-yr LTROs
22 Dec 2011

21. 0
50
100
150
200
250
2007 2008 2009 2010 2011 2012
0
10
20
30
40
50
60
70
80
2007 2008 2009 2010 2011 2012
Reduced funding stress and lower volatility following
the three-year LTROs
21
Source: Bloomberg
Last observation: 11 July 2012
Implied stock market
volatility in the euro area
3 month Euribor-OIS
spread (basis points)
Sources: Bloomberg and ECB calculation.
Last observation: 11 July 2012

22. Lower tail risk following the three-year LTROs
Source: ECB, Bloomberg. Based on options on DJ Eurostoxx 50. PDF’s show the probabilities that option market participants
attach to different future underlying instrument outcomes. Option-implied PDFs contain information on risk and market
uncertainty. Area under each line sum up to 1. Three-month horizon.
Probability density function of Eurostoxx 50
0
0.0002
0.0004
0.0006
0.0008
0.001
0.0012
0.0014
0.0016
0.0018
0.002
1250 1500 1750 2000 2250 2500 2750 3000 3250 3500
density
index points
5 August 2011
21 December 2011
5 March 2012
Early March
2012
Summer 2011
before SMP
Late
December 2011
22

23. The responses from fiscal policy
23

24. • General principle:
• Impose controls on national budgets and the insurgence of
imbalances
⇒ build, on this basis, mechanisms for cross-country financial
solidarity
• Safety nets are provided by EFSF / ESM
• These funds ensure forms of ex-post cross-country risk sharing
• EFSF lending capacity €440 bn and ESM €500 bn, with total
combined lending capacity of €700 bn
• “Six-pack”
• Macroeconomic surveillance procedure which will detect and
correct divergences at an early stage
• Increased automaticity
• “Two-pack”
• Further strengthening of surveillance mechanisms in the euro area
A number of initiatives
24

25. • “Fiscal compact”
• A balanced budget rule, concerning structural budget
deficit and not its cyclical component, aimed to restore
market confidence and the ability of national fiscal
policy to smooth out the effect of adverse economic
shocks
• Fiscal compact requires national balanced budget rules
to be enforced at constitutional level or equivalent
A number of initiatives
25

26. • A number of Member States, and especially those under stress,
have embarked on ambitious programmes of structural reforms,
concerning
• Labour markets
• Product markets
• Pension and health care system
• Tax system
• Public administration reforms and expenditure reductions
• Business environment
• Competition law
• Sector regulators
• Judicial system
• Privatisations
Structural reforms
26

27. The “four presidents’ report”
A long-term perspective
27

28. 1.An integrated financial framework
• Key elements:
• Single banking supervision
• Common deposit insurance and resolution framework
Four building blocks
28

29. 2.An integrated budgetary framework
• Establish mechanisms that prevent and correct
unsustainable fiscal policies
• Common agreements on upper limits to annual
budget balances and government debt levels for
individual Member States
• Issuance of sovereign debt beyond the commonly
agreed level will have to be justified and receive
prior approval
• Set up of a framework for budgetary discipline and
competitiveness
• Euro area fiscal body, such as a treasury office
Four building blocks
29

30. 3.An integrated economic policy framework
• Promote economic integration
• Ensure that unsustainable policies do not jeopardise the
stability of EMU
• Enforce the framework for policy coordination
Four building blocks
30

31. 4. Strengthening democratic legitimacy and
accountability
• Promote mechanisms to make joint decision-making
legitimate and accountable
Four building blocks
31

32. EU leaders have taken a number of steps based on
the report
• €120Bn “Compact for Growth and Jobs” and initiatives to
complete the single market for goods and services
• Single supervisory mechanism for banks, involving the ECB
• Once the single supervisory mechanism is in place, the
European Stability Mechanism (ESM) will be able to directly
recapitalise banks, with strict conditionality and control
• The EFSF / ESM can stabilise government bond markets also
for Member States which do not participate into IMF/EU
programmes, with ex-ante conditionality
The European Council of end-June 2012
32

33. Thank you for your attention
33