(Archived Content)
TG-855
The United States and Europe: Crucial Partners in the World Economy
Bruegel Institute, Brussels
Too much has been made in United States and European press reports about trans-Atlantic clashes over economic policies. Frequently the focus on the discussions among the countries overshadows the decisive and unified response. Today, I would like to emphasize the broad areas where there has in fact been close cooperation, to review the signal achievements that have been made, and to discuss the still lengthy agenda to restore sustainable and balanced growth. My main message is that much has already been accomplished by working together, and I am confident that this close cooperation will continue as we address the pending challenges. The bulk of conversation with our European partners is over differences in tactics, as we are largely agreed on the strategic directions. This is a crucial partnership for us. Together, the United States and Europe represent about half of the global economy. The European Union is the United States' largest export destination (20 percent of total exports; 35 percent of total services exports).
Retrospective: Review of the last two years of achievements
In response to the most globally synchronized recession the world has seen, we have mounted the most globally coordinated response the world has attempted. In April 2009, with the global economy contracting at an annualized rate of 6 percent, huge numbers of people facing a catastrophic loss of jobs and savings, and trade in free fall, President Obama and other G-20 leaders together committed to undertake an unprecedented fiscal expansion. The cooperation has been remarkable: 20 countries, representing 85 percent of global GDP, emerging economies alongside advanced economies, joined forces and agreed to mount a significant common response to a common challenge. This action, coupled with coordinated efforts by central banks and the international financial institutions, constituted the largest and the most comprehensive stimulus program in history. The result is clear: the global economy is now well on its way to recovery.
We have also worked hard together to strengthen global financial regulation and supervision to address the weaknesses that contributed to such a devastating financial crisis. Much has already been agreed toward strengthening the financial oversight tools, to raise capital standards and to expand resolution authority. There also has been substantial progress on the regulation of derivatives and consumer protection. In the United States, the Dodd-Frank law has introduced historic new oversight of our financial system consistent with our G20 commitments.
Through the G-20, we have bolstered the lending capacity of the international financial institutions like the International Monetary Fund, the World Bank and other multilateral development banks. Beyond providing them with larger capital bases, we have enhanced their lending tool kits to be more effective and relevant in supporting countries facing financing strains.
The United States has also been supportive of European efforts to address sources of instability in the European Union. We held many conversations to discuss how best to address the Greek debt crisis. The IMF/European support package for Greece was a major step for Europe, and will be crucial in giving that country breathing space to pursue its economic adjustment. We also welcomed Europe's efforts to build financial backstops. These include the European Financial Stability Mechanism and the European Financial Stability Facility, ensuring that other countries can be shielded from excessive market pressures. We were also pleased with the results of European leaders to address lingering concerns around European banks with a series of stress tests designed to restore confidence.
Current State of the Recovery
The U.S. economy has made substantial progress over the past year. We have completed four consecutive quarters of growth. Real GDP has returned close to its pre-crisis level, private job growth has resumed, conditions in most financial and credit markets have normalized and the housing market has stabilized. Recent data indicate some slowdown in economic growth, in part because the stimulus has reached its peak and the boost from the inventory cycle is now fading. Nevertheless, it is important to emphasize the gathering strength in final private demand, notably rapid growth of business investment and moderate growth of consumer spending. To be sure, vulnerabilities remain. High unemployment adds to uncertainty and the softness of the housing market, while households are still working hard to strengthen their balance sheets, so we must continue our efforts to support the recovery.
It's encouraging that the European economies are also on the path to recovery, but again there are uncertainties. The European recovery gained strength in the second quarter led by a surge in growth in Germany. However, activity may now be slowing again as the boost from stimulus and trade normalization fades. Moreover, domestic demand remains quite sluggish, including at the core. The European periphery, from Greece to Portugal to Ireland, remains particularly weak as extensive adjustments are still needed to overcome the financial crisis and restore conditions for growth.
Agenda Ahead for US and Europe: Growth
Our joint priority must remain focused on policies to ensure balanced, self-sustaining global recovery. We must take care that there is a smooth transition from a recovery based on policy stimulus to a sustained expansion based on private demand and growing productive capacity, while avoiding a reversion to the imbalances that marked the early years of this century.
Let me highlight five key areas where the United States and Europe will need to work closely together:
First, restoring balance to global growth is a key priority. While imbalances declined during the crisis, this was largely a cyclical phenomenon, and now there are signs that they are widening again. The U.S. economy can no longer be the driver of global demand. U.S. households must continue to consolidate balance sheets through maintaining significantly higher savings rates, and the Administration is committed to restoring fiscal sustainability and raising exports. Countries with current account surpluses need to do more to boost domestic demand, including through greater exchange rate flexibility in some countries in Asia. But advanced surplus economies also have a role to play in boosting domestic demand. While the recent data in the EU show some pick up in domestic demand, the region also has benefited from rising net exports and more can be done to strengthen demand trends in countries like Germany without undermining their long term fiscal path and export competitiveness.
Second, ensuring a credible path to fiscal sustainability over the longer term must be a key priority. In Toronto this July, President Obama again joined with G-20 leaders and agreed to maintain stimulus until the recovery is assured while charting a common path to fiscal sustainability. They committed to halve deficits by 2013. And they committed to at least stabilize government debt-to-GDP ratios by 2016. The President's budget is consistent with achieving a rapid reduction in the fiscal deficit from 10 percent this year to 4 percent by 2015, and the Fiscal Commission has been tasked to suggest additional adjustment to lower the deficit further to achieve primary balance and long term sustainability.
Important progress is being made in Europe to strengthen the coordination and credibility of fiscal targets under the Stability and Growth Pact (SGP). Just last week, EU Finance Ministers agreed to introduce the "European Semester" as a mechanism for earlier coordination of fiscal and structural policies. There is also significant progress toward an agreement to strengthen and expand sanctions under the SGP, again which will help ensure the credibility of member states' committed fiscal paths over the medium-term. Separately, there is a renewed focused on age-related spending challenges including pensions. Many countries from Portugal in the years before the crisis to Greece earlier this summer and France and Spain this fall have or are starting to address the sustainability of public pension systems.
Of course, countries need to make judgments about how steeply to pull back stimulus based on evolving national circumstances as well as global conditions. In the near term, those countries that have the capacity must not rush for the exits, especially in a world in which fiscal austerity has been forced on so many and in which the momentum of the recovery of activity remains quite modest.
Third, structural reform must also be part of the solution. In the United States, President Obama has signed a major health care package that not only expands coverage but will also help contain costs over the long run, helping both our fiscal outlook and our competitiveness. He has also pushed initiatives focused on new investments in infrastructure and education. Just last week, the President announced two targeted policies that will help to improve the long-run potential of the U.S. economy: a $50 billion investment in infrastructure to rebuild U.S. roads, railways, and runways; and an enhanced, permanent Research and Experimentation tax credit. These policies are also designed to support demand and job creation in the immediate term, meaning that the President is acting both to support the recovery today while building a firmer foundation for growth in the years and decades ahead.
We welcome efforts in Europe to address long-term pension costs and to improve the flexibility of labor markets, and we are mindful of the work that is being done by the member States and the European Commission to fully implement the Services Directive. A more harmonized services sector, and a deeper Single Market, could speed up the removal of the bottlenecks that hamper investment and productivity, and dampen Europe's growth potential. We would encourage continued efforts to open markets and boost productivity growth which should contribute to raising confidence and building productive capacity both in the core and in the periphery.
Fourth, we should remain focused on completing our agenda for financial regulatory reform. An important step was made last weekend toward agreement on Basel III, which will significantly raise the quantity and quality of our bank capital and limit leverage, and will materially raise levels of resilience of our banking systems. We are reforming our financial supervisory structures to ensure that we are looking at risks to the system as a whole, rather than focusing narrowly on specific institutions. [In the United States, we will have the Financial Stability Oversight Council (FSOC), and in Europe there will be the European Systemic Risk Board (ESRB).] The G-20 Leaders also agreed to fundamentally overhauling the OTC derivatives market to reduce the dangerous inter-linkages between firms that contributed to the financial crisis and to make our financial market infrastructure more robust. (The United States has already enacted legislation to achieve this and is in the process of its rule making. The EU will be following shortly, and we are working very closely together to avoid regulatory arbitrage.) We are also strengthening our financial systems by: integrating compensation practices into supervision and risk management, improving oversight of hedge fund advisors, and reducing conflicts of interest at credit rating agencies. The G-20 members still have much to do on improving national and cross border resolution regimes, but we are proud to say that in the United States, we now have an authority to resolve systemically important non-bank financial institutions in a manner as robust as our bank resolution system at the FDIC, and to put an end to the perception of "too-big-to-fail".
Fifth, and finally, the United States and Europe must continue to work together in the multilateral arena. The G-20 is now the primary group for global economic cooperation and must retain relevance as the crisis fades into the past. We must work together to nurture the global recovery and to address imbalances. We must also continue working together on reforms to ensure a more robust and relevant international architecture, that reflects the changing realities of the global economy. The agenda includes working together to ensure the effectiveness and legitimacy of the IMF and the other international financial institutions, including governance reforms that boost the voice and participation of the dynamic emerging and developing economies that are new key drivers of global growth.
To conclude, I think it's important to reiterate that the strong cooperation between the United States and its European partners including in the context of the G-20 has played a key role in reversing the worst economic downturn since the Great Depression. As we move forward, we must continue working effectively together to address common challenges, to ensure that our economies remain on the path to sustained growth and recovery and that those who have lost their jobs can get back to work as soon as possible.
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