Since the beginning of the 21st century, the world economy has confronted at least three crises with a significant impact on financial stability: the dotcom bubble that burst around 2001, the Great Financial Crisis starting in 2007, and the economic and social shock generated by the Pandemic in 2020. Regardless of their very different scopes and origins, they have some features in common and provide useful lessons to address the current environment of financial volatility, inflationary pressures, growing liquidity constraints and a sharp increase in interest rates, aggravated by the war of aggression against Ukraine.
We should not underestimate the importance of political stability on economic and financial stability (…)
First, financial crises take a long time to materialise but, when they do, they develop much faster than expected. History has proved this time and again. The Great Financial Crisis that began in the US derivatives and real-estate markets in 2008 slowly but surely extended to sovereign debt three years later and ultimately unleashed a deep economic and social crisis with a lasting and structural impact.
Second, financial crises are far more damaging when coupled with pre-existing imbalances: the starting point matters. Lessons learnt from the global financial crisis have led to the deleveraging of private non-financial sector balance-sheets and more resilient banks, thus leading to a more resilient growth model.
Third, financial stability cannot be taken for granted. Since the great financial crisis, a massive volume of regulation has been enacted at the global and European levels, while the multilateral financial system and the Eurozone have been reinforced. This has proved to be very effective in dealing with the pandemic and the energy shock. But no crisis is similar to the previous one: regulatory and supervisory frameworks need to be continuously tested, adjusted and reinforced in order to be able to respond to a rapidly changing world.
Fourth, coordination and determination are key elements to tackle global shocks efficiently. Our joint response to the pandemic is a good example in this regard. When the COVID-19 pandemic hit the world there was a fast and coordinated response at the European and international levels, with an unprecedented supply of liquidity to ensure financial stability throughout the world. We coordinated our economic policies and reinforced the financial safety-net to provide space for governments to support their people. Within the EU, in record time we set up new instruments to support national treasuries and joined forces to develop vaccines and to make sure they would reach all Europe’s citizens equally – this we cannot take for granted either. Furthermore, a massive investment and reform programme is leading to a strong recovery and unprecedented investments to reinforce the economies that were most severely hit.
The European response to the pandemic was guided by three principles: unity, determination and solidarity. They have proved to be the right ones and should also guide us now as, this time around, we confront a new episode of financial stress triggered by the energy shock derived from the war at the EU’s doorstep.
Defence and security considerations were, of course, the top priority when war broke out, but they were soon joined by concerns about the economic impact of rising energy and other raw-material prices. Unbridled inflationary pressures, unseen for many decades, led central bankers to accelerate the normalisation of monetary policy, in a sharp turnaround from the ‘low for long’ scenarios projected for years.
This has led a growing number of vulnerable countries to call for financial support from the IMF, and even to a serious episode of financial instability in the UK’s sovereign debt market leading to a change of government and an unprecedented U-turn in economic policy. Furthermore, bubbles are bursting in the crypto space and a readjustment of stock prices is taking place, affecting the market valuation of certain large big-tech corporations and corporate debt.
The eurozone has shown a remarkable resilience so far, with broadly stable risk premiums in the sovereign debt markets despite the new monetary policy stance. Fortunately, the European Central Bank learnt the lessons from the sovereign debt crisis of 2012 and enacted appropriate mechanisms this time around to ensure monetary policy transmission and prevent market fragmentation before intensifying the interest-rate increase.
Despite growing liquidity constraints across the globe, risks to financial stability are not materialising. The Euro Zone remains strong and united, but we must continue to be vigilant.
This leads to the fifth key takeaway from past experience: we must anticipate possible risks and act in a decisive manner in order to be always ahead of the curve. And so we have tried to do in Spain. When energy prices started to surge in the summer of 2021, we called on the European Commission to act as fast as possible and put forward different proposals to curb the price surge. One year later, the Iberian mechanism, essential to contain electricity prices, has been approved and specific proposals are being discussed at EU level. Now we must be quick and ambitious to act, overcoming old inertias and ensuring that energy regulation is fit for the present and for the future.
Trust is the ultimate value to protect in times of stress and uncertainty.
Besides measures to respond to the price increase, we have also just adopted a significant mortgage relief package for most vulnerable and middle-class families that might be severely affected by the fast interest rate increase. This does not respond to any material macroeconomic risk, as the housing market has changed drastically since 2007. The outstanding stock of debt with variable interest rates has gone down and the average outstanding period for payment has fallen from 18 to 10 years. More than 70% of new mortgages are now at fixed rates and households and the corporate sector are less indebted and have a strong financial position thanks to the important income support provided since 2020. Non-performing loans are at historical minimum.
Nevertheless, we have anticipated the potential impact on households of the revision of interest rates that will come in the next few months and especially in the first half of 2023, preventing risks from materialising instead of reacting ex post. We have worked very intensely with the financial sector to establish an array of instruments for families to extend the duration of their mortgages, and to revise and freeze monthly payments, with a reinforced protection for the most vulnerable that are also affected more heavily by the general price increases caused by the international energy shock.
Finally, let me stress the importance of the invisible, intangible assets and levers underpinning economic developments. Keynes was right: animal spirits dominate the financial markets and can trigger a bank run, which may or may not be justified, a run on a country, which may again be justified or not, or against a currency. Trust is the ultimate value to protect in times of stress and uncertainty.
The Spanish government is determined to pursue an economic policy that enhances market confidence in the economy, on the basis of fiscal responsibility, social justice and future-proof structural reforms. This has enabled the adoption of the 2023 budget for the third successive year. And our draft Budgetary Plan has been validated by the European Commission and the IMF. We should not underestimate the importance of political stability on economic and financial stability, ‘doing what you say and saying what you do’, as we have done since we took office in 2018.
Furthermore, Spain is seizing the unique opportunity offered by the Recovery Plan, an unprecedented instrument of European solidarity supporting an ambitious programme of investments and reforms to support growth, job creation and the modernisation of the entire economy building on the twin green and digital transitions.
The Spanish Recovery Plan and the Next Generation EU funds underpin the extraordinary performance of the labour market and the dynamism of consumption, and public and private investment. This explains why GDP growth has exceeded 5 % in 2022, above the most optimistic forecasts and even the upward revisions by several international institutions.
We have learnt the lessons from the past and ensured financial stability in order to have a solid basis to respond to current challenges. This time around, Europe has provided the right response, based on solidarity, unity and determination. Let us continue on this positive path.
Image: Spanish First Deputy Prime Minister Nadia Calviño at the conversation with Mairead McGuinness on ‘Key topics for financial stability in Europe’. Photo: ©Elcano Royal Institute.
