Unedited Event Transcript Restoring Sustainable Growth and Job Creation in Europe Peterson Institute for International Economics, Washington, DC December 18, 2014 Keynote Address Fabrizio Saccomanni, Director General Emeritus of the Bank of Italy, former Minister of Economy and Finance of Italy Chair: C. Fred Bergsten, Peterson Institute for International Economics Fred Bergsten: Could I ask everyone to resume his or her seats and we will resume the program? It’s a particular pleasure to introduce as our luncheon speaker, an old friend and very high former official, Fabrizio Saccomanni. Fabrizio, as I’m sure all of you know, was until earlier this year, Minister of Economy and Finance in Italy. He’d been in that position for about a year in what was obviously a very crucial time for Italy’s response to the crisis and an effort to put the economy back on a stronger footing for the future. And he’ll talk to us I’m sure in part about that. For many years, Fabrizio was a leading light at the Banca d’Italia. He began there back in 1967, was Managing Director for International Affairs from 1997 and most recently served as Senior Deputy Governor of the bank just prior to his move to the Ministry of Finance. Fabrizio spent five years here in Washington on detail to the IMF, so he has that in his background as well. He spent three years at the European Bank for Reconstruction and Development in London as well. And so, has a very rich background across the whole range of international economic and financial institutions as well as in Italy. Since he left government earlier this year, he has a very rich and diversified portfolio. He teaches at the London School of Economics, he teaches in Rome, he’s become Vice President of the Italian equivalent of the Council on Foreign Relations and is actively engaged with us here at the Institute as a member of our Advisory Committee and a good friend, a close confidant and colleague for many years. And I think there’s nobody better to talk to this group today about where Europe is going, some ideas for how to strengthen the outlook that we’ve been talking about this morning than Fabrizio Saccomanni. Welcome back to the Institute. 1 Fabrizio Saccomanni: Well, thank you, Fred, for your very kind words. It feels so very good to be back to the Peterson Institute and I’m glad to see a lot of old friends who have joined us for it to hear my little talk. I think the topic has been indicated that I should discuss about the outlook for the European economies, for the European Union, the Eurozone and also take into account to the role of the Italian presidency in the second half of this year and more generally, the Italian economic situation. Now, I think a lot of the issues that I will be addressing have already being discussed in the panel this morning where a lot of interesting ideas have been mentioned. So, I will try to address in many ways the same questions, bringing in the experience I’ve made as Minister of Finance and Deputy Governor of the Bank of Italy in the crucial period of the European crisis. So, let me first briefly mention what is the—in terms of the economic outlook or what are the possible scenarios for the European economy. I mean, the first scenario is the rosy one. I mean, if you talk to some of my colleagues in what is called the Core Europe, they continue to be rather confident that, “Oh, if we continue to apply the medicine that the doctors have indicated to us…” I mean, for Europe of supply side plus the structural reform or plus fiscal consolidation, then a moderate recovery is probably going to take place and inflation will gradually move back to 2%, consumption and investment will pick up based on low interest rates, the easy monetary policy of the European Central Bank, the decline of oil prices. So, they expect a return of confidence that would support this kind of rosy scenario. In my feeling, the probability of this scenario taking place is very low. I mean, I would call it the impossible dream in many ways because there are so many, so many difficulties in implementation. Now, the second type of scenario, which I would call a muddle-through scenario is probably the one who has the higher probability, which assumes – as some of the panelists have indicated this morning – a continuation of the situation of very low growth or near stagnation with low inflation, but no technical deflation in the technical sense of the word. I mean, very low inflation for a long period. And now, the impact of this situation on the policy framework of the European Union is probably going to be sort of affected by this situation in the sense that one can assume that the process of fiscal consolidation will probably slow down in a number of countries. There is the probability of the activation of the excessive deficit procedure by the European Union in connection with some countries. 2 The pace of our structural reform is probably going to be delayed. There will be pressure for the European Central Bank to accommodate these developments with a more supportive policy, monetary policy, possibly with some degree of quantitative easing. And, as it has been indicated, the interest rates are going to remain very, very close to zero for a long period. But there is going to be some probably tensions appearing on the spreads of particularly for some peripheral countries. The euro is probably going to continue to remain weak. I think I agree with what Fred said earlier on. I think one, just looking at the sort of the outlook for interest rates between within the United States and Europe in the period ahead, one would see a period of a possibly continued weakness of the euro. But nevertheless, the unemployment in this scenario is going to remain high, particularly among young people. So, I think the key issue here is that we are going to have serious political risks in Europe, certainly social tensions and growing support for political parties that are against the euro, against austerity, against the European Union more generally. So, this is a very, very disturbing scenario, which however, would not necessarily precipitate the European Union in a full-fledged crisis. Then the third scenario instead is a crisis scenario or a crisis of a new existential crisis of the euro. Namely, a crisis that could indeed bring again the question whether the euro as it is can continue to survive. And, the features of this crisis obviously would be that there would be severe spreading out of deflation throughout Europe, which will make fiscal consolidation and debt reduction very, very difficult to achieve and so there will be higher real interest rates, there will be a sharp widening of the spreads. So, there would be the risk that at the time when the economy is in depression, you’ll have an additional contraction impact from higher interest rates that will affect consumption and investment in a very negative way. And then I think that would probably bring back what was called the redenomination risk of the euro. Namely, the risk that people would be asked to accept repayment of their claims on the euro with a different currency. And so, again, the policy scenario under this type of situation would be to put all the burden on the European Central Bank. There will be obviously a lot of pressure for the ECB to adapt a policy of quantitative easing. There would be also a strong possibility in this type of generalized situational crisis for the activation of the outright monetary transactions, which has been sort of announced in 2012, but not activated because it is a conditional instrument that requires some sort of a memorandum of 3 understanding that every country would have to sort of agree with the European Central Bank and possibly with the troika. But, in a situation of generalized crisis, I assume that the drafting of this memorandum of understanding would not be very difficult. I mean, everybody knows what should be included in these type of documents and under the pressure, the drafting could be facilitated. But then again, in a situation like this, the pressure for the breakup of the euro or to exit from the Eurozone or sort of re-suspending key elements of the European construction would be very, very strong. And also, there might be a very strong financial repercussions throughout the world economy given the size of the European Union. Now, this third scenario is probably, I mean, has a low probability, but low but not negligible. And I think it would be wrong to ignore the risk that this situation may appear. Now, how is the European Union shaping up its policy response to deal with these type of scenarios? Because of the three scenarios I have outlined only one is rosy, but with almost zero probability. The other two are rather serious. So, I think the first conclusion that one, I mean, has to remember, is that the first existential crisis that Europe was confronted with found the European Union institutions not prepared. As it has been mentioned, we didn’t have the instruments to deal with the sovereign banking crisis that took place after Lehman Brothers. And then, we were forced by the crisis to develop, I would say under duress, the kind of institutions and the instruments that were needed to cope with the crisis.