Fiscal and Monetary Policy- the Response of Global Economic Crisis Especially in Eu Essay

monetary and financial form _or_ system of organisation-The response of global sparing crisis especially in EUIntroductionMonetary and monetary authorities across the globe prolong responded quickly and decisively to these extraordinary developments. In particular, against the background of promptly receding pretentiousnessary pressures and risks, the Euro system has interpreted monetary constitution and fluidness management measures that were unprecedented in nature, scope and timing. Since October last year they reduced the engross rate on the main re pay operations. They besides erectd absolute liquidity bear out to the banking system in the euro ara to substantiate the flow of reference work. Governments in the euro atomic number 18a come re deeded swiftly to stabilize the financial system and to counteract the adverse impact of the financial crisis on the literal parsimoniousness.Both monetary and financial authorities will need to wait credible and effective, and to fulfill their various(prenominal) responsibilities. In so doing, they will lay solid foundations for future sparing recovery and long-term economical growth and job creation. The crisis has shown how important it is to have an indep removeent primordial bank firmly committed to the nonsubjective of cost constancy. At the same time, organizations moldiness make a strong and credible commitment to a path of fiscal consolidation and thus comply with the Stability and Growth Pact. except they must besides resist the temptation to further increase the size of the remark measures, as this could erode trust in the sustainability of existence finances and deprave the effectiveness of the measures already pick out. seeetary economic situationThe financial markets, which was triggered by a systematic under-pricing of risk, particularly in the US sub-prime mortgage market, has now developed into a sufficienty-fledged financial and economic crisis at g lobal train. While the world scrimping continues to face a severe and synchronized downturn, recent international business confidence indicators suggest that the pace of the descent in economic body process is slowing down somewhat. almost forecasters expect that the global economy is belike to recover in 2010.The economic prospects dwell fraught with uncertainty. Comp atomic number 18d with a few months ago, overall risks to global economic growth have fetch to a greater extent equilibrate. A stronger positive confidence effect than expected triggered by the monetary and fiscal indemnity measures could lead to a more sustained recovery in global lead and in global trade, and a quicker normalization of financial market and credit conditions. If global constitution actions fail to flow an appropriate agreement between economic stimulus and longer-term sustainability, financial market conditions could turn unfavorable again. Global inflation evaluate have continued to d iminish promptly. This is mainly due(p) to lower commodity prices, saplesser stab market conditions and greater global economic slack. Risks to global inflation seem to be broadly balanced in the short to medium term. Inflation risks depend on how efficiently the authorities eat up the policy stimulus. Euro activityIn global developments, economic activity in the euro force field has withal contracted sagaciously since the second half of 2008. The euro state economy has shrunk by somewhat 4% over the past cardinal quarters, the worst decline since the fasten on of Economic and Monetary Union. For the menstruum quarter, there is evidence that the economy has shrunk further, though at a slower pace. The economy is no longer in free fall we argon seeing the first signs of stabilization. Indicators of consumer confidence and business sentiment have continued to improve somewhat. We are also seeing some encouraging signs of normalization in financial markets.The euro area ec onomy is likely to be very weak for the remainder of past year. The unfeigned gross domestic product growth are broadly in line with the most recent forecasts from the IMF and the European Commission. Both institutions expect the euro area economy to contract by 4% or more in 2009, followed by a gradual recovery in 2010. The project gradual recovery reflects the significant macroeconomic stimulus under way and the measures taken to make the financial system function normally twain inside and outside the euro area. Euro price developmentInflation in the euro area has declined rapidly since it reached its highest level, 4%, last summer. In May, The decline over this period is primarilydue to the marked fall in global commodity prices, and particularly oil prices. Inflation rates are likely to enter negative territory during the summer, but we expect them to turn positive by the end of 2009. This can largely be explained by base effects from energy prices. These effects are of no co ncern to the ECB, which aims to maintain price stability in the medium term. In other words, its monetary policy strategy aims to ensure that short-term excitableness in inflation rates does non lead to volatility in long-term inflation expectations. It is reinforced by the anticipation that prices will decline further in the future. As a consequence, inflation expectations become dis fixed and negative, and firms and households whitethorn decide to postpone investments and major purchases.Medium-term inflation expectations remain hale anchored at levels consistent with price stability, low or negative inflation rates for a short period of time may help to sustain real income and may therefore bump around snuff iting. But compensate if inflation rates to turn positive again by the end of this year, the weak economic outlook for the euro area is expected to keep domestic price pressures delivered for some time. Monetary and financing conditionsFinancing conditions in the e uro area, external financing costs have been declining since October last year, and particularly sharply since the start of this year. Following policy hobby rate cuts, bank lending rates have fallen significantly. This indicates that the pass-through implement from policy rates to the real economy has continued to function in recent months, even though there is evidence that banks margins have widened. With credit spreads across all rating classes decreasing from their record highs and with railway line prices rising, the overall cost of financing for euro area non-financial corporations is diminishing. In general, the recent positive signs from financial markets point to a gradual improvement in confidence among investors. Monetary policyThe ECB has acted in a by the bye, decisive and appropriate manner since the start of the financial market. When the escalating financial crisis led to a rapid decline of inflationary pressures. The interest rate on the main refinancing operat ions now stands at 1.0%, its lowest level since the launchof the euro. This level is appropriate taking into account all information and analyses. Money market rates have fallen even further to record lows, and the loan interest rates charged by banks have declined. Substantive monetary policy easing is already being felt in the real economy.In amplification to lowering the policy interest rate quickly and sharply, we have resorted to highly non-standard liquidity operations in order to provide the financial system with the liquidity that was so urgently needed. withstand October, They adopted a fixed-rate full allotment procedure in all their open market operations. This gives banks as a lot important bank liquidity as they want at our key policy interest rate, against an expanded list of eligible collateral. Coupled with the fact that essentially all financially sound euro area credit institutions can participate in the Euro systems refinancing operations, these measures have significantly eased the banks balance sheet constraints, thereby avoiding a sudden stop in the supply of credit and the emergence of a systemic crisis. Policy measuresBoth monetary and fiscal policy-makers have reacted in a forceful and timely manner, aiming to restore confidence. And indeed, as regards the Euro systems monetary policy and liquidity management measures. Confidence has returned to financial markets, and business surveys are picking up. Global and domestic demand to increasingly benefit from the significant economic stimulus and the measures taken so far to bring the financial system back to normal functioning. pecuniary policy measuresFiscal authorities in the euro area have demonstrated their willingness and capacity to act rapidly and in a interrelated manner in exceptional circumstances. It is important to distinguish between measures think to condescend the banking empyrean and fiscal policy measures aimed at stimulating demand. Support for the banking sect orGovernment support for the banking sector was necessary it has safeguarded the stability of the financial system. The price of this success, however, is that governments have incurred substantial fiscal costs and credit risks that are ultimately borne by valuatepayers. Following the adoption of aconcerted European action plan on 12 October 2008, euro area governments announced national measures to support the banking sector. These measures consist of government guarantees for interbank lending, recapitalization of financial institutions in fractiousy, increase the coverage of retail deposit insurance and asset relief schemes.Overall, euro area governments committed about 23% of euro area GDP to financial sector support measures. For the euro area, the various support measures adopted so far are expected to have only a small direct impact on government deficits, whereas the impact on debt is expected to be about 3% of GDP. Finally, contingent liabilities related to the financial rescue measures are expected to be about 8% of GDP, excluding government guarantees on retail deposits. These figures, however, do not reflect the very different developments taking place across euro area countries.Rising long-term government bond yields may only have a gradual impact on government borrowing costs, as changes in interest rates only affect the cost of newly issued debt and debt at variable interest rates. However, they may signal both a reduced willingness on the part of investors to provide long-term funding as well as difficulty in accessing capital market funds. So far, most euro area countries have enjoyed relatively low interest rates on new government debt issuance, despite facing considerably more difficult market conditions. Looking ahead, as the economy recovers and disputation for financing increases, governments may face higher bond yields again. Use of fiscal policyIn addition to providing financial support to the banking sector, euro area governments re acted forcefully to counter the negative impact of the financial turmoil on the real economy. Besides the operation of automatic stabilizers, which provide a significant cushion to the euro area economy by way of lower tax revenues and higher spending on unemployment benefits, the discretionary use of fiscal policy helped to mitigate the effects of the global economic downturn. However, fiscal stimulus measures need to remain short and be combined with measures that ensure fiscal sustainability over the medium run. This will preserve trust in the sustainability of humanity finances and support both the recovery and long-term economic growth.While the recent coordinated fiscal loosening has been broadly accepted as a legitimate and necessary step in the short run, given the exceptional economic circumstances, it also entails a significant fiscal burden. The latest for sale economic point to dramatic developments in euro area cosmos finances. In addition to a rapidly deteriorating general government deficit, which is expected to be above 6% of euro area GDP in 2010, the euro area debt ratio will increase by about 15 percentage points to above 80% of GDP by 2010. These figures are very high, though they compare favorably with other major economic regions that have also provided a substantial fiscal impulse to their economy. The budget deficit in both the joined Kingdom and the join States is projected to be about 14% of GDP in 2010.Against this back bring down, euro area countries must reject calls for additional fiscal loosening. In the underway environment, any further fiscal stimulus is likely to be counterproductive as it could hamper the economic recovery in two ways. First of all, even higher fiscal deficits could fuel market concerns about a countrys ability to bump its future debt obligations, thus putting upward pressure on interest rates. Second, increasing budget deficits would also raise concerns about a higher tax burden in the future, thus in ducing consumers to indite rather than spend any additional income.The financial sector support measures, combined with the Euro systems enhanced credit support measures, were successful in safeguarding the stability of the financial system. Together, these initiatives have the potential to tackle the crisis of confidence at its root also by taking into account the fundamental role of the banking sector in the functioning of the economy. The restructuring of the banking sector is the top policy priority, and progress in this domain is the key to economic recovery. Given the challenges which lie ahead, banks should take appropriate measures to prove their capital base and, where necessary, take full value of government support and in particular recapitalization measures.Fiscal policy can contribute to macroeconomic stability also through discretionary actions. When assessing the merits of the different measurestaken, we should differentiate between measures such as (1) expenditu re increases and (2) tax cuts, and (3) measures like guarantees and loan subsidies to specific sectors of the economy. Moreover, this type of support would be difficult to reverse and might act as a brake on long-term growth.Turning to the effectiveness of fiscal measures to stimulate demand (spending increases and tax cuts), it crucially depends on the behavior of economic agents, and that in turn also affects the size of the fiscal multipliers (the GDP effect of fiscal stimulus measures). The expectation that higher government spending today may lead to higher taxation in the future would induce both households and firms to save rather spend any additional income, thus reducing the size of the fiscal multiplier. Therefore, the public perception of overall fiscal sustainability plays an important role in the impact of the assessive national fiscal stimuli. The effectiveness of fiscal stimulus measures also depends on the extent to which private investors respond positively to tax policy, with their investments likely to be more responsive in the case of temporary tax breaks, as they provide an incentive to bring prior future investment plans. At the same time, there is a risk that fiscal stimulus measures may crowd out private investment by putting upward pressure on interest rates.Fiscal stimulus measures should be timely, temporary and targeted. Timely means that the measures take effect when they are needed any delays in assessing the cyclical situation, in taking decisions and implementing the measures may fail to prevent a drop in output. Temporary implies that the fiscal impulse should only last as long as the box in question. Targeted relates to the expected size of the multiplier effect. In addition to these TTT criteria, the measures should be consistent with other policy objectives such as fiscal sustainability, long-term economic growth and the functioning of the market mechanism. Implications of policy measuresThe current crisis has increased t he role of the government in the economy. Some bank rescue operations have gnarly outright nationalizations, so governments now have significant exposure to the financial sector.Similarly, the large fiscal stimuli packages adopted by many countries have led to a large increase in the size of the public sector in the economy.At the same time, the turmoil is being interpreted by some as a crisis of the market economy. It has encouraged critics of the market economy to speak out and demand a much larger role in the economy for governments.The financial system clearly needs a fundamental overhaul. Financial institutions have to take a different approach and adopt appropriate incentives. We need to strengthen the regulation of the financial system, and in particular, we must improve the international cooperation between national supervisors of the financial sector.But the policy-makers must not get carried away by recent events they should act in a calculated way, and not throw the bab y out with the bathwater. While governments have had no alternative but to support systemically relevant financial institutions, they should, as a rule, keep their assistance to specific sectors or firms to a minimum. And when they do intervene, they should prepare clear and credible communicate strategies. No matter how serious the current crisis is, the market economy remains the best way to organize our economic affairs.An exit strategy is a comprehensive programmed to withdraw and neutralize measures taken during the financial crisis, without causing any harm to the economy. If they have no well-defined exit strategy, governments may get bogged down and the positive impact of the measures taken may be undermined. A well thought-out exit strategy is needed to reassure economic agents that a timely restoration of the level performing field in the different sectors of the economy is the ultimate objective. As such, an exit strategy needs to contain clear criteria about the timing of the withdrawal of the financial support and the reversal of the fiscal stimuli.Euro area governments did not lay out clear exit strategies when they announced the stimuli. Some of their measures do not expire mechanically or are not explicitly designed to be temporary. The possible difficulties of reversing the fiscal stimulus packages may hinder the return to sound fiscal positions in the short run. Under these circumstances, the peer pressure mechanism, on which the EU fiscal framework is based, may be weakened thusmaking more difficult a return to sound fiscal policies. As a matter of fact, countries with high fiscal deficits may be tempted not to put political pressure on their peers. Protracted excessive deficits may undermine the credibility of the EU fiscal framework, thus casting doubts on fiscal sustainability and jeopardizing the Stability and Growth Pact.The current crisis has taught us an important lesson about the importance of preserving the publics trust in the sou ndness of public finances. At the current juncture, euro area governments must make credible commitments to return to sound fiscal policies. Doing so in full compliance with the Stability and Growth Pact is the most credible exit strategy. This requires, first, a full reversal of the fiscal stimulus measures taken so far. This is necessary to ensure an efficient tryst of resources by minimizing distortions in the incentives of economic agents and by avoiding a permanent increase in the size of the public sector. Second, governments must live up to their commitment to maintain fiscal discipline. This means that credible fiscal consolidation plans have to be implemented as early as possible, including a consolidation effort of at least 1% of GDP per annum where necessary. Understanding the monetary policy from the crisisThe current crisis demonstrates, once again, how important it is for central banks to remain independent of political influence. Even if we are experiencing the wors t economic downturn since the 1930s, long-term inflation expectations in the euro area remain solidly anchored in line with the ECBs definition of price stability. Although central banks may be charged with additional tasks in the aftermath of the crisis, their primary objective must remain the maintenance of price stability. We cannot allow any conflicts of interest to arise. The high-level expert group headed by Jacques de Larosire, condition Governor of the Bank of France and Managing Director of the IMF, has identified a number of weaknesses in the supervisory framework both inside and outside Europe that contributed to the figure of speech-up of the current crisis.The important role played by monetary psychoanalysis and in particular the role of asset prices when assessing the risks to price stability over themedium term. Price stability is our primary objective, but this does not imply that we only focus on short to medium-term movements in inflation. all build-up of fin ancial imbalances which could pose risks to price stability in the longer term could be overlooked under a restrictive short-term approach. The ECBs assessment of risks to price stability is well equipped to unwrap these types of risk as it is based on a comprehensive economic and monetary analysis its long-familiar two-pillar strategy. The first pillar, the economic analysis, is common to most central banks. This analysis basically consists of identifying risks to price stability in the short to medium term by analyzing the interplay between aggregate supply and aggregate demand in the economy.The second pillar, the monetary analysis, plays a more prominent role at the ECB than at other central banks. The ECB pays special attention to monetary developments in recognition of the fact that monetary growth and inflation are closely related in the medium to long term. Analyzing developments in credit, and in particular loans to the private sector, is reformatory in extracting the re levant signals from the monetary developments. This analysis also implies a regular monitoring of asset price developments and their implications. This analysis will become even more prominent in the future. ConclusionThe fiscal and monetary authorities have responded forcefully and their efforts are slowly starting to bear fruit. The pace of the economic capsule appears to be slowing down, and confidence indicators have improved somewhat. The crisis has highlighted the importance of sound public finances. Governments need to merge during good economic times in order to have room for man oeuvre during not-so-good times. With respect to monetary policy, the crisis has demonstrated the importance of having an independent central bank credibly committed to price stability.The fiscal and monetary authorities have an important role in sustaining the economic recovery. Governments must devise and order credible strategies to exit from the banking sector and to ensure that the discretio nary policy measures adopted during the crisis will be reversed. Their full compliancewith the Stability and Growth Pact is the best tool to solidly anchor market expectations. Most importantly, we will continue to deliver on what we are expected to deliver, which is to maintain price stability, and to provide an anchor of confidence in difficult times.The current crisis has shown how important it is for countries to consolidate during good economic times and to build a fiscal reservoir from which they can draw in periods of drought. Many euro area countries failed to do so. They suddenly found themselves in this turbulent environment burdened by high fiscal deficits and debt ratios.As regards monetary policy, it is equally important to draw up a strategy for withdrawing in due air the extraordinary measures that have been implemented or announced. The ECB obviously cannot maintain the current degree of support indefinitely. We are providing substantial short-term support to the fi nancial system and the real economy, and thereby ultimately maintaining price stability. In fact, we are prompt to take appropriate actions once the macroeconomic environment improves. We will ensure that the measures taken can be quickly unwound and the liquidity provided absorbed. This includes, for instance, unwinding the increase in the average maturity of our refinancing operations. Being prepared to exit from our non-standard measures as soon as the macroeconomic conditions justify such a move helps to maintain price stability over the medium term and to ensure a firm anchoring of longer-term inflation expectations.ReferencesAlan Auerbach and Yuriy Gorodnichenko, 2012a, measuring stick the Output Responses to Fiscal Policy,American Economic Journal Economic Policy,Alan Auerbach and Yuriy Gorodnichenko, 2012b, Fiscal Multipliers in Recession and Expansion, NBER Chapters, in Fiscal Policy after the Financial Crisis, edited by Alberto Alesina and Francesco Giavazzi (Universit y of Chicago Press). 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