Euro area countries need to react flexibly to economic changes

Governor of Eesti Pank Ardo Hansson said on Saturday at the high-level Ambrosetti Financial Markets Workshop in Italy that the experience of the euro area shows that countries in a monetary union need to have a responsible economic policy and should be ready to react flexibly to economic changes.

Mr Hansson used his presentation to compare the advantages and disadvantages of a sharp adjustment for countries suffering an economic crisis.

He said that one advantage of a sharp adjustment is that the rapid reaction of economic policy makers means there is a shorter period of high uncertainty weighing on economic activity, especially on investment decisions. Another advantage is that a rapid adjustment frees up resources for new businesses and activities. Mr Hansson emphasised that a sharp adjustment can help avoid reform fatigue in a society and prevents debts from building up too far in both the public and private sectors.

At the same time, economic policy makers need to be careful that the speed of rapid changes does not create problems by forcing viable firms out of business. It is also important for governments to explain clearly to society why the changes are needed and what effect they will have. He showed a comparison of Estonia’s adjustment during the economic crisis with the reactions of four other euro area countries, namely Greece, Ireland, Spain and Portugal. The comparison makes it clear that the faster adjustment in Estonia helped the country exit the crisis more successfully in terms of economic growth, employment, fiscal balance and debt.

The relatively rapid long-term growth in the Estonian economy and its ability to adjust have been based on a strong fiscal policy, a flexible labour market and relatively low debt levels, particularly in the public sector, explained Mr Hansson. The ability of the Estonian economy to escape from difficulties was aided by well-capitalised banks, consistent structural reforms and the desire to adapt economic policy quickly to changes in the economy. Unlike Estonia, several countries in the euro area were hindered in their reaction to the crisis by an excessively large financial sector.

Mr Hansson said that Estonia’s experience in the economic boom showed that a strong external anchor in the form of a credible fixed exchange rate arrangement might lead to policy complacency. The experience of the euro area during the economic crisis has proved that the economic policy of countries in a monetary union needs to be responsible and ready to react flexibly to economic changes.

The Ambrosetti Financial Markets Workshop on Friday and Saturday in Cernobbio, Italy, was attended by leading decision-makers from the world of financial and monetary policy. Ardo Hansson gave a presentation in the Saturday morning session on the Agenda for Europe.

For more information on the conference, see http://www.ambrosetti.eu/en/news/2014/financial-markets-workshop

See the presentation here

Source: Bank of Estonia

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