A warm welcome to you all. I am accompanied by Stephen Cecchetti, who is the BIS Economic Adviser and Head of our Monetary and Economic Department. Before Steve and I take your questions on this year's Annual Report, I would like to highlight its main messages.
In a number of crucial respects, the picture today is better than it was a year ago, and much better than it was two years ago. The gap between world demand and productive capacity is closing. The global economy is growing at a respectable rate. In some of the economies hardest hit by the financial crisis, output is back to its pre-crisis level. The resurgence of demand has put concerns about deflation behind us. And international regulatory reform has proceeded speedily. The agreement on Basel III is a major step forward.
After four years, however, the financial crisis and the ensuing policy responses still cast long shadows. Global growth is uneven. As evidenced by the sovereign debt crises that have erupted, the threats posed by the unsustainable trajectories of public sector debt have materialised. With energy and commodity prices soaring, inflation has become a reality in many countries and a threat in others. In the crisis-hit countries, the repair of private sector balance sheets still has some way to go, and excess capacity still burdens the financial and construction sectors. Financial systems remain vulnerable. And looking outside the countries that were at the centre of the financial crisis, we also see several emerging market economies in which domestic asset prices and credit are surging - all too familiar signs of the build-up of financial vulnerabilities. And as these developments unfold, global monetary and financial conditions remain unusually accommodative.
These developments raise serious risks for the economic outlook and financial stability. And they all reflect the challenges left by the financial crisis. The boom phase of the financial cycle had raised output growth beyond sustainable rates while masking sectoral distortions and growing vulnerabilities. The resulting imbalances now need to be rectified, and as they are, growth is bound to be slow. Policymakers should not hinder this inevitable adjustment.
The overarching policy challenge is to build a solid foundation for robust, stable and sustainable growth. This requires urgent policy actions now - fiscal, monetary, structural and prudential - taking a long view to avoid larger costs in the future. All of these play a role in a new policy framework designed to ensure lasting monetary and financial stability.
Let me say a few words about each of these - both the actions and the framework.
First, the need for fiscal consolidation is even more urgent than it was a year ago. Pushed up by commitments to ageing populations, industrial countries' fiscal trajectories have been on an unsustainable path for some time. But the financial crisis, and the response to it, brought the fiscal reckoning forward. In countries that experienced asset price and credit booms, policymakers have come to recognise the significant hole left by the collapse in temporarily inflated revenues. While fiscal problems are most apparent in several euro area countries, other major economies also need to manage their situations carefully and make efforts to consolidate fiscal positions quickly, not least because they have a big impact on global financial conditions.
Second, there is a need to normalise monetary policy. Globally, real short-term interest rates, already negative, fell further over the past year. Normalising rates would reduce the incentives to take excessive risk and would support necessary structural and balance-sheet adjustments. It would help restrain the build-up of financial imbalances in the economies where growth is most vibrant and contribute to correcting current account imbalances. The more active use of macroprudential measures in emerging market economies is welcome, but it cannot substitute for monetary tightening. Normalising monetary policy can also complement the structural policies needed to move us away from the unsustainable combination of leverage-led and export-led growth.
Third, excess capacity in the financial and real estate sectors must be addressed. In the financial sector, tough stress tests, supported by recapitalisation measures, are essential. But they need to be complemented by policies that reduce excess capacity in the financial sector and lay the basis for sustainable profitability. Without a stronger and leaner financial system, it will be impossible to withdraw the extensive public support that is still in place.
Fourth, Basel III needs full and consistent implementation worldwide. Beyond that, we need higher standards and credible resolution mechanisms for systemically important financial institutions; we must monitor and reduce the risks posed by shadow banking systems; and the financial statistics we use must be improved.
The road ahead is likely to be bumpy. Making sure that banks are prepared for shocks requires building strength now. Instead of taking the maximum time to reach the minimum standards, there is a good case for going faster and going further. Perhaps this time we will see a virtuous race to the top.
The more enduring lessons of the crisis, however, are not just about policy actions, but also about policy frameworks. Building a solid foundation for monetary and financial stability requires fiscal policy that builds up the buffers required for crisis management; monetary policy that actively supports financial stability; and regulation and supervision that has a strong macroprudential orientation. This framework necessarily rejects short-termism in favour of a long-term view. And it builds on the principle that keeping one's house in order is essential but not enough: international policy cooperation is critical.