Drastic conventional and non-conventional measures and a long-term strategy are needed to normalize the world financial system, European Central Bank Governing Council member Athanasios Orphanides said on Tuesday.
“Drafting a long-term strategy to normalize the world financial system is of great importance,” Orphanides, who also heads the central bank of Cyprus, told a news conference presenting the bank’s 2008 report.
“The financial crisis which peaked during September-October 2008, leading to the biggest recession of the past 60 years, was the result of an underestimation of investment risks... and the lack of a powerful and effective supervisory framework.”
The ECB seems certain to cut its main policy rate by 25 basis points to a record low 1.0% on Thursday, but there is uncertainty over further, non-standard steps that it may announce.
Such steps could include the ECB “printing money” by expanding its balance sheet through purchases of bonds or other assets. This would mean the ECB joining other central banks such as the US Federal Reserve in a policy of quantitative easing.
“(The) vicious cycle is not easy to overcome without drastic conventional and non-conventional measures (which) several governments and central banks have adopted and continue to adopt,” Orphanides said.
“Along with interest rate cuts and the non-conventional measures taken by central banks, there are also fiscal stimulus measures by governments. In the euro zone this is easier to implement by countries where fiscal consolidation has taken place so that there is room for fiscal expansion,” he said.
“These decisions must be taken within a well thought-out framework. Measures to confront the crisis must be temporary and well-targeted so that countries’ long term fiscal balance is not put at risk,” the central banker said.
The 16-nation euro zone economy is not expected to recover until the second half of next year, the European Commission projected on Monday as it lowered previous GDP forecasts, reflecting the depth of the recession.
Despite positive signs, the Commission expects the euro zone economy to shrink by 4.0% this year with the overall fiscal shortfall tripling by 2010.
Orphanides said the ECB’s six rate cuts since October 2008, totaling 300 basis points, coupled with liquidity injections in the interbank market, had helped to subdue financial market turmoil and keep long term inflation expectations stable. (Reuters)