Trichet warns against stoking future crisis

ECB chief stresses need to correct structural problems / Sliding exports push Japan to worst downturn in 35 years

The president of the European Central Bank warned yesterday that short-term measures aimed at solving the economic and financial turmoil could sow the seeds of a future crisis.

Jean-Claude Trichet told the European Parliament that there would be no solution to the financial and economic crisis until the structural problems in the world economy were corrected.

M. Trichet said the world remained out of balance in terms of the financial system, macroeconomic factors, and governance of the financial sector.

"The present crisis does not just offer us an opportunity to rebalance, it provides an obligation to rebalance these three intertwined domains of the global economy," M. Trichet said. "And yet we also need to make sure that our decisions today do not lay the ground for similar disorder in the future."

Governments around the world, including the US and the UK, are unleashing massive stimulus injections into their economies to bolster growth and unfreeze lending markets.

But the ECB head warned that though policy makers must take measures to ease the short-term crisis they also had to ensure that a recovery would be sustainable.

"First, credible exit strategies must be planned and promptly implemented once macroeconomic measures have had their desired effects; and second, policies must aim not only to stimulate domestic demand over the short run but also to foster longer-term structural adjustments," M. Trichet said.

The ECB has been less aggressive than the Bank of England and the US Federal Reserve in cutting interest rates to deal with the crisis, even though the eurozone faces a deepening recession. Some critics have argued that rate cuts, along with other stimulus measures, risk stoking future inflation.

"As regards monetary policy, our guiding principle has been and continues to be to ensure price stability in the euro area in the medium term," he said.

M. Trichet's cautionary words on the uses of monetary policy came as the Bank of England's deputy governor for monetary policy defended the option of using "quantitative easing", in a move seen as paving the way for in effect printing money.

Charles Bean said in a speech that asset purchases by the Bank to ease monetary policy are "likely to prove useful now that Bank Rate is nearing its floor". The measure would push down yields on assets, increase the supply of money and boost spending, he said.

Mr Bean defended the plan against critics: "It is true that some – often corrupt – governments have resorted to 'printing money' in order to finance their spending when taxes are hard to gather. But if the Monetary Policy Committee chooses to finance asset purchases through the issuance of central bank money, it will not be to finance the Government's budget deficit." Instead it will aim to increase the supply of money and credit to achieve the Bank's 2 per cent inflation target, he said.

Mr Bean said the rate cuts already made by the Bank would be a "powerful stimulus" once they had taken effect during this year, and stressed that it did not have to make more cuts for there to be a stimulus. He added that the rate cuts and measures to boost credit could see conditions start toimprove later this year.

Japan's government came under growing pressure to announce new stimulus measures yesterday, after sliding exports drove the country into its worst downturn for nearly 35 years.

The world's second-biggest economy contracted by 3.3 per cent in the last three months of 2008. The slowdown was worse than gloomy forecasts had predicted and amounted to an annualised fall of 12.7 per cent, the fastest since Japan's export-led economy was hit by the oil crisis in 1974.

The Japanese government is relying on a stimulus package that it announced last year, but the dramatically deepening recession led to calls for further urgent action to deal with the double pressure of falling exports and weak domestic demand.

In his speech, M. Trichet argued that international authorities needed to pay more attention to the links between macroeconomic and financial stability, with closer collaboration between global institutions such as the International Monetary Fund (IMF) and informal groups including the Financial Stability Forum.

Echoing remarks made last week by Lord Turner, the chairman of the Financial Services Authority, M. Trichet said the IMF needed to monitor major economies more closely instead of focusing just on developing countries. Lord Turner criticised the US for preventing the IMF from publishing reports on its financial system, which is at the heart of the crisis.

"The crisis provides the painful lesson that industrial economies also need surveillance – indeed rigorous surveillance," M. Trichet said.

He demanded more rigorous regulation of the financial system to stop banks from targeting short-term returns and to shine a light on risks to the system caused by insufficiently regulated markets, products and institutions.