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(photo credit: Sivan Farag)
The unprecedented drama in the financial world may be almost behind us, but uncertainty over what lies ahead is challenging a full recovery, according to global financial leaders.
"Today, we are less frightened about the crisis than a year ago, but still much uncertainty remains about what lies ahead," Bank of Israel Governor Stanley Fischer said Thursday at President Shimon Peres's Tomorrow Conference. "There are many open issues about how long the recession will last; the shape of long-term growth; the role the dollar will play; the role of the market, the state and the regulatory system; the shifting of the gravity system away from the West to Asia and emerging-market economies, and other reforms."
French Foreign Trade Minister Anne-Marie Idrac said uncertainty was a major global challenge for the future, as it was causing "confusion to know whether or not we are out of the crisis."
At a panel discussion entitled "The Global Economic Crisis," Baron David De Rothschild, executive chairman of the Rothschild Group, and Idrac both said as long as the unemployment situation did not improve, the crisis could not be declared to be over.
"Deflation was avoided by the intervention of governments and the implementation of vast state stimulus packages, creating huge deficits," Rothschild said. "Today, credit spreads have improved, the bond market has been revived, corporate earnings have stabilized and we are seeing a rally in stock markets over the past three months.
"However, this is only a partial reflection of recovery in the real economy. Unemployment is still a major world issue, and no one can talk of a final recover while people are still losing their jobs."
Deutsche Bundesbank President Axel Weber, who is also a member of the European Central Bank's interest-rate committee, said it was worrying that there is more optimism about the financial markets than the real economy.
"This is not the time for renewed exuberance," he said. "The financial crisis has shown that banks remain the primary link between the financial system and the real economy. Temporary backlashes are still likely to occur.
"Banks are still exhibiting weaknesses. Over the next two years we are going to see major losses on banks' balance sheets because of exposure to the domestic credit market, as some risks to corporate earnings are going to materialize over the next months."
Weber said better bank regulation was the most important building block in a stable financial system.
"Apart from better risk-management practices, higher capital ratios and economizing on liquidity, banking supervision needs to go one step further," he said. "Systematic risk needs to be identified and combated. Central banks as the core institutions will get more responsibility, and the more we can agree on global standards such as accounting standards, the more decisive it will be. Otherwise we will fail again, trapped by things that look the same but are not the same."
Rothschild said banks would have to follow new rules, show more transparency and accountability, meet higher levels of regulation and basically change their behavior.
"We still have a hard road ahead before we can say that the crisis is behind us," he said. "Governments are faced with huge deficits, which will have an impact on growth. To cope with the deficits created in countries which instituted huge stimulus packages, governments will have to raise taxes, cut public expenditure and boost savings."
Regarding monetary and fiscal exit strategies, the most pressing issue currently faced by central bankers, Weber said given the macroeconomic outlook, there was no need to rush to exit expansionary monetary-policy measures. At its October 8 meeting, the ECB decided to leave its key interest rate unchanged at the record-low of 1 percent.
"Maintaining price stability has always been, and will continue to be, the primary objective of monetary policy in the euro-system," he said. "Hence, the monetary-policy stance is determined by risks to price stability, which are fortunately currently not present at the policy-relevant time horizon.
"However, to stabilize expectations and to safeguard public confidence, it is essential to develop a credible exit framework now. The challenge in terms of communications will be to make clear the difference between developing and implementing an exit framework."
Given the enormous rise in public deficits and the strain this will put on future budgets, Weber said a fiscal exit strategy would have to kick in as soon as the recovery has firmed up, which means no later than 2011.