This shortcoming has clearly contributed to the situation we face today. Unwinding its consequences is the key challenges the euro area faces. So let me now discuss how we can address that challenge. Fixing EMU for the long-term Unwinding the euro area’s imbalances What is the way out of this situation for the euro area? First and foremost, the imbalances that accumulated in certain euro area countries have to be remedied by those countries themselves. Under present rules, other member states can only provide some interim financial assistance and have indeed done so via the EFSF/ESM. The indispensable national consolidation effort by the more indebted countries is the implication of a system where fiscal, economic and financial policies are basically decentralised. But despite a difficult start, a significant rebalancing is now happening within the euro area. Across the euro area, strong budgetary consolidation is taking place. The IMF forecasts that the euro area’s primary budgetary position will be almost in balance this year. This is quite an achievement in an international context: Japan, for example, will have a 9% of GDP primary deficit this year, the U.S. 6.5% and U.K. more than 5%. And the euro area is not only performing well on average: each individual member country will have this year a primary budget deficit lower than those three countries. 4  BIS central bankers’ speeches  Important improvements are also taking place in competitiveness. Member States have now started to undertake structural reforms to facilitate intra-euro area adjustment.
Some countries therefore ran persistent deficits in good times or maintained high levels of debt. But the greater imbalances in fact emerged in the private sector. Looking at the data for EMU’s first decade, imbalances in the private sector far exceeded those in the public sector. 5  Tobias Adrian, Paolo Colla and H. Song Shin (2012), “Which financial frictions? Parsing the evidence from the Financial Crisis of 2007–2009”, Federal Reserve of New York Staff Reports. 6  Schoenmaker, D. (2011): “The Financial Trilemma”, in Economics Letters, 111 pages 57–59. BIS central bankers’ speeches  3  Between 1999 and 2007, the ratio of public debt to GDP in EMU declined on average by 5.6 percentage points. But in the same period, the ratio of private sector debt to GDP increased by 26.8 percentage points. For the same period, in the stressed countries, the cumulative increase in the private debt ratio to GDP versus the public debt one, amounted respectively, to 49 and 24 per cent for Portugal, 75 and minus 35 per cent for Spain, 101 and minus 10 per cent for Ireland, 217 and 4 per cent for Greece. Private debt levels were able to increase so significantly because the integration of national markets allowed for higher borrowing from abroad and increased leverage. For instance, from 2001 to 2006 MFI holdings of cross-border securities issued by non-MFIs increased by almost 44%. And as we now know, these flows were not perfectly optimised by rational private agents.