Milan, Italy — September 12, 2014

Good Afternoon! I am very pleased to speak before this distinguished group today. I would like to thank our Italian hosts for their gracious hospitality.

This meeting brings together policy makers from two diverse regions that face some common challenges and opportunities. Today I would like to briefly discuss the current state of the global recovery. Then I would like to address the challenges. In our view, downside risks have increased. These include geopolitical and financial market risks that Asia and Europe share. Policy responses will differ across regions, but there are some common themes. While Europe’s immediate priority must be to support demand, both regions share the challenge of strengthening growth potential through structural reform. Allow me to elaborate on these points in more detail.

The global recovery in 2014 remains uneven and is proving weaker than expected. Some of the reasons are temporary. For example, the U.S. experienced a surprisingly soft first quarter before activity picked up in the second quarter. However, there have also been downward surprises in the euro area, where activity stagnated due to persistent weakness in investment, and Japan, where output contracted more than expected following the VAT increase.

Alongside supportive central bank policies, financial conditions have continued to ease over the last few months. Sovereign bond yields have edged further down and equity prices have generally risen.

Looking ahead, although gradual improvements in the current medium-term growth outlook remain broadly in place, the downside risks increase the challenges for policymakers. These risks are evident at both the global and regional levels, and I will highlight some of them.

We are seeing geopolitical risks in Ukraine and the Middle East. The full impact of sanctions on Russia remains uncertain, while risks of oil price increases are higher. The Ebola epidemicin western Africa is also of concern to the entire world.

There is also a risk of rising longer-term interest rates in financial markets. This is especially true if U.S. rates increase abruptly as QE is wound down, and will depend on how the U.S. Fed communicates its policy stance. The timing of QE exit must strike a delicate balance between the risks of a premature withdrawal of stimulus and financial market volatility on the one hand, and asset price bubbles on the other.

As bank regulations are tightened across the globe, close monitoring is warranted of the growth of shadow banking activities in both advanced and emerging economies. This presents potential systemic risks.

Focusing on Europe, in the euro area there is a risk of stagnation in the medium-term. Adverse shocks—domestic or external—could lead to persistently lower inflation or even price declines. This is underscored by disappointing second quarter growth—including in core economies—high unemployment, and the recent decline of inflation and inflationary expectations. Similarly, the recovery in much of Emerging Europe has already slowed, with weaker growth in Russia and Turkey. Some emerging economies may face a sudden worsening of financial conditions and a reversal of capital flows due to higher interest rates and shifting market sentiment.

While the impact of geopolitical tensions so far seems restricted to a few countries, a general tightening of financial conditions could further undermine confidence. A number of linkages with Russia—particularly energy supply and foreign direct investment—could transmit shocks to growth, trade and financial flows. The Baltics and other East European countries are most likely to be affected.

What does this mean for Europe’s economic policies?

For the euro area, supporting demand remains important. The ECB measures announced in June and this month are appropriate. They should significantly expand the ECB’s balance sheet and strengthen its forward guidance, helping to counteract the dangers of an extended period of low inflation. We also welcome the ECB’s willingness to do more.

The current broadly neutral fiscal stance is appropriate, but negative growth surprises should not trigger additional consolidation. Instead the pace and composition of fiscal adjustment should be tuned to support both the recovery and long-term growth. It should support growth potential and job creation.

Greater public investment could help to stimulate the economy in the short-term and raise long-term growth potential. This is especially relevant for countries with minimal debt sustainability concerns. Investment has been weak in the euro area even compared to past crisis episodes.

Another priority is balance sheet repair and completion of the banking union. Banks should continue to build capital and have plans to address further needs following the Comprehensive Assessment.

In emerging Europe, strengthening fiscal positions will help mitigate the negative effect of higher interest rates and create space to counter downturns. In the medium term, fiscal buffers would lower borrowing needs and risk premiums.

At the same time, addressing issues such as NPLs and debt overhangs would reduce bank funding costs and support credit growth.

Finally, structural reforms in Europe are crucial to a more durable recovery. In the euro area, this means freeing up labor, product and services markets; implementing the Services Directive; negotiating free trade agreements; and further integrating energy markets. In emerging Europe, improving the business environment, strengthening external competitiveness, and making labor markets more flexible would help boost potential growth and to cope with external shocks.

Turning to Asia, the region’s growth momentum also cooled in early 2014, but a second-half rebound is expected. The Q1 slowdown reflected slower exports to advanced economies, lower domestic demand in China following measures to rein in credit growth, and specific domestic factors in some cases (for example, Japan and Thailand).

Going forward, stronger economic activity in advanced economies should lift Asian exports. Healthy labor markets and favorable financial conditions should continue to support domestic demand. Asia will remain the world’s fastest-growing region.

The main downside risks for Asia stem from a sharp tightening of global liquidity and protracted weak global growth. As in Europe, a sudden tightening of global liquidity could lead to capital outflows, asset price volatility and higher interest rates. Some also face risks from prolonged weak growth in their own countries. In some Asian economies (including China), a sharp decline in house prices or housing-related activities poses a risk.

Inflation is forecast to remain generally low, stable, and close to government targets. Monetary policies across the region remain generally accommodative, although tightening has started in some cases (such as Malaysia and the Philippines).

Monetary normalization should also proceed over the forecasting horizon across most of Asia. Slack is negligible, and in some cases (for example, Malaysia) the output gap is positive, and inflation is expected to rise.

Fiscal policy will be typically neutral in 2014, with underlying balances broadly unchanged from 2013. Only Japan, Malaysia, and Australia are expected to undergo a noticeable fiscal tightening.

Similar to emerging Europe, fiscal policy should focus on gradually rebuilding buffers to better cope with future shocks and support sustained and inclusive growth. Fiscal consolidation is desirable across most of Asia, particularly where debt levels in relation to GDP are higher (Here, I would refer to Japan, India, and Malaysia).

Another common challenge is to continue structural reforms to reduce near-term vulnerabilities and bolster medium-term growth. Efforts to reduce vulnerabilities should include: financial, state-owned enterprise and local government reforms in China, and fiscal reforms in Japan. Reforms to bolster long-term growth should include: further product and labor market reforms in Japan, and measures to remove structural impediments to investment in India, ASEAN and frontier economies.

To conclude: the global recovery is weak and uneven. Asia and Europe share common risks from geopolitical tensions and possible financial market stresses, in addition to risks specific to each region and requiring a sustained policy response. Both regions also need to continue structural reforms, which remain key to achieving more sustainable growth.

Thank you for your attention.