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TORONTO (Reuters) - Bank of Canada Governor Mark Carney welcomed last week's European debt-crisis agreement but warned on Monday that a third of the euro zone should be ready to face substantially lower living standards to regain competitiveness.
Carney, also head of the G20's Financial Stability Board (FSB), said Europe's peripheral countries would have to restore competitiveness through fiscal and structural reforms, which he said are the responsibility of citizens, companies and governments but not of central banks.
"A sustained process of relative wage adjustment will be necessary, implying large declines in living standards for a period in up to one-third of the euro area," he said in the prepared text of a speech on deleveraging in advanced economies.
Carney's stark message followed an historic agreement on Friday by 26 EU member states - all of them except Britain - that they would pursue deeper fiscal integration as part of efforts to overcome the debt crisis.
In a meeting billed by some as a last chance to save the euro, the leaders also agreed to cap their permanent bailout fund at 500 billion euros and to provide up to 200 billion euros in bilateral loans to the International Monetary Fund (IMF) to help it combat the crisis.
Carney reserved his applause, however, saying much remains to be done.
"The challenge is deploying those means as effectively and efficiently as possible," he said. "We're encouraged by the potential for a more active role of the IMF that was signaled in last week's decisions, but we have to see the implementation."
Markets were likewise skeptical about the long-term plan's ability to quell the two-year-old debt crisis. Global stocks and the euro slid on Monday.
Carney's speech focused on the implications of the global shift toward debt reduction, saying it meant the world was entering a prolonged period of deficient demand.
"If mishandled, it could lead to debt deflation and disorderly defaults, potentially triggering large transfers of wealth and social unrest."
Austerity measures alone are not enough, he said. Some debt restructuring may happen, but the best option is boosting economic growth through painful reforms to boost competitiveness.
For Canada, the biggest challenge is "reducing our economy's reliance on debt-fueled household expenditures," Carney said, noting that Canadian households are now more indebted than American and British households.
Canadian governments cannot be expected on a sustained basis to pick up the slack from less consumer spending, leaving action by the well-funded corporate sector as the only sustainable option available, he said.
Canadian companies have the means and incentives to act, and should invest to improve productivity and increase their exposure to fast-growing emerging markets. They should recognize that commodity prices are likely to stay high for some time, and that they can benefit from Canada's resilient financial system.
In his role as FSB chairman, Carney warned that delaying tough reforms on global banks was not the answer to the current economic problems, which he characterized as a paucity of credit demand rather than a scarcity of supply.
"Relaxing prudential regulations would run the risk of maintaining dangerously high leverage - the situation that got us into this mess in the first place," he said.
Reporting Jennifer Kwan and Jon Cook in Toronto, and Louise Egan and Randall Palmer in Ottawa; Editing by Peter Galloway