Peter Praet: Beyond monetary policy - on the importance of a proper
alignment of economic policies in EMU
Speech by Mr Peter Praet, Member of the Executive Board of the European Central Bank, at
the conference "Beyond Monetary Policy", organised by the US-Korea Institute at SAIS and
Reinventing Bretton Woods Committee, Contribution to the Panel on Realignment of Economic
Policy: Beyond Monetary Policy, Washington DC, 7 October 2016.
* * *
I would like to thank Christophe Kamps for his contributions to this speech.
In my speech on monetary transmission in the euro area at the SUERF conference in New
York yesterday, I stressed the constraints and challenges that central banks had to confront
while operating for many years near the effective lower bound on interest rates. The challenges
monetary policy had to confront in the euro area were in particular born of weaknesses in the
institutional framework of our monetary union.
In my contribution today, I would like to address the topic from this particular perspective, and,
starting with monetary policy, go beyond monetary policy by setting out the policy requirements
for the smooth functioning of EMU.
First, I want to explain how ECB monetary policy has maintained price stability over recent
years in the face of a series of adverse shocks, and despite an incomplete institutional
environment.
Second, it is clear that monetary policy cannot be the only game in town for too long a period.
I will thus stress the need for other policy areas to contribute to supporting the recovery and to
fostering long-term growth.
Third, I will argue that we need determined progress towards deepening the institutional
foundations of EMU if we want the euro area and its Member States to become more resilient
to adverse shocks in the future.
I will conclude that 'secular stagnation' - one of the issues for discussion proposed by the
organisers - is not Europe's destiny if we make sufficient progress along these dimensions.
The ECB's response to disinflationary pressures
Like the central banks of other advanced economies the ECB has since 2008 operated in an
environment characterised by a sequence of adverse shocks exerting strong disinflationary
pressures. And the ECB, like other central banks, has responded to these shocks with forceful
and unprecedented monetary policy measures. These measures everywhere were taken with
the objective to ensure price stability.
What is special about the euro area is that to reach this objective the ECB at times had to take
complementary measures to ensure the singleness of monetary policy. As you will recall the
period 2011-12 was characterised by extreme financial fragmentation along national borders,
putting at risk not only monetary policy transmission and price stability but the very existence
of EMU.
The ECB stepped in forcefully in the summer of 2012 with the Outright Monetary Transactions
(OMT) programme, which proved highly effective in addressing tail risk, thus restoring market
functioning and confidence in the integrity of the euro area.1
Around the same time, euro area Leaders recognised that the institutional foundations of EMU
were too fragile and called on the Presidents of major European Institutions to develop a
specific and time-bound roadmap towards deepening EMU.2
I will return to this later.
By summer 2014, the ECB was confronting further risks to price stability linked to a too
prolonged period of low inflation. Our ability to provide additional accommodation through
standard measures was however constrained as policy interest rates approached zero. We
have therefore gradually deployed three new, non-standard measures to secure medium-term
price stability: a series of targeted long-term refinancing operations, a negative deposit facility
rate, and an asset purchase programme including private and public securities.3
These measures have led to a very significant easing of financing conditions across the euro
area, thereby providing considerably support to the recovery. ECB staff estimates suggest that
in the absence of our policy package inflation would have been negative in 2015. We also
estimate that our measures will raise the inflation rate by more than half a percentage point,
on average, over 2016 and 2017. They will contribute to increasing real GDP growth by more
than one and a half percentage points cumulatively between 2015 and 2018, which will support
job creation.4
At present, the Governing Council of the ECB is very closely monitoring economic and financial
market developments. While so far the recovery of the euro area economy has appeared
resilient to the continuing global and political uncertainty, there are downside risks. Against this
background, we will preserve the very substantial amount of monetary support that is
necessary to secure a return of inflation to levels below, but close to 2% over the medium term.
And if needed, we will not hesitate to act by using all the instruments available within our
mandate.
The need for decisive action at national level
To reap the full benefits of our monetary policy measures, national economic and fiscal policies
must contribute much more decisively.
Of particular importance are determined structural reforms to increase potential output and the
resilience of the economy to shocks. At the beginning of the millennium Blanchard and Wolfers
convincingly showed that the rise of unemployment in Europe since the 1960s could be
explained by the interaction of adverse economic shocks with insufficiently flexible labour
market institutions.5
Transactions, one year on", speech at the conference "The ECB and its OMT programme organised by the
CEPR, the DIW and KfW, Berlin, 2 September 2013.
2
At the June 2012 European Council meeting the President of the European Council, in cooperation with the
Presidents of the Commission, Eurogroup and ECB, presented a first report entitled "Towards a Genuine
Economic and Monetary Union". Since then the Presidents have presented two follow-up reports, respectively
submitted to the European Council meetings in December 2012 (again entitled "Towards a Genuine Economic
and Monetary Union") and in June 2015 (entitled "Completing Europe's Economic and Monetary Union"), the
latter with the additional cooperation of the President of the European Parliament.
3
For details on the ECB's monetary policy measures and their transmission see Praet, P. (2016), "The ECB's
monetary policy response to disinflationary pressures", speech at the ECB and its Watchers XVII conference,
Frankfurt am Main, 7 April 2016.
4
See Draghi, M. (2016), "Working together for growth in Europe", introductory remarks at Deutscher Bundestag,
Berlin, 28 September 2016.
5
See O.J. Blanchard and J. Wolfers (2000), "The role of shocks and institutions in the rise of European
unemployment: the aggregate evidence", The Economic Journal 110 (March), C1-C33.
If anything, the crisis has corroborated this finding. Now, it is sometimes argued that structural
reforms should not be undertaken in a context of weak demand. Yet, the short-term effects of
structural reforms depend a lot on the credibility and type of reform and their interaction with
other policy measures.6
If reforms are well-targeted there is no justification to postpone their implementation.
At the same time, fiscal policies can and should contribute to the recovery. It is, of course, true
that fiscal space varies widely across individual euro area countries. Those countries with fiscal
space should use it to increase public spending in areas conducive to long-term growth, such
as public infrastructure, education and research and development. Countries without fiscal
space should not bend the commonly agreed rules, which by the way provide sufficient
flexibility to address the short-term costs of structural reforms. Regardless of fiscal space there
is ample room in all euro area countries to refocus public spending on productivity-enhancing
items.
All what I just said, of course, applies much more broadly than just to the euro area context. It
is very much in line with the three-pronged approach advocated by the IMF in the context of
its Global Policy Agenda.7
The need for decisive action at European level
However, beyond the three-pronged approach, it will be necessary to fortify the institutional
foundations of EMU. For the resilience of the euro area depends not only on structural reforms
at the national level but also on effective risk-sharing mechanisms preventing the resurgence
of financial fragmentation that plagued the euro area in the 2011-12 period.
The priority should be on strengthening the potential for private-sector risk sharing. Two key
initiatives in this respect are the Banking Union and the Capital Markets Union. The Banking
Union holds the promise to break the sovereign-bank nexus. The creation of the Single
Supervisory Mechanism and the Single Resolution Mechanism are important steps in this
direction. Further steps are under discussion, such as the creation of a fiscal backstop for the
Single Resolution Fund and a European Deposit Insurance Scheme. These additional
arrangements are inspired by similar institutions in the United States.
The 5 Presidents' Report of June 2015 also calls for further integration in the fields of economic
union and fiscal union, with a view to increasing the resilience and shock-absorbing capacity
of the euro and its member states. The rationale for economic union is to foster real
convergence among euro area member states, while the rationale for fiscal union is to provide
insurance against shocks that may overwhelm national budgets or overburden monetary
policy. Going into this direction will require member states' willingness to make a leap forward
in sharing sovereignty similar in scope to the one made when the Maastricht Treaty was
signed.
Conclusion
Let me conclude.
The ECB has taken determined and unprecedented action to maintain price stability and to
prevent the euro area from settling into a bad equilibrium. For the euro area and its member
states to thrive it is important that member states individually and collectively contribute
decisively to strengthening the recovery and the resilience of the euro area economy. I am
convinced that if - as prescribed by the Treaty - "member states regard their economic policies
as a matter of common concern", they can take action conducive to increasing the euro area's
long-term growth potential and resilience to adverse shocks. In this sense Member States
collectively control the destiny of the euro area and through well-aligned policies can make
sure that "secular stagnation" will not take hold in the euro area.