Peter Praet: The euro area economy, monetary policy and structural
reforms
Remarks by Mr Peter Praet, Member of the Executive Board of the European Central Bank,
at the European Treasurers Club, Brussels, 26 October 2016.
* * *
Today I will give you an assessment of the euro area economy and share some thoughts on
where I see us heading and on what is needed to ensure long-run sustainable growth.1
I would like to thank Danielle Kedan for her contributions to this speech.
Starting with the positive news, we have good indications that the euro area economy is
heading for a continued moderate, but steady recovery, which seems to have become
resilient to global economic and political uncertainty. Real GDP growth has expanded for the
13th consecutive quarter, growing by 0.3%, quarter-on-quarter, during the second quarter.
The latest incoming economic indicators point to similar growth rates for the coming quarters.
While it is true that the uncertainty following the UK vote will significantly weaken the outlook
for foreign demand and thereby dampen export growth, robust domestic demand should
partly counteract the negative impact on growth stemming from the external environment.
Solid domestic demand is anticipated to remain the driving force behind real GDP growth.
Consumption expenditure is expected to grow strongly this year and to remain buoyant
thereafter. Most notably, consumption is boosted by improving labour market conditions, with
unemployment falling steadily despite a rise in participation. Moreover, euro area consumers
are still benefitting from higher real disposable incomes, reflecting past declines in oil prices.
Business investment is also expected to continue recovering amid support from a number of
factors, such as improvements in corporate profitability and a need to modernise the capital
stock after years of low investment and physical depreciation.
All these developments, of course, are gaining significant support from the effective
passthrough of our accommodative monetary policy measures. Taken together, our measures
have led to a significant and broad-based easing in financing conditions through both price
and quantity channels, which bolters consumption and investment expenditure.
In terms of financing costs, since the beginning of June 2014, bank lending rates for euro
area households and NFCs have fallen sharply, with even more pronounced declines for
small and medium-sized enterprises (SMEs).2
For additional information on the effectiveness of the ECB's non-standard monetary policy
measures, see ECB, "The transmission of the ECB's recent non-standard monetary policy
measures", Article, Economic Bulletin, Issue 7/2015.
Corporate bond yields have fallen significantly, too, amid support from the Corporate Sector
Purchase Programme (CSPP), which began in June of this year. The new series of targeted
longer-term refinancing operations (TLTRO-II) are also providing additional stimulus by
allowing banks to secure long-term funding under very attractive conditions.
In terms of quantities, bank lending to the private sector has been gradually recovering since
early 2014. In the latest bank lending survey, released last week, banks continued to report
that the ECB's Asset Purchase Programme (APP) and the negative deposit facility rate had
contributed to more favourable terms and conditions on loans, and are supporting lending
volumes.3
ECB Bank Lending Survey, October 2016.
Meanwhile, other survey data indicate improvements in the availability of external sources of
4
financing for SMEs.
]ECB Survey on the Access to Finance of Enterprises in the euro area, October 2015 to
March 2016.
Corporate bond issuance has also picked up since the announcement of the CSPP in March,
while the TLTRO-II should help to further support bank lending volumes to the non-financial
private sector.
So our policy measures are clearly effective and are trickling down to the funding rates that
matter most for the real economy, such as the ones faced by SMEs, which provide jobs for
around two-thirds of those in employment in the euro area.5
See ECB, "Small and Medium-sized enterprises in the euro area: economic importance and
financing conditions", Box 6, ECB Monthly Bulletin, July 2013.
Favourable financing conditions, along with other factors such as employment gains and
improvements in the demand outlook, are expected to further support private consumption
and investment expenditure going forward. Investment however remains well below its
precrisis levels and its sensitivity to the borrowing conditions faced by companies is lower than
historical norms. According to the September ECB staff macroeconomic projections, annual
real GDP growth is expected to increase by 1.7% this year, and by 1.6% in each of the next
two years.
Turning to price developments, headline inflation increased in September to 0.4% in
year-onyear terms, owing mainly to a continued increase in annual energy inflation. So although
price dynamics are improving, inflation remains at low levels - far below the level which we
consider consistent with our price stability objective - reflecting past declines in oil prices and
weak wage growth. Underlying inflation in particular has yet to show clear signs of a more
dynamic upward movement. The annual rate of HICP inflation excluding food and energy has
continued to hover around 1% as domestic cost pressures remain fundamentally weak. Yet,
as the effect of past oil price declines fades, annual HICP inflation is expected to pick up
from 0.2% this year to 1.2% in 2017. Moreover, we expect that as the recovery continues
and economic slack falls, inflation will gradually accelerate further to 1.6% in 2018.
Although the euro area recovery is showing signs of resilience, material downside risks
remain, mainly stemming from the external environment and significant uncertainties
following the outcome of the UK referendum. Moreover, our baseline scenario for growth and
inflation in the euro area remains crucially dependent on the current supportive financing
conditions staying in place.
Therefore, we will ensure that monetary policy continues to play its role in facilitating the
cyclical recovery. By ensuring accommodative financing conditions that buoy demand,
monetary policy is helping to raise output back to its potential level. As reiterated after last
week's Governing Council meeting, we remain committed to preserving the very substantial
amount of monetary accommodation which is necessary to secure a sustained convergence
of inflation towards levels below, but close to, 2% over the medium term. To this end, the
Governing Council's assessment in December will benefit from the new staff macroeconomic
projections and the work of the Eurosystem committees on options to ensure a smooth
implementation of our purchase programme until March 2017, or beyond, if needed.
Nevertheless, potential growth in the euro area is low after years of decline, while structural
unemployment remains high. The European Commission estimates that the potential growth
rate of the euro area economy this year is just 1%, less than half that of the United States.6
European Commission, European Economic Forecast, Spring 2016.
Low potential growth casts a shadow over the long-run economic prospects for the euro
area, creating a negative feedback loop. Because low potential growth dampens
expectations of future income, it curbs consumption and investment today, which further
lowers rates of potential growth tomorrow. This can lead to a permanent destruction of
productive capacity, including jobs.7
For further discussion, see Praet, P., "Lifting potential growth in the euro area", Speech at the
Welt-Währungskonferenz, 23 April 2015.
It is therefore imperative that decisive action is taken now in order to propel the on-going
cyclical recovery into a structural recovery. Long-run growth depends on the efficiency with
which resources are allocated, the ease of doing business, the incentives for investment and
confidence in public institutions. Making strides in these areas requires structural reforms
aimed at supporting investment, enhancing productivity and increasing flexibility in the
markets for labour, goods and services. Structural reforms will go a long way, not only in
bolstering the trend of long-run growth but also in reducing the fluctuations around that
trend.8
For further details, see Praet, P. "Structural reforms and long-run growth in the euro area",
Intervention on panel at 43rd Economics Conference of Oesterreichische Nationalbank, 15
June 2015.
Such reforms are the means of addressing the ongoing adjustment difficulties faced by the
economy and of preventing secular stagnation - which is not inevitable. However, such
reforms are outside of the scope of monetary policy and fall under the remit of other national
and European policymakers.
As the benefits of structural reforms can take time to materialise, they must be implemented
without undue delay and are needed in order to reap the full benefits from our monetary
policy measures. The highly accommodative stance of monetary policy creates ideal
conditions for the implementation of structural policies, as it can help to cushion the potential
short-term adjustment costs of such policies by supporting current demand conditions.
To conclude, the euro area economic recovery remains resilient despite the continued
headwinds stemming from global economic and political uncertainties. Nevertheless, in order
to transform the cyclical recovery into a structural one, and thereby ensure resilience of
growth in the long-run, other policymakers must play their part. The support to demand from
monetary policy must be complemented with supply policies that bolster the potential growth,
productivity and flexibility of the euro area economy.