Gaston Reinesch: How to achieve stronger growth in the EU?
Opening remarks by Mr Gaston Reinesch, Governor of the Central Bank of Luxembourg, at
the Eurofi Financial Forum 2015, Luxembourg, 9 September 2015.
* * *
Ladies and gentlemen,
Distinguished guests,
At the outset, I would like to thank Eurofi and its President Jacques de Larosière for inviting
me to make the opening remarks to this afternoon's debates on "How to achieve stronger
growth in the European Union", a highly topical subject, to say the least.
I will focus on the euro area and structure my remarks in two parts.
First, I will touch upon the economic outlook in the euro area. I will do so in light of the European
Central Bank's (ECB) staff euro-area macroeconomic projections, which have been published
last week, referred to hereafter as the "staff projections".
Second, I will proceed with a broad overview of the issues and challenges of longer term
growth in the euro-area and put forward some avenues for reflection and discussion.
The information available from the staff projections indicate a continued though somewhat
weaker economic recovery and a slower increase in inflation rates compared with previous
expectations. As far as inflation is concerned, the staff projections foresee an annual
Harmonized Index of Consumer Price Inflation (HICP) of 0.1% in 2015, 1.1% in 2016 and 1.7%
in 2017.1 In comparison with the June projections,2 the outlook for inflation has been revised
down, largely owing to lower oil prices and, to a much lesser extent, a slower closing of the
negative output gap. Furthermore, taking account of the most recent developments in oil prices
and recent exchange rates, there are downside risks to the September staff inflation
projections.
Concerning the economic situation, recovery is expected to continue, albeit at a somewhat
weaker pace than earlier expected, reflecting in particular the slowdown in emerging market
economies, which is weighting on global growth and foreign demand for euro area exports.
Domestic demand should be further supported by the monetary policy measures of the ECB
and their favorable impact on financial conditions as well as by the progress made in fiscal
consolidation. Moreover, the decline in oil prices should provide support for household real
disposable income and corporate profitability and, thereby, enhance private consumption and
investment.
Overall, this assessment is broadly reflected in the staff projections which foresee an annual
real GDP growth of 1.4% in 2015, 1.7% in 2016 and 1.8% in 2017. Again compared with the
projections in June, the outlook for real GDP growth has been revised downwards. This is due
primarily to lower external demand owing to weaker growth in the emerging markets. The risks
to this outlook are tilted to the downside, reflecting in particular the increased uncertainties
related to the external environment. Notably, current developments in emerging market
economies have the potential to further affect global growth adversely via trade and confidence
effects.
Before addressing the second part of my remarks, let me revert to the evolution of the output
gap, i.e. the difference between actual and potential output. The negative output gap is
expected to narrow gradually over the projection horizon, which is encouraging news.
However, it is also necessary to stress that while the output gap is narrowing, it is occurring
against a background of weak potential output growth, which is estimated to be around 1%
over the projection horizon.
This is below its pre-crisis level. In noting this, we should, moreover, not overlook the fact that
since the late 1990s the euro area experienced a steady decline of potential output growth:
from about 2% in 2000, it declined continuously to about 1.5% before the crisis. There is indeed
a problem in long-term growth dynamics. This problem is not new but has deepened over time.
With this in mind, let us consider very briefly fiscal and monetary policy before focusing later
on structural reforms. Starting with fiscal policy, it should support the economic recovery,
particularly through growth-enhancing public investment, material and immaterial, while
remaining fully compliant with the Stability and Growth Pact. A full and consistent
implementation of the Pact is crucial to maintain confidence in the euro area's framework. This,
in turn, would have positive implications for future growth prospects, which should help ensure
debt sustainability and be conductive to future fiscal space.
With regard to monetary policy, which has to be focused on the primary objective of maintaining
price stability over the medium term, its highly accommodative stance has contributed and
continues to contribute to support economic activity and investment, narrow the negative
output gap and foster economic growth. Let us also bear in mind the important fact that price
stability, as well as financial stability, is a conditio sine qua non for a stable and growing
economy. The monetary policy stance currently provides a window of opportunity to implement
reforms.
This brings me to the third crucial policy area, which can and should contribute decisively to
future growth, namely structural reforms. There exists a large consensus that structural
reforms are needed to boost potential output and productivity growth in the euro area and to
reduce unemployment which is much too high, especially, but not only, among the youth.
Incidentally, let me say that I prefer speaking more generally of increased productivity rather
than increased competitiveness, the latter being a more elusive and relative concept. The world
as a whole can become more productive, but it cannot gain in competitiveness. Structural
reforms, notably in product and labour markets, but also through actions improving the
business environment, can have two key effects and here I refer to ECB President Draghi's
speech this year at the ECB Forum on Central Banking, which took place in Sintra earlier this
year.3
First, they lift the path of potential output, either by raising the inputs to production - the supply
and quality of labor and the amount of capital per worker - and by ensuring that those inputs
are used more efficiently, that is to say by raising total factor productivity. Second, they make
economies more resilient to economic shocks by facilitating price and wage adjustments as
well as a swift reallocation of resources within and across sectors. These two effects are
complementary. An economy that rebounds faster after a negative shock is an economy that
grows more over time and it suffers lower hysteresis effects. And the same structural reforms
will often increase both short-term flexibility and long-term growth. A comprehensive and
credible package of structural reforms will therefore help increase resilience and growth and
reduce unemployment.
Structural reforms are often considered with a critical eye, if not fiercely opposed. Three
considerations are mainly mentioned in this context: the "ugly" argument, which has to be
resisted; the "bad" argument, which calls for careful refutation; and the "well meant" argument,
which raises an issue that needs to be addressed.
The ugly argument can be considered as a problem of collective action and rent-seeking.
Structural reforms touch vested interests.
The benefits of such reforms are large, but spread among the whole economy and are partly
backloaded. Disadvantages, albeit globally low, are concentrated in relatively small groups,
who are highly motivated to oppose them. This kind of opposition should be resisted and these
arguments discarded.
The bad argument has some intellectual merits. It states that in a situation of significant
economic shock, structural reforms may have a negative effect on short-term demand. Such a
conclusion, implying that structural reforms should be postponed - and here again I refer to
President Draghi's speech4 - has nevertheless to be rejected. The reason for such a rejection
is that the short-term impact of structural reforms does not simply depend on when they are
implemented but how, the credibility of reforms and their interactions with other policy
measures. And if structural reforms are well designed along such parameters, they can in fact
have a largely neutral, if not positive, impact on short-term demand even in adverse cyclical
conditions.5
Then, there is a line of argumentation stemming from the more general concern of increasing
inequality in our economies. In the context of structural reforms, this issue has to be taken
seriously. European citizens are sensitive to the problem of increased inequality. Or,
successful reforms require the acceptance of citizens and their conviction that such reforms
will eventually increase per capita income without adverse inequality effects.
Structural reforms have therefore to be designed in such a way as to avoid increased inequality
and, if needed, accompanied by budgetary redistributive measures. For example, and this is
also relevant in the more general context of growth, it seems that there is scope in a lot of
countries for tax reforms, which could be both efficiency and equality enhancing, whilst being
revenue neutral.
All this being said, structural reforms in the euro area are necessary and should be seen
beyond the confines of national economies. This is important in order to enhance all possible
mutually reinforcing effects and positive spillovers. Further, it would also be helpful to
strengthen coordination, minimize national discretion and think of the euro area as being one
economy and not the simple addition of 19 economies. The implementation of measures
should be enforced and national parliaments should be involved to ensure democratic
accountability and local ownership.
So far, I used the term "structural reforms". However, the term "structural policies" might be a
more appropriate and all-encompassing terminology. In that sense, let me very broadly
mention how other policy areas or initiatives can through different channels contribute to
enhance medium and long-term growth: first, innovation; second, the transition to a low carbon
economy; third, the completion of the Financial Union; and fourth, institutional reforms in the
governance of the economic pillar of the Economic and Monetary Union.
Technological progress, product and process innovations are key drivers to long-term growth
as recalled by Professor Christopher Pissarides in his presentation at the Sintra ECB Forum
on Central Banking,6 who stated that Europe as a whole was not doing very well in this field,
although there were exceptions.
This points to the need to improve the ecosystem of innovation throughout the different stages,
from basic research to successful market applications. There is still a too broad and deep
Death Valley along this process.
Second, the transition to a low carbon and more resilient economy represents another key
challenge in this respect. This is a global problem. Europe is, however, a key player in this
field, as the forthcoming United Nations climate change conference in Paris demonstrates.
Climate preservation is not only a necessity but also, as continuously stressed for example by
Nicholas Stern,7 an opportunity for the enhancement of the co-evolution of growth and
structural change.
Third, the Financial Union has also a strong potential to support future growth. The Banking
Union has to be completed and the Capital Markets Union has to be launched successfully.
You will discuss that in detail over the next days.
Allow me only to touch on one specific element, which by the way was considered important
enough by "The Economist" for a cover story some months ago, with the title "The Great
Distortion - A Dangerous Flaw at the Heart of the World Economy",8 namely the difference in
taxation between debt and equity. This point has also briefly been touched upon in the
comprehensive Eurosystem contribution to the Commission's Green Paper on Building a
Capital Markets Union.
Let me quote part of the relevant paragraph:
"Initiatives in taxation should aim to reduce the preferential treatment of debt financing as
opposed to equity financing...
This can facilitate a greater reliance by firms on equity and have a positive impact on their
access to other forms of finance. It could also be important to rebalance the financial structure
of firms, especially in those countries where the level of indebtedness in the non-financial
corporation sector is still significant."9
Fourth, and last but not least, there is also a case to contemplate institutional innovation and
governance change in the Economic pillar of the Economic and Monetary Union.
Let me on this point quote Mario Draghi's response during last week's monetary policy press
conference to a question by a journalist.
"If I look at the ECB - now, of course I am a biased observer here - you would judge that the
integration of monetary policy has been pretty successful. Why that? Because we moved from
a rules-based system that we had in the 1980s and 1990s to an institution-based system where
you have co-decision.
Co-decision in our sense, not co-decision in the way it's been used in Brussels between
Parliament and different institutions. So it's a sharing of responsibility and a sharing of
sovereignty, within the same institution. And what I have been arguing is that the same path
ought to be adopted in other areas, one of which is the budgetary area, where we now
coordinate our actions based on a set of rules, one of which is the Stability and Growth Pact.
Another one is the six-pack and so on. Now, we think, and I certainly think, that this system is
not completely satisfactory, for a variety of reasons that you've seen in the last few years, and
so it would be a good thing if we were to move to a common institution also in the budgetary
area. And this is a point that's been made in the Five Presidents' report so it's not only my own
view."10
Ladies and Gentlemen,
I hope that some of these inevitably piecemeal and largely incomplete remarks offer some food
for discussion for the upcoming debates.
Thank you very much for your attention.