Vítor Constâncio: Challenges for global economic growth
Remarks by Mr Vítor Constâncio, Vice-President of the European Central Bank, at the
71st Plenary Meeting of the Group of Thirty, Versailles, 30 May 2014.
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Thank you for the invitation to speak in this session.
Our subject this morning is the "challenges for global economic growth". But let me first focus
on the positive. Compared to this time last year, or indeed anytime since the financial crisis,
our starting point seems brighter. Notwithstanding the dip in growth in the first quarter of the
year, we see now evidence of greater traction in many advanced economies.
Progress, of course, varies across countries. Private sector deleveraging is moderating. The
drag from fiscal consolidation has lessened. Improving labour markets are bolstering
confidence and supporting demand.
But growth remains modest. In many countries, GDP levels are still below or barely above
pre-crisis peaks. Euro area GDP in 2013 was 1.7% below 2007 levels; US was 5.9% higher;
Japan was 0.4% higher; and in all countries growth rates are far short of pre-crisis trends.
The recovery path remains fragile and unemployment is too high, particularly in Europe.
Policy actions in the past two years have helped to curtail near-term risks. But risks to global
growth remain tilted to the downside. And new challenges and sources of risk have arisen.
There are now too many potential headwinds: a decline in potential growth of advanced
economies resulting, among other things, from negative demographic trends and lacklustre
investment; a new trend of lower growth of world trade possibly stemming from limits to
continue extending supply chains (the elasticity of trade to GDP used to be close to 2 and
has been flat at 1 since 2008); a retrenching of financial integration; a structural decrease of
emerging countries growth rates. In more immediate terms, the risks stem from the possible
reversal of risk assessment and consequently of compressed risk premia; secondly, risks
relate, in particular to emerging economies as they adjust to normalising monetary conditions
in the US and confront structural headwinds following a decade of stellar growth.
In my remarks I will touch on some of these general challenges for the global outlook, before
discussing specific issues for the euro area.
The global challenges
The spillover effects of monetary normalisation in the US
At the global level, perhaps the issue that has received the greatest focus in recent months
has been the implications of prospective US monetary normalisation. The announcement by
the US about tapering about a year ago prompted sharp currency falls and asset price
declines in several emerging markets. Further bouts of market volatility have been observed
since then, including in January and February this year.
The episode has renewed debate about the spillover effects of monetary policies in
advanced economies. There is no academic consensual view about the causes of capital
flows. In-depth studies show that perceptions of global and relative risks, accompanied by
mere volatility of capital markets associated with uncertainty, provide better explanations
than monetary policy effects.1 Nevertheless, spillovers are an unavoidable aspect of financial
integration and the negative aspects of monetary normalisation in the US should not be
overstated. We forget too easily that accommodative monetary policy has had positive
spillovers since the start of the financial crisis. The gradual exit from unconventional policies
in the US reflects the welcome recovery of a key pillar support for the global growth.
Clearly, policymakers in advanced economies should not be exempt from the responsibility
to tread with care. In particular, clear and credible communication by central banks is
important to minimise uncertainty and negative spillover effects from exiting unconventional
monetary policy. International cooperation in an era of globalisation can provide significant
gains. I agree with Raghuram Rajan when he highlights that global welfare does not depend
only of domestic optimization of policies, important as they are. Emerging markets should
also accept more flexibility in their exchange rates. The fact that in the second round of
instability the countries with imbalances were the ones that suffered most, suggests that
sound domestic policies are a crucial buffer to minimise adverse spillovers.
But I would also emphasise that the international community - mainly the IMF - must provide
help in the form of improved liquidity facilities that reduce the incentive to build up excessive
reserves and can be activated without stigma.
The structural slowdown in emerging markets
A second global theme has been the remarkable moderation of growth in emerging markets.
To take just one statistic, aggregate emerging market growth has slowed sharply in recent
years, from just under 8% in 2010 to around 4.5% last year.
One component of this slowdown has been a structural moderation. In retrospect, the early
part of this century stands out as an exceptional period for emerging economies. Between
2000 and 2010, aggregate growth in emerging markets averaged 6% on an annual basis.
That compared to around 4% in the preceding two decades. The future looks less rosy.
Estimates from the IMF2 point to a significant moderation in potential growth in large
emerging markets.
The factors behind the slowdown are varied. But a common theme is that several countries
are reaching the limits to their current growth models. China has become overly reliant on
credit and investment; in India structural reforms slowed; Russia and Brazil have failed to
diversify growth models and domestic investment has languished.
The answers to such problems are structural reforms and ambitious efforts which became
now necessary. In view of emerging economies' growing importance, the success of this
process of reform and adjustment will have a profound impact on the global outlook in the
coming years.
Waning global trade integration
The third global theme I would like to touch on is the future for global trade. In recent years,
world trade has been puzzlingly weak. Before the financial crisis, global imports typically rose
considerably faster than activity. In the three decades before the great recession, trade rose
almost twice as fast as output (an elasticity of trade to GDP growth averaging 1.8). But since
2011, world trade has plateaued relative to world GDP around the level reached in 2008.
Some of this weakness is likely to be cyclical. Global business investment, which typically
has high trade content, has surprised on the downside in recent years and that has probably
restrained the pace of global trade. As investment recovers, it should also spur a pick-up in
global trade in the medium term.
However, there are a number of structural factors that could underlie the slow global trade
growth. A first factor may be slower progress in trade liberalisation. While stalled talks at the
global level have led to increased efforts towards bilateral and regional deals, the recent
impetus towards trade growth seems to have lessened. A second factor stems from waning
integration through global supply chains. Anecdotal evidence suggests that in the wake of a
series of supply disruptions, firms are aiming to reduce the complexity and length of their
supply chains. Perhaps, therefore, we might be approaching some natural limits of global
trade integration. This would have profound implications for the global economy. For euro
area countries, which are highly open to trade and where an important component of the
recovery remains driven - for now - by external factors, the prospects for trade are also
crucial.
Challenges for euro area
Let me now turn to the main challenges facing the euro area.
The euro area outlook is slowly improving. Four successive quarterly increases in activity,
reflecting broad-based improvements across countries, provide encouraging signs that the
recovery is gaining some momentum. Yet the pace of growth remains moderate. Demand is
still weak and investment is 20% below its 2007 level. A subdued first quarter for this year
underscores that the economy is far from being back to full health. Unemployment is way too
high in many countries. Moreover, the recovery in real activity has been accompanied by a
gradual, but pronounced, fall in inflation rates.
Against this background, I shall elaborate on three challenges for the euro area:
(a) completing the repair of the banking system; (b) spurring productivity and
competitiveness; (c) managing low inflation.
Repairing the euro area's banking system
Let me start with the rehabilitation of the financial system, which is crucial, in the short term,
to strengthen confidence and stability and, in the long term, to spur economic growth.
2014 will be an important year for completing the process of bank balance-sheet repair,
through the creation of the banking union, with a single supervisory mechanism (SSM) and a
single resolution mechanism (SRM). The ECB is currently undertaking the comprehensive
assessment of banks before the SSM takes up its supervisory tasks.
Banking union can bring significant benefits in terms of reducing European fragmentation of
markets and leading to the sector's restructuring with general efficiency gains. At the same
time, it will strengthen our ability to monitor developing financial risks. With a micro-prudential
task and an extensive set of powers, the SSM should be able to monitor risks stemming from
individual banks in the system and address them in a timely fashion. This is supported by the
macro-prudential task conferred to the ECB for addressing risks from a system-wide
perspective. Coupled with other components of the banking union - the SRM, rules for bail-in
of shareholders and creditors, and eventually a deposit guarantee scheme - these reforms
put European financial stability on a much sounder footing.
Spurring productivity growth and competitiveness
Yet improvements in financial system are not a sufficient condition for improved growth
prospects. More needs to be done to spur productivity growth through reforms that foster
innovation and competitiveness.
A recent, positive aspect has been that stressed euro area countries have taken significant
steps in this regard. By reducing unit labour costs relative to euro area partners they have
improved competitiveness and adjusted external imbalances. In 2013, all stressed countries
- except Cyprus - registered a surplus in their current account balances. Cyprus is expected
to run a surplus in 2014. Compared to 2009, the current account (and capital transfers)
balance has improved by about 16pp (of GDP) in Greece, around 14pp in Cyprus and
Portugal and between 10pp and 12pp in Ireland, Slovenia and Spain. Although weak
domestic demand has contributed to declining current account surpluses, rebalancing has
also been aided by strong export performance. Unit labour cost developments during the
crisis have helped. In the past five years, the cumulative unit labour cost differential vis-à-vis
the euro area fell by more than 20pp in Ireland, 16.5pp in Greece, 13.5pp in Spain, and 9pp
in Portugal.
Yet euro area-wide potential growth has also declined. Falling capital accumulation and
labour utilisation have brought potential growth from a level close to 2% in the years
preceding the crisis to less than 1% on average between 2008 and 2012.3 A recent study4 of
the Centre for European Policy Studies makes for sobering reading, suggesting that the
prospective decline in the working age population (averaging 0.6% per annum until 2030)
would translate to an annual growth rate of about only 1% to 1.5% until 2030. The long-term
prospects of the euro area hinge, therefore, on generating a sizeable boosting of our
productivity performance.
Dealing with low inflation
The final issue I wish to discuss is the low inflation in the euro area. We have witnessed a
pronounced, albeit gradual, fall in inflation in the past year, standing at 0.7% in April, up from
0.5% in March. Euro area inflation is expected to remain low for a prolonged period of time.
To judge the appropriate policy response, we need to understand the drivers of the low
inflation outturns.
A significant part of the fall can be explained by global factors. Indeed, the majority of
advanced economies have seen a decline in inflation since 2011 and in most advanced
economies inflation is now below central bank price stability objectives. In this generalised
fall, lower energy and food contributions have played an important role. In our case, the euro
appreciation since the first quarter of 2012 explains a reduction of 0.5pp in our inflation rate.
This is connected with the fact that energy and food prices account for 80% of the overall
decline in HICP inflation since that date.
Another part reflects the process of internal devaluation to regain price competitiveness in
some euro area countries. Domestic inflation excluding food and energy has fallen well
below the euro area average. The recent fall in services price inflation in the euro area, for
example, is almost entirely accounted for by stressed euro area Member States.
Nonetheless, we are not complacent about the risks from a protracted period of low inflation.
To date, we see no distinct signs of deflation and economic agents are not postponing
purchases. But we recognise that, if too prolonged, periods of low or negative inflation could
unleash forces that may affect the outlook, by destabilising inflation expectations and
aggravating the burden of the debt overhang of both governments and households. Given
these concerns, the ECB Governing Council has reaffirmed forward guidance and stressed
its readiness to act with other measures if required.
Conclusions
Let me conclude. A session entitled "global challenges" can quickly nudge the speaker
towards a rather pessimistic view, seeing only obstacles and impediments to a sustainable
recovery path. But we should not let that happen. Of course, the recovery remains fragile and
risks loom large. But the global outlook has begun to improve. Whether it is managing the
exit from unconventional monetary policies, addressing structural challenges, completing the
repair of the banking system or responding to too low inflation, policy makers know their
agenda and are taking action.
Euro area authorities are doing their part. Significant progress has been made towards
banking union and in enacting structural reforms to restore competitiveness - although more
remains to be done. At the ECB, we are ready to act to avoid low inflation becoming
entrenched in a way that would destabilise the outlook for growth.