In this context, there was a much stronger case to reform fast so that internal devaluation could take place more quickly. A one-off price adjustment has distributional effects ex post, but it does not affect the perception of real rates going forward – insofar as it boosts future income, it may indeed raise inflation expectations and lower real rates. By contrast, if adjustment is gradual, it creates disinflationary expectations and real rates increase. In other words, a slower adjustment makes the contractionary effect of reforms more prolonged. This seems to have been borne out from our experience with adjustment during the crisis. Countries that have enacted a more frontloaded reform strategy have, on the whole, seen better outcomes than those that have applied a more staggered approach. Today’s low inflation expectations in the region as a whole may indeed be telling us that the approach was on average too staggered, and that it is time to accelerate. In this country, Latvia, for instance, a frontloaded programme of fiscal consolidation and structural reforms led to a fast adjustment of wages and prices and a fast rebound in growth and job creation. The Latvian economy began growing again six quarters after it entered recession, and has been on an upward path since. A similar, if less dramatic picture was visible in Ireland, where the economy stabilised after eight quarters, while unemployment levelled off and then fall from the first quarter of 2012. In both countries, prices took around two years to fully adjust and have been rising since.

Benoît Cœuré: Structural reforms – learning the right lessons from the crisis Keynote speech by Mr Benoît Cœuré, Member of the Executive Board of the European Central Bank, at the Bank of Latvia Economic Conference 2014, Riga, 17 October 2014. *  *  *  Summary One lesson that we learned after the financial crisis is that achieving sustainable economic growth is always about both demand and supply. Moreover, policies that support demand empower policies that support supply, and vice versa. In the post crisis environment of a large debt overhang, partly structural unemployment and weak productivity levels, supply-side policies can increase the effectiveness of demand-side policies and help empower demand. By raising potential growth they create more space for spending (governments, firms and households). Additionally, by reactivating/reskilling the workforce, they allow employment to respond faster to higher demand. Finally, they ensure that higher demand is channelled towards the right sectors. While their long-term positive effects are undisputed, structural reforms, especially in times when monetary policy is at the lower bound, are seen to have negative short-term effects through increasing real interest rates. However, structural reforms can be effective in the short run as they raise expectations of higher incomes and cause firms to increase investment today and bring forward the economic recovery. Achieving a positive short-term impact from structural reforms depends on both the pace and composition of reforms. First, instead of the traditionally gradual approach, reforms need to be frontloaded (as e.g. in Latvia).