If these conditions are met through institutional reform plans (until 2025), relying on deeper convergence, entailing, for example, Competitiveness Authorities and further financial and fiscal reforms, including the Deposit Insurance Scheme, Capital Markets Union and European Fiscal Board, should help resolve the quadrilemma. In the words of the Report: “...the Macroeconomic Imbalance procedure (MIP) could be utilised as a tool not only to prevent and correct imbalances but also to foster reforms and monitor progress in each euro area Member State towards these common standards. Significant and sustained convergence towards similarly resilient economies should be a condition for access to a shock absorption mechanism to be set up...”. As central bankers we need to be aware of the role and importance of structural reforms. And we also need to communicate this to the general public. However, even if convergence in TFP as a source of sustainable catching up gets kick-started and risks arising from it eventually get ironed-out, fiscal and macroprudential policies will still be needed to take care of residual idiosyncratic shocks. Moreover, we are directly responsible for getting macroprudential policy right, and in order to be able to do that, we need a profound understanding of all the issues relevant for its smooth and efficient implementation. Some of the critical issues for macroprudential policy at this point in time encompass (i) cross-border spillovers, (ii) the coordination of macroprudential and monetary policy and (iii) devising an internally consistent structure of macroprudential instruments.

While the nature of shocks and propagation mechanisms still largely remain on the battlefield of economic theory, empirically observed patterns and the consequences of the materialisation of risks necessitate our reaction, which should be based on our best knowledge and abilities. Allow me to get into more detail here. Optimal policy responses in a multi-country setting require a careful examination of real and financial cycles, both domestic and international. For that purpose, let us look at five important patterns that seem to characterise them. First, financial cycles seem to have a lower frequency and higher amplitudes compared to standard business (real) cycles. Credit and asset price cycles may take long to develop their potential to destabilize the financial system. Further on, such a potential may emerge regardless of watchful micro-prudential supervision or stable inflation. The resulting notion of systemic risk may be identified as the interplay of macroeconomic shocks that make financial sector vulnerable, the contagion resulting from financial interconnectedness and endogenous financial imbalances associated with credit booms, credit leverage and risk taking behaviour of financial institutions 3. Second, there are still no mechanisms in place to engineer sustainable synchronisation of cyclical movements across Europe. The question of cyclical synchronisation arises as particularly important within the international setting. This is the factor that makes policy responses even more complex, especially within a currency union such as the euro area, where the damage of suboptimal policy responses might exceed mere fiscal costs and output losses – they may threaten the future of the euro itself.