Second, they must focus not only on competitiveness, but also on increasing the rate of productivity growth in the economy. When thinking about the composition of reforms, one should have in mind innovation (see firms’ market entry and turnover), adoption (e.g. information and communication technology) and reallocation (labour market reforms). But while the full benefits of these efforts are still emerging, aggregate demand should be supported to counteract the potentially destabilising effect of lower prices and higher real interest rates. This can be done by fiscal policy, when it is available without questioning longterm debt sustainability. And it can be done by monetary policy, even when interest rates have reached the lower bound, by expanding the central bank’s balance sheet and channelling liquidity to the real economy. *** Dear Governor Rimšēvičs, ladies and gentlemen, The early classical economist Jean-Baptiste Say argued that the real purchasing power in the economy is about real production1. This claim is often summarised, as “supply creates its own demand”2, although that phrase does not appear in Say’s writings. While Say’s Law has its limitations, it nonetheless initiated a fruitful academic discussion about how supply and demand interact in the economy. There is a tendency nowadays to ignore this discussion and look for simple answers to what is a complex economic problem. Some argue that demand side policies are the only way out  1  Jean-Baptiste Say (1834): “A Treatise on Political Economy”. 2  John Maynard Keynes (1936), “The General Theory of Employment, Interest and Money”.

Designing reforms in the right way and creating a productivity-enhancing environment can maximise the former, and let me add: the faster, the better. But while the full benefits of these efforts are still emerging, aggregate demand should counteract the potentially destabilising effect of lower prices and higher real interest rates. This can be done by fiscal policy, when it is available without questioning long-term debt sustainability. And it can be done by monetary policy, even when interest rates have reached  18  For an explanation of this phenomenon in the US context see Bernanke, B (2005), “Productivity”, remarks at the C. Peter McColough Roundtable Series on International Economics, January 2005. 19  Andrews, D., C. Criscuolo and C. Menon (2013), “Do Resources Flow to Innovative Firms? Cross-Country Evidence from Firm-Level Data”, OECD Economics Department Working Papers, forthcoming. 20  Andrews, D., C. Criscuolo (2013), “Knowledge-based capital, innovation and resource allocation”, OECD Economics Department Working Papers No. 146. 21  World Bank (2013). 22  Veugelers, R. (2011), “Mind Europe’s early-stage equity gap”, Bruegel Policy Contribution 2011/18, December 2011. 23  See also speech by Cœuré, B. (2013), “Completing the single market in capital”, ICMA Capital Market Lecture Series 2014, Paris, 19 May 2014. BIS central bankers’ speeches  7  the lower bound, by expanding the central bank’s balance sheet and channelling liquidity to the real economy.24 This is what the ECB has been doing and will continue to do. It is sometimes argued that monetary policy can weaken the incentives to reform.