mario draghi : the monetary policy of the european central bank and its transmission in the euro area speech by mr mario draghi, president of the european central bank, at the opening of the academic year 2012 – 2013, universita bocconi, milan, 15 november 2012. * * * financial markets and the disruption caused to the transmission of monetary policy the year that is about to end will be remembered not only for the effects the european sovereign debt crisis has had on the euro and for the significant weakening of the european economy, but also for the responses to these challenges by the ecb, national governments and the european union. the artificial calm in the markets prior to the crisis had, in europe, for a long time allowed misguided economic policies or simply encouraged inaction in countries that had profound need for fiscal consolidation and structural reforms. the outbreak of the crisis substantially increased risk aversion : the weaknesses of these countries were exposed ; in an environment of already weak growth, investors turned away, sovereign spreads started to rise. soon, the solvency of the governments of these countries was questioned, and with it the solvency of the financial institutions located there. within the euro area, less and less money circulated between banks in different countries. doubts about the future of the euro area in its current form encouraged a speculative movement which lead to further increases in sovereign spreads. all the governments of the weaker countries responded with fiscal consolidation policies, initially hesitant, then more vigorous. but economic activity continued to weaken and spreads continued to grow. it was a situation which has brought into focus the nature of the “ ideal ” fiscal consolidation – one which reduces the deficit and the debt with the least negative consequences for a country ’ s gdp. the prevailing evidence indicates that it should be concentrated on reductions in current spending and not on tax increases. even those who do not share this approach agree, however, that it is essential that the process be perceived as credible, irreversible and structural so that it can affect sovereign spreads, and that price stability conditions as well as conditions on financial markets are such that they do not interfere with fiscal consolidation. in response, the ecb lowered its benchmark interest rates. under normal circumstances, such reductions would have been transmitted in a relatively uniform way to households and firms across the euro area. but that ’ s not what we found. in some countries, the rate cuts were fully passed on. in others, the interest rates charged on bank loans to the real

and the economy adjusts more slowly, fiscal policies need to be more expansionary, and for longer, and this can in turn generate spillovers on other participating economies and on the single monetary policy. to give an example of this interaction, ireland and spain were two countries that experienced relatively similar shocks emanating from the financial and construction sectors. both saw their primary deficits deteriorate by around 13pp of gdp between 2007 and 2009. however, by 2012 ireland had reduced that deficit by more than 7pp of gdp, whereas in spain the primary deficit was less than 2pp lower. this certainly reflected stronger consolidation efforts in ireland as part of its adjustment programme. but it also reflected the faster adjustment in prices and wages in the irish economy, which helped unemployment to begin stabilising in late 2010, while in spain it rose until early 2013. of course many other factors were at play as well, but the point is that economic flexibility matters for the size and duration of deficits. and what this implies is that, if structural reforms do not happen, there can be a form of “ structural dominance ” over fiscal policies. when a shock hits fiscal policies are forced to do all the heavy lifting to stabilise the economy and, over time, fiscal space becomes progressively exhausted. indeed, this is one explanation for why the stability and growth pact ( sgp ) rules have not been as effective as we hoped. there is a correlation between the ease with which countries comply with the rules and their progress on structural reforms. effectively, through lack of reforms some countries have put themselves in a position of excessive deficit dependence, which then makes the difficulty and costs of meeting their obligations higher. the conclusion, therefore, is that constantly tinkering with our common fiscal rules while leaving governance of structural policies entirely at the national level makes little sense. if fiscal policies are to be freed from structural dominance, then we need an equally strong framework in both domains. and it is fair to say in the eu context that the macroeconomic imbalance procedure ( mip ) has less teeth and has not benefited from the same level of ownership and political attention than the stability and growth pact. we could also envisage some complementarities between the two. for example, it does make sense to take into account structural reforms when assessing compliance with the sgp, as the commission now intends to do. 9 this is because structural reforms not only for a review see mckinnon, r. ( 2001 ),