Press Release - Structural reforms on the way to a complete Economic and Monetary Union
Speech by Benoît Cœuré, Member of the Executive Board of the ECB, at the International Conference on Structural Reforms in Advanced Economies, Hertie School of Governance, Berlin,17 June 2016
Introduction
Many people would like central bankers to remain quiet about the need for structural reforms. In the end, we have a clear and narrow mandate defined as price stability[1].And in undergraduate-level economics we learn that inflation in the long run is always and everywhere a monetary phenomenon. So why do we bother? And why should we, unelected policymakers, venture into policy debates so obviously shaped by political considerations?
I agree that central bankers should tread very cautiously in other economic policy areas. But monetary policy, and particularly so in a monetary union, does not operate in a vacuum. Although central bankers take their decisions independently, they also have to take into account what other parties are doing. As I have already said elsewhere, monetary policy is independent and interdependent.[2]
In this respect, there are at least three reasons why central bankers cannot be indifferent to structural reforms. First, the combination of low potential growth and the debt overhang inherited from the crisis threatens the European social contract, a contract that was established in the post-war era and that was fair and affordable at that time[3]. This in turn is a threat to the sustainability of our social market economy, which is the environment in which our monetary policy operates. Second, factor reallocation over time and across sectors is necessary in order to adjust to shocks and therefore key to the smooth transmission of monetary policy. And third, convergence between economies is both an economic and political prerequisite for a well-functioning monetary union.
I will argue today that for structural reforms to successfully lift potential growth in a monetary union, they have to fulfil two important criteria: (i) they need to be comprehensive and well sequenced and (ii) all-encompassing.
“Comprehensive” means that a narrow focus on labour market reforms is not sufficient. Structural reforms are also about incentivising innovation, competition and fighting rent-seeking and monopolistic structures. They entail offering new income chances – particularly for the younger generations – by reducing and redistributing rents, and by encouraging economic players to adjust.[4]
“All-encompassing” means that reforms cannot focus only on addressing inefficiencies in Member States, but have to take into account externalities and inefficiencies at the level of the Union. This implies reforms in the area of economic governance, and progress in completing the Single Market. And they will form the basis for a better functioning Economic and Monetary Union.
Why do we need structural reforms?
Potential output growth in the euro area, as in other advanced economies, has been on a steady downwards trajectory for several decades. There are however a few things that make our situation even more problematic than that of other large economies. First, the decline in trend growth has gone much further here than in, for instance, the US: the European Commission estimates potential output growth in the euro area to be about 1% this year, half of the equivalent figure for the US. In contrast, the difference in 1992 was small: euro area potential output growth was estimated at 2.6%, compared with 2.8% for the US.[5] Although this is already a serious problem in itself[6], a close examination of the composition of potential output uncovers the full extent of the problem. Total factor productivity in the US has consistently outperformed the euro area for the last 15 years and is expected to continue doing also in the coming decade[7]. In other words, using Paul Krugman’s famous words, the euro area trend growth risks becoming a product of “perspiration rather than inspiration”[8].
There are two issues associated with this observation. First, as we know from the growth literature, input-based growth risks incurring diminishing returns. Second, in an imperfect monetary union, it raises the question of how those inputs are being allocated.
Indeed, when it comes to allocating capital, we are still making a bad job of allocating and utilising existing resources[9]. The high-risk projects with high expected returns, which we would like to see giving a boost to potential growth, are more difficult to finance than in other parts of the world. This is mainly because of Europe’s bias towards bank and debt financing as opposed to equity[10], and the persistent fragmentation of our financial systems, not to mention high administrative burdens[11].
page source http://www.ecb.europa.eu/
