NEWS Release - Creating stability in an uncertain world - Speech by Peter Praet, Member of the Executive Board of the ECB, at the conference "Brexit and the implications for financial services" jointly organised by SUERF and hosted by Ernst & Young, London, 23 February 2017
Resilient recovery in the euro area
The economic recovery in the euro area is continuing at a moderate, but firming, pace, and is broadening gradually across sectors and countries.
Real GDP growth has expanded for 15 consecutive quarters, growing by 0.4% during the final quarter of 2016 according to the Eurostat flash estimate. Economic sentiment is at its highest level in nearly six years and unemployment is back to single-digit figures. Looking beyond the euro area, the global economy, too, is showing increasing signs of a cyclical upturn.
The euro area economy has been resilient in the face of a number of risks and uncertainties at global level. One example of its improving resilience is the fact that domestic demand is now the mainstay of real GDP growth. Previously, growth in euro area was closely correlated with the strength of international trade, but that relationship has weakened recently; last year’s growth would not have been possible in view of the lacklustre international conditions.
Our monetary policy measures have been a key contributor to these positive economic developments. The comprehensive set of measures introduced since June 2014 has worked its way through the financial system, leading to a significant easing of financing conditions for consumers and firms. Together with improving financial and non-financial sector balance sheets, this has strengthened credit dynamics and supported domestic demand.
The recovery has been accompanied by a broad-based improvement in measures of confidence. Measured confidence for industry, construction, services and households is in positive territory, and particularly strong for measures of future expectations. This is in line with the normally high correlation between measures of confidence and economic activity. Households and businesses which are confident about the future are more likely to spend and invest than those which are concerned.
Despite the resilient recovery in the euro area, and strong indicators of confidence across all sectors, measures of political and policy uncertainty have been rising recently, although asset markets are not significantly pricing in tail risks. The recent bouts of uncertainty are a source of concern, and represent a downside risk to the economic outlook. Today I would like to discuss the potential impact of uncertainty on economic activity and the role of institutions in counteracting uncertainty and providing stability.
Uncertainty and economic developments
The economic literature – both theoretical and empirical – finds a link between heightened uncertainty and lower economic activity in the short run. There are usually fixed costs involved with investment, from creating new capital such as building a factory to hiring new staff, which cannot be recovered if the investment decision is reversed. So faced with an increase in uncertainty, businesses pare back investment plans. Similarly, if households fear unemployment or lower income from employment in the future they may reduce consumption today.[1]
The literature uses a number of different measures of uncertainty. Such measures usually move with each other, and generally peak in recessions. At the current time, most measures of uncertainty for the euro area do not appear especially elevated. The economic recovery has been resilient and steady for a number of years, the financial sector is more robust than it was pre-crisis, and most measures of financial sector volatility are markedly below the peaks witnessed during the crisis.
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