31 January 2014

ECB/Cœuré: The structural aspects of euro area adjustment

Cœuré said it was crucial to continue with the reform process in all euro area countries, including those unaffected by the crisis. He concluded on a cautiously optimistic note regarding the future.

Given the observed benefits of structural reforms, why has implementing them been so costly for some stressed countries?

• The first contributing factor is that most of the countries involved entered the crisis with rigid institutions and structures. An instantaneous adjustment of relative prices was not feasible due to nominal wages and prices being "sticky". As a result, both the duration and the real cost of adjustment have increased sharply, as did the burden borne by the more vulnerable members of the society, affecting the political acceptability of reforms.
• Second, when reforms were undertaken, there were implementation obstacles. Ex ante the approach to structural reforms was broad-based and aimed at all critical weaknesses in a comprehensive manner. But ex post it turned out that it was easier to change institutions and rules in the labour market than in product and services markets.
• The third contributing factor was that, while this supply-side adjustment taking place, there were also constraints on the demand side. To begin with, the reform process had to start in an environment where fiscal policies had, by necessity, to become contractionary to restore debt sustainability and market access. Moreover, the credit transmission channel was impaired.

Assessment

In my view, the option of delaying reforms was simply not there for euro area countries.  Political economy reasons suggest that reforms are often implemented under the pressure of economic crises. Also, one can exaggerate the effect of the zero lower bound. The ECB has employed various standard and non-standard measures that have helped to smooth the adjustment process for stressed countries. The expansionary monetary policy stance has ensured that inflation expectations remained well anchored over the medium term, thereby ensuring that short-run price adjustments do not translate into longer-term deflationary expectations.

Conclusion

The crisis has been long and painful for many people in Europe. Nevertheless, and in spite of persistent challenges, much of the macro-economic adjustment has now taken place. Looking back, 2013 was certainly the year of the turnaround.

Since 2008, the current account deficits of stressed countries have narrowed substantially. Greece, Spain and Portugal moved from double-digit deficits and in 2013 achieved slight current account surpluses. Over the same period, the current account balance of Ireland went from a deficit of around 5 per cent of GDP to a surplus of around 5 per cent of GDP. Some of the adjustment certainly reflects a decline in imports due to the cyclical compression of domestic demand. But in Spain, Portugal and Ireland, the larger part of the adjustment is attributable to robust export performance. Structural improvements have played an important role in the adjustment of current account imbalances and, in fact, cyclical factors are estimated to account for less than half of the adjustment observed so far.

Export growth has also been the engine of the positive GDP growth rates since the second quarter of 2013 in some crisis countries. With the return to positive growth rates last year, the upward trend in the unemployment rate came to an end in most euro area countries. In Portugal unemployment has started to decline. Let me stress that this is not enough and unemployment rates, particularly among young people, remain unacceptably high in many crisis countries. However, the labour market reforms undertaken give us confidence that unemployment will start falling faster once the recovery picks up.

It is, therefore, crucial to continue with the reform process in all euro area countries, including those unaffected by the crisis. Undertaking reforms simultaneously can boost GDP more than in a situation where each country acts alone. And importantly, a simultaneous approach will also help to make the reforms more socially acceptable. It will underscore the simple truth that in the euro area we are all in the same boat, and we are all heading in the same direction, across countries as well as within countries.

Full speech

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