23 January 2023

ECB's Lagarde: New challenges in a changing world

Completing Europe’s capital markets union (CMU) will be key to financing the green and digital transitions. Equity investors tend to have a greater appetite than banks for high-risk, high-return projects and equity finance tends to increase green innovation.

Challenges for Europe in 2023

...As this new global map takes shape, we enter 2023 facing three big challenges.

The first challenge is to reconsider how we can best protect Europe’s critical interests in a fast-changing world. As an economy that is very open to trade and deeply integrated into global supply chains, we are vulnerable to geopolitical headwinds. For example, 35% of Europe’s manufacturing output is absorbed outside the EU, much more than for the United States or China.

So, as the next chapter in the globalisation story is being written, we need to ensure that Europe is a leader, not just a follower. And as the French President and German Chancellor have recently argued, we have the capacity to do so.^[8]

Already now, Europe is the top trading partner for 80 countries, compared to just over 20 countries for the United States.^[9] That gives us unique bargaining power to shape openness in a European direction and strengthen ties with key partners, such as those on whom we rely for critical resources.

And where we see our interests being threatened, we can use our economic weight more strategically – something we have already started to see with the unprecedented sanctions placed upon Russia.

But we must also be prepared for a future in which the global economy could fragment. And the best insurance against a more uncertain world is building more resilience at home. So, the second challenge for Europe is to develop more our own sources of growth.

Here, the new global map presents Europe with an opportunity.

As energy security becomes imperative, we can put climate-related investment needs – especially in clean energy – at the centre of our growth model, strengthening domestic demand. These investment needs will amount to almost half a trillion euro on average per year until 2030.^[10]

We can also use the green transition as a spur to digitalise the European economy, since digital technologies could reduce global emissions by one fifth by 2050.^[11] That could increase productivity growth and help ensure that green investment does not put excessive pressure on prices.

But the ambitions of this new growth model will require an enormous amount of financing. And here the financial sector can play a crucial role, if the enabling policies are put in place.

Completing Europe’s capital markets union (CMU) will be key to financing the green and digital transitions. Equity investors tend to have a greater appetite than banks for high-risk, high-return projects and equity finance tends to increase green innovation.^[12] But the full and swift implementation of the Commission’s ambitious CMU Action Plan will be crucial here.

Some progress is being made. The Commission has recently put forward proposals on harmonising national insolvency laws and facilitating public listing. It is also tackling issues that have held back the growth of European capital markets, like putting equity financing on an equal tax-footing with debt financing. And Europe’s recent agreement on a minimum level of taxation for large corporates will support tax harmonisation within the EU, the absence of which has often been seen as a barrier to capital market integration.^[13]

The third big challenge facing Europe is the high inflation environment. And this, of course, is the challenge that concerns me the most.

Inflation in Europe is far too high, partly due to our vulnerability to the changing geopolitics of energy. Decoupling from Russia last year pushed up energy inflation in the euro area to extraordinary levels.

But while energy inflation has recently been coming down, underlying inflation continues to rise. As a result, it is vital that inflation rates above the ECB’s 2% target do not become entrenched in the economy.

We must bring inflation down. And we will deliver on this goal.

In less than half a year, we have raised the ECB interest rates by 250 basis points, the fastest increase in our history. And we have made it clear that ECB interest rates will still have to rise significantly at a steady pace to reach levels that are sufficiently restrictive, and stay at those levels for as long as necessary.

In other words, we will stay the course to ensure the timely return of inflation to our target.

Conclusion

Let me conclude.

The transition from one year to the next is traditionally associated with quiet reflection, when we take stock of things that have come to pass. But as the poet Rainer Maria Rilke once wrote: a new year is “full of things that have never been”.

As we head into 2023, a changing world brings with it new challenges, but also opportunities. And let there be no doubt: with more self-confidence, more assertiveness and the right policies in place fuelling green and digital growth, Europe can adapt and thrive.

But some things never change: namely, the ECB’s commitment to price stability. We will play our part in Europe’s next chapter by bringing inflation back to our 2% target.

ECB

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