Speech by Vítor Constâncio, Vice-President of the ECB, at the G30 Meeting in Washington, 9 October 2016.
Turning to recent euro area developments, the recovery is continuing its moderate but steady pace, supported mainly by the ECB’s expansionary policies, which have significantly improved financial conditions, reduced financial fragmentation and supported economic activity and inflation. In the absence of our measures, both growth and inflation in the euro area would have been significantly worse, as our models calculate that inflation and growth would be lower by 0.8 and 0.7 percentage points, respectively, than the forecast values of 0.2% and 1.7% for this year.
For three years now, inflation has been quite low with a level of 0.4% in 2014, 0% last year and 0.2% forecast for this year. However, the recent flash estimate for September at 0.4% may indicate a movement compatible with our baseline scenario that foresees a gradual increase to levels above 1% by next spring, if no major downward movement in commodity prices takes place. Additionally, the normalisation of inflation depends on the continued closing of the negative output gap and more dynamic wage behaviour.
In the first half of 2016 the euro area grew at an annualised rate of 1.7%, similar to last year’s growth rate. This figure is far from being impressive, especially considering that the euro area is in the early phase of a recovery after the second recession in 2012 and 2013. On the other hand, the unemployment rate, albeit falling, still remains above 10% amid a continuous increase in the participation rate in the labour force since the crisis. One positive aspect is that our policies have contributed to a decrease in financial fragmentation and that the dispersion of GDP growth and inflation across euro area countries is at the lowest level since the beginning of monetary union in 1999. Another positive note is that the recent growth was largely driven by domestic demand. Moreover, the recovery has proved resilient to a series of adverse shocks over the past year: the slowdown in China last summer, the acute stock market turbulence in the early part of this year and, most recently, the uncertainty created by the UK referendum.
At the same time, this resilience reflects to a large degree the amount of monetary expansion – actual and expected – that is embedded in financial prices. Indeed, with the five packages of measures we have adopted since June 2014, we have reduced the cost of capital, produced rebalancing effects in other asset markets, improved credit supply conditions and restored credit volume growth since the latter part of 2014, after two years of negative developments.
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Monetary policy is effective in correcting cyclical fluctuations, but it also contributes to medium-term growth by increasing capacity-building investment and by accelerating the closing of the output gap, thereby avoiding hysteresis effects in the labour market and in the capital stock that are detrimental to potential growth. Nevertheless, it is indisputable that long-term economic growth is mostly determined by supply-side factors such as productivity, technological innovation, the business environment and the quality of public institutions. In all euro area countries there is room for improvement in these areas. This requires governments to continue to implement a comprehensive and focused suite of structural reforms.
Fiscal policy also needs to play a larger role in supporting the recovery. Fiscal expansion can contribute to increased interest rates by expanding the supply of safe assets. Conceptually, in terms of overlapping generations models with small Ricardian effects, this would also push upwards the real equilibrium interest rate.
While many euro area countries have very limited fiscal room for manoeuvre, those that have some should use it. All countries, however, should look at ways to enhance the composition of their fiscal policies with a view to making it more growth-friendly, particularly in the area of taxation and the share of public investment. Only with the right combination of structural and fiscal policies is it possible to fully reap the benefits of our accommodative monetary policy and increase the euro area’s potential growth.
Full speech on the ECB website
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