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Economic divergences and heterogeneity remain high in the euro area. This concerns in particular the fragmentation in some markets and diverse and weak loan growth across participating countries. While monetary policy in this situation has alleviated the severity of the downturn, let’s not forget Wicksell’s insights. Monetary policy cannot alter the level and distribution of income in a durable way.
The distortions at the heart of the current vertical, horizontal and spatial fragmentation can finally only be addressed by adequate economic policies outside the realm of monetary policy. Indeed, other stakeholders have to take the leading role by continuing to address the underlying structural weaknesses that are affecting our economies.
Let me mention three policy areas that I consider fundamental in this regard.
The first policy realm relates to policies aimed at the financial sector. Governments and financial sector authorities need to further encourage the repair of banks’ balance sheets. Banks in the euro area finance the backbone of our economic system: households and small and medium-sized companies.
The decision to establish a European Single Supervisory Mechanism (SSM) is an essential institutional step overseeing such a process. The SSM will contribute to greater financial integration, a level playing field and greater financial stability. It should be complemented by a unified European framework for bank resolution and recovery, and with a Single Resolution Mechanism with the authority to wind up banks in a timely and impartial manner. To complement this, further efforts are essential for banks to build up sufficient capital, remove legacy risks from their balance sheets and to make these balance sheets fit for lending. Repairing the financial sector is the best way to ensure that the debt crisis does not bear a permanent impact on income distribution, and hence that it does not impose a permanent constraint on monetary policy.
The second policy area that I would like to mention is fiscal policy. It is normally the role of fiscal policy (including in its tax dimension) to deliver any income distribution that society would like to implement based on a normative prior. It is normally the role of fiscal automatic stabilisers to cushion the economic and distributional impact of a deep economic recession of the sort we are experiencing. I say “normally” because we are not in normal times. Fiscal imbalances and weak sovereign balance sheets have prevented fiscal policies from cushioning the large and protracted financial and economic shocks of the past five years.
The lesson from this is clear. Running excessive fiscal deficits at the expense of future generations can be very costly in times of crisis. Therefore, maintaining sustainable fiscal budgets is a necessary condition to achieve distributional equality, both inter-temporally and intra-temporally.
Let me finally mention the structural economic policy domain. Structural policies are key to making an economy more flexible so that it can optimally and rapidly respond to negative economic shocks and avoid the higher costs in terms of lost output and higher unemployment associated with the slower and more protracted adjustments made by rigid economies.
It is designed in such a way that it curtails rent-seeking behaviours in labour, product and capital markets, structural reform will not only unleash competition and innovation but it will also temper the distributional and social consequences of the needed adjustments. Structural labour market policies are a case in point. They can help to prevent labour market adjustments from falling disproportionately on outsiders, including the younger generation.