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The first development that gives comfort is the improving solvency of the banking sector. But banking sector must be well-regulated. Indeed, there is a widespread agreement that one of the main causes of the global financial crisis was the excessive deregulation of the financial sector in the previous two decades.
Increased banking sector resilience has helped shield the recovery from external shocks and sustain its internal momentum. The banking system has been able to weather, among other things, the crisis in emerging market economies, the collapse in oil and commodity prices, and the consequences of the UK referendum. And healthier banks have provided the necessary supply of credit to maintain the pace of the recovery.
This credit reversal has in turn supported a second benign characteristic of the recovery: the fact that it has become increasingly driven by domestic sources of growth.
Domestic demand has now replaced foreign demand as the main driver of growth. Over the past two years, domestic demand has on average added more than a percentage point to GDP growth, supported by very accommodative financing conditions. By contrast, net exports, which were a key growth engine for most of the crisis period, have barely contributed to GDP growth since end-2013 as the global environment has deteriorated.
This shift in the composition of growth is important, from an inflation perspective, since it makes the recovery in the euro area less vulnerable to external shocks.
So even if there are many encouraging trends in the euro area economy, the recovery remains highly reliant on a constellation of financing conditions that, in turn, depend on continued monetary support. The ECB will continue to act, as warranted, by using all the instruments available within ECB’smandate to secure a sustained convergence of inflation towards a level below, but close to 2%.
There is need to recognise that we operate under a still significant degree of uncertainty. Whether the economic recovery becomes more solid, and how quickly inflation dynamics become more self-sustained, depends not just on the current monetary policy stance, but also on other policies. Restoring a sense of direction – and therefore confidence – would be the simplest and yet most powerful way to deliver economic stimulus.