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A decade after the global financial crisis, the level of economic activity in the euro area remains disappointingly low. It took nine years for real per capita GDP to surpass its 2007 level. Likewise, euro area inflation has stubbornly remained below the ECB’s aim for much of the past decade.
Throughout this period, the ECB has acted decisively to support euro area demand and raise inflation onto a sustainable path towards our aim of below, but close to, 2% over the medium term. This has included lowering the key ECB rates to record low levels and adopting a wide range of non-standard monetary policy measures.
By contrast, the contribution from fiscal policy to macroeconomic stabilisation in the post-crisis period has been muted at best. From 2010 to 2012, economies representing around one-third of euro area GDP carried out procyclical fiscal tightening to restore confidence in their public debt, which significantly contributed to the second recession in that period. Since then, fiscal policy has been broadly neutral.
Mr Luis de Guindos says: “At our last meeting, the Governing Council responded to the continued shortfall of inflation with respect to our aim. Recent economic data point to a more protracted weakness in the euro area economy. Prominent downside risks remain and inflationary pressures are muted. We introduced a package of measures designed to support the euro area expansion, the ongoing build-up of domestic price pressures and, thus, the sustained convergence of inflation to our medium-term aim.
“We also noted the need for countries with fiscal space to act in a timely and effective manner and for all countries to reinforce their efforts to achieve a more growth-friendly composition of public finances.”
The euro area risk outlook is again tilted to the downside. This is a conjunctural concern. The global decline in the natural rate of interest over the past quarter of a century, however, poses structural challenges.
Mr Luis de Guindos concludes: “Policy rates will likely remain low, by historical standards, and may hit their lower bounds more frequently than in the past. We have learned from the experience in Japan that it is possible to get caught in a vicious cycle of declining inflation expectations, falling inflation and a binding lower bound on nominal interest rates from which it is difficult to escape.
“It is thus of utmost importance that we enhance the firepower of euro area stabilisation policy by means of a policy mix that, while continuing to make full use of monetary policy, assigns a more substantive role to fiscal stabilisation policy. Laying the institutional foundations for a European fiscal capacity would be an important step in this direction.”