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Economic and monetary challenges - Prospects of the EU economy and the Eurozone
Towards a sustainably higher growth potential in the euro area
By Knot Klaas - President, De Nederlandsche Bank
European integration has historically stimulated the advancement of living standards. In the 1950s, trade integration contributed to the recovery from the Second World War. After the oil crises in the 1970s, Europe agreed to realize the Internal Market by 1992. And after the fall of the Berlin Wall, former communist countries profited from EU accession. But in the wake of the financial crisis, the EU’s effectiveness in promoting higher living standards is in doubt. Some now believe that Europe is the problem, rather than the solution to economic woes. Especially in the euro area, where growth is lower than in other advanced economies and unemployment is high, this sentiment could eventually erode public support for the euro and the European project.
Part of the explanation to low growth is related to the imbalances that developed before the crisis in a number of countries, e.g. housing market bubbles, eroded price competitiveness, current account deficits and high public and private sector debt. Another important part of the problem is more structural in nature. The European Commission projects potential growth in the euro area at only 1.1%. Several countries failed to adapt their economies to the changes in the economic environment seen in recent decades. These include the monetary union, but also ongoing globalisation, which increased capital flows and trade competition. While structural convergence was clearly needed, structural differences between countries only widened.
To raise growth potential in a sustainable way, a mix of instruments is needed. Monetary policy is playing its part. So far, the ECB has taken many measures, including lower policy rates, enhanced liquidity provision and purchases of assets. In general, however, what monetary policy can achieve in terms of growth is limited at the current juncture. Monetary stimulus is reaching its limits and – if maintained for too long – comes with risks of negative side-effects like financial imbalances and misallocations. Central banks can buy time, but cannot solve structural problems. Obviously, additional measures are required. Unfortunately, budgetary leeway is limited in most countries. Public debt remains high at 94% of GDP on average, and Europe needs to preserve the credibility of its fiscal rules.
By far the most effective way to increase growth are structural reforms.
By far the most effective way to increase growth will be structural reforms. They would increase the resilience and adaptability of Member States, especially after crises. Reforms also increase growth potential. The OECD estimates that moving towards best practices via reforms could raise GDP by 4-7%. Possible measures include liberalization of the service sector and of regulated professions. Another priority should be to stimulate innovation, R&D and the application of ICT. The quality of institutions should also improve, for instance the efficiency of the judiciary system in protecting property rights.
First and foremost, reforms are the responsibility of Member States. They reap most of their benefits and bear most of their costs. Still, difficult measures are often only taken when they are urgently needed. This is why Europe should also stimulate reforms. Mechanisms like Europe 2020 and the Macroeconomic Imbalances Procedure aim to achieve this. Unfortunately, the implementation of policy recommendations remains incomplete so far. European coordination may thus need to become more binding in the future. Strict compliance with the rules is necessary to reduce existing vulnerabilities more quickly, and to better prevent new ones. That would also reduce the probability of future calls on public risk sharing schemes like the European Stability Mechanism. The shared responsibility for risks should go hand in hand with better control of these risks.
These measures by individual countries and at the euro area level would contribute to better economic performance and a more robust monetary union. They would bring a much needed positive perspective for euro area citizens.