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Productivity, innovation and technological progress

How our economy grows and generates new opportunities over time depends in part on people coming up with great ideas and new, smarter ways of doing things. To make good monetary policy decisions, we need to better understand how innovation, technological progress and productivity affect the way our economy works.

Why were productivity, innovation and technological progress part of our strategy review?

Understanding how the economy grows

Our job is to keep prices stable. To do that well, we need to understand how our economy works and grows over time. Today’s economy is much more advanced compared to the one our grandparents knew when they were young. The telegraph and typewriters of old have given way to smart phones and webpages, for example. Each generation comes up with great ideas, and new ways of doing things, that improve how our economy works.

The importance of productivity

One concept that helps us understand all this change is productivity. In short, it describes how much effort we need to create or produce something. That could mean anything from how much we get done at work today, to how fast factory machines can put together finished products. If productivity increases, it means we are getting better at doing something. Innovative ideas and new technologies lie at the heart of this process.

We make decisions with the economy in mind

How fast our economy can grow over time is largely dependent on two things: how much our population grows and how fast productivity increases. Because we make monetary policy decisions with the economy in mind, the Governing Council discussed productivity, innovation, and technological progress as part of our strategy review.

How do productivity, innovation and technological progress affect our monetary policy?

Big changes in the economy

Our population is not growing by as much as it used to. That means our society needs to become more productive for our economy to grow more. This task is important because there have been big changes in the economy that have made our job of keeping prices stable more challenging.

For example, people are living longer and saving more so that they can live comfortably in their retirement. Since the financial crisis, people prefer to invest in safe assets rather than risky ones. Economies are no longer growing as fast as they once did, which makes businesses less optimistic about the future, so they invest less.

A decline in the “natural rate of interest”

These changes are beyond the control of central banks. But they have led, together with other changes, to a fall in the so-called “natural rate of interest”. That is the interest rate at which the economy runs smoothly and inflation – the rate at which the overall prices for goods and services change over time – remains stable. If central banks increase their interest rates above the natural rate, it slows growth in the economy and inflation tends to fall. If central banks reduce their interest rates below the natural rate, it boosts growth in the economy and inflation tends to rise.

Because there is a limit to how low interest rates can go, a fall in the natural rate of interest means that central banks have less room to stimulate their economies using interest rate policy alone. This is one of the reasons why we, like other central banks around the world, have introduced new monetary policy tools. They help us maintain price stability.

But more productivity growth can boost the natural rate of interest. This, in turn, gives central banks more room to boost their economies using their interest rate policy, while still keeping inflation in check.

Who or what can increase productivity growth?

Our governments can influence how productive we are through the decisions they make. For instance, they could spend money on investment in new technologies that will make it easier to produce goods or to work more effectively. They could support education and promote research and development, or pass new laws that make it easier for people to do business or set up companies. These decisions can improve productivity in the economy and help it to grow over time.

READ MORE
Key factors behind productivity trends in EU countries
STRATEGY REVIEW
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