Regional divergence in the euro area

Speech by José Manuel González-Páramo, Member of the Executive Board of the ECB,
International Conference on “The Role of Government in Regional Economic Development”, rede (Research in Economics, Energy and the Environment), Universidade de Vigo,
Baiona, 19 September 2005

Dear colleagues,

First of all I would like to thank the research group in Economics, Energy and the Environment and the University of Vigo for inviting me to Baiona and giving me the opportunity to participate in this stimulating event.

The topic of this international conference that I am pleased and honoured to open is “The role of Government in Regional Economic Development”. Under this heading, most of the very interesting papers that will follow my presentation will discuss the design of policies that could help the poorer regions of a country to grow faster and converge towards the richer regions. I will deal with this topic from a euro area point of view and take a macro perspective. In particular, I will concentrate on the issue of economic divergences in our Monetary Union and their policy implications. More concretely, I will endeavour to tackle three fundamental questions: are inflation and growth dynamics systematically different across euro area countries? What is behind the observed differences in performance? What are the policy challenges related to these divergences?

The issue of how to deal with heterogeneity in a diverse single currency area has been an issue at the heart of the debate in Europe all along the road to deeper economic integration, and indeed well before the single currency was introduced. This matter has attracted renewed interest in recent public discussion, in particular after media reports sounded the alarm about increased divergence of growth rates in the euro area in the last quarter of 2004. In this context, almost seven years since the introduction of the euro provide us with some perspective, albeit surely still an incomplete one, to deal with this topic.

The terms of the debate are very familiar. While inflation and growth differentials are a normal phenomenon in any monetary union, their occurrence in the euro area context is combined with institutional and economic characteristics that are, to a large extent, unique, such as a lack of significant centralised fiscal transfer mechanisms and decentralised responsibility for fiscal and other economic policies, together with limited labour mobility and rigidities in labour and product markets. Against this background, monetary policy in EMU is conducted by the ECB with the primary objective of maintaining price stability in the euro area as a whole; it does not, therefore, directly address differences in national economic developments that may emerge across the euro area.

To deal with this issue, I believe it is important to first address the main facts related to economic differentials in the euro area and then to briefly analyse the factors that may explain those differentials. I will follow this structure in my presentation today and will then examine the implications for economic policies.

The facts: regional divergence in the euro area

What are the main facts related to inflation and growth dispersion among euro area countries?

A first look at the data shows that the dispersion of inflation across the euro area countries has broadly stabilised since the inception of the euro. Looking back to the beginning of the 1990s, the degree of inflation dispersion, measured as the unweighted standard deviation among the 12 euro area countries, was characterised by a strong downward trend. The high degree of dispersion in the early 1990s – around 6 percentage points – was mainly the result of very high levels of inflation in a few countries. Between 1994 and 1998, inflation dispersion declined, and in the second half of 1999 reached its lowest level since the start of the Stage Three of EMU, namely less than 1 percentage point. Since then, with the exception of a modest increase over the period from 2000 to 2002, it has changed very little. By way of comparison, it is worth noting that since 1999 inflation dispersion across the euro area has been fluctuating around the level observed for the 14 metropolitan statistical areas in the United States.

At the same time, inflation differentials in the euro area appear to be very persistent, in the sense that many countries have systematically maintained either a positive or a negative inflation gap with the euro area average since the introduction of the euro. This persistence seems to be a feature specific to the euro area, where 7 of the 12 economies have recorded annual inflation rates either consistently above or consistently below the euro area average since 1999.

A first insight into the possible causes of inflation differentials can be gained by referring to their accounting components. For this purpose, it is useful to distinguish between internal factors – such as unit labour costs, profit margins and net indirect taxes – and external factors – such as import prices. In 9 of the 12 countries, internal factors have been the most important contributors to the inflation differentials in relation to the euro area average. Import costs have also played a major role in a few cases (Belgium, France and Luxembourg). As regards the internal sources of inflation differentials, the main contributions have come from unit labour costs and the gross operating surplus. In Germany, France and Finland, in particular, below-average dynamics in both these variables have contributed significantly to the negative inflation differentials in relation to the euro area average. The positive gaps for Greece, Ireland, Italy and Spain were the result of dynamics above the euro area average in both unit labour costs and profits.

The diversity of inflation rates among euro area countries also has an important sectoral dimension. Overall, the degree of dispersion in the upward movement of services prices across the euro area countries has been higher than that observed for the Harmonised Index of Consumer Prices (HICP) as a whole. At the other extreme, the rates of increase in non-energy industrial goods prices converged significantly throughout the 1990s, levelling off at a low degree of dispersion from 1999 onwards.

Let us turn now to economic growth. A first look at growth dispersion within the euro area, measured by the unweighted standard deviation, suggests that it is not particularly abnormal, as compared with recent and past history. In fact, this growth dispersion has been fluctuating around the low level of 2 percentage points since the 1970s; since 1999 it has even experienced a slight downward trend.

As in the case of inflation differentials, euro area growth dispersion is not unusually large compared with that in other currency areas, although it shows a certain degree of persistence. Some euro area countries (Greece, Spain and Ireland) have been, since the mid-1990s, persistently growing above the euro area average, while others (Germany and Italy) have been systematically performing below the euro area average.

From a supply-side perspective, a growth accounting exercise, where overall GDP growth is decomposed into its different components following a standard production function approach (capital, labour and total factor productivity), suggests that total factor productivity has played a prominent role in explaining dispersion among euro area countries over the last 30 years, although its contribution seems to have decreased since the 1990s. In parallel, the contribution from capital has displayed an increasing trend while that of labour has shown a decreasing contribution.

Focusing upon demand components, total investment, exports and imports have shown a downward dispersion trend since the mid-1990s. If we look at the sectoral breakdown, agriculture and construction feature the highest dispersion, with no defined trends in any sector other than manufacturing, where a clear decline can be seen since the late 1990s.

This account of the facts related to economic divergences in the euro area can be further completed with a reference to the basic characteristics of European business cycles. A first insight into this issue can be obtained from the decomposition of real GDP into its cyclical and trend components, which shows that the current degree of dispersion in overall real GDP growth largely reflects lasting trend growth differences and not cyclical differences. In addition, a close look at simple correlation coefficients of year-on-year GDP growth rates indicates that correlations across countries have increased in the last 30 years. Moreover, on the basis of the analysis of monthly and quarterly industrial production data, recent research work concludes that synchronisation of European cycles is high and this strong co-movement dates from before the establishment of Monetary Union. From a different perspective, the quarterly chronology of peaks and troughs in GDP across European countries confirms that the euro area countries share relatively similar duration and amplitude of the business cycle. Similarities seem to be the norm rather than the exception, with a complete cycle lasting on average about six to seven years.

All in all, the main facts can be summarised in two conclusions. Current inflation and growth differentials among euro area countries are not large when compared with historical trends or observed differences in other currency unions. However, they tend to be persistent.

The causes of regional divergence in the euro area

In order to better discuss the origins of inflation and growth differentials, it is useful to make a distinction between three groups of driving factors: (i) transitory factors related to the convergence process; (ii) factors related to long-lasting or permanent differences in national economic structures; and (iii) policy-induced factors related to the conduct and operation of national fiscal and structural policies or to the various regional responses to euro area-wide policies.

The convergence process

Starting with differentials that were caused by the process of convergence prior to Stage Three of EMU, the one-off convergence of nominal interest rates towards the low rates prevailing in the best-performing countries in terms of credibility was an important temporary factor shaping economic differentials in the first years of the euro area’s existence. The adoption of the euro led to a significant reduction in both nominal and real interest rates and in financial costs in countries that had experienced higher inflation rates in the past, as well as a higher degree of integration with the financial markets of the rest of the euro area. This contributed to a surge in domestic demand in those countries, exerting sustained upward pressure on prices, particularly in the non-tradable goods and services sectors.

A second important factor was the implementation of the Single Market programme in the first half of the 1990s and the subsequent introduction of the euro in 1999. Both added to a marked decline in price level dispersion, mainly for tradable goods, which has also contributed to generating some of the inflation differentials observed in the first years of the euro. Looking ahead, the importance of this type of price level convergence for euro area inflation differentials should diminish over time.

While market integration and increased cross-border price transparency has led to convergence in the price of traded goods, a large proportion of consumer price inflation is accounted for by prices of goods and services that are not traded between countries. In this respect, the Balassa-Samuelson effect has often been discussed in relation to persistent inflation differentials in the euro area. At the centre of the Balassa-Samuelson hypothesis are differences in productivity growth between countries’ tradable and non-tradable goods sectors. In essence, this theory states that countries with large differences between their labour productivity growth rates in these two sectors – due, for instance, to a process of catching-up in income levels – will also tend to experience higher overall inflation rates. The Balassa-Samuelson effect reflects an equilibrium phenomenon: since international competition puts downward pressure on prices in the tradable goods sector, upward price pressures arise only in the non-tradable sector and the resulting inflation differentials across countries do not need to be reabsorbed. Opinions differ as to the extent to which the Balassa-Samuelson hypothesis is relevant to the euro area, partly because it is difficult to quantify the effect with any precision. Overall, there is a growing consensus that this theory constitutes only a partial explanation for the persistent inflation differentials observed in the euro area. Moreover, the size of the Balassa-Samuelson effect for countries currently in the euro area is likely to diminish over time, provided that convergence in terms of GDP per capita among those countries proceeds.

Finally, as regards the role of a catching-up effect in explaining observed growth differentials in the euro area, it is equally worth noting that gaps between euro area countries in terms of real per capita GDP seem very persistent. There are no clear indications of a tendency for countries to converge toward a common level of income, with the notable exception of Ireland and to a lesser extent Spain.

To sum up, current and past differential developments in the euro area economies can be only partly explained in terms of a process of transitory convergence. We should then look to the role played by other factors, more structural or more institutional in nature.

Structural differences

The facts presented thus far indeed appear to lend support to the argument that differences in economic developments between euro area countries stem to a significant extent from structural factors. I will concentrate on two of them.

One first element that may have contributed to lasting inflation and output differentials in the single currency area relates to member countries’ differing exposure to changes in the determinants of the external trade and in prices of raw materials. Fluctuations in these factors coupled with differences between economies in the degree of openness, in the composition of international trade and in trade links with non-euro area partner countries might be relevant factors behind inflation and growth differentials.

A second important structural factor relates to rigidities in wage and price-setting. The process of adaptation to changing economic conditions typically requires the continuous adjustment of relative prices across regions and sectors. Such a mechanism, which is a normal and desirable feature of a market-based economy, may give rise to short-lived inflation differentials across the regions and sectors of a monetary union in the face of demand and supply shocks. However, the presence of rigidities affecting the price and wage formation mechanism delays the necessary adjustment and gives rise to distortions in relative prices after such shocks, thereby contributing to lasting inflation and growth differentials. Recent provisional evidence gathered by the Eurosystem Inflation Persistence Network – a research network studying the patterns, determinants and implications of inflation persistence in the euro area and its member countries – helps to shed some light on the importance of rigidities in the price-setting behaviour of firms in the euro area. For instance, the Network calculates that average consumer price duration – the time elapsing between two successive price changes – in the euro area is between four and five quarters, compared with an estimate of around two quarters for the United States. This seems to indicate that, on average, there is greater rigidity in price-setting in the euro area than in the United States. Looking at the sectoral pattern, energy and unprocessed food prices seem to change most frequently, while services prices appear to be modified less frequently. If prices for services are indeed characterised by a systematically longer adjustment process, this could, given the large weight of this sector in the euro area economy, generate significant and persistent inflation divergence.

This conclusion would seem to sit well with the evidence I cited earlier that the services sector (which accounts for most of the price dynamics of the non-tradable sector) contributes significantly to overall inflation dispersion. It is also supported by the evidence on the importance of unit labour costs in explaining differentials in changes in GDP deflators across the euro area, given that a large share of the total output of the services sector is accounted for by employment compensation. Overall, this suggests that a substantial part of the persistent divergence of price developments may stem from differences in wage developments and in wage-setting mechanisms across euro area countries, including – in some cases – the automatic indexation of nominal wages to prices.

The role of policies

Finally, both euro area-wide and regional policies may have played a role in shaping the degree of heterogeneity in the currency union. Fiscal policies in particular could be one of the sources of output differentials in the euro area insofar the use of fiscal instruments had been inappropriate. In this respect, there is some evidence that the pro-cyclical effects of the fiscal policies of euro area countries may have helped to increase cyclical differences in the recent past. Furthermore, recent evidence exists that large fiscal deficits tend to reduce business cycle synchronisation by creating idiosyncratic fiscal shocks.

One such shock, which is the recourse to increases in indirect taxes and administrative prices, also has a particular bearing on the issue of inflation differentials. In effect, changes in administered prices, which account for around 6% of the HICP, and indirect taxes can generate inflation dispersion, at least in the short to medium term.

In principle, monetary policy could also add to growth and inflation dispersion in a currency union via its differentiated transmission across countries, particularly in the presence of differing degrees of nominal rigidities. In this respect, however, there is no conclusive evidence of systematic differences in the transmission of monetary policy impulses across regions in the euro area. The effects of monetary policy depend critically on the monetary policy regime in place, and the change in policy regime due to the introduction of the euro may have modified the transmission mechanism of monetary policy in the euro area, making it more difficult to properly and reliably extrapolate from historical experience.

Furthermore, in the public and political domains it has often been argued that the combination of uniform interest rates and inflation differentials imply different “real” interest rates across countries. It is maintained that such a difference might have a destabilising impact on national economies because, for example, countries with above-average inflation would experience lower real interest rates, which would in turn fuel domestic demand and inflation. And countries with below-average inflation would suffer from higher real interest rates, resulting in further downward pressure on domestic demand and inflation and thereby adding to the original inflation and growth differentials.

In my opinion, these views are to a large extent misleading since they neglect relevant economic considerations.

First of all, the aforementioned argument is generally made with reference to ex post measures of the real interest rate, calculated by subtracting the currently observed level of inflation from nominal interest rates. However, what matters for investment and consumption decisions are ex ante measures of real interest rates, namely the difference between market interest rates and economic agents’ expectations with regard to inflation developments over the relevant horizon. The dispersion across countries of ex ante measures of real interest rates is significantly lower than that of ex post measures. In the case of long-term interest rates, it has been approximately half that of real interest rates measured using realised inflation since 1999. Furthermore, again since 1999, the dispersion of ex ante measures of real interest rates has been about one-third of that prevailing before the introduction of the euro.

Second, and perhaps even more fundamentally, our assessment of the consequences of different real interest rates should obviously depend on the underlying causes, which could be manifold. For example, if a country’s lower-than-average inflation rate is due to higher-than-average productivity growth, this would be an indication that the country in question has strong investment prospects, even if its real interest rate is higher than that of other countries.

Finally, in a monetary union, where exchange rates among countries are by definition fixed, there are strong market-based forces that work in a stabilising manner. In particular, if a country has below-average inflation on account of weak demand, it will gain a competitive edge in relation to other countries. Over time this tends to increase demand in that country (and reduce it in others). As shown in a number of recent studies, the competitiveness (or “real exchange rate”) channel, although slow to develop, eventually becomes the dominant adjustment factor.

It must be noted that, as a consequence of the prolonged inflation differentials observed over recent years, the euro area countries have experienced marked differences the evolution of the indicator of national competitiveness. At the same time, we need to be aware of the fact that this re-equilibrating mechanism could be effective only after an extended period in the euro area, and some of the persistent divergences observed may indeed be harmful if not timely addressed.

The implications of regional divergence for the design of economic policies

What can policy-makers do to tackle regional divergences? Should we worry about regional heterogeneity in the first place?

Shocks, smoothing and policies

A proper answer to the first question, in terms of the potential role for structural and fiscal policies and for monetary policy, requires that prior consideration be given to the size and nature of regional differences and to their effect on consumption and welfare.

Several arguments could be put forward in support of taking a sanguine view on this matter. Inflation differentials are not unusually large at present and may be partly attributed to transitory phenomena. Growth rate dispersion and output gap differentials are not higher than historically, nor are they abnormally different to those in the United States or other federal countries. Further, although output per capita differentials have been very persistent over the last 30 years, the amount of risk sharing (i.e. the variance of consumption smoothed out through capital and credit markets or by tax-transfer schemes or other mechanisms) has increased dramatically since the early 1990s. This implies that EMU is probably working and asymmetries in output should be less of a concern.

A more balanced view, however, would be that these arguments are true but do not tell the whole story. Dispersion in the euro area is larger than that observed across regions of certain individual countries. In addition, as illustrated by the decline in competitiveness in recent years, the exchange rate channel seems to be operating in a very sluggish fashion.

An additional, related consideration centres on the nature of the shocks. The economic asymmetries observed among countries in a monetary union can be the result of either common shocks that propagate differently across countries or idiosyncratic shocks. This distinction is not only theoretically appealing but also crucial in terms of its policy implications. If variations in economic activity between countries with different institutions, economic structures or economic policies are driven by a common cause, national or regional policies designed to counteract the variations may be ineffective. If, on the other hand, asymmetries are the result of idiosyncratic shocks, then national policies aimed at influencing economic activity would have a role to play. This question is of particular interest in the euro area, where the use of a common monetary policy in response to idiosyncratic shocks is not feasible.

Different attempts can be found in the literature to provide a solution to this issue. The results of recent papers that apply a VAR methodology allow us to conclude that country-specific shocks, more than euro area-wide or global shocks, are responsible for the output gaps in the euro area countries and may have a long-lasting effect, thus helping to generate persistent differences across countries.

Structural and fiscal policies

Thus national policies would appear to enhance the ability of countries to address shocks and divergences. Starting with structural policies, it is widely recognised that two factors are crucial to the smooth adjustment to changing economic conditions and the efficient functioning of the labour and product markets in a single currency area: first, the mobility of factors of production and, second, the flexibility of wage and price-setting behaviour.

On the mobility of factors of production, a clear dichotomy can be observed in the euro area. On the one hand, the process of integrating capital and financial markets has already come a long way. A continuous increase in cross-border financial and capital flows is being observed, as well as increasing competition in the provision of financial services. Further action is needed, though, to remove the remaining market segmentation and regulatory impediments to free competition. If we take the deep, liquid and unified US financial markets as a benchmark, it is patent that the euro area still has some way to go, especially as regards the integration of equity markets, the establishment of common legal and regulatory frameworks, and the consolidation of the banking sector. Further integration of the European financial markets would help to reduce the volatility of consumption by increasing opportunities for risk sharing and consumption smoothing, and would also promote a more homogeneous transmission mechanism of monetary policy.

On the other hand, labour appears either to be too slow to react to wage and demand conditions or is prevented from doing so by persistently distorted price signals, leading to relatively low labour mobility between countries and regions, as well as between sectors and professions. This points to a need for more flexible labour markets in the euro area, particularly at the national and regional levels. While some discernible progress with regard to labour market reform has been seen in almost all countries of the euro area over the past decade, labour markets still appear to be too rigid and unresponsive to economic conditions – as indicated by the persistently high level of structural unemployment and the low labour force participation rates observed in most countries.

As regards the need to promote flexibility in wage and price-setting, it is crucial to continue the process of strengthening effective competition, for instance through liberalisation and deregulation, in order to improve the efficiency of price signals in the goods and services markets, and thereby enhance the efficiency of resource allocation in the economy.

Turning to fiscal policies, it is clear that proper fiscal reforms can also help to enhance the ability of individual countries to respond to economic shocks. In particular, sound government finances are crucial to allowing a country to let automatic stabilisers work fully without running the risk of excessively high deficits. This represents an important mechanism in the process of macroeconomic adjustment in response to regional divergence. Historical experience shows that discretionary fiscal policies are – especially in view of the implementation and impact lags involved – a blunt and imprecise instrument when it comes to responding to cyclical fluctuations. It is thus particularly important that governments prevent discretionary policy measures from acting pro-cyclically over the business cycle, thereby exacerbating divergences across countries in the wake of asymmetric shocks.

All in all, structural and fiscal policies that are aimed at fostering greater mobility of production factors, in particular labour, and more flexibility in price and wage-setting can increase the effectiveness of those re-equilibrating mechanisms that sometimes appear too slow to operate in the euro area.

Monetary policy

Moving to the side of monetary policy, I must recall that the establishment of the euro area spurred a far-ranging academic, but also political, debate on the proper design and conduct of monetary policy in a monetary union. More recently, these discussions have also tended to focus upon the implications of inflation differentials for the formulation of monetary policy in a single currency area, particularly where such differentials are coupled with, or are the product of, nominal and real structural rigidities. From this ongoing debate some important general conclusions can be drawn.

First, there is a broad consensus among academics, observers and policy-makers that monetary policy should focus on maintaining price stability in the single currency area as a whole. It should thus anchor inflation expectations and contribute to increasing market transparency, thereby facilitating the necessary adjustment of relative prices across different countries or sectors in the presence of economic shocks.

By contrast, it is widely recognised that assigning to monetary policy the additional role of directly addressing the balance between the sectors or regions of the single currency area in the process of adjustment to shocks would overburden monetary policy to the detriment of its primary role. This is particularly the case when, as discussed previously, asymmetries are mainly caused by idiosyncratic shocks. In that case, national economic policies are better instruments to enhance the ability of individual countries to respond to economic shocks and regional divergences.

Second, the very design of monetary policy can cater for regional or national diversity. In fact, the presence of long-term equilibrium inflation differentials across countries constitutes one of the central justifications for a central bank aiming to maintain the inflation rate in the currency area as a whole at a very low level, although not too close to zero.

Third, it is important for the central bank to take into account regional and sectoral information on the source and nature of economic shocks, which includes monitoring and understanding the underlying reasons for inflation differentials, even if policy is formulated with a view to maintaining price stability for the currency area as a whole.

Finally, by maintaining a medium-term orientation in the conduct of its monetary policy, a central bank can facilitate the necessary adjustment of relative prices across regions and sectors in the presence of asymmetric shocks.

Let me say that those principles are indeed present in the ECB’s monetary policy strategy.

First, as laid down in the Treaty establishing the European Community, the primary objective of the Eurosystem is to maintain price stability for the euro area as a whole. By keeping price levels stable, monetary policy contributes to the adjustment of relative prices and facilitates their role in guiding the allocation of resources across the sectors and countries of the euro area. This is the best contribution that monetary policy can make to economic welfare and the attainment of high levels of economic activity and employment. In May 2003 – as part of its review of the ECB’s monetary policy strategy – the Governing Council of the ECB clarified its price stability objective, explaining that, in pursuing price stability, it aims to maintain inflation rates “below but close to 2%” over the medium term. By specifying that it aims to keep the inflation rate close to the upper bound of its definition of price stability, the Governing Council made it clear that this also takes into account the implications of inflation differentials across the countries of the euro area. In particular, it provides an adequate safety margin to prevent some regions from structurally operating at negative inflation rates. It was thus recognised that inflation differentials could pose a risk for regions with structurally lower inflation rates in terms of the potential costs of adjustment associated with the possible presence of downward nominal rigidities.

Second, while the ECB’s internal work, analysis and assessment of economic information, its policy deliberations and its decisions are fully aligned with the goal of maintaining price stability for the euro area as a whole, this does not mean that the ECB looks exclusively at euro area-wide information. In order to achieve its objective and, in particular, to conduct its broad-based analysis of the risks to price stability over the medium term, the ECB regularly reviews and analyses all relevant information relating to the various sectors and countries of the euro area. Thus, we closely monitor sectoral and national developments in order to better formulate our assessment of the economic situation and its likely evolution for the euro area as a whole. Indeed, it is essential that the monetary policy-maker is able to understand the source and nature of economic shocks – whether demand or supply-related, whether permanent or temporary – and to assess their effects on the economy as a whole in order to formulate the best possible monetary policy response. In this respect, the analysis of disaggregated information is crucial, as many shocks of euro area-wide relevance originate in specific countries or sectors.

Finally, a key element of the ECB’s monetary policy strategy is its medium-term orientation, which implies that it does not attempt to maintain or restore price stability in the very short term in the wake of economic changes. This allows the ECB to formulate the best possible monetary policy taking due account of the nature of economic shocks and, at the same time, to provide flexibility for individual economies or sectors to adjust gradually after localised or asymmetric shocks.

Final remarks

Dear colleagues,

It is time for me to conclude. I have today stressed a factual point: growth and inflation differentials among euro countries are far from being large, whether from a historical perspective or compared with other monetary unions. They appear to be, however, relatively persistent.

While differences across countries can be seen as a normal feature in any monetary union, lasting economic differentials that are the product of misaligned national policies and/or deep-seated structural inefficiencies may be damaging for the national economies and need to be addressed by national policies. In particular, it is crucial that countries pursue suitable structural policies aimed at enhancing their flexibility and adaptability to continuously changing conditions in the monetary union.

On the monetary policy front, by anchoring inflation expectations and increasing transparency, the ECB’s monetary policy is contributing to the adjustment of relative prices, thereby facilitating their role in guiding the allocation of resources across countries and sectors. As an indication of the success of this strategy, I draw your attention to the fact that inflation expectations at the level of the individual countries are more closely aligned than observed inflation rates. Given the importance of expectations for future developments in wage and price-setting behaviour, this implies that a powerful mechanism has been put in place to help keep economic developments across the individual countries of the euro area closely bound together.

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