Managing Europe’s economic recovery after the pandemic
Speech by Luis de Guindos, Vice-President of the ECB at the London School of Economics German Symposium
Frankfurt am Main, 10 February 2022
Thank you for inviting me to this symposium to speak about Europe’s economic recovery. When I joined you last year, our discussion was very engaging, so I’m very much looking forward to our exchange here today.
In my opening remarks, I will cover three key goals for the EU economy: recovery, renewal and resilience. Achieving these three goals will be essential to addressing the key challenges faced by the European economy as we emerge from the pandemic and transition towards a zero-carbon and digital economy.
To illustrate where we stand, I will start with the euro area economic outlook and the ECB’s monetary policy. I will then move on to discussing how further deepening Economic and Monetary Union can help tackle the longer-term economic challenges for our financial sector and economic governance.
Euro area economic outlook and the ECB’s monetary policy
Exceptional fiscal and monetary stimulus has been essential in supporting the ongoing recovery of the euro area economy. While real GDP returned to its pre-pandemic level in the final quarter of 2021, growth moderated during that period and economic activity is likely to remain subdued in the early part of this year. However, we expect growth to rebound strongly over the course of 2022. Over the next three years, we anticipate that euro area growth will remain above its long-term average.
As has been widely discussed, there has been significant volatility in the path of inflation since the start of the pandemic. Measures to contain the spread of the coronavirus (COVID-19) initially depressed inflation by curtailing economic activity. However, inflation has risen sharply in recent months and it has further surprised to the upside in January, reaching 5.1%. This is primarily driven by higher energy costs that are pushing up prices across many sectors, as well as higher food prices. Inflation is likely to remain elevated for longer than previously expected, but to decline in the course of this year.
That is the central case, but there are upside risks to that outlook. Inflation could turn out to be higher if price pressures feed through into higher-than-anticipated wage rises, or if the economy returns to full capacity more quickly than foreseen.
Our monetary policy measures have enabled us to successfully navigate the pandemic emergency. In view of the progress on economic recovery and towards our medium-term inflation target, at our February meeting the Governing Council confirmed the decisions taken at our monetary policy meeting last December. Accordingly, we will continue reducing the pace of our asset purchases step by step over the coming quarters, and will end net purchases under the pandemic emergency purchase programme (PEPP) at the end of March.
At the same time, in view of the current high level of uncertainty, we need more than ever to maintain flexibility and optionality in the conduct of monetary policy. We stand ready to adjust all of our instruments, as appropriate, to ensure that inflation stabilises at our 2% target over the medium term.
Regarding the future path of our policy rates, our forward guidance on the conditions under which they will be raised is clear. To reiterate, we would need to see inflation reaching 2% well ahead of the end of the projection horizon and durably for the rest of the projection horizon. We would also need to judge that realised progress in underlying inflation is sufficiently advanced to be consistent with inflation stabilising at 2% over the medium term.
Some other central banks have either already raised rates or indicated that they will soon do so. In making comparisons, it’s worth remembering that the euro area is at a different stage of the economic cycle, just as it was when the pandemic started. So it’s natural that central banks around the globe won’t necessarily start raising rates at the same time. We are guided by our forward guidance conditions and will act if, and when, they have been met.
In its new monetary policy strategy, the ECB gives financial stability considerations greater prominence in its monetary policy deliberations. Financial stability is a precondition for price stability. By the same token, while monetary accommodation supports financial stability via a number of channels, it might also lead to the build-up of systemic risks, which warrants monitoring from a macroprudential perspective. By addressing financial stability risks, including possible risks stemming from the unintended effects of monetary accommodation, macroprudential action enables monetary policy to focus on its primary objective of price stability.
A robust banking union and a deeper capital markets union
Fiscal and monetary policy support have been indispensable to avoiding a much deeper economic downturn. But we should not overlook the decisive role played by the EU financial sector in weathering the crisis. Our financial sector was more resilient than in the past, thanks to the progress we have made on deepening European Economic and Monetary Union and enhancing the EU’s regulatory and supervisory framework since the global financial crisis. This has been crucial for absorbing the shock of the pandemic and paving the way towards recovery. Banks had reinforced their buffers and the banking union allowed our single banking supervisor to respond decisively and uniformly, ensuring that banks continued to fund the real economy.
However, despite the important progress made, we cannot afford to rest on our laurels. New challenges are looming, and we need to strengthen the EU’s banking and capital markets further to be ready to face them.
Progress on completing the banking union and deepening the capital markets union is not just needed to make the financial sector more resilient to future shocks. It will also help the sector address some of its structural challenges. These include low bank profitability, growing competition from fintech giants and a fragmentation of debt and equity markets along national lines.
A strong financial sector, with a complete banking union and deeper capital markets union as its foundations, is all the more important as the EU faces up to the generational challenge of renewing our economy by making it greener and more digital. The European Commission estimates that additional private and public investment of about €650 billion will be required over the next eight years alone. This funding cannot be mobilised without a strong and robust financial sector.
Against this background, we need to see political agreement on an ambitious workplan to make progress with the key missing elements of the banking union and to ultimately complete the project. This would enable banks to conduct their business across the banking union without being hampered by national borders, allowing financing to reach the most promising projects. This increased integration would also make the banking sector more resilient.
The workplan should therefore include proposals to achieve a fully integrated banking market as well as proposals to improve the crisis management framework, including by setting up a European deposit insurance scheme. Another element that is crucial if banks are to become more resilient is the ongoing implementation of the Basel agreement on banking regulation in the EU. This will lead to a stronger prudential framework and help tackle emerging risks, such as environmental and social risks.
Creating a genuine capital markets union is another priority that can help us tackle the EU’s longer-term economic challenges. Important progress has been made since the European Commission’s first Action Plan from 2015 and we welcome the four legislative proposals put forward by the Commission in November 2021. In particular, the proposed European Single Access Point will make it easier for investors to identify suitable firms and projects, thus improving companies’ access to funding. To best reap the benefits of a diverse and broad investor base, easy access for as many investors as possible is key.
The Commission’s most recent capital markets union package is an important step forwards. But further work is also needed to achieve a deeply integrated capital market in the EU that can easily operate across borders, including in green markets. In particular, harmonising insolvency rules, withholding tax and capital markets supervision across Member States are legislative projects we consider particularly important. Similarly, the debt-equity bias, which favours debt over equity financing, should be reduced, and venture capital frameworks across Member States should be harmonised. Both are important policies to promote financing for innovation. Only with adequate private financing can we harness the full potential of public recovery programmes and EU climate policies in fostering the green and digital transitions.
Importantly, banks and capital markets complement each other in financing the real economy. This means that these two projects – banking union and capital markets union – will reinforce each other and must be developed in parallel.
The future of economic governance
Finally, let me turn to a further aspect of deepening Economic and Monetary Union, which is crucial for securing a sustainable long-term recovery – the EU’s Stability and Growth Pact. The ongoing review of the EU’s economic governance framework will be key in this respect.
The review is essential for resilience, because the fiscal framework needs to ensure the right balance between sustainable fiscal positions and sustainable growth. And it is essential for the renewal of our economies because substantial public investment will be indispensable to driving and complementing the private investment that is needed for the digital and green transitions.
To achieve these goals, four elements are particularly crucial:
- First, the fiscal rules should become simpler, more transparent and more predictable. There should be less reliance on the output gap, which is unobservable, and greater focus on an expenditure-based rule.
- Second, a realistic, gradual, and sustained adjustment of public debt is important to rebuild fiscal space. The debt rule, which defines the speed of debt reduction within the SGP, would need to be reformed to guide such an adjustment.
- Third, a broadened, fully independent assessment by strengthened independent fiscal institutions could help to reduce the procyclical tendencies in fiscal policymaking and support national ownership.
- And fourth, fiscal policy should become more growth-friendly. The unprecedented financing provided by the EU in the form of the Next Generation EU programme will need to be complemented by sustained nationally financed investment.
Let me make one final point – after 30 years of the Maastricht Treaty, and 30 years of building Economic and Monetary Union, we should keep looking forwards. In the long term, we need to look towards building a central fiscal capacity. If appropriately designed in an efficient countercyclical fashion, with buffers created in good times that can be released in downturns, this central fiscal capacity could play an important role in enhancing both macroeconomic stabilisation and convergence in the euro area.
Let me conclude. We have to remain ambitious on the path to ensure the recovery, renewal and resilience of the EU economy. The joint fiscal, monetary, regulatory, and supervisory response to the COVID-19 crisis has been instrumental for the recovery. It has shown what can be achieved when we all work together in a coordinated manner, while fully respecting our mandates.
Similarly, the necessary renewal of our economy and the need to further increase the resilience of the European financial system call for joint action by all relevant stakeholders. We need to make progress, in parallel, on the banking union, the capital markets union and fiscal governance. This is now more crucial than ever if we are to achieve the key goals for our economy and ensure the welfare of present and future generations.
At the same time, in view of the current high level of uncertainty, we need to maintain flexibility and optionality in the conduct of monetary policy. The ECB stands ready to adjust all of its instruments, as appropriate, to ensure our primary target of price stability.
Thank you for your attention.
- European Commission (2021), “The EU economy after COVID-19: implications for economic governance”, Communication from the Commission to the European Parliament, the Council, the European Central Bank, the European Economic and Social Committee, the Committee of the Regions, 19 October.
- European Commission (2021), “Capital markets union: Commission adopts package to ensure better data access and revamped investment rules”, 25 November.
- All these legislative projects are included in the 2020 CMU action plan adopted by the European Commission on 24 September 2020. In particular, Action 10 aims to alleviate the tax burden associated with investing across borders. Action 11 aims to make the outcome of cross-border investment more predictable by harmonising insolvency proceedings. Finally, Action 16 aims to propose measures for stronger supervisory coordination or direct supervision of European capital markets by the European Supervisory Authorities.
- Constâncio, V. (2017), “Synergies between banking union and capital markets union”, speech at the joint conference of the European Commission and European Central Bank on European Financial Integration, Brussels, 19 May.
- ECB (2021), “Eurosystem reply to the Communication from the European Commission “The EU economy after COVID-19: implications for economic governance” of 19 October 2021”, 1 December.