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08 October 2015

ECB: EMU – disappointed expectations and how to move forward

ECB's Praet outlines why the EMU has been disappointing so far and how to improve its performance implementing structural reforms such as encouraging firms to grow in size or to enter new markets, improving the efficiency of financial markets through the CMU project and completing the Single Market.

Remarks by Peter Praet, Member of the Executive Board of the ECB, at the 5th SEEK Conference on “Overcoming the Crisis: How to Foster Innovation and Entrepreneurship in a Diverging European Economy?”, Mannheim


Our policy has clearly contributed to stabilising the macroeconomic environment. We have always decisively addressed signs of a de-anchoring of inflation expectations. But stabilisation policy can ultimately only buy time for the second type of policy response to be implemented – addressing institutional weaknesses. So has the time bought by our actions been used well? In my view the answer is a qualified yes.

In terms of structural reforms, a great deal of activity has taken place since 2010. To give just a few examples, Greece, Portugal and Spain have all taken measures to improve competitiveness (such as increasing wage decentralisation), to strengthen competition (such as reducing barriers to entry in professional services), to enhance economic efficiency (such as improving the functioning of the judicial system), and to raise employment (such as increasing flexibility over working arrangements). Similar reforms have also been implemented in Italy, Slovenia and Cyprus.

Overall this had led to several countries improving their positions in global rankings of structural policies, which should now put them in a stronger position to reap the microeconomic benefits of monetary union. We should nonetheless not forget the lesson of the pre-crisis period that reform momentum can wane as economic conditions improve. The recommendations in the recent “Five President’s” report therefore aim to keep up that momentum by setting out a process of convergence towards “similarly resilient economic structures”. 

We have also seen, in recent years, a strengthening of institutions in other areas where vulnerabilities were revealed by the crisis. We now have a reinforced European framework that should, if implemented effectively, produce stronger governance over fiscal policies, while also allowing some flexibility for the possible short-term costs of implementing structural reforms. It is important, however, that the assumptions underlying decisions to use such flexibility are spelled out in a clear and transparent way ensuring a consistent application over time and across countries.

Perhaps most importantly, policymakers have acknowledged that sustainable financial integration does not follow automatically from sharing a currency. In short, a monetary union comprised of sovereign states requires a Banking Union. That has now largely been brought into being with the creation of the Single Supervisory Mechanism and the Single Resolution Mechanism, backed by a Single Resolution Fund.

Banking Union should, in principle, support the functioning of the EMU framework in two crucial ways. First, European banking supervision should improve the capacity for micro- and macro-prudential policies to be used counter-cyclically, thereby helping contain boom-bust dynamics. Second, European banking resolution should provide a framework for harmonised and predictable burden-sharing through the private sector, which is key to create the conditions for deeper retail banking integration, and hence for the financial risk-sharing benefits of monetary union to materialise. What is needed now is for Banking Union being completed in all the areas that have been identified.

The challenge of lifting productivity

[...] in my view further reforms will be needed to decisively shift expectations, in particular in the priority area of raising total factor productivity (TFP) which is ultimately what drives long-term growth. The difference between the euro area and the US in this regard shows the possibilities we have for improvement. [...]

Many euro area economies are characterised by a high proportion of micro and small firms, especially in comparison with the US. While small firms can add important value to the economy – indeed, young firms create most net new jobs – that value diminishes if they do not grow over time. [...]

Within firms, firms that stay small tend to be less likely to invest in new technologies, in particular ICT investments that are crucial to succeed in the digital economy. [...]

This demonstrates that creating the conditions for a more dynamic distribution of firm growth could make a decisive difference to TFP developments in the euro area – and this is where the need for further structural reforms comes in. Let me lay out just a few of the channels through which structural reforms could support this process.

Structural reforms and firm dynamics

First, by removing regulations that encourage firms to stay below certain size thresholds. [...]

Second, by making it easier for new firms to enter markets and non-productive ones to exit. [...]

Third, by improving the efficiency of financial markets so that resources can be reallocated between growing and shrinking firms. In this context the key structural reform is advancing with the Capital Markets Union project, which should help deepen markets in Europe for early stage venture capital, as well creating new opportunities for market financing [...]

Fourth, by improving human capital, especially in the area of digital skills. [...]

Finally, efforts to complete the Single Market – which can be considered a structural reform – would strengthen incentives for firms to innovate and grow in order to benefit from the greater demand of a larger market and to exploit economies of scale. [...]

Full speech

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