What role for fiscal vs monetary policy? Which has more scope left?

How to combine them?

SUERF conference - Racing for Economic Leadership: EU and US Perspectives

Presentation by Marco ButiDirector General for Economic and Financial Affairs

16 October 2019

The euro area outlook is clouded…

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

Sep 17 Jan 18 May 18 Sep 18 Jan 19 May 19 Sep 19

Forecasts for 2019Euro area real GDP growth (%)

IMF ECFIN OECD ECB Consensus

0.8

1.0

1.2

1.4

1.6

1.8

2.0

2.2

2.4

2.6

Sep 18 Nov 18 Jan 19 Mar 19 May 19 Jul 19 Sep 19

Forecasts for 2020EA real GDP growth (%)

IMF ECFIN OECD ECB Consensus

…and downside risks to growth remain prominent

-10

-8

-6

-4

-2

0

2

4

6

8

10

Apr.17 Oct.17 Apr.18 Oct.18 Apr.19

Economic sentiment indicator, change since 17-Q1

EA19 DE ES FR IT NL

3mma

0

1

0

50

100

150

200

250

300

Jan.11 Jan.13 Jan.15 Jan.17 Jan.19

Global Economic Policy Uncertainty Index6 mma

Source: www.policyuncertainty.com

Start of the Europeansovereign debt crisis

Brexit vote and2016 US Presidential elections

Shift in US trade policy; withdrawal from Iran deal; instability in emerging market economies

Inflation remains subdued

1.0

1.5

2.0

2.5

3.0

Jan

10

Sep

10

Ma

i 11

Feb

12

Okt

12

Jun

13

Mrz

14

No

v 14

Au

g 1

5

Ap

r 1

6

De

z 1

6

Sep

17

Ma

i 18

Jan

19

Long-term inflation expectations

ECB SPF 5Y ahead

5Y5Y inflation swap

ECB medium-term objective

-1

0

1

2

3

Jan 10 Jan 12 Jan 14 Jan 16 Jan 18

Headline HICP and core inflation

HICP

Core Inflation

%

Interpretation of the slowdown: two views

Cyclical slowdown

Diagnosis

• Unemployment reaching record low, wage inflation before the slowdown

• Decreasing interest rates and flat yield curve due to monetary accommodation

• Monetary policy with enough space to act; fiscal policy less effective

Policy prescription

➔ Go slow

Secular stagnation

Diagnosis

• Wage inflation stubbornly low: Phillips curve rather flat, risk of inflation trap

• Structurally low interest rates and flat yield curve reflect low r*

• Monetary policy increasingly constrained; fiscal policy more effective

Policy prescription

➔ Act now

Monetary easing continues, but faces increasing constraints

-1.0

-0.5

0.0

0.5

1.0

1.5

1M 3M 6M 9M 1Y 2Y 3Y 5Y 7Y 10Y 15Y 30Y

% 1M Eonia forward curve

28.12.2018

07.06.2019

27.09.2019

Source: Bloomberg

0

1

2

3

4

5

6

7

2004 2006 2008 2010 2012 2014 2016 2018

CCCI of HHs

CCCI of NFCs

Last observation: July 2019

Composite credit cost indicators

Sources: ECB, Bloomberg, Datastream, DG ECFIN calculations

Fiscal stance has been broadly neutral

Development over years• Contractionary and

pro-cyclical in 2011-2014

• Broadly neutral in 2015-2017

• Turning mildly expansionary since 2018 / 2019

➔ Change in fiscal stance has helped economic recovery in the euro area since 2015

Fiscal stance in the euro area

-4,0

-3,5

-3,0

-2,5

-2,0

-1,5

-1,0

-0,5

0,0

0,5

1,0

1,5-0,75

-0,50

-0,25

0,00

0,25

0,50

0,75

1,00

1,25

1,50

1,75

2,00

2012 2013 2014 2015 2016 2017 2018 2019

Change in SB Change in SPB DFE Output Gap (rhs - inverted)

exp

an

sio

nary

co

ntr

acti

on

ary

Broadly neutral

➔ Time to shift to a more supportive stance?

Fiscal policy: differentiation is key

• Need for a moderate fiscal expansion to support ECB in fighting the slowdown

• But differentiation across countries is key

• Focus on productive spending for sustainable & green growth

• Need to convince some Member States

Fiscal stimulus: positive and lasting effects

• r < g

• no monetary policy response for 2 years assumed (lower bound)

→ Modest positive GDP spillovers to other trading partners

→ Small improvement in government debt-to-GDP ratio in trading partners

GDP

Debt-to-GDP ratio

Temporary 2 year fiscal stimulus in Germany and NetherlandsDebt-financed 1 % of GDP increase in productive public investment

… and other challenges too: Climate change, Digitalisation, Inequality, Ageing

Structural challenges facing the EU economy

The productivity challenge…Labour productivity and TFP developments in euro area and EU28 compared to US and Japan

Structural policy responses

Policy choices in autumn to address both short-term and long-term challenges

c)

Adequate ST/LT

policy mix

Structural reforms:

• Feasible

• Forward-looking

• Fair

a) b)

Monetary policy:

• Patient

• Persistent

• Prudent

Fiscal policy:

• Timely

• Targeted

• Temporary?

Questions:a) Can monetary policy achieve internal and external equilibrium alone?b) Time to shift from a neutral to expansionary fiscal stance?c) What positive incentives for structural reforms?

THANK YOU

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