I was in Brussels on Monday to present my latest briefing paper to the European Paliament’s Economic and Monetary Affairs committee. The paper addresses issues related to inflation differentials in the euro area and argues that the ECB’s failure to meet its inflation target is significantly complicating the process of adjustment throughout the euro area.
After the briefing, I attended the committee’s “monetary dialogue” session with Mario Draghi. In this session, Draghi repeated a line that he has been using over the past few weeks about how monetary and fiscal policies cannot work unless countries implement a set of unspecified “structural reforms.” In light of these comments, I’ll repeat the last few paragraphs of my paper here.
As the ECB takes a more active role in battling the ongoing slump, Mario Draghi has intensified his rhetoric about structural reforms. The transcript of his September press conferences shows fifteen uses of this phrase. Draghi now says he has “concluded that there is no fiscal or monetary stimulus that will produce any effect without ambitious and important, strong, structural reforms.”
It is hard to find a logic (at least one based on macroeconomic theory as we know it) for this argument. It is certainly the case that potential output growth in the euro area is currently low and can be improved by various policy reforms. However, it is also true that there is currently a very large shortfall between aggregate demand and the current supply potential of the euro area economy, a shortfall summarised in an unemployment rate of over 11 percent. So there is room for fiscal and monetary stimulus to boost the economy, even without structural reforms. In addition, to the extent that we are worried about deflation, the initial impact of structural reforms that boosted the supply capacity of the euro area would be to further depress inflation.
My point here is not to argue against structural reforms. There are many such reforms that can have an important positive effect over the medium- and longer-run (though we know little about the magnitude of their potential impact). But it is important for the ECB to take responsibility for its crucial role in the shorter-term macroeconomic management of the euro area and ECB officials continually placing structural reforms at the heart of discussions of this issue is unhelpful.
Draghi has many very well-qualified economic advisers — one of the very best, Frank Smets, was sitting beside him at the monetary dialogue. Let’s hope they can pursuade him to abandon this unfortunate and unnecessary line of rhetoric.