Christine Lagarde has called on European governments to boost public investment and increase harmonisation in services, banking and capital markets to rebalance the region’s economy away from exports to domestic demand.
Giving her first big policy speech since replacing Mario Draghi as European Central Bank president on November 1, Ms Lagarde said Europe had a “moment of opportunity” to tackle the challenges presented by trade tensions and technological disruption.
“We have a unique possibility to respond to a changing and challenging world by investing in our future, strengthening our common institutions and empowering the world’s second-largest economy,” she told a banking conference in Frankfurt on Friday.
The new ECB president drew a distinction between general government spending and “productive expenditure — which, in addition to infrastructure, includes R&D and education”. She said productive investment had fallen as a share of overall public spending in most eurozone countries, while “new investment needs are emerging”.
The ECB would “continue to support the economy and respond to future risks”, she said, adding that monetary policy “cannot and should not be the only game in town”.
Promising to “continuously monitor the side-effects of our policies”, she said the ECB would launch “in the near future” the first strategic review of its policy objectives and tools since 2003.
Jens Weidmann, the head of Germany’s central bank, spoke a few hours after the new ECB boss and delivered a clear warning that he would oppose any effort to signal that interest rates would be lower for longer by changing its inflation guidance.
Laying down a marker ahead of the strategic review, the Bundesbank president said he would look unfavourably on any shift to a more symmetrical target that accepted a period of inflation in excess of its objective.
“A one-off promise of ‘lower for longer’ holds the allure of a monetary stimulus now, at the cost of higher inflation in the future,” he said. “But when the time comes to make good on the promise, the benefits have already been reaped, and only the cost of higher inflation remains. At this point, policymakers have an incentive to renege on their promise as well.”
The US Federal Reserve has already launched a strategic review, as part of which it is considering introducing a “make-up” rule that would mean if it undershoots its inflation target it would promise to overshoot it by a similar amount in the future.
But Mr Weidmann said this would present “a communication challenge and a credibility risk” for the ECB because it would breach its main objective to achieve inflation below, but close to, 2 per cent.
The Bundesbank chief opposed many of Mr Draghi’s loosening policies but lost out to Ms Lagarde in the race to succeed him.
Echoing a core message of her predecessor, Ms Lagarde pointed out that eurozone public investment remained “some way below its pre-crisis levels”. She said: “It is clear that monetary policy could achieve its goal faster and with fewer side-effects if other policies were supporting growth alongside it.
“While investment needs are of course country-specific, there is today a cross-cutting case for investment in a common future that is more productive, more digital and greener,” she said.
She argued that the eurozone had been slower to embrace innovation and new technologies and, as a result, total factor productivity growth had risen by only half as much in the region as it had in the US since 2000.
To increase productivity, Ms Lagarde said that the EU needed more integration in areas such as services, capital markets and the banking sector. “All of this would be a game changer, not just for our own stability and prosperity, but for that of the global economy, too,” she said.
Christine Lagarde must resist pressure on the ECB’s inflation target
“The answer lies in converting the world’s second-largest economy into one that is open to the world but confident in itself — an economy that makes full use of Europe’s potential to unleash higher rates of domestic demand and long-term growth.”
Her speech was warmly welcomed by senior bankers at the event. Christian Sewing, chief executive of Deutsche Bank, said: “This was the most encouraging speech I have heard for several years in Europe.”
But some economists were underwhelmed by the lack of detail on her monetary policy plans.
“For the time being, [Ms] Lagarde meets the expectations that she could become the leading economic and political voice for Europe rather than quickly shaking up the ECB,” said Carsten Brzeski, economist at ING.