European Central Bank (ECB) President Mario Draghi is to be commended for doing something that only a few other central bankers have attempted, and almost none have done successfully.
In his speech Friday to the Jackson Hole, Wyo., gathering of central bankers and economists, he linked the ECB's willingness to do more to the progress governments make in implementing supportive measures. He did so by making five points that should be mandatory reading for Europe's political leaders.
First, Draghi opened his speech by remarking that "no one in society remains untouched by a situation of high unemployment." As he illustrated in the data and analysis provided, which included an insightful discussion of the additional challenges of a monetary union, Europe faces an urgent unemployment problem that involves worrisome economic, financial, policy, political and social dimensions. It is also "a source of fragility for the monetary union."
Second, Draghi discussed the solutions to Europe's unemployment predicament by noting that "the only conclusion we can safely draw, in my view, is that we need action on both sides of the economy: aggregate demand policies have to be accompanied by national structural policies." This isn't a fudge, nor is he dodging the heated debate among economists regarding the role of cyclical and structural forces. Rather, it is an honest assessment of the situation facing Europe, acknowledging that "estimates of the degree of cyclical and structural unemployment have to be made with quite some caution."
Third, and based on his policy analysis, Draghi acknowledged that the ECB is ready and able to do more within its mandate by using "all available instruments." And for those who worry about the balance of risks, Draghi argued that "the risks of 'doing too little' — i.e., that cyclical unemployment becomes structural — outweigh those of 'doing too much' — that is, excessive upward wage and price pressures."
Fourth, Draghi rightly stressed that the ECB's policy effectiveness is critically linked to progress made by governments in delivering a more comprehensive policy response. He was blunt about this, stating that "aggregate demand policies will ultimately not be effective without action in parallel on the supply side." Indeed, "no amount of fiscal or monetary accommodation . . . can compensate for the necessary structural reforms in the euro area." As such, if the ECB continues to carry most of the policy burden, as it has done for most of the post-crisis period, it is only a matter of time until the potential costs of its unbalanced policy stance outweigh the benefits.
Finally, Draghi helped to set the policy agenda for the politicians. In favoring a more accommodating fiscal stance, he argued that "existing flexibility within the rules" allows for budgetary loosening along with pro-growth tax reforms. And in pushing for more meaningful structural reforms he singled out "labor markets, product markets and actions to improve the business environment."
In venturing well beyond monetary policy, and in linking further monetary measures to policy actions elsewhere, Draghi exposed himself and the central bank he leads to a broader set of reputational and credibility risks. He should be commended and supported for doing so. Now it is the turn of the politicians to be more forthcoming in delivering on their economic governance responsibilities.
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