Monetary Policy and European Growth

Time and again “experts” from all areas try to exert pressure on the European Central Bank to relax its anti-inflationary monetary policy in order to increase economic growth in the euro area. But monetary policy is not the answer to Europe’s ills. Indeed, a babel of criticism may prevent people from seeing that the euro area has witnessed ample economic progress since the euro’s launch. The broad macroeconomic fundamentals of sustained growth are, in fact, more favorable today than they have been for years. Europe’s challenge is to exploit this economic potential. It is thus important to be clear about what monetary policy can and cannot do to contribute to Europe’s growth so that other necessary – though often politically difficult – reforms are not neglected. Although there are some theoretical ambiguities, the best available evidence suggests that, in the longer term, inflation is harmful to both output and welfare. The corollary of this is that the best contribution a central bank can make to assure that growth is achieved over the long run is to pursue a policy aimed at maintaining price stability over the medium term. This consensus view is enshrined, explicitly, in the statute of the ECB, which unambiguously states that its “primary objective...shall be to maintain price stability.” But what about the short term? Many commentators suggest that a monetary policy directed at price stability may lead to protracted, and in extreme cases, permanent negative movements in output. The mechanism invoked is