RegStream

Interview with Philip R. Lane, Member of the Executive Board of the ECB, conducted by András Szigetvari13 January 2025

Is the inflation crisis in the euro area already over?

The recently released inflation figure shows that inflation stood at 2. 4 per cent in December 2024, down from 2. 9 per cent a year earlier. In late 2022, inflation had reached 10 per cent. Compared with these figures, we have made significant progress in terms of bringing inflation down, not all the way to 2 per cent, but close. But an important concept for us is that inflation should be sustainably at 2 per cent. We had a decline in energy prices, which ultimately brought down overall inflation. That is not going to continue. For inflation to be at our target of 2 per cent sustainably, there would need to be a further decline in services inflation from around 4 per cent today.

What can the ECB do?

We need to ensure that interest rates follow a middle path. If interest rates fall too quickly, it will be difficult to bring services inflation under control. But we also don’t want rates to remain too high for too long, because that would weaken the inflation momentum in such a way that the disinflation process would not stop at 2 per cent but inflation could materially fall below target. That is also undesirable. The markets don’t expect us to keep the policy rate at 3 per cent. I agree that the direction is clear. But what we will have to work out this year is the middle path of being neither too aggressive nor too cautious in our actions.

What does that mean in practice? Could you specify where interest rates will end up?

It would be a mistake to try and inhibit our future decision-making and provide reference points about exact values. We think inflation pressure will continue to ease this year. Wages in the euro area rose considerably in 2023 and 2024. But the information we have is that wage increases in 2025 will be significantly lower, meaning that inflation will continue to decline. But we also need to make sure that the economy does not grow too slowly, because then we face a new problem, which is that inflation might stabilise below the target.

A survey published in the Financial Times a few days ago suggests that a large number of economists think the ECB was too slow in reducing interest rates given that growth in the euro area is very weak. How would you respond to this criticism?

We lowered the interest rate from 4 per cent in June to 3 per cent in December. Our primary focus is on inflation. Of course, we also look at the economy as well. We don’t want to do any unnecessary damage to the economy. Growth is a basic driver of inflation dynamics. Please remember that there are also positive economic trends. Unemployment in the euro area remains at 6. 3 per cent, so the labour market is resilient. We expect a moderate recovery in the economy. We do not see the kind of recessionary risk that would call for a dramatic acceleration in monetary easing.

The situation is not the same for all euro area countries. Germany and Austria suddenly fell by the wayside and have not been growing for the past three years. Why is that?

The ECB can only respond to the overall performance of the euro area as a whole. We cannot customise monetary policy to different countries. If the whole euro area were suffering as much as Germany and Austria, monetary policy would adapt. Some EU countries are growing at solid levels – Spain is the most visible example among the larger countries. So for the countries where there is a shortfall, we need to understand the reasons for this. Some countries are more reliant on manufacturing, which is facing challenges globally. The car industry, in particular, faces major challenges. But energy-intensive sectors have also seen a big impact from the Russia-Ukraine war.

How concerned are you about that? If there is a major structural crisis, it will take parts of the euro area a long time to recover.

It’s important to differentiate between cyclical and structural problems. But we have to acknowledge that these interact. For example, if you have a structural challenge in manufacturing but other sectors in the economy are growing more strongly, then these can pick up the slack. Investment is currently low, but if investment improved due to lower interest rates, it would alleviate the structural problems. So cyclical and structural factors really do interact.

But isn’t the ECB exacerbating the crisis: lower interest rates could boost investment activity. Admittedly, that’s not an option if the ECB strictly adheres to its inflation target of 2 per cent.

There is no big conflict between delivering the 2 per cent inflation target and making sure the economy grows at a sufficient pace. We don’t have to bring the euro area into a recession to achieve our goal of price stability. And if the economy is not growing quickly enough, we will undershoot our target. An inflation of 2 per cent requires the economy to grow and invest. Mario Draghi’s report on strengthening the competitiveness of the euro area is very rich. In fact, many of the proposed action points would not require extra spending. A key topic is accelerating reforms. It’s about ensuring that the European economy is sufficiently integrated, that we have a domestic market large enough for the biggest companies to be able to grow fast enough. There are also sectors where additional public expenditure is needed. But deepening the Single Market is a top priority.

The Draghi report also calls for more investment. Many EU Member States are now beginning to consolidate their budgets as agreed. Won’t tightening our belts lead to a next crisis?

The deficits of euro area countries average around 3 per cent. In 2019 that figure was 0. 5 per cent. So, we’re seeing a lot more fiscal support for the economy. But the challenges are of course serious, due to demographics, the green transition and defence spending needs. It will be a challenge to keep the deficits at around 3 per cent. But we’re not seeing fiscal tightness as we did before the pandemic.

At the same time, though, countries like the United States or Japan are laughing at Europe for trying to keep the deficit at 3 per cent. Their debt levels are twice as high.

There is a serious debate going on in the United States about whether it would be wise to narrow the deficit. But focusing on Europe, the Draghi report emphasises that if reforms boosted the growth rate of the euro area economy, the fiscal situation would look a lot better. So we should focus the debate on how Europe can grow more quickly.

What reforms could boost growth in the euro area without creating additional expenditure?

Europe has plenty of ways to grow faster. It is becoming more and more important to scale up economic activity. Expanding markets for goods and services by way of more integration would help our economy.

Could you give a concrete example?

One is the energy market, which in Europe is still fragmented. A single market would be more efficient. Another is the telecoms industry. In the United States there are a few large providers, in Europe there are a lot, some of which may not be able to reach the necessary size. Universities are another example. Research is very fragmented in Europe so we cannot reach the kind of concentration the United States has for example in Cambridge, Massachusetts or Silicon Valley.

Austria’s economic research institutes forecast low growth in the coming years – similar to what we saw between 2010 and 2019. But inflation rates are expected to be much higher than in that period. One explanation is that globalisation is different now, with cheap products from China not playing as much of a role as they used to. Is this the case?

We are expecting the euro area to grow by 1. 1 per cent this year and 1. 4 per cent in 2026. Such low growth rates present a major challenge, it would be better for Europe to grow more quickly. One important point is that we have to accept the reality of demographic change. The number of people leaving employment is growing while there are fewer younger people taking their place. Migration can help, up to a point. Growth rates per capita matter. We have to think about the implications of this for inflation. Still, we think that some of the factors keeping inflation too low before the pandemic no longer apply.

What factors are those?

Apart from some global factors, the contribution of governments to demand plays a role, as I mentioned before. The banking sector also looks different now. While lending was very weak in many parts of Europe before the pandemic, now the banking system is well capitalised. We are seeing downward pressures on prices coming out of China. The Chinese economy is not producing inflation, the real estate sector is undergoing a big adjustment and export prices are falling. But we should be able to achieve a medium-term inflation rate of 2 per cent, if monetary policy is set correctly and downside pressures do not emerge.