Draghi: “Europe must return to growth. The central bank cannot do this in place of governments”

“The main driver of long-term growth – namely the development and spread of new technologies – lies beyond the influence of any central bank. Growth should become an explicit objective shared by all governments.” This is one of the key passages from the speech delivered by Mario Draghi at the Swiss Federal Institute of Technology in Zurich, during the Swiss National Bank’s Karl Brunner Distinguished Lecture.

“Europe’s usual response, with each country acting on its own, will not be enough in the world it now finds itself facing,” said the former ECB president. “National reforms continue to be important, but they cannot provide the scale on which technology – and, consequently, growth – now depend. Only integration can do that.”

Draghi began by drawing on the ideas of the economist Karl Brunner, to whom the series of lectures is dedicated. “The central bank could not ensure price stability on its own. It needed a fiscal authority whose incentives were compatible with its own,” he recalled.

This approach, he explained, is evident in the Maastricht Treaty, which granted the ECB independence and set price stability as its primary objective, whilst at the same time introducing the prohibition on monetary financing, the no-bailout clause and the procedures for excessive deficits.

But “whether this distinction holds up in practice, however, depends on more than just the rules”. Ultimately, it depends on the relationship between the cost of debt and growth, referred to by the former prime minister as “r minus g”.

“If the interest rate a government pays on its debt exceeds the rate of economic growth, the debt-to-GDP ratio automatically rises, unless the government runs a primary surplus,” said Draghi. “The wider the gap, the larger the surplus required and the greater the temptation to put pressure on the central bank to monetise the debt.”

According to the former President of the ECB, the European framework contained two implicit assumptions. The first was that “growth would be ensured by other policies”. The second was that “a central bank committed to carrying out its remit and governments that respected the rules would, together, bring down interest rates”.

For a time, Draghi observed, that was how things went. “That is, broadly speaking, what happened during the Great Moderation.” In the 1990s, the governments of advanced economies reduced their deficits whilst central banks anchored inflation expectations. Countries preparing for the euro also benefited from convergence.

“Then, in the first decade of the euro, growth arrived.” From 1999 to 2007, the euro area grew in real terms by just over 2 per cent a year. “That growth kept r close to g”. During those years, Draghi explained, “the central bank was able to fulfil its mandate using only the reference rate, and its independence was not seriously tested”.

But “there were warning signs in the structure”. “Growth stemmed more from credit and convergence than from the single market reforms on which the framework had relied,” he said.

The financial crisis and the sovereign debt crisis thus proved to be the test. “The growth that had been based on credit came to an end. And interest rates between countries began to diverge once again.” Between 2008 and 2011, he recalled, the spread on eurozone debt rose to 2.8 percentage points.

“With the collapse of growth and the decoupling of r from g, the authorities responsible for macroeconomic policy had to intervene and take responsibility for growth.” First it was the governments, then, above all, the central bank.

Between 2010 and 2013, Draghi said, “the fiscal policy stance therefore became markedly restrictive”. But “the result was that fiscal consolidation had a greater impact on growth than on interest rates”. From the second quarter of 2011 to the first quarter of 2013, “growth was zero or negative for eight consecutive quarters”.

Weak demand spilled over into monetary policy. “To restore price stability, monetary policy had to become highly expansionary.” Interest rates were cut to zero and then below zero, and the ECB began purchasing financial assets, primarily government bonds.

The measures, Draghi argued, “achieved their objectives”. At their peak, “they reduced long-term interest rates by around 140–150 basis points”. ECB estimates also indicate that they contributed to more than a quarter of growth in the eurozone between 2015 and 2019.

“It was independence, exercised correctly, that protected the project and kept monetary and fiscal policy separate,” said Draghi.

But that period cannot be repeated. “A system in which the central bank is responsible for growth is not sustainable, and today it no longer holds water.”

The problem today is, first and foremost, that of global interest rates. “Long-term interest rates in the eurozone are rising, increasingly for reasons beyond Europe’s control.” In recent months, he explained, “they have reached their highest levels in around the last fifteen years, moving in tandem with US Treasury yields”.

Part of the increase reflects inflation. “Global supply-side shocks have once again pushed prices upwards, most recently through the rise in energy prices caused by the conflict with Iran and the loss of refining capacity in Russia and the Middle East.”

However, “the bulk of the increase reflects the supply of debt”. This year, Draghi pointed out, the United States will record “a deficit of close to 6 per cent of GDP” and, assuming policies remain unchanged, “by 2030 its debt will exceed the post-war peak”.

Investment in artificial intelligence is also driving demand for capital. “It is forecast that the major US technology firms alone will invest nearly 800 billion dollars this year, predominantly in data centres for artificial intelligence.” Global investment in data centres “could exceed 3,000 billion dollars by 2030”.

Europe, too, is seeing its debt rise. “It is unlikely that this trend will be reversed,” said Draghi. According to IMF estimates, by 2040, advanced European economies will face additional expenditure on an ageing population, defence and the climate transition amounting to around 4.5 per cent of GDP.

The problem is that, at the same time, “growth in the eurozone has lagged behind the level of interest rates it now faces on global markets”. Europe, as Draghi summarised, “is absorbing the full impact of the rate rises, but only a fraction of the growth”.

Productivity is one of the areas where there is the greatest disparity with the United States. “Since 1999, output per hour worked has grown at a rate of around half that of the United States.” Since 2019, “0.3 per cent per year in the eurozone compared with 1.8 per cent in the United States”.

And European reforms, Draghi noted, have not kept pace. “The single market for services has been a goal since 1985; yet, over the last twenty years, barriers to trade in services within Europe have not fallen any faster than those faced by businesses from outside the EU.”

This is why the issue of growth is also becoming central to public finances. “Governments’ ability to achieve fiscal consolidation therefore depends on growth”. Interest rates, he said, are “increasingly set outside Europe”. “Growth is the one area where Europe can still make a difference”.

“An additional half a percentage point of growth per year, sustained until 2040 and with a portion of the increased revenue set aside, would enable Europe to cover around a third of the ground needed to achieve a sustainable debt trajectory.”

Growth on this scale, according to Draghi, is possible: “Growth of this magnitude is within our reach”. Rapid adoption of AI “could add up to 0.4 percentage points to total factor productivity growth over the next decade”, whilst “national reforms and those of the single market, taken together, could add around another half a percentage point per year”.

Fiscal consolidation will, however, remain necessary. If governments finance increased spending without further consolidation measures or reforms, “the average European debt-to-GDP ratio will reach 130 per cent by 2040”. Weighted by the size of the economies, “it will reach 155 per cent”.

“A certain degree of consolidation of public finances in the medium term is inevitable,” said Draghi. “But if this is to be achieved solely through spending cuts and tax rises, it is unlikely to produce the necessary results.”

And what about monetary policy? “The top priority is to keep inflation under control.” The second is “to avoid undermining growth more than is necessary”. Faced with inflationary shocks, he explained, “monetary policy today cannot take responsibility for growth, but it can ensure that the path of key interest rates is no steeper than is necessary to stabilise inflation in the medium term”.

“The stakes are high, because growth is sensitive to the expected path of interest rates”. The estimates cited by Draghi indicate that the rise in short-term interest rates anticipated since the end of last year “will reduce overall growth by 1.1–1.3 percentage points over the period 2026–2028”. These estimates, he pointed out, “predate the further rise in expected interest rates recorded since mid-August”.

Furthermore, the effects of the tightening may be more long-lasting. “The effects of monetary tightening may last longer than the tightening itself.” And “by weighing on investment and innovation, a restrictive policy may reduce productivity and potential output for some time”. With potential growth “at just over 1 per cent, Europe has little margin for error”.

This is why the central bank’s communication is also important. “It is important, especially at a time when global factors are playing a more significant role in driving up yields in Europe, to ensure that the expected path of monetary policy rates reflects the central bank’s intentions and not uncertainty about how it will react.”

But long-term growth is beyond the ECB’s control. “The main driver of long-term growth – namely the development and spread of new technologies – is beyond the influence of any central bank.”

Hence the need to think on a different scale. “Europe’s usual response, with each country acting on its own, will not be enough.” “Only integration can achieve this.”

According to Draghi, the completion of the single market and the capital markets union would make it possible to increase the return on capital and mobilise a larger share of European savings. “Faster growth would, in turn, improve the relationship between growth and interest rates, creating scope for public investment without undermining debt sustainability”.

Artificial intelligence is one of the most obvious examples. “The EU accounts for less than 5 per cent of global computing capacity for AI.” Raising this share to 15 per cent by 2030 would require around 1,300 billion euros in investment. The public intervention needed to mitigate the risk, however, would amount to around 100 billion.

The conclusion therefore returns to Brunner’s lesson. “Brunner’s condition remains valid: a central bank can only maintain currency stability if governments keep their debt under control”. But “what has changed is the way in which this condition can be met”. A framework of fiscal rules “cannot meet it on its own when growth is weak”.

“The further integration progresses, the more firmly growth can remain above interest rates and the more the central bank will be protected from political pressures. Growth and independence thus reinforce one another.”

And the task, according to Draghi, now falls to legislators. “For the constitution to endure, national and European legislators must now take full responsibility for growth as the Union’s objective.” The conclusion is clear: “If they do so, they will set Europe on the path to renewal.”