The ECB is now bound to a stance of vigilant patience. It significantly lowered its rates from June 2024 to June 2025 and could hardly go much further without risking the resurgence of financial imbalances, even as inflation hovered around 2% on average in the euro area. In a context now marked by war in the Middle East, strongly affecting energy prices and supply chains, uncertainty about the inflation path has re-emerged. At the same time, the constraints on growth in the euro area remain primarily structural. Monetary policy can smooth cycles, but on its own it cannot compensate for the lack of reforms and the necessary efforts to establish the conditions for Schumpeterian growth that raise potential output.<\/p>\n\n\n\n
With the Volcker turn at the very end of the 1970s, both theory and practice assigned monetary policy a primary objective: price stability. The idea that central banks could finely tune the inflation-unemployment trade-off was largely discredited by the experience of the 1970s\u20131980s: a \u201cstop-and-go\u201d regime in which unemployment did not fall while inflation persisted.<\/p>\n\n\n\n
With the profound transformation of the global economic and financial environment during the 1980s and 1990s\u2014which ushered in a regime of low inflation thanks to the globalization of the real and financial economy and to the technological revolution\u2014central banks were able, from the 1990s until the global financial crisis, to pursue policies supportive of growth.<\/p>\n\n\n\n
However, the return and strengthening of financial cycles\u2014asset price bubbles (in equities and real estate) and excessive indebtedness, followed by abrupt corrections\u2014have shown that controlled inflation does not in any way guarantee financial stability. Persistently low interest rates can encourage excessive risk-taking and fuel imbalances that are difficult to unwind.<\/p>\n\n\n\n
Hence the emergence, after 2008, of a framework in which central banks must safeguard multidimensional stability: inflation, growth, and financial stability. After the global financial crisis and during the pandemic, central banks cut rates to zero\u2014indeed into negative territory in the ECB\u2019s case\u2014and made massive use of quantitative easing to compress long-term rates and risk premia, and to avoid deflation and depression. These policies were effective in acute phases, but their prolongation, even as growth and credit were recovering, contributed to strong asset price valuations and a very significant rise in indebtedness, making subsequent adjustments more delicate.<\/p>\n\n\n\n
In the euro area, the persistence of inflation deemed too low relative to the 2% target justified this ultra-accommodative stance, even though globalization and digitalization suggested structurally low inflation. At the same time, insufficient reforms in member countries and the sensitivity of public debt to rising interest rates encouraged the ECB to maintain an accommodative policy for longer than the Federal Reserve.<\/p>\n\n\n\n
The post-Covid inflation shock, amplified by the war in Ukraine, led to rapid tightening\u2014highly effective in that, without breaking growth, it helped preserve the anchoring of inflation expectations at a low level. Today, as tensions in the Middle East revive uncertainties over energy prices and critical materials and equipment\u2014hence over inflation\u2014the ECB, like the Fed, once again finds itself walking a tightrope: on one side, the risk of slowing growth; on the other, the risk of a resurgence in underlying inflation if prices and wages enter a feedback loop.<\/p>\n\n\n\n
The situation is all the more complex within the euro area as inflation rates remain heterogeneous: France\u2019s needs differ from those of Spain or Germany. The ECB therefore favors a cautious, meeting-by-meeting approach, based on a careful reading of incoming data. Since the outbreak of war in the Middle East, it has also exercised significantly heightened vigilance and must anticipate as best it can any potential second-round effects should the conflict persist.<\/p>\n\n\n\n
Thus, although inflation is still close to target, upside risks linked to geopolitical tensions\u2014particularly in energy and supply bottlenecks across various sectors\u2014must be closely monitored. At the same time, expected growth in the euro area remains modest, around 1% to 1.5%. International institutions emphasize that without reforms to boost productivity, deepen the single market, and enhance labor mobility, potential growth will remain durably constrained.<\/p>\n\n\n\n
In such an environment, a further rate cut would not mechanically generate growth. It would above all risk fueling new imbalances and undermining the ECB\u2019s anti-inflation credibility. The conditions for a higher growth path\u2014and thus for better debt sustainability\u2014primarily depend on structural reforms: labor markets, pensions, innovation, human capital, and further integration of the single market. These are levers that monetary policy can neither decree nor replace.<\/p>\n\n\n\n
Olivier Klein
Professor of Monetary Policy at HEC<\/p>\n","protected":false},"excerpt":{"rendered":"
The ECB is now bound to a stance of vigilant patience. It significantly lowered its rates from June 2024 to June 2025 and could hardly go much further without risking the resurgence of financial imbalances, even as inflation hovered around 2% on average in the euro area. In a context now marked by war in […]<\/p>\n","protected":false},"author":1,"featured_media":6285,"comment_status":"open","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_acf_changed":false,"footnotes":""},"categories":[21,133],"tags":[],"class_list":["post-10257","post","type-post","status-publish","format-standard","has-post-thumbnail","hentry","category-bank","category-economical-and-financial-crisis"],"acf":[],"yoast_head":"\n