Excerpts from President Mario Draghi speech at the Brussels Economic Forum 2016:
As inflation is ultimately a monetary phenomenon, a committed central bank can always fulfil its mandate. And that is true independently of the stance of other macroeconomic policies.
But monetary policy does not exist in a vacuum. The situation of central banks is better described as independence in interdependence, since other policies matter a great deal.
First, for monetary policy to stoke demand and inflation, it matters crucially whether the financial system is able to relay our policy impulses efficiently to the economy. In the euro area that transmission mechanism has been impeded repeatedly in the past. That has diluted the effectiveness of our stimulus and lengthened the “long and variable” lags over which monetary policy works.
Second, it matters for monetary policy whether fiscal policy is steering aggregate demand in the same direction, and how strongly. Fiscal policy was contractionary for several years in the euro area following the loss of confidence in sovereign credit in 2010, and the negative effect on growth was exacerbated by the fact that consolidation in some countries was implemented mainly through tax rises rather than current spending cuts. This placed the full burden of macroeconomic stabilisation on monetary policy. And in a context of disrupted transmission, that has led to a slower return of output to potential than if fiscal policy had been more supportive.
This is why the ECB has said many times that fiscal policy should work with not against monetary policy, and the aggregate fiscal stance in the euro area is now slightly expansionary. But supporting demand is not just a question of the budget balance, but also of its composition, especially the tax burden and the share of public investment. So we should not see fiscal policy as solely a macroeconomic tool, which is only available to countries with strong public finances. We should also see it as a microeconomic policy tool that can enhance growth even when public finances need to be consolidated.
Third, it matters for monetary policy whether the right structural policies are in place. Structural reforms can help limit the depth and duration of shocks, which in turn supports the anchoring of inflation expectations and keeps real interest rates low. Such reforms can also reduce the transmission lag of our measures, since a more flexible, more responsive economy is likely to transmit monetary policy impulses faster.
Finally, uncertainty over the institutional stability of the euro area also matters for monetary policy, since it too can slow down the transmission of monetary policy.