Lagarde warns that European fiscal policies could fuel excess demand

EUROPEAN Central Bank (ECB) president Christine Lagarde warned on Friday (Dec 2) that some European governments’ fiscal policies could lead to excess demand, and that fiscal and monetary policies need to work in sync for sustainable, balanced economic growth.

“Fiscal policies that create excess demand in a supply-constrained economy might force monetary policy to tighten more than would otherwise be necessary,” she said at a conference hosted by the Bank of Thailand and Bank for International Settlements in Bangkok.

“Regrettably, at the moment, at least some of the fiscal measures that we are analysing from many of the European – and particularly eurozone – governments are pointing in the direction of the latter category,” she said, referring to measures that could trigger excess demand.

The European Commission expects the eurozone economy to shrink in the fourth quarter of 2022 and in the first three months of 2023, due to surging energy prices and rising interest rates, which undermine spending, borrowing power and confidence.

“We need higher investment and structural reforms to remove the supply constraints and ensure that potential output is not impaired by the changing global economy. And that’s a big question and an uncertainty that we have,” said Lagarde. 

“And in a world where external demand is more uncertain, we will also need to strengthen the domestic supply and demand through higher productivity growth.”

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With inflation running at five times its 2 per cent target, the ECB raised interest rates this year at its fastest pace on record. More hikes over the coming months are still likely, as price growth will take years to tame.

The ECB’s rate on bank deposits was increased by 200 basis points to 1.5 per cent in three months.

“What we central bankers have to do is deliver a monetary policy that anchors expectations... We need to signal to the public, to the observers, to the commentators, that in all scenarios, inflation will return to our medium-term target in a timely manner,” said Lagarde. REUTERS