Blog post by Pedro Baptista, Colm Bates, António Dias da Silva, Maarten Dossche and Marco Weissler | Euro area firms hold on to their workforce, despite poor economic conditions. For a significant share of workers this means a lower workload than usual. In turn, many put more money aside as they worry about job security and wages, as the ECB Blog shows.
When the economy slows down, so does labour productivity. This link is often attributed to the role of labour utilisation. In good times firms have more work to do, and their employees’ workloads increase. In bad times, productivity lags and firms engage in labour hoarding, i.e. they hold on to more workers than they actually need. For a significant share of employees, that comes with a lower workload than usual.
Drawing on the ECB’s Consumer Expectations Survey (CES) we explore how employees’ perceptions of their workloads affect their expectations regarding job security, chances of a pay rise, as well as their future spending and saving decisions. We find that, overall, workers who experience a lower workload tend to fear for their jobs and expect low wage increases. Also, they expect to be careful with spending money. To put it simply, during a downturn those who have less on their plate have more on their mind.
These results show that in an economy with weak growth yet a robust job market, labour hoarding and related low labour utilisation may drag on consumption.
Unequal workloads among workers and across sectors
To understand their economic expectations the ECB interviews consumers in 11 euro area member states on a regular basis (CES). In the survey’s June, July, and October 2024 editions, about 37% of respondents answered that they were working more than usual. On the other hand, 10% of workers reported a lower than usual workload, with 2% saying that their current workload was much lower and 8% saying that it was somewhat lower (Chart 1, left).
At first sight, it is surprising that the group of workers reporting higher workload is dominating, given the economic downturn. However, social bias effects lead to the fact that in such surveys many respondents tend to report that they have a lot of work to do. This is consistent with other CES information data showing a similar share of individuals working more than their contractual hours. In this context, the 10% of workers reporting a lower workload than usual is actually rather high.
Workloads are significantly lower in construction and industry than in other sectors, as illustrated in the second panel of Chart 1, which shows the net percentage of workers facing higher versus lower workloads. This, in turn, is in line with macroeconomic indicators which show weaker growth in these sectors in comparison with services. This suggests that the data effectively capture the cyclical component of workloads experienced by workers.

Chart 1
Workloads of employees in the euro area – by sector

Workload

Workload by sector

(percentage of employed respondents)

(net percentage between “higher” and “lower” reported workloads)

Sources: Consumer Expectations Survey.
Notes: Weighted data. Data are for June, July and October 2024. Net percentage refers to the difference between the share of respondents answering higher workload and those answering lower.

More job worries and less consumption
So, what impact does the lower than usual workload have on employees? First, workers who report lower workloads feel more at risk of losing their jobs within the next three months. Such fear scales alongside the change in workload, with workers who experience only modest workload changes not worrying much about losing their jobs. Yet, those who see big changes worry greatly. That effect applies to both those who see much higher workloads and those who see much lower workloads than usual. However, it is greatest for the second group. Their fear of losing their jobs is 8 percentage points higher than that of workers with no changes in workload (Chart 2). Furthermore, those who express very high and very low workloads are also more likely to express low job satisfaction.

Chart 2
Job loss expectations by workload perceptions

(percentage points)

Sources: Consumer Expectations Survey.
Notes: Weighted data. Data are for June, July and October 2024. Estimates are presented relative to the middle category and based on a linear regression with sector and country fixed effects, controlled for gender, age, income, and worker characteristics. The estimated coefficients are depicted in bars with the error bars representing the 95% confidence interval.

Second, lower workloads are associated with little hope of pay rises. Workers with higher workloads have higher wage expectations than those whose workloads are unchanged, while those with much lower workloads have lower expectations (Chart 3). In fact, workers reporting higher workloads expect wage increases three times larger than those experiencing much lower workloads. Applying a regression analysis that controls for job loss expectations and other individual characteristics further shows us that workers expect a currently low workload to impact their future earnings, even if their jobs aren’t at risk. Apparently, they are also factoring in lower productivity and weakened bargaining power.

Chart 3
Wage growth expectations by workload perceptions

(percentage points)

Sources: Consumer Expectations Survey.
Notes: Weighted data. Data are for June, July and October 2024. Estimates are presented relative to the middle category and based on a linear regression with sector and country fixed effects, controlled for gender, age, income, and worker characteristics. The estimated coefficients are depicted in bars with the error bars representing the 95% confidence interval.

Third, changing workloads could influence savings and consumption. And this is especially interesting for monetary policy considerations. Employees with less work than usual report that they expect to spend less and save more. This precautionary effect holds even when we control for job loss expectations and demographics (Chart 4).

Chart 4
Perceived workload and consumption behaviour

Marginal effects of workload perceptions on precautionary savings

Marginal effects of workload perceptions on spending growth expectations

(percentage of household income)

(percentage points)

Sources: Consumer Expectations Survey.
Notes: Weighted data. Data are for June, July and October 2024. Marginal effect estimates of the interaction between workload and job loss expectations are based on a linear regression with country fixed effects, controlled for gender, age, income, and worker characteristics. The estimated coefficients are depicted in bars with the error bars representing the 95% confidence interval.

Conclusion
Our results show that labour hoarding and the related substantial share of workers with low workloads could negatively impact wage growth and spending decisions. Workers with lower workloads are more pessimistic than others and expect to act accordingly. They worry most about losing their job and expect the lowest pay rise. Also, they plan to reduce consumption, and put more money aside. Thus, in a context of low growth and persistent labour underutilisation, weaker demand could have further knock-on effects on wage growth and consumer spending. This would then again weigh on economic growth.
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.
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India, Mexico, Brazil, and some other major emerging economies recorded strong growth, while the United States continued to extend its lead as the top destination for direct investment
Global foreign direct investment grew again in 2023 after declining the previous year. Inward direct investment climbed $1.75 trillion, or 4.4 percent, reaching a record $41 trillion, according to the IMF’s latest Coordinated Direct Investment Survey, which provides detailed information on direct investment positions between countries.
FDI rose in most regions, with Central and South Asia, Europe, and North and Central America contributing most. Direct investment between advanced economies grew by $880 billion, or 3.6 percent, while those from advanced economies to emerging market and developing economies rose by $538 billion, or 7.6 percent.
As our Chart of the Week shows, the United States extended its lead as the top destination for direct investment. Singapore recorded the largest gain in 2023, with its position rising $307 billion, followed by $227 billion for the United States and $164 billion for Germany. Meanwhile, the Netherlands and Luxembourg posted the steepest declines but remained in the top five, alongside the United States, China, and the United Kingdom.
Strong growth was also seen in many emerging economies. Most notably, India, Mexico, and Brazil each saw their inward direct investment positions rise by around $130 billion or about 20 percent, marking the largest increase for these three economies in total since the survey began in 2009.
—The IMF’s annual Coordinated Direct Investment Survey is the only worldwide source of bilateral FDI positions between economies. It aims to provide a geographic distribution of inward and outward FDI worldwide, contribute to a better understanding of the extent of globalization, and support the analysis of cross-border linkages and spillovers in an increasingly interconnected world. For more IMF data, see the beta version of our new data portal, which features a redesigned, unified platform for macroeconomic data.
 
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The LRS Taskforce in its new composition will continue to provide a forum for engagement between public- and private-sector experts to support the G20 Roadmap for enhancing cross-border payments.

The Financial Stability Board has renewed the composition of its Taskforce on Legal, Regulatory, and Supervisory matters (LRS Taskforce). The Taskforce aims to strengthen collaboration between the public sector and senior managers from the private sector to support the G20 Roadmap for enhancing cross-border payments.
Following a public call for nominations for senior private-sector applicants with significant experience and direct responsibilities related to cross-border payments in the areas of compliance, legal, cross-border operations or risk management, the FSB has invited 12 new members to join the Taskforce. The selection aims to achieve a diverse membership from both a geographic and business perspective.
The FSB LRS Taskforce will continue to work in close cooperation with the Bank for International Settlements’ Committee on Payments and Market Infrastructures (CPMI) Taskforce on Cross-border Payments Interoperability and Extension.
The LRS Taskforce composition is renewed periodically every two years.

 
Compliments of the Financial Stability Board – a global economic advisory boardThe post The Financial Stability Board appoints new members to its Taskforce on Legal, Regulatory and Supervisory matters first appeared on European American Chamber of Commerce New York [EACCNY] | Your Partner for Transatlantic Business Resources.

Speech by Piero Cipollone, Member of the Executive Board of the ECB, at an MNI Connect webcast

Today I would like to discuss the ECB’s balance sheet and its implications for our monetary policy.
In recent years, the monetary policy debate has mainly focused on our interest rate decisions. This is for good reason. In response to the biggest inflation shock in a generation, we embarked on the fastest tightening of monetary policy in the ECB’s history through rate hikes.
During this tightening phase, we used policy rates as the primary tool for setting our monetary policy stance, while normalising our balance sheet in a measured and predictable way. We initiated the gradual unwinding of our asset purchase programmes and recalibrated our targeted longer-term refinancing operations (TLTROs).[1] As a result, the size of our balance sheet has fallen by more than a quarter from its peak.
Policy rates remain our primary instrument and will therefore continue to attract the most attention. But we should not underestimate the important role that our balance sheet policies have played over time as a component of our overall monetary policy stance and in ensuring the smooth transmission of our monetary policy to the real economy. This still holds true today as we make our monetary policy less restrictive.
Inflation has now fallen substantially to levels close to 2%. Our latest projections foresee it converging towards our target over the medium term, and the risks to the inflation outlook – once sharply skewed to the upside – have now become more balanced.
At the same time, the euro area’s economic recovery remains weak – especially in the near term. The risks to the growth outlook are tilted to the downside and, if they materialise, may derail the recovery, with implications for the inflation outlook.
Against this background, the Governing Council has gradually been reducing the degree of monetary policy restriction by cutting policy rates towards neutral territory. While our direction is clear, we are very attentive to incoming information in view of the prevailing uncertainty about the economic environment. We continue to make decisions on a meeting-by-meeting and data-dependent basis. This gives us the option to adapt our interest rate path if necessary to ensure that inflation stabilises sustainably at our 2% medium-term target.
However, given the importance of financial conditions in determining the inflation outlook, we also need to consider the role played by the reduction of our balance sheet. In the tightening phase our rate decisions and balance sheet policies complemented each other, but they are now going in opposing directions.
This divergence has important implications across at least two dimensions.
First, it contributes to a steepening of the yield curve. Our rate cuts exert downward pressure primarily at the short end of the yield curve. At the same time, the gradual runoff of our asset purchase portfolios exerts upward pressure on long-term and, to a lesser extent, intermediate yields. This has been compounded by recent spillovers from the US.[2]
Second, it may affect credit supply. Declining levels of central bank liquidity could constrain banks’ ability to extend credit, resulting in tighter credit conditions and potentially slowing down the investment and consumption that are critical for economic recovery.
In setting the policy stance, we therefore need to consider the impact of the overall set of financial conditions resulting from our interest rate and balance sheet policies. In other words, we need to strike the right balance if we are to achieve our inflation aim without an undue negative impact on incomes and employment. A rate cut has a more contained easing effect when the balance sheet is simultaneously reduced. This has implications when discussing the appropriate policy rate path.
We also need to consider the potential risks to the transmission of our monetary policy. In the past, abundant levels of liquidity have acted as a safeguard against spikes in liquidity needs that emerged regardless of where our rates stood. With this in mind, we need to carefully monitor the transition from abundant to less ample excess liquidity, mindful of the potential implications for financial stability.
Today, I would like to take stock of the ECB’s experience with balance sheet policies, explaining why they remain a vital part of our monetary policy toolbox. I will then discuss the implications of the ECB’s balance sheet for our monetary policy in the current environment.
The ECB’s experience with balance sheet policies
At the ECB, balance sheet policies have served a dual purpose over time, allowing us to deliver on our price stability mandate amid exceptionally difficult circumstances.
First, during periods when interest rates approached their effective lower bound and inflation remained below target, the ECB used asset purchases to support an accommodative monetary policy stance.
For instance, the ECB launched its asset purchase programme (APP) in 2015 to stimulate the economy and inflation at a time when deflationary threats loomed large. Asset purchases and the associated provision of central bank liquidity worked in several ways – including through the portfolio rebalancing, exchange rate and credit channels – to generate a significant upward effect on both economic activity and inflation.[3]
Second, balance sheet policies have been pivotal to ensuring the smooth transmission of our monetary policy to the real economy, in both tightening and easing phases.
At times when we were lowering our policy rates, our TLTROs, launched in 2014, provided banks with long-term funding on favourable terms to incentivise them to lend to firms and households. This led to a persistent compression in lending rates and an increase in loan volumes over time.[4]
But balance sheet policies were also instrumental in ensuring the smooth transmission of monetary policy at times when we were increasing our policy rates. The announcement of our Transmission Protection Instrument (TPI) in 2022 allowed us to embark on the fastest rate hiking cycle in our history without sparking financial fragmentation in the euro area.
Of course, the stance and transmission functions of our balance sheet policies do not operate in isolation. There can be beneficial interactions between the two.
As rates increased, for example, euro area banks had sufficient liquidity to manage any maturity mismatches that arose. This – alongside strengthened regulation and supervision – helped them to emerge unscathed from the market turbulence in March 2023 that saw the collapse of three regional banks in the United States.
The proportionate use of balance sheet policies in an evolving economic landscape
The substantial expansion of the ECB’s balance sheet required careful monitoring of potential side effects. That is why the principle of proportionality lies at the core of how we use our balance sheet instruments.[5]
In its 2021 strategy review, the Governing Council assessed that its use of balance sheet measures – alongside negative interest rates and forward guidance – had indeed been proportionate, taking into account any side effects, for instance on inequality and the financial sector.[6]
Some concerns, however, require a more nuanced perspective.
For example, there is little evidence to suggest that excessive risk appetite may be attributable to larger central bank balance sheets. If this were the case, we should have seen less risk-taking in markets as central banks began to withdraw their market footprint.
But the opposite has been the case. Today equity markets are near all-time highs. This may be due to “animal spirits”[7], which have also been observed outside periods of central bank balance sheet growth. We saw them at play, for instance, during the dot-com bubble – a period when the cyclically adjusted price-to-earnings ratio hit its historic peak and central bank balance sheets were distinctly lean.
Moreover, as the Eurosystem gradually reduces its footprint in sovereign bond markets by reducing its holdings of euro area government bonds, concerns about the size of the balance sheet are becoming less and less justified (Chart 1).[8]

Chart 1
Size of euro area government bond market and the Eurosystem’s market footprint

(left-hand scale: EUR billions; right-hand scale: percentages)

Sources: Eurosystem and Centralised Securities Database.
Notes: The chart shows the evolution of the size of the euro area government bond market and splits it into outright holdings (yellow) and mobilised collateral (green), as well as what is not held or mobilised as collateral with the Eurosystem (blue). The Eurosystem market footprint is a relative measure, computed as the share of the Eurosystem’s euro area government bond (EGB) holdings compared with the nominal amount outstanding. Outright holdings are EGBs held by the Eurosystem via purchase programmes, adjusted by EGBs lent back via the securities lending against cash collateral facilities. Mobilised collateral includes EGBs mobilised as collateral for open market operations. The latest observations are for 31 January 2025.

Going forward, an evolving economic landscape suggests that balance sheet policies could be increasingly useful as monetary policy instruments. Let me highlight two developments that are particularly relevant here.
First, the non-bank financial sector has grown considerably over time and is becoming increasingly relevant in the funding of the real economy.
In the euro area, the financial assets of non-banks have more than doubled since the global financial crisis.[9] Compared with banks, non-banks are more responsive to monetary policy measures that influence longer-term interest rates, such as asset purchases.[10] Given that non-banks adjust their portfolios more actively in response to changes in interest rates, this also increases the need for sufficient liquidity in the system to facilitate these adjustments.
Second, geopolitical fragmentation means that the global economy is becoming more shock prone and subject to higher levels of uncertainty (Chart 2).

Chart 2
Global Economic Policy Uncertainty index

(index)

Source: Bloomberg.
Note: The latest observation is for December 2024.

In this environment, we need to remember that the euro area is subject to fragmentation risk. A key lesson from the sovereign debt crisis is that balance sheet policies have been instrumental in making the euro area a more “normal” jurisdiction from the perspective of monetary policy.
As we navigate an increasingly complex economic landscape, the transition from abundant to less ample excess liquidity represents an inflection point that also requires close monitoring.
In this environment, banks’ liquidity needs are met via a broad mix of instruments under our new operational framework. These include our short-term main refinancing operations (MROs) and three-month longer-term refinancing operations (LTROs) and will also include – at a later stage – structural longer-term credit operations and a structural portfolio of securities.[11]
However, the decline in excess liquidity warrants careful monitoring, as it could exert additional tightening pressures on financial and financing conditions, potentially exceeding the intended policy stance.
The implications of the ECB’s balance sheet for monetary policy in the current environment
It is in this context that I would like to talk about the implications of our balance sheet for monetary policy in the current environment.
The ECB’s balance sheet has been reduced at a faster pace than those of central banks in other major economies during their tightening cycles (Chart 3). So far, much of this decline can be attributed to banks’ repayments of TLTRO loans.[12]

Chart 3
Central bank total assets

(index = 100 at the start of the respective policy rate hiking cycles)

Sources: Bloomberg and ECB calculations.
Notes: The x-axis starts on 21 July 2022, 16 March 2022 and 15 December 2021 for the Eurosystem, Federal Reserve System, and Bank of England respectively. For the Bank of England, reserve balances are used as a proxy for the total balance sheet. The latest observations are for 12 February 2025.

Looking ahead, however, any further reduction in the size of our balance sheet will stem from the gradual unwinding of our asset purchase portfolios, as the Eurosystem no longer reinvests the principal payments from maturing securities.
As in the past, the normalisation of our balance sheet has implications for our monetary policy stance and the possible risks to monetary policy transmission.
The monetary policy stance
Let me start with the implications for our monetary policy stance.
Our reaction function for rate decisions is built around three well-known criteria: (i) the inflation outlook, (ii) the dynamics of underlying inflation and (iii) the strength of monetary policy transmission.
Inflation has fallen by around three-quarters from its peak in late 2022 (Chart 4). The disinflation process is well on track, and our staff projections see inflation averaging 2.1% this year, 1.9% next year and 2.1% in 2027.

Chart 4
Headline inflation

(annual percentage changes)

Source: Eurostat.
Note: The latest observation is for January 2025 (flash estimate).

Most measures of underlying inflation suggest that inflation will settle at around our 2% medium-term target on a sustained basis. In particular, the ECB’s measure of the persistent and common component of inflation (PCCI)[13] – a more forward-looking indicator of underlying inflationary pressures that tends to better predict future inflation – stood at 2.1% in December, and 2.0% when excluding energy.
Domestic inflation remains high, as wages and prices in certain sectors are still adjusting to the past inflation surge with a substantial delay. But our wage tracker is signalling a significant moderation in wage growth, and profits are partially buffering the impact on inflation.
It is the third leg of our reaction function – the strength of monetary policy transmission – that I would like to discuss in more detail, however.
As we cut interest rates, new borrowing for firms and households is becoming less expensive. But financing conditions continue to be tight – in part because our monetary policy remains restrictive and past rate hikes are still working their way through the economy.[14]
While credit continues to expand, lending to firms and households remains subdued by historical standards. In December, the annual growth rate of lending to firms was roughly two-thirds below its historical average.[15] Growth in housing loans increased gradually but also remained muted overall, at around one-fifth of its long-term average (Chart 5).[16]

Chart 5
Loans to firms and households

(percentage points)

Sources: ECB (BSI) and ECB staff calculations.
Note: The latest observations are for December 2024.

At the same time, the recent gradual recovery in lending has not kept pace with the nominal growth of the economy, as reflected in the continued decline of the loan-to-GDP ratio (Chart 6).

Chart 6
Ratio of bank loans to GDP

(percentages)

Sources: ECB (BSI), Eurostat and ECB staff calculations.
Note: The latest observation is for the third quarter of 2024.

While policy rates remain our primary instrument for adjusting our monetary policy stance, the normalisation of our balance sheet may also affect the stance through two key channels.
First, while our rate cuts exert downward pressure primarily at the short end of the yield curve, our quantitative tightening exerts upward pressure on long-term maturities and, to a lesser extent, intermediate ones. This serves to tighten financial conditions.[17]
Indeed, the runoff of the asset portfolios of central banks has arguably been one of several factors contributing to a steepening of sovereign yield curves in recent months – akin to a reversal of the duration risk channel previously associated with central banks through quantitative easing (Chart 7).

Chart 7
New duration risk absorbed by private investors

(EUR billions per basis point)

Sources: Bloomberg and ECB.
Notes: The chart shows the month-on-month change in the duration of government bonds held by private investors (i.e. investors other than the domestic central bank). Rates are approximated by weighted average maturity.

At its peak in early 2022, the impact of current and expected Eurosystem bond holdings in our asset portfolios lowered ten-year sovereign bond yields by around 175 basis points.[18] Due to quantitative tightening, however, the easing impact has now fallen to around 75 basis points and is expected to further reduce over time (Chart 8).

Chart 8
Impact of APP and PEPP sovereign bond holdings on ten-year sovereign risk premia

(basis points)

Source: ECB calculations.
Notes: The impacts are derived from an affine arbitrage-free model of the term structure with a quantity factor (see Eser et al., op. cit.) and an alternative version of the model recalibrated so that the model-implied yield reactions to the March PEPP announcement match the two-day yield changes observed after 18 March 2020. The model results are derived using GDP-weighted averages of the zero-coupon yields of the big-four sovereign issuers (DE, FR, IT and ES). The continuous line represents estimates based on real-time survey expectations. The dashed line is based on projections of the Eurosystem’s holdings of big-four sovereign bonds in the APP and PEPP as informed by the ECB’s December 2024 Survey of Monetary Analysts. The model abstracts from any potential holdings in a structural portfolio of securities. The latest observations are for January 2025 (monthly data).

According to ECB research, an expected €1 trillion reduction in bond holdings may raise long-term risk-free interest rates by about 35 basis points (Chart 9).[19]

Chart 9
Expected term premium impact from running down the asset portfolio by €1 trillion

(basis points)

Sources: ECB December 2024 Survey of Monetary Analysts (SMA) and Akkaya, Y. et al., op.cit.
Notes: The chart depicts the expected effect on the term premium of various assets with a ten-year maturity resulting from an expected €1 trillion decrease in the ECB’s bond holdings. Results are based on individual SMA responses from December 2022 until December 2023.

Second, an environment marked by declining levels of central bank liquidity may constrain banks’ ability to extend credit.
Research documents the strong relationship between loan supply and structural sources of liquidity, such as reserves obtained through credit easing programmes or those injected through quantitative easing interventions.
More specifically, a €1 change in non-borrowed reserves or credit easing reserves is associated with a corresponding change in credit of approximately 15 cents or 10 cents respectively.[20] In other words, a €500 billion drop in non-borrowed reserves – similar to the one expected in 2025 as a result of the decline in our APP and PEPP holdings – is associated with a €75 billion decline in credit supply, equivalent to about 0.6 percentage points of downward pressure on loans to the non-financial private sector.[21]
Accordingly, as central bank liquidity declines, we may see tighter credit conditions in the economy. This could slow down investment and consumption, with firms cutting back on capital expenditure and consumers reducing purchases of big-ticket items that require financing.[22]
Incoming data suggest that euro area GDP growth will remain subdued in the short term. Industrial production decreased notably in December and surveys indicate that manufacturing is continuing to contract, whereas services activity is expanding at a moderate pace (Chart 10).

Chart 10
Purchasing Managers’ Index

(diffusion indices)

Source: S&P Global.
Notes: “Output” and “New orders” correspond to the manufacturing and composite indices, and “Business activity” and “New business” to the services index. The latest observations are for January 2025.

Given the uncertain economic environment, we are yet to see a sustained rebound in investment (Chart 11).[23] And while we continue to expect consumption to be the main driver of the recovery, rising real incomes have not yet encouraged households to increase their spending in a commensurate manner (Chart 12).[24] In the face of subdued domestic demand, our latest staff projections forecast a slower economic recovery than had been forecast in the September projections.[25]

Chart 11
Detailed decomposition of euro area real GDP

(quarter-on-quarter percentage changes and percentage point contributions)

Sources: Eurostat and ECB staff calculations.
Note: The latest observations are for the fourth quarter of 2024 for real GDP, and for the third quarter of 2024 for the other components.

Chart 12
Real household disposable income and consumption

(second quarter of 2022 = 100)

Sources: Eurostat and ECB staff calculations.
Note: The latest observations are for the third quarter of 2024.

Moreover, geopolitical risks may create further headwinds for the recovery, which we will need to monitor carefully. Forthcoming findings from the ECB’s Consumer Expectations Survey (CES) suggest that consumers’ concerns about geopolitical risks are negatively affecting economic sentiment – leading to more pessimistic expectations, more elevated income uncertainty and, ultimately, a lower propensity to consume.
We are determined to ensure that inflation stabilises sustainably at our 2% medium-term target. As we gradually cut rates towards neutral territory, we need to be mindful of the fact that we now have two monetary policy tools working in opposing directions, given our ongoing quantitative tightening. This is a first in our history at the ECB.
We therefore need to ensure that we factor in the tightening of our balance sheet when calibrating our rate cuts to achieve our inflation aim. This is because the stance effects stemming from our rate cuts will be somewhat dampened by the tightening induced by the normalisation of our balance sheet.
This is an important consideration when discussing the appropriate policy rate path.
Risks to the transmission of our monetary policy
Similarly, we need to be mindful of the possible risks to the transmission of our monetary policy to the real economy in view of the prevailing uncertainty and potential risks to financial stability.
This cautious approach is crucial, especially given historical precedents where central banks faced unexpected challenges.
In late 2019, for instance, the Federal Reserve System was unexpectedly forced to temporarily reverse its balance sheet retrenchment due to liquidity challenges in financial markets.[26] In 2022 the Bank of England halted quantitative tightening and launched emergency gilt purchases to safeguard financial stability after pension funds’ liability-driven investment strategies exposed systemic risks.[27]
Recent bouts of market volatility also underscore that we should remain alert to the emergence of financial stability risks that may endanger transmission. Last August several factors converged to spark substantial market volatility.[28] The VIX, a market index that measures the implied volatility of the S&P 500 index, recorded its largest ever one-day spike (Chart 13).[29]

Chart 13
VIX index

(percentages)

Source: ECB staff calculations.
Notes: Long run average calculated since January 2000. The latest observations are for 7 February 2025.

Faced with such episodes of volatility, the further decline in our balance sheet must remain on a gradual and predictable path to avoid financial amplification effects.[30] This is especially important in an environment where euro area banks are already tightening their credit standards, especially for firms and consumer credit, due to higher perceived risks related to the economic outlook (Chart 14).[31]

Chart 14
Credit standards, demand for loans to firms and contributing factors

(net percentages)

Source: ECB (bank lending survey).
Notes: “Actual” values are changes that have occurred, while “expected” values are changes anticipated by banks. Net percentages for the questions on credit standards for loans are defined as the difference between the sum of the percentages of banks responding “tightened considerably” and “tightened somewhat” and the sum of the percentages of banks responding “eased somewhat” and “eased considerably”. Net percentages for the questions on demand for loans are defined as the difference between the sum of the percentages of banks responding “increased considerably” and “increased somewhat” and the sum of the percentages of banks responding “decreased somewhat” and “decreased considerably”. “Other financing needs” as unweighted average of “M&A and corporate restructuring” and “debt refinancing/restructuring and renegotiation”; “Use of alternative finance” as unweighted average of “internal financing”, “loans from other banks”, “loans from non-banks”, “issuance/redemption of debt securities” and “issuance/redemption of equity”. The net percentages for “Other factors” refer to an average of the further factors which were mentioned by banks as having contributed to changes in credit standards or changes in loan demand, respectively. The latest observations are for the fourth quarter of 2024 (January 2025 bank lending survey).

Our balance sheet policy instruments continue to be a crucial item in our toolbox. The expectation that we will use them if necessary protects the smooth transmission of our monetary policy and reduces the likelihood that we will need to use these tools in the first place.
Moreover, in an environment of heightened uncertainty, even in the context of excess liquidity, we need to remain prudent and be ready to step in should another shock emerge. We should maintain the flexibility to swiftly expand liquidity facilities if stressful conditions arise.
Conclusion
Let me conclude.
The ECB’s experience with balance sheet policies to date demonstrates their importance both for the monetary policy stance and for the transmission of our monetary policy to the real economy. They are a vital part of our toolkit.
While policy rates remain our primary instrument for adjusting the monetary policy stance, we should also consider the role played by quantitative tightening in influencing overall financial and financing conditions – be it through the yield curve or through the bank lending channel.
To strike the right balance, we should ensure that our rate decisions adequately compensate for the tightening induced by the reduction of our balance sheet.
Thank you.

Annexes

18 February 2025

Slides

In December 2021 the Governing Council decided to discontinue net asset purchases under the pandemic emergency purchase programme (PEPP) at the end of March 2022 and adjusted the path of net asset purchases under the asset purchase programme (APP). In addition, in October 2022 the Governing Council decided to recalibrate the third series of targeted longer-term refinancing operations (TLTRO III) as part of the monetary policy measures adopted to restore price stability over the medium term.
The tightening of policy expectations and long-term rates in the US over the fourth quarter of 2024 and the first weeks of 2025 has exerted upward pressure on euro area long-term yields.
See, for instance, Rostagno, M. et al. (2021), Monetary policy in times of crisis: A Tale of Two Decades of the European Central Bank, Oxford University Press; Arce, Ó. et al. (2020), “A Large Central Bank Balance Sheet? Floor vs. Corridor Systems in a New Keynesian Environment”, Journal of Monetary Economics, Vol. 114, October, pp. 350-67; Andrade, P. et al. (2016), “The ECB’s asset purchase programme: an early assessment”, Working Paper Series, No 1956, ECB, Frankfurt am Main, September; Rostagno, M. et al. (2021), “Combining negative rates, forward guidance and asset purchases: identification and impacts of the ECB’s unconventional policies”, Working Paper Series, No 2564, ECB, Frankfurt am Main, June; and Sims, E. and Wu, J.C. (2021), “Evaluating Central Banks’ tool kit: Past, present, and future”, Journal of Monetary Economics, Vol. 118, March, pp. 135-160.
Benetton, M. and Fantino, D. (2021), “Targeted monetary policy and bank lending behavior”, Journal of Financial Economics, Vol. 142, No 1, October, pp. 404-429; Altavilla, C. et al. (2020), “Mending the broken link: Heterogeneous bank lending rates and monetary policy pass-through”, Journal of Monetary Economics, Vol. 110, April, pp. 81-98; Barbiero, F. et al. (2024), “Targeted monetary policy, dual rates, and bank risk-taking”, European Economic Review, Vol. 170, November.
Proportionality is a fundamental principle of EU law that requires that any action taken by the ECB is suitable, necessary and proportionate to the objectives pursued. See Chiti, M.P. et al. (2020), “The Principle of Proportionality and the European Central Bank”, European Public Law, Vol. 26, No 3.
ECB (2021), “An overview of the ECB’s monetary policy strategy”, July; Altavilla, C. et al. (2021), “Assessing the efficacy, efficiency and potential side effects of the ECB’s monetary policy instruments since 2014”, Occasional Paper Series, No 278, ECB, Frankfurt am Main, September.
“Animal spirits” is a Keynesian expression referring to human psychological factors influencing investment decisions. See also Akerlof, G. and Schiller, R. (2009), Animal Spirits: How Human Psychology Drives the Economy, and Why It Matters for Global Capitalism, Princeton University Press.
Historically, the main concerns surrounding a large market footprint have been that: (i) it exerts downward pressure on term and credit risk premia, thereby flattening the yield curve; (ii) it may increase collateral scarcity and thus lead to strains in repo markets; (iii) it may reduce the space to undertake monetary policy easing in the future in times of stress or when rates are at the effective lower bound; and (iv) it should not become larger than needed to steer rates.
Financial Stability Committee (FSC) high level task force on NBFI (2024), “Eurosystem response to EU Commission’s consultation on macroprudential policies for non-bank financial intermediation (NBFI)”, November.
Work stream on non-bank financial intermediation (2021), “Non-bank financial intermediation in the euro area: implications for monetary policy transmission and key vulnerabilities”, Occasional Paper Series, No 270, ECB, Frankfurt am Main, September.
ECB (2024), “Changes to the operational framework for implementing monetary policy”, 13 March.
All TLTRO III loans were paid back in full by the end of 2024.
Bańbura, M. and Bobeica, E. (2020), “PCCI – a data-rich measure of underlying inflation in the euro area”, Statistics Paper Series, ECB, No 38, October.
In addition, the aggregate lending rate can be influenced by composition effects. First, a loan’s price is only observed if the borrower is not discouraged and the lender does not reject the application. Second, a significant shift from riskier to safer borrowers can exert downward pressure on lending rates – without this rebalancing, rates would be higher. Evidence from both hard and soft data supports the presence of such downward pressure.
In December, the annual growth rate of lending to firms edged up to 1.5% – still well below the historical average of 4.3%.
In December, housing loans grew at an annual rate of 1.1% – significantly below the long-term average of 5.1%.
Recent evidence indicates that interest rates remain sensitive to quantitative tightening surprises even during periods of market calm and positive economic growth (see D’Amico, S. and Seida, T. (2024), “Unexpected Supply Effects of Quantitative Easing and Tightening”, The Economic Journal, Vol. 134, No 658, February, pp. 579-613; and Lloyd, S. and Ostry, D. (2024), “The asymmetric effects of quantitative tightening and easing on financial markets”, Economics Letters, Vol. 238, May).
The sovereign bond yield here relates to an average of the “big four” economies, i.e. Germany, France, Italy and Spain.
Akkaya, Y. et al. (2024), “Quantitative Tightening: How do shrinking Eurosystem bond holdings affect long-term interest rates?”, The ECB Blog, 14 November. Similar results are obtained in Costain, J., Barrau, G.N. and Thomas, C. (2024), “The term structure of interest rates in a heterogenous monetary union”, BIS Working Papers, No 1165, Bank for International Settlements, 1 February. Importantly, these results underscore that the estimated impact of quantitative tightening on long-term interest rates is broadly comparable in magnitude to the inverse effects of quantitative easing documented in previous studies (see, for example, Eser, F. et al. (2023), “Tracing the Impact of the ECB’s Asset Purchase Program on the Yield Curve”, International Journal of Central Banking, Vol. 19, No 3, August; and Altavilla, C. et al. (2021), “Asset Purchase Programs and Financial Markets: Lessons from the Euro Area”, International Journal of Central Banking, Vol. 17, No 4, October).
Altavilla, C., Rostagno, M. and Schumacher, J. (2024), “When banks hold back: credit and liquidity provision”, Working Paper Series, No 3009, ECB, Frankfurt am Main.
A similar quantification is obtained in Altavilla, C. et al., “Central Bank Liquidity Reallocation and Bank Lending: Evidence from the Tiering System”, Journal of Financial Economics (forthcoming). The findings of this paper highlight that a reduction in central bank reserves affecting banks with lower liquidity holdings can have significant contractionary effects on loan supply.
For theoretical and empirical evidence on how quantitative tightening affects the real economy, see Kumhof, M. and Salgado-Moreno, M. (2024), “Quantitative easing and quantitative tightening: the money channel”, Staff Working Papers, No 1090, Bank of England, August; and Altavilla, C. et al. (2024), op. cit.
In the third quarter of 2024, investment growth was entirely explained by an exceptional rise in Irish non-construction investment. Excluding Ireland, investment contracted by 0.6% in the third quarter. See Cipollone, P. (2025), “Interview with Reuters”, 6 February.
Baumann, A. et al. (2025), “Are real incomes increasing or not? Household perceptions and their role for consumption”, Economic Bulletin, Issue 1, ECB.
ECB (2024), “Eurosystem staff macroeconomic projections for the euro area, December 2024”, December.
Anbil, S. et al. (2020), “What Happened in Money Markets in September 2019?”, FEDS Notes, Board of Governors of the Federal Reserve System, 27 February.
Pinter, G. (2023), “An anatomy of the 2022 gilt market crisis”, Staff Working Papers, No 1019, Bank of England, March.
These included a weaker-than-expected US jobs report, diminished market liquidity during the summer break and a rapid unwinding of yen-funded carry trades.
Todorov, K. and Vilkov, G. (2024), “Anatomy of the VIX spike in August 2024”, BIS Bulletin, No 95, Bank for International Settlements, 29 October.
On the interaction between liquidity and the external finance premium, see Altavilla, C. et al. (2024), “Macro and micro of external finance premium and monetary policy transmission”, Journal of Monetary Economics, Vol. 147, Supplement, October.
See ECB (2025), “The euro area bank lending survey – Fourth quarter of 2024”, January.

 
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Banking systems are largely insulated from inflation, but vulnerabilities at some banks could lead to tradeoffs between containing inflation and protecting financial stability
Before the pandemic, investors worried about how persistently low inflation and interest rates would crimp bank profits. Paradoxically, they also worried about bank profitability when post-COVID reopening sent inflation and central bank interest rates soaring. The failure of Silicon Valley Bank and other US lenders in early 2023 appeared to validate these fears.
Our new research on the relationship between inflation and bank profitability helps us make sense of these concerns. Most banks are largely insulated from shifts in inflation—the exposure of income and expenses tend to offset each other. Yet some have significant inflation exposures, which may lead to financial instability if concentrated losses lead to wider panics in the banking sector. As several major central banks are reassessing their monetary policy frameworks in the aftermath of the post-pandemic inflation surge, a deeper understanding of the links between inflation and bank profitability can help design better monetary policy frameworks.
Our findings imply that central banks may need to consider financial stability when setting their policy stance to combat inflation.
Inflation matters
Does inflation matter for bank profitability? This question has received surprisingly little attention. We answer it by combining balance sheet and income data for more than 6,600 banks in advanced and emerging economies with nearly three decades of IMF economic data.
Most lenders appear largely hedged against inflation with both bank income and expenses rising with inflation to similar degrees. Income and expenses tied to borrowing and lending are exposed indirectly to inflation, because they primarily react to policy rates that fluctuate in response to inflation. In contrast, other income and expenses—revenues from non-traditional banking activities, services, salaries, and rent—are exposed directly to price changes.
At the country level, the impact of inflation on bank income and expenses individually varies widely across banking systems. Shifts in inflation are reflected in income and expenses much more rapidly in some countries than in others. But, again, since both income and expenses rise with inflation to similar degrees in most countries, most banking systems appear largely hedged to inflation.
Concentrated exposures
So, can inflation be a cause for concern?
Our research identifies specific vulnerabilities: some banks are particularly susceptible to inflation due to different risk management and business models. Outliers in both advanced and emerging market and developing economies stand to see large losses when inflation and interest rates spike.
Strikingly, 3 percent of banks in advanced economies and 6 percent of banks in emerging economies are at least as exposed to elevated interest rates as Silicon Valley Bank at the onset of its failure. Banks in emerging economies also appear more exposed to inflation directly, possibly due to more widespread price indexation.

Policy implications
Amid high inflation, tightening monetary policy, while necessary, could lead to meaningful losses for banks with large exposures. Customers and investors may then reassess risks across all banks, which could lead to panics and financial instability.
Strengthening prudential regulation and supervision, heightening required risk management at banks, improving transparency, and using granular risk assessments accounting for key factors our research highlights for a broad set of banks would all help to systematically contain inflation exposures.
Despite these improvements, if losses at individual banks leave room for wider contagion, central banks may need to balance raising rates to contain inflation against the potential for financial instability.
 
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Each year, the EIB Investment Survey provides a snapshot of the issues facing EU firms and their ability to invest and grow their business. While the survey looks at trends across the European Union, it also hones in on individual countries and provides detailed information on how companies are weathering challenges such as tighter financial conditions, the demands of climate change, and the need to innovate and improve digitalisation amidst growing uncertainty.
Highlights of the results for individual countries include:
Digitalisation and innovation:

Danish firms excel in innovation and the adoption of digital technologies. They are more likely to innovate than the average EU firm (49% vs 32%). Moreover, Danish firms are ahead of EU firms on the adoption of advanced digital technologies (84% vs. 74%), particularly medium and large firms and manufacturers.

Czech firms are innovative and use state-of-the-art technologies. The share of Czech firms that have innovated during the preceding financial year is above the EU average (48% vs. 32%). A higher share of Czech firms has adopted advanced digital technologies than EU firms (91% vs. 74%).
Italian firms’ investment in innovation and digital technologies is very close to their EU peers.

Climate change:

In Finland, almost all (99%) of firms have taken action to reduce greenhouse-gas emissions, which is higher than the EU average of 91%. Additionally, 49% of Finnish firms see the transition to stricter climate standards and regulations as an opportunity, compared to 27% on average in the European Union.

French firms outpace their EU counterparts when it comes to investing in climate mitigating measures. But they spend less in adaptation investment and insurance coverage: 12% of French firms are insured against climate risks vs. 21% in the EU on average.
Nearly half of Swedish firms (49%) view the transition to stricter climate standards and regulations as an opportunity over the next five years, significantly more than the 29% of EU firms.

Overall investment:

Investment in Croatia is 26% above pre-pandemic levels (in real terms), driven by the strong expansion in the private sector. Croatian firms are notably more positive than the EU average about the political, regulatory and economic climate.

The share of Dutch firms investing reached a peak of 97% in 2024, surpassing the EU average (87%). However, the share of firms expecting to increase rather than decrease their investment (9%) has declined steadily since 2022 (22%).

Looking ahead to the next three years, Spanish firms plan to invest in expanding capacity. More Spanish firms report capacity expansion as their investment priority than the EU average (42% vs. 26%).

Explore the survey results

The EIB Investment Survey is conducted annually and includes data from approximately 13 000 firms in all EU Member States plus a sample from the United States. Its main results, the EIB Investment Survey: European Union overview, were released in October 2024. The survey provides information on firm characteristics and performance, past investment activities and future plans, sources of finance and the financing issues businesses face.

Investment trends

The European Union overview publication looked at broader investment trends and found that while many EU firms were satisfied with their overall level of investment over the last three years, a significant share (14%) felt they still were not investing enough to meet current challenges and to transform their business to remain competitive.

The share of firms expecting to increase rather than decrease investment halved in 2024, falling to a net balance of 7%, from 14% in 2023.

The EU overview also highlighted some important disparities between EU firms and their US counterparts.

The share of EU firms investing in expansion is 6 percentage points below the share of US firms (26% in the European Union vs. 32% in the United States).
EU firms devote 37% of their investments to intangible assets, focusing less on land, buildings, and infrastructure than US firms do (14% of EU firms vs. 24% of US firms).

Looking ahead, EU firms expect to continue investment in replacing instead of expanding capacity. This contrasts sharply with US firms, where 47% said they expected to expand capacity in the next three years, compared to 26% in the European Union.

Supply chain resilience

EU firms are highly dependent on trade, either with other EU members or with countries beyond the European Union. Political and trade tensions threaten to disrupt supply chains, although those risks dissipated somewhat in 2024. However, EU and US firms remain concerned about disruptions to their logistics and transport and their ability to comply with new regulations, standards and certifications.
In response to trade shocks, EU and US firms have adopted similar strategies: building up inventories, investing in digital tracking of supplies and diversifying suppliers. Despite the challenge, EU firms are less likely to reduce their reliance on international trade by cutting the amount of imported goods and services used in production.

Only 7% of EU firms are willing to scale back imported goods and services used in production, vs. 14% of US firms.

Climate change

EU firms continue to lead in climate change investments, whether to prepare for extreme weather or to reduce carbon emissions. EU firms are also less likely to see the green transition as a risk than their US counterparts.

One in three EU firms (34%) say that the transition to stricter climate standards and regulations will pose a risk to their business over the next five years, compared to 42% of US firms.
27% of EU firms even see the green transition as an opportunity.

Investment barriers

EU and US firms share concerns about the business environment, and say they have not seen any significant improvement in recent years. Firms in both regions mainly worry about the availability of staff with the right skills and uncertainty about the future.

In the European Union, 46% of firms say that energy costs remain a major obstacle to investment.
EU firms are also more likely to perceive business regulations and the availability of finance as major obstacles than their US counterparts.

Download the complete survey here

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NEW YORK—The Federal Reserve Bank of New York’s Center for Microeconomic Data today released the January 2025 Survey of Consumer Expectations, which shows that inflation expectations were unchanged at the short- and medium-term horizons, and increased at the longer-term horizon. Commodity price expectations rose across the board, with the expected price change for gas, food, medical care, education, and rent all increasing. Labor market expectations were mixed, with job loss and job finding expectations both rising and unemployment expectations falling to the lowest level since July 2021. Household spending growth expectations also declined in January, hitting the lowest level seen in the last four years.
The main findings from the January 2025 Survey are:
Inflation

Median inflation expectations were unchanged at 3.0% at both the one- and three-year-ahead horizons. Median five-year-ahead inflation expectations rose by 0.3 percentage point to 3.0% in January. This increase was driven primarily by respondents with a high-school education or less. The survey’s measure of disagreement across respondents (the difference between the 75th and 25th percentile of inflation expectations) increased at the one- and five-year horizons and was unchanged at the three-year horizon.
Median inflation uncertainty—or the uncertainty expressed regarding future inflation outcomes—was unchanged at the one-year horizon, declined at the three-year horizon, and increased at the five-year horizon.
Median home price growth expectations rose by 0.1 percentage point to 3.2%. This increase was driven by respondents in the West census region. This series has been moving in a narrow range between 3.0% and 3.3% since August 2023.
Year-ahead commodity price expectations rose across the board, increasing by 0.6 percentage point for the price of gas to 2.6%, 0.6 percentage point for the price of food to 4.6%, 1.0 percentage point for the cost of medical care to 6.8%, 0.2 percentage point for the cost of college to 5.9%, and 0.5 percentage point for rent to 6.0%.

Labor Market

Median one-year-ahead earnings growth expectations increased by 0.2 percentage point to 3.0% in January. This series has been moving within a narrow range between 2.7% and 3.0% since January 2024.
Mean unemployment expectations—or the mean probability that the U.S. unemployment rate will be higher one year from now—decreased by 0.6 percentage point to 34.0%, the measure’s lowest reading since July 2021. The decline was driven by respondents with no college degree, those with an annual income below $100,000, and those above age 40.
The mean perceived probability of losing one’s job in the next 12 months increased by 2.3 percentage points to 14.2%. This increase was broad based across demographic groups, but most pronounced for those over the age of 60. The mean probability of leaving one’s job voluntarily in the next 12 months also increased by 1.7 percentage points to 19.9%. This increase was most pronounced for those with an annual household income below $50,000.
The mean perceived probability of finding a job in the next three months if one’s current job was lost increased by 1.3 percentage points to 51.5%. This increase was driven by those with an annual household income below $100,000.

Household Finance

The median expected growth in household income increased by 0.2 percentage point to 3.0% in January. The series has been moving in a narrow range between 2.8% and 3.1% since August 2023.
Median household spending growth expectations declined by 0.4 percentage point to 4.4%, its lowest reading since January 2021, but remains above pre-pandemic levels. The decline was broad-based across age, income, and education groups.
Perceptions of credit access compared to a year ago improved in January, with the net share of households reporting it is easier versus harder to obtain credit than one year ago increasing. Expectations for future credit availability also improved.
The average perceived probability of missing a minimum debt payment over the next three months decreased by 0.9 percentage point to 13.3%. This series remains above its 12-month trailing average of 13.0%.
The median expected year-ahead change in taxes at current income level increased by 0.2 percentage point to 3.2%, but remains well below its 12-month trailing average of 3.9%.
Median year-ahead expected growth in government debt increased by 0.1 percentage point to 6.0%. This reading is well below the series 12-month trailing average of 8.6%.
The mean perceived probability that the average interest rate on saving accounts will be higher in 12 months decreased by 0.2 percentage point to 25.0%.
Perceptions about households’ current financial situations compared to a year ago deteriorated in January, with the net share of households reporting a worse versus better situation compared to a year ago rising. Similarly, year-ahead expectations about households’ financial situations also deteriorated in January.
The mean perceived probability that U.S. stock prices will be higher 12 months from now increased by 0.5 percentage point to 40.3%.

About the Survey of Consumer Expectations (SCE)

The SCE contains information about how consumers expect overall inflation and prices for food, gas, housing, and education to behave. It also provides insight into Americans’ views about job prospects and earnings growth and their expectations about future spending and access to credit. The SCE also provides measures of uncertainty regarding consumers’ outlooks. Expectations are also available by age, geography, income, education, and numeracy.
The SCE is a nationally representative, internet-based survey of a rotating panel of approximately 1,300 household heads. Respondents participate in the panel for up to 12 months, with a roughly equal number rotating in and out of the panel each month. Unlike comparable surveys based on repeated cross-sections with a different set of respondents in each wave, this panel allows us to observe the changes in expectations and behavior of the same individuals over time. For further information on the SCE, please refer to an overview of the survey methodology here, the interactive chart guide, and the survey questionnaire.
 
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By Marinela-Daniela Filip, Daphne Momferatou and Susana Parraga-Rodriguez | At the heart of the euro area’s competitiveness challenges lies weak productivity growth. The ECB Blog looks at how this makes it more difficult to carry out monetary policy.

While companies in the euro area are getting more productive, they are doing so at a much slower pace than their competitors. Weak productivity growth is putting monetary policy in a difficult situation. When the economy struggles to grow and loses competitiveness this can increase inflationary pressures and reduce the space for monetary policy to manoeuvre. In this post we take a closer look how the loss of competitiveness affects monetary policy, where the issue has come from, and what can be done to reverse the trend.
How exactly does monetary policy interact with productivity?
In general, productivity growth – i.e. how many goods and services can be produced per hour worked – is a key determinant of the overall potential of an economy to grow. That, in turn, affects its natural rate of interest, which is an important factor for effective monetary policy. This is because a central bank raising its policy rate above the natural rate can cool down the economy. Lowering the policy rate below the natural rate can stimulate the economy. At the natural rate of interest, savings and investment are balanced and the economy can grow at its full potential without overheating and pushing inflation up or down too much. At this rate the economy can operate with price stability and full employment – an ideal state that sometimes is referred to as a “goldilocks economy”.
Higher productivity leads to higher potential output, which eventually leads to a higher natural interest rate. This gives a central bank greater scope to stimulate the economy in difficult times via lower rates while still keeping prices stable. It also makes the transmission of monetary policy to the real economy more effective, i.e. policy interest rates translate more directly into how restrictive or loose the financing conditions for people and businesses are.
However, when resources are not allocated efficiently and productivity is low, firms struggle to increase output. This low economic growth makes firms more sensitive to interest rate changes. Then, even small rate hikes by central banks to ensure price stability can further dampen growth, leading to a vicious circle. This is because low growth makes businesses more cautious about investment. Business sentiment may further deteriorate when high uncertainty and geopolitical tensions make energy and other raw materials more expensive. In such a situation, the room for monetary policy to manoeuvre shrinks.
And what about price stability in particular?
When input costs are growing fast, strong productivity growth can help the central bank to contain inflation. How? A sudden increase in input costs such as wages and energy can lead to cost-push inflation if not accompanied by corresponding productivity gains. And when higher prices lead to higher wage demands, this can create a wage-price spiral.[1] That is why the ECB looks at unit labour costs (ULC) when it assesses wage and price developments. ULC are essentially the labour compensation needed to produce one unit of output and are a widely used indicator of competitiveness. Overall, lower ULC are associated with greater competitiveness. ULC developments can be decomposed into the contributions of compensation per employee and productivity. Robust productivity growth can go hand-in-hand with higher wages without compromising competitiveness. Chart 1 shows how the interplay of labour compensation and productivity significantly affects ULC. But production costs can of course also increase due to other factors, such as energy. Likewise, firms may push prices when seeking to increase their profits.
During the post-pandemic recovery, for example, high commodity prices and supply bottlenecks led to strong price increases in the euro area, initially alongside higher profits, requiring the ECB to increase interest rates.[2] Over time, the price increases fed into higher wage demands so that workers could make up for their lost purchasing power. This led to strong ULC increases and weak productivity growth, but they were buffered by higher profits and a wage-price spiral was avoided.

Chart 1
Euro area ULC and components

Sources: Eurostat and ECB calculations.
Note: Data for 2024 refers to the first three quarters of the year. The evolution of unit labour costs (ULC) in 2020 and 2021 was affected by the job retention schemes.

When assessing euro area ULC developments, it is important to also look at what is happening in individual member countries. Differences in competitiveness are normal in a currency union when they reflect temporary adjustments to shocks or catching-up processes. But longer-term divergences can result in the euro area’s single monetary policy becoming less than optimal for individual countries.[3] Countries with their own national currency have the option to regain competitiveness by lowering policy interest rates and devaluing their currency, but this option is no longer available in a currency union. The ECB sets its monetary policy by looking at the euro area as a whole and thus cannot address the specific needs of each country. That’s why it’s important to close competitiveness and inflation differentials between euro area countries. It doesn’t just strengthen the European economies; it also helps the ECB to implement its monetary policy more effectively.
Why is euro area productivity falling behind anyway?
Productivity in the euro area has been slowing consistently over the past three decades, falling behind that of the United States (Chart 2). This is due in part to inefficient work and ineffective technologies and the slow increase in machinery and equipment used per worker. Lacklustre productivity compared to other economies can also be traced to the weaker performance of European “frontier firms”. These are the most technologically advanced and productive companies within a particular industry, especially in the information and communication technology sectors. This relative underperformance is closely linked to lower firm dynamism (generally the rate at which firms enter, grow and exit the market), less investment and breakthrough innovation, and slower adoption of digital technologies.[4]

Chart 2
Labour productivity gap between the euro area and the United States

(USD 2010, purchasing power parity per hours worked)

Sources: Bergeaud, A., Cette, G. and Lecat, R. (2016), “Productivity Trends in Advanced Countries between 1890 and 2012”, The Review of Income and Wealth, September; also long-term productivity database.
Notes: The euro area represents the aggregation of Germany, Spain, France, Italy, the Netherlands, and Finland. As explained in the paper, in 2012 these six countries together represented 84% of euro area GDP. Last observation available is 2022.

So, what can we do?
Low productivity growth in the euro area and the loss of competitiveness is amplified by additional challenges already on the horizon. The recent energy crisis demonstrated why Europe needs to be competitive, resilient and less dependent on other regions. Mario Draghi’s report on the future of European competitiveness and Enrico Letta’s report on empowering the Single Market rightly stress the urgent need for policies to boost competitiveness and resilience. Coordinated and combined efforts are needed to develop and swiftly adopt concrete policy proposals such as the ones included in the recently published Competitiveness Compass for the EU. As detailed above, a more competitive economy also matters for the ECB, as it can support monetary policy in keeping prices stable, stabilising the economy, and thereby increasing the living standards of all euro area citizens.
The views expressed in each blog entry are those of the author(s) and do not necessarily represent the views of the European Central Bank and the Eurosystem.
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For topics relating to banking supervision, why not have a look at The Supervision Blog?

See I. Schnabel (2023). The risks of stubborn inflation. Speech at the Euro50 Group conference on “New challenges for the Economic and Monetary Union in the post-crisis environment”.
E. Hahn (2023). “How have unit profits contributed to the recent strengthening of euro area domestic price pressures?” ECB Economic Bulletin Issue 4/2023.
M.D. Filip, D. Momferatou and R. Setzer (2023). “Inflation and competitiveness divergences in the euro area countries” ECB Economic Bulletin Issue 4/2023
See M.D. Filip, D. Momferatou and S. Parraga-Rodriguez (2025). “European competitiveness: the role of institutions and the case for structural reforms” ECB Economic Bulletin Issue 1/2025

 
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