WEBVTT - Philip Lane on the Big Problems Facing the Euro-zone Economy 0:00:02.720 --> 0:00:16.560 Bloomberg Audio Studios, Podcasts, radio News. 0:00:18.600 --> 0:00:21.960 Hello and welcome to another episode of the All Thoughts Podcast. 0:00:22.120 --> 0:00:23.520 I'm Tracy Allaway. 0:00:23.239 --> 0:00:24.400 And I'm Joe Wisenthal. 0:00:24.680 --> 0:00:28.800 Joe, did you see last month the European Commission released 0:00:28.920 --> 0:00:33.199 a competitiveness compass with a bunch of recommendations for how 0:00:33.240 --> 0:00:35.320 to boost productivity in the Eurozone. 0:00:35.360 --> 0:00:38.919 I missed that, However, I know that there have been 0:00:38.960 --> 0:00:42.720 a number of sort of similar reports and studies. Mario Draghi, 0:00:42.880 --> 0:00:46.040 I think the former ECB chief last year put out 0:00:46.040 --> 0:00:51.600 this big thing. There's certainly been a source of debate, consternation, anxiety, 0:00:51.720 --> 0:00:52.120 so forth. 0:00:52.240 --> 0:00:57.120 So Mario Droggy's competitiveness report was four hundred pages and 0:00:57.160 --> 0:00:59.960 the European commission one was twenty seven pages. And I 0:01:00.080 --> 0:01:02.440 can't figure out whether or not that makes the Commission 0:01:02.640 --> 0:01:06.160 more productive than Joggy or less, Like their output is 0:01:06.200 --> 0:01:10.760 physically smaller, but maybe it's more efficient and succinct. You're 0:01:10.880 --> 0:01:14.240 absolutely right. This is kind of a tough spot for 0:01:14.319 --> 0:01:17.959 the Eurozone. So growth has been slowing while inflation is 0:01:17.959 --> 0:01:21.200 still kind of sticky. In fact, we had EU inflation 0:01:21.319 --> 0:01:24.600 for January recently and it came in slightly hotter than expected. 0:01:24.840 --> 0:01:26.960 I think it was something like two point five percent, 0:01:27.680 --> 0:01:31.800 and Europe's been dealing with an energy crisis, plus now 0:01:31.880 --> 0:01:35.959 the threat of tariffs emanating from the Trump administration and 0:01:36.000 --> 0:01:39.880 against all of those sort of short term immediate challenges, 0:01:40.400 --> 0:01:43.320 kind of hovering in the background is the sense that 0:01:43.400 --> 0:01:47.319 Europe is falling behind in key technologies like AI, that 0:01:47.400 --> 0:01:51.600 it's becoming less competitive, less productive relative to other places. 0:01:51.800 --> 0:01:53.880 Right, and it's sort of Implaicitt, well, you're saying here, 0:01:53.880 --> 0:01:57.240 but the other big, key source of anxiety is just 0:01:57.360 --> 0:02:01.800 the sort of core industrial super powers and their competitiveness, 0:02:01.880 --> 0:02:05.560 particular visa via China, and I'm thinking about oil, perhaps 0:02:05.680 --> 0:02:09.480 the chemical industry and so forth. And then you know, 0:02:09.560 --> 0:02:12.720 you layer onto it, as you already mentioned, the possibility 0:02:12.800 --> 0:02:15.600 of tariffs and the future of trade with the United 0:02:15.680 --> 0:02:17.840 States specifically, There's a lot going on. 0:02:18.160 --> 0:02:20.680 Yeah, all of this is a very long winded way 0:02:20.760 --> 0:02:25.079 of saying that Europe is facing both cyclical and structural 0:02:25.280 --> 0:02:28.359 problems or challenges. So I am very happy to say 0:02:28.400 --> 0:02:31.920 we have the perfect guests to discuss all of this. 0:02:32.080 --> 0:02:34.600 We're going to be speaking with Philip Lane, the cheap 0:02:34.639 --> 0:02:38.320 economist over at the European Central Bank. So Philip, thank 0:02:38.360 --> 0:02:39.640 you so much for coming on all. 0:02:39.560 --> 0:02:41.880 Thoughts, Good morning, it's great to be here. 0:02:42.400 --> 0:02:45.560 Why don't we start with the thing that is all 0:02:45.600 --> 0:02:48.400 over the news, which would be tariffs. Joe and I 0:02:48.560 --> 0:02:51.520 personally are kind of struggling to cover these because the 0:02:51.560 --> 0:02:54.640 headlines change so fast by the time we get a 0:02:54.639 --> 0:02:58.680 podcast out, like the news on trade restrictions has already changed. 0:02:59.320 --> 0:03:05.399 How does the ECB factor potential tariffs into its monetary policy, 0:03:05.520 --> 0:03:09.040 because you're forecast right now. I don't think they actually 0:03:09.080 --> 0:03:12.839 take tariffs into account, but we know that Trump has 0:03:12.919 --> 0:03:17.520 talked about imposing tariffs on the EU at some point. 0:03:18.919 --> 0:03:23.040 So let me make two differentiations there. Number one, of course, 0:03:23.240 --> 0:03:27.320 for a long time now there has been speculation about tariffs, 0:03:28.000 --> 0:03:31.200 so to the extent the speculation about tariffs is feeding 0:03:31.280 --> 0:03:36.040 into investor plans, consumer plans. It's there in the data, 0:03:36.600 --> 0:03:39.400 and as you said, a lot of the sentiment in 0:03:39.440 --> 0:03:42.560 disease are kind of subdued, and I think clearly the 0:03:42.720 --> 0:03:47.720 uncertainty about trade is one of those factors. What is true, though, 0:03:47.920 --> 0:03:51.640 is we have looked in great detail about different tariff scenarios, 0:03:52.200 --> 0:03:54.920 but until you really know the scope of what we're 0:03:54.960 --> 0:03:59.080 talking about, putting those into the baseline we haven't done. 0:03:59.480 --> 0:04:03.120 We will essentially at us when and if we see 0:04:03.160 --> 0:04:06.640 more detail, and of course this kind evolve. The trade 0:04:06.640 --> 0:04:11.320 policy configuration we have in spring twenty twenty five may 0:04:11.360 --> 0:04:14.000 not be the trade policy configuration we have in the 0:04:14.080 --> 0:04:17.040 autumn or next year. So I don't think it's kind 0:04:17.040 --> 0:04:20.839 of a zero one, one day only type event. It's 0:04:20.880 --> 0:04:23.200 something we will continually reassess. 0:04:24.279 --> 0:04:27.760 Sitting aside, obviously there's a lot of uncertainty. We don't 0:04:27.800 --> 0:04:31.120 know ten percent, twenty five percent, zero percent, we don't know. 0:04:31.160 --> 0:04:34.279 But how do you think about tariffs, because you know, 0:04:34.320 --> 0:04:37.120 you hear two different things when it comes to tariffs 0:04:37.120 --> 0:04:40.359 and cyclical policy. One is, okay, maybe you get some 0:04:40.400 --> 0:04:43.279 sort of like price shock or something like that, and 0:04:43.440 --> 0:04:46.960 maybe that's inflationary, maybe that's not. But then also the 0:04:47.080 --> 0:04:51.240 implication is that tariffs force a longer term adjustment and 0:04:51.360 --> 0:04:55.320 perhaps countries have to invest more to be more self sufficient, 0:04:55.400 --> 0:04:59.760 et cetera. When you think about the eurozones trading position today, 0:05:00.200 --> 0:05:03.120 what are the vulnerabilities and are how do you think 0:05:03.160 --> 0:05:06.000 about the sort of macro effects of how tarffs play out. 0:05:07.040 --> 0:05:09.480 I don't think there's any question in terms of output. 0:05:10.320 --> 0:05:14.880 The effect of introducing frictions into global trading system is 0:05:14.920 --> 0:05:18.360 a negative, so it has to be bad rabit. Now 0:05:18.360 --> 0:05:21.120 there will be mitigants, as you say, firms who will 0:05:21.160 --> 0:05:23.840 work out Okay, now I'm going to find another supplier. 0:05:24.560 --> 0:05:27.240 Now I'm going to build another plant somewhere else to 0:05:27.320 --> 0:05:30.839 kind of get around tarfs. But those are mitigants. They're 0:05:30.880 --> 0:05:33.200 not going to say, well, all of a sudden, that's 0:05:33.200 --> 0:05:36.159 a net positive. So I think there's no doubt it's 0:05:36.279 --> 0:05:39.960 net negative for output, as you say, for inflation, and 0:05:40.080 --> 0:05:45.239 there's many conjectures that. Of course, mechanically, if it turns 0:05:45.240 --> 0:05:48.239 out to be the case that there's more expensive imports 0:05:48.240 --> 0:05:52.440 from America, mechanically there's an operate effect from that. On 0:05:52.480 --> 0:05:54.919 the other hand, as we just talked about, if there's 0:05:55.240 --> 0:05:58.560 kind of a weakning of domestic demand in Europe, if 0:05:58.560 --> 0:06:01.000 there's a lot of trade frictions globally, if there's a 0:06:01.000 --> 0:06:05.160 weakening in the global economy, those are disinflationy forces. So 0:06:05.279 --> 0:06:09.240 in December we basically and now again in our January meeting, 0:06:09.960 --> 0:06:13.719 we've said for output, it's a downside scenario. For inflation, 0:06:13.800 --> 0:06:17.040 the effects are uncertain, but as you indicated earlier on 0:06:17.160 --> 0:06:21.600 there's also classic issues about price level versus inflation, how 0:06:21.640 --> 0:06:24.240 big this is compared to all the other factors we 0:06:24.320 --> 0:06:27.159 have to think about for inflation. So I would say, 0:06:27.279 --> 0:06:29.360 you know, I think it's very natural to focus on 0:06:29.400 --> 0:06:32.920 the economic effects and then we will look at the 0:06:33.000 --> 0:06:36.760 inflation effects as we see it unfold. Rather than taking 0:06:36.920 --> 0:06:38.920 a very strong exanity position on that. 0:06:40.160 --> 0:06:44.039 I'm going to ask a very broad question. But European 0:06:44.160 --> 0:06:47.520 growth has kind of been flatlining, and at the same 0:06:47.600 --> 0:06:51.600 time we had that inflation number recently coming in slightly 0:06:51.640 --> 0:06:56.560 hotter than expected. How would you characterize the EU economy 0:06:56.680 --> 0:06:57.120 right now? 0:06:57.960 --> 0:06:59.760 So I think what you have to go back to 0:06:59.839 --> 0:07:03.600 is twenty twenty two. So twenty two, on the one side, 0:07:03.600 --> 0:07:05.680 we were coming out of the pandemic. There was a 0:07:05.720 --> 0:07:09.440 burst of activity as we reopened, and remember Europe had 0:07:09.440 --> 0:07:12.320 a much longer lockdown than over here. But then we 0:07:12.360 --> 0:07:15.960 had the Russia Ukraine War in spring twenty two. So 0:07:16.440 --> 0:07:18.760 after that we had inflation going all the way to 0:07:18.800 --> 0:07:22.480 ten point six percent in October twenty two, and of 0:07:22.520 --> 0:07:25.760 course we had to respond to that by raising rates, 0:07:25.880 --> 0:07:28.880 which were in a low for long before then. So 0:07:28.960 --> 0:07:31.600 our policy rate went from minus zero point five to 0:07:31.680 --> 0:07:35.320 plus four hundred in terms of basis points, So there's 0:07:35.480 --> 0:07:38.360 a lot of adjustment. What that meant is in twenty 0:07:38.400 --> 0:07:41.720 twenty three we did flatline. In twenty three Q four 0:07:42.320 --> 0:07:45.840 the year Area economy group by zero point one. Now 0:07:46.080 --> 0:07:49.720 look in last year twenty four, there was a partial recovery. 0:07:50.200 --> 0:07:52.720 We went from zero point one in twenty three to 0:07:52.840 --> 0:07:56.280 zero point nine in twenty four, and that we expected 0:07:56.280 --> 0:08:00.640 that we expected consumption to recover in particular, now it 0:08:00.800 --> 0:08:03.280 wasn't as strong as we would like. Then we have 0:08:03.440 --> 0:08:05.680 as we just talked about new types of shocks hidden 0:08:05.720 --> 0:08:08.600 the economy. But let me emphasize is that we do 0:08:08.720 --> 0:08:12.120 think going back to this cyclical structural issue you raised 0:08:12.560 --> 0:08:16.800 that there is cyclical recovery as our baseline. We should 0:08:16.880 --> 0:08:20.280 expect to grow probably a bit above potential this year 0:08:20.320 --> 0:08:23.800 and next year. And essentially, if you think about a 0:08:23.840 --> 0:08:28.360 lot of factors are kicking in as we ease market policy, 0:08:29.040 --> 0:08:31.320 we still expect this year to be led by consumption, 0:08:32.160 --> 0:08:34.319 and then in twenty six more than this year, a 0:08:34.440 --> 0:08:38.160 recovery in investment, and then also I think a contribution 0:08:38.240 --> 0:08:41.480 from exports. So I think it's important, you know, if 0:08:41.480 --> 0:08:44.439 you kind of are too backward looking about this, you're 0:08:44.480 --> 0:08:48.320 looking at maybe the stagnation in twenty three, or you 0:08:48.360 --> 0:08:51.600 are looking in fairness at the Q four which did 0:08:51.600 --> 0:08:55.160 flat line a bit. But I think there's some cyclical 0:08:55.160 --> 0:08:59.240 factors in those key four data. On inflation. We're down 0:08:59.280 --> 0:09:03.040 from a zen point six in October twenty two to 0:09:03.240 --> 0:09:06.480 two point five in the most recent number. That's, by 0:09:06.520 --> 0:09:08.880 the way. I know there was some market speculation was 0:09:08.920 --> 0:09:11.960 that a bit high. From my point of view, what's 0:09:12.000 --> 0:09:15.840 been developing is a bit more energy inflation, But actually 0:09:15.880 --> 0:09:18.840 services inflation, which has been what we've been really looking at, 0:09:19.240 --> 0:09:22.280 came in softer than I would have expected. So it's 0:09:22.360 --> 0:09:26.040 not the case the overall inflation profile is too dramatic 0:09:26.559 --> 0:09:29.400 and what we think is fairly soon we would be 0:09:29.480 --> 0:09:33.080 back at our two percent target, And essentially that's why 0:09:33.080 --> 0:09:34.280 we cut rates last week. 0:09:35.120 --> 0:09:38.439 The market is still pricing in several more rate cuts 0:09:38.480 --> 0:09:42.160 for twenty twenty five. I take your point about the 0:09:42.200 --> 0:09:46.559 salience of services inflation, and obviously, you know, it's very 0:09:46.559 --> 0:09:50.400 common for central bankers to sort of recognize that there's 0:09:50.400 --> 0:09:53.520 always so much you can do about the energy price component. 0:09:53.840 --> 0:09:57.959 But given where inflation is in given what you describe 0:09:58.120 --> 0:10:02.880 as a cyclical recovery likely further impulse, does it make 0:10:02.960 --> 0:10:06.120 sense to still be cutting into that environment or at 0:10:06.120 --> 0:10:06.600 their depth. 0:10:07.320 --> 0:10:10.560 Well, I think we're trying to be cautious. So one 0:10:10.559 --> 0:10:14.439 of our kind of stable sentences is no preset path. 0:10:15.080 --> 0:10:19.000 So even if the market is pricing several cuts, you know, 0:10:19.320 --> 0:10:21.079 and I'm not saying that there is there any reason 0:10:21.280 --> 0:10:24.240 not to have that market view. From a policy point 0:10:24.240 --> 0:10:28.480 of view, our emphasis is really on agility. The energy 0:10:28.600 --> 0:10:32.160 situation is changing, it may change again in either direction 0:10:32.440 --> 0:10:35.200 in the coming weeks, and I say we have a 0:10:35.240 --> 0:10:38.560 balancing act. We do have the recovery, but we also 0:10:39.280 --> 0:10:43.040 know that essentially the disinflation is well on track. And 0:10:43.160 --> 0:10:47.080 as disinflation continues, finding if you like, the new normal 0:10:47.120 --> 0:10:50.520 for interest rates is essentially a part of our challenge. 0:10:51.160 --> 0:10:54.200 And when we cut last week from three hundred basis 0:10:54.200 --> 0:10:57.240 points to two seventy five, that was essential thinking, wow, 0:10:57.360 --> 0:11:00.400 this three hundred is not the new normal. I think 0:11:00.480 --> 0:11:03.440 we'll be in that search process as we go along. 0:11:03.840 --> 0:11:06.400 Since you brought up the new normal. I mean, one 0:11:06.520 --> 0:11:08.960 thing the US and Europe do have in common right 0:11:09.040 --> 0:11:12.840 now is this debate over the neutral rate, so our star. 0:11:13.679 --> 0:11:17.800 How useful is that idea when it comes to setting 0:11:17.920 --> 0:11:21.200 interest rates? And also when you look at the economy 0:11:21.320 --> 0:11:24.320 right now, how restrictive do you think rates actually are. 0:11:25.320 --> 0:11:28.920 I think it's important of narrative frameworks, and one of 0:11:29.000 --> 0:11:32.440 the narrative frameworks is when inflation is well above two percent, 0:11:33.320 --> 0:11:37.320 it's very important that everyone understands that munchopolicy is going 0:11:37.400 --> 0:11:41.280 to be restrictive, and that's important to be able to 0:11:41.360 --> 0:11:45.400 demonstrate that the policy rate is higher than so called normal. 0:11:46.080 --> 0:11:50.719 It's important to look at is demand dampening, is the 0:11:50.840 --> 0:11:54.319 pricing environment make them more difficult for firms to be 0:11:54.360 --> 0:11:58.280 able to get through price increases? As inflation comes back 0:11:58.360 --> 0:12:02.280 to more or less around target, those factors lose kind 0:12:02.320 --> 0:12:04.760 of resonance and you do have to kind of change 0:12:04.760 --> 0:12:08.319 the narrative framework. Now what we set in December, and 0:12:08.440 --> 0:12:11.839 I think this is maybe not rocket science, but maybe 0:12:12.600 --> 0:12:15.079 it's helpful. Is what we're going to do is we're 0:12:15.080 --> 0:12:19.160 going to set mount policy appropriately. Now the appropriate phrase 0:12:19.360 --> 0:12:21.480 is essentially saying what do we need to do to 0:12:21.600 --> 0:12:26.280 keep inflation around two And this is where the neutrality 0:12:26.520 --> 0:12:30.880 debate loses some relevance. You know what is the probability 0:12:31.200 --> 0:12:33.640 in the next number of months the world is neutral, 0:12:33.880 --> 0:12:37.959 so there's no shocks. So it's a nice hypothetical conjecture. 0:12:38.960 --> 0:12:42.000 But if you are more dealing with shocks, so whether 0:12:42.120 --> 0:12:47.640 downside shocks are upside shocks, manchopolicy has to if they're material, 0:12:47.800 --> 0:12:50.680 so they're there for the medium term, that not just noise. 0:12:51.240 --> 0:12:54.240 So I think now as you get closer to that zone, 0:12:54.960 --> 0:12:58.400 let's not talk about neutrality. Let's talk about what's appropriate. 0:12:59.160 --> 0:13:01.559 And then you do the standard wish list. You know, 0:13:01.760 --> 0:13:04.880 are we seeing, what are we seeing in the pricing data, 0:13:05.559 --> 0:13:08.040 what are we seeing in the activity data, what are 0:13:08.080 --> 0:13:11.319 we seeing in the transmission because again we have a 0:13:11.400 --> 0:13:14.720 bank based system over here in America, much more market 0:13:14.800 --> 0:13:17.720 based system. I mean the markets of course matter in Europe, 0:13:18.200 --> 0:13:20.520 but we pay a lot of attention to banks. And 0:13:20.720 --> 0:13:24.120 right now to one of the dimensions of the question 0:13:24.720 --> 0:13:27.160 is what we see is credits starting to pick up, 0:13:28.120 --> 0:13:32.040 So there is some easing there, but it's still very subdued, 0:13:32.400 --> 0:13:36.240 still well below historical averages. So what I would say 0:13:36.360 --> 0:13:39.599 is compared to the peak, this been some easy but 0:13:39.840 --> 0:13:43.440 it's not the case that that process has gone into 0:13:43.520 --> 0:13:45.760 a kind of new steady state. We're still in a 0:13:45.840 --> 0:13:46.679 recovery phase. 0:14:01.880 --> 0:14:03.600 I want to ask you a question that I've actually 0:14:03.840 --> 0:14:07.439 asked several policy makers in the US about the last 0:14:07.760 --> 0:14:11.880 several years. The nature of inflation in the US and 0:14:12.320 --> 0:14:16.800 in the Eurozone. Some similarities, some differences. The spike of 0:14:16.840 --> 0:14:19.600 the Eurozone was probably more pronounced a bit thanks to 0:14:19.680 --> 0:14:22.720 the energy shock specifically. But you know, obviously there's a 0:14:22.800 --> 0:14:26.680 sort of like cyclical component and then an energy specific component. 0:14:27.000 --> 0:14:31.280 What's interesting to me, setting aside energy, unemployment in the Aurozone, 0:14:31.280 --> 0:14:33.400 if I'm looking at this correctly, is actually like at 0:14:33.440 --> 0:14:37.040 a multi year low right now, lower than it was 0:14:37.280 --> 0:14:39.480 at the peak in twenty twenty two. What is your 0:14:39.680 --> 0:14:43.160 story for if we think of central banking as sort 0:14:43.160 --> 0:14:48.040 of working through this unemployment or employment activity inflation trade off, 0:14:48.400 --> 0:14:50.520 what is your employment for why the sort of core 0:14:50.600 --> 0:14:54.600 measures of inflation or services inflation have eased so much 0:14:55.040 --> 0:14:58.880 even at a time of what seems to be labor 0:14:58.920 --> 0:14:59.640 market tightness. 0:15:00.280 --> 0:15:03.560 All so, I think the labor market titaness is part 0:15:03.640 --> 0:15:06.920 of it. And actually the your area is an interesting 0:15:06.960 --> 0:15:09.640 place to look at that, because, of course, across the 0:15:09.840 --> 0:15:12.480 area you have some economies that are hotter than others, 0:15:12.880 --> 0:15:16.080 you've kind of a laboratory, So absolutely the kind of 0:15:16.120 --> 0:15:19.800 there is a correlation between a tight labor market and wages, 0:15:20.520 --> 0:15:24.560 but the strength of that effect is not big compared 0:15:24.760 --> 0:15:28.280 to the size of the inflation shock we had, which 0:15:28.520 --> 0:15:33.920 was essentially an intersection of two factors. One was the 0:15:34.240 --> 0:15:37.880 energy shock and to us the exit from the pandemic. 0:15:38.680 --> 0:15:41.280 So more or less exactly, at the same time in 0:15:41.400 --> 0:15:45.200 spring twenty two, we had the Russian innovation of Ukraine, 0:15:45.920 --> 0:15:48.680 and that wasn't just a kind of a level shift 0:15:48.760 --> 0:15:54.480 in energy from there until August twenty two, this really large, 0:15:55.120 --> 0:15:59.520 extreme run up in gas prices. But in the same 0:15:59.640 --> 0:16:03.280 six months, so spring to Autumn twenty two, this is 0:16:03.280 --> 0:16:06.160 when the European economy reopened. So actually, if you look 0:16:06.160 --> 0:16:09.200 at activity data is quite strong for those six months 0:16:09.560 --> 0:16:14.960 because tourism restarted, hospitality restarted, So this is a very 0:16:15.080 --> 0:16:19.360 unusual configuration of events. That reopening had a demand element 0:16:19.400 --> 0:16:22.680 to it, because of course people really wanted to spend, 0:16:23.320 --> 0:16:27.160 and of course the supply was still a pandemic constrained. 0:16:27.720 --> 0:16:32.200 So this, I would say, is weird, unusual, not representative, 0:16:32.480 --> 0:16:36.840 so not that surprise. Implementing the most basic macromodel only 0:16:36.880 --> 0:16:39.760 gets you so far, and then if you like, compared 0:16:40.400 --> 0:16:43.800 since then, and I think that's common across the US 0:16:44.080 --> 0:16:46.800 and Europe is a lot of what's happened is the 0:16:46.840 --> 0:16:49.920 supply side has recovered. The exact nature of it on 0:16:50.040 --> 0:16:52.640 both sides of Atlantic is there. And that recovering the 0:16:52.720 --> 0:16:56.600 supply side is essentially why you are able to have 0:16:57.040 --> 0:17:01.560 disinflation and recovery in economy. And as you say, we 0:17:01.640 --> 0:17:05.400 do have the lowest unemployment in the history of your area. Again, 0:17:05.520 --> 0:17:07.960 let me come back to this differences across the you area. 0:17:08.400 --> 0:17:12.160 Germany has been suffering. We know that unemployment has gone 0:17:12.240 --> 0:17:15.000 up in Germany, so the labor market is what you 0:17:15.000 --> 0:17:19.120 would expect. Spain has been very strong. Unemployment is coming 0:17:19.200 --> 0:17:22.159 down in Spain. And so when you think about the 0:17:22.280 --> 0:17:25.280 overall your area narrative, I mean, when you talk about 0:17:25.280 --> 0:17:27.200 the US economy, we all tend to think about the 0:17:27.280 --> 0:17:32.280 US and the aggregate, but of course the differences across California, Chicago, 0:17:32.560 --> 0:17:34.800 New York and so on. Same for US. There are 0:17:34.880 --> 0:17:38.440 big differences right now across some of the major countries. 0:17:39.640 --> 0:17:42.040 You touched on this earlier, but could you talk a 0:17:42.119 --> 0:17:46.560 little bit more about the transmission mechanism of lower rates 0:17:46.600 --> 0:17:49.840 and how those actually feed into the economy, and perhaps 0:17:49.960 --> 0:17:55.120 more importantly, how long they actually take to take effect. 0:17:55.359 --> 0:17:57.840 So in the US we hear the Federal Reserve talk 0:17:57.920 --> 0:18:01.439 a lot about long and variable lags, which gives them 0:18:01.520 --> 0:18:03.720 quite a lot of wiggle room to argue whether or 0:18:03.760 --> 0:18:07.159 not hikes or cuts are actually having an effect. How 0:18:07.240 --> 0:18:10.920 do you think about the transmission mechanism and the time 0:18:11.119 --> 0:18:13.639 frame for changes in policy to take effect. 0:18:14.119 --> 0:18:16.520 So, I mean, this is what keeps us busy, and 0:18:16.640 --> 0:18:20.240 this is why throughout this period. Some people don't like 0:18:20.320 --> 0:18:22.600 these phrases, but they're essential. We said we're going to 0:18:22.640 --> 0:18:26.320 be data dependent, and we said we have this reaction 0:18:26.520 --> 0:18:30.240 function where essentially, as we see the transmission in action, 0:18:31.119 --> 0:18:35.639 we can recalibrate our policy. So let me maybe explain 0:18:35.720 --> 0:18:39.879 why it's the complexity in the area. We were in 0:18:40.000 --> 0:18:43.879 a low for long environment. Even in December twenty one, 0:18:44.119 --> 0:18:48.080 when already inflation was picked up, the markets believed the 0:18:48.200 --> 0:18:51.840 policy rate would not go above zero until around twenty 0:18:51.880 --> 0:18:55.840 twenty seven. So there's high conviction that we were in 0:18:56.000 --> 0:18:57.560 this low for long period. 0:18:58.160 --> 0:19:02.240 This is my favorite chart that charts, Yeah, the MEDUSA 0:19:02.359 --> 0:19:06.440 charts of market expectations or rates, and they're always always off. 0:19:06.880 --> 0:19:10.280 Well, I mean, the world changes. Then we had this 0:19:10.359 --> 0:19:14.080 fairly rapid hiking cycle to four percent, and now we're 0:19:14.320 --> 0:19:17.080 coming down from that, and then the market is debating 0:19:18.080 --> 0:19:20.320 somewhere in the neighborhood of two percent, let's say, is 0:19:20.359 --> 0:19:23.640 the new steady state. So in terms of the how 0:19:23.840 --> 0:19:27.960 people are thinking about the financial system, some of it is, well, 0:19:28.080 --> 0:19:31.000 we're gone from an old steady state of basically at 0:19:31.040 --> 0:19:34.240 the floor. The new steady state is around two percent, 0:19:35.240 --> 0:19:38.680 and how do I value assets? How do I organize 0:19:38.720 --> 0:19:42.200 my saving my investment around that. So on top of 0:19:42.280 --> 0:19:46.200 the cyclical issue of as we ease rates, but we're 0:19:46.280 --> 0:19:50.320 easing from four hundred to in the neighborhood of two percent, 0:19:51.119 --> 0:19:54.680 we're not going back to the pre shock super low rate. 0:19:54.960 --> 0:19:57.639 I mean we don't expect to. So that that's an 0:19:57.680 --> 0:20:01.520 additional factor in transmission. Let me emphasize a couple of things. 0:20:01.560 --> 0:20:05.000 One is about the bank based system, and then in 0:20:05.080 --> 0:20:07.920 one is how the economy responds. So in a bank 0:20:08.000 --> 0:20:11.280 based system, and we had new numbers this morning essentially 0:20:11.560 --> 0:20:14.840 because of course banks are partly funded by deposits, partly 0:20:14.880 --> 0:20:20.280 funded by market funding deposits. They have responded, but not 0:20:20.480 --> 0:20:23.280 one for one. There's still lots of zero interest overnight 0:20:23.359 --> 0:20:27.680 deposits funding banks. So the one for one transmission of 0:20:27.760 --> 0:20:31.480 the policy rate that works in the runny market, it's 0:20:31.560 --> 0:20:33.919 soft both on their way up and on the way 0:20:34.000 --> 0:20:37.040 down for the banking system. So we have taken their 0:20:37.040 --> 0:20:40.440 account in the banking system with a mix of deposit 0:20:40.600 --> 0:20:45.360 funding and market funding, the transmission is slower. And then 0:20:45.560 --> 0:20:49.760 on the economic side, one issue we talked about last 0:20:49.800 --> 0:20:53.760 week was has an investment. That's the classic interest rates 0:20:53.800 --> 0:20:57.320 sensitive area. And we are seeing mortgage loans pick up 0:20:57.400 --> 0:21:00.439 quite a bit in Europe, but we haven't seen housing 0:21:00.600 --> 0:21:05.280 investment move up yet. And this goes back to here 0:21:05.320 --> 0:21:08.960 to some extent. Okay, someone's decided I'm going to start 0:21:09.000 --> 0:21:13.560 a new project, getting the permits, finding the workers, all 0:21:13.600 --> 0:21:16.040 of that takes time. And so this is why I 0:21:16.160 --> 0:21:19.120 said to you earlier on, we think the big recovery 0:21:19.240 --> 0:21:21.879 investment is going to take a while. It's not all 0:21:22.040 --> 0:21:24.679 going to happen this year in twenty five, it's going 0:21:24.760 --> 0:21:27.480 to go into twenty six. So a long way to 0:21:27.640 --> 0:21:31.200 summarize where we are is it's multi year. It really 0:21:31.359 --> 0:21:34.880 is a long lag. And again from word go, from 0:21:34.960 --> 0:21:38.280 the time we started hiking, I am the easy be 0:21:38.720 --> 0:21:41.720 flagged quite a bit. We haven't done this very often. 0:21:42.240 --> 0:21:45.000 How much of an evidence space do we have about 0:21:45.760 --> 0:21:49.320 how long are those lags? How powerful this transmission? And 0:21:49.480 --> 0:21:52.240 in the context of a pandemic and a war. So 0:21:52.359 --> 0:21:54.520 for all of those reasons, it really goes back to 0:21:55.440 --> 0:21:59.320 I'm reassured that transmission is working. I see it, but 0:21:59.400 --> 0:22:02.880 I'm also validated if you like that it takes real time. 0:22:03.280 --> 0:22:06.119 It takes real time before it transmits all the way 0:22:06.160 --> 0:22:06.960 to the economy. 0:22:07.720 --> 0:22:10.880 Tracy, I just remembered something, And you know, you started 0:22:10.960 --> 0:22:13.200 the episode talking about some of the big structural things 0:22:13.240 --> 0:22:14.840 that we should get to do you remember in the 0:22:14.920 --> 0:22:17.520 blog a sphere like the twenty tens. I just remember this, 0:22:17.880 --> 0:22:19.600 the sixth versus the structs debate. 0:22:20.119 --> 0:22:21.560 Oh no, I don't remember that. 0:22:22.040 --> 0:22:23.640 Some people were like, oh, it is the US face 0:22:23.760 --> 0:22:27.119 like just a cyclical challenge where we need more demand 0:22:27.480 --> 0:22:29.440 or is there a structs thing where we need to 0:22:29.520 --> 0:22:31.800 like structurally change how the US economy works? 0:22:31.840 --> 0:22:32.320 Do you remember that? 0:22:32.560 --> 0:22:32.960 Anyway? 0:22:33.359 --> 0:22:35.880 It occurs to me like every time there's some big 0:22:35.960 --> 0:22:38.800 economic shock of any you get this debate right, how 0:22:38.880 --> 0:22:42.680 much is it a cyclical thing where you know, economies 0:22:42.720 --> 0:22:44.879 go up and down, inflation goes up and down, unemployment 0:22:44.920 --> 0:22:48.440 goes up and down, versus something structural deeper with the 0:22:48.480 --> 0:22:52.640 economy perhaps which demand policies, whether they be fiscal or monetary, 0:22:52.760 --> 0:22:56.200 are sort of to some extent insufficient to address them. 0:22:56.240 --> 0:22:59.840 And obviously, you know Tracy mentioned in the beginning these competitiveness, 0:23:00.359 --> 0:23:03.159 so the Dragging Report, all that stuff. Do you feel 0:23:03.320 --> 0:23:08.400 like we're at a moment where it's important for Europe 0:23:08.920 --> 0:23:13.520 to be thinking about like deep structural issues or is 0:23:13.600 --> 0:23:15.640 it just weird sort of taking our eye off the ball. 0:23:15.800 --> 0:23:17.680 And then in the end these are still sort of 0:23:17.960 --> 0:23:20.000 cyclical challenges for the economy. 0:23:20.280 --> 0:23:22.400 Well, let me make a few points about this, because 0:23:22.400 --> 0:23:25.520 of course this debate is ongoing. First of all, I 0:23:25.600 --> 0:23:28.680 think it's important to recognize there isn't a clear bright 0:23:28.800 --> 0:23:32.320 line between cyclical and structural because of course, if an 0:23:32.359 --> 0:23:36.720 economy faces structural issues more or less, if your pessimism 0:23:37.040 --> 0:23:40.280 on a structural basis, it will lower demand. So so 0:23:40.400 --> 0:23:44.680 cyclical policy is called for even if the origin is structural. 0:23:45.560 --> 0:23:47.560 But let me say, on top of all the structural 0:23:47.600 --> 0:23:50.879 issues which are global. Every country debates, had to deal 0:23:50.960 --> 0:23:54.399