Update on economic and monetary developments

Summary

The ECB’s monetary policy measures have continued to preserve the very favourable financing conditions that are necessary to secure a sustained convergence of inflation rates towards levels below, but close to, 2% over the medium term. Incoming data since the Governing Council’s meeting in early March confirm that the cyclical recovery of the euro area economy is becoming increasingly solid and that downside risks have further diminished. ^[1] At the same time, underlying inflation pressures continue to remain subdued and have yet to show a convincing upward trend. Moreover, the ongoing volatility in headline inflation underlines the need to look through transient developments in HICP inflation, which have no implication for the medium-term outlook for price stability.

Available indicators point to sustained global growth at the beginning of 2017, while the recovery in international trade has continued. The global recovery is broadening, with the improvement in growth being widespread across countries. International financial conditions have remained overall supportive, despite significant policy uncertainty. Global headline inflation has increased further, mainly driven by energy prices. However, oil prices have recently undergone some volatility.

Euro area financing conditions remain very favourable. Comparing developments between the Governing Council meetings of 9 March and 27 April, bond, equity and foreign exchange markets overall show only small movements.

Incoming data, notably survey results, suggest that the ongoing economic expansion will continue to firm and broaden. The pass-through of the monetary policy measures is supporting domestic demand and facilitates the ongoing deleveraging process. The recovery in investment continues to benefit from very favourable financing conditions and improvements in corporate profitability. Employment gains, which are also benefiting from past labour market reforms, are supporting real disposable income and private consumption. Moreover, the signs of a stronger global recovery and increasing global trade suggest that foreign demand should increasingly add to the overall resilience of the economic expansion in the euro area. However, economic growth continues to be dampened by a sluggish pace of implementation of structural reforms, in particular in product markets, and by remaining balance sheet adjustment needs in a number of sectors. The risks surrounding the euro area growth outlook, while moving towards a more balanced configuration, are still tilted to the downside and relate predominantly to global factors.

Inflation has been recovering from the very low levels seen in 2016, largely owing to higher energy price increases. After reaching 2.0% in February, euro area annual HICP inflation declined to 1.5% in March 2017. Measures of underlying inflation, however, have remained low and are expected to show only a gradually rising trend over the medium term, supported by the monetary policy measures, the expected continuing economic recovery and the corresponding gradual absorption of slack.

Broad money growth remained robust, while the recovery in loan growth to the private sector observed since the beginning of 2014 is proceeding. The euro area bank lending survey for the first quarter of 2017 indicates that net loan demand has increased and bank lending conditions have eased further across all loan categories. The pass-through of the monetary policy measures put in place since June 2014 thus continues to significantly support borrowing conditions for firms and households and credit flows across the euro area. Moreover, financing costs for euro area non-financial corporations are estimated to have remained favourable in the early months of 2017.

At its meeting on 27 April 2017, based on the regular economic and monetary analyses, the Governing Council decided to keep the key ECB interest rates unchanged. The Governing Council continues to expect the key ECB interest rates to remain at present or lower levels for an extended period of time, and well past the horizon of the net asset purchases. Regarding non-standard monetary policy measures, the Governing Council confirmed that the net asset purchases, at the new monthly pace of €60 billion, are intended to run until the end of December 2017, or beyond, if necessary, and in any case until the Governing Council sees a sustained adjustment in the path of inflation consistent with its inflation aim. The net purchases will be made alongside reinvestments of the principal payments from maturing securities purchased under the asset purchase programme.

Looking ahead, the Governing Council confirmed that a very substantial degree of monetary accommodation is needed for euro area inflation pressures to build up and support headline inflation in the medium term. If the outlook becomes less favourable, or if financial conditions become inconsistent with further progress towards a sustained adjustment in the path of inflation, the Governing Council stands ready to increase the asset purchase programme in terms of size and/or duration.

External environment

Surveys point to sustained global growth in the first quarter of 2017. The global composite output Purchasing Managers’ Index (PMI) excluding the euro area increased in March (see Chart 1), driven by a rise in the services index while the manufacturing PMI remained broadly unchanged at three-year highs. In quarterly terms, the PMI remained at about the same level in the first quarter of 2017 relative to the previous quarter, pointing to ongoing robust growth. Quarterly PMIs weakened in the United Kingdom and to a lesser extent in the United States, but picked up in Japan. Among emerging market economies (EMEs), quarterly PMIs decreased in China, but improved in Russia, India and Brazil – albeit remaining below the expansionary level.

The recovery is broadening, with the improvement in growth being widespread across countries. Indeed, the dispersion of quarterly growth rates across countries has narrowed considerably in recent quarters. In particular, activity in commodity exporters has stabilised following the rebound in commodity prices, while temporary downturns caused by domestic factors in countries such as Turkey are also bottoming out.

Global financial conditions remain broadly supportive. Equity markets have moderated recently as investors had some concerns about the ability of the new US administration to follow through on policy pronouncements. Yet despite significant policy uncertainty, financial markets have been generally resilient, with risk aversion low. The Federal Reserve System increased its official interest rates at its March meeting. While other major central banks are expected to maintain an accommodative stance, markets have also been buoyed by expectations that monetary tightening in the United States will be gradual. In China, financial conditions have tightened for banks and bond yields have increased, but benchmark bank lending rates have remained unchanged. Financial conditions in most other EMEs have improved with financial markets rebounding and, following some weeks of outflows, capital has flowed back towards EMEs.

The recovery in global trade continued at the start of the year. Growth in global goods imports increased to 2.8% (in three-month-on-three-month terms) in February, the strongest figure in more than ten years (see Chart 2). The rise in momentum was mainly driven by EMEs, with particularly strong improvements in central and eastern Europe and Latin America. Leading indicators also confirm the positive trend. The global PMI for new export orders increased to 52.5 in the first quarter of 2017, pointing to a sustained recovery in global trade growth.

Global inflation increased further in February, mainly driven by energy prices. Annual consumer price inflation in the countries of the Organisation for Economic Co-operation and Development (OECD) reached 2.5% in February, a level not seen in almost five years. Excluding food and energy, OECD annual inflation remained unchanged at 1.9% compared with figures for January. Slowly diminishing spare capacity at the global level is expected to give some support to underlying inflation looking forward, while the current oil futures curve anticipates very stable oil prices, pointing to a very limited contribution from energy prices to inflation.

Since late last year when members of the Organization of the Petroleum Exporting Countries (OPEC) and 11 non-OPEC producer countries agreed to cut oil production, Brent crude oil prices have fluctuated in the range of USD 49 to USD 56 per barrel. While global oil production dropped in January as expected, in February oil supply in both OPEC and non-OPEC countries increased, raising concerns about whether the supply curtailment would be complied with. At the same time rising US crude oil inventories and shale oil supply further weighed negatively on oil prices, sending them back to USD 50 per barrel where they had stood at the end of November 2016. Since the beginning of April, prices have reverted to a mild positive trend owing to a new decline in US inventories and outages in Libya’s largest oilfield due to renewed geopolitical tensions. Expectations that the OPEC cut would be extended for the second half of 2017 have also recently been priced in. Non-oil commodity prices have decreased by around 5%, in US dollar terms, since early March. This has been driven largely by a substantial decline in the price of iron ore, due to high stocks at Chinese ports and expectations of a moderation in Chinese steel demand and, to a lesser extent, due to a decline in food prices. Other non-ferrous metal prices remained broadly stable.

The outlook for economic activity in the United States remains broadly robust. Real GDP expanded at an annualised rate of 2.1% in the fourth quarter of 2016, supported primarily by consumer spending and private investment. Survey and hard data have diverged at the start of 2017, with consumer and business sentiment continuing to be robust, while industrial production, core capital goods orders and consumer spending are softening. However, some of the factors holding back consumption are temporary, including exceptionally warm weather weighing on energy consumption, and delays in tax refunds. At the same time, labour market conditions continued tightening in March, with the unemployment rate reaching 4.5% (below the Federal Open Market Committee’s estimate of full employment) and annual growth in average hourly earnings at 2.7%. In March annual headline consumer price index (CPI) inflation in the United States decreased to 2.4%, mostly stemming from a decline in the energy component. The main components of core inflation also moderated, leading to a fall in CPI excluding food and energy to 2.0%.

Economic growth in Japan remains modest. Real GDP increased by 0.3% quarter on quarter in the fourth quarter of 2016, with both domestic demand growth and net trade remaining subdued. After some weakness in January, industrial production and real exports have rebounded and remain on average above last year’s levels for the same period. Moreover data on private consumption point to some tentative signs of a recovery, supported by developments in the labour market. However, the tightening in the labour market, with the unemployment rate at its lowest level since 1994, has not led to an acceleration in wage growth. Headline CPI inflation increased to 0.4% in January year on year. At the same time, annual growth in CPI excluding fresh food and energy – the Bank of Japan’s preferred measure of core inflation – also strengthened somewhat, to 0.2%.

Following robust growth in the UK economy last year, recent indicators point to a softer start into 2017. In the final quarter of 2016, real GDP increased by 0.7% quarter on quarter. However, recent indicators overall suggest that the pace of economic expansion softened at the start of this year. In particular, there are signs that rising inflation is curtailing real incomes and private consumption. The pick-up in inflation over recent months has been driven largely by energy prices and the depreciation of the pound sterling since the UK referendum on EU membership. In March 2017 annual CPI inflation stood at 2.3%. On 29 March 2017 the UK government gave formal notice of its intention to withdraw from the European Union, paving the way for EU-UK negotiations in accordance with Article 50 of the Treaties.

Economic growth in the Chinese economy stabilised. Real GDP grew at 6.9%, in year-on-year terms, in the first quarter of 2017, slightly higher than in the previous quarter. Growth was mainly driven by consumption, while the contribution of gross fixed capital formation was the lowest since early 2015. However, overall momentum in the first quarter was weaker than in the last quarter of 2016. It was also weaker than what some available indicators suggested, in particular for investment and construction, which could reflect a residual seasonality affecting the estimate for the first quarter. Annual CPI inflation fell to 0.8% in February, from 2.5% in January, as food and tourism services prices fell after the Chinese New Year holiday. Inflation excluding food and energy decreased to 1.8% from 2.2%. Meanwhile, annual producer price inflation rose to 7.8%, which is attributed to rising ferrous metal and energy prices. Reductions in overcapacity in heavy industry have pushed up raw material prices but this is likely to be temporary.

Financial developments

Overall, euro area government bond yields have slightly declined since early March. The slight decline during the period under review (9 March to 26 April 2017) has taken place in the context of heightened political uncertainty surrounding the French presidential elections. As a result, a phase of declining yields between late March and the day before the first-round results of the French elections were known was partially offset by rising yields in the aftermath of the vote. Overall, the euro area ten-year overnight index swap (OIS) yield declined by 5 basis points while sovereign bond yields decreased on average by around 15 basis points. Across countries, the declines ranged from a few basis points to around 70 points, while some marginal increases were observed in Italy and the Netherlands. Spreads vis-à-vis the rate on German ten-year bonds overall remained unchanged or decreased slightly in most countries, with the exception of Greece and Portugal (where the declines reached around 70 basis points) and Italy and the Netherlands (where spreads rose marginally).

Euro area equity prices have increased since early March. At the end of the period under review the equity prices of euro area non-financial corporations (NFCs) were around 5% higher than at the beginning, while prices rose by almost 7% for financial corporations. Overall, the recent positive developments in the euro area stock market have led equity prices of banks to now stand around 70% higher than the lows recorded in the aftermath of the United Kingdom’s referendum on EU membership in June 2016 (see Chart 3). As has been the case for bonds, political uncertainty has also affected developments in the euro area equity market: euro area equities mostly moved sideways ahead of the outcome of the French presidential elections only to then rise significantly. Since early March equity prices of NFCs in the United States and the United Kingdom have risen significantly less than in the euro area, while they declined marginally in Japan. The equity prices of financial corporations underperformed relative to NFCs in all three economic areas. Market expectations of equity price volatility increased significantly in the euro area to around 23% ahead of the French elections, but reverted to the levels prevailing in early March, i.e. around 14%, in the aftermath. In the United States, by contrast, market-based expectations of equity price volatility remained broadly stable from early March.

Spreads on bonds issued by NFCs declined marginally during the period under review. On 26 April, investment grade NFC bond spreads (on average for rating classes AAA, AA, A and BBB) were 4 basis points lower than in early March and still around 25 basis points lower than in March 2016, when the Governing Council announced the launch of the corporate sector purchase programme (CSPP). Spreads on non-investment grade NFC and financial sector debt (which is ineligible for purchase under the CSPP) also declined over the same period, by 10 and 4 basis points respectively.

In foreign exchange markets, the euro recorded a small depreciation in trade‑weighted terms. In bilateral terms, from 9 March, the euro appreciated by 3.2% against the US dollar and by 2.9% against the Chinese renminbi. Such developments were more than offset by a weakening of the euro vis-à-vis the currencies of other principal trading partners of the euro area. In particular, the euro depreciated against the pound sterling (by 2%) and against the currencies of most other non-euro area EU Member States. In the case of the Czech koruna, the euro weakened against it slightly (by 0.3%) following the discontinuation of the koruna’s exchange rate floor (see Chart 4).

The euro overnight index average (EONIA) remained stable during the review period, at around -35 basis points. Excess liquidity increased by around €243 billion, to approximately €1,608 billion. The increase was primarily attributable to the final targeted longer-term refinancing operation in the second series (TLTRO-II), which resulted in a net injection of liquidity of around €200 billion (see Box 5 in this issue of the Economic Bulletin for more details on TLTROs). In addition, the purchases under the expanded asset purchase programme (APP) continued to contribute to rising excess liquidity.

The EONIA forward curve has shifted downwards by around 10 basis points on average across maturities. An initial upward movement of the curve, which lasted until around mid-March, was more than reversed in the remainder of the review period. Overall, the EONIA forward curve for maturities above eight years moved downwards by around 15 basis points, while the three to seven-year segment declined by some 10 basis points. Forward rates declined only more marginally for shorter maturities. The curve remains below zero for maturities prior to early 2020.

Economic activity

The domestic demand-driven economic expansion in the euro area is firming and broadening. Real GDP increased by 0.5%, quarter on quarter, in the fourth quarter of 2016 (see Chart 5), on the back of positive contributions from domestic demand and, to a lesser extent, changes in inventories. At the same time, net trade provided a strong negative contribution to GDP growth, as import growth significantly outpaced the rise in exports. The latest economic indicators, both hard data and survey results, remain buoyant and point to ongoing growth in the first half of 2017, at around the same rate as that observed in the fourth quarter of last year.

Consumer spending rose again in the fourth quarter of 2016, thus continuing to be an important driver of the ongoing recovery. Quarterly private consumption growth increased further to 0.5%. This improvement in growth took place despite a rise in the euro price of oil of almost 15% between the third and fourth quarter of last year. On an annual basis, consumption rose by 1.9% in the fourth quarter, after 1.8% in the third quarter. This slight increase was in contrast to a sharp slowdown in the growth of households’ real disposable income, to 1.1%, year on year, from 1.6% in the third quarter. This decline, in turn, mirrored the increase in annual inflation, as measured by the private consumption deflator, between the third and fourth quarter. It should be borne in mind, however, that income growth, despite the latest decline, remains relatively high by historical standards. Indeed, consumer spending during the ongoing recovery has been benefiting from rising real labour income for households, which has primarily reflected rising employment and lower oil prices. The slightly higher consumption growth, alongside falling real income growth, between the third and fourth quarter resulted in a fall in the household saving rate.

Euro area labour markets continue to improve, thus supporting income and spending. Employment rose further, by 0.3%, quarter on quarter, in the fourth quarter of 2016, resulting in an annual increase of 1.2%. As a result, employment currently stands 3.4% above the last trough in the second quarter of 2013. However, compared with the pre-crisis peak in the first quarter of 2008, employment is still down by almost half a percent. The unemployment rate in the euro area edged down to 9.5% in February 2017, i.e. 2.6 percentage points below its post-crisis peak in April 2013 (see Chart 6). This decline was broad-based across age and gender groups (see also Box 2). However, the degree of underutilisation of labour remains high and considerably above that suggested by the unemployment rate (see Box 3). Survey information points to continued improvements in labour markets in the period ahead.

Consumption growth is expected to remain robust. After having improved in the fourth quarter of 2016, consumer confidence increased again in the first quarter. As a result, consumer sentiment stands well above its long-term average and close to its pre-crisis peak level in 2007. Moreover, data on retail trade (up to February 2017) and new passenger car registrations (for the full first quarter) are in line with positive growth in consumer spending in the first quarter of 2017, at a similar pace to that observed in the fourth quarter. Moreover, further employment growth, as suggested by the latest survey indicators, should also continue to support aggregate income and consumer spending. Finally, households’ net worth relative to disposable income continues to rise, owing largely to valuation gains on real estate holdings. This development should add support to overall consumption growth.

Investment growth rebounded strongly in the fourth quarter, after the weak outcome in the third quarter. Total investment rose by 3.3%, quarter on quarter, in the fourth quarter of 2016, reflecting a strong rise in non-construction investment. The 6.4% rise in non-construction investment was due to a sharp increase in investment in intellectual property products, in turn reflecting the transaction of assets by a small number of large economic operators in Ireland. By contrast, investment in machinery and equipment contracted slightly in the fourth quarter. Meanwhile, the small increase in construction investment, of 0.1%, quarter on quarter, reflected a rise in investment in homes, which was partly offset by a decline in investment in other buildings and structures.

Incoming information suggests that both business investment and construction investment continued to rise in the first quarter of 2017. Continued positive growth in business investment is indicated by the average level of industrial production of capital goods in January and February, which was 0.2% up on that in the fourth quarter of 2016. Moreover, confidence in the capital goods sector was, on average, higher in the first quarter than in the previous quarter, and the assessment of order books in the capital goods sector improved both overall and in terms of orders from abroad, alongside the observed gradual improvement of the external environment. With regard to construction investment, monthly construction production data point to positive growth in the first quarter of 2017. Furthermore, survey indicators on the demand situation and the assessment of order books in the sector, as well as building permits, are still in line with positive underlying dynamics in the short term.

The recovery in investment is expected to continue in the medium term. Business investment is expected to be supported by domestic and external demand and favourable financing conditions, in the context of the accommodative monetary policy. Improving corporate profits should also support investment. As regards construction investment, factors such as households’ rising disposable income and improving lending conditions should underpin demand in the sector. Downside risks to the outlook for business investment relate to remaining deleveraging needs in some countries.

Monthly trade data point to a continued rise in euro area exports in the near term. Total euro area exports rose by 1.8% in the fourth quarter, mainly on account of a rebound in goods exports, supported by a weaker effective exchange rate of the euro and a gradual rebound in global trade. Monthly trade in goods outcomes for January and February suggest that extra-euro area exports continued to firm in the first quarter of 2017. The export growth momentum (in three-month-on-three-month percentage changes) seems to be driven by demand mainly from Asia (including China) and improvements in Russia as well as the United States.

Euro area exports are expected to rebound as global trade continues to firm. Survey indicators signal improvements in foreign demand, and new export orders have risen. In addition, the effective exchange rate of the euro depreciated in the first four months of 2017 and could spur competiveness gains for euro area exporters. However, any emergence of protectionist tendencies around the world could pose downside risks to the outlook for foreign demand and hence euro area exports in the longer term.

Overall, the latest economic indicators are, on balance, consistent with ongoing real GDP growth in the first and second quarters of 2017, at around the same rate as in the fourth quarter of last year. Industrial production (excluding construction) displayed a small decline in February 2017 following a rise of the same magnitude in the previous month. As a result, average production over these two months stood broadly at the same level as in the final quarter of 2016, when production rose by 0.9% on a quarterly basis. More timely survey data are also in line with continued positive growth dynamics in the near term. The composite output Purchasing Managers’ Index (PMI) averaged 55.6 in the first quarter of 2017, compared with 53.8 in the fourth quarter, before rising to 56.7 in April from 56.4 in March (see Chart 5). At the same time, the European Commission’s Economic Sentiment Indicator (ESI) rose to 107.9 in the first quarter from 106.9 in the fourth quarter. Consequently, both the ESI and the PMI, which remain above their respective long-term averages, are approaching their recent peaks at the beginning of 2011.

Looking ahead, the ongoing economic expansion is expected to continue to firm and broaden. The pass-through of the monetary policy measures is supporting domestic demand and facilitates the ongoing deleveraging process. The recovery in investment continues to benefit from very favourable financing conditions and improvements in corporate profitability. Employment gains, which are also benefiting from past labour market reforms, are supporting real disposable income and private consumption. Moreover, the signs of a stronger global recovery and increasing global trade suggest that foreign demand should increasingly add to the overall resilience of the economic expansion in the euro area. However, economic growth continues to be dampened by a sluggish pace of implementation of structural reforms, in particular in product markets, and by remaining balance sheet adjustment needs in a number of sectors. The risks surrounding the euro area growth outlook, while moving towards a more balanced configuration, are still tilted to the downside and relate predominantly to global factors. The results of the latest round of the ECB’s Survey of Professional Forecasters, conducted in early April, show that private sector GDP growth forecasts were revised upwards for 2017 and 2018 in comparison with the previous round conducted in early January.

Prices and costs

Headline inflation fell back in March. After reaching 2.0% in February, headline inflation declined to 1.5% in March (see Chart 7). The decline was driven in particular by lower inflation rates for the volatile components energy and unprocessed food, but also by lower HICP inflation excluding food and energy.

Measures of underlying inflation have remained subdued. The annual rate of HICP inflation excluding food and energy declined to 0.7% in March 2017 from 0.9% in February – the lowest level over the last two years. The decline resulted to a large extent from the deceleration in the very volatile travel-related components of services. This most likely reflected mainly price effects linked to the timing of the Easter holidays (with Easter being in April this year but in March last year), which are thus likely to be of a more temporary nature. HICP inflation excluding food and energy has remained well below its long-term average of 1.4%. Furthermore, most alternative measures also do not indicate a pick-up in underlying inflationary pressures. This may reflect in part the lagged downward indirect effects of past low oil prices but also, more fundamentally, continued weak domestic cost pressures.

Some pipeline pressures have built up at the early stages of the production and pricing chain. At the early stages of the pricing chain, above-average global producer price inflation (excluding oil) and strong growth in import prices for intermediate goods point to a build-up of pipeline price pressures. Intermediate goods are also the main driver of recent increases in producer price inflation for total industry (excluding construction and energy) in the euro area, which rose to 2.1% in February 2017 from 1.5% in January. Further along the pricing chain some upward pressure is visible in the annual inflation for import prices of non-food consumer goods, which continued their marked pick-up since November 2016 and rose further from -0.1% in January to 0.6% in February. However, domestic producer price inflation for non-food consumer goods remained largely flat at a subdued level, recording 0.2% in February, and so has not as yet provided support for non-energy industrial goods inflation (see also the discussion in Box 4 entitled “What can recent developments in producer prices tell us about pipeline pressures?”).

Wage growth in the euro area has been picking up slightly, but remains low. Annual growth in compensation per employee rose from 1.3% in the third quarter of 2016 to 1.5% in the fourth quarter, but continues to stand well below its long-term average (since 1999) of 2.1%. Factors that may have been weighing on wage growth include still significant slack in the labour market, weak productivity growth and the ongoing impact of labour market reforms implemented in some countries during the crisis. Additionally, the low inflation environment over the last years may be still contributing to lower wage growth through backward-looking formal and informal indexation mechanisms.

Longer-term market-based inflation expectations have declined somewhat, while survey-based measures remained stable. Since early March market-based measures of inflation expectations have declined across all maturities (see Chart 8). The five-year forward inflation rate five years ahead declined to around 1.6%, which is around 10 basis points lower than the level observed in early March 2017. By contrast, the survey-based measures for long-term inflation expectations for the euro area from the April 2017 ECB Survey of Professional Forecasters (SPF) remained stable at 1.8%.

Residential property prices in the euro area accelerated further. According to the ECB’s residential property price indicator, prices for houses and flats in the euro area increased by 3.8% on a year-on-year basis in the fourth quarter of 2016, up from 3.4% in the third quarter, which points to a strengthening and broadening of the house price cycle.

Money and credit

Broad money growth remained robust. The annual growth rate of M3 remained broadly stable in February 2017 (at 4.7%, after 4.8% in January), hovering around a rate of 5.0% since mid-2015 (see Chart 9). The low opportunity cost of holding liquid deposits in an environment of very low interest rates and the impact of the ECB’s monetary policy measures continued to support M3 growth. Annual M1 growth was again the main contributor to M3 growth. Its pace remained stable in February (at 8.4%).

Broad money growth was again driven by domestic sources of money creation. Purchases of debt securities in the context of the public sector purchase programme (PSPP) continued to have a considerable positive impact on M3 growth (see the orange bars in Chart 9). By contrast, the contribution of credit to general government from monetary financial institutions (MFIs) excluding the Eurosystem remained negative (see the green bars in Chart 9).

Domestic counterparts other than credit to general government also exerted a positive impact on M3 growth (see the blue bars in Chart 9). On the one hand, this reflects the gradual recovery in the growth of credit to the private sector. On the other hand, the significantly negative annual rate of change in MFIs’ longer-term financial liabilities (excluding capital and reserves) continued to support M3 growth. This is partly explained by the flatness of the yield curve, which is linked to the ECB’s monetary policy measures and has made it less attractive for investors to hold long-term deposits and bank bonds. The availability of the targeted longer-term refinancing operations (TLTROs) as an alternative to longer-term market-based bank funding also played a role.

The MFI sector’s net external asset position continued to exert downward pressure on annual M3 growth (see the yellow bars in Chart 9). This development reflects ongoing capital outflows from the euro area. PSPP-related sales of euro area government bonds by non-residents make an important contribution to this trend.

The recovery in loan growth is proceeding. The annual growth rate of MFI loans to the private sector (adjusted for sales, securitisation and notional cash pooling) was broadly stable in February (see Chart 10). Across sectors, the annual growth of loans to non-financial corporations (NFCs) decreased somewhat, while that of loans to households remained stable. The significant decrease in bank lending rates seen across the euro area since summer 2014 (owing notably to the ECB’s non-standard monetary policy measures) and overall improvements in the supply of, and demand for, bank loans have supported the recovery in loan growth. In addition, banks have made progress in consolidating their balance sheets, although the level of non-performing loans remains high in some countries and may constrain bank lending.

The April 2017 euro area bank lending survey suggests that loan growth continued to be supported by eased lending conditions and increasing demand across all loan categories. In the first quarter of 2017, credit standards for loans to enterprises and for loans to households for house purchase eased slightly. The ECB’s expanded asset purchase programme (APP) has had an easing impact on credit terms and conditions across all loan categories. The net easing impact was stronger for terms and conditions than for credit standards. Euro area banks reported that the APP has contributed to an improvement of their liquidity position and their market financing conditions. They have mainly used the liquidity obtained from the APP to grant loans. Furthermore, the ECB’s negative deposit facility rate was said to be having a positive effect on lending volumes, but weighing on banks’ net interest income. Banks also reported increasing net loan demand from households and NFCs. This increase was driven by a variety of factors, in particular the low general level of interest rates, merger and acquisition activity and favourable housing market prospects.

The decline in bank lending rates, which started in early 2014, has flattened at the beginning of 2017 (see Chart 11). Between May 2014 and February 2017, composite lending rates on loans to euro area NFCs and households fell by 117 and 106 basis points, respectively. Composite lending rates for NFCs and households have decreased by significantly more than market reference rates since the announcement of the ECB’s credit easing measures in June 2014. The reduction in bank lending rates on NFC loans was especially strong in vulnerable countries, thereby contributing to mitigating previous asymmetries in monetary policy transmission across countries. Over the same period, the spread between interest rates charged on very small loans (loans of up to €0.25 million) and those charged on large loans (loans of above €1 million) in the euro area narrowed considerably. This indicates that small and medium-sized enterprises have generally been benefiting to a greater extent from the decline in bank lending rates than large companies.

The net issuance of debt securities by NFCs remained robust in the first quarter of 2017. The latest ECB data show that the net issuance of debt securities by euro area NFCs increased again in January and February 2017, after declining in December 2016 mainly due to seasonal factors. Issuance activity continued to be supported by the ECB’s purchases of non-bank investment-grade corporate bonds, among other factors. Preliminary data suggest that issuance remained robust in March. The net issuance of listed shares has been modest in the first months of 2017.

Financing costs for euro area NFCs are estimated to have remained favourable in the first months of 2017. In the first quarter of 2017, the overall nominal cost of external financing for NFCs is estimated to have barely changed compared with December 2016. The level observed in March was only slightly above the historical low level recorded last summer. However, the cost of equity financing remains at high levels compared with the cost of debt financing, reflecting a relatively high equity risk premium. By contrast, the cost of debt financing has continued to decline in recent months, thus reaching a new historical low.

Boxes

The ECB’s asset purchase programme and TARGET balances: monetary policy implementation and beyond

This box analyses the increase in TARGET balances since the start of the asset purchase programme (APP) and explains why the current dynamics differ from those observed during previous episodes of rising balances. ^[2] TARGET balances are the claims and liabilities of euro area national central banks (NCBs) vis-à-vis the ECB that result from cross-border payments settled in central bank money.^[3] Net payment inflows into a country increase the TARGET claim (or reduce the TARGET liability) of its NCB while net payment outflows have the opposite effect. The total TARGET balance, which is the sum of all positive balances, is only affected when central bank money flows between countries with positive and negative balances.^[4] Cross-border flows of central bank money, as reflected in changes in TARGET balances, are recorded in the balance of payments of euro area countries.^[5] According to balance of payments accounting, these flows must be mirrored in other components of the balance of payments, such as the current account or portfolio investment flows.

Sizeable TARGET balances can be a consequence of the injection of large amounts of excess liquidity by the euro area’s decentralised central banking system. TARGET balances emerge when the central bank reserves created in one jurisdiction flow to another. During the sovereign debt crisis, there was a demand-driven increase in excess liquidity as banks substituted Eurosystem funding for market-based funding that had dried up. Although the initial provision of liquidity via refinancing operations was TARGET-neutral,^[6] TARGET balances increased as this liquidity subsequently flowed from vulnerable to less-vulnerable countries in the context of severe market stress.^[7] Since the start of the expanded APP, however, the renewed increase in excess liquidity has been predominantly supply-driven, resulting from asset purchases by NCBs and the ECB rather than stress-related recourse to refinancing operations.^[8] The APP – and in particular the public sector purchase programme (PSPP) – gives rise to increasing TARGET balances (see Chart A) by inducing large cross-border liquidity flows. These flows arise (i) during APP implementation and (ii) via further portfolio rebalancing.

The financial structure of the euro area contributes to the current increase in TARGET balances because cross-border payments are an inherent feature of decentralised APP implementation in an integrated market. APP implementation is distinct from that of refinancing operations because it can entail immediate cross-border payments, as purchases are not limited by national borders. In fact, around 80% of APP purchases by volume have involved non-domestic counterparties, while around 50% have involved counterparties resident outside the euro area, many of which are concentred in the United Kingdom.^[9] The latter have historically accessed TARGET2 via major euro area financial centres, particularly Germany and, to a lesser extent, the Netherlands.^[10] The main financial centres in the euro area have always been located in countries which, during the sovereign debt crisis, came to be viewed as less vulnerable.^[11] The settlement of APP transactions is therefore associated with structural cross-border flows to these locations.^[12]

The rise in the total TARGET balance has followed the upward path implied by cross-border payments for APP transactions, suggesting that other financial flows did not further increase the balance after the implementation of the APP. Chart B shows how the total TARGET balance has actually evolved alongside a simulated balance illustrating how it would have evolved if the only cross-border payments in the system had been those stemming from APP implementation.^[13] The actual balance is currently below the simulated balance, indicating that subsequent cross-border liquidity flows are not giving rise to additional increases in the total TARGET balance; it instead suggests that there are some net cross-border liquidity flows back to countries with TARGET liabilities from those with claims.

Payments related to subsequent portfolio rebalancing are also affected by the financial structure and keep TARGET balances elevated. Since the launch of the APP, there has been a broad-based rebalancing towards non-euro area debt securities in the euro area as a whole which has been driven to a significant extent by the persistently negative interest rate differentials between euro area bonds and bonds issued by other advanced economies.^[14] Euro area residents’ net purchases of non-euro area debt securities in this period have consisted almost exclusively of debt securities issued by other advanced economies, in particular the United States. Such international portfolio rebalancing usually takes place through actors located in major euro area financial centres, thereby contributing to the accumulation of reserves in particular locations and to the persistence of TARGET balances.^[15] This mechanism is evident in the net external assets of a country’s MFIs, which mirror the transactions of the non-banking sector with the rest of the world (see Chart C) and the way in which the associated payment flows are channelled (see Chart D).^[16] A breakdown of MFIs’ net external assets for the largest TARGET-liability countries shows that the payment flows associated with international portfolio rebalancing are mainly channelled via TARGET.^[17]

Since the launch of the PSPP, developments in the balance of payments of the euro area countries with the largest TARGET claims and those with the largest TARGET liabilities have differed markedly from the developments observed during the sovereign debt crisis and have followed broadly similar patterns in both groups. In the period from mid-2011 to mid-2012, TARGET-liability countries experienced a sudden stop in foreign inflows to domestic MFIs and bond markets (see Chart Ea). At the same time, domestic residents reduced their holdings of foreign securities to repatriate liquidity, while domestic MFIs shifted funds into foreign deposits. Moreover, TARGET-liability countries were running a combined current account deficit. Correspondingly, TARGET-claim countries received foreign inflows to domestic MFIs and securities, while recording a surplus in the current account. Since the start of the PSPP, foreign investors have reduced their exposure to debt securities in TARGET-liability countries, albeit on a markedly smaller scale than during the sovereign debt crisis, and in a similar fashion as in TARGET-claim countries (see Chart Eb). Moreover, residents from both country groups have rebalanced towards foreign debt and equity securities, while recording inflows into domestic equities.^[18] Following the external adjustment process in TARGET-liability countries over recent years, the current account has registered a surplus since the start of the PSPP, as has continued to be the case in TARGET-claim countries.

Overall, the underlying factors driving the current increase in TARGET balances are of an intrinsically different nature to those in previous episodes of rising balances. The increase in TARGET balances in the period from mid-2011 to mid-2012 was triggered by a replacement of private sector funding of banks by central bank funding in a period of stressed bank funding conditions, as also evidenced by a range of financial market, banking and balance of payments statistics.^[19] By contrast, the current increase in TARGET balances is largely attributable to the interplay between the decentralised implementation of the APP and the financial structure of the euro area.

Recent developments in youth unemployment

The rate of youth unemployment peaked at above 24% in the euro area in 2013 for the age group 15-24. Since then, the youth unemployment rate has declined faster than the total unemployment rate and remained around 21% in 2016, about 6 percentage points higher than in 2007. Against this background, this box describes some key recent features of youth unemployment across the euro area countries.

A close monitoring of developments in youth unemployment is necessary in view of potential scarring effects of unemployment, especially at the beginning of one’s career. ^[20] Long periods of unemployment at a young age can result in increased risks of future unemployment, human capital losses and lower earnings. Youth unemployment rates are normally higher than total unemployment rates, but large differences across countries point to potential problems with labour market functioning in some countries.

Youth unemployment in the euro area remains above its pre-crisis level, but the ratio of youth unemployment to total unemployment has hardly changed. Youth unemployment is particularly high in Greece, Spain and Italy, following sharp rises during the crisis (Chart A). However, in spite of the very high youth unemployment rates, the ratio of youth unemployment to total unemployment did not change significantly between 2007 and 2016, which suggests that youth unemployment has moved in line with total unemployment (Chart B). Thus the very high levels of youth unemployment during the crisis reflect both the intensity of the crisis and relatively high youth unemployment in the pre-crisis period. In this regard, it is worth noting the large heterogeneity across countries. While for the euro area as a whole, the youth unemployment rate is 2.2 times higher than the total unemployment rate, in Italy and Luxembourg it is more than 3 times higher. By contrast, the youth unemployment rate in Germany is only about 1.7 times higher than the total unemployment rate.

The youth unemployment rate is declining faster than the total unemployment rate, reflecting its higher sensitivity to the cycle. Between 2007 and 2013 the youth unemployment rate in the euro area increased by about 9 percentage points. In the same period, the total unemployment rate increased by about 4.5 percentage points (i.e. half as much as youth unemployment). Similarly, during the recovery, youth unemployment has been declining faster than total unemployment. Between 2013 and 2016, the youth unemployment rate declined by about 3.5 percentage points, while the total unemployment rate decreased by about 2 percentage points (Chart C). Slovakia, Greece and Spain – followed by Portugal, Ireland and Cyprus – are among the countries with the largest reductions in youth unemployment. In Greece and Spain, the declines in unemployment rates were accompanied by declines in participation rates.^[21]

The share of young unemployed remaining unemployed for more than a year is lower than the share of total unemployed doing so. As expected, the share of young people that remain unemployed for more than one year is smaller than the corresponding figure for total unemployed, reflecting the fact that young people are more prone to intermittent transitions between activity and inactivity (e.g. to acquire further education or training). However, in some countries the share for young unemployed is close to the share for total unemployed (Chart D).

Overall, the relationship between youth unemployment and total unemployment has not changed since the crisis, but the high costs associated with youth unemployment indicate the need for policy measures to improve labour market functioning in some countries. Such policy measures include: (1) improving the quality and the labour market relevance of education, including via well-developed apprenticeship systems; (2) ensuring a well-functioning and responsible wage setting system, including when setting minimum wages; (3) enhancing the role of public employment services and the provision of active labour market policies with a view to supporting the unemployed during labour market transitions and increasing their employability; (4) increasing working time flexibility in order to facilitate a combination of work and education and to ease the transition from education to employment in the labour market.

Assessing labour market slack

Despite broad improvements in euro area labour markets since the start of the recovery and a marked decline in unemployment rates across many euro area economies, wage growth remains subdued, suggesting that there is still a considerable degree of labour market slack. This box looks at developments in wider measures of labour market slack in comparison with the rather narrow definition of the unemployment rate.

The broadening of the recovery in activity is becoming increasingly apparent in euro area labour markets, with more countries and sectors recording positive employment growth. Overall, the “employment-rich” recovery^[22] has led to an increase in the number of persons employed of just under five million since the middle of 2013, offsetting virtually all of the employment losses seen over the crisis period. Moreover, there has been a notable broadening of the labour market recovery, as evidenced by the narrowing of the dispersion of employment growth rates across euro area economies and sectors over the past two years, and almost all euro area countries are now recording positive quarter-on-quarter employment growth (see Chart A). Unemployment has declined somewhat faster than expected – albeit still remaining high compared with pre-crisis levels (see Chart 6 in Section 3) – and labour shortages reportedly appear to be emerging in some countries (most notably in Germany).

However, despite significant increases in employment, euro area wage growth remains subdued, suggesting that there may still be a high degree of underutilisation of labour – or labour market “slack” – over and above the level suggested by the unemployment rate. Chart B shows that since the start of Economic and Monetary Union (EMU) labour shortages have typically tended to signal rising wage pressure, but the co-movement seems to have broken down over the course of the recovery, which may suggest that the degree of labour market slack is still high and is containing wage growth.^[23]

The unemployment rate is based on a rather narrow definition of labour underutilisation. According to the International Labour Organization’s definition of unemployment (on which the euro area headline unemployment rate is based), job-seekers are considered unemployed if they are (i) without work; (ii) available to start working within two weeks; and (iii) actively seeking work.^[24] However, wider definitions may also be relevant for assessing the overall degree of labour market slack, with two groups being particularly worthy of consideration: first, those who are without work but do not meet one of the other two criteria; and, second, those who are employed on a part-time basis but want to work more hours. The first group falls within the inactive category and the second group within the employed category.

Currently around 3½% of the euro area working age population are marginally attached to the labour force – that is, categorised as inactive, but simply competing less actively in the labour market. Referred to as the “potential additional labour force”,^[25] this category comprises both (i) those who are not currently seeking work, despite being available (mainly “discouraged” workers; and (ii) those who are actively seeking work, but are not (yet) available to begin work (perhaps because they have received a job offer with a start date some time in the future or because they are not able to start work within the next two weeks). The latter sub-group currently amounts to almost 1% of the euro area working age population, while the former sub-group is somewhat larger – currently amounting to around 2.6% of the working age population – with the majority being discouraged workers who are not actively seeking work because they do not think work is available. This sub-group, however, can be relatively quick to rejoin the labour force as labour market conditions improve.^[26] While movements in the number of those who are “available, but not seeking work” are typically countercyclical (as is unemployment), the numbers reporting that they are “seeking work, but not available” had been following a downward trend prior to the recovery, but have remained flat since the rebound.

In addition, a further 3% of the working age population are currently underemployed (i.e. working fewer hours than they would like). Part-time employment has been rising across most euro area economies for over a decade, mainly owing to structural factors (such as the growth in services and in part reflecting the rise in female participation in the labour force).^[27] However, a non-negligible share of these part-time workers would like to work more hours. Currently there are around seven million underemployed part-time workers across the euro area – an increase of around one million since the start of the crisis. Moreover, the number has declined only very modestly over the past two years, despite the robust employment growth seen during the recovery.

Combining the estimates of the unemployed and the underemployed with the broader measures of unemployment suggests that labour market slack currently affects around 18% of the euro area extended labour force. ^[28] This amount of underutilisation is almost double the level captured by the unemployment rate, which now stands at 9.5% (see Chart C). The broader indicator is widely used by both the US Bureau of Labor Statistics and the OECD.^[29] As well as suggesting a considerably higher estimate of labour market slack in the euro area than shown by the unemployment rate, these broader measures have also recorded somewhat more moderate declines over the course of the recovery than the reductions seen in the unemployment rate.

Cross-country differences remain significant (see Chart D) – both in terms of levels of the broader indicator and when these levels are compared with developments in unemployment rates. In Germany, the broader indicator (and all three of the main components) has been declining since 2013, as has the actual unemployment rate, providing further evidence of growing tightness in the German labour market. Elsewhere, however, these broader measures show that the degree of labour market slack is still considerable. In France and Italy, broader measures of labour market slack have continued to increase throughout the recovery, while in Spain and in the other euro area economies, they have recorded some recent declines, but remain well above pre-crisis estimates.

While these broader measures cannot be taken entirely at face value, euro area labour markets appear subject to a greater degree of labour market slack than the level suggested by the unemployment rate. These broader measures may overestimate the effective degree of labour market slack somewhat, in that they (i) overestimate the remaining capacity of underemployed part-time workers somewhat, since a proportion of their time (typically around half) is already spent working; (ii) may overestimate how far those in the potential additional labour force are willing and able to find work (i.e., the extent to which they are suitably skilled for local labour markets); and (iii) do not make allowances for the lower job finding probabilities of many of the very long-term unemployed (i.e., those out of work for two years or more – currently estimated to account for around one-third of the unemployment totals across the euro area).^[30] Adjustments to the broader measures to deduct the very long-term unemployed and to allow for the time that the underemployed spend working still result in estimates of labour market slack of the order of 15% across the euro area in the final quarter of 2016 (on a four-quarter moving average basis).

Despite a clear improvement in many labour market indicators, labour markets in most euro area countries – with the notable exception of Germany – appear to still be subject to a considerable degree of underutilisation. The level of the broader indicator of labour underutilisation is still high, and this is likely to continue to contain wage dynamics.

What can recent developments in producer prices tell us about pipeline pressures?

Consumer price inflation of non-energy industrial goods in the euro area has remained subdued thus far. The short-term outlook for this component of the Harmonised Index of Consumer Prices (HICP) can typically be informed by what are known as pipeline pressures. These pipeline pressures may have already emerged at early stages in the overall pricing chain. This box discusses recent developments in global and domestic producer prices, which are important indicators in the pricing chain.

Pipeline pressures often have their origin at the global level. In particular, commodity prices can pass through to euro area industrial producer prices via the cost of imported energy (see Chart A). This pass-through can also be more indirect if commodity prices have an impact on global non-energy producer prices. This may subsequently also have an impact on the price of imported goods, which form part of the supply chains used in domestic production. The annual rate of import prices for intermediate goods is continuing to increase rapidly. This is not only a reflection of the recovery in producer prices globally but also of the recent euro exchange rate depreciation. The recent upturn in euro area non-energy producer price inflation mirrors to a large extent that in global non-energy producer price inflation (see Chart B), reflecting the use of imported intermediate goods.

Recent producer price developments early in the pricing chain point to evidence of some pipeline pressures. Movements in headline producer price inflation (industry excluding construction and the energy sector) are typically dominated by those for the intermediate goods sector, reflecting both their high weight and amplitude (see Chart C). Headline producer prices can therefore not be taken as a direct indicator of price pressures for final consumer price inflation. However, the stronger and more sustained producer price developments are in intermediate goods industries that are further upstream in the production and pricing chain, the greater the likelihood is that they may be passed through to producer prices in non-food consumer goods industries. Correlation analysis suggests that producer price inflation in intermediate goods industries generally has its strongest co-movement (at 0.7 on average) with producer price inflation in non-food consumer goods industries with a lag of somewhat more than half a year^[31]; however, there have been episodes where this co-movement lapses. The recent upturn in producer prices for intermediate goods could hence tentatively point to some pipeline pressures emerging at later stages over the coming months.

Pipeline price pressures tend to be gradually dampened along the production chain. It is likely that the degree of dampening depends on the number of production stages (from crude materials to final consumption goods) and the timing of the respective pricing decisions. One explanation is that each stage may have some degree of manoeuvre to adjust margins and that there may be sufficient leeway in the timing of pricing to gauge the persistence of cost shocks from upstream stages. In this regard, firms may be making use of hedging instruments to protect themselves against the risk of, for example, exchange rate volatility. Moreover supply contracts can sometimes be fixed for several months ahead, thus offering a temporary buffer against cost shocks. The relative movements in Purchasing Managers’ Index (PMI) input and output prices in the industrial sector suggest that there may generally be stronger variation in margins in the intermediate goods sector than in the non-food consumer goods sector – where the latter would be at the later stages of the pricing chain for consumer prices for non-energy industrial goods (see Chart D).^[32] At the same time the upward movement in PMI input prices has been relatively stronger than in output prices in the non-food consumer goods sector, which according to correlation analysis could herald a pick-up in producer price inflation in that sector around half a year later.

Producer prices of non-food consumer goods industries have continued to increase very moderately so far. Over the 12 months to February 2017, the year‑on-year growth rate of prices charged in domestic sales hovered just above zero, while that of prices charged in sales in other euro area countries has often even been negative (see Chart E)^[33]. Upward pipeline pressures for the corresponding prices at the consumer level have recently mainly come from import prices for non‑food consumer goods, which have picked up to 0.6% year on year in February, the first positive reading in a year. Correlation analysis suggests that producer price inflation in non-food consumer goods industries has its strongest co‑movement (at almost 0.7) with consumer price inflation in non-energy industrial goods with a lag of more than half a year.^[34]

In summary, producer price data currently provide mixed signals regarding pipeline pressures for HICP non-energy industrial goods prices. While it is likely that some upward pressure has emerged at the early stages, it may take some more time for this to filter through to the later stages of the pricing chain. It is also likely that this upward pressure would be dampened through margin or other adjustments along the production chain unless firms could suspend such adjustment in an environment of strongly increasing demand. In this regard, annual growth in production volumes remains positive despite softening somewhat in recent quarters (see Chart F). Moreover, survey data on capacity utilisation in the non-food consumer goods industries, to the extent that they reflect the evolution of demand relative to supply, may point to some strengthening in pricing power.

The targeted longer-term refinancing operations: an overview of the take-up and their impact on bank intermediation

Targeted longer-term refinancing operations (TLTROs) provide financing to euro area credit institutions with a maturity of up to four years at attractive conditions. Two series of operations were launched. The first series of eight operations (TLTRO-I) was announced in June 2014.^[35] It was followed by a second series of four operations (TLTRO-II), announced in March 2016.^[36] Under TLTRO-II, banks could borrow up to 30% of the amount of their existing stock of loans to non-financial corporations and households (excluding loans to households for house purchase). Moreover, banks were given the opportunity to repay funds borrowed under TLTRO-I early and switch to TLTRO-II funds. Such a shift of funding was rendered attractive for two reasons: first, it lengthened the maturity of bank funding and, second, it lowered the cost as the average cost of TLTRO-I funding stands at around 10 basis points, while the maximum rate banks will have to pay for TLTRO-II funding is zero.

The TLTROs provide incentives for bank lending to the real economy. In the case of TLTRO-I, the incentives for lending were two-fold. First, banks whose net lending over a reference period exceeded a bank-specific benchmark could borrow more in the final six TLTRO-I operations and the maximum additional amount was set at three times the amount by which their net lending had exceeded their benchmark. Second, banks which did not meet their lending benchmarks were required to repay their TLTRO-I borrowings early. Incentives for lending are provided in a different form under TLTRO-II. Rather than penalising banks that fail to meet their benchmarks, TLTRO-II provides rewards, in the form of lower interest rates, for banks which outperform their benchmarks. Banks whose eligible net lending in the period between 1 February 2016 and 31 January 2018 exceeds their lending benchmarks will benefit from a rate reduction. The TLTRO-II rate can be as low as −40 basis points.^[37]

The TLTROs have eased bank funding conditions, ensuring that the monetary policy stimulus reaches euro area households and firms. The TLTROs reduced the marginal funding costs of banks that participated in the operations and, in parallel, provided them with incentives to increase their supply of targeted credit. The design of the measure thereby ensured that the reduction in funding costs that banks benefit from is passed on to borrowers. Moreover, to the extent that market-based funding has been replaced with TLTRO funding, the measure has contributed to a reduction in the supply of bank bonds. All other things being equal, a decline in bank bond issuance generally reduces banks’ bond market funding costs, further easing funding conditions both for banks that bid in the TLTRO operations and for those that did not. The resulting more favourable credit conditions for borrowers (when the reduction in funding costs is passed on) in turn encourage borrowing and expenditure for investment and consumption.

Banks’ total TLTRO-II borrowings currently stand at €739 billion. The first TLTRO-II operation (TLTRO-II.1, settled in June 2016) attracted bids amounting to €399 billion, which largely reflected shifts out of TLTRO-I funding and into TLTRO-II funding (see Chart A). The second and third TLTRO-II operations (TLTRO-II.2 and TLTRO-II.3) allotted €45 billion and €62 billion respectively. Take-up in the final operation (TLTRO-II.4) was substantially higher at €233 billion, of which a significant share (€216 billion) constituted a net increase in TLTRO borrowings. The significant take-up in the final operation reflects the overall attractive pricing of TLTRO-II compared with banks’ alternative market-based funding, and, to some degree, incentives for back-loading take-up.^[38] Overall, outstanding TLTRO credit (including outstanding TLTRO-I credit) stood at €761 billion as at end-March 2017 and was concentrated in the first and final TLTRO-II operations (see Charts A and B).

The joint impact of TLTRO-I and TLTRO-II on bank intermediation cannot be easily split into the separate contributions of the two series at present. While high bidding volumes are welcome, they do not constitute the right metric for assessing the effectiveness of the two TLTRO series. The measure of success is rather the improvement in funding conditions of final borrowers brought about by the TLTROs. Given the large set of banks that bid in both series, the significant rollover of TLTRO-I funding into TLTRO-II funding and the relatively short period since the settlement of the first TLTRO-II operation for which bank lending data are available, it is currently difficult to split the overall impact of the TLTROs into the contribution of TLTRO-I and the additional impact of TLTRO-II. Instead, evidence of their joint impact on bank intermediation is provided below.

The TLTROs, together with the other non-standard measures introduced since June 2014, have proven effective in supporting the transmission of lower policy rates into better borrowing conditions for the euro area non-financial private sector. The rates on loans to non-financial corporations declined markedly immediately after the announcement of the first series of TLTROs (see Chart C). The declines were sharper in countries where the composite lending rates to non-financial corporations had been elevated, thus, overall, the cross-country dispersion of lending rates also declined in parallel. Moreover, in vulnerable countries, banks that borrowed under TLTRO-I reduced their rates by more than banks that abstained from bidding.^[39] Finally, banks surveyed in the euro area bank lending survey have repeatedly reported that the TLTROs – including those of the second series – have contributed to an easing of the terms and conditions on loans to enterprises and, albeit to a lesser extent, an easing of credit standards (see Chart D).

The TLTROs seem to be supporting higher intermediation volumes in less vulnerable euro area countries and a slowdown of the contraction in bank lending in vulnerable countries. Chart E compares the evolution of lending to non-financial corporations by the set of banks that bid in both TLTRO-I and TLTRO-II with lending by banks that did not participate in any operations in the two series of TLTROs. Prior to the introduction of TLTRO-I net lending by both groups of banks evolved largely in parallel. Lending by banks that did not participate in the TLTROs appears to have remained largely unchanged subsequently. In vulnerable countries, they have continued to shed loans at a relatively stable pace and there has been only a very gradual slowdown in the contraction in lending by this group of banks. By contrast, banks that bid in both series of TLTROs have significantly reduced the pace at which they had been cutting lending to non-financial corporations. In less vulnerable countries, bidders appear to have increased intermediation volumes.

The full impact of the TLTROs is still unfolding. While the pass-through of the first TLTRO series into improved bank lending conditions is already advanced, the full impact of TLTRO-II is still to materialise, as the concomitant funding cost benefit for banks is only gradually being passed on to borrowers in the form of better terms and conditions and less stringent credit standards on new bank loans. It is also worth recalling that the take-up in TLTRO-II.1 was by and large driven by shifts out of TLTRO-I funding. Significant take-up net of redemptions of TLTRO-I funding occurred only in TLTRO-II.4. The impact of this final operation is yet to materialise.

Articles

The slowdown in euro area productivity in a global context

Higher labour productivity growth is a key factor in raising living standards in advanced economies. However, labour productivity growth in the euro area has long been low, even before the recent global slowdown. Against such a backdrop, this article assesses the slowdown in euro area productivity growth from a wide range of theoretical perspectives used to explain the global deceleration. These include the role of changes in sectoral composition of the economy, the impact of the global financial crisis, the possibility of measurement errors, a deceleration in the rate of technological progress and diffusion, declines in business dynamism, and the misallocation of factors of production. The article also considers more specific local factors which may account for the longer-lasting productivity weaknesses in the euro area, and argues that structural reforms are necessary to counter the area’s long-standing productivity deficit with the United States.

1 Introduction

Higher labour productivity growth is a key factor in raising living standards in advanced economies. This is particularly the case in the euro area, in view of the rapid increase projected in the age of the workforce. Recent research suggests that while demographic effects have so far had only a modest impact on euro area productivity growth, rates of workforce ageing over coming decades are projected to increase, equivalent to forgoing around one-quarter of projected productivity growth over the 2014-35 horizon.^[40]

Recent labour productivity growth in the euro area has, however, been low – by both historical and international standards – albeit against the backdrop of a generalised slowdown in global labour productivity growth. Given this broader deceleration, considerable debate remains as to the underlying causes. Some argue that the slowdown reflects factors which are mainly cyclical, related to the impact of the global financial crisis, while others emphasise longer-standing structural drivers such as changes in the sectoral composition of the economy, measurement errors, a deceleration in the rate of technological progress and diffusion, or declines in business dynamism and misallocation of factors of production.

This article assesses the post-crisis ^[41] slowdown in euro area productivity growth from a global perspective. Section 2 presents a number of stylised facts concerning the recent slowdown in euro area productivity growth. Section 3 provides a growth accounting decomposition, showing that the slowdown in euro area labour productivity growth can be traced – at least since the global financial crisis – to reductions in the rates of both capital deepening and total factor productivity (TFP) growth. Section 4 assesses the ability of current explanations emerging in the wider literature to explain the global productivity slowdown, while Section 5 considers area-specific reasons behind the ongoing productivity deficit with the United States. The box considers the contribution of structural reforms to productivity growth and assesses the potential role of the recently created national productivity boards. Section 6 concludes.

2 Some stylised facts on euro area productivity growth

Regardless of the metric chosen to measure productivity, euro area labour productivity growth has slowed markedly since the onset of the global economic and financial crisis (see Chart 1). Over the period 2008-16, annual growth in euro area labour productivity per person employed slowed to an average of around 0.5% (based on a three-year moving average), from an average of around 1.1% over the course of the decade to 2007. If we consider only the post-crisis period of recovery from 2013 to 2016, euro area labour productivity growth averaged just 0.6% per year. Moreover, the slowdown is evident – albeit to varying degrees – regardless of whether productivity is measured as output per person employed, as output per hour worked, or in terms of TFP.

Recent euro area labour productivity growth has been low, both by historical and international standards. Chart 2 shows that the marked slowdown seen in euro area labour productivity growth since the crisis reflects a wider generalised trend across advanced (and emerging) economies since the Great Recession of 2008-09. Nevertheless, from the early 1990s to the present, the euro area has gone from being one of the regions of fastest-growing labour productivity, to one of the slowest.

The decline in euro area labour productivity growth is widespread at the sector level, reflecting a marked slowdown in within-sector rates, rather than a shift in industrial structure towards sectors with low labour productivity. The secular trend towards services as an ever-greater proportion of the total economy might be expected to result in a reduction in aggregate labour productivity growth, as productivity growth in these sectors is typically lower than in other (mainly industrial) sectors. However, a shift-share analysis shows that the decline in aggregate labour productivity growth at the euro area level owes rather more to a marked slowing of within-sector rates of labour productivity growth than to compositional effects. Using the standard ten-sector national accounts breakdown of economic activities (NACE A10^[42]), Table 1 decomposes the 0.71 percentage point decline in average annual labour productivity growth between the pre-crisis period 1996-2007 and the period 2008-16 into (i) the share due to a slowing of within-sector rates of labour productivity growth (holding employment shares constant at 2007 levels); (ii) the decline due to the effects of a changing employment composition (holding sectoral labour productivity growth at pre-crisis averages); and (iii) the cross effect, whereby aggregate labour productivity growth is typically boosted by faster employment growth in high labour productivity growth sectors.^[43] The table shows that since the onset of the crisis, within-sector rates of labour productivity growth have fallen considerably, while sectoral employment shifts have slightly supported aggregate labour productivity growth, as the labour adjustment which occurred over the crisis was concentrated in sectors with lower productivity. The predominance of the slowdown in within-sector rates of growth as the main driver of the aggregate deceleration also holds if the crisis period is excluded (i.e. when considering the 2013-16 period of recovery only).

The pattern of weak labour productivity growth at the sectoral level can also be seen using a more detailed NACE 64-sector breakdown (available on an annual basis, currently ending in 2014). As shown in Chart 3, almost two-thirds of the 61 sectors for which data were available show falls (often significant) in average rates of labour productivity growth between the two periods (see the sectors to the right of the 45° line), particularly in the manufacturing sectors and the more traded market services (such as wholesale trade, financial and insurance services, legal and managerial services, and travel-related services).^[44]

3 A growth accounting approach for the euro area and the United States

3.1 Decomposing labour productivity growth

Taking a growth accounting approach shows that the post-crisis decline in average growth in labour productivity in the euro area and the United States can be traced back to both a marked reduction in TFP growth in comparison with pre-crisis rates and, since 2013, a virtual absence of capital deepening. Using data from the European Commission’s AMECO database, Chart 4 decomposes the rate of labour productivity growth for the two economies into drivers of capital deepening (i.e. the rate at which the capital-labour ratio is increased) and of TFP (reflecting underlying productivity growth from greater efficiencies in production processes and technological progress), for the pre-crisis period 1996-2007 and for the period 2008-16, since the onset of the global financial crisis. A comparison between developments in both economies in the periods before and after the onset of the Great Recession in 2008 shows, overall, (see the first two columns for each economy in Chart 4) that the marked decline in labour productivity growth looks to be driven by a sharp reduction in the underlying rate of TFP growth in both economies. Over the 2008-16 period as a whole, capital deepening did not decline in the euro area and suffered only a moderate decline in the United States; this was largely as a result of significant shedding of labour during the depths of the crisis period (in particular during the period 2008-09).

However, over the period 2013-16, capital deepening virtually stagnated in the euro area and the United States. Although it is of interest to compare the periods before and after the onset of the global financial crisis, it is worth noting that the latter period can be divided into two distinct sub-periods. The first of these periods (2008-12 inclusive) was marked by strong declines in real GDP in both economies (albeit these declines did not last as long in the United States as in the euro area, where they spanned both the Great Recession and the sovereign debt crisis). The second period covers the recovery, which began in 2013. Decomposing the interval since the onset of the crisis into these two sub-periods confirms the broad slowdown in TFP growth in the post-crisis period compared with pre-crisis averages (see the first and final columns for each economy in Chart 4), and suggests an almost complete absence of capital deepening in the aftermath of the crisis in both economies over the 2013-16 interval.

3.2 Factors behind the post-crisis slowdown in capital deepening

Capital deepening refers to the process of increasing the capital-labour ratio by giving labour more capital to work with. However, the capital-labour ratio may also indicate “artificial” capital deepening in periods of low net investment if significant shedding of labour mechanically increases the ratio of the existing net capital stock to a reduced workforce. Chart 5 shows that during the depths of the crisis, both economies saw some support to capital deepening – and, indeed, a slight increase in the rate of capital deepening in the euro area – mainly as a result of heavy shedding of labour in some countries and sectors (which mechanically supported capital deepening, notwithstanding markedly reduced net investment^[45]).

The slowdown in capital deepening since 2013 reflects both a slower rate of net investment and a recovery in employment growth. Net investment has almost halved in the United States from pre-crisis rates, to around 1.7% per year over the 2013-16 period, but has fallen much more in the euro area (and from a lower starting rate) to just 0.6% per year – which is around one-quarter of the euro area’s pre-crisis average annual rate of net investment.^[46] However, the decline in capital deepening in both economies since 2013 also reflects a marked offsetting effect arising from growth in employment, which has been relatively strong in relation to the extent of the rebound in activity. This effect has contained the rate of capital deepening and, in fact, fully offset the low (albeit now modestly expanding) rate of investment growth in the euro area.

A number of reasons have been put forward to explain the slowdown in capital deepening since 2013. These include (i) the strong concentration of the recovery in consumer-driven sectors (common to both economies) where growth is heavily concentrated in those services that are often the most labour-intensive^[47] and in which the potential for capital-labour substitution remains somewhat limited, coupled with a persisting weakness in investment in construction (particularly in the euro area); (ii) the impact of the global financial crisis and ongoing credit constraints in its aftermath (discussed in Section 4.1, below); and (iii) some further potential for offset to the “artificial” degree of capital deepening seen over the depths of the crisis. All three of these elements are likely to help explain the lower rates of capital deepening seen in both the United States and euro area economies over the period of recovery.

3.3 A broader trend decline in TFP growth

Considered over the longer term, and from a more global perspective, it is the slowdown in TFP growth which seems to have been the key contributor to the slowdown in labour productivity growth since the mid-1990s (see Chart 6). While estimates vary as to the magnitudes of pre- and post-crisis rates of TFP growth seen in each of the euro area and the United States (due mainly to differences in methodology^[48]), a consistent finding is that TFP growth in both has decelerated significantly since the crisis. Including estimates for 17 other advanced economies (see the shaded area in Chart 6), it becomes clear that a generalised decline in average rates of TFP growth is broadly detectable across advanced economies for the period since the mid-1990s (albeit with a modest rebound from the negative rates of growth seen in the euro area during the depths of the global financial crisis). Euro area TFP performance had been lacklustre, in comparison with most advanced economies, since the mid-1990s.

4 Causes of the productivity slowdown: contrasting views

A range of competing explanations has been put forward in the literature to explain the secular decline over recent years in headline productivity growth generally, and in TFP growth in particular. This section assesses the potential of each of these factors in helping to explain the euro area’s recent slowdown in productivity growth in the context of the wider global deceleration.

4.1 The impact of the crisis on euro area productivity growth

The global financial crisis which began in 2008 is likely to have contributed to the slower average rate of euro area productivity growth since the crisis. Several mechanisms are typically associated with slower productivity growth following financial boom-bust cycles. First, the reallocation of resources previously associated with the build-up of housing imbalances in some euro area economies prior to the onset of the Great Recession may be hindered by ongoing credit supply constraints in a slow-to-recover financial system.^[49] These constraints are likely to limit the expansion of small and young, but highly productive, firms. Second, regulatory forbearance and inadequate insolvency regimes may also lock capital into firms with low levels of productivity, so that the cleansing effects typically associated with recessions do not occur. Lastly, risks of hysteresis, associated with protracted periods of private sector balance sheet repair, may weaken domestic demand and investment, thereby potentially limiting technological innovation.^[50]

Significant though the crisis may have been in further reducing euro area productivity growth in the period since 2008, it does not, however, shed light on the more fundamental issue; why euro area productivity growth was comparatively slow (from an international perspective) before then. This can be explained by an examination of the underlying determinants of labour productivity growth; these are explored in detail below.

4.2 Measurement errors in outputs and inputs

It is often suggested that mismeasurement may simply underestimate the real rate of productivity growth now seen in advanced economies. A number of areas of concern regarding mismeasurement are discussed in the literature. These include the mismeasurement of information and communications technology (ICT)-related goods and services, arising from the difficulty in measuring improvements in the quality of ICT hardware and software – in the United States, in particular, measured hardware prices have recently shown falls which some see as implausibly small in comparison with historical data. The literature also identifies the lack of an encompassing measurement of intangible investments in the national accounts^[51]; and considers the broader notion that many recent innovations are simply not marketed and therefore not captured in the national accounts, so that the growth in GDP, on which productivity dynamics are based, is significantly understated.

Notwithstanding the benefits of innovations associated with increasing numbers of free digital goods and the “sharing economy”, market-based TFP growth has slowed considerably over several consecutive decades. As Robert Gordon notes, far-reaching welfare implications for consumers associated with earlier innovations – including the invention of electricity and the telephone – have been around since well before the ICT revolution.^[52]

Potentially more relevant are the concerns regarding inadequate measurement of both intangible investments and improvements in the quality of ICT-related goods and services and of labour, which may bias estimates of outputs and inputs and result in misleading conclusions regarding labour productivity and TFP growth. Attempts to mitigate these deficiencies are ongoing and include (i) concerted efforts aimed at creating better measures of “intangible assets” in national accounts data sources via the inclusion of “intellectual property products” in the European System of National and Regional Accounts (ESA 2010)^[53]; (ii) attempts to reassess the development of ICT-based prices (and the wider link between ICT and productivity growth); and (iii) greater efforts to better isolate the impact of improvements in skills. However, given the internationally synchronised slowdown in TFP growth seen since the onset of the Great Recession across countries at varying levels of economic development and with differing economic structures and varying degrees of educational attainment, mismeasurement seems unlikely to be a major cause of either the slowdown in TFP growth which has been measured across economies, or the marked decline in euro area TFP growth observed since the onset of the crisis.

4.3 A decline in the rate of technical progress

A widely-held view suggests that the decline in aggregate productivity growth across advanced economies is likely due to a slowing in the rate of technological progress across sectors, with technological innovations of recent years simply less “revolutionary” than in the past. ^[54] As a result, it is argued, recent technological innovations may simply be less pervasive compared with earlier inventions such as the railway, electricity or the telephone, so that the impact on TFP growth is likely to be much lower.

In a similar vein, others explain the slowdown in US TFP growth since the early 2000s as a sign that the productivity-enhancing effect of ICT innovations has run its course – as suggested by the fact that the slowdown in US productivity growth is most pronounced in sectors in which ICT is produced or intensively used.^[55] However, many counter that the full impact of the ICT revolution has not yet been realised and point to the potential yields from, for example, miniaturised products with embedded connectivity, artificial intelligence, robotics, self-driving cars, drones, 3D printing, cloud services and big data, arguing that substantial gains in aggregate productivity are likely to be seen only with a considerable lag^[56]. Moreover, the argument that a slowdown in the pace of technological progress explains the marked deceleration in euro area TFP growth since the crisis seems somewhat unconvincing, not least because the euro area saw less of a boost to TFP growth from the ICT revolution than that seen in, for example, the United States.

More generally, the available evidence – in terms of research and development (R&D) expenditure and high technology patents – does not point to a sharp slowdown in global technological progress in recent years. As shown in Chart 7, R&D expenditure relative to GDP typically increased in both the euro area and the United States following the onset of the Great Recession (i.e. during the period 2008-13 (interval limited by data availability)), suggesting that there has not been a major decrease in the resources devoted to innovation. Similarly, while high-tech patent applications submitted and granted have declined somewhat from their respective peaks in the early 2000s, they remain high by historical standards (see Chart 8). However, in explaining the euro area’s longer-term “productivity deficit” with the United States, the higher incidence of US high-tech patenting activity per inhabitant remains notable (as does a higher absolute number of patent applications to the European Patent Office by US enterprises in comparison with euro area-based firms).

More anecdotally, there have been important technological advances in recent years which may still bring substantial gains in aggregate productivity, albeit with a lag. These advances are likely to enhance networking and cooperation, as well as to increase the accessibility of products and services and the speed at which they can be supplied.

4.4 A decline in the rate of technology diffusion and an increase in input misallocation

Potentially more important than any possible waning of innovation may be the fact that the pace of technology diffusion has declined, so that the latest inventions are not incorporated into the production processes of businesses as rapidly as in previous years. For technological innovations to have a noticeable impact on the TFP growth of businesses, corresponding changes in organisational structures and business models are often needed. One possible indicator of the extent of technology diffusion, as proposed by the OECD, is the gap between the labour productivity growth of global frontier firms – those creating the new knowledge – and non-frontier firms, also called “laggards”, operating in the same sector.^[57] According to this indicator, technology diffusion declined in the early 2000s in advanced OECD economies (when comparable cross-country firm-level data for Europe became available), as shown by the increasing gap in the labour productivity performance of frontier and non-frontier firms operating in the same sector (see Charts 9a and 9b).

The slowdown in technology diffusion has been particularly pronounced in services in the euro area, relative to other advanced economies. Using the CompNet dataset^[58] to analyse the labour productivity performance of firms in five large euro area countries (Belgium, Spain, France, Italy and Finland) and approximating the labour productivity growth of non-frontier firms using the performance of the median firm^[59] in each sector, Charts 9a and 9b show that the gap in labour productivity between the frontier firms operating in the OECD and the non-frontier firms operating in euro area countries widened prior to the global financial crisis. Although evident in both manufacturing and services, technological diffusion looks to have been noticeably slower in euro area services than in services in other advanced economies. This productivity gap declined moderately during the crisis, possibly due to the exit from the market of the least productive non-frontier firms, but it appears to have widened again – at least as far as services are concerned.

Three key explanations for these developments are (i) the increasing importance of so-called “tacit” learning-by-doing knowledge; (ii) a slowdown in the rate of laggard firms’ investment in intangibles; and (iii) a decrease in business dynamism. While the factors behind the slowdown in technology diffusion are still not fully clear, various mutually consistent explanations have been put forward. The literature emphasises the increasing importance of investment by firms in human capital so as to enhance their absorptive capacity.^[60] Furthermore, among non-frontier firms, investment in intangible assets (e.g. R&D activity, firm-specific skills and various forms of intellectual property), which is another crucial determinant of the absorptive capacity of firms, has not kept pace with technological innovation and is thus likely to have negatively affected technology diffusion.^[61] Chart 10 shows that the labour productivity growth gap between frontier and non-frontier firms is larger where investments by laggards in intangibles are lower relative to investments by frontier firms (after controlling for NACE sector).

A further reason for the slowdown in technological diffusion may be related to a fall in business dynamism, or the extensiveness of “creative destruction”. Given that young and high-growth firms can be key drivers of innovation – not least, by exerting pressure on incumbents to innovate and become more productive, and by speeding up labour reallocation – the literature finds a significant link between business entry rates and technological creation and diffusion.^[62] While comparable cross-country data on business closures and openings are not available for the entire euro area, data for the EU-14 suggest a downward trend in the rate of business “churn” (i.e. the process of firms exiting the market and being replaced with new firms); a similar decline has also been recorded in the United States (see Chart 11).

Business dynamism affects the allocation of capital and/or labour across firms and this can have a direct impact on within-sector labour productivity growth. A significant determinant of labour productivity growth is the degree of efficiency with which such production inputs are allocated across firms, even within narrowly defined sectors (“allocative efficiency”).^[63] Given the heterogeneity in the performance of firms, significant aggregate labour productivity gains can stem from the reallocation of resources (including labour and capital) from low- to high-productivity firms; research suggests that this may explain up to half of the aggregate labour productivity growth in a mature economy.^[64] The most frequently used, albeit imperfect, indicator of capital and labour misallocation is the dispersion in the marginal revenue product of capital and labour across firms within a given sector.^[65] The intuition underlying this measure is that for allocative efficiency to be achieved in a given sector where firms are assumed to face the same marginal costs, resources should flow across firms until the marginal productivity of inputs is equalised. However, the presence of frictions in labour, product and credit markets may hinder reallocation and can thus significantly dampen labour productivity dynamics. The larger the dispersion in the marginal revenue product of capital and labour, the greater the potential drag on aggregate labour productivity growth.

There is evidence in several euro area countries of rising inefficiency in the allocation of capital, compared with flatter dynamics for the misallocation of labour. Again using the cross-country, cross-sector CompNet data, capital misallocation appears to have been rising since the early 2000s in most euro area countries for which data are available (with the exception of Slovakia; see Chart 12a). Moreover, this upward trend has been mainly driven by the services sectors. Meanwhile, the increase in labour misallocation has been much less marked (see Chart 12b), with Spain even recording a slight decrease. Similar trends have been noted for capital and for labour in other mature economies, such as the United States and Japan.^[66]

5 Additional constraints in the euro area

Aside from the global factors considered above, there may be a number of additional European-specific factors, resulting from structural rigidities, which help to explain the long-standing labour productivity gap between the euro area and the United States. These may be connected with more highly regulated product, labour and financial markets, legal and regulatory obstacles to sectoral reallocation, or wider structural impediments such as a lower prevalence of ICT-relevant skills in the euro area. Similarly, there may be a tendency in the euro area towards a less wholesale approach to restructuring (in order to better exploit the full range of benefits from ICT investments). Recent research has also highlighted the role of managerial quality, given the need to reorganise production processes to adjust to new technologies.^[67]

Highly regulated product and labour markets and “business unfriendly” framework conditions constitute a significant impediment to TFP growth. In many structural areas euro area countries are often very far from best practice. For example, on the basis of indicators related to the “ease of doing business” – undoubtedly, a major prerequisite for innovative and productive activity, – only one euro area country (Finland) features in the global top ten, while many are not even among the top 30.^[68] Similarly, a simple correlation analysis shows that across the euro area countries, a higher TFP growth trend is typically associated with better contract enforcement mechanisms and fewer impediments to obtaining credit (Charts 13 and 14).

Recent work by the OECD also highlights the adverse consequences of administrative and bureaucratic impediments which are manifested in an increase in the overall costs of debt workout (the process of repaying, restructuring or reshaping the profile of a debt), and in impediments to firm entry and exit, which are in turn an important determinant of cross-country differences in labour productivity (see Box). Improvements in areas such as regulatory quality, insolvency regimes, licencing, employment protection, public procurement rules and quality of public administration would be likely to spur labour productivity growth in the euro area by improving the allocation of resources across sectors and firms, and fostering innovation and its diffusion.

6 Concluding remarks

The slowdown in euro area productivity growth since the economic and financial crisis is likely to stem from a combination of cyclical and secular forces. On the cyclical side, increased uncertainty and credit restrictions arising from the long-running crisis are likely to have held back some innovative activities and growth of firms with high productivity, slowed the reallocation of resources from less to more productive units, as well as reduced the willingness of firms to take on entrepreneurial risk. Nevertheless, the marked slowdown seen since the crisis represents the continuation of a downward trend in labour productivity growth across advanced economies, which began in the mid-1990s.

From a longer-term perspective, labour productivity growth in the euro area has been weak by international standards for two decades. This deficit is likely to reflect long-standing structural rigidities – including more highly-regulated product and labour markets – which constrain business growth and innovation in the euro area to a greater extent than in many other advanced economies. There is now a significant and growing body of evidence highlighting the mechanisms and extent of “business unfriendly” administrative and bureaucratic burdens on labour productivity growth. These relate, inter alia, to deficiencies in institutional and regulatory quality, impediments to entry and exit of firms, limitations on credit availability, higher debt workout costs, deficiencies in systems of contract enforcement, and the design of employment protection legislation.

Structural reforms to boost labour productivity growth in the euro area are particularly pressing in the light of the area’s aging population and because the full beneficial effects of such reforms are only visible over the medium term. While the economic recovery is firming, a reinvigoration of the reform process is needed to translate the cyclical pick-up into a stronger trend productivity growth. Reforms addressing key institutional weaknesses such as bottlenecks and inefficiencies in the regulatory system, inefficiencies and waste in public administration, poor control of corruption and malfunctioning judicial systems appear to be critical in many euro area countries. Better debt workout mechanisms, including enhanced efficiency of judicial processes and out-of-court mechanisms, would help alleviate the debt burden of viable, productive firms, facilitate exit of unviable firms and open markets for new start-ups. In many cases, these reforms are likely to entail relatively low short term economic costs, yet are key to instilling confidence, improving the business environment, and boosting labour productivity. The completion of a capital markets union would also provide entrepreneurs and innovators with alternative sources of financing for innovative projects. Finally, enhancing further efforts to improve skills acquisition and mobility would aid sectoral reallocation and thus allow all citizens to benefit from a higher growth economy.

By placing labour productivity growth firmly at the core of post-crisis economic policy, the newly created National Productivity Boards could help to increase the impetus for further structural reforms which are needed to boost labour productivity growth in the euro area – in a sustainable way – over coming decades. The success of the NPBs will, however, depend in large part on the various agents involved being willing to undertake the necessary reforms.

Harmonised statistics on payment services in the Single Euro Payments Area

The annual payments statistics compiled by the European System of Central Banks (ESCB) have recently been significantly enhanced. This is due to the need to reflect substantial developments in the payments market in Europe, in particular the implementation of the Single Euro Payments Area (SEPA). This article presents the rationale for the enhancements made to the payments statistics and describes how reporting has been improved and harmonisation increased. It provides an overview of the results of the first production rounds in accordance with the new reporting framework, highlighting the enhanced detail, quality, comparability and usability of the statistics. Moreover, the article highlights the need for further updating of the reporting requirements to keep the statistics fit for use.

Introduction

Payments statistics serve two main purposes: (i) to provide an overview to the general public and relevant stakeholders of the world of payments in Europe in terms of volumes, values, services, providers and systems; and (ii) to support ESCB policy decisions in this area with relevant statistical information. Both purposes entail updating the reporting framework to take into account the evolution of the payments market. A new legal act ^[74] was adopted in late 2013, which led to the enhancement of European payments statistics by requiring them to reflect – among other things – changes brought about by the implementation of SEPA through the related European legislation, in particular the Payment Services Directive ^[75] (PSD). The new legislation was also aimed at better covering innovations, especially regarding payment initiation channels. Further work on these aspects is still needed in the light of ongoing developments in technology and legislation.

In order to enhance the legal framework for European payments statistics, a structured merits and costs procedure was followed, which involved the relevant ESCB committees and working groups and culminated in the final decision of the ECB Governing Council in 2013. The procedure was set up to assess the merits and costs of preparing new or enhanced ESCB statistics, with the aim of minimising the reporting burden. It was launched in 2011, prior to an overhaul of the existing statistics on payments aimed at reflecting new conditions, in particular those created by SEPA. The procedure comprised a fact-finding exercise, a costs assessment and a merits assessment, followed by the matching of merits and costs related to the proposed enhancements. The fact-finding exercise enabled input to be gathered from the perspective of data reporters, collectors and users, at both the national and European levels; it was intended to support the development of an appropriately defined and harmonised reporting population, and to prepare for the costs assessment through the establishment of various options for future reporting. The costs assessment distinguished between implementation costs and running costs, specified per actor involved in the reporting process and per new item to be reported. The merits assessment combined quantitative and qualitative considerations regarding the usefulness and relevance of the data for the fulfilment of ESCB tasks. The proposed enhancements (especially those with higher costs) were then reviewed, taking into account their merits, in order to determine the actual changes to implement under a cost-conscious approach. Following the merits and costs procedure the reporting population was expanded and the reporting framework enhanced and harmonised to ensure better comparability, in particular through methodological changes and new breakdowns. The enhancements help ensure that payments carried out in both SEPA and domestic formats are more closely monitored, and that new information is set out on payment service providers and payment services. These enhancements are analysed in more detail in the subsequent sections of this article.

This article considers the process that led to the current enhanced payments statistics, their implementation and prospects for further enhancements. The second section discusses the recently enhanced legal framework. The third section focuses on the results of the first production rounds based on the new methodology. The fourth section concludes, looking ahead to the next review of the legal framework for European payments statistics.

Legal framework and recent enhancements

The legal framework for the compilation of payments statistics has recently been enhanced following the ECB’s merits and costs procedure. Up to reference year 2013 these statistics were collected on the basis of the reporting framework set out in an ECB Guideline ^[76] addressed to Eurosystem national central banks (NCBs). In the absence of actual data, the Guideline allowed for NCBs to compile the statistics on a best efforts basis, relying on external data sources.^[77] NCBs could also provide estimates or provisional data if actual figures were not available.

In order to increase the quality and comparability of data across countries, and thus the usability of the statistics, it was considered necessary to harmonise the reporting obligations and to expand the reporting population to all relevant institutions. Accordingly, as of reference year 2014, payments statistics have been collected on an annual basis in line with Regulation ECB/2013/43, which is addressed to all payment service providers and payment system operators resident in the euro area.^[78] Payment service providers (PSPs) are institutions – defined in the PSD – which provide payment services throughout the European Union. They comprise mainly credit institutions, electronic money institutions and payment institutions. Payment system operators (PSOs) are legal entities that are legally responsible for operating a payment system. In accordance with the provisions of the Regulation, the ECB maintains and publishes a list of institutions operating in the European Union with relevance for payments statistics. This list comprises all PSPs and PSOs resident in EU countries.

Payments statistics are compiled through harmonised data collection managed at the national level by each EU NCB. PSPs and PSOs report the statistics to the NCB of the Member State of residency. The NCBs then aggregate the data and submit the national statistics to the ECB. The latter carries out the final level of aggregation to produce euro area and EU figures and publishes all the datasets.

Close cooperation between the ECB and the statistical departments of the NCBs is crucial for the production of high-quality statistics. During the annual production rounds for payments statistics, the ECB and NCBs closely cooperate through bilateral and multilateral interactions, and the ECB ensures the required degree of cross-country harmonisation. In particular, in accordance with the ECB’s Statistics Quality Framework and quality assurance procedures, the ECB carries out a comprehensive set of quality checks on the data reported by each NCB. These checks have been jointly developed and agreed on within the ESCB and relate to the completeness of the data provided and the consistency of the statistics. Revisions to previously transmitted data are also analysed and plausibility checks are performed to detect outliers in the reported data (i.e. observations with a clearly larger or smaller value than other observations of the time series). During the production, the NCBs are given enough time to address the issues detected and to correct any potentially incorrect data. More in-depth analysis of the statistics takes place outside the regular production rounds, when there is more time for fine-tuning concepts related to the technical reporting or the underlying methodology.

Results of the first annual production rounds based on the enhanced methodology

Compared with the previous reporting framework, several important methodological changes – in addition to the expansion of the reporting population – have been introduced in the enhanced statistics. Overall, the methodology applied to both existing and new requirements has been aligned with the definitions given in the relevant EU legislation, such as the PSD, Electronic Money Directive ^[79], Regulation on MFI balance sheet statistics ^[80] and European System of Accounts (ESA 2010) Regulation ^[81]. First of all, to monitor the changes brought about by SEPA, a new concept of residency has been adopted: the new statistics mark a shift from using the location of the payer or the terminal^[82] as the basis for the reporting to using the residency of the PSP. This is in line with the principle that, within SEPA, consumers, businesses and public administrations can advantageously execute both domestic and cross-border^[83] payments in euro via a single institution and under the same conditions, irrespective of the physical location of the payer, the payee or the PSPs involved.

The enhanced requirements now enable payments involving domestic PSPs only to be distinguished from those also involving PSPs resident outside the reporting country. Moreover, for all main categories of sent payments, a breakdown by counterparty country is required when the counterparty belongs to the European Union. Information is also requested on cross‑border payments received. This enables cross-country payment patterns within SEPA to be detected.

The statistics show that in the European Union most payments are still carried out between PSPs resident in the same country. In particular, as can be seen in Chart 1 below, within the euro area, around 2.5% of credit transfers and 1.7% of direct debits initiated in 2015 were sent to an account held at a PSP resident in another country. This means that the vast majority – above 97% – were still domestic. For the European Union as a whole, the shares were 2.9% and 1.7% respectively; however, data are not available for all non-euro area countries. Compared with cross-border credit transfers and direct debits, the share of cross‑border card payments is higher for both the euro area and the European Union: in the euro area, 7.6% of card payments sent from accounts held at euro area PSPs were cross‑border payments; for the European Union as a whole, the share was 7.4%. Around 92.5% of EU card payments were still domestic.

Overall, the new statistics illustrate how the usage of card payments has increased in recent years to the extent that they account for almost half of all cashless payments in the European Union. In particular, in the five-year period up to the end of 2015, the share of card payments increased from 39% to 47% in the European Union and from 34% to 41% in the euro area.^[84] Consequently, the relative shares of credit transfers and direct debits decreased; in 2015 the shares were 26% and 21% respectively in the European Union and 25% and 26% respectively in the euro area (see Chart 2) – a reduction of a few percentage points compared with five years earlier.

Furthermore, the new statistics differentiate between SEPA and non-SEPA payments for credit transfers and direct debits. A sub-category entitled “of which: non-SEPA” has been added for reporting the total number of transactions and the total value of transactions in relation to both credit transfers and direct debits. This is in order to obtain information on payments made with niche products, TARGET2 payments and payments in currencies other than the euro; all of which use non‑SEPA standards. Several other new indicators have also been introduced, as shown in the table below.

The harmonisation of the reporting population and underlying methodology across countries, made possible by framing the requirements within an ECB Regulation, has resulted in a clear improvement in the comparability and usability of the statistics. In particular, in contrast with the previous reporting framework, the Regulation provides a comprehensive set of data definitions to be applied in a similar way by all reporting agents. When needed, further clarifications have been agreed on within the applicable ESCB committees and working groups. This is to ensure that the quality of the statistics remains high and that the national figures can be used for country comparisons despite certain country-specific phenomena. As an example, in Germany one-off direct debits initiated by a payment card (electronic direct debits known as “ELV” transactions) were previously reported under card payments. With the adoption of Regulation ECB/2013/43, as of reference year 2014 these transactions have been reported as direct debits, in accordance with the underlying payment service used. This change enhances the comparability of data across countries.

The new requirements have significantly enhanced the quality and overall comparability of the statistics, and remaining instances of inconsistency within and across countries are expected to be phased out soon. These inconsistencies are mainly due to the reclassification of certain data. Relevant examples are offered by the figures on credit transfers, direct debits and book entries in selected countries. Chart 3 below shows the impact of the reclassification of book entries from direct debits to the category “debits from the accounts by simple book entry” as of reference year 2014, which is mostly explained by the changes in reporting implemented by German and Austrian PSPs. Simple book entries are payments initiated by a PSP without a specific transaction order so as to credit or debit a customer’s account without the use of a payment instrument. According to the PSD, these are not payment services and are therefore not included in credit transfers or direct debits.

Finally, the expectation is for the homogeneity and reliability of data to increase over time. In fact, different practices followed by NCBs have been further harmonised through continuous dialogue within the central bank community and with the reporting agents.

Next review of the ECB legal framework for European payments statistics

As technological, regulatory and other developments are impacting the retail payments landscape, the data collection may be reviewed at regular intervals and adjusted to market developments to keep the statistics fit for use. The need to continuously enhance statistical reporting in the field of payments is felt worldwide. The ECB and some Eurosystem NCBs are actively contributing to the work underway at the global level in their capacity as members of the Committee on Payments and Market Infrastructures (CPMI) of the Bank for International Settlements (BIS). Methodological and definitional issues are currently being analysed by CPMI members, and a more general restructuring of the format of the statistics on payments, clearing and settlement systems published by the BIS is underway. This restructuring and analysis includes the removal of obsolete information and the addition of new indicators relevant in analysing today’s evolving landscape. Payments fall within the scope of this analysis, especially considering the high relevance of technological advances and regulatory changes for the demand and the supply side of the payment industry.

As was the case with the latest update of the reporting framework, where a new or substantially enhanced regulation on statistics is introduced by the ECB, it will always be preceded by a systematic assessment of the merits and costs associated with collecting the new data. ^[85] A review of the appropriateness of current reporting requirements, i.e. a post-implementation assessment, is also part of the procedure. The purpose is to evaluate the continued relevance of the statistics, in particular whether they adequately meet the specified needs of the users and the new requirements. In the initial stage of the procedure the existing methodology can also be updated.^[86] The implementation of any additional new requirements would increase the burden on businesses and should therefore be preceded by a careful, in-depth assessment of the associated benefits and costs.

Conclusions

Significant developments in the European payments market called for the payments statistics compiled by the ESCB to be updated. Following a merits and costs procedure carried out in 2011 and 2012, a new ECB Regulation on payments statistics was introduced at end-2013. Correspondingly, as of reference year 2014, all payment service providers and payment system operators resident in the euro area have been obliged to report the information included in the Regulation to the NCB of the Member State of residency.

In addition to the expansion of the reporting population, several new requirements and enhancements were added to keep the statistics fit for purpose. Existing definitions and concepts were clarified and aligned with the relevant European legislation. The ECB and NCBs cooperated closely in making these amendments.

The new statistics show that the quality and comparability of the data has improved thanks to more harmonised reporting across countries and institutions. However, some inconsistencies still exist across countries. These are currently being analysed and further clarification is being provided. Overall, it is expected that the homogeneity and reliability of the data will increase over time.

In order to keep pace with the technological, regulatory and other developments that are impacting the payments landscape in Europe, the statistical reporting requirements may be reviewed at regular intervals.

In addition to European payments statistics, the ECB and some Eurosystem NCBs are also contributing to the work related to updating statistics on payments, clearing and settlement systems in CPMI countries published by the BIS.

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