And if structural reforms are well-designed along these parameters, they can in fact have a largely neutral, if not positive impact on short-term demand – and even in adverse cyclical conditions. Credibility of reforms First, if reforms are credible their positive effects on short-term demand, via confidence, can more than compensate for any negative effects on inflation via increased supply. This is because, for firms, an upward shift in potential growth implies higher expected revenues and higher future profitability, which should in turn encourage them to bring forward investment into the present. And investment, remember, raises both supply tomorrow and demand today. It can therefore in no way be construed as being detrimental to our monetary policy objective. A similar logic applies to households and their life-cycle income. Reforms that raise expectations of life-cycle income should immediately support current consumption. To give just one example of this effect, an extension of the retirement age should lift not only medium-term supply – by expanding the active population – but also short-term demand, by reducing the need for precautionary savings ahead of retirement. But credibility is crucial in determining how quickly these positive effects materialise. If there is uncertainty about the timeline over which reforms will be implemented, or about the commitment of successive governments to maintaining them, it will take longer for firms and households to adjust their expectations and the benefits of reforms will be delayed.
15 Moreover, if reforms are not perceived to be sustainable under a wide variety of conditions Moreover, if reforms are not perceived to be sustainable under a wide variety of conditions – for example, if a pension reform is unrealistic over the longer-term – agents will anticipate a reversal in the future and refrain from adjusting their behaviour today.– for example, if a pension reform is unrealistic over the longer-term – agents will anticipate a reversal in the future and refrain from adjusting their behaviour today. We have used our Euro Area and Global Economy (EAGLE) 16 model to analyse for a medium-sized euro area country the effect of credibility and timely implementation 17 – in this  13  Andrews, D., A. Caldera Sanchez, and A. Johansson (2011), “Housing Markets and Structural Policies in OECD Countries.” OECD Working Papers, No. 836, January 2011. 14  Gnocchi, S., A. Lagerborg, and E. Pappa (2014), “Do labor market institutions matter for business cycles?”, Journal of Economic Dynamics and Control, vol. 51, February 2015. 15  Giavazzi, F., and M. McMahon (2008), “Policy Uncertainty and Precautionary Savings.” NBER Working Papers 13911, National Bureau of Economic Research. 16  Gomes, S., P. Jacquinot, and M. Pisani (2010), “The EAGLE. A model for policy analysis of macroeconomic interdependence in the euro area.” ECB Working Paper Series No. 1195, May 2010.