26  See for example Bean, C. et al (2011) “Monetary Policy after the Fall”, in Macroeconomic Challenges: The Decade Ahead, Federal Reserve Bank of Kansas City. BIS central bankers’ speeches  9  if there was collateral damage, it could be justified for a period of time to offset the danger of a much larger risk to price, financial and economic stability in the future. When imbalances are regional or sectoral in nature, however, interest rate policy would seem too blunt a tool. We need more surgical instruments, namely an effective macro-prudential policy framework. For example, tools such as loan-to-value ratios or debt-to-income ratios could be used to limit credit misallocation to non-productive sectors, without at the same time harming sectors where capital needs to flow. Conclusion Let me conclude. Real economic convergence supports the cohesion and smooth functioning of monetary union. What I have tried to illustrate today, however, is that there are no shortcuts to achieve it – and least of all by riding the upswing of the financial cycle. As Hyman Minsky demonstrated, what goes up must sadly come down. One way to begin a more sustainable convergence process, in the near term, is through reallocating resources where they are most productive. But the challenge for euro area countries does not stop there. Raising productivity is a complex process that reaches across the economy and into many different policy domains, be they education, judicial systems or administrative capacity.
The majority of countries with relatively strong GDP growth rates prior to the crisis also experienced a relatively strong downward adjustment, in some cases undoing much of the welfare gains that were achieved since the launch of the euro. Some might see this as evidence that the assumptions of the neoclassical growth model need to be qualified – that absent credit-driven growth, there is no reason to believe that euro area economies should converge towards similar levels of productivity, or even rates of productivity growth.12 Indeed, endogenous growth models allow for persistent divergences as some forms of capital exhibit non-diminishing returns. Yet, I think it is too early to draw such a conclusion. The neo-classical assumptions have not yet been properly tested, simply because capital did not flow where the marginal return would have been highest. What the euro area needs, in my view, is to “re-run” the convergence process, but with the appropriate conditions in place to ensure efficient allocation of resources, and the right framework to make convergence sustainable. Let me explain in more detail what that might entail. To begin with, catching-up economies have to address the immediate after-effects of the previous misallocation of capital. The pre-crisis inflows into the non-tradable/services sector were associated with real exchange rate appreciation, rising unit labour costs (ULC) and increasing dependence on external financing. When the financial cycle turned, however, capital flows quickly reversed.