HB: What needs to be changed? Trichet: We certainly do need change in Europe – fundamental change. Not only in the area of surveillance and monitoring of fiscal policy, but also as regards structural reform policies and competitiveness policies. HB: Examples? Trichet: We need to improve drastically everything: the quality of the diagnosis and recommendations by the Commission, much more stronger procedures – and where necessary automatic procedures and tools – to prevent ex ante bad policies, and much more effective sanctions ex post. I will make all these points with the greatest energy in the Van Rompuy Committee. HB: Will the measures adopted by the ECB now dampen growth in Europe? Trichet: No. It is a complete fallacy to say that fiscal soundness dampens growth. It is exactly the contrary. It is the absence of fiscal credibility which dampens growth. Medium term sound and credible fiscal policies are a major prerequisite for confidence. And confidence of the households, confidence of the entrepreneurs and confidence of the investors is what is indispensable for the recovery. HB: Did you ever think that you would have to take such difficult decisions as President of the ECB? Trichet: I have had to take difficult decisions throughout my career – including as President of the Paris Club in the 80’s and Chairman of European Monetary Policy Committee in the 90’s as well as Governor of the Banque de France.
If productivity growth were high, one might expect that the return on capital might also be elevated, putting upward pressure on real rates. The late 1990s surge in productivity growth during the internet technology boom seems to be a good example of this type of phenomenon. If the growth in labor input and productivity were positively related with the equilibrium real short-term rate, then in the current environment this would be consistent with a relatively low r*. The potential labor force has grown very slowly in recent years (less than a ½ percent annual rate over the past five years), and productivity growth has been subdued – running at only 1 to 1½ percent annual rate on average over the past few years. In sum, by focusing on the components rather than on the overall real potential GDP growth rate, one might find stronger and more persistent relationships with the equilibrium real short-term interest rate. The second issue that I want to briefly explore concerns the degree of uncertainty about the equilibrium real short-term rate and its implications for monetary policy. The paper argues quite convincingly, I think, that when this uncertainty is high, then an inertial policy rule may be preferable – that is, would lead to higher expected welfare. While I think this is true, I also think it is important not to overstate the implications of this conclusion in today’s environment. Currently, short-term rates in the U.S. are low relative to the standard formulation of the 1999 Taylor Rule.