And they have been effective in easing financial conditions and supporting the recovery. Yet it is clear that, for all central banks, the structural backdrop has made monetary policy normalisation slower. Consider lower growth. It is now clear that the long-run growth potential of major economies has been falling for a number of years. For example, the Consensus forecasts for long-run growth real GDP for the US – that is the average growth six to ten years – stood at 3.1% in early 2003. The latest figure is just 2.2%. Long-run growth forecasts for the euro area were revised down from 2.2% to 1.4% over the same period. These lower forecasts represent in part the impact of ageing populations, but also reflect the falling trend in total factor productivity.4 This affects monetary policy because slower growth in potential output reduces what is often referred to as the equilibrium interest rate.5 While not directly observable in the real world, this widely used concept is organised around the notion of an equilibrium level of the rate of interest where there is neither upward nor downward pressure on inflation. If the equilibrium rate falls, the margin above the effective lower bound becomes compressed, reducing the space in which central banks can operate to provide accommodative policy. One might reasonably ask why central banks did not identify this trend sooner. The answer seems to lie in an overreliance on pro-cyclical estimates of potential output.
All these measures aimed to support bank funding markets and ensure that the flow and pricing of credit to the real economy was in accordance with our intended monetary policy stance. But a question often asked is why we did not resort to large-scale asset purchases at this point, as the Fed was already doing. Bear in mind that inflation developments in the euro area at the time did not suggest a tight stance. Headline inflation was rising steeply from its 2009 trough, exceeding 3% in October 2011, partly driven by an increase in underlying inflation. Inflation expectations were well anchored around our objective. Hence our diagnosis of the problem in this period focused more on monetarytransmission than on the policy stance. Our stance was not being transmitted evenly across all parts of the euro area. And so our measures in this period were specifically designed to remove those impairments in transmission. The main issue we faced was the perverse interaction between the euro area banking sector and institutional incompleteness of our monetary union, which had fundamental implications for our policy in a system of bank-based monetary transmission. While the first phase of the crisis can be interpreted as a severe recession amenable to monetary policy, this second phase was the consequence of institutional challenges that monetary policy could only aim to mitigate, but could not overcome.