This brings me to my second proposition. Because of the existence of the zero lower bound, it is far easier for monetary policy to fight inflation by raising interest rates than to combat deflation by lowering them. Although central banks world-wide have used a range of non-standard measures to stimulate economic activity and push inflation up to the target, in practice, this has proven to be extremely difficult. Moreover, as I pointed out earlier, the institutional set-up of the euro area rules out the easiest policy option to raise inflation, namely the monetisation of budget deficits. Furthermore, in the euro area as a whole, monetary policy was, for a long time, “the only 6  game in town”. With many sovereigns weighed down by excessive debt burdens, there was no space for fiscal policy to play its part in supporting monetary policy in stimulating the economy. Rather, in many countries, the necessary focus on austerity measures meant that monetary policy and fiscal policy were operating at cross-purposes. Unfortunately, those euro area countries with space to manoeuvre chose not to do so. To sum up, monetary policy can influence nominal economic variables. In the long run, however, it cannot influence real economic variables, which depend on the economy’s endowments of factors of production and the efficiency with which they combine to produce output. This highlights the importance of structural reforms to ensure that the economy operates as efficiently as possible.
In the long run, the level of output that an economy can generate depends on the capital stock, the labour supply and the productivity of factors of production. In the steady state, all these factors are outside the scope of monetary policy. Given that monetary policy cannot determine the long-run values of real economic variables then, the argument goes, it is best to let monetary policy focus on what it can really control, namely nominal variables or, in other words, prices. This brings me to my first proposition: by and large monetary policy cannot affect real economic developments in the long run. The long-run potential output of an economy depends on structural features of the economy, including demographic developments, labour force participation rates, levels of educational attainment and efficiency in product and labour markets. It also depends on the transformation of savings into investment, that is, the proper functioning of banks and financial markets. Success in these domains depends on other  2  policy makers, notably governments, which can undertake structural reforms and often play a major role in the provision of education. So what can monetary policy actually do? In the near term, monetary policy nevertheless has a role to play. By influencing aggregate demand, it can cushion the economy from the impact of adverse shocks. In this way, it can limit the volatility of output from its long-run, or potential, level. Moreover, by sustaining demand in the short run, it can prevent a cyclical downswing in the economy from becoming entrenched.