Yet we have also seen a strong and, thus far, persistent contraction in business investment, which may weigh on future productivity growth as such investment tends to raise the technology content of capital. A prolonged period of below-trend investment could also lead to an excess of savings over investment, and therefore a fall in the natural interest rate. Developments in labour supply have also been weak. One positive factor has been the increase in the labour participation rate in the euro area by around 1 pp during the crisis, whereas in the U.S. participation has fallen by more than 3 pp. However, this has to be set against an increase in euro area long-term unemployment from 3% to 6%, which creates a risk of workers’ skills being eroded and skill mismatches emerging. This is particularly  BIS central bankers’ speeches  1  relevant because unemployment is concentrated among those with lower skills: around 20% of low skilled workers are unemployed, compared with only about 7% of high skilled workers. Total factor productivity – which principally captures long-term technological progress – has fallen only marginally during the crisis, most likely reflecting the underutilised capacity in the inputs to production. However, this is no cause for comfort as TFP was on a declining trend in the euro area well before the crisis, and has recovered less quickly than in the United States.1 These developments create two interrelated challenges for policymakers. The first is how to prevent the fall in observed growth from feeding back into potential growth.
The pre-crisis consensus was clearly that monetary policy could not affect the supply side of the economy – while it could help stabilise output around its trend, it could not affect that trend. However, there has been some discussion recently among central bankers as to whether monetary policy can have more lasting effects. For example, if an extended period of low demand is creating hysteresis effects, a more accommodative monetary policy that boosts the economy may prevent a permanent downward shift in productivity. That is, it can for a time prevent a cyclical fall in growth from becoming structural too quickly. The jury is still out on this discussion. It is clear that the supply capacity of the economy is determined by its structural features, and monetary policy cannot substitute for this. Nevertheless, some see that monetary policy can play a “defensive” role in a period of  1  “Potential output, economic slack and the link to nominal developments since the start of the crisis”, ECB Monthly Bulletin, November 2013. 2  Claudio Borio, Piti Disyatat and Mikael Juselius, “Rethinking potential output: Embedding information about the financial cycle”, BIS Working Papers, February 2013. 2  BIS central bankers’ speeches  economic weakness. In our case, by delivering our price stability mandate, while we cannot raise growth potential, we can perhaps limit or delay the degree to which it falls.