I think is the highest goal, that any macroeconomist would like to achieve, namely make people change mind on important issues that were thought as settled and draw from this new perspective momentous economic and social policy implications. One of these issues is the role of fiscal policy and public debt

in a low-interest environment. Olivier, the floor is yours. Thank you for the incredibly kind word. It is truly a great honor to have been invited

to give this talk to an amazingly distinguished audience. It is also an immense personal

pleasure to be the dinner speaker for what will be Mario's last Sintra event, at least in this official capacity. Put simply, I'm simply in awe of what Mario has achieved

over the last eight years. He will probably be remembered for three words, which on their own and without having to take any posterior action, literally saved

Europe from tragedy. But remembering him just for these three words would be unfair. Behind the three words, there was a lot of preparation, both intellectual and political, to make sure that the three words were credible. Mario's contribution, I think, to the ECB

and to my trip in general is much deeper than just what history will remember, which is probably these three words. He has done it through a combination of, on the one hand, pragmatism and intellectual creativity, and on the other, an exceptional political

or geopolitical sense. That's really what defines him. Larry Summers, who gave the speech last year, I think had it right, which is, he

said, you sometimes meet policymakers who are exceptionally pragmatic and creative, and sometimes you meet policymakers who are extremely good politicians. It's very rare, it's exceptional that basically you meet somebody who fits both boxes.

I think when history is written, Mario will probably be there in the pantheon of the fathers of Europe. They created Europe, but he saved it, and that's at least

as important as creating it. Mario can relax, that's all the nice things I'm going to say about him. Because I want to move from Mario to the institution, to the ECB. I mean, the ECB is not one person, and you all know that. But through Mario's

influence and that of his predecessors, and I'm looking at Jean-Claude there as well, the ECB has achieved a truly amazing transformation. It is fair to say that when the ECB was put together at the start, we, or many of us on the other side of the pond, looked at what had been put together and were a bit worried,

be it about the two pillars, which looked like a strange combination. The lack of buying of sovereign bonds, the asymmetric inflation target,

all this to us looked like a recipe for disaster. I can say this now, I think some of us said it then. Now, and it came close, but what is extremely impressive is how much the ECB was able to modify, to transform itself,

and basically develop all kinds of new tools, which basically in the end have made it a very modern, a great central bank. I mean, if I think about again the provision of liquidity, the purchase of a much larger set of assets,

that was in the initial mandate, the negative interest rates. And it has done all this while maintaining, or indeed strengthening, its credibility, which is again an amazing achievement. So I would say that the ECB of today

is hardly recognizable today, at least to an outsider. It really has transformed itself and adjusted to the main changes which have taken place. So it is clear again that it deserves credit not for being a great central bank,

but having helped the recovery which has taken place since the financial crisis and the euro crisis. And here I cannot resist a zinger. I had many more in my initial draft and they have been removed by people with more sense.

But it seems to me that given how much it was able to change its skin without losing any credibility, I'm still disappointed that it has refused

and refuses to consider a higher target inflation. We all understand that if it could happen without the loss of credibility, it would help. My new twist on this is to think that maybe we could have a target inflation which is higher than usual, so long as the equilibrium real rates remain

very low, which is the time when you need it. So eventually we would go back if the real rates recover to something like the existing target. But for a while it might actually be very useful to have a higher one. I don't think that this implies that the ECB would lose credibility in the light of all the other things that it has done. But this was a parenthesis

and I will now move to the main part of the speech. So the main part of the speech is based on the idea that monetary policy, as good as it is, cannot do everything. And that the Euro macro policy architecture suffers from two serious weaknesses

which have shaped the history of the last 20 years and if nothing is done, could shape also part of the next 10 or 20 years. I'm going to leave aside, I'm going to focus on the Euro macro policy architecture,

not the Euro macro financial architecture which is a whole different topic which many people have much more expertise than I. So let me tell you what I see as the two weaknesses of the architecture.

The first one is an old one which we knew at the beginning and had been documented and has been documented since, which is the lack of adjustment of relative prices in a set of countries which suffer from different shocks. This was at the source of the large current account deficits in the south early on

and we know what happened and it is now partly at the source of the large current account surpluses in the north which are not as bad an issue but are still an issue for the Eurozone. I don't think that this issue is solved and I think it will come back to haunt us

or haunt you in the future. So that's the first thing I want to talk about. The second is newer and it comes from what I see as the inadequacy of current fiscal framework in the light of extremely low interest rates

which both have direct implications for optimal fiscal policy but also have put various constraints on what monetary policy can do. And it seems here again that at this stage fiscal policy is just not ready to do what it may have to do in the near future, of a more distant future.

So what I'm going to do is talk about each one. I'm going to talk about the first one because I think it has been under-talked in the recent past because somehow the current account deficits are partly gone or largely gone but I still think that's a major issue. But I'll focus much more on, as you could guess, on fiscal policy

which these days is what I think about when I go to sleep. The other thing I should say is that this is going to be very much 30,000 feet thinking. I'm not going to try to say the rules should be changed this way or that way. I think that it's important to start at that level.

Just think about the economics and then eventually come down at least closer to the ground. But this is, I'm not going to do it. So let me start with the first. And before that I want to start with what would the ideal architecture, macro architecture, macro policy architecture of a common currency zone

like the euro zone could be or should be. First, macro policy should be in charge of euro level output. That's not the way central bankers would say that. They would say that is in charge of maintaining inflation at target

but I've always thought that there was a close relation between the two which I've called the divine coincidence. But conceptually you basically want to make sure that aggregate output at the euro level is at the right level, is at potential. They would take care of micro policy. The second is for fiscal policy you should basically ignore macro

and you should run what I would call pure public finance policy which is what you need to do given the intergenerational redistribution that you may want to do, the aging of the population, how you deal with global warming. But you should not preoccupy yourself with what this will do to output because it's taken care of by the micro authority.

And then when you've done these two things there's absolutely no reason that demand in any particular country will be at the right level. It will be right at the aggregate level but not at the individual level. So you're going to have to have relative price adjustments in order to basically generate the demand, the fine demand

and the domestic demand that you need to achieve output. And if you do all these things and all these things work then you have the best of all worlds. It works perfectly. You have output at potential in all the countries. Fiscal does the right thing, pure public finance, and micro policy does its job.

Now unfortunately what we knew I think to start is that that's an idealized version which basically in practice doesn't quite work. And this is where I want to take the first point. So the first point is relative prices do not adjust

or at least do not adjust fast enough. And I think we knew that this was an issue. Some people thought that maybe it would improve under the pressure of having to do so but it hasn't. It hasn't happened.

And so if anything actually the downward wage rigidity which comes from low inflation has made it even harder to get wage decreases whenever they are needed. So I think the evidence from the last 20 years is relative price adjustment, wage and price adjustment works very, very slowly at best and maybe not at all.

Can it be solved? I think the honest answer is not easily because I see a set of major issues standing in the way. There has to be agreement as to what needs to be done,

what the configuration of current account deficits and surpluses should be ideally. That's the first point. The second point is how it should be achieved, where it should be achieved through inflation. In some countries deflation in others. And then even if in this room we all agreed on these things,

then you actually have to have it happen and you have to have these adjustments of wages and prices at the country level which have turned out to be very difficult to achieve. And on each of these I think that there has been very little progress. So let me just talk about what I see as the issues.

I'll start with an anecdote which I think is revealing. In 2015, the five presidents report, which you may remember, said that it would be good to have a council of competitiveness and then to have national councils of competitiveness to basically discuss what the adjustment should be.

Under the pressure of, I can't say it's not a secret, under the pressure of Germany, there was very strong objection to the word competitiveness and these councils have been created but in nearly all countries they are called councils of productivity. And I think if you think about it, I think this reveals a way of thinking about current accounts

and competitiveness which is an issue for these adjustments. So that's the first point. I think we don't quite agree on what the right structure of current accounts should be. The second is that there are two ways to adjust.

Suppose that you have current account deficits in the south, then you can have deflation in the south or you can have more inflation in the north. Now it turns out that if you're going to do these adjustments, it is infinitely better from a Euro point of view to do it through inflation because when you do it through inflation,

what you get is you get the appreciation and you also get real interest rates which actually goes down. When it's done through deflation, say you ask Portugal or Spain to do it, then there is deflation so you get some of the adjustment of relative prices you need but you get a real rate which goes up a whole lot.

So when you actually sit down and you forget politics, which I'm trying to do, the optimal adjustment to a set of current account deficits and surpluses implies inflation in the north, de facto it's in the north, less deflation in the south. If this is true, it actually has an implication

for optimal monetary policy at the central level which is that when you have large current account imbalances across countries, the best way to do it is to do it through more inflation rather than forcing deflation which means that target inflation for the ECB should actually be higher. But again here, I'm talking at 30,000 feet.

Something has to do it. The last point is suppose that we all agree in this room that Germany is going to have a lot of inflation which is going to allow the other countries to adjust without having deflation. Suppose we did this.

And it's still the issue of how you basically get these relative, these wage and price adjustments. Now there's something interesting about wage and price adjustments which is what we're asking countries to do, say, countries which have current account deficits, is to have wages go down relative to what they would have done and domestic prices or domestically produced goods prices go down.

So the reduction in the real wage is relatively small. The problem is that it has to come with a decrease in the nominal wage, a decrease in domestic prices. There is still a decrease in the real wage coming from the fact that you import goods and these are more expensive. But in effect, the problem of coordination is a larger problem of trust, which is workers will accept a cut in wages or slower wage growth

only if they know that the firms will actually pass this through to prices and the real wage will not be very much affected. There is basically no mechanism to obtain that kind of coordination at the national level except in a few countries. And the lack of trust is such that nobody wants to go first.

The workers don't want to be the first ones to cut, which I understand. And the firms cannot commit to prices given that price is going to all directions. So here again, I think for all three reasons, it's not working. And unless something is done at each of these margins,

understanding, agreeing as to what the right configuration is, agreeing to the best way of adjusting and then creating what I've been pushing in various countries with total lack of success, meetings of trilateral meetings with workers, firms and the state.

If this doesn't happen, then we may see problems again. I don't think we'll see the problems that we saw at the start of the euro. This was a shock, which was an enormous shock. But the notion that there will not be country-specific shocks in the future, I think just cannot be taken for granted.

Okay, now let me move to fiscal. I had a joke which I will move, but I'm going to put back, which is Ronald Reagan's quote in which he said,

the most hated nine words in the English vocabulary are, and you may know of a quote, I am from the government and I'm here to help you. And I suspect that some of you are going to react to my remarks on fiscal policy in the same way.

Good, but let me still try. I think we would all agree that interest rates, real equilibrium interest rates, have decreased a whole lot. And markets at least think that this is going to last for a long time. And it has been such a trend that it's hard to think that it's going to reverse any time soon.

So in that environment, and here I'm going to paraphrase in two sentences, the paper I gave at the AEA meetings, this has two general implications. The first one is an obvious one, which is that the cost of debt is smaller, and that's nearly an identity. But here, the refinement on that statement, it's not just a fiscal cost,

which clearly the debt dynamics are more favorable. It's the economic cost. And the notion is that if the rate is so low, it's probably because the risk-adjusted marginal product of capital, to be a bit nerdy about it, is also not very high, which means that the crowding effect of capital, which is there, is not terribly costly.

So I'm not going to go into this, but I would say in general, we should be more relaxed about that. That's the first implication. But on the benefit side, there is also an important point, now which is conceptually separate. It need not happen, but basically when interest rates are very low,

or neutral rates are very low, and you have very low inflation to start, then you get into what used to be called the zero lower bound, what is now called the effective lower bound, and monetary policy loses a lot of its ability to affect the economy, in which case you may be stuck, and I think that gives a fairly strong case

for using fiscal policy. So a combination of both, lower cost of debt, more need for fiscal policy to maintain demand, I think these are fairly straightforward and uncontroversial implications of the fact that the rates are very low. Now, the first thing I want to say is, well,

is your description of the world the right one? You know, a world in which interest rate is very low, monetary policy doesn't have a whole lot of room. I think so, so let me just develop that quickly. So I think, you know, we've all said many times,

don't trust markets, but if you look at the yield curves, we know that they're extremely flat. This is true here. We can also look at option prices to get a sense of, well, not the mean, but, you know, what some people believe. So what do you think is the probability, based on these option prices,

the probability that the markets put on the Yuribor rate three years from now being more than 1%? So here we're not talking about just the mean, we're talking about the answer is 0.3%.

So, you know, you may not be convinced, but there are people putting their money there. So I think we can assume, you know, it may not last forever, but I would say that we're clearly in for quite a while, so I'll take that here, just a hot tip to Larry. I think that when interest rates remain low, initially it was thought that maybe the financial crisis

was the source of the low rates, although they had decreased before. I think as time passes, it's clear that there's something else. The effects of the financial crisis are largely gone. So I think that Larry's secular stagnation hypothesis is no longer a hypothesis. It may not be there forever, but it's more.

It's a fact, and I think we should take this into account. The second issue is whether there is a euro gap. Is there a need for fiscal policy at this point to basically help monetary policy? The case would be there if there is an output gap, a negative output gap.

It would not be there if the economy for the eurozone as a whole is about there. I think we can discuss at length, and that goes to the discussion of output gaps and various other strange beasts, but my sense is inflation is far from, I think, where Mario would like to see it. Maybe he will disagree.

It is not that too, for sure. And I have the impression, looking at least at the countries at which I have looked, that there is one or two percent unemployment, which is above the structure of a likely structural unemployment rate. So my sense is, yes, there is a need for fiscal policy now.

Now, that sense is clearly much stronger if there is a recession. And I would say that the last few weeks, the last few months, and the trade issues suggest to me that that surely is a possibility. If there is a recession, I think it's fairly clear to me that monetary policy cannot do the job alone

and that fiscal policy will be needed. The third one is, has monetary policy lost how much room of maneuver monetary policy still has? And here, it seems to me that, again, there are many things

that the ECB or other central banks can do. They can buy many more assets than they do. And we have the Bank of Japan as an example. You can increase your balance sheets enormously. But whether this will translate into much lower rates and these rates having substantial effects on activity, I think one has to be skeptical.

So clearly, the ECB should try. It probably has some room to do things. But I'm not terribly optimistic that it can really on its own handle anything like a recession. So given this environment as I see it,

let me turn to the implications for fiscal policy, first in general and then for common currency areas such as the Eurozone. So let me start with general implications. I see three main implications. The first one is that whatever urgency there was in reducing debt,

the urgency is less. That's a matter of arithmetic. Whatever speed of adjustment was required, the right speed today, given the environment, is slower. So I'm not saying we should not care about that.

We should. But it is clear that it's less essential to decrease debt if it comes at some cost. The second implication is that if demand is too low to deliver output and potential, and again there is a discussion as to whether that's the case today,

but surely it would be the case if there is anything like a slowdown in the Eurozone, then you have to be ready, or the Eurozone has to be ready to use fiscal deficits for cyclical. Our cyclical in this sense becomes long. I mean, it may have to use primary deficits for quite a while.

The case of Japan is very scary in this way, which is maybe that fiscal policy deficits have to be used for quite a while, but I see no alternative. Now, again, you may want to use other measures, and that goes back to structural reforms

and kind of a repeated leitmotif that the fund had when I was there and still has, which is, well, you should do structural reforms. It's clear that you should do structural reforms, but the notion that they'll get you out, that they'll create such optimism as to increase demand or get you out of a recession, I think is a joke,

and therefore it should be done, but that's not enough. Fiscal, I think, is the only tool you have. The third one is if you're going to have primary deficits to maintain demand, there is no reason not to use them right, namely to actually use them to do good things to the supply side. So to the extent that there is an increase in primary deficits,

it seems to me that the priority should be on financing public investment or financing reforms, not just financing current consumption. So I think the main reason to do it is to boost demand. It's clear that this would be used to actually boost supply and potentially help growth in the future.

So I think these are the three implications. What I want to do last, and then I'll be done, is basically go down not from 30,000 feet to the ground, because I don't think I could actually walk there, but maybe to 10,000 feet and think about the implications for the euro area fiscal architecture.

So these are what I see as implications of what I've said so far. So it is really a repeat of what I've said except applied to the eurozone. So the first one is that the various rules defining target debt,

speed of adjustment to debt, should be revisited. At first they haven't been respected, and also I think that even if they made sense at some point, they don't make sense today. And basically there should be, you know, if tightening fiscal leads to an output gap,

because my policy cannot respond, then it seems to me that letting debt not decrease or increase very slowly is probably the thing to do. Now whether this is done for a formal change in rules or just by having the authorities in charge be more lenient, we know that there is some leeway, and that's not for me to decide.

So that seems to me that that signal should be set. Not that debt is irrelevant, not that debt is good, but that maybe the priorities should be somewhere else. The second on the use of primary deficits to do good things for the future, you probably are all aware of what fiscal austerity,

justified or not justified, did to public investment in the eurozone. So since 2007, the ratio of public investment to GDP for the average for the euro has been minus one percent.

So it decreased one percent of GDP. And the numbers are very scary in the countries where it should be the reverse. So it's basically 2.3 percent for Greece, 2.7 percent for Spain, 1.3 percent for Portugal, 1.9 percent for Italy. It seems to me that that's just wrong.

And therefore, if we have primary deficits, they should be used for projects like this. I think in this context, the idea of having what's known as a fiscal golden rule, which is a separation of the current account and the capital account, and being more lenient again about the use of debt for the capital account

is clearly something which should be introduced. I think we're all aware of the dangers of doing this. It has been introduced. It was introduced in the UK. And I was cheating on a large scale. But I think it can be done. Again, an anecdote here. I was in a euro country not long ago

where somebody in charge explained to me that reducing the age of retirement, making retirement earlier, was public investment. And the argument was fairly straightforward, which is that this liberated jobs for the young, and the young are the future.

So that's, I think, what you don't want to happen. But that can be taken care of by having some commission in Brussels, which basically puts a checkmark when you come with projects. But I think in the current context that would be important. Last two points which reflect the specificities of the Eurozone.

The third one has to do with the coordination of monetary and fiscal policy. In a world which I'm thinking about, there is a need for coordination between the two. Before that, it was separate. And in the ideal scheme, it is separate. But here, fiscal policy has to come to the rescue, if I may use that expression.

It is very difficult to do with 19 countries and 19 ministers of finance. So I think the argument for having somebody who would be the counterpart to Mario or to his successor, being in a position to say, yes, we need some common fiscal expansion or not,

is probably more relevant today than it ever was before. And then the last one is externalities, which are very relevant. Suppose that you need expansionary fiscal policy at the Euro level.

It is agreed that you should have a 1% increase in the fiscal deficit. How is it achieved? Well, if you let each country do what's best for itself, you will basically get an undersupply of fiscal expansion. And the reason you spill over is the fact that when you do a fiscal expansion in your country

and you're a small country in an open economy, basically you tend to benefit others, which is good but you don't care about. And therefore, the question is what can be done in this case. I think even if you say, look, I have fiscal deficits, the implication is countries will probably not do enough.

And so in this case, there is an argument for coordination, and I think it can be done in one of two ways. The first one is to have countries which are able to do it have a coordinated fiscal expansion. So by able, I mean that some countries may not be able to

because of their fiscal situation. And then in this first case, each country would basically issue its own debt. That's very much what happened in 2009 with the G20. Basically, it was a coordinated increase, and it helped, is my guess. But not all countries would be part of the scheme. Then the more ambitious one, which implies some risk sharing,

is basically to have a common budget and to do it from the common budget, issuing euro bonds in order to. And this would allow all countries to participate. It would clearly be better from an economic point of view, but it would have some of the implications which have made that kind of risk sharing

likely not happen quite yet. So let me conclude. I realize that I've offered kind of blue sky thinking, if you know the expression, basically. You know, stuff that academics can say, but politicians face more constraint.

I've realized all the complex geopolitical constraints that in the end will determine the outcome. But I still think it's the right place to start. I think it would be a waste to start by saying, should we go from 60 to something else without thinking about the bigger issues and then coming down from there.

Anniversaries, and this is the 20th anniversary, are good times to assess both progress and setbacks. And we need it to actually make bold moves. I think monetary policy has done that. And so, again, congratulations.

But the rest of the architecture is just not quite right there. And it may not be completely smooth sailing in the future. Let me stop on this terribly optimistic note. Thank you.