Ladies and gentlemen,
Welcome to the annual conference of Latvijas Banka! This year our theme is “A recipe for economic growth”.
As a euro area central bank, our mandate is to maintain price stability, defined as 2% inflation over the medium term. Allow me to emphasize this once again and very clearly. We are committed to our target of 2% and we shall deliver it. Our current outlook forecasts that we will achieve it in the second half of 2025.
Why do we, as a central bank, care about growth when our mandate is to maintain price stability? The answer is simple – economic growth and inflation (or deflation) are both the result of a complex interplay between aggregate demand and aggregate supply. These, in turn, are not influenced by monetary policy alone. In fact, there is little if anything that monetary policy can do about aggregate supply. At the same time, the primary goal of fiscal and structural policies is not price stability. But if fiscal and structural policies are at odds with monetary policy, it will take longer to achieve our price stability target and the path to it may be more volatile, neither of which is good for businesses and households.
In Latvia, we often tend to look at economic growth in terms of income convergence and we try to extrapolate from the data when we could reach the EU average level of GDP per capita. To be frank, aiming for an average is a somewhat minimalistic goal, but even that is very likely to be out of reach given the current set of policies. Overall, since regaining independence in 1990 Latvia’s convergence story has been truly remarkable. However, most of it dates back to the time before the global financial crisis. Last year our income per capita in purchasing power parity terms was at 73% of the EU-27 average, and over the last decade we have been converging at a rate of just one percentage point per year. Even if we assumed that our economy can somehow keep growing at the same pace in the future, which is by no means guaranteed, it would mean reaching the EU average income level by about 2050!
In addition, what if the euro area can’t keep up with the growth of the advanced economies in America or Asia? If the euro area grew at 1% per annum and we managed to squeeze out a mediocre 2% growth rate, that would mean some convergence towards the average. But that would be a failure both for the euro area and for Latvia.
How can we revive economic growth in the EU as a whole and in Latvia in particular? If we want to go where we haven’t been before, we need to do things that we haven’t done before. I will not present a recipe for growth in my introductory remarks, leaving that to the panel discussions. I would, however, like to briefly sketch the broader context in which we need to do the cooking.
First and foremost, our recipe for economic growth must take into account a fundamental decarbonization of our economic system during the next generation. To enable this transition, policymakers would need to discourage “brown” activities and support “green” or low carbon activities, while protecting the most vulnerable members of our society. Yet, we are still subsidizing fossil fuels while renewable energy projects are facing bureaucratic hurdles. In the EU, we have a strong system of social protection. But we must acknowledge that not everyone who faces disruption as a result of the climate transition will be compensated. There simply won’t be enough resources for that. It would also slow down the transition as it would reduce the incentives for change.
The climate transition and technological change beg the question of how the structure of the economy will evolve. It is not reasonable to expect that decarbonization can only take place within the existing industries. Some of the old industries will have to shrink and be replaced by new ones. This brings us to another question – can Europe lead this structural transition or will we focus on decarbonizing old industries instead?
Second, the external environment has become much more adverse. Violent conflicts are flaring up more frequently and on a larger scale. While Latvia, as a NATO member, enjoys the highest level of security there is, in our immediate region Ukraine continues to fight a full-scale war against an unjustified and unprovoked aggression by Russia. This is a key reason why we urgently need to revive economic growth. A stronger economy makes for a more resilient society. The adverse environment is here to stay, and we will need to continue supporting Ukraine as well as keep investing in our own defense.
As a result of the permanent shift in the geopolitical landscape, we have to accept that some of the ingredients in our recipe won’t be as readily and cheaply available as they once were. To paraphrase a famous saying by Winston Churchill, if we are given the choice between less efficiency and less security and we choose less security, we will end up with both. Security concerns must take precedence over mere efficiency considerations! The EU needs to both diversify our supply chains and design our products so that we are less dependent on particular suppliers, especially if they are not our friends or allies.
Third, who exactly are our societies in the cooking analogy? There is a saying that if you’re not at the table, you are on the menu. I truly believe that we’re not on the menu. But in the environment that we are now facing, nobody can just sit at the table and wait to be served either. We must roll up our sleeves, get in the kitchen and do the cooking!
John Kotter, one of the world’s most respected authorities on change management, has a simple but powerful model for successfully implementing change. It basically boils down to four steps:
1) set the stage by creating a sense of urgency and pulling together a powerful group to guide the change;
2) develop the change vision and strategy;
3) make it happen;
4) make it stick by creating a new culture.
Our experience here in Latvia but also in the EU more generally shows that we are rather good at the first two steps. We can diagnose and come up with a strategy. It is the implementation phase where we tend to get stuck. More often than not, we need a major crisis to really get going. For this time to be different, we must heed the change management expert’s advice on how to get it done: communicate for understanding and buy-in, empower others to act, produce short terms wins and don’t let up.
Let me conclude by quoting the Ukrainian heavyweight boxing champion Wladimir Klitschko, who recently said: “Don’t say to yourself: “What’s going to happen?” Ask yourself: “What can I do?” Be the driving force of your own life.” I don’t know about Klitschko's cooking skills, but he can certainly throw a strong punch. And so should we!
I look forward to fruitful discussions and concrete policy recommendations today.