Photographer: Krisztian Bocsi/Bloomberg

Draghi Gets Backing in Argument Over How to Best Spur Reforms

New study shows proactive monetary policy can create incentives for countries to reform economies

Mario Draghi is going to like this one.

A study being released at the European Central Bank’s yearly conference in Sintra, Portugal, is giving the ECB chief backing in a key argument with his mostly German-speaking critics.

The dispute centers around whether tough economic reforms are more likely to be triggered by the carrot or the stick. The ECB’s monetary policy lowers borrowing costs across the euro area, including for its weakest and least competitive economies. This may have lifted countries such as Portugal or Italy out of the crisis, but has it also given them less incentive to overhaul their economies.

Germans, like Bundesbank President Jens Weidmann, says it has, while Draghi is convinced that tough reforms are more likely to happen if the central bank creates favorable conditions.

The study by Philippe Aghion, Emmanuel Farhi and Enisse Kharroubi examines the impact of monetary policy stimulus on firms taking different regulatory environments into account. The results show that the growth-enhancing effect of monetary policy is much stronger in markets that aren’t heavily regulated. That, all else equal, should provide incentive for change.

Photographer: Speciale, Alessandro

“When competition is low, large rents allow firms to stay on the market and reinvest optimally, no matter how funding conditions change,” the authors write. “Cyclical fluctuations matter less for firms holding monopoly power than for those facing tight competition.”

This is true also in crisis times. Long-term government yields fell across the region after Draghi’s famous “Whatever it takes” speech in 2012, but not everyone benefited in the same measure.

“Heavily indebted sectors benefited disproportionately from this unexpected drop, but only in countries where product market regulation is rather low,” the study said.

This reinforces Draghi’s argument that his policies, rather than buying time for governments, actually are an incentive to overhaul economies and make them more competitive.

To hammer home the point for the attendees at the annual shindig, with Draghi himself in attendance, the authors opted for unusual clarity.

“Vindicating Mario Draghi’s point about to the complementarity between a pro-active monetary policy and structural reforms, this set of evidence supports the idea of a New European Growth Pact.”

Whether the apparent incentive will actually trigger reforms is another question.

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