Fiscal policy and growth in Europe: A Path to Strengthening Europe's Social Model
Keynote speech by Christine Lagarde, President of the ECB, at the European Meeting of the Trilateral Commission in Vienna, Austria, November 22, 2025
The relationship between central banks and governments has evolved over centuries, with central banks initially serving as financial providers to governments. However, history teaches us that central banks, when overly influenced by the state, tend to generate inflation. This insight emerged gradually, with Napoleon Bonaparte acknowledging the need for a central bank to serve the state without excessive state control in the 19th century.
Over time, central banks' operational independence has been linked to lower and less volatile inflation, as evidenced by empirical literature. Yet, there's a concern that short-sighted governments might attempt to manipulate central banks to finance their debt, especially when public debt is high, as it is in many jurisdictions today.
The session's focus on fiscal dominance raises questions about central banks' future. Europe's recent monetary-fiscal interactions during the pandemic demonstrate a successful partnership. The ECB's bond purchases and governments' debt increases stabilized the economy, achieving a faster recovery than after the global financial crisis. However, this partnership led to higher debt levels.
Despite the successful collaboration, the ECB's independence remains unchallenged. When faced with an inflation shock, the ECB increased rates at a record pace, showcasing its operational independence. The reduction in the balance sheet through quantitative tightening further reinforces the stance of monetary policy.
The main fiscal challenge in the euro area is not widespread rule-breaking but the need for governments to prioritize spending that supports potential growth and strategic priorities while consolidating budgets. The new EU fiscal rules offer an opportunity for countries to extend their fiscal adjustment period, focusing on public investment and structural reforms.
However, only a few countries have chosen this path, leading to 'fiscal stagnation' where consolidation measures weaken growth potential, creating a vicious cycle. This situation can trap the economy in a low-growth equilibrium, making the central bank's job more challenging.
Low productivity growth can put downward pressure on the natural interest rate, limiting central banks' rate cuts. Conversely, strong productivity growth can ease the central bank's role, especially in aging societies where it compensates for shrinking labor supply and wage pressures.
Governments deprioritize productive spending due to the pressure to sustain Europe's social model and support aging societies. Yet, productive spending is crucial for generating productivity gains, enabling Europe to sustain its social model and aging population. The goal should be to create a virtuous circle where productive spending boosts productivity growth, strengthening potential growth and the social model.
To achieve this, Europe can employ three strategies. First, countries should utilize the flexibility in fiscal rules by reallocating public spending to research and development and education, potentially boosting output by 6% over the long run. This approach ensures sustainable debt management through higher potential growth.
Second, Europe should pool resources in high-multiplier areas with cross-border benefits and clear returns to scale, as demonstrated by the European Organization for Nuclear Research (CERN) and the European Commission's Readiness 2030 initiative for defense procurement.
Third, EU budget instruments can mobilize private capital to address investment needs in green, digital, and defense transitions, estimated at €1.2 trillion annually. Well-designed EU programs, like the European Structural and Investment (ESI) funds, have shown significant crowding-in effects, attracting private investment.
By leveraging these opportunities, Europe can strengthen productivity growth while preserving its social model, reducing the risk of fiscal dominance. The key lies in turning these opportunities into growth-sustaining measures, just as Johann Strauss II transformed inspiration into timeless compositions.
Thank you.
