Philip Lane on the Big Problems Facing the Euro-zone Economy

There's a pretty widespread recognition that the EU is facing a bunch of economic challenges right now. Growth has been slowing and, as in many places, there's been post-pandemic inflation. But there are other issues too, including a sense that Europe is falling behind when it comes to key technologies like AI and semiconductors. There's also an ongoing energy crisis and the recent threat of tariffs from the US. So how is the European Central Bank evaluating and responding to these cyclical and structural challenges? How do one-off risks affect the direction of monetary policy? We speak with Philip Lane, chief economist at the ECB, about how the central bank is thinking about all these things. Read More:Trump’s Naughty List Could Put EU Cars, Machinery in Tariff CrosshairsECB Cuts Rates for Fifth Time as Euro-Zone Economy Flatlines Only http://Bloomberg.com subscribers can get the Odd Lots newsletter in their inbox each week, plus unlimited access to the site and app. Subscribe at bloomberg.com/subscriptions/oddlotsSee omnystudio.com/listener for privacy information.

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• 0:00Speaker 00

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• 1:04Tracy Alloway?

  Hello and welcome to another episode of the Odd Lots Podcast. I'm Tracy Alloway.

• 1:08Joe Weisenthal?

  And I'm Joe Weisenthal.

• 1:10Tracy Alloway?

  Joe, did you see last month the European Commission released a competitiveness compass with a bunch of recommendations for how to boost productivity in the Eurozone?

• 1:20Joe Weisenthal?

  I missed that. However, I know that there have been a number of sort of similar reports and studies. Mario Draghi, I think, the former ECB chief, last year put out this big thing. There's certainly been a source of debate, consternation, anxiety, so forth.

• 1:37Tracy Alloway?

  So Mario Draghi's competitiveness report was 400 pages and the European Commission one was 27 pages. And I can't figure out whether or not that makes the Commission more productive than Draghi or less. Like their output is physically smaller, but maybe it's more efficient and succinct. You're absolutely right. This is kind of a tough spot for the Eurozone. So growth has been slowing while inflation is still kind of sticky. In fact, we had EU inflation for January recently and it came in slightly hotter than expected. I think it was something like 2.5%. And Europe's been dealing with an energy crisis, plus now the threat of tariffs emanating from the Trump administration.

• 2:21Tracy Alloway?

  And against all of those sort of short term, immediate challenges, kind of hovering in the background is the sense that Europe is falling behind in key technologies like AI, that it's becoming less competitive, less productive relative to other places.

• 2:37Joe Weisenthal?

  Right. And it's sort of implicit in what you're saying here, but the other big key source of anxiety is just the sort of core industrial superpowers and their competitiveness, particularly vis a vis China. And I'm thinking about oil, perhaps the chemical industry and so forth. And then, you know, you layer onto it, as you already mentioned, the possibility of tariffs and the future of trade with the United States specifically, there's a lot going on.

• 3:03Tracy Alloway?

  Yeah, all of this is a very long winded way of saying that Europe is facing both cyclical and structural problems or challenges.

• 3:12Joe Weisenthal?

  Yes.

• 3:12Tracy Alloway?

  So I am very happy to say we have the perfect guests to discuss all of this. We're going to be speaking with Philip Lane, the chief economist over at the European Central Bank. So Philip, thank you so much for coming on All Thoughts.

• 3:26Speaker 05

  Good morning. It's great to be here.

• 3:28Tracy Alloway?

  Why don't we start with the thing that is all over the news, which would be tariffs? Joe and I personally are kind of struggling to cover these because the headlines change so fast. By the time we get a podcast out, like the news on trade restrictions has already changed. How does the ECB factor potential tariffs into its monetary policy? Because your forecast right now, I don't think they actually take tariffs into account, but we know that Trump has talked about imposing tariffs on the EU at some point.

• 4:04Speaker 05

  So let me make two differentiations there. Number one, of course, for a long time now, there has been speculation about tariffs. So to the extent the speculation about tariffs is feeding into investor plans, consumer plans, it's there in the data. And as you said, a lot of the sentiment indices are kind of subdued. And I think clearly the uncertainty about trade is one of those factors. What is true, though, is we have looked in great detail about different tariff scenarios. But until you really know the scope of what we're talking about, putting those into the baseline, we haven't done. We will essentially adjust when and if we see more detail.

• 4:49Speaker 05

  And of course, this can evolve. The trade policy configuration we have in spring 2025 may not be the trade policy configuration we have in the autumn or next year. So I don't think it's kind of a zero one, one day only type of event. It's something we will continually reassess.

• 5:09Joe Weisenthal?

  Sitting aside, obviously, there's a lot of uncertainty. We don't know 10%, 25%, 0%. We don't know. But how do you think about tariffs? Because, you know, you hear two different things when it comes to tariffs and cyclical policy. One is, okay, maybe you get some sort of like price shock or something like that. And maybe that's inflationary, maybe that's not. But then also, the implication is that tariffs force a longer term adjustment and perhaps countries have to invest more to be more self sufficient, et cetera. When you think about the eurozone's trading position today, what are the vulnerabilities? And what are, how would you think about the sort of macro effects of how tariffs play out?

• 5:52Speaker 05

  I don't think there's any question in terms of output. The effect of introducing frictions into global trading system is a negative. So it has to be bad for output. Now, there will be mitigants. As you say, firms will work out, okay, now I'm going to find another supplier. Now I'm going to build another plant somewhere else to kind of get around tariffs. But those are mitigants. They're not going to say, well, all of a sudden, that's a net positive. So I think there's no doubt it's net negative for output. As you say, for inflation, there's many conjectures. That of course mechanically, if it turns out to be the case that there's more expensive

• 6:33Speaker 05

  imports from America, mechanically there's an upward effect from that. On the other hand, as we just talked about, if there's kind of a weakening of domestic demand in Europe, if there's a lot of trade frictions globally, if there's a weakening in the global economy, those are disinflationary forces. So in December, we basically, and now again in our January meeting, we said for output, it's a downside scenario. For inflation, the effects are uncertain. But as you indicated earlier on, there's also classic issues about price level versus inflation, how big this is compared to all the other factors we have to think about for inflation. So I would say, you know, I think it's very natural

• 7:14Speaker 05

  to focus on the economic effects and then we will look at the inflation effects as we see it unfold, rather than taking a very strong ex ante position on that.

• 7:24Tracy Alloway?

  Hmm. I'm going to ask a very broad question, but European growth has kind of been flatlining and at the same time, we had that inflation number recently coming in slightly hotter than expected. How would you characterize the EU economy right now?

• 7:43Speaker 05

  So I think what you have to go back to is 2022. So 22, on the one side, we were coming out of the pandemic. There was a burst of activity as we reopened. And remember, Europe had a much longer lockdown than over here. But then we had the Russia-Ukraine war in spring 22. So after that, we had inflation going all the way to 10.6% in October 22. And of course, we had to respond to that by raising rates, which were in a low for long before then. So our policy rate went from minus 0.5 to plus 400 in terms of basis points. So there's a lot of adjustment. What that meant is in 2023, we did flatline. In 23, Q4, the area economy grew by 0.1.

• 8:31Speaker 05

  Now, if I look at last year twenty four, there was a partial recovery. We went from zero point one in twenty three to zero point nine in twenty four. And that, we expected that, we expected consumption to recover in particular. Now, it wasn't as strong as we would like. Then we have, as we just talked about, new types of shocks hitting the economy. But let me emphasize is that we do think, going back to this cyclical structural issue you raised, that there is cyclical recovery as our baseline. We should expect to grow probably a bit above potential this year and next year. And essentially, if you think about, a lot of factors are kicking in.

• 9:12Speaker 05

  As we ease monetary policy, we still expect this year to be led by consumption. And then in twenty six, more than this year, a recovery in investment. And then also, I think, a contribution from exports. So I think it's important, you know, if you kind of are too backward looking about this, you're looking at maybe the stagnation in twenty three. Or you are looking, in fairness, at the Q four, which did flatline a bit. But I think there's some cyclical factors in those Q four data. On inflation, we're down from ten point six in October twenty two to two point five in the most recent number. That's, by the way, I know there was some market speculation, was that a bit high?

• 9:55Speaker 05

  From my point of view, what's been developing is a bit more energy inflation. But actually, services inflation, which has been what we've been really looking at, came in softer than I would have expected. So it's not the case the overall inflation profile is too dramatic. And what we think is fairly soon, we will be back at our two percent target. And essentially, that's why we cut rates last week.

• 10:20Joe Weisenthal?

  The market is still pricing in several more rate cuts for twenty twenty five. I take your point about the salience of services inflation. And obviously, you know, it's very common for central bankers to sort of recognize that there's always so much you can do about the energy price component. But given where inflation is and given what you describe as a cyclical recovery and likely further impulse, does it make sense to still be cutting into that environment or at that depth?

• 10:52Speaker 05

  Well, I think we're trying to be cautious. So one of our kind of stable sentences is no preset path. So even if the market is pricing several cuts, you know, I'm not saying that there's any reason not to have that market view. From a policy point of view, our emphasis is really on agility. The energy situation is changing. It may change again in either direction in the coming weeks. And I say we have a balancing act. We do have the recovery, but we also know that essentially the disinflation is well on track. And as disinflation continues, finding, if you like, the new normal for interest rates is essentially a part of our challenge.

• 11:36Speaker 05

  And when we cut last week from 300 basis points to 275, that was essentially saying, well, this 300 is not the new normal. And I think we'll be in that search process, you know, as we go along.

• 11:49Tracy Alloway?

  Since you brought up the new normal, I mean, one thing the US and Europe do have in common right now is this debate over the neutral rate, so R star. How useful is that idea when it comes to setting interest rates? And also, when you look at the economy right now, how restrictive do you think rates actually are?

• 12:10Speaker 05

  I think it's important to have narrative frameworks. And one of the narrative frameworks is when inflation is well above 2%, it's very important that everyone understands that monetary policy is going to be restrictive. And that's important to be able to demonstrate that the policy rate is higher than so-called normal. It's important to look at, is demand dampening, i.e. is the pricing environment making it more difficult for firms to be able to get through price increases? As inflation comes back to more or less around target, those factors lose kind of resonance. And you do have to kind of change the narrative framework.

• 12:52Speaker 05

  Now, what we said in December, and I think this is maybe not rocket science, but maybe it's helpful, is what we're going to do is we're going to set monetary policy appropriately. Now, the appropriate phrase is essentially saying, what do we need to do to keep inflation around 2? And this is where the neutrality debate loses some relevance. You know, what is probability in the next number of months the world is neutral? So there's no shocks. So it's a nice hypothetical conjecture. But if you are more dealing with shocks, so whether downside shocks or upside shocks, monetary policy has to, if they're material, so they're there for the medium term, but not just noise.

• 13:36Speaker 05

  So I think now as you get closer to that zone, let's not talk about neutrality. Let's talk about what's appropriate. And then you do the standard wish list, you know, are we seeing, what are we seeing in the pricing data? What are we seeing in the activity data? What are we seeing in the transmission? Because again, we have a bank-based system over here in America, much more market-based system. I mean, the markets, of course, matter in Europe, but we pay a lot of attention to banks. And right now, to one of the dimensions of the question is what we see is credit starting to pick up. So there is some easing there, but it's still very subdued, still well below historical averages.

• 14:21Speaker 05

  So what I would say is compared to the peak, there's been some easing, but it's not the case that that process has gone into a kind of new steady state. We're still in a recovery phase.

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• 16:54Joe Weisenthal?

  I want to ask you a question that I've actually asked several policymakers in the US about the last several years. The nature of inflation in the US and in the eurozone, some similarities, some differences. The spike of the eurozone was probably more pronounced a bit thanks to the energy shock specifically. But, you know, obviously there's a sort of like cyclical component and then an energy specific component. What's interesting to me, setting aside energy. Unemployment in the eurozone, if I'm looking at this correctly, is actually like at a multi-year low right now. Lower than it was at the peak in 2022. What is your story for if we think of central banking as sort of working through this

• 17:37Joe Weisenthal?

  unemployment or employment activity inflation trade off? What is your employment for why the sort of core measures of inflation or services inflation have eased so much? Even at a time of what seems to be labor market tightness, no easing at all?

• 17:53Speaker 05

  So I think the labor market tightness is part of it. And actually, the euro area is an interesting place to look at that. Because of course, across the euro area, you have some economies that are hotter than others. You have kind of a laboratory. So absolutely, the kind of there is a correlation between a tight labor market and wages. But the strength of that effect is not big compared to the size of the inflation shock we had. Which was essentially an intersection of two factors. One was the energy shock and two was the exit from the pandemic. So more or less exactly at the same time in spring 22, we had the Russian invasion of Ukraine.

• 18:38Speaker 05

  And that wasn't just a kind of a level shift in energy. From there until August 22, you this really large, extreme run up in gas prices. But in the same six months, so spring to autumn 22, this is when the European economy reopened. So actually, if you look at activity data, it's quite strong for those six months. Because tourism restarted, hospitality restarted. So this is a very unusual configuration of events. That reopening had a demand element to it. Because of course, people really wanted to spend. And of course, the supply was still pandemic constrained.

• 19:20Speaker 05

  So this, I would say, is weird, unusual, not representative. So not that surprised. Implementing the most basic macro model only gets you so far. And then if you like compared since then, and I think that's carbon across. The US and Europe is a lot of what's happened is the supply side has recovered. The exact nature of it on both sides of the Atlantic is there. And that recovering the supply side is essentially why you are able to have disinflation and recovery in the economy. And as you say, we do have the lowest unemployment in the history of the euro area. Again, let me come back to this differences across the euro area.

• 20:00Joe Weisenthal?

  Yeah.

• 20:00Speaker 05

  Germany's been suffering. We know that unemployment has gone up in Germany. So the labor market is what you would expect. Spain has been very strong. Unemployment is coming down in Spain. And so when you think about the overall euro area narrative, I mean, when you talk about the US economy, we all tend to think about the US in the aggregate. But of course, there's differences across California, Chicago, New York, and so on. Same for us. There are big differences right now across some of the major countries.

• 20:31Tracy Alloway?

  You touched on this earlier, but could you talk a little bit more about the transmission mechanism of lower rates and how those actually feed into the economy? And perhaps more importantly, how long they actually take to take effect? So in the US, we hear the Federal Reserve talk a lot about long and variable lags, which gives them quite a lot of wiggle room to argue whether or not hikes or cuts are actually having an effect. How do you think about the transmission mechanism and the timeframe for changes in policy to take effect?

• 21:06Speaker 05

  So, I mean, this is what keeps us busy. And this is why throughout this period, some people don't like these phrases, but they're essential. We said we're going to be data dependent. And we said we have this reaction function where essentially as we see the transmission in action, we can recalibrate our policy. So let me maybe explain why it's the complexity in the euro area. We were in a low for long environment, even in December 21, when already inflation was picked up. The markets believed the policy rate would not go above zero until around 2027. So there's high conviction that we were in this low for long period.

• 21:50Tracy Alloway?

  This is my favorite chart, the Harry charts.

• 21:52Joe Weisenthal?

  The Medusa charts.

• 21:53Tracy Alloway?

  Yeah, the Medusa charts of market expectations of rates, and they're always, always off.

• 21:59Speaker 05

  Well, I mean, the world changes. Then we had this fairly rapid hiking cycle to 4%. And now we're coming down from that. And then the market is debating somewhere in the neighbourhood of 2%, let's say, is the new steady state. So in terms of the how people are thinking about the financial system, some of it is, well, we're gone from an old steady state of basically at the floor. The new steady state is around 2%. And how do I value assets? How do I organise my saving, my investment around that? So on top of the cyclical issue of as we ease rates, but we're easing from 400 to in the neighbourhood of 2%.

• 22:43Speaker 05

  We're not going back to the pre-shock, super low rate. I mean, we don't expect to. So that's an additional factor in transmission. Let me emphasise a couple of things. One is about the bank-based system. And then in one is how the economy responds. So in a bank-based system, and we had new numbers this morning, essentially because of course, banks are partly funded by deposits, partly funded by market funding. Deposits, they have responded, but not one for one. There's still lots of zero interest overnight deposits funding banks. So the one for one transmission of the policy rate, that works in the money market. It's softer, both on the way up and on the way down for the banking system.

• 23:28Speaker 05

  So we have taken into account in the banking system, with a mix of deposit funding and market funding, the transmission is slower. And then on the economic side, one issue we talked about last week was housing investment. That's a classic interest rate sensitive area. And we are seeing mortgage loans pick up quite a bit in Europe, but we haven't seen housing investments move up yet. And this goes back to like here to some extent. Okay, someone's decided I'm going to start a new project, getting the permits, finding the workers. All of that takes time. And so this is why I said here earlier on, we think the big recovery Investment is going to take a while.

• 24:13Speaker 05

  It's not all going to happen this year in twenty five. It's going to go into twenty six. So a long way to summarize where we are is it's multi year. It really is a long lag. And again, from where it go, from the time we started hiking. I and the ECB flagged quite a bit. We haven't done this very often. How much of an evidence base do we have about? How long are those lags? How powerful is transmission? And in the context of a pandemic and a war. So for all those reasons, it really goes back to. I'm reassured that transmission is working. I see it. But I'm also validated, if you like, that it takes real time.

• 24:55Speaker 05

  It takes real time before it transmits all the way through the economy.

• 25:00Joe Weisenthal?

  Tracy, I just remembered something. And, you know, you started the episode talking about some of the big structural things which we should get to. Do you remember in the blogosphere, like the twenty teens? I just remember this, the six versus the strux debate.

• 25:12Tracy Alloway?

  Oh, no, I don't remember that at all.

• 25:14Joe Weisenthal?

  Some people are like, oh, is the US face like just a cyclical challenge? Where we need more demand? Or is there a strux thing where we need to like structurally change how the US economy works? Do you remember that? Anyway, it occurs to me like every time there's some big economic shock of any. You get this debate, right? How much is it a cyclical thing? Where, you know, economies go up and down, inflation goes up and down, unemployment goes up and down versus something structural? Deeper with the economy perhaps, which demand policies, whether they be fiscal or monetary, are sort of to some extent insufficient to address them. And obviously, you know, Tracy mentioned in the beginning, these competitiveness reports, the Draghi report and all that stuff.

• 25:54Joe Weisenthal?

  Do you feel like we're at a moment where it's important for Europe? To be thinking about like deep structural issues? Or is it just weird sort of taking our eye off the ball? And then in the end, these are still sort of cyclical challenges for the economy?

• 26:12Speaker 05

  Well, let me make a few points about this because of course this debate is ongoing. First of all, I think it's important to recognize there isn't a clear, bright line between cyclical and structural. Because of course, if an economy faces structural issues, more or less, if you're pessimism on a structural basis, it will lower demand. So cyclical policy is called for, even if the origin is structural. But let me say, on top of all the structural issues, which are global, every country debates how to deal with aging, how to deal with climate change, how to deal with digitalization, AI and so on. In a European context, maybe there's two extra factors. One is the structure of Europe. That's literally a structural factor.

• 26:57Speaker 05

  We have choices and debates about essentially more integration, the single market. And as you mentioned earlier on, Tracy, last week, the European Commission announced this competitiveness compass. That's essentially a long to-do list to convert the Draghi report, the letter report, into essentially action. And of course, you can imagine in a European Union, there's a lot of things need step-by-step action. So I would say it's all aligned, but it's just, we have a new commission. It's basically a kind of an agenda for the next few years. But fundamentally, and this is where the Draghi report starts, is Europe had a very good idea 40 years ago now,

• 27:42Speaker 05

  that essentially, in a modern world, scale economies matter. If the European member countries essentially come together and build a single market, that will really help. That remains. And the intersection now is, I think, with digitalization, with other new technologies, scale economies really matter. It's really hard to think about, okay, if I have a big fixed cost investment, if I build some new AI kind of business model, rolling that out is a function of scale. So the European Union building scale through a single market, the case for it is now reinforced. So I think there's new energy about that. And then, of course, the other big one, maybe, Joe,

• 28:27Speaker 05

  just because I think this is interesting from a global point of view, is the global, if you like, equilibrium. One thing the ECB has worked on and identified is essentially when you, you can do this exercise of comparing economies. And what's interesting of the last 15 years is Europe and China have become more similar. The US has not become more similar. So if you think about which industries are important, activity, the composition of activity, and of course, this is immediate applications, like in the car industry now, China is much more similar to Europe. And with that, of course, if you think about individual firms who might have been

• 29:09Speaker 05

  used to certain margins, certain ability to obtain market share, they are under a new competitiveness challenge. So that is something where Europe is in between China and America. Everyone has their kind of structural priorities, but this issue of how do you not kind of try and build a wall, but how do you navigate this new world is important.

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• 30:55Tracy Alloway?

  So there's a general recognition that competitiveness is an issue, low productivity is an issue. And as you mentioned, there's probably multiple to-do lists and ideas about how you could go about addressing some of these issues. I guess my question is, how confident are you that the various parties within the European Union will be able to follow through on some of this? And actually turn their economies around? Because the other thing that's happening is we've had the rise of right wing parties in lots of places in Europe. And often those parties come with an agenda,

• 31:39Tracy Alloway?

  which is cutting spending and really cracking down on debt and things like that. So it feels like there's a tension there, right? How are you thinking about that?

• 31:50Speaker 05

  So I would say there's a shared identification of essentially the challenge. That what I would say is a lot of the problems your faces, let me not say problems, but a lot of the desires, what we want, a lot of these would look a lot easier to achieve with a faster growth rate. And this is one of the, going back to the 400 pages of the Draghi Report, some of those pages were devoted about, look, all of this debate about fiscal space, it looks a lot better if you get your economy to grow more quickly. So I think fundamentally, the identification that if we can grow more quickly, how to distribute resources, how to make progress on decarbonization,

• 32:35Speaker 05

  all of these issues would look a lot easier. So let me focus on the fact that there is a kind of more and more, and that education is the only way to square the circle is to commit to policies to improve the growth rate. But let me say, there's a huge opportunity here. You can look at the fact that Europe has been a bit slower in terms of, for example, adoption of AI. You might say, oh, my God, going more slowly. Under the hand, you may say, OK, here's a real opportunity. So to embrace the diffusion of new technologies. Again, if you look 30 years ago with the transmission of Internet to the business sector,

• 33:16Speaker 05

  that happened here first, but it then happened in Europe because, of course, European firms could see what was possible.

• 33:23Joe Weisenthal?

  Right.

• 33:24Speaker 05

  So I'd be, you know, in the optimistic camp that there's a lot of opportunities. And going back to the single market idea, again, it does require political will. It does require political leadership, but it's a huge opportunity here.

• 33:39Joe Weisenthal?

  Just on this point about the idea that the Eurozone is an unfinished project, that there's still more opportunities for integration between the member nations. And one very crude way of sort of looking at European fragmentation, so to speak, and there are probably multiple ways, is just looking at like sort of, you know, in fact, that there is not a uniform sovereign spread, right? Because each country has its own bond market, and we saw that play out very dramatically in 2011 and 2012. But lately, spreads for some countries are widening out again. It's come in a little bit, but say, the French-German 10-year spread is certainly higher than much of the sort of post-2014 period, not as high as it was in 2011 and 2012.

• 34:22Joe Weisenthal?

  How much, when you look at these spreads, is this a function of part of the agenda of some of the parties in Europe is essentially capital S sovereignty? This idea that like, is it compatible to talk about creating a single market, finishing the project of integration at the same time as there is this big push for a sort of like nationalist sovereign agenda?

• 34:49Speaker 05

  So I think what you've seen in Europe is essentially, I'm not seeing that debate these days too much.

• 34:55Joe Weisenthal?

  OK.

• 34:56Speaker 05

  No one is really saying the answer is to kind of go on a nation-state basis. Because, of course, you can see. Going back to the scale economy issue, it's really hard to think about being a small country in today's world. So the value of the European Union is, I think, common. I don't think there's any anti-EU, serious anti-EU kind of proposals in any of the national systems. And going back to the spread issue, I mean, there's nothing like the situation we had 50 years ago. So of course, going back to the vision here that essentially the European Union is a unique structure. And I think that's very important because sometimes, you know, in my career, I've heard, why can't it just be like the US?

• 35:42Speaker 05

  And of course, this kind of one line.

• 35:45Tracy Alloway?

  Do people still say that?

• 35:46Speaker 05

  I get it. But of course, you need a certain amount of fiscal integration. We have stepped forward with more joint debt and so on. You do need a certain amount. You need to make sure your banking systems don't require, you know, a lot of fiscal support, i.e. they have to be well-capitalized and well-regulated, and we've come a long way on that. And you have to make sure every member country is following fairly stable policies. So we don't have the really large property bubbles, the big current account deficits we had. So Europe is quite a kind of stable environment, not super-growing fast. So dynamism is an issue, but stable, yes. But stability is, if you like, a kind of minimal condition.

• 36:31Speaker 05

  And I think this is where the conversation is. Let's move on from being stable to being, delivering more of what we want. And if we grow more quickly, we can do more on all of the different dimensions of policy that Europeans want.

• 36:47Tracy Alloway?

  Just going back to the very beginning of this conversation, we were talking about energy prices increasing and feeding into inflation. I mean, energy price is just one of many external shocks to the European economy in recent years. As a central banker, what can you do to actually offset those types of supply-side shocks?

• 37:13Speaker 05

  So what we have to make sure is when we had a really big energy shock and we had to make sure and to be able to provide the reassurance to everyone that we will make sure inflation comes back down to 2%, not overnight, but in a realistic timeframe. And essentially throughout the whole process to keep inflation expectations stable. So in contrast to 1970s, this has happened. So the famous second round or third round effects, they were there to an extent that they'd have to a catch-up phase for wages, which is now maybe nearly over. But no, I think the central bank world, once it was diagnosed that we needed to act, that has not been the biggest headache here.

• 37:56Speaker 05

  So for central banks, that's our offer or our promise. We will deliver price stability in the medium term. That doesn't mean there won't be shocks, but when there is a shock, we get it back down to 2% in a realistic timeframe.

• 38:10Joe Weisenthal?

  One of the things that we saw recently is that the Federal Reserve has removed itself from the NGFS, an organization where central banks think about the greening of the financial system, the effect of climate change on its goals and so forth. The ECB is a member of this organization. Over the last several years, various political reasons, I'm sure inflation and the energy shock, it feels like many organizations, certainly in the US, have lost some of their motivation to prioritize climate. What is that like in Europe? Is there any change in the amount of energy and interest and prioritization of climate

• 38:53Joe Weisenthal?

  change issues, both at the ECB specifically, but also at the sort of political and corporate satellites around it?

• 39:01Speaker 05

  So I think the assessment is pretty stable and that that's not just in central banking, but in many dimensions. The assessment is the world is getting hotter. The assessment is policy is needed, both to slow that down and to cap it, but also to make sure the economy and society adapts to hotter temperatures. So it's, I think, important for central banks to prepare the financial system for that. It's important for central banks in how we do monetary policy to recognize the effects of these climate shocks and also the underlying transition issue. So what is true, which is inevitable, these are pretty big policies. Yeah.

• 39:43Speaker 05

  There's big policies, but of course, all the time you have to think about recalibration. What exactly is the right subsidy policy for heat pumps, for example? So to move housing away from using oil and gas towards using heat pumps. What is the right policy and the right timeline for getting people to move from petrol and diesel cars to electric vehicles? I would view all of that as recalibration, tactical adjustments. But again, coming back to where we started with the European Commission's agenda for the next few years, decarbonization remains central to that. So I would say we're learning a lot.

• 40:26Speaker 05

  The evidence from all of the severe weather effects, not just in Europe but around the world, people see it. They see it every day, how they live their lives. So I think the identification of the problem is there, but of course, making sure that the trade-offs are recognized, the scope for new technologies to help and to be sensible about what you ask different parts of the economy, whether it's households, large corporates, small corporates, the banking system, that's essentially is evolving work in progress.

• 40:59Tracy Alloway?

  So I can't pass up an opportunity to talk more about the hairy charts of market expectations of the future path of interest rates, Medusa charts, spaghetti charts, people call them sometimes. The market currently is pricing in at least three more 25 basis point cuts. Is that reasonable in your mind? Is the market finally going to get this one right?

• 41:27Speaker 05

  Okay, I'm going to sidestep that to some extent because philosophically, the world is subject to shocks. So going back to when you get these market revisions, that's their point in time view right now. Let's see what happens. So my role is not really, I think, too overly common on the market view. But let me go back to the peak inflation of late 22. Our staff, the Earth Systems staff, I think, did a pretty good job of providing the timeline, saying, look, where you are now, around 10% inflation, you're going to be basically back

• 42:07Speaker 05

  around 2% in 25. That was a kind of timeline that's been very stable. And under that timeline, which has really been followed, then, of course, the market is recognizing the interest rates you need when you're at 10% or 5% or 3% inflation are not the interest rate you need when you're around 2%. So I think in that context, the predictability of how disinflation works has held up fairly well. The big issue was how did that inflation erupt in the first place and the scale of it. But once we got to the peak, going from peak back to 2% has been, I think, in line with how the macro modeling community would think about it. So I don't think there's

• 42:52Speaker 05

  been all that surprising so far. And so let me go back to this year. What I would say is, as we've talked about, there's a lot going on in the world. And so the fluctuation of inflation, what would be the appropriate monetary policy is very much going to depend on a lot of policy decisions around the world.

• 43:11Joe Weisenthal?

  The recent discovery maybe in the US about DeepSeek created a lot of anxiety about Chinese growth in AI, but also just sort of hammered home. There are a lot of areas where China seems to be doing very well at the technological edge. And obviously, we all know the incredible story with batteries, electric cars, the technology for green power. They have a growing petrochemical

• 43:36Joe Weisenthal?

  They even have a growing pharmaceutical industry. These are industries that I really think of as core to, you know, a big part of when I think of European industry, pharma, automobiles, chemicals and so forth. I'd like to just hear your thoughts about this more broadly. How anxious does that make you? And are there opportunities with respect to China, especially if the US's reliability as a trading partner grows more questionable?

• 44:07Speaker 05

  So let me focus on the economics.

• 44:09Joe Weisenthal?

  Yeah.

• 44:09Speaker 05

  Of course, there's a parallel political debate, which is not for me. But economically, what we've had for a long time now is China growing, becoming a bigger share of the world economy.

• 44:20Joe Weisenthal?

  Yeah.

• 44:21Speaker 05

  And the most basic point is that operates in both demand and supply.

• 44:25Joe Weisenthal?

  Yes.

• 44:26Speaker 05

  So as they get more productive, the technologies, they diffuse around the world. So that, you know, those who are able to buy a cheap electric vehicle, to buy cheap solar panels, windmills, all of those, I mean, there is a kind of global impact of that. Also, as China gets richer, again, their interest in buying exports from Europe and from America goes up. So the baseline, of course, is essentially the world gain richer is win-win. Now, of course, there is a debate about industrial policy and, you know, under what circumstances, whether for economic security reasons or for kind of stability of various industries,

• 45:08Speaker 05

  you recognize that there are concepts such as kind of countervailing tariffs. So Europe imposed in a very calibrated way tariffs on Chinese EVs a while ago. But essentially that was done within, I think, WTO rules, which is basically if you think the origin of some of the low prices out of China are, if you like, unfair subsidies.

• 45:31Joe Weisenthal?

  Yeah.

• 45:32Speaker 05

  Then the handbook says you can counter veil that and correct that. So what I would say is there are kind of WTO mechanisms that can go a long way in dealing with any kind of identification of. If you like unfair subsidies, but I think we should remember the world getting richer, technologies getting invented, wherever they get invented, creates global possibilities. I'll call them possibilities.

• 45:59Joe Weisenthal?

  Yeah.

• 46:00Speaker 05

  But I would say, and I said it earlier on, is the fact that China is becoming more similar, whether in chemicals, auto and so on, does create adjustment issues. It does mean the kind of price at which a European firm can sell its output around the world is compromised. The answer to that is not to say, look, I wish this new competition didn't exist. The answer is, okay, how do we adjust? So I would say individual sectors, adjustment issues, that's always been true with trade, but also to recognize that rising real incomes in China are, you know, add to the world's demand as well.

• 46:38Tracy Alloway?

  All right, Philip Lane, truly the perfect guest to discuss all of this. Thank you so much for coming on the show.

• 46:44Speaker 05

  Well, thank you for having me.

• 46:58Tracy Alloway?

  Joe, I thought that discussion was really interesting and it's been a while since we've had a Europe centric episode. One thing I was thinking is it's kind of amazing how much politics is intertwined with the economy and monetary policy right now. And we asked a bunch of questions along these lines, but there's a broad recognition of the challenges that Europe faces and there are some concrete ideas about what to do about those. But at the same time, it feels like politics is heading in the other direction away from multilateralism, as you pointed out. And even, I mean, even Belgium, so Brussels is like the seat of the European Union.

• 47:42Tracy Alloway?

  Even Belgium has a far right party in power now. So, you know, it seems like an uphill battle.

• 47:50Joe Weisenthal?

  Yeah, right. I mean, I really liked the way he framed the answer when we sort of pivoted to structural questions. Because sure, there's always structural questions, but Europe seems to have both external structural questions and internal structural questions. And it's hard to think about. Addressing some of the external structural questions such as how and do you sort of have a competitive AI sector? Do you want a competitive AI sector? But how would you have one, given the scale of investment? Or can you compete with the scale of Chinese chemicals or autos? At the same time, as the internal structure still is not complete, there are

• 48:35Joe Weisenthal?

  still individual states and obviously there are formal trade barriers between the states, but there's, you know, there are different countries still in different financial markets and a not fully integrated banking system. And whether, as you say, there's the appetite currently in today's 2025 politics to talk about further integration is a challenge.

• 48:56Tracy Alloway?

  Definitely an open question. Shall we leave it there?

• 48:59Joe Weisenthal?

  Let's leave it there.

• 49:00Tracy Alloway?

  This has been another episode of the Odd Lots Podcast. I'm Tracy Alocke. You can follow me at Tracy Alocke.

• 49:06Joe Weisenthal?

  And I'm Joe Weisenthal. You can follow me at the Stalwart. Follow our producers, Carmen Rodriguez, at Carmen Armin, Dashell Bennett, at Dashbot, and Kale Brooks, and Kale Brooks. For more Odd Lots content, go to Bloomberg.com/oddlots. We have transcripts, a blog, and a newsletter. And you can chat about all of these topics 24/7 in our Discord, discord.gg/oddlots.

• 49:27Tracy Alloway?

  And if you enjoy Odd Lots, if you like it when we do Europe-centric episodes, then please leave us a positive review on your favorite podcast platform. And remember, if you are a Bloomberg subscriber, you can listen to all of our episodes absolutely ad-free. All you need to do is find the Bloomberg channel on Apple Podcasts and follow the instructions there. Thanks for listening.

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