The Central Bank, Growth and the European Construction

Good evening, and welcome to the tenth edition of the Karl Brunner Distinguished Lecture. It's so good to see you all here at ETH Zurich for the annual public event organized by the Swiss National Bank, and a warm welcome to everyone who is joining us remotely through the live stream. I'm Tanya König, and I'm looking forward to guiding you through this lecture today. Like every year, you will be hearing from a leading economist, and this time it's one of the most famous ones, also known as a European central banker or an Italian politician. But before we hear from our guest speaker, I'd like to hand over the stage to the President of ETH Zurich. Please welcome Joël Mesot.

Thank you, Tanya. Ladies and gentlemen, it is a great pleasure to welcome you once more here at ETH Zurich. Today's event is special in several ways. The Karl Brunner Lecture is being held for the tenth time, making it a small anniversary. Over the past years, this lecture series has established itself as an important platform for discussion on monetary policy, economic development and global challenges. To mark this anniversary, the SNB has given itself, and all of us, a special gift, with Mario Draghi as tonight's speaker.

It would take an hour to list all of his accomplishments, and Martin Schlegel will highlight some of them later, I guess. Among many things, his name has recently been very much associated with the so-called Draghi report on the future of European competitiveness. Completed in 2024, the report presents a detailed analysis of Europe's economic situation and provides concrete recommendations on how Europe can secure sustainable growth and adapt to a rapidly changing world. I can promise you that most presidents of universities have read a big part of the report and debated it.

At the heart of the matter lies a question that could hardly be more timely: can Europe play an independent role between the two superpowers, the US and China? This question does not concern only economic policymakers; it concerns all of us. If Europe wants to continue to have an independent geopolitical voice in the future, this will ultimately only be possible on the basis of economic strength. And in the age of artificial intelligence, robotics, quantum computing and other disruptive technologies, economic progress is hardly conceivable without leadership in those digital technologies.

And this is where universities come into play, since today they are much more than just places for imparting knowledge. They train the talented individuals who develop tomorrow's technologies. They generate the foundational knowledge from which new industries emerge. And they combine scientific excellence with entrepreneurial activity. ETH Zurich has upheld this tradition since its founding more than 170 years ago. It is closely linked to Switzerland's economic development, and over generations it has helped ensure that our country remains one of the world's most innovative economies, despite its limited natural resources.

Zurich in particular offers a striking example of this today. In recent years the region has evolved from a traditional banking hub (sorry, Martin, to say that; sorry to the bankers here) into one of Europe's leading deep-tech hubs. For example, all the big AI companies are present in Zurich today. ETH Zurich and the University of Zurich have played a significant role in this transformation. Our research yields new insights, and our students, researchers and alumni are founding companies that bring innovative technologies to market. One concrete example is the SCION network technology, which was developed at ETH Zurich and now forms the basis of the Secure Swiss Finance Network, an initiative co-initiated by the Swiss National Bank. Thank you, Thomas, for having pushed this. This example vividly illustrates how cutting-edge research can lead rapidly to concrete solutions for the security of critical infrastructure.

Personally, I'm convinced that digital technologies, and AI in particular, have enormous potential to contribute to the well-being of society. However, this requires that we develop and use these technologies with sound judgment, responsibility and transparency. And this is precisely the approach that ETH is consistently pursuing. Together with EPFL, the ETH in Lausanne, we have developed Apertus, an open and transparent language model. Our goal is to contribute to a European AI landscape based on openness, scientific traceability and sovereignty, which serves as an important complement to today's closed AI models. Let's be bold. Have a dream. Maybe we can announce at the 2027 AI Summit in Geneva the launch of something like a CERN of AI. Let's discuss that tonight.

This is an example showing why collaboration with our European partner institutions is so important to us. Scientific excellence does not arise in isolation, but rather within strong international networks. For Switzerland, therefore, unimpeded access to European research programmes such as Horizon Europe is key, and we are very pleased that it is now possible again.

Ladies and gentlemen, our societies face major challenges. Technology, when used wisely and responsibly, can turn these challenges into opportunities. The key to long-term prosperity lies in the combination of economic strength, technological innovation and social responsibility. And therefore I'm very much looking forward to hearing our guest speaker's assessment of the steps needed to ensure financial stability and economic prosperity in Europe. Dear Mr Draghi, thank you very much for joining us today. And now I turn the floor back to Tanya. Thank you very much.

Thank you very much, Joël Mesot, for having us here. And now we'll hand over to the host of tonight's event, the Chairman of the Governing Board of the SNB, Martin Schlegel.

Introducing Mario Draghi

Ladies and gentlemen, welcome to the Karl Brunner Distinguished Lecture. This is the tenth anniversary of this event, and for this truly special year we have a truly outstanding speaker: Mario Draghi. I'm very honoured that Mario Draghi accepted our invitation.

But this year is also special for a different reason. It is the last lecture for Joël Mesot as ETH President. Joël will soon step down as President of ETH Zurich, and Joël has always been a great supporter of this event. So I would like to thank you, Joël, and ETH Zurich, for the kind hospitality over all the years. And of course we are looking forward to working in future with your successor, Günther Dissertori, who is also here.

The SNB started this event in honour of the Swiss economist Karl Brunner. Karl Brunner believed that central banking should rest on sound rules and sound institutions. It should not depend on how gifted the person at the top of the central bank is. Brunner might have said: a good central bank system should work without a Mario Draghi. Brunner was maybe right in normal times. But Mario Draghi did not lead the ECB in normal times. Instead, he showed how important one person at the top can be when times are not normal.

Mario Draghi hardly needs an introduction. We all know his achievements. Mario Draghi has held many positions over the years, and over the years he has collected almost as many nicknames as positions. In Italy they call him l'Americano, because of his time at MIT and the World Bank, and also il Prussiano, because of his legendary seriousness. But all over the world he's simply Super Mario, because he saved the euro. Just like our speaker, the game character Super Mario always moves forward with determination.

The reports of Mario Draghi's determination date back to 1971. Back then, Franco Modigliani, who was a professor at MIT and later a Nobel laureate, was visiting the Banca d'Italia. Mario Draghi had just graduated from La Sapienza, and he was determined to do a PhD. So he approached Modigliani to ask for a place in MIT's doctoral programme. The problem was that the application deadline had already passed, and he also needed some funding. But against these odds, Mario Draghi became the first Italian to earn a PhD in economics from MIT.

Forty years later he showed his determination once again, but this time on a global scale. In the euro crisis in 2012 he said three words (you all know them): "whatever it takes." Ladies and gentlemen, I can say these words changed my life, and I can tell you why. Back then I was the Head of Foreign Exchange at the Swiss National Bank, and the Swiss National Bank had the minimum exchange rate in place, of 1.20 Swiss francs per euro. At the time, the pressure on the minimum exchange rate was huge. My team and I would sit at our trading desks and look at these flickering screens. We had to buy billions of euros, and this every day. And then, after the words "whatever it takes," the euro–Swiss franc exchange rate moved away from the floor, almost magically. I can assure you, Mario Draghi's words made my job back then a lot easier.

But then, ten years later, they made my job more difficult. His three words had a comeback after the Credit Suisse crisis. Some people said the SNB could simply have said it would do whatever it takes to save Credit Suisse. So I went back to Mario Draghi's speech, and I noticed a small but very important nuance. He actually said much more than three words. What he actually said was: "Within our mandate" (and this he repeats) "within our mandate, the ECB is ready to do whatever it takes to preserve the euro." So the key is "within our mandate." Mario Draghi made clear that a central bank has to act always within its mandate. Karl Brunner would have found Mario Draghi's reference to the mandate reassuring. At a moment when much depended on his determination, Mario Draghi acted within the mandate.

When it comes to managing crises, Mario Draghi has few equals. In Italy's finance ministry he navigated the public-finance reforms of the 1990s. As Chair of the Financial Stability Board, he turned the FSB into a powerful international organization. And as President of the ECB, he saved the euro and created new tools for fighting crises. These accomplishments are truly remarkable, and therefore this past spring Mario Draghi received the prestigious Karlspreis for his outstanding contributions to Europe. Tonight he will hold the Karl Brunner Lecture for his outstanding contributions to central banking. So, ladies and gentlemen, let's welcome Mario Draghi on stage with a warm round of applause.

Brunner's condition

Well, let me thank the previous two speakers, both the President of ETH and the Chairman of the Swiss National Bank. They paid me extraordinary compliments; I don't want to blush now, but certainly I don't think I deserve all of that. And thank you for this warm applause. It's a pleasure to give today the Karl Brunner Lecture.

Karl Brunner was one of the economists whose ideas shaped what would become the monetary constitution of Europe. In 1968 he introduced the term "monetarism" into the vocabulary of economics. With Milton Friedman and others, he helped re-establish the view that inflation is a monetary phenomenon, and that responsibility for the price level rests with the central bank.

Yet Brunner was equally clear about the limits of this responsibility. The central bank could not deliver price stability alone. It needed a fiscal authority whose incentives were compatible with its own. If a government ran permanent deficits large enough for its debt to keep rising relative to output, the pressure to monetize that debt would build. Over time, the two regimes could not coexist, and the monetary regime was the more likely to give way.

These ideas are recognizable in the Maastricht Treaty. It gave the ECB independence and a primary objective of price stability, and it created the separation between monetary and fiscal policy necessary to make independence sustainable: the prohibition of monetary financing, the no-bailout clause and the excessive deficit procedure.

Whether that separation holds in practice, however, depends on more than rules. Ultimately it turns on the relationship between borrowing costs and growth, or, as economists used to say in shorthand, r minus g. If the interest rate r that a government pays on its debt is above the growth rate g of the economy, the debt ratio rises by itself unless the government runs a primary surplus. The wider the gap, the larger the surplus that is needed, and the stronger the temptation to pressure the central bank to monetize. The same relationship was central to Brunner's own analysis.

The European framework contained two implicit assumptions about how r and g would be kept close. The first was that growth would be delivered by other policies. Monetary policy was seen as neutral in the long run, and fiscal policy could at best smooth the cycle. Growth would have to come from the supply side, especially from completing the single market. Monetary union was expected to reinforce those gains.

The reference values in the EU fiscal rules assumed this growth would be relatively strong. A deficit of 3% of GDP stabilizes debt at 60% of GDP only if nominal growth is 5% a year. At the time, that meant real growth of around 3% and inflation of around 2%. But while fiscal policy was governed by explicit rules and enforcement procedures, growth was largely taken for granted. After 1992, with no common timetable, progress on the single market slowed and was never completed. National structural policies were coordinated only through recommendations that carried no sanction.

The second assumption was that the central bank doing its job and governments following the rules would together bring interest rates down. A credible central bank lowers the premium investors demand for inflation risk. Sound public finances lower the premium they demand for holding government debt. With both falling, r would move towards g. And lower interest rates would in turn support investment and growth, so that the process would sustain itself.

This is broadly what happened during the Great Moderation, in two stages. In the 1990s, governments across advanced economies reduced deficits while central banks anchored inflation expectations. Long-term interest rates fell steadily. Estimated term premia fell with them, most sharply where central banks were strengthening their monetary policy frameworks.

Countries preparing for the euro benefited twice: from this process, and from convergence towards the single currency. Governments determined to join ran primary surpluses of between 2 and 3% of GDP on average in the late '90s. The prospect of the euro took the devaluation risk out of their debt. By 1999, long-term yields in Italy and Spain had fallen by more than 8 percentage points since the start of the decade, to around 4%, compared with a drop of only around 3 percentage points in the United States.

In the euro's first decade, growth followed. Lower rates lifted activity most strongly in the periphery, as capital flowed in from the core and credit and investment expanded. From 1999 to 2007 the euro area grew a little over 2% a year in real terms, somewhat below the 3% the fiscal rules had assumed. But that growth kept r close to g. Over those years, the gap between the average interest rate on euro area government debt and nominal growth averaged 0.6 percentage points. The central bank could meet its mandate with the policy rate alone, and its independence was never seriously tested.

But there were warning signs in the construction. Growth came more from credit and convergence than from the single market reforms the framework had counted on. The primary surpluses of the late '90s reflected an exceptional effort to qualify for the euro. They were far above the average since 1960, which was close to zero. Once they faded, keeping debt stable would depend on growth keeping pace with interest rates. For a decade, then, the construction held. But it had not yet been tested by a period in which r and g moved apart.

The test

The financial crisis, and the sovereign debt crisis that followed, provided that test. The growth that had rested on credit disappeared, and interest rates across countries diverged again as investors began to doubt the public finances of several countries. The gap between r and g on euro area debt widened to 2.8 percentage points over 2008 to 2011. With growth collapsing and interest rates moving away from growth rates, the macroeconomic authorities had to step in and take responsibility for growth.

During the first part of the financial crisis, governments did so. In 2009 and 2010, fiscal and monetary policy were both strongly expansionary. But once the sovereign debt crisis began, governments fell back on the lesson of the '90s: that consolidation would bring interest rates down. Some went even further and believed it would raise growth as well, by restoring confidence in the public finances. The fiscal stance therefore tightened sharply. Between 2010 and 2013, the euro area's cyclically adjusted balance tightened by 3.7 percentage points of GDP. Worse, this included countries that were not under market pressure.

But the conditions were now different. In the '90s, the private sector expanded as interest rates fell. In 2010, banks and firms were deleveraging and could not fill the gap left by the state, so fiscal multipliers were unusually high. The result was that consolidation acted on growth more than on interest rates. From the second quarter of 2011 until the first quarter of 2013, growth was flat or negative for eight quarters in a row. By then, output in the euro area was around 3.5% below its potential. ECB simulations suggest that, had fiscal policy leaned against the downturn, the shortfall would have been about half as large.

Monetary dominance

The same weakness in demand fed through to monetary policy, because its effect was disinflationary for the whole euro area. Core inflation fell to 0.6% in January 2015, and longer-term inflation expectations fell to around 1.5%. Restoring price stability required monetary policy to become highly expansionary. That brought weak growth inside the central bank's concerns. With no other policy supporting demand, lifting the economy was the channel through which monetary policy could bring inflation back to target.

This required the central bank to act on a scale, and with instruments, it had not used before. Rates were cut to zero and then below it. If markets believe that zero is the floor, then once rates reach zero, the only direction they can move is up, and that expectation is priced into the whole yield curve. Removing that floor therefore had an effect larger than the size of the cuts would suggest. At its peak, the negative rate policy is estimated to have added around 0.3 percentage points to annual GDP growth and 0.2 to inflation.

To reach long-term rates, the central bank bought assets, above all government bonds. And this worked through a channel that Brunner, in his long collaboration with Allan Meltzer, had helped to develop. Monetary policy acts through the relative prices of the whole range of assets, not through a single interest rate. Assets are imperfect substitutes for one another. When the central bank buys long-dated bonds, investors who sell them move into other assets: the bonds of other member states, bank bonds, corporate debt. The premium falls on all of them, and financing conditions ease across the economy. In the euro area, where the government bond market is split along national lines, that effect is, if anything, stronger.

The measures achieved their goals. At their peak, they lowered long-term interest rates by around 140, 150 basis points. ECB estimates imply that they accounted for more than a quarter of euro area growth between 2015 and 2019. Without them, around 2.5 million fewer people would have been in work, and inflation would have fallen below zero in 2016.

The concern at the time was fiscal dominance. It was wrong in principle and in practice. It was wrong in principle because the founders of the Treaty drew the line clearly. The central bank may not lend to governments, but it may buy and sell their securities in the market as a means of conducting monetary policy. What separates the two is the purpose. With inflation far below target and falling, purchases of securities were essential to deliver on the mandate. This was an exercise of monetary dominance. If inflation is a monetary phenomenon, then responsibility for it rests with the central bank, whether it is too high or too low. The ECB accepted that responsibility in full, as the founders intended. The Court of Justice of the European Union took the same view. It ruled that the purchases fell within monetary policy and, given the safeguards attached to them, did not breach the prohibition of monetary financing.

But the concern was also wrong in practice. The purchases did not pull the central bank into the orbit of fiscal policy. They removed the condition in which fiscal dominance takes root, a debt ratio rising by itself because interest rates exceed growth rates, and with it the pressure to monetize this debt. By lowering borrowing costs and supporting growth, monetary policy helped reverse the differential between interest rates and growth, which averaged minus 1 percentage point between 2015 and 2019. So growth was above interest rates. With deficits narrowing as the economy recovered, that was enough to lower the euro area debt ratio from 93% of GDP in 2014 to 84% in 2019.

Or did the purchases tie the central bank's hands when inflation returned, as some had feared? In 2022 it raised rates at the fastest pace in its history, despite holding a large portfolio of bonds and incurring losses on it. Independence, properly exercised, is what protected the construction and kept monetary and fiscal policy separate.

Two forces

But a central bank carrying growth is not a durable arrangement, and today it no longer holds. Two forces are now at work that the central bank cannot, and should not, offset.

First, long-term interest rates in the euro area are rising, and increasingly for reasons outside Europe's control. In recent months they have risen to their highest level in around 15 years, moving in step with US Treasury yields. This is part of a longer shift. Longer-term yields across advanced economies now move together far more closely than when the euro was designed. And last year, global factors shaped the very long end of the euro area curve more than in any year of the past decade.

The construction did not anticipate this. It assumed that governments which kept their own finances in order would be rewarded with lower borrowing costs. Budget discipline still matters, but it cannot insulate a government from changes in global interest rates. Now even a government with sound finances cannot fully control what it pays to borrow.

Part of the rising yields reflects inflation. Global supply shocks have pushed inflation up again, most recently through the rising energy prices caused by the conflict with Iran and the loss of refining capacity in Russia and the Middle East. Because long-term yields reflect expected inflation over the life of a bond, higher inflation raises them directly.

The larger part reflects the supply of debt, above all from fiscal policy, which has become pro-cyclical in almost every major economy, and most of all in the United States. This year the United States will run a deficit of close to 6% of GDP, and on current policies its debt will pass its post-war record by 2030. Private borrowing draws on the same pool of capital. The largest US technology firms alone are expected to invest close to 800 billion dollars this year, mostly in AI data centres, equivalent to around a sixth of total US business investment. Global data centre investment could pass three trillion by 2030. Much of it is financed with debt. AI-related bond issuance this year could reach around 300 billion, equivalent to roughly a third of net new US corporate bonds.

Europe is adding to the supply of debt too, with Germany's fiscal expansion and a French deficit above 5% of GDP. This is unlikely to reverse. On existing policies, the IMF puts the extra spending Europe's advanced economies face from ageing, defence and the climate transition at about 4.5% of GDP by 2040. That is an increase roughly three times as fast as in the two decades before the pandemic.

With more long-term debt to hold, investors are demanding a higher premium to hold it. In the 2010s, central bank purchases compressed the term premium, holding euro area long-term yields well below those in the United States. Today, with inflation above target, the central bank can no longer do so. Instead, as it unwinds its earlier purchases, it is adding to the term premium, by a further 20 basis points in the euro area by the end of the decade.

Second, growth in the euro area has fallen behind the interest rate it now faces globally. The immediate boost from higher deficits and AI investment is mostly being felt in the United States, which also tends to gain more from faster productivity growth if AI delivers. Europe imports the full rise in rates, but only a fraction of the growth.

This gap is not yet visible in the interest bill. Debt issued in the low-rate decade still carries low coupons, so the average rate governments pay, around 2.25%, remains well below nominal growth of around 3.5%. But every year around one sixth of that debt is rolled over at today's rates, and the average rate is climbing with it. The European Commission projects that early in the next decade the average interest rate on euro area debt will rise above the rate of growth.

On current trends, growth will not rise to close the gap. Year after year, the reforms meant to deliver growth have been left unfinished. The single market in services has been a goal since 1985. 1985! I can't say I was a child. Yet over the past 20 years, barriers to trading services within Europe have fallen no faster than those facing firms from outside. Capital markets union has been on the agenda for more than a decade (well, it's 14 years), and since 2014 the frictions a saver faces when investing in equities in another euro area country have fallen by half as much as those for investing in the United States.

And productivity growth in the euro area has lagged far behind that of the United States. Since 1999, output per hour has grown at about half the US rate, and since 2019 it's even worse. Growth rates have diverged further: 0.3% a year in the euro area, against 1.8%, six times as much, in the United States.

The IMF has recently set out what lies ahead for Europe on its current path. If governments finance their higher spending needs without further consolidation or reforms (for which I see no appetite around), the average European debt ratio reaches 130% of GDP by 2040, or, weighted by the size of the economies, 155% of GDP.

Some fiscal consolidation over the medium term is unavoidable. But if this has to be done through spending cuts and tax rises alone, it's unlikely to deliver what is needed. Over the past three decades, the typical consolidation in Europe delivered three to four percentage points of GDP in total. Weighting countries by the size of their economies, those that need to adjust would now have to improve their primary balances by six to seven percentage points of GDP, almost twice as much. And even the smaller efforts have never been politically easy.

Whether governments can deliver consolidation therefore depends essentially on growth. Of the two forces that drive debt, the interest rate is increasingly set outside Europe. Growth is the one Europe can still move. Half a percentage point of extra growth a year, sustained to 2040, with part of the extra revenue saved, would take Europe roughly a third of the way to a sustainable debt path. The remaining effort would then be close to what Europe has managed before.

Growth of that order is within reach. Fast AI adoption could add about 0.4% to total growth over the next decade, and domestic and single market reforms together could add roughly another 0.5 percentage points a year. Without that growth, debt ratios will keep rising by themselves, and the temptation will be to finance them through the central bank. History suggests that, faced with the choice between major budgetary tightening and monetary financing, governments have more often turned to the central bank than made the hard decisions themselves.

What monetary policy can do

What, then, can monetary policy do? Well, the first priority is to control inflation. In a phase of worsening debt dynamics, markets will start to test the central bank's commitment. If they come to doubt that price stability takes precedence over government financing, the inflation premium will return. Borrowing costs will rise and fiscal positions will worsen. The cycle can feed on itself. Weaker public finances raise the expectation that debt will one day be monetized. That expectation raises inflation expectations, which raise borrowing costs again, which weaken public finances further. At the limit, the central bank will not be able to raise rates without adding to expectations of monetization. So that's why the first priority is to control inflation.

The second priority is to avoid making growth weaker than it needs to be. Faced with inflationary shocks, monetary policy cannot take responsibility for growth today. But it can ensure that the path of policy rates is no higher than stabilizing medium-term inflation requires. And this is consistent with putting price stability first.

The stakes are high, because growth is sensitive to the expected path of rates. Estimates suggest that the rise in expected short-term rates since the end of last year will reduce growth by between 1.1 and 1.3 percentage points in total over 2026 to 2028. Those estimates predate the further rise in expected rates since mid-August.

The effects of monetary tightening can also outlast the tightening itself. Productivity growth is usually seen as the preserve of structural and fiscal policies, unaffected by monetary policy. But in both the United States and the euro area, roughly half of productivity growth since 1999 has come from capital deepening, which depends on the cost of capital. By weighing on investment and innovation, restrictive policy may lower productivity and potential output for some time. With potential growth at little more than 1%, Europe has little margin for error.

When shocks are frequent and complex, getting the path of rates right is largely a matter of communication. Markets have to understand how the central bank will react in each scenario. The reason is that markets do not price a single path for interest rates. They price every path they think possible, weighted by its likelihood, and the rate path today reflects the average. So if markets know how the central bank will react, most of that weight sits on one path. If they do not, they have to allow for other reactions: for example, that when supply shocks hit, central banks simply raise rates in line with headline inflation. And that possibility pulls the average path up. The expected path of rates can end up higher than price stability requires.

It's important, especially at a time when global factors play a larger role in driving yields higher in Europe, to ensure that the expected path of policy rates reflects the central bank's intentions, and not uncertainty about how it will respond. The premium placed on communication today makes clear that the skill most required is the ability to explain.

Growth through integration

A main driver of growth over the long run, the development and spread of new technology, is beyond any central bank's influence. Growth should become an explicit objective shared by all governments in Europe. Europe's habitual response, with each country acting on its own, will not be enough in the world it now faces. National reforms still matter, but they cannot supply the scale on which technology, and so growth, now depends. Only integration can.

Recent research shows what the absence of scale costs. Between 2008 and 2023, the difference between the value of American and European listed firms grew from around 3 trillion dollars to 34 trillion dollars. And the gap is not the work of a few superstar firms, or of a difference in sectors. It is widest among young firms, and in industries where returns to scale are highest. The same research points to the cause. European firms still grow with their home economies: a 1% rise in a country's GDP is associated with a 0.8% rise in the sales of its firms. The sales of American firms, by contrast, bear no relation to the size of their home state; they grow with the size of the US market.

Supranational reforms have therefore become the lever that matters most for growth. A detailed plan for delivering these reforms has been laid out in the report on Europe's competitiveness, and much of it is now in the EU's joint roadmap. The first thing we must do is implement that roadmap. That will also make it possible to finance the investment Europe needs in technology, clean energy and defence at a time of tight public finances.

Finishing the single market and capital markets union will raise the returns on capital in Europe, which for large European firms are around a fifth lower than in the United States. Together with a monetary policy that keeps rates no higher than needed, that would allow the private sector to carry a larger share of the investment. More of Europe's high savings could then be invested at home, and more foreign savings attracted, as investors look to diversify away from US assets. Last year, international debt issuance in Europe reached its highest level since the single currency was introduced, and foreign portfolio inflows were close to historical highs.

Faster growth would in turn improve the balance between growth and interest rates, creating room for public investment without weakening debt sustainability. And fiscal space would be further enhanced if that investment were allocated to the level, national or European, where it is most efficient.

AI is one of the clearest examples today. Secure access to computing capacity benefits all Europeans, yet it is undersupplied when each country acts alone. The EU hosts less than 5% of the world's AI computing capacity. A recent study estimates that raising this share to 15% by 2030, roughly in line with the EU's weight in the world economy, would require about 1.3 trillion euros of investment. The public-sector share necessary to de-risk this investment, estimated at around 100 billion euros, is a prime candidate to be financed through the EU budget. Even the full amount would take only 5% of the next EU budget, which is the budget under negotiation now, and would spare national budgets while they are being consolidated. That sum is well within reach.

Brunner's condition still holds. A central bank can keep money stable only if governments keep their debt under control. What has changed is how that condition can be met. A fiscal framework cannot meet it alone when growth is weak. The further integration goes, the more firmly growth can stay above interest rates, and the better insulated the central bank will be from political pressure. Growth and independence then reinforce each other.

A generation ago, Europe gave itself a monetary constitution that has held through every crisis since. It rests on an independent central bank with a clear priority for price stability, and on budgetary discipline. That framework remains the right one. But for the constitution to endure, legislators at national and European level must now take full responsibility for growth as an objective of the Union. If they do, they will set Europe on course to renew itself. Thank you.

Questions from the floor

Thank you very much. We're moving to the Q&A now. So now you have the opportunity to ask your questions, and I'll start with you, Martin Schlegel.

Thank you very much. This was really most interesting. You clearly showed the importance of growth for Europe. One factor that you didn't mention is demographics. So how does this factor in?

Well, it makes the case for growth even more compelling. Because even though demographics is a negative force for growth, that's why technological progress becomes even more important. And demographics, I mean, it does many things, but it also makes financing needs even greater. And not only demographics because of birth rates: the longer the life expectancy, the higher the health care expenses and the funding of the health care system are going to be. So it makes the case for growth even more compelling. I mentioned climate, I mentioned defence, I mentioned technology; I should have mentioned demographics also, as something that will weigh on our budgets in the future.

Thank you very much. Questions from the audience? Yes?

Thank you for the presentation; it was very interesting. I'm myself a student here at ETH Zurich, and a student organizer as well. When we as students, as the young generation, read your report on European competitiveness, or for example the ambitions laid out by the Rhine Group, we see an immense importance placed on European talent, universities, students and so on; on mitigating the pull of American venture capital, which is too attractive; and on Europe attempting to reverse this brain drain, let's say. However, as students we don't really experience these opportunities, or it's hard for us to identify the opportunities to get in touch with people like you, or with the efforts you're working on, to understand how exactly we can contribute. And I was wondering what your ideas are on bridging this gap between the generations that does seem to exist. To give a very precise, provocative point: if you look at the members of the Rhine Group, there is only one person, one official member, who's under 30 years old, which is Leopold Aschenbrenner, incidentally. It's just a point that I thought I'd raise. We're curious: how do we bridge this gap between generations that we perceive, or experience ourselves?

Well, that is true. I think that is a good point. But just let me make one small defence of the Rhine Group's composition. The members, yes, are, I mean, not necessarily senior people, but they're all pretty established, and not young. But we also had attendance from a certain number of researchers, who were there basically as contributors. So we didn't have only senior people or well-established people contributing to this. And so we are trying; we've opened up this year, and I think we do plan to open up even further in the years to come to the young, to students. These were not students; these were postgraduate students. But perhaps next year we'll also have students there.

But the more general point is valid. What we could do is to open up our system, open up our industry, open up our workplaces. I would say I'm pretty optimistic that technology also offers a lot of hope. Technology, especially recent technology, is inherently disruptive. Disruption is a friend to the youth. And I think the more we go down this path, the more the gap will be, not closed, but narrowed. So, insisting on technology, insisting on disruption. Also, it's disruptive technology that raises productivity most.

Nationalism and scale

So before we solve matters of policy, it seems we need to solve matters of politics, in coming to an agreement. It seems like the reason why many of these things haven't happened is that there's a very, very strong drive to protect national sovereignty, which is to say to protect national champion companies, to not surrender local regulators' sovereignty, individual policies that countries have very strong incentives to keep, and that they identify with very strongly as part of their identity. And this is a collective action problem, because every single country in Europe can benefit from uniting, but every single country has a very, very strong incentive, on a very political level, with things like nationalist or populist movements, to demonstrate that it stands by these symbols of state sovereignty. And so in order to solve this political problem, it seems there needs to be some kind of discourse in which you can reach out to individual people who feel that nationalism is important, and convince them that integration is actually more important, something that's necessary for the future. So do you have an outlook on how to make that change?

I couldn't agree more with what you said. I think that, in a sense, is what I've been trying to do in the last four years. The argument goes as follows. Making the case that countries will grow only if they act together, because scale has become an essential component of growth, should sort of push rational people to say: oh yes, that way I'm becoming less poor, perhaps even more affluent; I'll be able to finance all the needs I have. All these needs pop up every day, and they were not here; they were not with us as dramatically five years ago, six years ago, as they are with us today. But now Europe needs many things, as I've said before. And to do that, you need growth. To get growth, you need scale. You get scale only if you overcome nationalism. Not 100%; as you said, nationalism is important. But on certain things, like the single market for services, like the capital markets union, like, for example, intellectual property rights for innovation. The report makes many, many cases like that. So I think that's what I've been trying to do. I don't know whether I'm going to see the success of this.

Thank you. Maybe taking Switzerland as an example: Switzerland is actually one of the oldest pragmatic federations, which grew over centuries. So maybe to your question: how can Europe actually do what the Swiss did over such a long time?

Well, in a sense, that's a good example. Switzerland, if I am correct, became a true federal state in 1848. It was a confederation before; even though it's still named a confederation, it's a federal state. And Europe is, I would say, halfway towards that. It's partly a confederation and partly a federation, and it has to take one more step.

It's going to be very difficult to share everything. For one thing, we should, for example, agree about foreign policy. We should agree about the number one judgment, which is who the enemy is for us. So you can easily guess that there would be a variety of opinions around the European Council table. So certain things are more difficult to agree on, but I don't think we should start from the difficult ones.

Frankly, it really boggles my mind to think that the banking union was launched in 2012, exactly two or three months before the famous speech, just to impress, because markets were pressing on the euro. And so the leaders launched the banking union. Markets were totally unimpressed. But basically that was the time. And now we are, what, 14 years later, and still we debate. I mean, we've done lots of things, but it's not finished yet. And that's a low-hanging fruit. And I believe that even the single market for services is very low-hanging fruit.

After export-led growth

Thank you very much. My question goes, again, to growth. Growth goes up and down, and in the past it was quite nice. But the big difference this time is when the business model is broken. And when we look at the big elephant in the room, Germany, now we have the business model completely broken. It doesn't work anymore; there's the energy problem; the work ethic is not what it used to be. How can we get growth in this environment, where it's actually not just a number? It is a business model which is completely broken, and we don't know how to get it up again.

Yes, I think that touches on something I haven't really explained during the lecture. I was saying that the response to the great financial crisis was a fiscal tightening after 2011, and that this was by and large wrong, because it depressed growth and made debt problems even bigger. But there is another side to that. We expanded our exports after that date. So our growth model became export-led growth. And to do that, of course, we compressed public investment, we compressed public demand, and our wages didn't grow, because we had to be competitive and export more. So that was our growth model since 2011, 2012. We were not like that before, you know. We didn't have such a big surplus before the great financial crisis.

Now this model is in crisis because of tariffs, because of protectionism, and more generally because of weaponization, because of geoeconomics. Until four or five years ago, or perhaps three years ago, it didn't matter where you would buy your stuff and where you would sell your stuff. You would do this based on efficiency. Now it does matter. So this export-led growth model is in crisis. On top of that, the Chinese, who were a great export market, have now become a huge competitor, and they are selling almost everything we used to produce at a lower price. So tariffs, increased competition and many other reasons, even the increased cost of inputs, are conspiring against an export-led growth model.

We are the most open economy in the world; we draw around 51, 54% of our GDP from trade. In the United States it's only 27%, and in China it's 32%. Before, in the old world, this was all in all a symptom of strength. We were open, we would trade a lot, and by and large we survived for 15 years. And now it doesn't work any longer. So we have to turn to a model like the US, and to some extent like China. We have to invest much more at home.

By the way, the last part of this picture is that in this period of time we forgot about our infrastructure. We under-invested in practically everything, from roads to education, to science, to research. And so now we have to turn that back. And by the way, Germany has started doing it, in defence admittedly, and some of the defence expenditure, admittedly, goes abroad. But a lot stays home. And I think gradually all countries will turn much more attention to domestic investment. I think that's the other big way to change.

And technology, of course: accelerating the diffusion of AI, the adoption of AI. That's also extremely important. Whatever we'll be able to achieve on frontier AI, today, if we look at the economic contribution that AI can give to the whole economy, it comes from the adoption of AI, the widespread adoption of AI by companies. And that's the other pillar.

Why economics

Thank you very much. So the Q&A is closed. Maybe I just want to use the last 30 seconds to know why you wanted to study economics in the first place.

Well, I'll tell you why. I grew up in a family where, especially, I mean, we talked a lot about economics. The economic aspect of a policy, any policy, was important. And so that's why. But by the time I chose the subject, all my classmates were choosing, well, two things basically: law and medicine. And I remember they used to laugh at me when I said I wanted to study economics, and I won't tell you what they were saying, because I would offend some professions and some jobs. But basically I was the only one in my class to choose economics. And so they were all doctors and lawyers, one physics and one mathematics. That's it.

Well, we're glad.

I liked economics even before.

Thank you very much. One more time, thank you very much, Mario Draghi.