Philip Lane on the Big Problems Facing the Euro-zone Economy
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Bloomberg Audio Studios. Podcasts. Radio. News. Hello and welcome to another episode of the Oddbots podcast. I'm Tracey Alloway. And I'm Joe Wiesenthal. 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? 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. 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 Joggy 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. 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. Right. And it's sort of implicit in what you're saying here. But the other big...

The 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. Yeah. All of this is a very long winded way of saying that Europe is facing both cyclical and structural problems or challenges. So I am very happy to say we have the perfect time.

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.

Good morning. It's great to be here. 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 is

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. 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. 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 event. It's something we will continually reassess.

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, etc. When you think about the eurozone's trading position today, what are the vulnerabilities and what are how do you think about the sort of macro effects of how tariffs play out? 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 who will work out, OK, 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 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 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.

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?

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 rates 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.

Now, if I look at last year, '24, there was a partial recovery. We went from 0.1 in '23 to 0.9 in '24. 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 it, a lot of factors are kicking in.

As we ease monetary policy, we still expect this year to be led by consumption. And then in 26, 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 23.

Or you are looking, in fairness, at the Q4, which did flatline a bit. But I think there's some cyclical factors in those Q4 data. On inflation, we're down from 10.6 in October 22 to 2.5 in the most recent number. That's, by the way, I know there was some market speculation. Was that a bit high? 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 2% target. And essentially, that's why we cut rates last week.

The market is still pricing in several more rate cuts for 2025. 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?

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 probably seeing 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. 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. Since you brought up the new normal, I mean, one thing the U.S. 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?

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.

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 too? And this is where the neutrality debate loses some relevance.

you know, what is the 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, not just noise. 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 wishlist. 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. 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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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 obviously, there is 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 unemployment or employment activity inflation tradeoff? 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?

So I think the labour market tightness is part of it. And actually, the EU area is an interesting place to look at that. Because, of course, across the EU area, you have some economies that are hotter than others. You have kind of a laboratory. So absolutely, there is a correlation between a tight labour 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. And that wasn't just a kind of a level shift in energy. From there until August '22, you had 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.

So this, I would say, is weird, unusual, not representative. So I'm 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 common 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 EU area. Again, let me come back to this differences across the EU area. Germany has 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 Eur 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.

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 U.S., 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? 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 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. This is my favorite chart, the hairy charts. Yeah, the Medusa charts of market expectations of rates. And they're always, always off. 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 neighborhood of 2%, let's say, is the new steady state.

So in terms of how people think about the financial system, some of it is, well, we're going 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 organize 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 neighborhood of 2%. 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 emphasize 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. So we have to take 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 the classic interest rate sensitive area.

And we are seeing mortgage loans pick up quite a bit in Europe, but we haven't seen housing investment 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 to you earlier on, we think the big recovery investment is going to take a while. It's not all going to happen this year in 25. It's going to go into 26. 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 goes, 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. It takes real time before it transmits all the way to the economy.

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 in like the 2010s? I just remember this, the six versus the structs debate. Oh, no, I don't remember that at all. Some people are like, oh, is the U.S. face like just a cyclical challenge where we need more demand? Or is there a structs thing where we need to like structurally change how the U.S. 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, right?

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 and the drug report and all that stuff. Do you feel like we're at a moment where it's important for Europe to

to be thinking about deep structural issues, or is it just weird taking our eye off the ball and then in the end, these are still cyclical challenges for the economy? 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 pass an instrument 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. 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 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 to 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, 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 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 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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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.

is we've had the rise of right-wing parties in lots of places in Europe, and often those parties come with an agenda 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? So I would say there's a shared identification of essentially the challenge.

that what I would say is a lot of the problems you're facing, 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 400 pages of the Draghi report, some of those pages are 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 decarbonisation, 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 identification 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, okay, 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 that happened here first. But it then happened in Europe because, of course, European firms could see what was possible. So I'd be 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.

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, the 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 the

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. 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?

So I think what you've seen in Europe is essentially, I'm not seeing that debate these days too much. 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 15 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? Yeah.

And of course, this kind of one line. Do people still say that? 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 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. And I think this is where the conversation is. Let's move on from being stable to 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.

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?

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 the 1970s, this has happened. So the famous second round or third round effects, they were there to an extent. There did have to be 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.

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.

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 U.S.,

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

So I think the assessment is pretty stable and 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 recognise the effects of these climate shocks and also the underlying transition issue. So what is true, which is inevitable, these are pretty big policies. 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, decarbonisation remains central to that. So I would say we're learning a lot today.

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 recognised.

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 an evolving work in progress.

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? Yeah.

Okay, I'm going to sidestep that to some extent because, you know, 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, you know, my role is not really, I think, too kind of overly common on the market view. But let me go back to the peak inflation of late 22.

We, well, our staff, the Eurosystems 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 around 2% in 2025. 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 it's 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.

The recent discovery maybe in the US about deep sea create a lot of anxiety about Chinese growth and 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 industry. They even have a growing pharmaceutical industry. These are industries that I really think of as core to 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? So let me focus on the economics. Yeah, 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. And the most basic point is that operates in both demand and supply. Yes. So as they get more productive, the technologies, they diffuse around the world. So, 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

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 getting richer is win-win. Now, of course, there is a debate about industrial policy and under what circumstances, whether for economic security reasons or for kind of stability of various industries, 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. Yeah. Then the handbook says you can countervail 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. 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. All right, Philip Lane, truly the perfect guest to discuss all of this. Thank you so much for coming on the show. Thank you for having me. Thank you.

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 questions

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

uphill battle. Yeah, right. I mean, I really like 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 still individual states and obviously there are formal trade barriers between the states, but 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.

Definitely an open question. Shall we leave it there? Let's leave it there. This has been another episode of the All Thoughts Podcast. I'm Traci Allaway. You can follow me at Traci Allaway. And I'm Joe Weisenthal. You can follow me at The Stalwart. Follow our producers, Carmen Rodriguez at Carmen Arman, Dashiell Bennett at Dashbot, and Kale Brooks at Kale Brooks.

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