Financial Markets & Risks - Essay Example

Then we’ll make an assessment of the impact on the banking system if short-term interest rates were to rise. And at last let’s provide an explanation of the actions the ECB might take if the rumours of liquidity problems in other institutions prove to be correct. Over the last few years, the euro area has witnessed a gradual recovery in economic activity. The recovery started in the second half of 2003 and has now led to ongoing trend growth rates that seem to be close to our present estimates of the potential growth rate of the euro area economy.

Several factors are behind the relatively gradual pace of this recovery, including oil price increases, the restructuring and reshaping of the productive sector triggered by global competition, and a possible decline in potential output growth. First, taking a longer-term perspective, there is some evidence that, underlying the moderate growth rates over the last few years, there may have been a decline in trend potential output growth in the euro area, particularly when comparisons are drawn with most of the 1980s and 1990s.

The trend potential output growth rate seems to have moved closer to the lower bound of the previously estimated range of 2.0-2.5%. The sustained decline in euro area labour productivity growth has been identified as the main factor explaining lower potential output growth. Euro area labour productivity growth (measured per hour worked) was 2.4% in the euro area from 1981 to 1990. However, during the period 1996-2004, productivity fell to 1.3%. Decomposing trend labour productivity growth, in turn, shows that this decline reflects both lower growths in total factor productivity and less capital deepening.

There is a wide consensus that the still significant structural rigidities in the euro area factor and product markets are likely to explain the lacklustre