Fiscal policy and growth in Europe: A Keynote Speech by Christine Lagarde, President of the ECB
Vienna, 22 November 2025
The relationship between central banks and governments has evolved significantly over the centuries. Historically, central banks were often established to provide governments with financing, but this approach has its pitfalls. Monetary history teaches us that central banks, when heavily influenced by the state, tend to generate inflation.
This realization emerged gradually. In the early 19th century, Napoleon Bonaparte, the founder of the Banque de France, acknowledged the importance of a central bank serving the state without excessive state control. However, it wasn’t until the second half of the 20th century that the understanding of operational independence’s role in reducing inflation became more widespread.
Despite these lessons, there’s a persistent concern that short-sighted governments might attempt to manipulate central banks for their debt financing, especially when public debt is high, as it is in many jurisdictions today. This concern is particularly relevant in the context of the session’s question: whether central banks might eventually face a regime of fiscal dominance, where governments with large spending needs force them to provide finance, regardless of the inflationary consequences.
In recent years, Europe has navigated monetary-fiscal interactions effectively. During the pandemic, monetary and fiscal policies worked in harmony to stabilize the economy. The ECB’s large-scale bond purchases and governments’ increased debt to finance furlough schemes and support instruments were successful in a swift economic recovery. Real activity in the euro area returned to pre-pandemic levels within seven quarters, compared to 29 quarters after the global financial crisis.
However, this collaboration came at a cost, as it led to higher debt levels. Public debt as a share of euro area GDP rose by around 15 percentage points relative to its pre-pandemic level by early 2021. Yet, the ECB’s operational independence has remained intact, as demonstrated by the swift increase in interest rates to combat the largest inflation shock in a generation, bringing inflation back to the 2% target.
The main fiscal challenge in the euro area, according to Lagarde, is not widespread fiscal rule violations but rather governments’ need to prioritize spending that supports potential growth and strategic priorities while consolidating budgets. The new EU fiscal rules offer countries an extended adjustment period of up to seven years if they commit to public investment and structural reforms that enhance productivity and long-term growth.
However, only seven out of 20 euro area countries have chosen this path, leading to a situation called ‘fiscal stagnation,’ where consolidation measures weaken growth potential, creating a vicious cycle. This scenario can make central banks’ tasks more challenging, as it may trap the economy in a low-growth equilibrium.
To address these challenges, Lagarde proposes three strategies:
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Countries should utilize the flexibility provided by fiscal rules, reallocating public spending to research and development and education, which could significantly boost productivity and growth. This approach would lead to more sustainable government debt levels without relying on higher taxes or cuts to productive expenditure.
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Europe should pool its collective resources more efficiently in high-multiplier areas with cross-border benefits and clear returns to scale. This includes strategic areas like research and development for innovation and defense to deter hostile actors, as demonstrated by the success of the European Organization for Nuclear Research (CERN) in the 1950s.
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The EU budget instruments should be utilized to mobilize private capital, as Europe faces unprecedented investment needs for green, digital, and defense transitions. Private investment is crucial, and well-designed EU programs can play a significant role, as evidenced by the European Structural and Investment (ESI) funds, which have generated substantial private investment and productivity gains.
By implementing these strategies, Europe can strengthen productivity growth while preserving its social model and reduce the risk of fiscal dominance in the future. Lagarde concludes by emphasizing the importance of leveraging Europe’s flexibility and collective strength to support higher growth, drawing inspiration from the creative legacy of Johann Strauss II, who made the most of his time to compose timeless works.