European Central Bank President Christine Lagarde called for a new policy mix in Europe on Friday and noted major movements in global trade and traditional economic models.
"Ongoing trade tensions and geopolitical uncertainties are contributing to a slowdown in world trade growth, which has more than halved since last year. This has in turn depressed global growth to its lowest level since the great financial crisis," she said in a debut speech at the European Banking Conference in Frankfurt, adding that there had been changes of a more structural nature.
"We are starting to see a global shift — driven mainly by emerging markets — from external demand to domestic demand, from investment to consumption and from manufacturing to services."
Emerging economies have relied on global trade and supply chains to boost their growth. However, the emergence of trade conflicts and technology are disrupting those economic models, the former head of the International Monetary Fund (IMF) said, adding that this was also the case in Europe.
"World trade is being reordered as new technologies disrupt conventional supply chains and workplace organization, and as potential new risks emerge from climate change. All this obviously has implications for our external sector, not least because the euro area's exports are intense in capital and intermediate goods," she said.
The world economy has focused on international trade and opening up markets as a means to grow further in the last decades. However, certain countries, including the U.S., have recently shifted attention away from multilateral trade, bringing with it economic uncertainty that has soured sentiment and occasionally roiled financial markets.
Lagarde noted that the euro zone must adapt to these new realities and boost domestic growth.
"Europe needs to innovate and invest to respond to these challenges and preserve its competitiveness in the longer run. But it also suggests that the high rates of trade growth that we are used to seeing are no longer an absolute certainty," Lagarde warned.
The euro area is set to grow 1.1% this year and 1.2% in 2020, according to ECB forecasts released in September. These were lowered from a previous estimate made in June. Lagarde said that while she believed the region should remain open to multilateral trade, it should also focus on taking advantage of its domestic market.
"The answer lies in converting the world's second largest economy into one that is open to the world but confident in itself — an economy that makes full use of Europe's potential to unleash higher rates of domestic demand and long-term growth," she said.
Euro zone governments, in particular those that have budget surpluses, have been under pressure to spend more and thus boost the 19-member region that all share the euro currency — which struggled since the sovereign debt crisis of 2011.
Lagarde renewed that pressure on euro zone leaders to do more. "In my view, since our challenges are common ones, we must meet them with a common response. This involves moving towards a new European policy mix, which has a number of key elements."
She later added: "One key element here is euro area fiscal policy, which is not just about the aggregate stance of public spending, but also its composition. Investment is a particularly important part of the response to today's challenges, because it is both today's demand and tomorrow's supply."
However, the debate over further investment is dividing euro countries. Countries such as Germany and The Netherlands, which are deemed to have the fiscal capacity to spend more, are reluctant to do so as they do not want to increase their debt levels.