By Brian Blackstone

European Central Bank President Mario Draghi on Friday signaled a departure from the austerity-focused mind-set that has dominated economic policy-making in the euro zone since the onset of the region's debt crisis nearly five years ago, as officials struggle with stagnant economies, weak prices and high unemployment.

Speaking at the Federal Reserve Bank of Kansas City's annual conference Jackson Hole, Wyo., Mr. Draghi said European central bankers and politicians each have a role to play in boosting demand and reducing joblessness. For its part the ECB is willing to take more stimulus measures if needed to keep low rates of inflation from becoming embedded in expectations of future price growth, he said.

"It would be helpful for the overall stance of policy if fiscal policy could play a greater role alongside monetary policy, and I believe there is scope for this, while taking into account our specific initial conditions and legal constraints," Mr. Draghi said in his prepared remarks.

Although Mr. Draghi's comments didn't constitute an endorsement of rampant deficit spending to boost euro-zone economies, they nevertheless marked a shift away from years of preaching by ECB officials that governments needed to shrink deficits and undertake economic reforms even during times of economic weakness.

Critics say that mixing fiscal austerity with labor-market reforms exacerbated Europe's downturn, even though they have long-term payoffs.

Mr. Draghi's comments came days after a report showed that the euro-zone economy stalled in the second quarter, fanning fears that the bloc's roughly $13.5 trillion economy is stuck in a lasting rut of stagnation and high unemployment.

The GDP data "confirm that the recovery in the euro area remains uniformly weak, with subdued wage growth even in non-stressed countries suggesting lackluster demand," he said.

His remarks signaled a new approach to these risks: combining policies to stimulate demand with efforts to make labor markets more flexible. With inflation at very low levels--annual inflation in the euro zone was just 0.4% last month, far below the ECB's 2% target--policy makers should cast aside any fears that stimulus policies may lead to inflation and instead focus on keeping high unemployment from taking root in Europe, he suggested. The euro zone's unemployment rate was 11.5% in June, far higher than in the U.S., U.K. and Japan.

"The risks of 'doing too little'" and allowing temporary unemployment to become more entrenched "outweigh those of 'doing too much'--that is, excessive upward wage and price pressures," Mr. Draghi said.

The package of stimulus measures the ECB approved in June--which included record-low interest rates, new four-year loans to banks and preparations to purchase bundled bank loans known as asset-backed securities--should improve demand, Mr. Draghi said.

Plans to purchase ABS are "fast moving forward and we expect that it should contribute to further credit easing," he said.

The euro's recent decline against other currencies should also help boost demand and prices, he said. The euro has declined from a peak of around $1.40 against the U.S. dollar in the spring to $1.324 midday Friday. A weaker exchange rate helps growth via exports, and raises inflation by increasing the cost of imported goods.

Recent exchange-rate movements should be "sustained by the diverging expected paths of policy in the U.S. and the euro area," Mr. Draghi said. The Federal Reserve is widely expected to raise interest rates by the middle of next year, whereas the ECB is expected to keep its main lending rate near zero for years.

"We stand ready to adjust our policy stance further," Mr. Draghi added, an indication that large-scale purchases of public and private debt, known as quantitative easing, remain an option to keep inflation from staying too low for too long.

Turning to fiscal policy, Mr. Draghi said policy makers should use the flexibility embedded in European budget rules "to better address the weak recovery and to make room for the cost of needed structural reforms." He also backed proposals for a significant boost in public investment.

In addition, "it may be useful to have a discussion on the overall fiscal stance of the euro area," Mr. Draghi said, with better coordination of policies aimed at "a more growth-friendly overall fiscal stance."

Although Mr. Draghi didn't mention specific countries, the remark suggests that euro members with balanced budgets, such as Germany, should be doing more to stimulate their economies and Europe more broadly.

(END) Dow Jones Newswires

August 22, 2014 14:44 ET (18:44 GMT)

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