Public Information Notice: IMF Executive Board Discusses the Monetary and Exchange Rate Policies of the Euro Area and the Trade Policies of the European Union

November 6, 2001

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case.

On October 19, 2001, the Executive Board concluded the discussion of the monetary and exchange rate policies of the euro area and the trade policies of the European Union. The background section of this PIN reflects information available at the time of the Executive Board meeting.1


Under a cumulation of adverse supply and demand shocks, the euro area's three-year old economic upswing came to a virtual standstill in the second quarter of 2001. Higher oil prices, a weakening euro, animal diseases, and bad weather propelled headline HICP inflation to 3.4 percent in May 2001, undermining purchasing power and consumer demand. In addition, a marked downward correction in global equity prices (particularly in the technology sector) and faltering business confidence have dampened business investment since the last quarter of 2000. With a deteriorating external environment, the area's export growth came to a halt in the first half of 2001. Cyclical indicators reflecting developments in the third quarter of 2001, including after the events of September 11, suggest that area-wide growth is likely to have weakened further.

With softening activity, headline HICP inflation has declined to 2½ percent in September, mostly as a result of falling oil and food prices. In spite of core inflation cresting at 2¼ percent in early summer, wage moderation has continued to prevail across the area.

The external value of the euro has been broadly stable, and it remains weak bilaterally vis-à-vis the U.S. dollar and in real effective terms. The area's current account has deteriorated from a surplus of about 1½ percent of GDP in 1997 to approximate balance in 2000, reflecting not only the sharp rise in energy prices but also a low response of trade flows to the sustained real exchange rate depreciation since 1996.

After raising interest rates by a total of 175 basis points during 2000, the European Central Bank (ECB) reversed some of this tightening in May and August (by 25 basis points each time). A further 50 basis points cut was announced by the ECB's Governing Council on September 17, in concert with the U.S. Federal Reserve and other central banks. Over the last few years, fiscal policy in the area as a whole has shifted away from an earlier more restrictive stance, indeed turning expansionary in some countries in 2000 against a background of faster-than-projected growth. In 2001, fiscal policy for the area as a whole is anticipated to be broadly neutral.

In the latest staff's estimates—which are subject to an unusually large margin of uncertainty—the euro area's real GDP is projected to grow by 1.7 percent in 2001 and 1.6 percent in 2002. The area's cyclical rebound is expected to take place in the second half of 2002, as both domestic and external demand start recovering from the economic fallout from the September 11 events. Headline inflation is currently expected to average about 2¾ percent in 2001 and ease back to about 1½ percent in 2002.

Executive Board Assessment

Executive Directors noted that, in the face of large and global disturbances–including the earlier rise in energy prices, the downward correction in equity markets, and the marked slowdown in world trade growth–the euro area's expansion has proven less resilient than anticipated. Against this already sluggish background, the economic repercussions of the events of September 11 will likely dampen near-term growth prospects yet further. Nonetheless, Directors considered the area's macroeconomic fundamentals to be sound, with low underlying inflation and much strengthened fiscal positions providing a base for a new cyclical upswing on the back of supportive policies.

Directors noted that the area's cyclical setback should not detract from the considerable macroeconomic achievements of the last few years rooted in price stability, employment-friendly wage setting, fiscal consolidation, and a measure of structural reform. These elements have provided the basis for faster income growth and job creation, especially in those countries that have implemented labor market reforms and sustained wage moderation. Structural rigidities remain pronounced, however, and Directors urged that reform efforts be stepped up across the area, especially in countries where labor market reforms have been lagging in recent years. More broadly, they highlighted the positive impact that growth-supportive macroeconomic and structural policies by the euro-area countries would have on global economic prospects at the present juncture.

Turning to monetary policy, Directors noted that risks to price stability are receding, and that the European Central Bank (ECB) has properly reversed a significant portion of the monetary tightening it undertook in 2000. Directors commended the swift action by the ECB, in concert with the U.S. Federal Reserve and other central banks, to shore up confidence and provide sufficient liquidity to the banking system in the aftermath of the events of September 11.

Looking ahead, Directors expected risks to price stability to diminish further, particularly as weaker growth prospects and abating price pressures have increased the likelihood for continued wage moderation in 2002. They noted that the recent growth in M3 in excess of the ECB's reference value appears to some extent to reflect temporary velocity shocks related, inter alia, to portfolio shifts, and should therefore not be given undue weight in policy assessments. A number of Directors encouraged the authorities to continue their efforts to improve market understanding of the policy framework underlying the ECB's monetary decisions.

Against this background, Directors saw room for further monetary policy easing, particularly if the euro appreciates, with some of them favoring early easing to further tip the scales in favor of a firmly grounded recovery in the course of 2002.

In discussing the factors responsible for the weakness of the euro's external value, many Directors noted the role played by the much steeper rise of stock market capitalization in the United States than in the euro area, the ongoing international diversification by euro-area investors, and the increased issuance by non-residents of euro-denominated liabilities.

On fiscal policy, Directors strongly endorsed the objective embedded in the Stability and Growth Pact (SGP) that member countries reach and maintain budgetary positions close to balance or in surplus over the medium term. In their view, this objective provides an anchor for assuring fiscal discipline while allowing for budget outcomes to vary over the cycle and across countries, as required for a well-functioning monetary union with a high degree of fiscal decentralization.

In considering how this might best be achieved, Directors discussed the merits of a framework that would combine the free play of automatic stabilizers with adherence to preannounced expenditure paths. In the view of a number of Directors, a key advantage of this approach would be to safeguard the medium-term orientation of the SGP while providing a stabilizing framework for monitoring each member state's position relative to its medium-term deficit objective. In contrast, focusing on meeting annual nominal deficit targets would, in the face of the global slowdown, require offsetting the operation of the automatic stabilizers, thus delaying the projected recovery. Other Directors, however, considered that reference to expenditure paths could usefully support the achievement of medium-term SGP objectives, but should not replace nominal deficit targets.

Directors welcomed recent indications that, albeit with variations across countries, fiscal developments for the area as a whole broadly appear to strike an appropriate balance between cyclical considerations and medium-term consolidation objectives. Most Directors agreed that, especially in light of the present generalized slowdown, the automatic stabilizers should be allowed to work. Directors generally did not see the need for significant discretionary fiscal policy actions to counteract the growth slowdown at this point, in view of the likely temporary nature of the adverse shocks and the effects such actions would have on fiscal positions.

Directors underscored the key role that resolute and broad-based structural reforms would play in raising the area's growth potential and rebuilding confidence. They welcomed the recent progress made toward more competitive product markets. Directors looked forward to further steps in areas such as public procurement, state aid, administrative reforms, and the reduction of the regulatory burden on business. Directors regretted that relatively little has been done to address the work disincentives associated with tax and social benefits systems in many euro area countries, or to free up labor markets, including through more flexible wage formation processes. Referring to the progress made by some countries on the basis of partial steps, Directors urged the authorities to aim for the major improvements in economic performance that should accrue from a more vigorous implementation of labor market reforms. Some Directors considered that a renewed effort toward structural reforms, aimed at enhancing the area's productivity growth rate, could also contribute to a stronger euro over time.

Directors expressed their appreciation for the intensive preparations to ensure a smooth changeover to the euro banknotes and coins, and welcomed assurances that the changeover would not lead to an increase in prices. They looked forward to a successful completion of this reform of unprecedented scope, which should result in greater price transparency and enhanced competition.

Referring to the integration of capital markets as one of the greatest potential benefits of the EMU, Directors expressed the hope that the Lamfalussy Report's recommendations for streamlining the legislative process would soon come into play, and encouraged the authorities to speed up implementation of the Financial Services Action Plan. Noting that integrated capital markets pose new challenges to financial crisis prevention and management, they highlighted the need for a significant strengthening of information exchange among supervisors and of their decision-making processes.

Directors considered that further improvements in the availability, timeliness, and quality of euro-area statistics would be highly desirable, particularly in the areas of short-term cyclical indicators and balance of payments statistics, and they urged the authorities to continue efforts in these areas.

Directors welcomed the completion of three Reports on Standards and Codes (ROSCs) for the euro area (covering payments systems issues, and the transparency of monetary policy and payments system oversight) and expressed broad agreement with their findings.

It is expected that the next consideration by the Executive Board of the monetary and exchange rate policies of the euro-area countries in the context of their Article IV obligations will be based on the standard 12-month cycle. An interim staff report will be issued for the information of the Executive Board to provide adequate context for bilateral consultations with euro-area countries prior to the 2002 Spring Meetings.

As regards the trade policies of the European Union (EU) as a whole, Directors expressed their conviction that a new trade round would provide a much needed boost to global growth prospects, and urged the EU to continue to accord high priority to reaching agreement on the scope of such a round, and to show leadership and flexibility as a means of furthering the negotiations. They welcomed the EU's "Everything-but-Arms" initiative for the least developed countries, and the proposed steps to simplify the EU's General System of Preferences. While these initiatives will be helpful in improving market access for eligible countries, Directors emphasized that more rapid progress in opening highly protected sectors to all trading partners would not only benefit developing countries, but also entail significant gains for the EU itself. In this regard, they highlighted the essential contribution that a comprehensive reform of the EU's Common Agricultural Policy would make both to support trade liberalization and to prepare for EU enlargement.

Euro Area: Selected Economic Indicators

  1996 1997 1998 1999 2000 20011

  In percent
Real Economy            
Change in real GDP 1.5 2.4 2.9 2.7 3.5 1.7
Change domestic demand 1.1 2.0 3.8 3.3 3.0 1.2
Change in consumer prices 2 2.3 1.6 1.2 1.1 2.4 2.7
Unemployment rate 3 11.4 11.4 10.8 9.9 8.8 8.4
  In percent of GDP
Public Finance            
General government balance -4.4 -2.7 -2.2 -1.3 -0.8 -1.14
Public debt 77.7 76.9 75.0 73.9 71.4 69.7
  In percent
Money and Interest Rates            
Change in M3 (end of year)2 3.9 4.2 5.0 6.3 4.8 6.45
Money market rate (3 month money) 4.7 4.2 4.0 3.1 4.6 3.66
Government bond yield (10 year bonds) 7.2 5.9 4.8 4.6 5.4 4.76
  In percent of GDP
Balance of Payments            
Trade balance 2.0 2.2 2.0 1.5 0.9 1.3
Current account 1.1 1.6 1.0 0.4 -0.1 0.2
Official reserves (US$ billion)       257.1 242.6 238.67
  In percent
Exchange Rates            
Nominal effective rate 0.1 -8.8 -0.1 -4.5 -9.4 2.38
Real effective rate 0.6 -9.9 -3.2 -4.8 -10.5 0.68

Sources: IMF staff and European Central Bank. Except for M3 and official reserves, aggregates are based on WEO PPP-weights rather than Eurostat's ECU-based weights.
1 IMF Staff projections.
2 Harmonized definition.
3 In percent of labor force.
4 Data do not include mobile telephone license receipts.
5 August 2001, 3-month moving average of year-on-year percent changes.
6 October 11, 2001.
7 Total reserves minus gold (Eurosystem definition); end September.
8 September 2001 relative to 2000 average.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. In the present case, Fund staff held discussions with European Union institutions, including the European Central Bank, in the context of the Article IV consultations with the euro area's member states. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and the summary is transmitted to the country's authorities. This PIN outlines these views as expressed during the October 19, 2001 Executive Board meeting. The ECB's observer at the Fund participated in that meeting.


Public Affairs    Media Relations
E-mail: E-mail:
Fax: 202-623-6278 Phone: 202-623-7100