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Europe Needs Comprehensive Action to Revive Growth

Worker in a car factory in Spain: Europe needs long and short term solutions to boost growth (photo: Felix Ordonez/Reuters)

CRISIS IN EUROPE

Europe Needs Comprehensive Action to Revive Growth

IMF Survey online

June 18, 2012

  • High unemployment, weak growth undermining stability in Europe
  • Structural reform agenda could boost GDP by 4 ½ percent over five years, help rebalancing within the euro area
  • Weak competitiveness, recession in Southern Europe calls for additional policies to reenergize growth

Europe needs to revive economic growth to help break the vicious cycle that keeps many countries stuck in crisis mode—the feedback loop between weak government finances, weak banks, and weak growth that continually undermine each other. Europe also needs to tackle older challenges that hinder growth potential, the IMF said in a new paper.

Policymakers in Europe have taken unprecedented actions in recent months to stave off economic and financial troubles, the IMF said. Countries are reducing government debts and deficits, and capital is being provided to weak banks. 

Risks have been reduced by a strengthening of the euro area’s anti-crisis firewall, lending by the European Central Bank, and the introduction of the new fiscal compact.  

But with the recession continuing, and unemployment high and on the rise in many countries, policymakers need to do more, the IMF said.

In a new paper analyzing the problem of low growth in Europe, staff from the International Monetary Fund said both long-term and short-term solutions are needed. Because structural reforms deliver their potential gradually, product and services market reforms, as well as labor market and pension changes, should be implemented without delay. 

The analysis shows large-scale reforms could boost GDP by 4½ percent over five years. A quarter of this gain would come from countries coordinating reforms and acting together. This demonstrates the importance of a concerted approach, although each country will need to design its own agenda to tackle specific priorities. 

The IMF said half of these gains, roughly 2¼ percent, could come from product and service market reforms, underlining the importance of tackling vested interests in sectors such as distribution and regulated professions. The North should focus on increasing labor participation and improve services efficiency, while the South urgently needs better functioning labor markets. 

Fostering growth now

The IMF said policymakers need to take a two-pronged approach to boosting growth.

“Structural reforms should be implemented now to anchor medium-term growth prospects,” said Rodrigo Valdés, a deputy director in the IMF’s European Department, who led the team that produced the analysis.  “But these reforms need to be complemented to sufficiently boost growth in the short term; hence policymakers must supplement them with policies to promote demand, external in some cases, internal in others.”

Demand is uneven across Europe; still growing in Northern Europe but collapsing in the South. To help rebalancing, the competitiveness gap accumulated in the South since the adoption of the common currency needs to be reversed. 

This means somewhat higher inflation in the North than the South, nominal wage restraint in the South, and letting wages rise with market and productivity developments in the North. Structural reforms are also key to facilitating the change of relative prices and wages across countries and sectors. 

The dampening effects from unavoidable reduction of government debts and deficits and banks raising capital and selling off non core business assets need to be lessened through action on several fronts. 

Ongoing monetary policy support remains essential. The pro cyclicality of nominal fiscal targets during an economic downturn could be substituted with a focus on improving structural fiscal balances, where there is fiscal space. Common pools of resources can be strengthened and better targeted, including more forceful interventions to improve labor market conditions.

To secure credit availability, bank restructuring needs to be pursued further and foreign direct investment facilitated. Consideration should be given to having common pools of resources taking stakes in banks. Over time, these banks should be subject to centralized regulation and supervision, resolution authority, and common backstops. 

Lowering unemployment is urgent, and growth is the only secure route to accomplish this, the IMF said.


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