## The Impact of the ECB’s Targeted Longer-term Refinancing Operations on Bank Lending ## Source details **Canonical URL:** [The Impact of the ECB’s Targeted Longer-term Refinancing Operations on Bank Lending](https://www.imf.org/-/media/files/publications/cr/2022/english/1eurea2022001.pdf) ## Other formats - [Markdown version](/-/media/files/publications/cr/2022/english/1eurea2022001.pdf.md) - [Structured JSON version](/-/media/files/publications/cr/2022/english/1eurea2022001.pdf.json) --- ### TLTROs — take-up, measured effects, and counterfactuals - Since 2020Q1 the outstanding amount of TLTROs has surged during the pandemic (tripled over the period referenced). - Staff panel-data regressions (2004–21, country-level, two-stage approach) find: - A one-percentage-point increase in the TLTRO take-up rate (relative to banking sector assets) boosts net lending growth in the euro area by about 12 to 23 basis points (y/y). - The impact on lending rates is not statistically significant. - Counterfactual on corporate lending: - Without access to TLTROs or other alternative cheap funding sources, corporate loan growth would have been 0.5 percentage points below the annual average of 2.6 percent observed over the last five years. ### Policy design, amplification, heterogeneity, and limits - Changes in TLTRO terms during the pandemic: - Tripled the “TLTRO effect,” accounting for almost half of new lending growth. - Lower borrowing rates and higher borrowing allowance increased banks’ willingness to bid. - Targeting and heterogeneity: - TLTRO effect on net lending growth is significantly higher in countries where banks have higher regulatory capital and lower nonperforming loans (NPL) ratios. - Stronger banks are better positioned to take advantage of TLTRO funding; rebuilding capital buffers and effective NPL resolution would amplify the channel. - Scope and limits: - TLTRO funding does not seem to improve credit conditions for assets outside the borrowing eligibility (e.g., mortgages); banks with higher TLTRO take-up seem to raise mortgage rates and cut back on mortgage lending. - No evidence of safe-asset hoarding via sovereign carry of government debt with yields above TLTRO rates was found during the period of strong quantitative easing. - Design sensitivity: - Increasing the share of eligible loans from 55 percent to 60 percent for banks that face borrowing constraints could boost the impact of TLTRO take-up on net lending growth by around 10 percent, partly due to banks’ anticipation effects. *Source: IMF staff analysis as presented in the supplied chapter content.* --- ### Pandemic context, macro backdrop, and near-term outlook ### Pandemic, vaccination, and activity - Vaccine rollout and uncertainty: - About 76 percent of the euro area population had received at least one vaccine dose (as of early December). - Ongoing concerns about newer and more transmissible Covid-19 variants and waning vaccine efficacy cloud a durable recovery. - Activity and labor markets: - Euro area real GDP contracted by about 6½ percent in 2020. - Real GDP: declined by 0.2 percent (q/q) in 2021Q1; rebounded by just above 2 percent (q/q) in 2021Q2 and 2021Q3. - Euro area output remained about ½ percent below its pre-pandemic level in 2021Q3. - Unemployment rate: 7.3 percent (October, seasonally adjusted). - Labor shortages: 23.3 percent of managers identified labor shortages as a limiting factor for production. - Inflation and supply pressures: - Headline and core inflation: 4.9 and 2.6 percent (November), respectively. - Trimmed-mean measures: 2.5 percent (recent months). - 5y5y inflation swap rates: 1.9 percent in December. - Sectoral mismatches estimate: contributed 0.25 p.p. to core inflation in September 2021. - Nonenergy goods inflation: 2.4 percent (November estimate). ### Near-term and medium-term outlook (2021–2026 highlights) - Near-term GDP and demand: - Real GDP growth estimated to have accelerated to about 5¼ percent in 2021 and set to moderate to about 4¼ percent in 2022. - Private consumption is set to be the main driver of growth. - Excess savings and labor: - Accumulated stock of excess savings: around €780bn as of 2021Q2 (7 percent of 2021 GDP); not expected to be dissaved in the baseline. - Output gap projected to decline from 4½ percent in 2020 to ½ percent in 2022. - Inflation projections: - Projected averages for 2021: HICP inflation of 2.5 percent and core inflation of 1.4 percent. - HICP inflation projected to decline but remain above 2 percent in 2022. - Negotiated wages increased by 1.3 percent in 2021Q3 (y/y). - Medium-term: - Output should return to potential and close the output gap in 2024. - Core inflation expected to remain below the ECB’s inflation target throughout the projection horizon under a flat Phillips curve and stable inflation expectations. - Economic scarring projected to decline and disappear by 2025 given higher potential growth from RRF-related investments. ### Key macro projections and indicators (selected rows) - Real GDP (2017–2026 row): 2.6 1.8 1.6 -6.4 5.2 4.2 2.2 1.7 1.5 1.4 - Private consumption: 1.8 1.5 1.3 -7.9 3.7 5.5 2.2 1.6 1.7 1.5 - Gross public debt: 87.5 85.5 83.6 97.3 97.7 95.4 94.3 93.2 92.1 90.9 - Current account balance (percent of GDP): 3.2 2.9 2.3 2.0 2.8 2.9 3.0 2.9 2.8 2.7 *Source: IMF staff analysis as presented in the supplied chapter content.* --- ### Monetary policy, asset purchases, and ECB strategy ### ECB programs, asset purchases, and liquidity - Pandemic Emergency Purchase Program (PEPP) total: €1.5 trillion (ongoing purchases under PEPP and APP). - ECB plans (reaffirmed in December): - Reduce net purchases to zero under the PEPP by end-2022Q1. - Temporarily increase APP net purchases to €40 billion in 2022Q2 and €30 billion in 2022Q3. - Return to pre-pandemic level of €20 billion in 2022Q4. - Reinvestment policy: - Principal payments from maturing securities purchased under the PEPP will be reinvested until at least the end of 2024, with flexibility across time, asset classes and jurisdictions. - Liquidity provision: - Overall liquidity provided through longer-term refinancing operations amounted to €2.2 trillion in September, equivalent to more than half of euro area bank excess reserves. ### Strategy review, targets, and tools - ECB Governing Council changes (July 2021): - Formally adopted a symmetric inflation target of 2 percent. - Included owner-occupied housing (OOH) costs in the measurement of the HICP (with implementation challenges and a roadmap). - Increased focus on financial stability risks and macro-financial linkages; incorporated climate change considerations. - Policy stance and instruments: - Policy rates are primary instruments; unconventional tools (forward guidance, asset purchases, LTROs) remain important when key rates are close to the effective lower bound. - Announced policies suggest asset purchases will revert to pre-pandemic levels in 2022Q4, with flexibility to adjust if inflation projections continue to be below target in 2023 and beyond. - Self-imposed limits: - Several countries could breach the 33 percent issuer limit in coming years; options include raising the issuer limit (but remaining below 50 percent) and/or tolerating deviations from the capital key for longer. - Opportunity to lift purchase limit on supranational or institutional bonds (currently 10 percent of PSPP holdings) with upcoming EU bond issuance for NGEU. ### Communication and contingency - Policy guidance for upside inflation risks: - If sustained wage pressures and durable supply disruptions cause persistent inflation overshooting, the ECB could: - Scale down and terminate asset purchases and TLTROs, - Gradually adjust key interest rates, - Potentially adjust reinvestment strategy of principal from maturing securities. - Clear communication about transitory versus permanent impacts and forward guidance is essential to anchor expectations. *Source: IMF staff report content unit 1eurea2022001.* --- ### Fiscal policy, NGEU, and public finance guidance ### Fiscal stance and NGEU disbursements - Euro area aggregate headline deficit projected at 6.6 of GDP in 2021. - Automatic stabilizers projected at 1.2 percent of GDP; discretionary measures projected at 1.5 percent of GDP. - As of December 2021: - 26 countries had applied for € 33 billion of grants and seven countries had applied for €166 billion of loans under the RRF. - €54.3 billion already disbursed to 20 countries. - Pre-financing typically 13 percent of total grants and loans and about 0.4 percent of 2021 GDP. - Planned RRP spending composition: - Nearly 40 percent devoted to climate change-related investments (target 37 percent). - 16 percent directly on digital infrastructure (total digital-related spending above 20 percent when accounting for education and public administration). - 10 percent on upgrading healthcare systems. - 8 percent on improving social inclusion. - NGEU financing: - EU expected to raise around €800 billion and become a major debt issuer during 2021–26. - EU members committed to contributing up to 0.6 percent of Gross National Incomes annually to cover any shortfall in EU own resources against debt service requirements. ### Public finance indicators (selected numerical series) - Overall fiscal balance (percent of GDP): -0.9 -0.4 -0.6 -7.2 -6.6 -3.9 -2.4 -1.9 -1.6 -1.6 - Primary balance: 0.8 1.2 0.8 -5.9 -5.4 -2.7 -1.3 -1.0 -0.7 -0.7 - Structural balance: -0.6 -0.4 -0.7 -4.7 -5.0 -3.5 -2.3 -2.0 -1.7 -1.6 - Gross public debt: 87.5 85.5 83.6 97.3 97.6 95.4 94.3 93.2 92.1 90.9 ### Medium-term guidance and fiscal rules reform - Once expansion is entrenched, high-debt countries should embark on gradual fiscal adjustment to rebuild buffers; credible adjustment plans should be formulated now. - Proposed reforms to EU fiscal framework considerations: - Transitional arrangement desirable to avoid destabilizing application when the general escape clause is deactivated in 2023. - European Fiscal Board proposal: single debt anchor; net expenditure growth as an operational rule; single escape clause; keep 3 percent of GDP deficit as a reference. - IMF staff exploring alternatives; an expenditure growth rule with a debt anchor remains a pertinent option. - Central fiscal capacity and green investment fund: - A central fiscal stabilization capacity and an EU-level climate investment fund could enhance resilience and efficiently prioritize carbon reduction investments. - Excluding green investments from fiscal rules risks “creative accounting”; a dedicated green investment fund is proposed instead. *Source: IMF staff report content unit 1eurea2022001.* --- ### Banking system resilience, financial stability, and macroprudential guidance ### Asset quality and stress tests - NPLs for the euro area reached 2.7 percent (lowest on record) during 2021H1. - EBA July 2021 stress test: - Most systemically important banks remain well capitalized. - Pandemic-linked recession would induce bank CET1 capital losses of, on average, 5 percentage points in an adverse macroeconomic scenario. - Liquidity and support: - Debt moratoria and credit guarantees limited vulnerabilities; credit guarantee schemes, capital conservation measures, and lower capital charges enabled banks to continue lending and absorb impairments. ### Policy recommendations for prudential normalization and restructuring - Prudential standards normalization: - Normalize prudential standards gradually in line with pre-announced timelines. - Supervisors should clearly communicate availability and usability of buffers. - Rebuilding capital buffers should be linked to pace of recovery. - Loss recognition and transparency: - Continue efforts for timely bank loss recognition and greater balance sheet transparency. - Monitor adequacy of loan loss provisioning, with intensified inspections where of concern. - Phasing of borrower support: - Continued borrower support should become more targeted; phase out debt moratoria while reducing guarantee coverage gradually. - Reform insolvency regimes to develop out-of-court workouts and fast-track procedures, especially for SMEs. - Targeted firm support instruments: - Micro and unincorporated SMEs: grants and hybrid financing (subordinated and profit participation loans). - Larger incorporated firms: equity and preferred equity injections and subordinated debt instruments (e.g., convertible bonds). - Incentives for efficient debt restructuring: make debt forgiveness nontaxable, provide tax credits to private creditors that grant haircuts, offer haircuts on government claims. ### Macroprudential and nonbank sector measures - Macroprudential tools for residential real estate: - Consider gradual adoption of tighter LTV, DSTI or LTI limits; loan maturities below 30 years; amortizing loans. - Nonbank financial sector: - Investment funds exposed to illiquid assets may need liquidity buffers, limits on liquidity risk, lock-up periods, or early redemption penalties. - Expansion of supervisory perimeter to systemic investment firms with “bank-like” risks and over € billion in assets (value in source omitted). - Financial architecture: - Priority: banking union endpoint, further reforms in prudential oversight, resolution, deposit insurance, and progress on Capital Markets Union (CMU). - Establish a single AML/CFT rulebook and harmonize AML/CFT supervision. *Source: IMF — EURO AREA POLICIES chapter (excerpt).* --- ### Labor markets, reallocation, and social policy ### Job Retention Schemes (JRS) and reallocation - JRS were essential in containing unemployment rises and are being phased out as the pandemic abates to support economic transformation. - Reallocation pressures: - Changes in consumer behavior and working practices (e.g., increased telework) will shift employment across sectors and occupations. - Policy recommendations to facilitate reallocation: - Support job-to-job transitions via reskilling and upskilling while workers remain on JRS. - Gradual adjustment of JRS generosity and tightening of eligibility to promote job search. - Use temporary and targeted hiring subsidies and wage-loss insurance, linked to vocational training, to incentivize vulnerable workers to move to lower-pay initial occupations and enhance retention. ### Scenario analysis — Box 5 (10-year simulations) - Two scenarios: moderate impact and strong impact from pandemic-induced long-term changes. - Sectoral implications: - Lower demand for nonresidential construction, business travel, and industries relying on large gatherings. - Increased demand for virtual services; information and communication sector concentrated gains. - Construction, trade, food, accommodation, and transportation expected to see largest declines relative to pre-pandemic trends. - Occupational implications: - Largest increases in employment of information and communication technology professionals. - Employment of sales and service workers set to decline in all the largest countries. - Overall magnitude: - Pre-pandemic baseline: about 5 million jobs would be created over next 10 years; pandemic could reduce this by up to 1½ million. - Policy emphasis: - Targeted protection and support for vulnerable groups; national RRPs focusing on education and training to support digital skills. *Source: IMF staff report content unit 1eurea2022001.* --- ### Climate-related policies, NGEU investment, and CBAM ### Climate policy and investment needs - EU “fit for 55” aims: reduce greenhouse gas emissions by at least 55 percent by 2030 (relative to 1990) and achieve net-zero by 2050. - European Commission estimate: - Additional investment needs about €1,000 billion for 2021–30 (1.1 percent of the EU’s estimated 2021 GDP a year). - Adopted RRPs expected to provide €177 billion (1.7 percent of the EU’s estimated 2021 GDP) over next five years. - NGEU financing: - Green bonds expected to account for 30 percent of the raised funds. ### RRP impact on emissions and value added (Box 6) - Model: dynamic CGE based on extended GTAP, baseline year 2019, 18 sectors, GHG emission module. - Two-phase results: - Investment phase (2021–26): additional spending increases output and raises GHG emissions initially by about 2 percent compared to 2019. - Construction and services account for about ¾ of the 1.2 percent value-added increase in the investment phase. - Mitigation phase: investment and productivity gains reduce energy intensity; model suggests GHG emissions decline by about 4.5 percent CO2 equivalent in the mitigation phase. - Aggregate over both phases: - Value added expected to expand by 1.4 percent; GHG emissions estimated to decline by 2.1 percent compared to 2019 levels. ### Carbon Border Adjustment Mechanism (CBAM) design guidance - Recommendations: - Phased implementation in close collaboration with trading partners. - Weight actual embodied carbon content increasingly rather than benchmark levels. - Accompany CBAM with reduction in free allowances in affected sectors to enhance WTO compatibility. - Protect vulnerable households and avoid undermining market incentives for decarbonization. *Source: IMF staff report content unit 1eurea2022001.* --- ### External sector, current account, REER, and external vulnerabilities ### Current account and external position - Current account surplus increased to 2.9 percent of GDP in 2021H1 from 2.0 percent in 2020, projected to moderate to 2.6 percent of GDP for 2021 as a whole. - Assessment: external position in 2021 assessed as moderately stronger than level implied by medium-term fundamentals and desirable policies (staff CA gap: 1.4 percent of GDP in one assessment; staff CA gap: 1.5 percent of GDP in other tables). - Foreign asset and liability position (2021H1, percent of GDP): - NIIP: 5.1 (in one table) and -3.3 (in another mid-2021 table — source contains differing mid-2021 NIIP figures depending on subsection). - Gross Assets: 270.0 / 271.2 - Gross Liabilities: 275.1 / 274.4 - Debt Assets: 103.9 / 104.3 - Debt Liabilities: 104.2 / 104.0 ### REER and valuation gaps - Through November 2021: NEER appreciated by 2.2 percent; REER appreciated by 1.0 percent relative to same period in 2020. - Staff CA gap implies projected REER gap of -4.1 percent in 2021 (elasticity 0.35). - EBA model outputs: - EBA REER index model suggests overvaluation of 6.2 percent. - EBA REER-level model implies overvaluation of 0.1–0.2 percent in different sections. - Staff REER gap range: -6.4 to -1.8 percent (or -6.4 to -1.9 percent in variant). ### Policy guidance on external sector - Short-term: focus on containing Covid-19 and reducing scarring; NGEU and national initiatives can reduce CA surplus by supporting investment and consumption. - Monetary: remain accommodative until inflation durably converges to ECB objective. - Fiscal: maintain support until expansion is firmly in train then consolidate gradually. - Structural: creditor countries should strengthen investment; debtor countries should raise productivity, reduce structural and youth unemployment, and enhance competitiveness. - Euro area-wide: progress on banking and capital markets union and a fiscal stabilization capacity could reinvigorate investment and reduce aggregate CA surplus. *Source: IMF staff report content unit 1eurea2022001.* --- ### Major risks, scenarios, and policy priorities ### Upside scenarios - Faster-than-expected resolution of the health crisis could: - Increase mobility and activity, trigger strong unwinding of excess savings, and significantly boost consumption. - Benefit from a stronger global recovery or a productivity spurt from accelerated automation and digitalization. ### Downside risks and adverse feedback loops - Key risks: - Pandemic resurgence, vaccine efficacy erosion (e.g., Omicron), renewed containment measures. - Long-lasting supply shortages and persistently high energy prices. - Large second-round nominal wage and price effects leading to durable inflation overshooting and earlier monetary normalization. - Higher sovereign yields and slower recovery increasing financing challenges for high-debt countries. - Prolonged health crisis with insufficient policy support leading to bankruptcies, job losses, increased scarring, and inequality. - A sharp slowdown in China, particularly via real estate vulnerabilities, creating headwinds for the euro area. - Financial amplification: - Higher loan losses from expiry of support measures would increase impairment charges and reduce banks’ willingness to lend. - Elevated debt levels and contingent liabilities could increase public sector vulnerabilities and reduce ability to roll over debt. ### Risk matrix highlights (selected) - Global resurgence of Covid-19: Likelihood: Medium; Expected impact: High. - Disorderly transformations (impeded reallocation): Likelihood: Medium; Expected impact: High. - De-anchoring of inflation expectations in the U.S.: Likelihood: Medium; Expected impact: Medium. - Faster than expected rebound in activity: Likelihood: Medium; Expected impact: Medium. - Higher and persistent inflation: Likelihood: Medium; Expected impact: Medium. - Escalation of trade tensions: Likelihood: Low; Expected impact: Medium. ### Policy priorities - Maintain accommodative monetary stance until inflation durably converges to the ECB’s objective while being ready to respond to persistent inflation. - Keep fiscal support until expansion is firmly in train, then pursue gradual consolidation—high-debt countries should prepare credible adjustment plans. - Shift policy support from broad liquidity lifelines to targeted solvency support and efficient debt restructuring for viable firms. - Facilitate labor market reallocation with reskilling/upskilling, targeted hiring subsidies, and wage-loss insurance tied to training. - Strengthen banking and capital markets union, and consider central fiscal stabilization capacity and a green investment fund to support structural transformation. *Source: IMF staff appraisal as presented in the supplied chapter content.* --- ### Statistical and measurement work: OOH in HICP, data reforms, and priorities ### Owner-occupied housing (OOH) measurement trade-offs and roadmap - Trade-off among options: imputation versus speed of implementation. - Net acquisitions (ECB-preferred) is conceptually closest to HICP requirement of actual monetary transactions but implementation is slow due to data gaps. - Rental equivalence allows faster compilation but involves more imputation. - Implementation timeline and challenges: - Official quarterly HICP including OOH costs expected by 2026 under the roadmap. - Key obstacles: lack of timely monthly data on construction and house prices and difficulty separating asset prices from shelter services. - Quantitative example: - Inclusion of OOH under net acquisitions would have increased HICP inflation by around 0.4 percentage points in 2021H1 given plausible weights. - Comparable OOH weights: 10 percent (close to U.S. 11.6 percent); 15 percent (Japan 15 percent, Netherlands 15.8 percent, Norway 14.1 percent). ### Ongoing ESS–ESCB data work and priorities - Eurostat and ESCB initiatives: - Experimental quarterly indices combining HICP with stand-alone OOH price index planned to start in April 2022. - Continued work on G20 Data Gaps Initiative (DGI-2) recommendations. - Release of EU inter-country input-output tables for 2010–18 and annual production thereafter. - New reporting requirements for banks (monthly data for January 2022, quarterly for Q1 2022) under recast balance sheet regulation. - Centralised Securities Database (CSDB) enhancements (e.g., identification of green bonds) and timelier securities statistics. - AnaCredit updates and reporting manual second edition published May 2019. *Source: Annexes and statistical sections of the supplied chapter content.* --- *Italic line with source attribution omitted here because the pipeline provides source attribution separately.* ### 1. The Impact of the ECB’s Targeted Longer-term Refinancing Operations on Bank Lending ____ 13 ### 1. The Impact of the ECB’s Targeted Longer-term Refinancing Operations on Bank Lending ____ 13 ### Pandemic context and macro backdrop - Vaccine rollout and pandemic uncertainty - About 76 percent of the euro area population had received at least one vaccine dose (as of early December). - Ongoing concerns about newer and more transmissible Covid-19 variants and waning vaccine efficacy cloud a durable recovery. - Output, activity, and labor markets - Euro area real GDP contracted by about 6½ percent in 2020. - Real GDP declined by 0.2 percent (q/q) in 2021Q1 and rebounded by just above 2 percent (q/q) in 2021Q2 and 2021Q3. - Euro area output remained about ½ percent below its pre-pandemic level in 2021Q3. - Unemployment rate: 7.3 percent (October, seasonally adjusted). - Labor shortages: record 23.3 percent of managers identified labor shortages as a limiting factor for production. - Inflation and supply pressures - Headline and core inflation: 4.9 and 2.6 percent (November), respectively. - Trimmed-mean measures of inflation: 2.5 percent (recent months). - 5y5y inflation swap rates: 1.9 percent in December. - Sectoral mismatches estimate: contributed 0.25 p.p. to core inflation in September 2021. - Nonenergy goods inflation: 2.4 percent (November estimate). ### Fiscal and EU recovery initiatives - Fiscal stance and deficits - Euro area aggregate headline deficit projected at 6.6 of GDP in 2021. - Automatic stabilizers projected at 1.2 percent of GDP; discretionary measures projected at 1.5 percent of GDP. - Next Generation EU (NGEU) and RRF disbursements - As of December 2021: 26 countries had applied for € 33 billion of grants and seven countries had applied for €166 billion of loans under the RRF. - €54.3 billion already disbursed to 20 countries. - Pre-financing typically 13 percent of total grants and loans and about 0.4 percent of 2021 GDP. - Planned RRP spending: nearly 40 percent devoted to climate change-related investments (target 37 percent); 16 percent directly on digital infrastructure (with total digital-related spending above the 20 percent target when accounting for education and public administration); 10 percent on upgrading healthcare systems; 8 percent on improving social inclusion. - To finance NGEU, the EU is expected to raise around €800 billion and become a major debt issuer during 2021–26. - EU country members committed to contributing up to 0.6 percent of Gross National Incomes annually to cover any shortfall in EU own resources against debt service requirements. ### Monetary policy stance and asset purchases - ECB programs and decisions - Pandemic Emergency Purchase Program (PEPP) total: €1.5 trillion (ongoing purchases under PEPP and APP). - ECB plans (reaffirmed in December): reduce net purchases to zero under the PEPP by end-2022Q1; temporarily increase APP net purchases to €40 billion in 2022Q2 and €30 billion in 2022Q3; return to the pre-pandemic level of €20 billion in 2022Q4. - Principal payments from maturing securities purchased under the PEPP will be reinvested until at least the end of 2024, with flexibility across time, asset classes and jurisdictions. - Liquidity provision - Overall liquidity provided through longer-term refinancing operations amounted to €2.2 trillion in September, equivalent to more than half of euro area bank excess reserves. ### Box 1 — Key findings on the TLTROs’ impact on bank lending - TLTRO take-up and aggregate effect - Since 2020Q1 the outstanding amount of TLTROs has surged during the pandemic (tripled over the period referenced). - Staff panel-data regressions (2004–21, country-level, two-stage approach) find that a one-percentage-point increase in the TLTRO take-up rate (relative to banking sector assets) boosts net lending growth in the euro area by about 12 to 23 basis points (y/y). - The impact on lending rates is not statistically significant. - Counterfactual on corporate lending - Without access to TLTROs or other alternative cheap funding sources, corporate loan growth would have been 0.5 percentage points below the annual average of 2.6 percent observed over the last five years. - Policy design and amplification effects - Changes in terms and conditions during the pandemic tripled the “TLTRO effect,” accounting for almost half of new lending growth. - Lower borrowing rates and higher borrowing allowance increased banks’ willingness to bid for TLTRO funding. - Increasing the share of eligible loans from 55 percent to 60 percent for banks that face borrowing constraints could boost the impact of TLTRO take-up on net lending growth by around 10 percent, partly due to banks’ anticipation effects. - Heterogeneity and targeting - The TLTRO effect on net lending growth is significantly higher in countries where banks have higher regulatory capital and lower nonperforming loans (NPL) ratios. - Stronger banks are better positioned to take advantage of TLTRO funding; rebuilding capital buffers and effective NPL resolution would help amplify the TLTRO lending channel and ensure efficient monetary transmission. - Scope and limits of TLTROs - TLTRO funding does not seem to improve credit conditions for assets outside the borrowing eligibility, such as mortgages; banks with higher TLTRO take-up seem to raise mortgage rates and cut back on mortgage lending. - No evidence of safe-asset hoarding via sovereign carry of government debt with yields above TLTRO rates was found during the period of strong quantitative easing. *Source: EURO AREA POLICIES, INTERNATIONAL MONETARY FUND — chapter 1 content from the provided PDF content unit.* ### 14. The banking system remains resilient even as lifeline support measures expire. The ### 14. The banking system remains resilient even as lifeline support measures expire. The ### Banking system resilience and lifeline support measures - The European Banking Authority (EBA) stress test published in July 2021 indicated that most systemically important banks remain well capitalized. - ECB actions: - ECB has ended its recommendation to suspend bank dividends, moving to a case-by-case review starting from September 2021 while continuing bank capital relief measures. - Effects: - These measures have boosted confidence, bringing European bank equity valuations back to their pre-pandemic levels. - Many borrower and income support measures, including debt repayment and insolvency moratoria, have gradually expired. - Corporate bankruptcies increased modestly in recent months but remain below their pre-crisis level. ### Financial conditions, credit, and asset valuations - Financial conditions remained favorable through the pandemic, contrasting with dynamics during the global financial crisis (GFC). - Market and credit developments: - Ample liquidity and improved market sentiment supported soaring equity prices. - Sovereign yields have been contained at low levels but have drifted up since the beginning of 2021Q3 due to higher realized inflation and concerns about soaring energy prices. - Since 2021Q2, increases in inflation risk premia have been largely offset by a continued decline in real risk premia (see Box 2). - Credit conditions for firms and households were broadly stable in the first 3 quarters of 2021 after a significant tightening in early 2020. - Bank lending rates have remained at historically low levels. - Credit to households grew at 4.3 percent yoy in 2021Q3—the highest pace since 2009—with mortgage loans as the main driver. - Credit to NFCs (non-financial corporations) began to pick up at the end of 2021Q3, recording 1.6 percent y/y growth. ### Drivers of euro area long-term sovereign yields (Box 2) - Secular context: - Long-maturity euro area government bond yields have experienced a secular decline since the early 2000s. - Average triple AAA euro area sovereign yields have been negative since mid-2019, averaging around -0.3 percent. - Decomposition and drivers: - Yield models decompose yields into nominal expected rate and nominal term premium; the analysis jointly estimates real and inflation risk premia with expected real and inflation rates using a macro-finance model with an affine term structure model. - The fall in sovereign yields has been primarily driven by a decline in the real risk premium. - Expectations of real short-term rates have remained relatively stable since 2014. - Investors have required a smaller compensation for inflation risks since early 2019, reflecting a fall in inflation expectations and the impact of the pandemic. - More recently, inflation risk premia have started recovering as inflation volatility has increased. - Strong demand for sovereign bonds has been supported by ECB purchases and lower uncertainty over the projected path of short-term policy rates following the ECB’s forward guidance that rate increases were unlikely in the near term. - Weak economic growth since the sovereign debt crisis has contributed to increased preference for bonds, with investors tolerating even deeper negative term premia. - Contrast with the U.S.: the U.S. has seen an increase in the inflation risk premium since 2020 amid a volatile real risk premium. ### External sector and current account - Current account: - The current account surplus increased to 2.9 percent of GDP in 2021H1 from 2.0 percent of GDP in 2020, largely reflecting a sizable increase in net exports of services. - The goods balance also improved in 2021H1 despite a sharp increase in imports of goods, particularly in 2021Q2. - Exchange rates: - Through November 2021, the NEER and the REER appreciated by 2.2 and 1.0 percent, respectively, relative to the same period in 2020. - Assessment: - The external position in 2021 is assessed as moderately stronger than the level implied by medium-term fundamentals and desirable policies (ESA, Table 2), after being broadly aligned in 2020. - This assessment is preliminary and subject to wide uncertainty due to preliminary data and Covid-19 adjustors for 2021. ### Outlook and projections - Baseline and pandemic assumptions: - The baseline assumes continued rollout of effective vaccines and therapies, greater resilience of activity to Covid-19 cases, and that Covid-19 may become endemic. - The baseline assumes further progress in protecting the euro area population against severe effects of the virus and possible variants, bringing hospitality and mortality rates to low levels in 2022 and beyond. - Near-term outlook (2021–22): - Real GDP growth is estimated to have accelerated to about 5¼ percent in 2021 and is set to moderate to about 4¼ percent in 2022. - Private consumption is set to be the main driver of growth, supported by improving consumer confidence and gradual normalization of the household saving rate. - The accumulated stock of excess savings is around €780bn as of 2021Q2 (7 percent of 2021 GDP) and is not expected to be dissaved in the baseline. - The output gap is projected to decline from 4½ percent in 2020 to ½ percent in 2022. - Inflation: - The transitory uptick of headline inflation is projected to continue well into 2022, with step declines in early 2022 as base effects dissipate. - Projected averages for 2021: HICP inflation of 2.5 percent and core inflation of 1.4 percent. - HICP inflation is projected to decline but remain above 2 percent in 2022. - Second-round effects are assumed limited; aggregate labor market slack is likely to persist, keeping core inflation below 2 percent from 2022 throughout the forecast horizon. - Negotiated wages increased by 1.3 percent in 2021Q3 (y/y), broadly in line with the pre-pandemic average. - Medium-term prospects: - Output should return to potential as demand and supply normalize; a strong recovery led by domestic demand is projected to close the output gap in 2024. - The unemployment rate is expected to return to pre-crisis levels soon thereafter. - A flat Phillips curve and stable inflation expectations imply core inflation will remain below the ECB’s inflation target throughout the projection horizon. - Economic scarring (output loss relative to pre-crisis trend) is projected to decline and disappear by 2025 given a higher path for potential growth, partly due to significant RRF-related investments. ### Household savings during Covid-19 (Box 3) - Excess savings: - Excess savings in the euro area amount to €780b as of 2021Q2, corresponding to 7 percent of GDP. - A steep drop in expenditures amid broadly stable disposable income has driven a continuous build-up of excess savings since 2020Q1. - Drivers: - Empirical analysis (panel regressions for 10 euro area countries, 2000Q1–2021Q2) points to forced savings (captured by the Oxford Covid-19 Government Response Stringency Index) as the main driver of recent excess savings. - Precautionary motives (unemployment expectations and the VIX index) played a smaller role. - Vaccinations contributed to a drop in the savings rate in 2021Q2 relative to previous quarters. - Forced savings were driven by foregone consumption in contact-intensive service sectors: transport, hotels, and recreation and culture explained around 55 percent of the drop in expenditure in 2020; restaurants contributed a further 25 percent. - Composition and distribution: - Monetary data show most savings were channeled to currency and deposits, and, to a lesser extent, loan repayments. - Distributional evidence is mixed: card transactions and bank data for France suggest high-income households accounted for a large share of the rise in savings, while European Commission survey responses indicate a broad-based increase across income and age groups. - Prospects and macro effects: - A significant rundown of excess savings appears unlikely in the short term. - Even a modest reduction in excess savings would have large macroeconomic effects: simulations show that under a moderate dissaving scenario—a 3.5-percent-of-GDP decline in the saving stocks relative to the October WEO baseline over 2022–23—GDP would increase by a similar amount. ### Risks and distributional impacts - Key risks: - Uncertainty is high and dominated by the pandemic’s evolution and legacies. - Risks include vaccine and therapy efficacy against more transmissible variants (e.g., Omicron), behavioral changes, and potential renewed containment measures that could impede recovery and increase scarring. - Limited fiscal space in some countries raises vulnerability to adverse shocks. - Distributional concerns: - The recovery is likely to be uneven across countries and sectors, amplifying inequality. - Countries with larger shares of contact-intensive services face slower recoveries. - Young and low-skilled workers, disproportionately employed in hard-hit sectors, may see increased within-country income inequality as policy support is withdrawn. *Source: IMF staff analysis as presented in the supplied chapter content.* ### 23. A faster-than-expected resolution of the health crisis could have large positive indirect ### 23. A faster-than-expected resolution of the health crisis could have large positive indirect effects, while other factors could also improve growth prospects. ### Faster resolution of the health crisis and upside growth scenarios - Reduced cases, hospitalizations, and mortality would have direct positive effects on mobility and activity and could lead to a strong unwinding of excess savings, significantly boosting consumption. - A stronger-than-anticipated global recovery could boost growth. - A productivity spurt from pandemic-induced accelerating automation and digitalization could also boost growth. ### Inflation risks and transmission channels - Inflation risks are to the upside if supply disruptions persist longer than expected, hindering the recovery and resulting in sustained price pressures. - Long-lasting supply shortages of intermediate inputs and persistently high energy prices would dampen the recovery. - Large second-round effects on nominal wage growth and prices could lead to inflation durably overshooting the ECB’s target, prompting monetary policy normalization earlier than currently expected. - Monetary tightening aimed at reining in demand would: - slow the recovery, and - increase debt service repayment stresses of leveraged households and firms. - Higher sovereign yields and a slower recovery would increase financing challenges facing high-debt countries. ### Adverse macro-financial feedback loops and risks - A prolonged health crisis with insufficient support measures (due to declining policy space in some countries) would result in substantial bankruptcies and job shedding, increasing economic scarring with repercussions for income inequality and social cohesion. - Higher-than-expected loan losses due to expiration of policy support and/or negative spillovers from exposures abroad would increase impairment charges and diminish banks’ willingness to lend, negatively affecting liquidity-constrained households and firms. - Elevated debt levels and sizable contingent liabilities—including from borrower-support measures and sovereign-bank links—could substantially increase public sector vulnerabilities. - A large shift in market perception would undermine high-debt countries’ ability to roll over and service their debt. - A sharp slowdown in China triggered by rising vulnerabilities in the real estate sector could create important growth headwinds in the euro area, particularly through trade linkages. - Direct financial exposures of euro area’s financial institutions are limited. However, exports of goods and services to China account for about percent of the euro area’s total exports. ### Escalation of trade tensions - Trade tensions with the U.S. have declined but have not been fully resolved. - Further delays in implementing the Northern Ireland protocol could increase frictions between the EU and U.K. - Failure to reach a long-term solution on regulatory equivalence for U.K.-based central counterparties could potentially lead to financial market disruptions, despite plans to extend temporary equivalence beyond the current deadline of 30 June 2022. - Tension with China could grow, particularly following the recent freezing of the investment agreement with China and mutual imposition of sanctions. - Disagreements about carbon border adjustments could also disrupt trade flows. ### The critical role of policy effectiveness and coordination - A premature withdrawal of policy support and slower-than-anticipated implementation of the RRPs would weaken the recovery. - Inability to counteract undue tightening of financial conditions—including due to shifts in market sentiment or potential spillovers from faster-than-expected U.S. monetary policy normalization—would adversely affect growth momentum by: - straining leveraged corporates and households, and - limiting policy space of high-debt countries. - Insufficient efforts to address labor market rigidities, debt overhang, and inefficient insolvency processes could impede efficient reallocation of resources, leading to: - significant labor market hysteresis, - low productivity growth, and - sizable economic scarring. - Belated withdrawal of emergency lifelines could lock labor and capital in unproductive firms and industries and hinder needed structural transformation. - An uneven recovery across countries could weaken policy coordination efficiency and lead to fragmentation that curtails the benefits of a single market. - Diverging views among ECB Governing Council members may become more visible as the pandemic recedes, complicating policy communication, especially related to forward guidance. ### Authorities’ views on the outlook and risks - Authorities projected a strong rebound in 2021 and robust growth in 2022, although headwinds from supply bottlenecks and elevated energy prices were likely to persist in the coming months. - The strong recovery would be supported by: - improving labor market conditions, - reduction in the households’ savings rate, - continued favorable financing conditions, and - supportive policies, including deployment of funds under the Recovery and Resilience Facility. - Job creation is projected to continue, supporting a further decline in the unemployment rate and re-absorption of residual workforce still on job retention schemes. - Over the medium term, the authorities expected potential growth to return to pre-pandemic levels, with limited scarring from the pandemic. - The authorities noted that risks surrounding the growth outlook remained high, with pandemic dynamics the primary source of uncertainty. - Risks from China’s real estate market warranted close attention given potential spillovers. - The authorities viewed recent high levels of inflation as largely transitory, driven by energy prices and transitory factors likely to fade in early 2022, but warned that growing supply-demand imbalances and potential wage dynamics could pose upside risks. ### Monetary policy: continued focus on underlying inflation dynamics - In July 2021, the ECB Governing Council concluded its strategy review and announced key changes: - formally adopting a symmetric inflation target of 2 percent; - including owner-occupied housing (OOH) costs in the measurement of the Harmonized Index of Consumer Prices (HICP); - increasing focus on financial stability risks and macro-financial linkages; and - incorporating climate change considerations in disclosure, risk assessment, the collateral framework, and corporate sector asset purchases. - The ECB reiterated that policy rates are primary instruments but that unconventional tools (forward guidance, asset purchases, and LTROs) would continue to play important roles when key rates are close to the effective lower bound. - The adoption of a 2-percent symmetric inflation target removes ambiguity around the previous “below, but close to, 2 percent” formulation and better anchors inflation expectations; the ECB would accept transitory periods of inflation moderately exceeding the target without actively seeking to overshoot the target. - With underlying inflation having undershot the target for many years and medium-term dynamics projected to be weak under the baseline, a highly accommodative monetary stance will likely be needed for an extended period. - Under the announced-policies baseline: - headline and core inflation are projected to decline in 2023 once transitory factors dissipate, and - while gradually recovering, remain below the 2 percent target over the medium term. - The Governing Council decided to end net PEPP purchases while overall gradually reducing asset purchases in 2022, underscoring flexibility to adjust course given elevated uncertainty. - Announced policies suggest overall asset purchases will revert to pre-pandemic levels in 2022Q4, but the ECB may need to provide further support via additional asset purchases if inflation projections continue to be below target in 2023 and beyond. - Given that several countries could breach the 33 percent issuer limit in the coming years, the ECB’s self-imposed limits on asset purchases will likely need to be revisited before they become binding; options include raising the issuer limit (but remaining below 50 percent) and/or tolerating deviations from the capital key for a longer period. - The upcoming issuance of EU bonds to finance the NGEU provides an opportunity for the ECB to lift its purchase limit on supranational or institutional bonds, currently set at 10 percent of the Public Sector Purchase Program (PSPP) holdings. - TLTROs have been effective in boosting bank lending to corporates and households. With first loan repayments under TLTRO III due in 2022H2, concerns around cliff-edge effects may warrant extension of the program through 2022 and beyond if there is sufficient credit demand. ### Policy guidance for upside inflation risks and communication - Policy should remain agile and ready to respond to potential upside inflation risks. - If sustained wage pressures—from a stronger-than-projected recovery or durable supply-side disruptions—result in persistent inflation overshooting, the ECB is well-equipped to respond by: - scaling down and then terminating asset purchases and TLTROs, followed by - a gradual adjustment of key interest rates towards historically more typical positions, and - potentially adjusting its reinvestment strategy of principal from maturing securities purchased under the APPs and PEPP. - Clear communication about transitory versus permanent impacts of pandemic-related developments and the ECB’s actual forward guidance would be essential to anchor inflation expectations over the medium term. ### Measurement of owner-occupied housing (OOH) in HICP and implementation challenges - Including OOH costs in the HICP would provide a more accurate reflection of consumer spending, but implementation will take time. - The ECB has expressed a preference for the net acquisitions approach for computing OOH costs, which is conceptually closest to the HICP requirement of being based exclusively on actual monetary transactions. - Implementation challenges mean full implementation will take many years; under the roadmap, the official quarterly HICP including OOH costs will become available by 2026. - Challenges include lack of timely monthly data on construction and house prices and the difficulty of separating asset prices and shelter services. - The ECB should explore hedonic methods suited for compiling monthly house price indices and/or real estate asking prices from web portals rather than administrative property transaction data, and assess feasibility of compiling monthly output-based construction price indices for residential housing. ### Climate-related considerations in monetary policy - The ECB plans to reflect climate change risks in its policy framework, including: - incorporating climate change criteria in corporate bond purchases, - introducing disclosure requirements for eligibility as collateral and asset purchases, - new indicators for green financial instruments and institutions’ carbon footprints and exposures to climate-related physical risks, - conducting system-wide stress tests with the European Systemic Risk Board and the European Commission, and - reviewing valuation and risk control measures in its collateral framework. - The ECB’s detailed roadmap of climate actions will be implemented in line with progress on EU policies and initiatives in environmental sustainability disclosure and reporting, with calibration of most envisioned measures spread over 2021–24. - Enhanced monitoring, stress testing, and disclosures are welcome and will improve accounting for climate-related risks. - Integrating the climate agenda into monetary policy operations faces practical and political challenges: - green corporate asset purchases are constrained by market depth; - green TLTROs may influence credit quality of bank lending; - green adjustments to the collateral framework may interact with the ECB’s balance sheet risk management; - effectiveness of green monetary policies in changing relative prices of carbon-intensive activities is lessened if firms’ financing sources are easily substitutable; - resource allocation impacts of green monetary operations could raise questions of democratic legitimacy and proportionality, potentially undermining the ECB’s independence. *Source: 1eurea2022001 - 23. A faster-than-expected resolution of the health crisis could have large positive indirect effects, while other factors could also improve growth prospects.* ### 40. The ECB is investigating the scope for a digital euro, while a decision on issuance will ### 1eurea2022001 - 40. The ECB is investigating the scope for a digital euro, while a decision on issuance will ### Digital euro: rationale, benefits, and risks - A digital euro could help maintain the "strategic autonomy" and competitiveness of the euro in a world with private stable coins and other central bank digital currencies. - Potential benefits for citizens: cheaper, more secure, and faster payments. - Design constraints and risks to mitigate: - Risks to the payment system. - Risks to financial stability and integrity. - Risks to central bank operations. - Existing strong euro payments infrastructure implies limited urgency for introducing a digital euro. - Eventual success depends on attractiveness, efficiency, operational resiliency, and public trust; careful design is required. ### Monetary policy context and role of fiscal support - Continued fiscal support at the EU and national levels is reducing the burden on monetary policy. - With policy rates close to their effective lower bound for an extended period, staff analysis suggests: - A gradual fiscal consolidation in the next few years, especially for countries with fiscal space, helps reduce scarring. - Despite a flat Phillips curve, such consolidation also modestly lifts core inflation relative to a rapid-consolidation scenario. - The draft national budgets for 2022 imply a gradual withdrawal of fiscal support. ### ECB views on stance, instruments, and inflation risks - The ECB considers maintaining an accommodative stance necessary given a subdued medium-term inflation outlook. - Commitment to use both conventional and unconventional policy instruments to preserve favorable financing conditions and support durable convergence of inflation to the 2-percent inflation target. - The Governing Council plans to review monetary policy instruments in the context of fresh macroeconomic projections in December; asset purchases and TLTROs would remain part of the toolkit given the effective lower bound on policy rates. - Self-imposed limits related to asset purchases are unlikely to be binding in the near term but could be adjusted—within existing legal constraints—if necessary to achieve price stability. - Risks to the inflation outlook warrant close monitoring: - Some wage inflation may assist in achieving the inflation target. - Inflation uncertainty has increased, pushing up inflation risk premia. - Maintaining clear and effective communication on inflation outlook and monetary policy stance is key given market expectations for earlier lift-off of policy rates. - Continued monitoring of inflation developments, including potential second-round effects, is important. ### Strategy Review and measurement changes - Formalization of the symmetric inflation target helped better anchor inflation expectations while allowing moderate and transitory upward deviations when interest rates are close to their lower bound. - Integration of financial conditions in monetary policy strategy is important in the face of rising asset prices in a low interest rate environment. - The ECB noted that the existing monetary operational framework may amplify climate-related market inefficiencies and that incorporating the green aspect into monetary instruments requires careful analysis. - On owner-occupied housing (OOH) costs in the HICP: - The ECB is committed to pursue the net acquisitions approach, which better captures increases in housing prices. - Plans to explore how implementation challenges can be addressed in a timely manner. - Incorporation of OOH costs in the HICP is not expected to have a meaningful impact on average prices over the longer term. ### Fiscal stance for 2022 and short-term composition - Aggregate euro area fiscal stance (as measured by the level of the aggregate euro area structural balance) for 2022 remains accommodative at -3.5 percent of potential GDP. - A 1.5 percent of GDP improvement in the structural balance would appear to imply a contractionary fiscal impulse, but most of this reflects phasing out of temporary lifelines and NGEU spending will provide an additional impulse. - Continued supportive fiscal policy, especially for countries with fiscal space, could speed up the EU-wide recovery and reduce the burden on monetary policy. - Fiscal stance at the national level should reflect country-specific circumstances, including medium-term fiscal sustainability considerations. - If aggregate demand pressures surprise on the upside, fiscal accommodation could be reduced accordingly, especially in countries with high debt. ### Public finance indicators (selected projections and historical values) - Public Finance (percent of GDP) — historical and projections: - Overall fiscal balance: -0.9 -0.4 -0.6 -7.2 -6.6 -3.9 -2.4 -1.9 -1.6 -1.6 - Primary balance: 0.8 1.2 0.8 -5.9 -5.4 -2.7 -1.3 -1.0 -0.7 -0.7 - Structural balance: -0.6 -0.4 -0.7 -4.7 -5.0 -3.5 -2.3 -2.0 -1.7 -1.6 - Structural primary balance: 1.3 1.3 1.0 -3.3 -3.8 -2.4 -1.3 -1.0 -0.7 -0.7 - Gross public debt: 87.5 85.5 83.6 97.3 97.6 95.4 94.3 93.2 92.1 90.9 - Sources: IMF, World Economic Outlook. (Projections 1/) ### Medium-term fiscal guidance and investment reallocation - Once expansion is firmly entrenched, high-debt countries should embark on gradual but steady fiscal adjustment to rebuild buffers. - High-debt countries should formulate credible adjustment plans now and be ready to implement them once expansion is underway. - NGEU grants can partially mitigate the drag from spending restraint. - Improving quality of spending and progressivity of taxes can boost growth and mitigate impact of spending restraint. - Changes to composition of fiscal policies can create space for investment to boost potential growth and accelerate green and digital transformations. - Southern euro area countries need to devote additional resources to R&D, where levels of R&D spending are half those of northern countries. - Reforming tax policies is necessary to ensure those benefiting most from growth contribute commensurately; scope exists for tax reforms to boost women’s labor force participation. - Taxes on carbon emissions, combined with transfers to lower-income households, would help address climate change. ### Reforming the EU fiscal rules: rationale, options, and process - Widespread recognition that the EU fiscal framework needs reform: current framework is intricate, procyclical, and creates inconsistency and overlap. - Complexity has led to unintended violations, exploitation of loopholes, and discretionary enforcement; many high-debt countries failed to reduce debt ratios pre-pandemic despite robust growth. - Deep consultation will be needed; a transitional arrangement may be desirable to avoid destabilizing application when the general escape clause is deactivated in 2023. - Possible transitional measures: suspend application of the debt benchmark and use flexibility to limit adjustment to that consistent with existing expenditure growth rule, excluding NGEU-financed spending. - European Fiscal Board proposal highlights: - Single debt anchor. - Net expenditure growth as a single operational rule. - Single escape clause based on independent economic judgement. - Keep the 3 percent of GDP overall fiscal deficit as a reference. - Creation of new instruments including central fiscal stabilization capacity and mechanisms to prevent counterproductive spending cuts. - Alternatives under consideration: - Country-specific debt targets that allow differentiation. - Fiscal standards with independent fiscal councils or qualitative assessments by the European Commission. - IMF staff exploring alternative reform proposals, aiming to produce a concrete proposal in early 2022; an expenditure growth rule with a debt anchor remains a pertinent option. - Design issues under consideration: degree of country-specificity, role of debt sustainability assessments, and how to allow room for stabilization and green investments. - Further strengthening national fiscal councils, the European Fiscal Board, and national medium-term budget frameworks could play an important role. ### Central fiscal capacity and green investment fund - A central fiscal capacity for macroeconomic stabilization would enhance euro area resilience and provide incentives by making access contingent on compliance with fiscal rules. - An EU-level investment fund focused on climate investment would help achieve common climate goals efficiently by prioritizing investments that achieve largest carbon reduction at lowest cost and coordinating cross-country projects. - Excluding green investments from fiscal rules risks "creative accounting," undermining balanced resource allocation, disincentivizing maintenance budgeting, and weakening oversight; a green investment fund is proposed instead. ### Authorities’ views (selected) - ECB: Maintain accommodative monetary stance; review instruments in December; continue asset purchases and TLTROs if needed; emphasize communication and monitoring of inflation. - European Commission: - Agrees fiscal policy should remain accommodative in 2022. - Views draft 2022 budgets as broadly appropriate, with a 1 percent of GDP expansionary stance based on net primary expenditure relative to medium-term potential growth (including RRF support and excluding temporary emergency Covid-19 measures), but cautions some governments increased permanent net current expenditure significantly. - Stresses that without adjustment in primary balances beyond what is already decided, public debt would continue to increase for several countries; high-debt countries should start gradual consolidation in 2023, taking advantage of RRF, provided economic and health conditions allow. - Relaunched consultation to reform fiscal rules; sees need for thorough analysis and debate and some flexibility until reform is in place, but views staff proposal for a formal time-bound transitional arrangement as difficult to agree and implement. - Assessment: countries submitted ambitious and well-calibrated RRPs; additionality judged high; implementation risks acknowledged. - Operational arrangements between Commission and member states will specify monitoring, verification mechanisms for milestones and targets, and indicative timeline for payment requests. - Commission stands ready to provide technical assistance to improve implementation and absorption capacities. - Recovery and Resilience scoreboard will track RRP progress. - Preliminary Commission analysis shows investment resulting from the RRPs could lift EU real GDP by 1.3 percentage points by 2026. ### Selected additional numeric findings and scenarios - ECB inflation target: 2-percent. - Climate stress-test result (September 2021): portfolios most vulnerable to climate risk are 30 percent more likely to default in 2050 compared with 2020 in a “hot house world” scenario. - Draft 2022 budgets imply a 1 percent of GDP expansionary stance (European Commission assessment). - Preliminary Commission projection: RRP-driven investment could raise EU real GDP by 1.3 percentage points by 2026. *Source: IMF staff report content unit 1eurea2022001.* ### 56. The NGEU recovery package can complement policies at the national level to help the ### 56. The NGEU recovery package can complement policies at the national level to help the ### NGEU package: objectives, allocation, and governance - Purpose: - Help the recovery, facilitate reallocation, build forward better, and tackle inequality. - Allocation principle: - Funds have been allocated to countries based on the impact of the pandemic and per capita income, aiming to mitigate increases in divergences between countries and boost potential growth. - Complementary reforms in national RRPs: - Green and digital transformations, public administration, education, and healthcare. - Should be accompanied by other structural reforms aimed at enhancing governance, promoting competition, improving labor markets, the business environment, and pension sustainability. - Disbursement considerations: - Future disbursements of funds should be linked to implementation progress. - Policymakers face a tradeoff between disbursing rapidly and ensuring investments and reforms are of high quality and aligned with countries’ implementation capacity. - Transparency and accountability: - NGEU funds should adhere to the highest standards of transparency and accountability despite strong existing EU public financial management and anticorruption frameworks. - Role of the new European Public Prosecutor Office in investigating any misuse of NGEU funds is critical. - Enhancing transparency of beneficial ownership in procurement, AML/CFT information exchange, and audit mechanisms will contribute to maintaining high quality of reforms and detecting abuse. *Italic line omitted as pipeline provides source attribution separately.* ### Labor market policies: managing reallocation and minimizing social costs - Role of Job Retention Schemes (JRS): - Extensive deployment of JRS has been essential in containing the increase in unemployment. - As the pandemic abates and demand for workers increases, these schemes are being phased out to support post-pandemic economic transformation and reallocative needs. - Reallocation pressures: - Changes in consumer behavior and working practices could lead to meaningful employment shifts across sectors and occupations, in addition to large shifts already implied by pre-crisis trends. - Policy recommendations to minimize unemployment and inactivity: - Support job-to-job transitions, including through reskilling and upskilling workers while still under JRS. - Gradual adjustment of the generosity of JRS and tightening of eligibility criteria to promote job search. - Temporary and targeted hiring subsidies and wage-loss insurance to incentivize vulnerable workers to move to occupations and sectors that offer lower pay initially and to pave the way for job creation given lingering employer uncertainty. - Link hiring subsidies and wage-loss insurance to vocational training during the transitional period to increase retention likelihood once insurance payments end. - Notes on wage-loss insurance: - Wage loss-insurance is given for a fixed period of time to compensate, partially or fully, the loss in earnings from switching to a lower-paying job. - While in principle such schemes should be pre-funded by an insurance premium levied on employers or employees, they have generally been introduced as nonfunded schemes financed via other sources. ### Need for rethinking labor market policies (structural context) - Pre-existing structural transformations: - Difficulties managing pre-pandemic structural transformations already suggested the need for a fundamental rethink of labor market policies; the pandemic increased the urgency. - Reallocative flows induced by the pandemic are likely to be low compared to those already associated with pre-existing transitions related to automation, digitalization, and climate change mitigation. - Lessons from episodes of large reallocations: - High degrees of labor and product market flexibility and a focus on training low-skilled workers are particularly important in determining success (episodes include Finland in the 1990s, Canada in the mid-2000s, and the Czech Republic in the 1990s). - Distributional concerns: - The pandemic continues to disproportionately affect low-skilled and young workers, exacerbating underlying inequality trends. - Targeted policy implications: - Provide educational and vocational programs adapted to ongoing transitions and post-pandemic labor demand. - National RRPs focusing on education and training to support digital skills could facilitate more rapid transitions to new occupations. - Planned labor market reforms (modernizing labor codes, strengthening active labor market policies, improving access to childcare and early childhood education) could ease bottlenecks and support reallocation. - Improve coverage of social safety nets in a progressive and means-tested manner to mitigate impacts on the vulnerable while limiting leakage to unintended beneficiaries. ### Box 5 — Potential Labor Market Reallocation in the Euro Area (summary of scenario analysis) - Analysis framework: - 10-year simulations exploring how changes in final demand affect sectoral output and labor. - Two scenarios considered: moderate impact and strong impact, differing by extent of long-term economic changes from the pandemic. - Increased telework and preference for social distancing are primary forces of change. - Sectoral implications: - Lower demand (relative to pre-crisis trends) for nonresidential construction and business travel and for industries that depend on large gatherings. - Increased demand for virtual services, benefiting IT and computer-related occupations; information and communication sector concentrated gains. - Construction, trade, food, accommodation, and transportation expected to see largest declines relative to pre-pandemic trends; magnitudes vary across countries. - Occupational implications: - Largest increases in employment of information and communication technology professionals in several large euro area countries. - Employment of sales and service workers set to decline in all the largest countries. - Overall magnitude: - Reallocation induced by the pandemic is likely to be much smaller than that caused by preexisting transitions related to automation, digitalization, and climate change mitigation. - Under the pre-pandemic baseline, about 5 million jobs would be created over the next 10 years, with the pandemic reducing this by up to 1½ million. - Policy emphasis: - Targeted policies to protect and support vulnerable groups who may struggle to transition, including adapted educational and vocational programs. - National RRPs focused on education and training could facilitate transitions. - Improve social safety net coverage progressively and means-tested. ### Authorities’ views on labor markets - Consensus: - Authorities concurred that JRS played a crucial role in buffering labor market impacts and noted schemes were largely phased out as recovery took hold. - Current labor market picture: - Mixed: continued slack combined with pockets of labor shortages in some strongly recovered sectors. - Vacancies had strongly recovered but factors such as desire for teleworkable jobs and reduced mobility affected labor supply, slowing matching. - Policy support: - European Commission agreed on need for re-skilling and up-skilling, noting limits to re-skilling. - Recommendations for Effective Active Support to Employment—providing hiring and transition incentives, promoting entrepreneurship, and strengthening employment services support—were viewed as well designed to create jobs and facilitate reallocation. ### Climate policies, NGEU, and RRPs - EU climate policy package: - EC’s “fit for 55” suite aims to reduce greenhouse gas emissions by at least 55 percent by 2030 (relative to 1990) and achieve net-zero emissions by 2050. - Package increases centrality of carbon pricing: reducing Emissions Trading System (ETS) cap, extending ETS to the maritime sector, and introducing a new ETS for road transport and buildings. - Establishes a fund to help the most vulnerable households and proposes a CBAM applying carbon pricing to certain industrial imports and emission-intensive sectors at high risk of carbon leakage. - Design considerations for CBAM: - Careful consideration and phased implementation in close collaboration with trading partners recommended. - Should increasingly weight actual embodied carbon content rather than relying on benchmark levels. - Should be accompanied by a reduction in free allowances in affected sectors to enhance WTO compatibility. - Investment needs and RRP contribution: - Estimates point to high levels of spending required to achieve climate goals. - Model simulations suggest proposed RRP investments would contribute to a reduction of GHG emissions by about 2½ percent CO2 equivalent compared to 2019 levels (see Box 6). - 2021–27 EU budget targets at least 25 percent of funds going to green spending, including through the Just Transition Mechanism. - Scope to do more, particularly through Common Agricultural Policy (CAP) to encourage GHG emissions cuts in agriculture. - Additional measures: upgrade building codes; mitigate environmental impacts of steel, cement and petrochemical production; change energy generation composition in some EU countries; vehicle emissions standards. - Coordinated national policies: - Increasing road fuel taxes can encourage a shift toward hybrid or electric vehicles; where politically difficult, “fee-rebates” could be used. - Reduce emissions in the building sector via binding regulations and subsidies to retrofit older buildings and those of low-income households. - Protect most vulnerable from unintended consequences (e.g., higher energy prices) while avoiding interference with market dynamics or dampening incentives for decarbonization. - National agricultural policies (land use regulations, tax and spending policies) needed to reduce emissions in that sector. - An EU-level climate investment fund could play a key role in helping member states achieve climate goals. ### Authorities’ views on financing and CBAM - Investment need estimate: - The European Commission noted the EU’s additional investment needs were estimated at about €1,000 billion for the 2021–30 period (1.1 percent of the EU’s estimated 2021 GDP a year). - Adopted RRPs in total are expected to provide €177 billion (1.7 percent of the EU’s estimated 2021 GDP) over the next five years. - Funding instruments: - Modernization, Innovation, and Just-transition funds, along with Invest EU, should help firms and member states achieve climate goals. - In terms of NGEU financing, green bonds are expected to account for 30 percent of the raised funds. - CBAM designed with long phase-in and care for WTO compatibility. ### Box 6 — Sectoral Analysis of the Recovery and Resilience Plans (summary) - Model and scope: - A dynamic computable general equilibrium (CGE) model based on an extended GTAP model and Data Base covering EU27 and rest of world, 18 production sectors, and a GHG emission module. - Baseline year: 2019. - Focuses on impact of additional RRP spending on value-added and CO2 emissions for all EU countries; does not include other measures (e.g., the ETS). - Two-phase impact (investment phase 2021–26 and mitigation phase): - Investment phase: - Additional spending boosts demand through public expenditure and investment with limited immediate effect on emissions. - GHG emissions initially would increase in virtually all sectors in tandem with output (a total of about 2 percent compared to 2019 levels). - Manufacturing emissions would decline, reflecting changes in relative prices and composition of industries. - Construction and services expected to be biggest beneficiaries of proposed spending, accounting for about ¾ of the 1.2 percent value-added increase in the investment phase. - Mitigation phase: - Investment in climate-friendly projects and improvements in total factor productivity and industry composition would reduce energy intensity and emissions. - Using GHG abatement coefficients from the International Energy Agency, model suggests GHG emissions would decline by about 4.5 percent of CO2 equivalent in the mitigation phase, despite a slight increase in transportation emissions due to higher activity and international trade. - Aggregate results: - Over both phases, value added is expected to expand by 1.4 percent and GHG emissions is estimated to decline by 2.1 percent compared to 2019 levels. - Modeling assumptions and caveats: - Investment and mitigation phases are analytically distinguished though in reality they would be continuous. - Simulations used the upper ceiling of IEA abatement costs to estimate a floor for CO2 reduction, assuming efficient direction of climate-related funds to mitigation. *Italic line omitted as pipeline provides source attribution separately.* ### 64. Large- p pp pp p ’ ### 64. Large- p pp pp p ’ ### Asset quality and bank lending - Debt moratoria and credit guarantees limited vulnerabilities from reductions in earnings and consumer spending, preventing a surge of loan defaults and bankruptcies. - NPLs for the euro area reached their lowest level on record, at 2.7 percent, during 2021H1. - Credit guarantee schemes, capital conservation measures, and lower capital charges for SME loans, infrastructure investment and sovereign exposures enabled banks to continue lending and absorb impairments without a significant change in their capital ratios. ### Stress tests and capital resilience - The July 2021 stress test confirms banks can absorb potential near-term loan losses, but vigilance remains warranted. - The European Banking Authority (EBA) stress test suggested the pandemic-linked recession would induce bank CET1 capital losses of, on average, 5 percentage points in an adverse macroeconomic scenario. - Risks that could affect bank capital: rise in corporate sector insolvencies as public guarantee schemes are lifted; more complete recognition of credit losses; possible correction in asset values (especially real estate markets). - Even when most banks stay above regulatory capital minima, loan losses and depleted capital buffers may leave them little headroom to lend, particularly for banks heavily exposed to hard-hit sectors in high-leverage private-sector countries. ### Financial sector policy recommendations - Prudential standards normalization: - Normalize prudential standards gradually, in accordance with pre-announced timelines. - Supervisors should clearly communicate the availability and usability of buffers. - Rebuilding capital buffers should be linked to the pace of the recovery to support continued credit provision. - The ECB’s decision to assess dividend payouts and share buybacks on a bank-by-bank basis, while lifting its previous general recommendation to restrict these, is appropriate. - Loss recognition and transparency: - Supervisors should continue efforts to achieve timely bank loss recognition. - Greater balance sheet transparency will support bank-led triage of viable borrowers. - Monitor adequacy of loan loss provisioning, especially if asset quality of loans that benefited from government support worsens. - Where of particular concern, regulators may intensify on-site inspections or direct banks to undertake independent asset quality reviews. - Phasing and targeting of borrower support: - Over time, any continued borrower support should become more targeted. - Phasing out of debt moratoria has been appropriate; coverage of government loan guarantees could be reduced gradually to avoid abrupt tightening while increasing monitoring incentives for lenders. - Reform insolvency regimes—develop out-of-court workouts and fast-track procedures, especially for SMEs—and harmonize them across the euro area to help banks remove NPLs from balance sheets. ### Targeted firm support and debt restructuring - Policy support should shift toward distressed but viable firms as recovery gains momentum. - Viability assessments should be conducted by financial institutions familiar with firms’ business models and based on transparent criteria. - Where policy space is limited, prioritize viable firms with activities essential for economy and society. - Use of flexibility in the EU State aid framework will be required; support should be calibrated to mitigate moral hazard, market concentration, and public sector balance sheet risks. 23 - Recommended instruments by firm size: - Micro and unincorporated SMEs: grants and hybrid financing instruments such as subordinated and profit participation loans. - Larger incorporated firms: equity and preferred equity injections and subordinated debt instruments (e.g., convertible bonds). - Incentives for efficient debt restructuring: - Make debt forgiveness nontaxable (or offer loss carryovers). - Provide tax credits to private creditors that grant haircuts. - Offer haircuts on government claims. ### Macroprudential measures and residential real estate - Low interest rates and rising house prices suggest activating some macroprudential measures to prevent excessive risk taking. - ECB evidence: new mortgage loans in countries with higher house price growth historically have higher LTV and LTI ratios. - Countries that imposed borrower-based macroprudential measures (limits to LTV and LTI) experienced reductions in riskier loans. - Policy options: - Gradual adoption of tighter LTV, DSTI or LTI limits for mortgages. - Loan maturity limits below 30 years. - Amortizing loans with principal and interest payments. - These measures would help restrict systemic risk from rising house prices in affected countries. ### Nonbank financial sector and investment funds - Some investment funds, especially those exposed to real estate and other illiquid assets, experienced significant redemption pressures at crisis onset; pressures receded but stretched asset valuations remain a risk. - A strong macroprudential framework for investment funds might include liquidity buffers, limits on liquidity risk, lock-up periods, or early redemption penalties, possibly subject to prudential triggers. - Such measures would encourage consistent risk management and mitigate spillovers to the broader financial system. - The ECB’s expansion of the supervisory perimeter to systemic investment firms with “bank-like” risks and over € billion in assets will raise microprudential oversight where spillover and reputational risks are highest. - The EC’s reviews of the Alternative Investment Fund Managers Directive and the Money Market Funds Regulation are timely. ### EU Banking Package and financial architecture - The EBA/Commission’s Banking Package aims to support lending and contribute to the green transition, and appropriately enhances supervisory powers and fit and proper requirements and addresses ESG-related risks. - The package may widen the gap between EU capital regulations and Basel III standards in some areas, notably the long phase-in period for treatment of certain bank exposures. - Priority projects: - Banking union endpoint: a single, borderless banking system to support stability, growth, and monetary transmission. - Further reforms in prudential oversight, resolution, and deposit insurance to engender trust and remove rationale for defensive host-jurisdiction measures that limit cross-border fungibility of liquidity and capital. - Capital Market Union (CMU) to enhance financing and investment options; focus on lowering information costs, ensuring consumer protection, enhancing pension portability, and improving national bankruptcy processes. - Establish a single AML/CFT rulebook and harmonize AML/CFT supervision to ensure consistency of financial integrity oversight. ### Authorities’ views on financial risks and reforms - Authorities agree credit risks warrant continued vigilance despite recent indications of bank strength. - ECB Banking Supervision expects some rise in NPLs as support measures are phased out and losses are more fully recognized. - ECB supervisory priorities: improvements in banks’ credit risk management, actions on forbearance, unlikely-to-pay assessments, implementation of IFRS-9, and examination of leveraged finance, unregulated nonbanks, and prime brokerage risks. - Authorities intend to normalize pandemic-related macroprudential guidance (including IFRS-9 risk identification guidance and policies on use of the capital conservation buffer and liquidity coverage ratio) as economic conditions improve, in line with communicated timelines. - ECB and ESRB see rising vulnerabilities in residential real estate markets, especially where amplified by high household debt; borrower-based macroprudential tools should be tightened in several countries and consideration given to introducing a minimum set of harmonized borrower-based tools in the EU in 2022. - European Commission view: delayed application of final Basel III standards in the Banking Package was unavoidable; proposed adjustments reflect specific European financial system features and are mostly transitory, with the end-point representing faithful implementation of the framework. - Authorities call for an ambitious Banking Union workplan and speedy resolution of debates on European deposit insurance to foster cross-border consolidation, risk-sharing, and economies of scale. - EC to continue CMU initiatives, including creation of the single access point (ESAP) for corporate disclosure and harmonization of national insolvency regimes. ### Trade policies, global tax, and vaccines - EU trade policy aims to support recovery and transform the economy, promoting open strategic autonomy and actions to reform the WTO, including restoring effective dispute settlement and strengthening rules on domestic subsidies, intellectual property rights, and technology transfer. - Recent developments: - June 2021: EU and U.S. agreed to resolve a 17-year Boeing-Airbus dispute and temporarily suspend punitive tariffs. - October 2021: agreement on U.S.-imposed tariffs on EU steel and aluminum exports. - Ratification of the EU-China CAI was suspended in May 2021; EU-Mercosur ratification likely to require actions addressing Amazon deforestation. - May 2021: EC adopted a proposal to address foreign industrial subsidies, giving the EC power to impose measures to alleviate distortive effects of financial contributions by non-EU governments to companies active in the EU. - Proposed global minimum tax: - Expected to take effect by 2023. - Two-pillar agreement would (i) levy a global minimum effective corporate income tax of at least 15 percent on large multinationals (with more than € 50 million in revenue), and (ii) allocate new taxing rights to market jurisdictions. - Implementation requires unanimous backing from all EU members and must avoid undermining low-income countries’ ability to enforce effective tax rates above the agreed minimum. - Global vaccine access: - Goal: vaccinate at least 40 percent in every country by end-2021 and at least 60 percent by mid-2022, as recommended by the multilateral Task Force on Covid-19 vaccines. - EU member states pledged to donate 200 million Covid-19 vaccines to poorer nations (September 2021), on top of an earlier commitment to deliver about 250 million doses. - Overall mobilization has been slow; recent commitment to deliver 100 million doses by the end-2021 is welcome. - Authorities’ trade views: - EU trade policy and proposed instruments are seen as WTO-consistent. - The EC considers the WTO Ministerial Conference (MC12) an important opportunity for strengthening the global trading system, including facilitating compulsory licensing of intellectual property rights of pandemic-related vaccines, equipment and medicines, and launching formal WTO reform discussions. - Progress toward trade and investment agreements has been uneven; EU suspended WTO dispute settlement proceedings against the U.S. and deferred scheduled rebalancing duties to allow more time for global solutions on overcapacity and de-carbonization issues. *Source: IMF — EURO AREA POLICIES chapter (excerpt).* ### 82. The authorities noted that the EU remains a major supplier of vaccines to the world. ### 82. The authorities noted that the EU remains a major supplier of vaccines to the world. ### Vaccine production and exports - The EU continues to export nearly 80 percent of its vaccine production. - Shipments reach more than 150 countries. - Authorities emphasized EU efforts to deliver vaccines to low- and middle-income countries and continued exports even when vaccines were scarce domestically. ### Economic outlook and near-term risks - Output increased sharply in the second and third quarters of 2021 thanks to high vaccination levels, continued forceful policy support, and increasing adaptation of households and business to pandemic dynamics. - Growing supply-demand imbalances, elevated energy prices, and potential disruptions related to rising infections are likely to slow growth momentum in 2021Q4. - The recovery should continue in 2022, with output gradually converging to its pre-pandemic path over the medium term. - The recovery is likely to be uneven across countries and sectors, potentially increasing inequality and disparities both across and within countries. - High uncertainty is tied to pandemic dynamics and legacies: - Risks that could impede the recovery: lower vaccine efficacy (including to variants such as Omicron), incomplete vaccination coverage, further restrictions and reduced social mobility, expiration of policy support, potential correction in real estate markets, spillovers from a sharp slowdown in China. - Upside scenarios: faster-than-expected adjustment to Covid-19, material unwinding of large excess savings increasing consumption, pandemic-induced acceleration of automation and digitalization boosting productivity and potential growth. ### External position - The external position in 2021 is assessed as moderately stronger than the level implied by medium-term fundamentals and desirable policies. - Assessment consistent with a strong recovery in trade that induced a widening of the current account surplus in the first half of 2021. - Assessment is preliminary and subject to wide uncertainty due to preliminary data and Covid-19 adjustors for 2021. ### Monetary policy and the ECB - The ECB should look through transitory inflation pressures and provide necessary support to lift inflation durably to its inflation target. - Underlying inflation dynamics expected to remain weak over the medium term; the ECB will likely need to sustain a highly accommodative monetary policy stance for an extended period. - Asset purchases are set to gradually decline in 2022; further support via additional asset purchases may be needed if inflation projections continue to be below target in 2023 and beyond. - The Governing Council’s focus in their December statement on retaining flexibility to adjust course as needed was appropriate. - A careful review of the ECB’s self-imposed limits on asset purchases will help ensure that those rules do not unduly constrain monetary policy operations. - The ECB is well equipped to respond should high inflation prove more durable than expected by adjusting unconventional and conventional policy instruments. - Clear and effective communication is essential to anchor market expectations given extraordinary uncertainty. - Formal adoption of a symmetric 2-percent inflation target has improved clarity on the ECB’s target and its response to temporary inflation overshooting. - Strengthened link between monetary and financial analysis underscores a holistic approach to dealing with stretched asset prices. - Climate-related measures (enhanced monitoring, stress testing, and disclosures) will allow supervisors and banks to better account for climate-related risks. - Proposed inclusion of OOH costs into the HICP will more accurately reflect consumer spending; ways to improve timeliness of construction and house price indices should be explored. - The scope for greener central bank policies requires careful analysis. ### Fiscal policy guidance - Fiscal policy should remain supportive but increasingly shift toward more targeted interventions as recovery continues. - Broad lifelines such as job retention schemes should be reduced, with support increasingly targeted to the most affected sectors and households to limit scarring. - Individual countries should calibrate fiscal positions to their economic situation, including medium-term fiscal sustainability considerations. - Credible medium-term consolidation plans should be put forward now, with timing of consolidation depending on country circumstances. - High-debt countries should gradually rebuild fiscal buffers once expansion is firmly in train. - Shift composition of public spending toward green and digital investments to increase potential growth while bringing deficits down. ### NGEU and reform priorities - The NGEU package is an opportunity to push reforms, close investment gaps, support green and digital transitions, and increase potential growth. - The package can help address divergence among EU countries by supporting potential growth and cushioning drag from future spending restraint. - Policymakers must balance timely disbursement with ensuring supported investments and reforms are high quality and implemented in line with national RRPs. - Funds need to adhere to highest standards of transparency and accountability. - Progress needed on structural reforms to enhance governance, promote competition, increase labor market flexibility, improve business environment, and ensure pension sustainability. ### EU fiscal framework reform - The EU fiscal framework should be reformed to better prevent debt distress while allowing adequate room for macroeconomic stabilization and green investment. - Surge in public debt due to the pandemic has made applying current fiscal rules difficult and could require unrealistically large—and counterproductive—adjustments by some high-debt countries. - A time-bound transitional arrangement would be desirable until new rules become effective, as completing reform before the general escape clause is lifted in 2023 will be difficult. - Further strengthening of national fiscal councils, the European Fiscal Board, and national medium-term budget frameworks could play an important role. - A green investment fund at the EU-level could efficiently finance investment to meet common climate goals, given cross-border benefits of reducing carbon emissions. ### Labor market and social policy - Structural policies should focus on facilitating reallocation of resources, protecting the vulnerable, and mitigating poverty and inequality. - Job retention schemes should be phased out gradually; labor market policies should shift to facilitating reallocation. - Recommended measures: training to reskill and upskill workers; careful use of temporary and targeted hiring subsidies and wage-loss insurance. - Improve coverage of enhanced social safety nets with greater reliance on progressivity and means-testing to mitigate pandemic impact on vulnerable groups. - Targeted policies needed to help the young, women, low-skilled, and other vulnerable groups to avoid rising inequality and poverty. ### Climate policy and energy - EU policies to address climate change are critical to facilitate green transition and achieve EU goals. - “Fit for 55” agenda is welcomed for giving a more central role to carbon pricing. - Design and phase-in of proposed carbon border adjustment mechanism should ensure compatibility with WTO rules, consider views of trading partners, be based increasingly on actual embodied carbon content rather than benchmark levels, and honor other international commitments. - Additional national steps to reduce greenhouse gas emissions in agriculture, building, and transport sectors should be considered. - In the context of the current spike in energy prices, policy measures to protect the most vulnerable should not undermine green goals or weaken the European energy market. ### Financial sector policies and supervision - Continued and gradual normalization of financial sector policies is appropriate; supervisory vigilance is critical. - Crisis-related prudential accommodations for banks should be normalized over time per pre-announced timelines. - Tightening macroprudential stance would help address stretched asset valuations and elevated household debt in some jurisdictions. - Corporate sector policies should shift from broad liquidity support to targeted solvency support for intrinsically viable firms. - Supervisors should ensure banks maintain sufficient buffers, loan loss recognition is sufficiently forward-looking, and provisioning levels are appropriate. - Recently announced banking package enhances supervisory powers and fit and proper requirements and addresses ESG-related risks, but widens gap between EU capital regulations and Basel III standards concerning implementation timelines and treatment of certain exposures. - Timely and faithful implementation of internationally agreed bank capital standards would help underpin global financial stability. ### Financial architecture and integration - Progress on bank supervision and resolution, underpinned by common European deposit insurance, would help create a truly single market and help European banks respond to structural challenges of low profitability and accelerating digitalization. - Continued progress toward CMU (Capital Markets Union) remains important to create a more balanced and efficient financial system in Europe. - Establishing a single AML/CFT rulebook and harmonizing AML/CFT supervision would help ensure consistency of financial integrity oversight. ### Global engagement: trade, taxation, vaccines - EU engagement on global issues such as trade, taxation, and vaccine availability remains crucial. - EU leadership on WTO reform and negotiation of new WTO agreements is welcome. - EU should continue engagement with major trading partners to address underlying sources of global trade tensions and investment distortions. - Prompt resolution of outstanding technical issues is needed to finalize the proposed global corporate minimum income tax. - As one of the leading exporters of Covid-19 vaccines, the EU should continue efforts to increase global vaccine production, which is critical to ending the pandemic. *IMF staff appraisal as presented in the source content.* ### 96. It is proposed that the next consultation on euro area polices in the context of the ### 1eurea2022001 - 96. It is proposed that the next consultation on euro area polices in the context of the ### Macroeconomic Projections and Key Indicators - Real GDP: 2.6 1.8 1.6 -6.4 5.2 4.2 2.2 1.7 1.5 1.4 (2017–2026 row). - Private consumption: 1.8 1.5 1.3 -7.9 3.7 5.5 2.2 1.6 1.7 1.5. - Public consumption: 1.1 1.1 1.8 1.3 3.5 0.1 0.9 1.1 1.1 1.1. - Gross fixed investment: 3.9 3.1 6.7 -7.0 4.7 4.0 3.1 2.4 1.9 1.9. - Final domestic demand: 2.1 1.7 2.6 -5.8 3.9 4.0 2.1 1.7 1.6 1.5. - Stockbuilding (contribution): 0.2 0.1 -0.1 -0.5 0.3 0.0 0.1 0.0 0.0 0.0. - Exports: 5.6 3.6 2.7 -9.1 6.4 6.2 4.5 3.8 3.3 3.2. - Imports: 5.2 3.8 4.7 -9.1 7.3 5.8 4.7 4.0 3.6 3.5. - Potential GDP: 1.5 1.3 1.4 -2.0 3.4 2.0 1.8 1.5 1.4 1.4. - Output gap: -0.6 -0.1 0.1 -4.3 -2.6 -0.6 -0.2 0.0 0.1 0.1. - Employment growth: 1.6 1.6 1.3 -1.5 0.6 1.0 0.8 0.3 0.3 0.2. - Unemployment rate: 9.1 8.2 7.6 7.9 7.9 7.7 7.4 7.3 7.2 7.1. - GDP deflator: 1.1 1.5 1.7 1.6 1.4 2.0 1.5 1.6 1.6 1.8. - Consumer prices: 1.5 1.8 1.2 0.3 2.5 2.6 1.4 1.6 1.6 1.7. - Overall fiscal balance (percent of GDP): -0.9 -0.4 -0.6 -7.2 -6.6 -3.9 -2.4 -1.9 -1.6 -1.6. - Primary balance: 0.8 1.2 0.8 -5.9 -5.4 -2.7 -1.3 -1.0 -0.7 -0.7. - Structural balance: -0.6 -0.4 -0.7 -4.7 -5.0 -3.5 -2.3 -2.0 -1.7 -1.6. - Gross public debt: 87.5 85.5 83.6 97.3 97.7 95.4 94.3 93.2 92.1 90.9. - Current account balance (percent of GDP): 3.2 2.9 2.3 2.0 2.8 2.9 3.0 2.9 2.8 2.7. - 2021 data notes: EURIBOR 3-month offered rate -0.3 -0.3 -0.4 -0.5; 10-year government benchmark bond yield 0.9 1.2 0.4 -0.1 0.3 (latest monthly available data for 2021). - Exchange rates (end of period) 2021: U.S. dollar per euro 1.18 1.14 1.11 1.22 1.14; Nominal effective rate (2005=100) 106.1 107.8 105.7 114.6 110.5; Real effective rate (2005=100, ULC based) 87.3 85.5 84.0 87.3 82.4. ### External Sector Assessment — Overall Findings and Policy Guidance - Overall Assessment: The external position in 2021 is assessed as moderately stronger than the level implied by medium-term fundamentals and desirable policies. Assessment is preliminary and subject to wide uncertainty from preliminary data and Covid-19 adjustors for 2021; final assessment to be provided in the 2022 External Sector Report. - 2021 CA developments: - Seasonally adjusted CA surplus increased to 2.9 percent of GDP in H1 2021, projected to moderate to 2.6 percent of GDP for 2021 as a whole. - Services and primary income balances recovered strongly; goods balance constrained by supply chain disruptions. - Private and public sector saving increased, outpacing investment. - Policy recommendations (short-term and medium-term): - Short-term: Continue focusing on containing Covid-19 outbreak and reducing scarring. Recent national and EU-level initiatives, including NGEU, support these efforts and could reduce the CA surplus by supporting investment and consumption. - Monetary policy: Remain accommodative until inflation durably converges to the ECB’s medium-term price stability objective. - Fiscal policy: Maintain fiscal support until expansion phase is firmly in train; then gradually consolidate toward medium-term objectives. - Structural policy: Countries with excess CA surpluses should strengthen investment and potential growth; countries with weak external positions should raise productivity, reduce structural and youth unemployment, and enhance competitiveness. - Euro Area-wide initiatives: Banking and capital markets union and fiscal capacity for macroeconomic stabilization could reinvigorate investment and reduce aggregate CA surplus. ### Foreign Asset and Liability Position - Background: NIIP fell to about -23 percent of GDP by end-2009, rose to about -5.1 percent of GDP by mid-2021. - Drivers of change: Stronger CA balances and modest nominal GDP growth; net increase in outbound FDI and debt portfolio securities; partially offset by milder increase in inbound portfolio equity and other investments. - Levels (2021H1, percent of GDP): NIIP: 5.1; Gross Assets: 270.0; Debt Assets: 103.9; Gross Liabilities: 275.1; Debt Liabilities: 104.2. - Assessment: NIIP-to- ratio projected to rise further at a moderate pace given continued CA surpluses. Overall NIIP financing vulnerabilities appear low, but large net external debtor countries retain greater sudden-stop risk. ### Current Account — Quantitative Assessment and Gaps - 2021 figures (percent of GDP): CA: 2.6; Cyclically Adjusted CA: 2.3; EBA Norm: 0.8; EBA Gap: 1.5; Covid-19 Adjustment: 0.3; Other Adjustment: -0.4; Staff CA Gap: 1.4. - Model estimates and staff judgment: - EBA model CA norm: 0.8 percent of GDP; implies gap of 1.5 percent of GDP. - IMF staff assesses a somewhat higher CA norm than EBA model due to policy commitments and uncertainties (demographics, large-scale immigration). - Covid-19 transitory adjustments estimated at 0.3 percent of GDP. - Staff CA gap assessed at 1.4 percent of GDP for 2021, range 0.6 to 2.2 percent of GDP; assessment preliminary pending more 2021 data. ### Real Exchange Rate (REER) - Background: CPI-based REER appreciated by 1.0 percent in first 11 months of 2021 vs same period 2020; nominal appreciation 2.2 percent partially offset by weaker euro area inflation; ULC-based REER depreciated by 1.4 percent. - Assessments: - Staff CA gap implies projected REER gap of -4.1 percent in 2021 (elasticity 0.35). - EBA REER index model suggests overvaluation of 6.2 percent; EBA REER-level model implies overvaluation of 0.1 percent. - Staff assesses REER gap range: -6.4 to -1.8 percent. - Heterogeneity across member states: REER gaps range from undervaluation of 9.6 percent in Germany to overvaluation of 5.4 percent in Belgium. - Policy implication: Net external debtor countries need to improve external competitiveness; net external creditor countries should boost domestic demand. ### Capital and Financial Accounts; Reserves and FX Intervention - Flows: Mirroring CA surplus in 2020, euro area experienced net capital outflows largely driven by portfolio investment; 2021 net capital outflows driven by outbound FDI and portfolio debt investment. - Assessment: Gross external indebtedness of euro area residents increased by 8 percentage points of GDP due to increases in short-term debt securities and government and Eurosystem liabilities. - FX intervention and reserves: Euro has status of a global reserve currency; reserves held by euro area economies are typically low relative to standard metrics, but the currency is free floating. ### Risk Assessment Matrix — Major Risks, Likelihood, Impact, and Policy Responses - Global resurgence of the Covid-19 pandemic - Likelihood: Medium; Expected impact: High. - Expected effects: Delayed recovery, scarring, higher unemployment, corporate insolvencies, bank capital shortfalls. - Policy responses: Deploy containment measures; support healthcare; alleviate funding tightness; sustain support to households/firms, especially SMEs; maintain accommodative monetary stance; develop NPL strategies; boost EU policy response and address structural issues nationally. - Disorderly transformations (impeded reallocation) - Likelihood: Medium; Expected impact: High. - Expected effects: Income polarization, higher unemployment, adverse social/political consequences, bank balance sheet strains. - Policy responses: Protect vulnerable groups; enhance bankruptcy/insolvency procedures; provide incentives for debt restructuring and business entry; active labor market policies; training and reskilling programs. - Widespread social discontent and political instability - Likelihood: Medium; Expected impact: High. - Policy responses: Target vulnerable populations; active labor market policies to facilitate reallocation. - De-anchoring of inflation expectations in the U.S. - Likelihood: Medium; Expected impact: Medium. - Policy responses: Maintain accommodative monetary stance; draw on EU support lines; high-debt countries announce credible medium-term consolidation plans. - A sharp slowdown in China - Likelihood: Medium; Expected impact: Medium. - Policy responses: Accelerate structural reforms; adopt accommodative fiscal stance where space exists; continue accommodative monetary policy. - An abrupt shift in market sentiment - Likelihood: Medium; Expected impact: High. - Policy responses: Maintain accommodative monetary stance; explore additional policy options; draw on EU support lines; high-debt countries announce credible consolidation plans. - Faster than expected rebound in activity - Likelihood: Medium; Expected impact: Medium. - Policy responses: Scale back supportive policies and tighten as needed; facilitate resource reallocation; embark on fiscal consolidation in high-debt countries. - Higher and persistent inflation - Likelihood: Medium; Expected impact: Medium. - Policy responses: Gradually taper unconventional tools before raising key policy rates; enhance communication to anchor inflation expectations; use macro- and micro-prudential tools; accelerate structural fiscal reforms. - Insufficient policy support and coordination - Likelihood: Low; Expected impact: Medium. - Policy responses: Maintain accommodative monetary stance; provide continued fiscal support until expansion is firmly in train; implement structural reforms; protect the vulnerable. - Escalation of trade tensions - Likelihood: Low; Expected impact: Medium. - Policy responses: Re-double efforts for economic integration/cooperation; scale up domestic public investment; contingency planning and collaboration between U.K. and EU authorities. *Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1eurea2022001.pdf* ### Annex I. The Impact of Coordinated Post-Covid Monetary and ### Annex I. The Impact of Coordinated Post-Covid Monetary and Fiscal Policies in the Euro Area ### Macro context and motivation - Euro area activity is set to recover strongly from a deep recession in 2020. - Labor market slack is projected to persist, along with weak underlying inflation dynamics. - Monetary policy is constrained by the effective lower bound (ELB). - Fiscal policy could temporarily provide additional support to reduce scarring, create jobs, and lift underlying inflation. - The ECB’s target of percent is expected to remain unmet over the projection horizon after some temporary acceleration in 2021. ### Role of fiscal policy when monetary policy is constrained - Fiscal policy can play an important role in supporting recovery when monetary policy is constrained by the ELB. - When interest rates are near the ELB, output and inflation respond more strongly to fiscal support. - Increased government spending could crowd in private consumption and investment, shrink medium-term output losses, reduce labor market scarring, and increase inflation. ### Scenario: More gradual withdrawal of support in 2022–23 - Baseline policy: Under the October WEO baseline, the aggregate euro area structural fiscal balance improves by 4 percentage points between 2022 and 2025, frontloaded in 2022. - Alternative: Allowing for additional spending of 2 percent of GDP over several years (for example 2022–23) would: - Help close the output gap as early as 2022Q3. - Reduce cumulative five-year (2021–25) output loss by between 20 to 50 percent. - With productivity-enhancing measures, raise potential output by an average of 0.2 p.p. every year starting from 2022. - Boost hours worked by 1½ percent over 2022–23, partially offsetting the 3½ percent drop in hours worked between 2019Q4 and 2021Q2. - Fiscal multiplier assumptions: - The cumulative two-year fiscal multiplier considered ranges from 0.6 to 1.3. - Literature estimates cited include 1.6–2.8, 1.5, 3.6–3.8, and 1–2.7 with median 1.8. - Composition and efficiency matter: - Lower multiplier from general transfers; higher multiplier from public investment. - Efficient public investment helps ensure that higher output and favorable financing conditions prevent worsening debt-to-GDP dynamics. - A much larger fiscal package could trigger premature monetary tightening and ultimately worsen debt dynamics. ### Impact on inflation - The impact on inflation would be mild: - The slower withdrawal of fiscal support over 2 years would temporarily increase demand. - Starting from 2022, core inflation would accelerate, peaking at 0.2 p.p. higher than the baseline projection. - In later years, the temporary demand boost fades and persistent productivity gains make the output gap less positive, reducing inflationary pressure. - Equivalencies noted: - This effect is equivalent to an increase in asset purchases by the ECB of 3 to 6 percent of GDP. ### International spillovers (U.S. policies) - The euro area is expected to benefit from a combination of U.S. Covid-related policies via positive spillovers. - U.S. fiscal packages and measures cited: - American Rescue Plan (8.2 percent of GDP) - American Jobs Plan (10.1 percent of GDP) - American Families Plan (6.9 percent of GDP) - A new flexible AIT framework from the Federal Reserve, together with these packages, would have a net positive spillover to euro area output and inflation. - The trade channel is expected to be the most important spillover mechanism, as higher U.S. consumption increases demand for euro area exports. *Prepared by Vina Nguyen, drawing from Balakrishnan et al., forthcoming.* ### 8. Each option would involve some degree of compromise, notably regarding imputation ### 8. Each option would involve some degree of compromise, notably regarding imputation ### Trade-offs among statistical options for including OOH costs - The trade-off boils down to compromising on the use of imputation versus speed of implementation. - Net acquisition and user-cost approaches can be modified to minimize undesired links with interest rates and/or house prices, but doing so would require accepting a higher degree of imputation (Options 1B and 3). - Option 1A could be adjusted to remove links to house prices, but that would require compilers to either: - estimate land price movements, or - assume that land price and dwelling structure price inflation rates are equal (also a form of imputation). - Rental equivalence (Option 2) would likely involve a larger extent of imputation, but: - representativity and rent-control concerns can be circumvented, and - it would allow for a faster compilation of an aggregate OOH costs’ index. - Each option would require some degree of legislative change to the HICP regulation, and Option 1 would also require changes to the Short-term Statistics Regulation. ### ECB preference and research priorities - The ECB Governing Council recommended a roadmap to include OOH costs in the HICP using the net acquisitions approach. - Rationale: conceptually closest to the HICP requirement of being based exclusively on actual monetary transactions and minimizing imputation. - Key challenges delaying full implementation for several years: - lack of timely monthly data on construction and house prices, - inability to separate asset prices and shelter services. - Recommendation: additional research to address these computational and data challenges should be prioritized. ### Implications for monetary policy and index design - Inclusion of OOH costs would affect the level and the volatility of inflation and the dispersion across countries. - Empirical notes from the euro area: - OOH inflation rose steadily over the past decade, eased to below 3 percent pre-pandemic, and rose to 3.5 percent more recently. - HICP inflation remained below 2 percent for most of this period. - OOH inflation has been overall more volatile than HICP inflation; there is large divergence across euro area countries. - Quantitative example: - Depending on the weights of the OOH component, its inclusion under the net acquisitions approach would have increased HICP inflation by around 0.4 percentage points in 2021H1. - Footnote on comparable weights: An OOH weight of 10 percent in the HICP would be closer to the U.S. (11.6 percent) while 15 percent would resemble Japan (15 percent), the Netherlands (15.8 percent), and Norway (14.1 percent). - Policy guidance: - Monetary policy would need to adjust accordingly. - Any changes to the reference index should ensure the inflation target remains credible, transparent, and well-understood by the public. - Because inclusion of OOH costs under any statistical approach should exclude asset price movements and therefore not fully reflect rising house prices, clear communication will be crucial to minimize criticism that the index understates living costs. ### Annex III — Statistical issues and ongoing ESS–ESCB workstreams - Institutional context: - European statistics are developed, produced, and disseminated by the European Statistical System (ESS) and the European System of Central Banks (ESCB), which operate under separate legal frameworks and cooperate closely. - Pandemic-related statistical work: - ESS and ESCB simplified processes while maintaining quality and provided additional data during the Covid-19 pandemic. - ECB and Eurostat published methodological guidance and explanatory notes for national compilers and users on statistical effects of pandemic measures. - Joint template developed to identify the impact of Covid-19 related government policy measures on government revenue, expenditure and debt; Eurostat developing guidance on statistical treatment. - Eurostat collected and published metadata on timing and severity of Covid-19 impact starting with 2020Q1. - ECB Governing Council modified TLTRO III terms on December 10, 2020 (extension by an additional 12 months to June 2022; three additional three-year operations in June, September and December 2021; borrowing allowance raised to 55 percent of eligible loans). - Data standards and quality initiatives: - Continued work on the 20 recommendations of the second phase of the G20 Data Gaps Initiative (DGI-2). - Eurostat and the ECB jointly support the Special Data Dissemination Standard Plus (SDDS P). By August 2021, 13 euro area countries (and 18 EU member states overall) had adhered to the SDDS Plus. - Ongoing quality assurance for statistics underlying the Macroeconomic Imbalance Procedure (MIP); the ESS–ESCB quality assessment report latest in July 2021; 2021 MIP visits postponed and to resume in 2022. - Priority areas for improvements (selected highlights): - Climate change: - ECB presented an action plan on July 8, 2021 to include climate change considerations in its monetary policy strategy; develop experimental indicators starting in 2022. - ESCB Statistics Committee STC Expert Group report (October 2020) identified data demands, methodological challenges, and priorities for indicators on financial exposures to climate risk and carbon footprints. - Committee on Monetary, Financial and Balance of Payments Statistics’ CFBS Task Force completed recommendations on sustainable finance and climate-related risks. - National accounts: - Active participation in updates to the System of National Accounts (SNA) and Balance of Payments manual (BPM) targeted for completion by 2025. - EU inter-country input-output tables for 2010–18 released in spring 2021 in current prices; followed by annual regular production. - Guidelines to reduce vertical discrepancies between non-financial and financial sector accounts expected finalized in 2021, implementation progressively until the 2024 coordinated European benchmark revision. - Price statistics: - Outcome of the ECB Monetary Policy Strategy Review (July 2021) recommends Eurostat start providing—first on an experimental basis—quarterly indices combining the HICP with the existing stand-alone owner-occupied housing (OOH) price index; Eurostat plans to start releasing the new index in April 2022. - First dissemination of quarterly house sales indices took place in October 2020. - Financial accounts: - ESCB improving availability of data for the non-bank financial sector and households’ financial portfolios; more granular reporting for the financial sector to be launched by euro area countries in 2022 and published by the ESCB. - External statistics: - As of March 2021, new b.o.p. and i.i.p. details being collected by the ECB following amended ECB Guideline (ECB/2011/13); euro area aggregates for new details to be released in 2022. - Modernization of intra-EU trade in goods statistics: exchange of micro-data on intra-EU exports between Member States to start in 2022; preparatory IT testing in 2021. - Exchange of customs data between Member States for extra-EU trade quality improvements also to start in 2022. - Monetary and financial statistics: - Regulation ECB 2020/59 amending Regulation ECB 2013/43 on payment statistics published December 11, 2020; introduces new reporting on innovative payment services, channels, payment schemes, and fraudulent payment transactions. - Recast Regulation on balance sheet items of credit institutions (ECB/2021/2) adopted January 22, 2021; new reporting requirements commence with monthly data for January 2022 and quarterly data for Q1 2022. - Long-term strategy to increase efficiency of banks’ data reporting: Integrated Reporting Framework (IReF) and Banks Integrated Reporting Dictionary (BIRD). - Selected data projects and publications: - €STR: - Published first on October 2, 2019; external auditor assessed compliance with IOSCO principles; statement of compliance published on September 30, 2020. - ECB started publication of compounded €STR rates on April 15, 2021. - Money Market Statistical Reporting (MMSR): - Amended regulation adopted on November 26, 2020 to ensure continued daily reporting by branches located in the United Kingdom. - Centralised Securities Database (CSDB): - New attributes being gradually added (e.g., identification of green bonds); unique joint ESCB compilation of securities issues statistics directly from micro data at t+10 days after end of month becoming a reality in the last quarter of 2021. - Securities holdings statistics adapted to support PEPP and timeliness improved. - AnaCredit: - Second edition of the AnaCredit Reporting Manual published May 2019; new Q&As published due to the Covid-19 crisis. *https://www.imf.org/-/media/files/publications/cr/2022/english/1eurea2022001.pdf* ### 6. The ECB, Eurostat and the OECD actively cooperate on statistics and research ### 6. The ECB, Eurostat and the OECD actively cooperate on statistics and research ### Cooperation on income, consumption and wealth (ICW) and linking macro and micro data - The ECB, Eurostat and the OECD cooperate on statistics and research concerning the joint distribution of income, consumptions and wealth (ICW) as well as linking macro and micro data on household wealth. - The ESCB Statistics Committee’s Expert Group on Distributional Financial Accounts is developing distributional results on household wealth which are consistent with the national accounts by 2022. - This work will continue to support the recommendations of the G-20 Data Gaps initiative, which, in their newest version, have emphasized the development of distributional accounts as one of four main priorities. - In December 2020, Eurostat published experimental results for all EU Member States regarding the distribution for income and consumption, accompanied by metadata and qualitative information. - References to relevant ECB survey material: - 3rd wave of the Household Finance and Consumption Survey (HFCS)—upon request, the micro data of the survey is available to external researchers. - ECB publications cited: ecb.sps36 and ecb.sps37 (as referenced in the source text). ### Eurostat technical work on public sector accounting (EPSAS) - Technical work by Eurostat is ongoing towards modernizing and harmonizing public sector accounting in the context of the European Public Sector Accounting Standards (EPSAS). - Ongoing technical work has focused on drafting screening reports assessing the consistency of individual International Public Sector Accounting Standards (IPSASs) with the draft EPSAS Conceptual Framework. - Eurostat expects to complete this assessment by end-2021. ### Context from the supplement to the 2021 Article IV staff report (selected economic findings with exact figures) - The rapid spread of the Omicron variant led to updated near-term projections, but the medium-term outlook remains broadly unchanged. - Projections revised in the January 2022 Update of the World Economic Outlook: - Euro area GDP growth in 2022 has been revised down to 3.9 percent (-0.3 p.p. relative to the staff report projections). - Growth in 2023 revised up to 2.5 percent (+0.3 p.p.). - The output gap is still expected to close in 2024. - Average headline inflation for 2022 has been revised up to 3.0 percent (+0.4 p.p. relative to the staff report projections). - Staff expect headline and core inflation to remain below the ECB’s new symmetric 2 percent target over the projection horizon. - Recent developments and data: - Preliminary data point to a slowdown in real GDP growth to 0.3 percent (q/q) in 2021Q4, below staff’s projection of 0.6 percent. - Estimated 2021 growth outturn of 5.2 percent is in line with the January 2022 WEO Update. - Headline inflation reached 5.0 percent (y/y) in December 2021. - Core inflation increased to 2.7 percent (+0.1 p.p.). - The unemployment rate declined to a record low of 7 percent in December. - Total hours worked remained about 2 percent below pre-crisis levels in 2021Q3. - Risk from Russia–Ukraine tensions: - For the euro area as a whole, about ⅓ of natural gas imports comes from Russia. - Natural gas accounts for 20 percent of the energy mix in the euro area. - Escalating tensions pose a downside risk to growth and an upside risk to inflation through elevated food and energy prices and other channels. *EURO AREA POLICIES — STAFF REPORT FOR THE 2021 ARTICLE IV CONSULTATION WITH MEMBER COUNTRIES ON COMMON EURO AREA POLICIES — SUPPLEMENTARY INFORMATION* ### 4. The updated EBA leaves staff’s assessment of the external position ### 4. The updated EBA leaves staff’s assessment of the external position ### Updated assessment and headline findings - The current account surplus declined to 2.2 percent of GDP in 2021Q3 from 2.9 percent of GDP in the first half of 2021, reflecting rising costs of imports, particularly energy. - The surplus increased in October and November 2021. - For 2021 as a whole, the euro area current account surplus projection has been revised up by 0.4 percentage points of GDP to 2.9 percent. - This revision marginally widens the staff current account gap estimate from 1.4 to 1.5 percent of GDP. - Staff continues to assess the external position in 2021 as moderately stronger than the level implied by medium-term fundamentals and desirable policies. - The assessment is preliminary and subject to a wide range of uncertainty arising from the preliminary nature of data and Covid-19 adjustors for 2021. The final assessment will be provided in the 2022 External Sector Report. ### Current account (CA): background and assessment - Background: - CA balance projected to increase to 2.9 percent of GDP in 2021 from 1.9 percent of GDP in 2020. - Services balance recovered strongly; primary income balance also recovered; goods balance constrained by supply chain disruptions. - Private and public sector saving increased compared to 2020, outpacing investment. - Some large creditor countries (e.g., Germany and the Netherlands) continued to have sizable surpluses. - At the end of the projection horizon, CA balance projected to be above the pre-pandemic level, driven by higher private sector savings in Italy and some smaller countries, including Ireland. - Assessment: - EBA model estimates a CA norm of 1.0 percent of GDP, against a cyclically adjusted CA of 2.5 percent of GDP — implying an EBA gap of 1.5 percent of GDP. - IMF staff analysis indicates a somewhat higher CA norm than the EBA model, considering policy commitments to reduce large net external liability positions (e.g., Spain), demographic outlook uncertainty, and impacts of recent large-scale immigration (e.g., Germany). - Adjustments for transitory Covid-19 impacts on consumption composition, medical goods, and tourism are estimated at 0.3 percent of GDP. - Considering other adjustments and uncertainties, IMF staff assesses the CA gap to be 1.5 percent of GDP for 2021, with a range of 0.7 to 2.3 percent of GDP. - This assessment is preliminary and may change as more data for 2021 becomes available; final assessment to be published in the 2022 ESR. ### Foreign asset and liability position (NIIP) and trajectory - Background: - NIIP fell to about -23 percent of GDP by end-2009, rising to about -3.3 percent of GDP by mid-2021. - Rise driven by stronger CA balances and modest nominal GDP growth. - Relative to 2020, NIIP increased by 1.3 p.p. of GDP, reflecting primarily net increase in outbound FDI and debt portfolio securities, partially offset by milder increase in inbound portfolio equity and other investment. - Gross foreign positions as of mid-2021: assets about 271.2 percent of GDP; liabilities about 274.4 percent of GDP. - Net external assets elevated in large creditors (e.g., Germany and the Netherlands); net external liabilities remained high in some countries, including Portugal and Spain. - Assessment: - Continued CA surpluses over the medium term suggest NIIP-to-GDP ratio will rise further at a moderate pace. - Overall NIIP financing vulnerabilities appear low. - Despite rising CA balances, large net external debtor countries still bear a greater risk of a sudden stop of gross inflows. - Key mid-2021 figures: - 2021H1 (% GDP) NIIP: -3.3 - Gross Assets: 271.2 - Debt Assets: 104.3 - Gross Liab.: 274.4 - Debt Liab.: 104.0 ### Real exchange rate (REER) - Background: - CPI-based REER appreciated by 0.5 percent in 2021 compared to 2020, reflecting a nominal appreciation of 1.7 percent, partially offset by weaker euro area inflation relative to trading partners. - ULC-based REER depreciated by 2.1 percent. - Assessment: - Staff CA gap implies a projected REER gap of -4.1 percent in 2021, applying an estimated elasticity of 0.35. - EBA REER index model suggests an overvaluation of 6.2 percent. - EBA REER-level model implies an undervaluation of 0.2 percent. - Consistent with the staff CA gap, staff assesses the REER gap to be in the range of -6.4 to -1.9 percent. - Substantial heterogeneity across member states: REER gaps range from an undervaluation of 12.2 percent in Ireland to an overvaluation of 5.1 percent in Belgium. - Implication: need for net external debtor countries to improve external competitiveness and for net external creditor countries to boost domestic demand. ### Capital and financial accounts: flows and vulnerabilities - Background: - Mirroring the CA surplus in 2020, euro area experienced net capital outflows largely driven by portfolio investment, offsetting net inflow of direct and other investment. - Net capital outflows in 2021 largely driven by outbound FDI and portfolio debt investment. - Assessment: - Gross external indebtedness of euro area residents increased by 0.4 percentage point of GDP in the first half of 2021 as higher external debt of deposit-taking institutions offset a reduction in Eurosystem and nonfinancial sector liabilities. ### FX intervention and reserves - Background: - The euro has the status of a global reserve currency. - Assessment: - Reserves held by euro area economies are typically low relative to standard metrics, but the currency is free floating. ### Potential policy responses and recommendations - Short-term priorities: - Continue focusing on containing the Covid-19 outbreak and reducing scarring from the crisis. - Recent initiatives at national and EU levels, including NGEU, support these efforts and could potentially help reduce the CA surplus by supporting investment and consumption, thereby increasing imports. - Monetary policy: - Should remain accommodative until inflation has durably converged to the ECB’s medium-term price stability objective. - Fiscal policy: - Fiscal support should remain in place until the expansion phase is firmly in train, before gradually consolidating towards medium-term objectives. - Country-level actions if pre-Covid policy gaps persist: - Countries with excess CA surpluses should continue to strengthen investment and potential growth. - Countries with weak external positions should undertake reforms to raise productivity, reduce structural and youth unemployment, and enhance competitiveness as the acute phase of the pandemic recedes. - Euro area-wide initiatives: - Further work on banking and capital markets union and fiscal capacity for macroeconomic stabilization could reinvigorate investment and reduce aggregate CA surplus. ### Table 2 – Selected consolidated metrics for 2021 (as reported) - 2021 (% GDP) CA: 2.9 - Cyc. Adj.CA: 2.5 - EBA Norm: 1.0 - EBA Gap: 1.5 - Covid-19 Adj.: 0.3 - Other Adj.: -0.4 - Staff Ca Gap: 1.5 *International Monetary Fund — Euro Area Policies, excerpt: "4. The updated EBA leaves staff’s assessment of the external position"* --- _Source: https://www.imf.org/-/media/files/publications/cr/2022/english/1eurea2022001.pdf_