## From Vaccination to V-Shaped Recovery

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### The Virus Strikes Back but Vaccination Begins
- New waves of infection have afflicted advanced and emerging European economies.
- Vaccination is under way but the pace of progress is still moderate and varies significantly across countries, with the biggest lags in several non-EU emerging European economies.
- Data reference point: Data as of April 5, 2021 (figure context).

### The Recovery Pauses
- Reopening in summer 2020 triggered a rapid recovery in 2020:Q3 followed by a resurgence of COVID-19 cases and new containment measures that reduced mobility and slowed activity.
- The slowdown from new containment measures reduced activity to a much lesser extent than in spring 2020.
- Sectoral divergence:
  - Industrial production has returned to pre-pandemic levels.
  - Services are still contracting.
- Countries with sizeable service sectors (Croatia, Italy, Montenegro, Spain) lagged the rest of Europe by about 1 percentage point in the second half of 2020.

### The Policy Response
- Fiscal support in 2021 is projected to be about 1.5 percentage points of GDP higher than in the October World Economic Outlook.
- Central bank actions:
  - Several central banks cut policy rates further (Iceland, Moldova, North Macedonia, Romania, Serbia); Russia hiked rates; Turkey hiked rates reversing 2020 stimulus.
  - European Central Bank increased the pandemic emergency purchase program by €500 billion to €1.85 trillion and extended targeted longer-term refinancing operations to mid-2022.
  - Emerging European central banks (Hungary, Poland, Romania, Turkey) continued expanding balance sheets.
- Fiscal support delivered in 2020:
  - About 7.5 percentage points of GDP in advanced European economies.
  - About 6 percentage points of GDP in emerging European economies (excluding Turkey and Russia).
- Budgetary plans for 2021 envisage lower support by about 1 percentage point of GDP for European economies.

### Effective Policies Cushioned the Economy in 2020
- Europe’s activity contracted by 5.2 percent in 2020, 1.8 percentage points less than forecast in the October World Economic Outlook.
- Key policy impacts in 2020:
  - Job retention schemes, deployed by about 40 European countries, protected 68 million jobs at their peak.
  - Corporate sector policies (guaranteed credit, debt moratoria, job retention schemes) provided lifelines; corporate bankruptcies declined in 2020 despite the downturn.
  - Financial policy measures, together with support to households and firms, helped shield banks: nonperforming loans remained largely contained, common equity Tier 1 capital ratios showed resilience, and credit continued to flow.

### Outlook and Risks
- Growth projections:
  - Europe’s GDP is expected to rebound by 4.5 percent in 2021.
  - GDP growth is projected at 3.9 percent in 2022 on the assumption that vaccines become widely available in the summer of 2021 and throughout 2022.
  - Long-term output losses relative to the pre-COVID-19 trend are projected at about 1.5 percent of GDP by 2025.
- Inflation:
  - Inflation is projected to edge up by 1.1 percentage points to 3.1 percent in 2021, partly due to higher commodity prices.
  - Inflation expectations remain around or below targets.
- Risk assessment:
  - Near-term risks are tilted to the downside: virus mutations, vaccination delays, tightening financial conditions, social unrest, and greater medium-term scarring.
  - Upside possibilities: speedier vaccine production and distribution, greater resilience of activity to the virus, stronger policy implementation (for example, Next Generation EU), and improved international policy coordination.

### Policy Recommendations
- Immediate priorities:
  - Accelerate production and distribution of vaccines.
  - Continue emergency support to households and firms to limit scarring from unemployment, missed education and training, and low investment.
- Fiscal policy:
  - Fiscal policy needs to play an increasingly larger role as monetary policy approaches the effective lower bound in several economies.
  - Fiscal measures should stimulate investment and facilitate job creation and reallocation.
- Labor market policies:
  - Extend lifelines while activity remains soft and gradually shift to fostering reallocation: promote job search, enhance training and reskilling programs, and provide well-targeted hiring subsidies.
- Monetary policy:
  - Remain accommodative as long as underlying inflationary pressures stay subdued.
  - Central banks should credibly communicate resolve to avoid a premature pick-up in real yields while allowing temporary price increases related to pandemic dislocations or volatile commodity prices.
- Corporate sector support:
  - Shift from broad liquidity provision to targeted support for viable firms and strengthening solvency (including via hybrid instruments).
  - An equity gap of 2-3 percent of GDP remains to be covered, lest 15 million jobs be put at risk.
- Financial policies:
  - Continue macro-prudential measures to enable banks to keep credit flowing.
  - Preserve provisioning standards while providing time to replenish capital buffers as crisis measures expire.

### Fiscal Simulations and Strategic Redeployment
- IMF staff analysis of a fiscal package comprising:
  - Additional transfers targeted at households in need;
  - Hiring subsidies to reintegrate the unemployed faster;
  - Temporary investment tax credits to bring forward investment;
  - Equity support schemes for viable firms in need of capital.
- Simulation results:
  - Additional support of 3 percent of GDP over 2021−22 could lift output by about 2 percent by the end of 2022.
  - Such support could more than halve the medium-term scarring due to robust supply-side effects.
  - This package would have greater benefits for low-income households and fewer side effects than additional monetary stimulus, bring inflation closer to target in many countries, and help rebuild monetary policy space.
- Longer-term strategy:
  - Redeploy fiscal resources freed from temporary support to accelerate infrastructure investment, especially digital and green technologies.
  - When a robust expansion is in place, roll back large deficits and rebuild fiscal buffers within credible medium-term plans.
  - Improve social safety nets and labor market institutions to address inequality and cope with disruptive technological changes and automation.

*This report reflects data and developments as of April 7, 2021.*

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_Source: https://www.imf.org/-/media/files/publications/reo/eur/2021/april/english/text.pdf_