## Executive Summary

## Source details

**Canonical URL:** [Executive Summary](https://www.imf.org/-/media/files/publications/reo/eur/2025/october/english/text.pdf)

## Other formats

- [Markdown version](/-/media/files/publications/reo/eur/2025/october/english/text.pdf.md)
- [Structured JSON version](/-/media/files/publications/reo/eur/2025/october/english/text.pdf.json)

---

### Europe Is Converging to a Mediocre Growth Trajectory
- Europe has skillfully weathered many large shocks, but the lingering damage is starting to leave a mark; growth momentum is fading toward a mediocre medium-term outlook.
- Recent positive growth in the first half of 2025 was driven by frontloaded exports to the United States and associated investment, with Ireland a notable contributor; excluding Ireland, growth was modest.
- Trade between the United States and the European Union accounts for almost a third of global goods and services trade and 20 percent of EU exports.
- October 2025 IMF forecast assumptions and related facts:
  - The estimated effective US tariff rate on EU goods after the US–EU trade deal is at 16.3 percent.
  - That rate is 4.3 percentage points higher than that anticipated in July and 15 percentage points higher than that in 2024.
  - The euro area’s nominal effective exchange rate has increased by 7.1 percent since March 2025.
- Headwinds to growth include higher US tariffs, a stronger euro, elevated uncertainty, and the risk that AI-related investments may produce sharp equity market valuation changes if returns disappoint.
- Financial market signals:
  - Long-term government bond yields have moved sideways or increased in many European countries.
  - Firms with higher trade exposure to the United States and higher sensitivity to uncertainty have experienced significantly larger stock price declines since April 2.

### Inflation Is On Target in Advanced Economies but Eases Unevenly across CESEE
- Advanced economies (AEs) show inflation on target overall, but inflation dynamics are easing unevenly across Central, Eastern, and Southeastern Europe (CESEE).
- Household behavior:
  - Private consumption remained stable at modest levels.
  - Catching up of real income growth because of declining prices supported consumption.
  - Saving rates remain elevated; recent IMF analysis finds the increase in the savings rate comes mostly from cyclical factors, especially rising interest rates, with more recent contributions from sentiment factors.
- Inflation specifics and country notes:
  - Euro area headline inflation is expected to average 1.9 percent in 2026 and 2.1 percent in 2027.
  - Euro area core inflation is expected at 2.1 percent in 2026 and 2 percent in 2027.
  - Switzerland: inflation expected to reach 0.6 percent in 2026 and 0.7 percent in 2027; headline inflation slowed to 0.2 percent (year over year) in July 2025.
  - United Kingdom: inflation will converge to 2 percent by the end of 2026.
  - CESEE countries: headline inflation of about 3.5 percent in 2026 and 2.9 percent in 2027; most CESEE countries will likely meet their inflation targets only in the course of 2027.
- Inflation risks are two-sided:
  - Downward risks: persistently stronger euro, further declines in energy prices, trade diversion from China.
  - Upward risks: possible countervailing duties against trade diversion, wage growth failing to moderate as anticipated.

### Outlook and Risks
- The growth slowdown extends across most European countries and goes beyond softening external demand.
- Key near-term risks:
  - Headwinds from uncertainty, trade tensions, and euro appreciation that dampen firms’ investment and market valuations.
  - Any financial sector repercussions would compound low productivity, an aging population, a shrinking labor force, and weak investment.
- Fiscal outlook:
  - With growth and consolidation falling short, European countries’ debt mountain could increase on average to 130 percent by 2040.
  - Associated fiscal pressures demand significant fiscal consolidation.

### Steady Macro Policies for Near-Term Stability
- Policy guidance:
  - Macroeconomic policies need to stay the course to safeguard hard-earned price stability.
  - Initiate fiscal consolidation and preserve trade openness.
  - Given the rise in international trade costs, Europe should broaden its trade relationships and promote multilateral cooperation.
- Monetary and financial policy notes:
  - Interest rate cuts and higher fiscal spending, including on defense, have so far failed to ignite private demand.
  - Increasing long-term spending pressures and lack of sufficient near-term fiscal consolidation have left investors asking for higher compensation to lend.

### Achieving Higher Growth: Moving from Recognition to Action
- The key to sustainably higher long-term growth is overcoming the perilous policy drift in structural reforms.
- EU-level priority areas include:
  - Dismantling the fragmentation in the single market.
  - Unlocking risk investment.
  - Scaling up the provision of European public goods.
  - Maximizing agglomeration gains.
- Aggregate productivity potential:
  - If just the top third of the EU’s production hubs could leverage agglomeration advantages associated with local availability of human capital and financing and research and development ecosystems as well as their US counterparts, aggregate EU labor productivity would be 8 percent higher.
- National-level priorities:
  - Reducing regulation.
  - Creating conditions inducive for innovation.
  - Making labor mobile.

### Securing Long-Term Fiscal Sustainability: Reforms and Adjustment
- Significant fiscal consolidation is required to address the projected increase in debt burdens.
- Policy design considerations:
  - Reforms must be appropriately bundled, sequenced, and timed to spread gains across society and countries and to build domestic support.
  - Social dialogue and strategic communication can help overcome political divide and backlash from vested interests.
  - Nimbler decision-making in the European Union would also help move decisions forward faster.

### Overcoming Policy Drift
- Recognition of the urgency to change needs to be translated into forceful action.
- Risks to reform momentum:
  - Ambitious plans—ranging from cutting red tape to introducing a 28th regime—are at risk of being watered down.
  - Prioritizing narrow national objectives over broader shared benefits and slow EU decision-making processes threaten to delay greater integration of Europe’s capital, labor, and product markets.
- Implementation levers:
  - Social dialogue and strategic communication to build support.
  - Appropriate bundling, sequencing, and timing of reforms.
  - Faster EU decision-making to accelerate integration and reform delivery.

*International Monetary Fund, Regional Economic Outlook—Europe, October 2025.*

### Executive Summary......................................................................................................v

### Executive Summary

### Europe Is Converging to a Mediocre Growth Trajectory
- Europe has skillfully weathered many large shocks, but the lingering damage is starting to leave a mark; growth momentum is fading toward a mediocre medium-term outlook.
- Recent positive growth in the first half of 2025 was driven by frontloaded exports to the United States and associated investment, with Ireland a notable contributor; excluding Ireland, growth was modest.
- Trade between the United States and the European Union accounts for almost a third of global goods and services trade and 20 percent of EU exports.
- October 2025 IMF forecast assumptions and related facts:
  - The estimated effective US tariff rate on EU goods after the US–EU trade deal is at 16.3 percent.
  - That rate is 4.3 percentage points higher than that anticipated in July and 15 percentage points higher than that in 2024.
  - The euro area’s nominal effective exchange rate has increased by 7.1 percent since March 2025.
- Headwinds to growth include higher US tariffs, a stronger euro, elevated uncertainty, and the risk that AI-related investments may produce sharp equity market valuation changes if returns disappoint.
- Financial market signals:
  - Long-term government bond yields have moved sideways or increased in many European countries.
  - Firms with higher trade exposure to the United States and higher sensitivity to uncertainty have experienced significantly larger stock price declines since April 2.

### Inflation Is on Target in Advanced Economies but Eases Unevenly across Central, Eastern, and Southeastern Europe
- Advanced economies (AEs) show inflation on target overall, but inflation dynamics are easing unevenly across Central, Eastern, and Southeastern Europe (CESEE).
- Household behavior:
  - Private consumption remained stable at modest levels.
  - Catching up of real income growth because of declining prices supported consumption.
  - Saving rates remain elevated; recent IMF analysis finds the increase in the savings rate comes mostly from cyclical factors, especially rising interest rates, with more recent contributions from sentiment factors.

### Outlook and Risks
- The growth slowdown extends across most European countries and goes beyond softening external demand.
- Key near-term risks:
  - Headwinds from uncertainty, trade tensions, and euro appreciation that dampen firms’ investment and market valuations.
  - Any financial sector repercussions would compound low productivity, an aging population, a shrinking labor force, and weak investment.
- Fiscal outlook:
  - With growth and consolidation falling short, European countries’ debt mountain could increase on average to 130 percent by 2040.
  - Associated fiscal pressures demand significant fiscal consolidation.

### Steady Macro Policies for Near-Term Stability
- Policy guidance:
  - Macroeconomic policies need to stay the course to safeguard hard-earned price stability.
  - Initiate fiscal consolidation and preserve trade openness.
  - Given the rise in international trade costs, Europe should broaden its trade relationships and promote multilateral cooperation.
- Monetary and financial policy notes:
  - Interest rate cuts and higher fiscal spending, including on defense, have so far failed to ignite private demand.
  - Increasing long-term spending pressures and lack of sufficient near-term fiscal consolidation have left investors asking for higher compensation to lend.

### Achieving Higher Growth: Moving from Recognition to Action
- The key to sustainably higher long-term growth is overcoming the perilous policy drift in structural reforms.
- EU-level priority areas include:
  - Dismantling the fragmentation in the single market.
  - Unlocking risk investment.
  - Scaling up the provision of European public goods.
  - Maximizing agglomeration gains.
- Aggregate productivity potential:
  - If just the top third of the EU’s production hubs could leverage agglomeration advantages associated with local availability of human capital and financing and research and development ecosystems as well as their US counterparts, aggregate EU labor productivity would be 8 percent higher.
- National-level priorities:
  - Reducing regulation.
  - Creating conditions inducive for innovation.
  - Making labor mobile.

### Securing Long-Term Fiscal Sustainability: Reforms and Adjustment
- Significant fiscal consolidation is required to address the projected increase in debt burdens.
- Policy design considerations:
  - Reforms must be appropriately bundled, sequenced, and timed to spread gains across society and countries and to build domestic support.
  - Social dialogue and strategic communication can help overcome political divide and backlash from vested interests.
  - Nimbler decision-making in the European Union would also help move decisions forward faster.

### Overcoming Policy Drift
- Recognition of the urgency to change needs to be translated into forceful action.
- Risks to reform momentum:
  - Ambitious plans—ranging from cutting red tape to introducing a 28th regime—are at risk of being watered down.
  - Prioritizing narrow national objectives over broader shared benefits and slow EU decision-making processes threaten to delay greater integration of Europe’s capital, labor, and product markets.
- Implementation levers:
  - Social dialogue and strategic communication to build support.
  - Appropriate bundling, sequencing, and timing of reforms.
  - Faster EU decision-making to accelerate integration and reform delivery.

*International Monetary Fund, Regional Economic Outlook—Europe, October 2025. *

### 1. Real Income Growth

### 1. Real Income Growth

### Real income and consumption dynamics
- Real income is defined as compensation per employee adjusted for the consumer price index.
- CESEE countries grew marginally lower than projected in the first quarter.
- CESEE is less reliant on the United States and hence less affected by export frontloading.
- Overall, domestic demand held up as real income growth remained solid—amid still-high wage growth—supporting consumer confidence and consumption more than in AEs.
- Strong public investment in some countries boosted first-quarter growth, although net exports remained subdued.
- In Ukraine, attacks on production facilities and weak agricultural exports offset the positive impulse from the reconstruction of energy infrastructure and continued accommodative fiscal stance.

### Labor market
- Job creation in the first half of 2025 was modest in AEs and started to trend down in CESEE.
- Labor market tightness has continued to reverse, and the average vacancies-to-unemployment ratio has fallen below the pre-pandemic level.
- The ECB’s latest wage tracker data continue to show easing pressures; however, employment expectations stay below long-term trend.
- Unemployment rates remain low in most European countries because of a declining labor force, especially in CESEE.

### Sentiment and activity indicators
- Purchasing Managers’ Index and consumer confidence series show activity and sentiment evolving across Composite, Manufacturing, and Services, and across EUR, AE excl. CESEE, and CESEE groupings (seasonally adjusted).
- Consumer confidence and PMI developments informed the assessment that consumption was better supported in CESEE than in AEs given the observed real income dynamics.

### Inflation and wages
- In the euro area, inflation has reached its target level; weak energy inflation, broad-based deceleration in services inflation, and the appreciation of the euro since February all contributed.
- United Kingdom: headline inflation started to pick up in the second half of 2024 on the back of regulated price increases, the employer National Insurance Contributions rate hike, and waning base effects from energy prices; the rise should be temporary.
- Disinflation in CESEE has been slower and uneven:
  - Inflation in most CESEE countries remained 1–3 percentage points above targets as of 2025:Q2.
  - Recently increasing again in a few countries (for example, Czech Republic, Romania, Serbia).
- Switzerland: headline inflation slowed to 0.2 percent (year over year) in July 2025, reflecting the strong Swiss franc and lower energy prices.
- Core inflation has been sticky in AEs, but services inflation—still above the target and pre-COVID trend—has begun to moderate.
- Inflation persistence has been stronger in services for many CESEE countries (Croatia, Hungary, Romania), entrenching high unit-labor cost growth and eroding competitiveness.
- Türkiye: still-high domestic demand slows disinflation, while gradual normalization of policies starts to improve the outlook.

### Inflation projections and risks
- Euro area headline inflation is expected to average 1.9 percent in 2026 and 2.1 percent in 2027.
- Euro area core inflation is expected at 2.1 percent in 2026 and 2 percent in 2027.
- Switzerland: inflation expected to reach 0.6 percent in 2026 and 0.7 percent in 2027.
- United Kingdom: inflation will converge to 2 percent by the end of 2026.
- CESEE countries: headline inflation of about 3.5 percent in 2026 and 2.9 percent in 2027; most CESEE countries will likely meet their inflation targets only in the course of 2027.
- Inflation risks are two-sided:
  - Downward risks: persistently stronger euro, further declines in energy prices, trade diversion from China.
  - Upward risks: possible countervailing duties against trade diversion, wage growth failing to moderate as anticipated.

### Specific country and regional projections
- AEs: projected growth is 1.3 percent in 2026, 1.5 percent in 2027, and converging to about 1 percent thereafter.
- CESEE: projected growth is 2.5 percent in 2026, 2.7 percent in 2027 and beyond.
- Russia: growth expected to slow to 0.6 and 1 percent in 2025 and 2026, respectively.

### Short-term drivers of household gross savings (model description)
- Panel 2 (EU: Contribution to Change in Gross Savings Rate) gives the (GDP-weighted) deviation in the household gross savings rate from its 2022:Q2 level and the model-based drivers of this deviation.
- The model is a fixed-effect panel regression (over 2000:Q1 to 2025:Q1 with fixed effects and year dummies for the global financial crisis and COVID-19, 2020/21) of the household gross savings rate on:
  - real household gross disposable income,
  - the short-term interest rate,
  - Harmonised Index of Consumer Prices inflation,
  - the general government balance (as percent of GDP),
  - general economic sentiment (European Commission survey demeaned),
  - the net financial wealth share (percent of GDP),
  - outstanding household loans (percent of GDP),
  - the old-age dependency ratio.
- Country sample: Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, the Netherlands, Portugal, and Spain. Other country grouping described in source.

### Fiscal and investment impulses
- Fiscal spending, including new defense and infrastructure spending, offers a limited demand offset of about 0.4 percentage point in 2026–27.
- NATO member EU governments announced plans to increase defense spending; the increase over the next five years is expected to be about 0.7 percent in the EU.
- An uptick in infrastructure investment mostly comes from Germany over a 12-year period, with its fiscal package, which will also boost euro area growth.
- Where defense spending results in a fiscal stimulus, near-term effects are expected to be modest because spending would be over an extended period of time, leak into imports, and, in countries with limited fiscal space, potentially delay growth-boosting investments.

### Trade, uncertainty, and exchange rate risks
- Uncertainty and trade policy will dampen euro area growth by about 0.5 percentage points in 2026–27.
- Higher tariffs constitute a direct adverse demand shock for EU exporters; uncertainty around trade policy remains very high and is expected to persist through 2026, weighing on investment and private consumption.
- Euro strengthening above the baseline would pose a downward risk for exports and growth; further appreciation could reinforce a structural reallocation in global portfolios in favor of euro area assets and add to the euro’s safe-haven status.
- Most CESEE currencies have moved in line with the euro except the Albanian lek, which strongly appreciated.

### Quantified contributions to euro area GDP growth revisions (October 2025 WEO vs. January 2025 WEO)
- Tariff/trade: −0.1 (2025), −0.2 (2026), (2027 not listed in row as given)
- Frontloading: 0.3 (2025), −0.1 (2026)
- Uncertainty & financial conditions: −0.1 (2025), −0.2 (2026), −0.1 (2027)
- Fiscal spending: 0.1 (2025), 0.2 (2026), 0.2 (2027)
- Overall impact: 0.2 (2025), −0.3 (2026), 0.1 (2027)

### Medium-term growth constraints and reform imperatives
- Europe’s medium-term growth is expected to remain subdued primarily because of low productivity growth and weakening labor supply.
- Weak and declining productivity growth presents Europe’s largest headwind to growth, particularly in AEs.
- Europe’s labor force is shrinking with population aging.
- Most CESEE countries suffer from a low capital stock because of still-depressed private investment rates.
- Analyses link low productivity to weak firm-level dynamics, stemming from:
  - large remaining intra-EU trade barriers,
  - insufficiently integrated and deep capital markets to fund innovation,
  - barriers to incentivize labor to move to areas of growth opportunities.
- A potential upside: AI could produce an estimated order of a 1 percent cumulative increase in the level of total factor productivity over five years; impact varies by AI-readiness and constrained by regional factors like electricity supply and funding for innovation.
- New analysis finds European production hubs underperform U.S. counterparts: for the same increase in employment density, European production hubs achieve about one-third less productivity gains than in the United States.
- Greater market integration, more mobile capital and labor, deeper capital and energy markets, and domestic structural reforms (labor market regulation, human capital, regulatory burden) would raise productivity and the potential benefits from AI.

### Fiscal outlook and risks
- Continued policy drift would amplify fiscal challenges: spending pressures from rising pension and health care needs, higher defense costs, energy security and climate spending are expected to double over the next two decades.
- Fiscal space is very limited for many countries because of already-high debt.
- Increasing sovereign yields underpin the importance of fiscal discipline; current market interest rates appear more sensitive to fiscal news than in the late 2010s.
- High-debt countries with high-risk premiums will see interest rates and debt servicing costs fall if they reign in deficits and put debt-to-GDP ratios on a sustainable path.
- Successful EU- and national-level reforms would alleviate some fiscal burden through higher growth, improving debt dynamics and lowering the need for difficult medium-term fiscal consolidation.

### Policy recommendations (near term)
- Maintain or transition to a neutral monetary policy stance in countries with inflation on target.
- Initiate fiscal adjustment at a pace attuned to fiscal risks and the cyclical position.
- Pursue EU-level and national structural reforms to deepen the single market, operationalize the capital markets union, reduce intra-EU barriers, and address domestic structural gaps to lift productivity and medium-term growth.

*International Monetary Fund — October 2025, Regional Economic Outlook: Europe (excerpt: "1. Real Income Growth").*

### 1. Core Defense Spending in European Union

### 1. Core Defense Spending in European Union

### Core defense spending: definition and presentation
- According to NATO accounting, core defense spending refers to government expenditures essential for the maintenance and operation of national armed forces, mainly those recorded in the Ministry of Defense budget.
- It covers personnel, operations, equipment procurement and maintenance, military pensions, research and development, peacekeeping, and contributions to NATO common infrastructure.
- Spending outside these core military functions, such as civil defense or war damage payments, is excluded.
- In the figure, whiskers span 50 percent of the data, from the bottom 25 percent to the upper 75 percent.

### Infrastructure spending: EU country sample (panel 2)
- EU country samples include Austria, Czech Republic, Denmark, Finland, France, Germany, Greece, Italy, Portugal, Slovenia, Spain, and Sweden.

---

### Monetary Policy: An Anchor by Remaining Focused on Price Stability

### Recent policy moves and stance
- The ECB has reduced its policy rate by a cumulative 200 basis points since it started its easing cycle in the second quarter of 2024 as inflation started to decline more durably, moving to a neutral stance.
- The Swiss central bank has progressively cut the interest rate to zero in response to sustained disinflation and negative output gaps.
- Some countries (for example, Iceland, Poland, Serbia) have maintained a tighter policy stance with real rates above neutral rates, reflecting inflation above target.

### Guidance and conditional thresholds
- With price stability within reach, policy decisions can become guided less by the latest data and more by forward-looking analysis; central banks must remain vigilant for unexpected changes in inflation or its drivers (wage growth, energy prices, inflation expectations, monetary transmission).
- In advanced economies (AEs), policy rate calibration should provide sufficient flexibility in response to significant inflation developments.
- Example calibration: with inflation expectations well anchored, it would take a cost shock that reduces core inflation by 0.2 percentage point for four consecutive quarters to justify a 25 basis point policy rate adjustment.
- If a shock materially alters the expected trajectory of inflation, monetary policy should respond decisively because the welfare costs of underestimating inflation persistence outweigh those of overestimating.

### Country-specific notes
- United Kingdom: the current gradual approach to further policy easing still strikes the right balance between supporting the economy and managing inflation risks.
- Switzerland: with limited room for further easing, careful tool calibration and enhanced communication are essential to guide expectations.
- CESEE: where inflation remains stubbornly above the target (for example, Hungary, Poland, Romania), monetary policy must account for lingering asymmetric risks and robust wage growth that may spill over into higher service prices; premature loosening risks de-anchoring inflation expectations.

---

### Financial Policy: Steering through Uncertainty

### Banking sector resilience and risks
- Banks are resilient, but elevated uncertainty and slower growth increase credit risks and reinforce the need for macro-prudential buffers.
- Capital and liquidity levels are generally strong, supported by steady—though slower—profit growth.
- Asset quality remains robust, with euro area banks’ nonperforming loans near record lows and credit quality continuing to improve in CESEE.
- The gradual recovery in real estate prices could mitigate the asset quality risk of some banks.
- Rising trade tensions could negatively affect corporate sector profitability and insolvency—especially for highly export-oriented and tariff-sensitive sectors (for example, steel and automotive)—implying credit risks for banks with higher exposure to extra-EU trade.
- Policy recommendation: macroprudential capital buffers should remain sufficient to preserve banking sector resilience complemented with microprudential responses where necessary.
- Banks should implement prudent lending standards and risk management practice, including appropriate asset classification and adequate provisioning.
- Maintaining borrower-based measures is essential for sound lending standards throughout the financial cycle (ECB 2025).

### Nonbank financial institutions (NBFIs) and crypto-related risks
- Liquidity and leverage vulnerabilities in the NBFI sector call for robust prudential policies and systemwide stress tests, as well as more data.
- Nonbanking financial institutions remain vulnerable to asset repricing and outflows induced by soaring market volatility.
- Increased interconnectedness of nonbanks, European banks’ exposure to NBFI risks, and vulnerabilities within the NBFI sector (including low liquidity and high leverage among certain participants) indicate a need for prudential measures (for example, leverage limits and liquidity requirements) and acceleration of plans for an EU system–wide stress test.
- Strengthening the resources and prudential powers of supranational authorities with oversight of NBFIs is critical given interlinkages between banks and nonbanks.
- Crypto assets and stablecoins are more widely used and mainstreamed with looming risks for financial stability, requiring enhanced monitoring.
- Significant use of stablecoins can have unintended consequences for monetary autonomy and monetary policy transmission and could amplify market volatility and lack of transparency through interconnectedness with traditional finance.
- To reduce potential dependence on decentralized private money, the EU is considering accelerating plans for the digital euro.
- Digital euro design considerations: non-remunerated holdings and individual balance caps are under consideration to balance benefits and risks; overly restrictive design choices could limit uptake and adjustments to these features over time could enhance benefits.

---

### Trade Policy: Judicious Use of Safeguard Measures and Expanding Internal and External Trade

### Principles for trade policy response
- Europe should remain committed to expanding trade by upholding open trade policy and strengthening regional and global agreements while recognizing shifting trade rules.
- Safeguards, if used, should adhere to World Trade Organization principles, be time limited, and be clearly communicated.
- Other support measures to mitigate tariff effects should be temporary, targeted, and directed at clear market failures.
- Policymakers should establish clear, transparent, and time-consistent trade-policy road maps to reduce uncertainty and support investment (IMF 2025c).

### Recent evidence and risks
- As of July 2025, there is limited evidence of trade diversion from China and other countries to the European Union despite the weakening of the Chinese renminbi alongside the US dollar.
- Import growth from China has not meaningfully accelerated in 2025, and the share of imports from China in total extra-EU and euro area imports has remained broadly stable.
- The EU trade surplus appears to weaken, and downside risks persist as gross data may understate trade diversion and long-term reallocation may be significant.

### Policy options to offset higher US tariffs
- Lowering implicit intra-EU barriers to trade by about 1¼ percentage points or lowering external trade barriers to the rest of the world by 3½ points could offset the effects of tariffs on EU exports introduced by the United States.
- Intermediate options are possible—for example, trading off 1 percentage point less effort in external tariff reduction for a ½ point further reduction in internal barrier reduction.
- Reductions would amount to only a fraction of the still significant intra-EU barriers estimated at an ad valorem equivalent cost of 44 percent on average for manufacturing sectors (as of 2020).
- Reducing external trade barriers will require cooperation with other countries; estimated remaining barriers to external goods trade are nearly twice the intra-EU level.
- Examples of external trade policy actions: ratifying the trade agreement with Mercosur; building deeper relationships with Switzerland and the United Kingdom; launching free trade agreement negotiations with the United Arab Emirates and other Gulf Cooperation Council countries; concluding a free trade agreement with Association of Southeast Asian Nations member countries.

---

### Achieving Higher Growth: Moving from Recognition to Action

### Three-pillar strategy outcomes and potential gains
- A three-pillar strategy could help advance national structural reforms and the EU single market, delivering substantial output dividends for the EU—of at least 9 percent in 10 years (Box 3).
- National-level reforms to improve labor and capital allocation can lift total factor productivity, the main driver of Europe’s substantive GDP per capita gap with the United States.
- Reforms include labor, fiscal-structural, business regulation, innovation, and governance reforms; better digital preparedness could raise potential benefits from AI.
- Potential gains from closing 50 percent of the policy gaps:
  - Over 9 percent in the Western Balkans.
  - 7 percent in CESEE countries.
  - About 5 percent in AEs.
- A more integrated EU single market can boost EU GDP by at least 3 percent over the next 10 years by addressing binding constraints that hinder firms’ ability to innovate and scale up within the EU single market.

*Source: text - 1. Core Defense Spending in European Union — https://www.imf.org/-/media/files/publications/reo/eur/2025/october/english/text.pdf*

### Box 2 in October 2025 Regional Economic Outlook: Europe Note 2 ”Making European Reforms a Success on the Ground” of this

### Box 2 — Making European Reforms a Success on the Ground (October 2025 Regional Economic Outlook: Europe Note 2)

### Internal trade barriers and comparison with the United States
- Analysis uses aggregated manufactured and mining goods trade data allowing direct comparison with the US (aggregated rather than sectoral approach).
- Intra-EU barriers for aggregate manufacturing goods hovered around 40 percent between 2007 and 2022.
- Intra-US barriers ranged between 21 and 26 percent over the same period.
- These internal barriers have remained roughly constant between 2007 and 2022 and are significantly higher than barriers to trade between US states.

### Estimated GDP level impacts from reforms
- The estimated level impact of about 9 percent 10 years out is derived by compounding:
  - Estimated impact of national reforms in EU countries of 5.7 percent (which bear fruit five years out).
  - Gains from single market reforms identified in Arnold and others (2025), which bear fruit over a 10-year period.
- These gains are described as a lower bound given:
  - Scope for further single market deepening.
  - A concerted EU- and national-level push likely amplifying effects.

### Regional and distributional effects of integration and reforms
- Synergies and complementarities between national- and EU-level reforms:
  - Allow for higher and longer-lasting growth gains, lifting GDP per capita across most regions.
  - Larger economic hubs (more open) would see the largest gains from exploiting economies of scale.
  - Less dense areas would on average gain in GDP-per-capita terms through greater access to cheaper and more varied goods.
  - A few regions may lose out as workers move to new opportunities, calling for targeted transfers to lagging regions to ensure gains are widely shared and resources remain productively allocated.

### Fiscal sustainability: projections and reform scenarios
- Without a bold policy response, over a 15-year horizon with no growth reforms, no fiscal consolidation, and no change in public programs:
  - Debt for the average European country would reach 130 percent of GDP by 2040.
  - On a GDP-weighted average basis, debt would reach 155 percent of GDP by 2040.
  - This is described as roughly a doubling from today’s level and would endanger debt sustainability.
- Two reform package scenarios (impact on average country debt-to-GDP ratio by 2040, relative to unchanged policy path):
  - “Ambitious” reform package (national and EU-level reforms, pension reforms, policies to catalyze private investment, deeper single market integration, greater centralization of EU public goods):
    - Would reduce the average country’s debt-to-GDP ratio by 25 percentage points by 2040.
    - Moves the debt trajectory about half of the way from the unchanged policy path toward the sustainable reference debt path.
  - “Moderate” reform package (implements about half of the ambitious reforms):
    - Would reduce the debt-to-GDP ratio by 15 percentage points by 2040, bringing the average country one-third of the way toward the reference path.
- Remaining gap to the reference debt path must be covered by fiscal consolidation; intensity depends on countries’ starting debt levels and circumstances.
- Reference path: based on a long-term debt anchor of 90 percent of GDP so that for the average European country, debt would remain below 90 percent of GDP from now until 2040 (not implying identical paths for all countries).

### Fiscal adjustment needs across countries
- Under the “moderate” reform package:
  - About three-quarters of European countries need fiscal consolidation to achieve the sustainable debt path.
  - The average European country would require an improvement in the CAPB of slightly above 3½ percent of GDP over the next five years.
- Under the “ambitious” reform package:
  - Fiscal adjustment needs for the average country could drop to slightly below 3 percent of GDP over the same horizon.
- For about one-quarter of European countries (mostly high-debt countries):
  - Consolidation of above 5 percent over five years would be required to achieve the sustainable debt path.
  - This exceeds the cumulative 3–4 percentage point improvement in CAPB achieved during previous periods of fiscal adjustment in Europe.
- Policy implications for high-debt countries:
  - May require tougher decisions: ramp up growth-lifting reforms or align public spending with available resources.
  - Possible discussions about the social contract in some AEs, involving trade-offs between spending priorities and protection of vulnerable households.
  - Some CESEE countries might have room to raise tax rates from relatively low levels.

### Costs of delaying reforms
- Delaying reforms increases adjustment needs:
  - If reforms are implemented with a five-year delay, the fiscal adjustment need increases by 1½ percentage points under the “moderate” reform package, from just above 3½ to more than 5 percent of GDP.

### Implementation strategies to increase reform success
- Communication and institutional trust:
  - Early outreach and clear articulation of objectives build consensus and correct misinformation (examples: Netherlands disability insurance reform 2002–06; Poland 1999 pension reform).
  - Strategic framing can improve public support; capacity development and robust monitoring are essential in non-EU CESEE countries.
- Social dialogue and independent institutions:
  - Platforms for social dialogue and engagement with unions and employers facilitate reform acceptance (examples: Germany’s Hartz reforms; Denmark’s tripartite negotiations and “flexicurity”).
  - Independent bodies (for example, Netherlands Bureau for Economic Policy Analysis) offer objective assessments fostering trust and reducing political resistance.
- Bundling, sequencing, and timing of reforms:
  - Bundling reforms helps spread gains more evenly across regions; careful sequencing can amplify impact and ease adoption.
  - Packages that provide net gains to a wide range of stakeholders (example: Hartz reforms paired benefit cuts with active labor market policies) can reduce resistance.
  - Governance reforms that first build trust increase benefits of later measures (examples: Estonia and Latvia).
  - Combining major pension and labor reforms may overwhelm workers—careful sequencing is preferable.
  - Implementing reforms during strong economic periods can improve public support and sustainability (example: Germany’s retirement age increase initiated in 2012).

### EU-level governance, budgetary tools, and decision-making
- To enhance resilience, reduce energy costs and volatility, and accelerate decarbonization, the EU must:
  - Establish a comprehensive, data-driven blueprint aligning national- and EU-level policies, close information gaps, and identify where joint action delivers greatest cost savings and impact.
  - Ensure better coordination and buy-in at implementation stage from both national and EU bodies.
- Suggested reforms to the EU Multiannual Financial Framework (Busse and others 2025):
  - Expand the provision of EU-level public goods.
  - Streamline the budget to enhance flexibility and performance-based budgeting.
  - Integrate common debt as a regular financing tool.
  - This approach would enable strategic coordination of reform efforts and investment in public goods to maximize impact.
- Policymaking process reforms to support structural reform agenda:
  - Consider adapting the EU’s policymaking hierarchy and shortening decision-making processes (for example, moving toward majority voting rather than unanimity, or allowing carve-outs for progress among the willing under unanimity).
  - Reduce regulatory fragmentation by introducing fully harmonized EU-level legislation from the outset, prioritizing regulations over directives whenever possible.
  - Strengthen enforcement of directives to prevent gold-plating and ensure consistent implementation.

### CESEE: spillovers from EU and global shocks (summary from Box 1 material included)
- CESEE countries have become more integrated in Europe’s single market, increasing exposure to euro area and global developments.
- Supply-side shocks in the euro area transmit substantively to CESEE output through production structures; countries deeply embedded in European manufacturing networks (for example, North Macedonia and Romania) closely follow euro area industrial output fluctuations.
- The effects of such shocks can last up to a year as they move through value chains via forward and backward linkages.
- Trade linkages are the key transmission channel:
  - Euro area shocks transmit more strongly to CESEE countries with stronger trade integration with the euro area.
  - Euro area shocks account for approximately 7.5–11.5 percent of the variance in industrial production over two years in CESEE EU member states, compared to less than 7.5 percent in the Western Balkans.
  - Less open economies in the Western Balkans are predominantly affected by domestic shocks.

*Source: Box 2 in October 2025 Regional Economic Outlook: Europe Note 2 ”Making European Reforms a Success on the Ground”.*

### Box 1. (continued)

### Box 1. (continued)

### Commodity price shocks and inflation dynamics in CESEE
- Global commodity prices are a key driver of inflation in CESEE.
- Price shocks contribute up to 35 percent to inflation variability after one year (Figure 1.3).
- Energy price shocks have a more pronounced impact in CESEE countries with high reliance on imported energy, elevated energy intensity, and limited energy source diversification.
- Food price shocks account for up to 20 percent of inflation variability in some countries, driven by the substantial weight of food in the consumer price index baskets across the region.
- Contributions to the long-term variance in economic activity: 30 percent to the long-term variance in their economic activity (versus 10–20 percent in CESEE EU countries).

### Policy findings and implications for convergence and resilience
- These results, in line with previous IMF advice (IMF 2024c; Kammer 2025b), underscore that safeguarding convergence will require policies to:
  - strengthen resilience to external shocks,
  - deepen the benefits of integration, and
  - ensure that CESEE countries can sustain robust and inclusive growth despite a turbulent global environment.
- EU accession offers a pathway to accelerate growth, where short-term volatility is outweighed by substantial long-term income gains.

*International Monetary Fund. Overcoming Europe’s Policy Drift: From Recognition to Action. October 2025.*

### Annex Table 1.1. Real GDP Growth

### Annex Table 1.1. Real GDP Growth

### Europe (aggregate)
- Europe: 1.9 1.5 1.6 1.8 1.4 1.6 1.7 0 .100 .1

### Advanced European Economies (aggregate)
- Advanced European Economies: 1.1 1.3 1.3 1.5 1.3 1.4 0.300 .1

#### Euro Area and selected members
- Euro Area: 0.9 1.2 1.1 1.4 0.8 1.2 1.3 0.4−0 .10 .1
- Austria: −10.30.81.6−0.30.81.60.600
- Belgium: 11.111.30.811.20.300 .1
- Croatia: 3.93 .12.72.63 .12.72.6000
- Cyprus: 3.42.92.82.82.52.730.40 .1−0.2
- Estonia: −0 .10.51.51.80.71.81.8−0.2−0.30
- Finland: 0.40.51.31.311.41.4−0.5−0 .1−0 .1
- France: 1.10.70.91.20.611.20 .1−0 .10
- Germany: −0.50.20.91.500.91.50.200
- Greece: 2.3221.521.81.300.20.2
- Ireland: 2.69.11.32.52.32.12.16.8−0.80.4
- Italy: 0.70.50.80.60.40.80.60 .100
- Latvia: −0.412.22.422.52.5−1−0.3−0 .1
- Lithuania: 2.72.72.92.12.82.52.5−0 .10.4−0.4
- Luxembourg: 0.41.22.12.31.62.22.3−0.4−0 .10
- Malta: 6.83.93.943.93.94000
- Netherlands: 1.11.41.21.41.41.41.40−0.20
- Portugal: 1.91.92.11.521.71.5−0 .10.40
- Slovak Republic: 2.10.91.72.51.31.72.5−0.400
- Slovenia: 1.71.12.32.51.82.42.5−0.7−0 .10
- Spain: 3.52.921.72.51.81.70.40.20

#### Nordic Economies and selected members
- Nordic Economies: 1.91.21.91.72.21.91.7−100
- Denmark: 3.51.82.21.62.91.81.6−1.10.40
- Iceland: −11.42.32.422.42.5−0.6−0 .1−0 .1
- Norway: 2.11.21.61.62.11.71.6−0.9−0 .10
- Sweden: 0.80.71.91.81.92.21.9−1.2−0.3−0 .1

#### Other European Advanced Economies and selected members
- Other European Advanced Economies: 1.11.51.61.71.31.71.70.2−0 .10
- Andorra: 3.42.41.61.51.91.61.50.500
- Czech Republic: 1.22.3221.61.81.90.70.20 .1
- Israel: 12.53.93.33.23.63.3−0.70.30
- San Marino: 0.711.31.211.31.2000
- Switzerland: 1.40.91.31.10.91.61.20−0.3−0 .1
- United Kingdom: 1.11.31.31.51.11.41.50.2−0 .10

### Emerging European Economies (aggregate)
- Emerging European Economies: 3.51.82.22.42.12.12.3−0.30 .10 .1

#### Central Europe and selected members
- Central Europe: 2.52.82.92.72.933−0 .1−0 .1−0.3
- Hungary: 0.50.62.12.31.42.62.8−0.8−0.5−0.5
- Poland: 2.93.23 .12.93.23 .1300−0 .1

#### Eastern Europe and selected members
- Eastern Europe: 4.20.81.31.51.51.21.5−0.70 .10
- Belarus: 42.11.41.62.821.4−0.7−0.60.2
- Moldova: 0 .11.72.23.50.62.551.1−0.3−1.5
- Russia: 4.30.611.11.50.91.1−0.90 .10
- Ukraine: 2.924.54.824.54.8000

#### Southeastern European EU Member States and selected members
- Southeastern European EU Member States: 1.31.41.82.81.82.73 .1−0.4−0.9−0.3
- Bulgaria: 2.833 .12.82.52.72.70.50.40 .1
- Romania: 0.811.42.71.62.83.2−0.6−1.4−0.5

#### Southeastern European Non-EU Member States and selected members
- Southeastern European Non-EU Member States: 3.62.83.43.93.43.73.8−0.6−0.30 .1
- Albania: 43.43.63.53.83.53.5−0.40 .10
- Bosnia and Herzegovina: 32.42.732.833−0.4−0.30
- Kosovo: 4.63.943.9443.9−0 .100
- Montenegro: 3.23.23.233.23.23000
- North Macedonia: 2.83.43.23.23.23.23.20.200
- Serbia: 3.92.43.64.63.54.24.5−1.1−0.60 .1

#### Türkiye
- Türkiye: 3.33.53.73.72.73.23.40.80.50.3

### Memorandum (selected country aggregates)
- World: 3.33.23 .13.22.833.20.40 .10
- Advanced economies: 1.81.61.61.71.41.51.70.20 .10
- Emerging market and developing economies: 4.34.244.23.73.94.20.50 .10
- Emerging and developing Europe: 3.51.82.22.42.12.12.3−0.30 .10 .1
- Emerging Europe excl. Belarus, Russia, Türkiye and Ukraine: 2.22.42.72.92.633 .1−0.2−0.3−0.2
- European Union: 1.11.41.41.61.21.51.60.2−0 .10
- United States: 2.822.12.11.81.720.20.40 .1
- China: 54.84.24.2444.20.80.20
- Japan: 0 .11.10.60.60.60.60.60.500

*Sources: IMF, World Economic Outlook (WEO); and IMF staff calculations.*

---


_Source: https://www.imf.org/-/media/files/publications/reo/eur/2025/october/english/text.pdf_