## _cr06287 ## Source details **Canonical URL:** [_cr06287](https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06287.pdf) ## Other formats - [Markdown version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06287.pdf.md) - [Structured JSON version](/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06287.pdf.json) --- ### Recovery, growth, and near-term outlook - Growth has picked up and broadened over the past twelve months after several years of disappointments. - During 2003-05 euro-area real GDP and domestic demand growth averaged only about 1½ percent. - Real GDP, final domestic demand, and household consumption all grew between 1¾-2 percent in the year through 2006:Q1. - Recovery may surprise on the upside during 2006 but remains fragile and relies on strong global growth. - Risks move to the downside further ahead given uncertainties in oil, currency, and financial markets. ### Inflation, monetary policy, and money - Headline HICP inflation reached 2.5 percent in May; core inflation (HICP excluding energy and unprocessed food) is running around 1½ percent. - Staff project inflation to fall back below 2 percent in 2008 absent significant indirect or second-round effects. - ECB raised its policy rate by 25 basis points in December, March and June, to 2.75 percent. - ECB rationale: headline inflation persistently above “close to but under 2 percent” objective since 2000; further tax/administered price hikes (notably VAT in Germany in 2007) and energy prices expected to keep inflation elevated near term. - Monetary aggregates and credit: M3 growth averaged 7½ percent in 2005; private sector credit expanding at double digit rates and broadening across sectors. - Staff view: monetary policy should remain accommodative until the recovery broadens—evidence being quickening employment—or signs of accelerating underlying price pressures. - Market and survey indicators: - Professional forecasters expect inflation to average 1.9 percent over the medium run. - 47 percent of those regularly surveyed expect headline inflation above 2 percent over the medium run (up from about 40 percent one year ago). - Break-even inflation rates have risen though survey measures remain anchored. ### Corporate sector, investment, and banks - Nonfinancial corporate profitability strong; leverage brought under control. - Market-based financing recovering; bank-based borrowing picked up more than a year ago and remains robust. - Enterprise loans largely funded restructuring and consolidation; lending surveys indicate capital expenditures are no longer a drag outside construction. - Limited retrenchment since the peak may curb investment growth going forward. - Financial sector indicators: many banks well capitalized and booking record profits; improvements supported by low interest rates, low costs of risk, cost containment, and booming mortgage demand. - Insurance sector weaker: record catastrophe claims (reinsurers) and negative repercussions from low interest rates; life insurers lowering or phasing out guaranteed rates of return. ### Fiscal positions, the SGP, and fiscal guidance - Take advantage of the recovery to make significant progress toward achieving broadly balanced fiscal positions by 2010, preferably by cutting expenditure in a manner that fosters labor supply. - Adjustment in 2005 exceeded projections; reformed Stability and Growth Pact (SGP) seen as gaining traction over fiscal policies in high deficit countries. - Staff advised eliminating fiscal deficits through annual structural adjustments of at least ½ percentage point of GDP; medium-term objective (MTO) emphasis on reducing public debt. - Recommendation for countries at some distance from underlying balance: identify measures equivalent to at least ½ percent of GDP annual adjustment over the coming years, focused on the expenditure side. - Cyclically-adjusted fiscal balance for the euro area improved by close to ½ percent of GDP in 2005. - Concern: absent significant reductions in cyclically-adjusted deficits the EDP in some countries risks becoming open-ended and damaging the Pact. ### Medium-term outlook, productivity, and demographics - Staff marked down potential real GDP growth to 1.8 percent. - Area productivity growth disappointing; improving corporate performance rooted mainly in cost containment, wage moderation, outsourcing, and reduced corporate taxation. - Population growth decelerating sharply and expected to turn negative around the turn of the decade; EU population will begin to fall around 2010. - AWG “no policy change” scenario: aging-related spending would rise by about 3¾ percent (4½ percent) of GDP on a net (gross) basis through 2050. - AWG plausible alternatives: net increase might well be 6 percentage points of GDP; allowing health care costs to rise with wages and assuming slowly growing formal long-term care would add a further 1½ percent of GDP. - Staff fiscal requirement: achieve structurally balanced budgets by 2010. ### Labor, productivity, and recommended structural reforms - Employment growth strong over the past decade; business-sector employment growth amounted to 15.2 percent in the euro area during 1995-2005 versus 12.2 percent in the United States. - Unemployment remains stubbornly high and participation rates low. - Productivity slowdown has offset a significant part of increased labor utilization of the past decade; likely drivers include high job turnover costs and insufficient competition in product and services markets. - Policy priorities: - Accelerate reform of product and services markets to ensure labor market restructuring translates into more employment rather than higher rents. - Use National Reform Programs under the reformed Lisbon Agenda to design consistent structural policies and develop national ownership. - Strengthen competition in services (services account for roughly two-thirds of EU GDP; only 8 percent of services output is traded). - Boost R&D spending (target 3 percent of GDP) and consider a European Institute of Technology. - Improve exploitation of ICT and human capital; reduce domestic regulation that limits tradability. ### External position, exchange rate, and global imbalances - External current account broadly balanced with modest net borrowing by corporate and public sectors; household savings stable for the area as a whole. - Real effective exchange rate of the euro broadly sideways around 5 percent above its long-term average over the past couple of years after 2002–03 appreciation. - Staff estimates: effective exchange rate within a range compatible with (or slightly above) medium-term equilibrium given cyclical position, net foreign liabilities, and terms of trade. - Exposure to a disorderly resolution of global imbalances: a sharp, multilateral appreciation of the euro (e.g., if dollar sentiment sours) could warrant an easing of monetary policy, assuming no other inflation outlook changes. - Trade policy priorities: - Conclude an ambitious Doha Round; effective access to EU agricultural markets is key. - Resist undisciplined bilateralism; seek stronger international discipline on FTAs and simple, liberal rules of origin. - Commission’s Aid for Trade agenda grew some 40 percent to almost euro 1 billion in 2005. ### Financial integration, supervision, and crisis preparedness - Unlocking financial integration can provide growth fillips while safeguarding stability. - Staff advocate tackling vested interests that impede integration of financial infrastructure and nation-specific layers added to EU-wide regulations. - Clarify and further integrate supervisory powers over complex cross-border groups to improve financial stability policies. - Priorities: - Remove remaining cross-border barriers (clearing and settlement, securities infrastructure). - Improve information flows between supervisors via a central repository on systemically-important financial institutions. - Adapt business continuity plans across the Eurosystem; prepare for a potential pandemic. - New Directive on AML/CFT promulgated October 2005; full implementation expected by end-2007. ### Risks, scenarios, and elasticities - Staff foresees actual growth around 2 percent in 2006; faster recovery scenario suggests 2½ percent output growth for 2006:Q2 and Q3. - Risks: - Near term: balance of risks somewhat to the upside. - Beyond 2006: risks skewed to the downside—dependency on external demand, global imbalances and exchange rate risk, flight from risk in capital markets, volatile oil prices, avian flu. - Richly-valued housing stocks and high household debt in some regions pose hazards for consumption as interest rates rise. - Staff estimate: a 10 percent hike in oil prices reduces real GDP growth by 0.2 percentage points and directly raises inflation by 0.1 percentage points. - Staff estimate: an increase by 10 percent per barrel would add 0.1 percent to inflation (Appendix II summary). ### Key quantitative indicators (selected series as reported) - Real GDP (in percent change): 3.0, 3.9, 1.9, 0.9, 0.8, 2.1, 1.3, 2.1, 1.8 - Private consumption (in percent change): 3.4, 3.2, 1.9, 0.9, 1.0, 1.5, 1.3, 1.8, 1.5 - Unemployment rate (in percent): 9.2, 8.2, 7.8, 8.3, 8.7, 8.9, 8.6, 8.0, 7.9 - Consumer prices (in percent change): 1.1, 2.1, 2.3, 2.2, 2.1, 2.1, 2.2, 2.2, 2.2 - General government balance (in percent of GDP): -1.3, -1.0, -1.9, -2.6, -3.0, -2.7, -2.3, -2.1, -2.0 - General government structural balance (in percent of GDP): -1.3, -1.7, -2.5, -2.7, -2.7, -2.4, -2.0, -1.8, -1.6 - General government gross debt (in percent of GDP): 72.1, 69.6, 68.3, 68.1, 69.3, 69.8, 70.8, 70.2, 69.6 - Current account balance (in percent of GDP, memorandum item): 0.4, -0.6, 0.2, 0.7, 0.5, 1.0, -0.1, -0.2, -0.2 ### Banking sector macro-prudential indicators (selected) - Regulatory capital to risk-weighted assets*: 11.00, 13.78, 11.36, 11.61, 11.50 - Regulatory Tier I capital to risk-weighted assets*: 7.24, 9.01, 8.35, 8.36, 8.42 - Loans to customers (percent of total assets): 43.73, 46.50, 46.37, 49.06, 48.40, 48.39 - NPLs to gross loans* (selected years): 3.60, 3.44, 3.41, 3.05 - ROA* (after tax and extraordinary items): 0.19, 0.29, 0.22, 0.30, 0.31, 0.42 - ROE* 1/: 11.54, 7.51, 5.74, 7.62, 7.76, 10.54 - Liquid asset ratio 1 (cash and T-bills): 4.59, 1.84, 1.87, 2.27, 2.32, 2.60 - Liquid asset ratio 2 (ratio 1 + loans to credit institutions): 18.98, 20.97, 20.05, 19.95, 19.53, 19.12 (*) Items included in the "core set" of FSIs. 1/ After tax and extraordinary items. ### Balance of payments and external statistics (selected) - Current account (in billions of euros, not seasonally adjusted): -99.2, -21.5, 53.3, 32.4, 49.7, -22.6, -10.0 - Current account (in percent of GDP): -1.5, -0.3, 0.7, 0.4, 0.6, -0.3, -0.5 - Net investment position (in percent of GDP): Assets 102.8, 110.8, 102.5, 106.5, 111.4, 131.8; Liabilities 110.6, 116.4, 112.2, 117.3, 123.6, 145.0; Net investment position -7.8, -5.6, -9.7, -10.9, -12.2, -13.1 - Memorandum: GDP (in billions of euros): 6,710.7, 6,999.9, 7,245.8, 7,453.0, 7,750.2, 7,997.6, 8,203.0 ### Statistical issues and data developments - Two major changes introduced in the euro area accounts at end-2005: (i) allocation of FISIM to final and intermediate consumption and net exports; (ii) use of chain-linked volume measures. Series revised back to 1995; publication for earlier years suspended. - Allocation of FISIM implied an upward revision to GDP levels, amounting to about 1 percent for recent observations. - Revised pre-1995 data unlikely to become available before end of the year at the earliest. - Eurostat and ECB released euro area accounts per institutional sector (annual coverage 1999–2004); quarterly institutional-sector accounts planned from spring 2007. - Gaps/weaknesses remain: intra-EU trade asymmetries, lack of harmonized high-frequency housing market indicators, comparability issues for labor productivity and hours worked, and adaptation of structural indicators to the 2005 Lisbon revamp. ### Staff appraisal: principal judgments and policy recommendations - The euro area is emerging from the doldrums and needs to translate cyclical rebound into sustained growth; persistently sluggish productivity inhibits sustained growth. - Policy package: harness synergies of fiscal adjustment, labor supply reforms, and competitive product and services markets; accelerate integration with NMS and the rest of the world. - Monetary policy: with inflation projected to ease over 24 months and activity uncertain beyond near term, monetary policy can remain accommodative; further tightening can await a firming of the recovery evidenced by accelerating employment. - Fiscal policy: consolidate during the recovery to rebuild buffers for aging-related pressures; reformed SGP regaining traction but preventive mechanisms could be buttressed by non-partisan national governance mechanisms (e.g., delegated independent forecasting). - Trade policy: redouble efforts to bring the Doha Round to a successful conclusion and resist undisciplined bilateralism; effective liberalization of agricultural market access is a priority. - Financial integration and supervision: remove remaining cross-border barriers (notably in clearing and settlement), clarify supervisory powers over complex cross-border groups, improve information-sharing and crisis coordination. *Source: IMF staff report excerpt (content unit _cr06287_).* ### Executive Summary ...................................................................................................... ### Executive Summary ### Recovery, growth, and near-term outlook - After several years of disappointments, growth has picked up and broadened over the past twelve months. - During 2003-05 euro-area real GDP and domestic demand growth averaged only about 1½ percent. - Real GDP, final domestic demand, and household consumption all grew between 1¾-2 percent in the year through 2006:Q1. - The recovery has been gaining traction and may even surprise on the upside during 2006, but the pick up in activity remains fragile and relies on strong global growth. - Risks move to the downside further ahead given uncertainties in oil, currency, and financial markets. ### Inflation and monetary policy - Headline HICP inflation reached 2.5 percent in May and is likely to stay above 2 percent for some time due to energy prices, further administered price hikes, and the expected VAT increase in Germany in 2007. - Core inflation (HICP excluding energy and unprocessed food) is running around 1½ percent. - Staff project inflation to fall back below 2 percent in 2008, as exogenous shocks have not triggered significant indirect or second-round effects. - There was broad agreement on the economic outlook but the ECB saw the risks to price stability more skewed to the upside than the staff. - The latest ECB rate hike is consistent with staff’s views, but staff advise that further withdrawal of accommodation should await a broadening of the upswing—as evidenced by quickening employment—or signs of accelerating underlying price pressures. ### Corporate sector and investment - Nonfinancial corporate profitability has been strong and leverage has been brought under control. - Market-based financing activities have begun to recover from recent lows; bank-based borrowing picked up more than a year ago and remains robust. - Enterprise loans have largely funded restructuring and consolidation; lending surveys indicate capital expenditures—previously stuck in a holding pattern outside construction—are no longer a drag. - Limited retrenchment since the peak may curb investment growth going forward. - Indicators show improving equity markets, reduced income leverage, recovering equity markets reducing balance sheet leverage, and increased corporate cash holdings. ### Banking and financial sector - Financial sector indicators point to improving positions: many banks are well capitalized and booking record profits. - Bank improvements have been supported by favorable financial market developments, low interest rates, low costs of risk, cost containment, and booming demand for mortgage loans. - Fundamental soundness has also been supported by improvements in governance, risk management, and regulation and supervision. - The insurance sector shows a less strong picture, suffering record catastrophe claims (reinsurers) and negative repercussions from low interest rates; life insurers have recently either lowered or phased out guaranteed rates of return. ### Fiscal and structural policy recommendations - Take advantage of the recovery to make significant progress toward achieving broadly balanced fiscal positions by 2010, preferably by cutting expenditure in a manner that fosters labor supply. - Adjustment in 2005 has exceeded projections and the reformed Stability and Growth Pact was seen as gaining traction over fiscal policies in high deficit countries. - Countries plan to move toward balanced budgets over the medium run, but plans are vague and prospects remain uncertain. - Accelerate reform of product and services markets to ensure that labor market restructuring translates into more employment rather than higher rents. - The National Reform Programs under the reformed Lisbon Agenda offer an avenue for designing consistent structural policies and developing national ownership of the Agenda. - Authorities pointed to the adoption of a directive that opens EU services markets to competition, even if less than originally sought. - Unlock the potential of financial integration to provide a fillip to growth while safeguarding stability. - The Commission noted major progress since EMU and new initiatives to foster supervisory collaboration and coordination. - Staff advocate tackling vested interests that hold up integration of financial infrastructure and add nation-specific layers to EU-wide regulations, and argue for clarification and further integration of supervisory powers over complex cross-border groups to improve financial stability policies. ### Labor, productivity, and demographic challenges - Key concerns focused on the area’s capacity to simultaneously stage solid employment and productivity growth over the medium run. - A marked slowdown in productivity growth has offset a significant part of the increased labor utilization of the past decade. - Population decline is set to start around 2010. - Adjusting Europe’s welfare states remains an uphill struggle; mutually reinforcing fiscal and structural policies are needed to address these medium-term challenges. ### External position and exchange rate - The area’s external current account is broadly balanced, with modest net borrowing by the corporate and public sectors. - Household savings remain stable; while balance sheets might be over-stretched in some regions, for the area as a whole rising indebtedness is offset by larger holdings of assets and low interest rates. - Following appreciation during 2002–03, supported by significant net FDI and portfolio inflows, the real effective exchange rate of the euro has been moving broadly sideways around 5 percent above its long-term average over the past couple of years. - Staff estimates suggest the effective exchange rate is within a range compatible with (or slightly above) medium-term equilibrium, considering the area’s relative cyclical position, net foreign liabilities, and terms of trade. *Source: Executive Summary (IMF staff).* ### 5. However, medium-term trends are ### 5. However, medium-term trends are ### Medium-term outlook and demographics - Area productivity growth has been disappointing. - Improving corporate performance is rooted largely in cost containment, supported by wage moderation and outsourcing, and reduced corporate taxation. - Population growth is decelerating sharply and is expected to turn negative around the turn of the decade. - Staff has marked down potential real GDP growth to a meager 1.8 percent. ### Productivity, employment, and corporate profitability - Labor productivity growth indicators (selected from source table): - 1987-1995: United States 1.1; Euro area 2.4; EU-15 2.3; EU-10 -2.8; Japan 4.7; China 4.3. - 1996-2005: United States 2.4; Euro area 1.2; EU-15 1.4; EU-10 4.4; Japan 2.0; China 5.6; India 3.9. - 2000-2005: United States 2.6; Euro area 1.0; EU-15 1.0; EU-10 4.7; Japan 1.9; China 8.7; India 4.1. - 2005: United States 1.8; Euro area 0.3; EU-15 0.5; EU-10 6.2; Japan 1.9. - Job creation has improved, comparable to the U.S. during its boom, but area-wide unemployment remains stubbornly high. - Unit labor cost and real wage indicators show labor cost pressures have been contained and wage moderation has helped maintain competitiveness. - Total returns to capital (equity indices) have helped restore corporate profitability. ### Growth projections and scenarios - Staff foresees actual growth around 2 percent in 2006, broadly in line with other projections. - Buoyant lead indicators point to 2½ percent output growth for 2006:Q2 and Q3 under a faster recovery scenario. - Latest Growth Projections (selected items from the presented table): - VAT effect on GDP 2/: 0.1-0.3 - IMF WEO Projection (June 2006) and Eurosystem Staff Projection figures are shown in the source figures (see original for full matrix). - Risks: - Near term: balance of risks somewhat to the upside. - Beyond 2006: risks skewed to the downside due to dependency on external demand, global imbalances and exchange rate risk, flight from risk in capital markets, volatile oil prices, and the avian flu. - Richly-valued housing stocks and high household debt in some regions pose hazards for consumption as interest rates continue to rise. - Staff estimates: a 10 percent hike in oil prices reduces real GDP growth by 0.2 percentage points and directly raises inflation by 0.1 percentage points. ### Monetary policy and inflation risks - The ECB views the risks to price stability as skewed to the upside, and has begun to raise rates. - After keeping interest rates unchanged for 2½ years, the ECB raised its policy rate by 25 basis points in December, March and June, to 2.75 percent. - ECB rationale: - Headline inflation has been running above the ECB’s close to but under 2 percent objective since 2000 and is projected to continue doing so through 2007 because of further tax (notably, VAT in Germany) and administrative price hikes as well as oil prices. - Imported manufacturing goods prices are increasing as a result of the strength of the global upturn. - Monetary and credit dynamics are strong: monetary aggregates are growing rapidly; private sector credit is expanding at double digit rates and becoming more broadly based across sectors; borrowing by households and non-financial corporations is rising more strongly. - Strong asset (notably housing) price dynamics confirm the stimulative impact of historically low interest rates. - Market expectations and indicators: - Inflation expectations remain anchored in survey measures, though break-even inflation rates have risen. - The ECB perceives a liquidity "overhang" as a key upside inflation risk as the recovery strengthens. - Credit growth has picked up across the board, including loans to households, consumer credit, and loans for house purchases with maturity over 5 years. ### Structural reforms and financial sector issues - Discussions emphasized strengthening medium-term growth via product and services market reforms and the interactions between macroeconomic adjustment and structural reforms. - Services market reforms focused on the financial sector, which appears to explain a significant part of Europe’s productivity gap. - Need identified for the financial stability framework to keep up with growing cross-border activities. - Box 1: Effectiveness and Role of Fund Surveillance (selected points) - Monetary policy: Fund staff argued monetary policy should remain accommodative until recovery became more sustained; the ECB kept rates unchanged for 2½ years and then raised them from 2 to 2¾ percent starting in December 2005. - Fiscal policy: Staff advised eliminating fiscal deficits through annual structural adjustments of at least ½ percentage point of GDP; staff welcomed the 2005 SGP reform but cautioned about implementation challenges. - Structural policy: Staff supported the reformed Lisbon Strategy as the right vehicle to increase national ownership but was concerned that absent public benchmarking the framework would have no teeth; progress with National Reform Programs has been mixed. - Financial sector issues: Staff argued for further integration of regulation and supervision to ensure Europe’s financial stability framework keeps pace with cross-border business. - Effectiveness: Fiscal and structural reforms have proceeded but in a much less decisive manner than advocated by staff. Specific outcomes included: (i) staff’s ½ percent fiscal adjustment “benchmark” is a feature of the reformed SGP; (ii) domestic fiscal governance advice met skepticism but is now on the agenda of the Finnish Presidency; (iii) benchmarking was not adopted in the reformed Lisbon Agenda; (iv) advice on integration of regulation and supervision received mixed reception but has motivated new ECOFIN initiatives. *Source: IMF staff report (text and figures provided in the content unit).* ### 10. As the baseline scenario for prices and activity finds confirmation in the data, a ### _cr06287 - 10. As the baseline scenario for prices and activity finds confirmation in the data, a ### Monetary policy stance, inflation outlook, and ECB actions - ECB judged a progressive withdrawal of monetary accommodation warranted to keep inflation expectations solidly anchored. - Professional forecasters continue to expect inflation to average 1.9 percent over the medium run. - Officials noted that 47 percent of those regularly surveyed are now expecting headline inflation above 2 percent over the medium run (up from about 40 percent one year ago). - Surveys of Europe’s purchasing managers suggest rising price pressures. - ECB officials considered the June hike warranted because inflation is expected to revert to its benchmark only slowly and the recovery is gaining traction; nevertheless, the hike leaves rates "in accommodative territory." ### Staff assessment of inflation risks and projections - Staff agreed with the ECB’s baseline projection through 2007 but considered the risks to price stability over the medium run to be more balanced. - Staff view built around various statistical measures of underlying inflation (core, median, trimmed mean, cross-sectionally and dynamically-filtered inflation) and small structural models suggests HICP inflation should moderate to just under 2 percent in 2008 and that the risks around this baseline are not significantly skewed to the upside. - Simple indicator of low fundamental price pressures: subdued current and expected ULC growth, with cyclical wage behavior overwhelmed by trend restraint related to structural changes. - Staff estimates suggest that 1 percent higher demand-driven output growth than projected would add 0.2 percent inflation contemporaneously. - Continued slack, a weak labor market, and strong global competitive pressures imply growing downside risks for international and domestic activity over time and some downside risks for domestic prices. ### Latest inflation projection numbers and oil effects (as presented) - HICP Inflation (EC Forecast May 2006 / June 2006; Eurosystem Staff Projection; IMF WEO Projection June 2006): numbers shown in charts and tables in source text (examples: 2.1 – 2.5; 1.6 – 2.8; 2.3; 2.2; 2.2; 2.2; 2.2; 2.2; 2.1; 1.9). - Oil effects on inflation (Direct effect, calculated by Fund staff): 0.3...0.3...0.3...... - Administrative price effects (Fund staff estimate): 0.4...0.4 4/0.4 4/0.40.40.1 - Assumed oil price increase 1/: -5.4 - Note: EC and Eurosystem staff forecasts are based on Brent crude oil prices; IMF forecasts are based on a simple average of spot prices of U.K. Brent, Dubai, and West Texas Intermediate crude oil. ### Money, M3, and neutral interest rates - Staff questioned whether historical comparisons provide a good measure of current monetary policy accommodation and whether the link between M3 and prices is clear enough for operational purposes. - Estimates of the neutral rate—historically taken to have been around 4 to 4½ percent—are impossible to pin down, but there is evidence for a downward trend consistent with revisions to potential output growth estimates (see Box 2). - Relation between M3 growth—which averaged 7½ percent in 2005—and prices has been unstable of late, reflecting shifting money demand outside the “core” household sector. - Contributions to M3 growth (1998–2005) showed brisk growth partly reflected corporate deposits and euros held overseas; chart categories include Corporate deposits 1/, Household deposits, Other 2/, Currency in circulation, euro changeover. ### Box 2 findings on declining neutral interest rates - Global interest rates, including those in the euro area, have shown a trend decline since the mid-1980s. - Possible explanations: moderating inflation, lower macroeconomic volatility, enhanced central bank credibility, favorable economic shocks, structural trends (technology, globalization); potentially less benign sources such as a global “glut” of savings and loose global monetary policy as well as the legacy of the Asian financial crisis and the bursting of the ICT bubble. - Declining long rates may reflect a declining term premium (which need not imply a decline in the neutral short rate); simple term-structure models for the euro area suggest a broadly stable term premium. - Declining long rates could partly reflect a falling euro-area growth potential, implying lower neutral short rates. - Overall assessment: lower macroeconomic volatility, relatively high global savings/low investment, and a falling euro-area growth potential suggest euro-area neutral rates likely have been moving down. - Changing area neutral rates increase uncertainty about the extent of monetary accommodation as illustrated by a Taylor rule; a time-varying neutral rate lowers the policy rate implied by the rule and makes the extent of policy accommodation less clear. - ECB staff agreed that lower area potential output growth may imply a lower neutral rate but emphasized international factors and the difficulty of estimating the neutral rate in real time; ECB staff thought the present level of rates was still below reasonable lower bound estimates for this rate. ### Staff recommendation on policy posture given risks - Considering risks to prices and uncertain prospects for activity beyond the near term, staff argued monetary policy needed to remain accommodative. - Continued tightening, barring unexpected shocks to domestic inflationary pressures, would require a further broadening of the recovery—notably better prospects for employment, of which there are as yet few concrete signs. - Caution in normalizing rates is warranted because of the unbalanced nature of the recovery, downside risks beyond 2006, the evolution of neutral rates, exchange rate risks, and volatility in financial markets. ### Structural policy issues: productivity, employment, and reforms - Overriding policy concern: overcoming the area’s inability to simultaneously achieve solid employment and productivity growth. - Employment growth has been remarkably strong over the past decade, broadly on a par with the United States; employment growth in the business sector amounted to 15.2 percent in the euro area during 1995-2005, relative to 12.2 percent in the United States. - Nonetheless, unemployment remains high and labor participation rates low. - Reducing unemployment and fostering labor force participation are primary avenues to boost per capita incomes and ease adjustment to aging—but must avoid triggering an offsetting slowdown in productivity, which has occurred since the mid-1990s. - The productivity slowdown relates partly to structurally moderating labor costs and reforms that have fostered adoption of more labor-intensive production processes and increased employment of the less skilled; cyclical factors and regularization of “underground” employment account for only part of total factor productivity deceleration. - Likely drivers of sluggish productivity include high job turnover costs and insufficient competition in product and services markets; rigidities impede reallocation in response to preferences, technologies, and globalization. - ECB research suggests deregulated sectors (telecommunications and transport) have shown strong productivity growth; wholesale and retail sectors and the financial sector have lagged. - Increasing evidence for the role of competition in fostering productivity-enhancing restructuring, including better management practices. ### Intra-area divergences and policy implications (Box 3) - Intra-area imbalances: current growth differences are not large but feature a falling cyclical component and a growing trend component related to demographics and differing structural reforms and productivity growth. - Cross-country inflation differentials are not sizable but are highly persistent, contributing to divergences in competitiveness and current account balances. - Policy implications agreed upon: - (i) more flexible wage setting and accelerated deregulation of the services sector; - (ii) fiscal policy in booming economies to be tightened more than standard measures of structural balances suggest, given the high correlation between asset prices and government revenues. - Fund staff noted the need to coordinate prudential action to address potential financial system stability issues in countries with high domestic credit growth; interlocutors questioned benefits and appetite for enhanced coordination under present circumstances. ### Lessons from successful reformers and recommendations - Successful long-term reformers pursued forward-looking strategies with functionally and intertemporally consistent fiscal and structural policies. - Fiscal adjustment centered mainly on welfare reform and the government wage bill, using labor supply and revenue improvements to cut taxes and maintain reform momentum. - Complementary actions enhanced factor and product market flexibility, enabling stronger job creation response to wage moderation while maintaining productivity growth. - Reforms were compatible with broadly stable income distributions in several cases. - Recent area-wide policy initiatives—the reformed Pact and the new National Reform Programs—offer promise but bolder steps will be needed for decisive progress. ### Fiscal developments, the SGP, and fiscal requirements - The cyclically-adjusted fiscal balance for the euro area improved by close to ½ percent of GDP in 2005, broadly in line with staff recommendations. - The area’s deficit remains large, mainly due to countries in the Excessive Deficit Procedure (EDP) under the Stability and Growth Pact (France, Germany, Greece, Italy, and Portugal). - SGP implementation is improving: Germany has been moved to one step short of sanctions (Article 104.9) for failing to reduce its deficit below 3 percent of GDP in a timely manner; countries are taking significant steps to abide by SGP commitments. - In their medium-term objectives (MTO), countries have given heavy weight to reducing public debt; 2006–08 fiscal targets generally feature an average annual structural adjustment of at least ½ percent of GDP for countries that have not reached their MTO. - Stability Programs now feature more prudent macroeconomic assumptions and a diminishing reliance on one-off measures. - Key test ahead: achieving adjustment during this recovery; new challenges to the EDP include Italy’s difficulties in correcting its fiscal deficit. ### Aging and medium-term fiscal requirements - AWG projections show a “no-policy change scenario” where aging-related spending would rise by about 3¾ percent of GDP through 2050. - Staff welcomed the AWG report but argued some of the AWG’s alternative scenarios—which suggest the expenditure increase could be considerably larger—appear more plausible than the baseline. - Given these projections, the key fiscal policy requirement is for countries to achieve structurally balanced budgets by 2010. - Historical caution: the 1998–2001 budgets led to a structural deterioration in fiscal balances of about 1½ percentage points of GDP. - Structural weakening is planned by non-EDP countries for 2006 (chart in source); staff and the Commission project a structural balance for the area that moves broadly sideways without specified measures to implement proposed adjustment paths. - Absent significant reductions in cyclically-adjusted deficits the EDP in some countries risks becoming open-ended and damaging the Pact. *Source: IMF staff report content provided in the supplied PDF excerpt.* ### Box 4. The Updated Demographic Perspective ### Box 4. The Updated Demographic Perspective ### Demographic projections and fiscal impact - The EU’s population will begin to fall around 2010. - Under the “no policy change” scenario in the AWG report: - This would add about 3¾ percent (4½ percent) of GDP on a net (gross) basis to public spending. - Under plausible alternative AWG scenarios: - The net increase might well be 6 percentage points of GDP. - Alternative AWG scenarios also indicate: - Allowing health care costs to rise with wages (rather than prices) and assuming a slowly growing proportion of formal long-term care would add a further 1½ percent of GDP to spending. ### Key caveats and critical assumptions - The “no change” projections assume: - A significant acceleration in TFP growth and a large sustained increase in employment—something Europe has not mustered since the 1970s. - Some budgetary assumptions are particularly critical: - Potential savings on education and labor market policies might not materialize if the experience of countries with high labor utilization in Europe is relevant. - The interaction between real growth/employment, taxes, and debt is ignored in the projections: - This omission downplays the policy challenge because higher spending would have to be met with higher taxes—which would hold back employment and growth—or more debt and interest payments, potentially creating fiscal sustainability problems. ### Cross-country differentiation in fiscal impact - Member countries have made vastly differing progress in addressing aging-related costs, which could affect the smooth functioning of the union. - The “no policy change” estimates suggest the net increase in spending would range from: - Lows of 0-2 percent of GDP (Austria, Italy) - To highs of 8-10 percent of GDP (Luxembourg, Portugal, Spain) ### Policy implications and governance - Staff argued for improving national governance mechanisms to help overcome pro-cyclical behavior during upswings and tackle the demographic challenge. - Key points on governance and institutions: - Delegation of forecasting to independent institutions is seen as an efficient way to address biases. - Independent institutions have considerable impact; their advice is often followed by governments; the quality of their analysis is mostly considered above or well above average; and there is a general perception that they have improved fiscal discipline. - National authorities are divided: some supportive, others skeptical—concerns include the wisdom of creating new institutions, their democratic legitimacy and accountability, and their likely effectiveness. - Such institutions need to reflect national arrangements and should eschew reaching normative (as distinct from “positive”) assessments. - The Finnish Presidency has made the issue a subject of discussion for the second half of this year. ### Interaction with structural reform agendas - The National Reform Programs (NRP) offer a potential vehicle to tap synergies between fiscal and structural adjustment to boost productivity and employment. - NRPs prepared in fall 2005 tend to be fairly comprehensive and forward looking, but vary in concreteness and often remain silent on complementarities and sequencing of reforms. - Key structural policy measures may entail either lower fiscal revenue or higher expenditure and therefore could complicate fiscal adjustment. - Specific reform areas highlighted: - Labor market reform: NRPs focus on active labor market policies and lower payroll taxation but generally avoid steps that might facilitate job turnover. - R&D spending: The target is 3 percent of GDP, including a proposal for a European Institute of Technology. - Services sector reform: Services account for roughly two-thirds of EU GDP; only 8 percent of services output is traded. Strengthening competition in services (including exempted services such as work agencies and liberal professions) and progress in sectors covered under separate directives (energy, railway, postal services) are important for productivity gains. - The revised services directive was welcomed, but dropping the country of origin principle (CoOP) could reduce potential output and employment gains from the directive by some 30-odd percent. ### Implementation and evaluation concerns - Concerns about NRP implementation linger despite improved ownership: - NRPs have fostered greater coordination at the national level and have been reviewed in parliaments and discussed with social partners in virtually all countries. - Specific targets and timetables are often missing from the programs, making evaluation of implementation difficult; a framework to evaluate consistently is under development. *Source: Box 4. The Updated Demographic Perspective, _cr06287 - Box 4. The Updated Demographic Perspective_* ### 29. Staff stressed that integration in its various forms had been a lasting engine of ### _cr06287 - 29. Staff stressed that integration in its various forms had been a lasting engine of ### Trade integration, Doha Round, and EU trade policy - Concluding an ambitious Doha Round agreement is the EU’s most important trade policy priority; the window of opportunity for agreement is closing rapidly. - Effective access to EU agricultural markets is key to an ambitious Round, including sensitive product designations that remain truly exceptional and are not unduly restricting. - The Commission noted its agriculture offer would create new export opportunities in all sectors, but any further flexibility is conditioned on the value of trade partners’ offers, including effective new access for manufactures and services in the more advanced developing countries. - Staff concern: a disappointing Doha outcome could spur a strategic shift towards FTAs, adding to proliferation and undermining the multilateral fabric of world trade. ### Free Trade Agreements (FTA) and rules of origin - As the EU’s interest in FTAs grows, it should seek stronger international discipline in this area. - Negotiations with Central America were launched in May; others with Asia are under consideration. - Defensive motives (reacting to others’ FTAs) suggest scope to agree mutual restraints or include open-access clauses for countries wishing to accede to existing FTAs. - Simple and liberal rules of origin are crucial to avoid burdening cross-border value chains. - The Commission aims for deep integration FTAs that ensure complementarity with the multilateral trading system and is seeking improved discipline on FTAs as part of the Doha Round. ### Aid for Trade, EPAs, and EU development policy - Aid for Trade and integration initiatives are increasingly prominent tools of EU development policy. - The Commission’s Aid for Trade agenda grew some 40 percent to almost euro 1 billion in 2005. - The Commission is examining ways to help channel stepped-up trade-related support by member countries. - Economic Partnership Agreement (EPA) negotiations on intra-regional integration and free trade with the EU continue with six ACP regions (77 countries); talks are targeted for completion at end-2007 but timelines will be difficult to meet in some cases. - Staff suggested EPA development impact depends partly on avoiding excessive discrimination favoring EU goods (e.g., through rules of origin) and services, and on the extent to which EPAs support open and competitive markets. ### Global imbalances and the euro area’s exposure - Notwithstanding a broadly balanced exchange rate and external position, the euro area remains precariously exposed to a disorderly resolution of global imbalances. - Authorities agreed the exchange rate of the euro was broadly appropriate from a multilateral perspective, aligning closely with its 1980–2005 average. - An orderly market-led resolution of global imbalances would have relatively limited effect on euro area activity; concerns focus on a disorderly resolution, notably a sharp, multilateral appreciation of the euro if market sentiment in the dollar were to sour. - Staff’s position: such a disorderly appreciation would warrant an easing of monetary policy, assuming no other changes to the outlook for inflation. ### Box 6: Reforms in the Euro Area and potential gains - Staff estimates indicate the euro’s exchange rate is broadly aligned on a multilateral basis; the area committed to contributing to an orderly resolution of global imbalances through enhanced structural reform, though progress has been slowed by popular resistance to labor and services market reforms. - Potential welfare and output gains from reform (as reported): - Liberalization of the services sector and full implementation of the services directive, including the CoOP, would boost employment by 600,000-2.5 million and GDP by 0.8-1.8 percent––the impact of the CoOP is between 10-30 percent. - A common clearing and settlement system would lead to lower transaction costs of up to 18 percent, increasing GDP by around 0.6 percent. - Integration of bond, equity, and bank markets would reduce firms’ financing costs, raising GDP by 1.1 percent and employment by 0.5 percent, about one million new jobs. - Integrated European mortgage markets could yield a net gain of 0.9 percent of GDP over 10 years. - Implementing the Lisbon reform package could raise Europe’s growth potential by ½ to ¾ percentage points over the medium term. ### Shared responsibility and recommended reforms to address imbalances - National authorities concurred that reducing global imbalances must be a shared responsibility, with all major regions putting in place appropriate policies. - Widening global imbalances have been driven by productivity differences, investor preferences, declines in US savings, weak domestic demand in much of Asia, exchange rate policies, and higher energy prices. - For the euro area, measures that boost employment and productivity—particularly through reforms of non-tradables (notably services) markets—would support global growth, promote faster convergence of the NMS, and help facilitate an orderly unwinding of global imbalances. - Staff example: implementing the Lisbon reform package could raise the EU's growth potential by ½ to ¾ percentage point over the medium term. - Reforms could prompt confidence effects that hasten beneficial effects for area growth and improve resiliency to a possible disorderly resolution of imbalances. ### Monetary policy outlook - The near-term outlook is propitious but prospects for sustained expansion are less assured; GDP growth should remain around 2 percent, and could be higher in the current year. - With inflation projected to ease over the next 24 months and activity prospects uncertain beyond the near term, monetary policy can remain accommodative. - Monetary conditions are appropriate; inflation is running above the close to or below 2 percent benchmark but is expected to fall back after 2007 as one-off shocks abate. - Absent significant indirect or second-round effects from exogenous price shocks, further tightening can await a firming of the recovery, evidenced by accelerating employment. - Risks of currency appreciation and uncertainties about the extent of monetary accommodation (due to the decline in potential growth and relatively high savings) warrant a cautious approach to raising rates. ### Fiscal policy, Lisbon process, and structural reforms - Boosting growth potential requires fiscal and structural policies pursued in a mutually reinforcing manner. - Demographic challenges (populations begin to decline around 2010) mean adjustments, rather than full revamps of welfare programs, may suffice if policy levers leverage synergies between fiscal adjustment, labor supply reforms, and competitive markets. - Countries at some distance from underlying balance need to urgently identify measures equivalent to at least ½ percent of GDP annual adjustment over the coming years, focused on the expenditure side. - The integrated National Reform Programs under the rejuvenated Lisbon process offer platforms for product and labor market reforms but need strengthening, with greater attention to boosting productivity—through R&D spending and intensifying competition in the internal market, especially services. ### Financial integration, supervision, and crisis preparedness - The EU FSAP and Lamfalussy process are fostering financial market integration, but the pace is too measured given opportunity costs. - Much of the euro area’s lagging productivity performance is linked to the financial services sector; remaining cross-border barriers need to be removed, using competition policy and forceful public intervention where stakeholders hinder open, market-based solutions (notably in securities clearing and settlement systems). - Clarification and further integration of supervisory powers over complex groups—supported by legal and regulatory changes at the national level—are necessary to improve prudential policies and crisis management. - Priority should be placed on improving information flows between Europe’s supervisors, notably by establishing a central repository with up-to-date information on systemically-important financial institutions to aid crisis coordination efforts. - Eurosystem actions to prepare for a potential pandemic include adapting business continuity plans to guarantee functioning of key market operations and infrastructure; challenges include increasing remote access facilities for ECB staff and consistency of business continuity plans across the Eurosystem. - A new Directive on AML/CFT was promulgated in October 2005 with full implementation expected by end-2007. ### Staff appraisal: key judgments and recommendations - The euro area is emerging from the doldrums and needs to translate cyclical rebound into sustained growth; persistently sluggish productivity is inhibiting sustained growth. - Policies should harness synergies of fiscal adjustment, labor supply reforms, and competitive product and services markets, and accelerate integration with NMS and the rest of the world. - Risks are tilted to the downside in 2007 and beyond because of unresolved global imbalances and the risk of further euro appreciation. - The key challenge for fiscal policy and the credibility of the Stability and Growth Pact is the need to consolidate as the recovery unfolds; the reformed Pact is regaining traction but preventive mechanisms could be buttressed by non-partisan national governance mechanisms. - Trade policy recommendation: redouble efforts to bring the Doha Round to a successful conclusion and resist undisciplined bilateralism; the EU should aim for effective liberalization of agricultural market access, keep sensitive product designations truly exceptional, and seek collective restraint on the proliferation of bilateral trade initiatives to renew commitment to multilateralism. - Strengthening competition in the services sector is highlighted as an effective measure to boost productivity, accelerate growth and demand, improve the attractiveness of holding euro assets, and facilitate an orderly adjustment to global imbalances. - Quality, availability, and timeliness of statistics are adequate for effective area-wide surveillance and have continued to improve. *Italic: IMF staff report excerpt.* ### 45. It is proposed that the next consultation on euro-area policies in the context of ### _cr06287 - 45. It is proposed that the next consultation on euro-area policies in the context of Article IV obligations of member countries follow the standard 12-month cycle. ### Consultation timing - It is proposed that the next consultation follow the standard 12-month cycle. ### Key macroeconomic indicators (selected series from Table 1) - Real GDP (in percent change): 3.0, 3.9, 1.9, 0.9, 0.8, 2.1, 1.3, 2.1, 1.8 - Private consumption (in percent change): 3.4, 3.2, 1.9, 0.9, 1.0, 1.5, 1.3, 1.8, 1.5 - Unemployment rate (in percent): 9.2, 8.2, 7.8, 8.3, 8.7, 8.9, 8.6, 8.0, 7.9 - Consumer prices (in percent change): 1.1, 2.1, 2.3, 2.2, 2.1, 2.1, 2.2, 2.2, 2.2 - GDP deflator (in percent change): 1.5, 1.3, 2.3, 2.6, 2.1, 1.9, 1.9, 2.0, 2.0 - General government balance (in percent of GDP): -1.3, -1.0, -1.9, -2.6, -3.0, -2.7, -2.3, -2.1, -2.0 - General government structural balance (in percent of GDP): -1.3, -1.7, -2.5, -2.7, -2.7, -2.4, -2.0, -1.8, -1.6 - General government gross debt (in percent of GDP): 72.1, 69.6, 68.3, 68.1, 69.3, 69.8, 70.8, 70.2, 69.6 - Current account balance (in percent of GDP, memorandum item): 0.4, -0.6, 0.2, 0.7, 0.5, 1.0, -0.1, -0.2, -0.2 ### Banking sector macro-prudential indicators (selected items from Table 2) - Regulatory capital to risk-weighted assets*: 11.00, 13.78, 11.36, 11.61, 11.50 - Regulatory Tier I capital to risk-weighted assets*: 7.24, 9.01, 8.35, 8.36, 8.42 - Loans to customers (percent of total assets): 43.73, 46.50, 46.37, 49.06, 48.40, 48.39 - NPLs to gross loans* (selected years): 3.60, 3.44, 3.41, 3.05 - ROA* (after tax and extraordinary items): 0.19, 0.29, 0.22, 0.30, 0.31, 0.42 - ROE* 1/: 11.54, 7.51, 5.74, 7.62, 7.76, 10.54 - Liquid asset ratio 1 (cash and T-bills): 4.59, 1.84, 1.87, 2.27, 2.32, 2.60 - Liquid asset ratio 2 (ratio 1 + loans to credit institutions): 18.98, 20.97, 20.05, 19.95, 19.53, 19.12 (*) Items included in the "core set" of FSIs. 1/ After tax and extraordinary items. ### Balance of payments and external position (selected items from Tables 3–4) - Current account (in billions of euros, not seasonally adjusted): -99.2, -21.5, 53.3, 32.4, 49.7, -22.6, -10.0 - Current account (in percent of GDP): -1.5, -0.3, 0.7, 0.4, 0.6, -0.3, -0.5 - Goods (in billions of euros): 7.7, 3.3, 128.5, 106.0, 105.2, 52.9, -3.5 - Portfolio investment — Equity (in billions of euros): -234.1, 131.3, 46.4, 31.8, 24.7, 139.8, 41.5 - Net investment position (in percent of GDP): Assets 102.8, 110.8, 102.5, 106.5, 111.4, 131.8; Liabilities 110.6, 116.4, 112.2, 117.3, 123.6, 145.0; Net investment position -7.8, -5.6, -9.7, -10.9, -12.2, -13.1 - Memorandum: GDP (in billions of euros): 6,710.7, 6,999.9, 7,245.8, 7,453.0, 7,750.2, 7,997.6, 8,203.0 ### Statistical issues, developments, and data gaps (Appendix I) - Data quality: Statistics for the euro area are produced by Eurostat and the ECB on the basis of member state reports and are of sufficient quality, scope and timeliness for macroeconomic surveillance, but important gaps and weaknesses remain related to the euro area’s young age, changing composition, and supra-national nature. - Major recent changes: - Two major changes introduced in the euro area accounts at end-2005: (i) the allocation of Financial Intermediation Services Indirectly Measured (FISIM) to the final and intermediate consumption of different sectors and activities, and to net exports; and (ii) the use of chain-linked volume measures. The dataseries were revised back to 1995 and publication for earlier years was suspended. - Revised pre-1995 data are not likely to become available before the end of the year at the earliest. - The allocation of FISIM implied an upward revision to GDP levels, amounting to about 1 percent for recent observations. - Revisions to GDP growth rates were relatively small, generally not exceeding 0.1 percentage points in terms of quarter-on-quarter growth. - Institutional-sector accounts: - On May 31, 2006, Eurostat and the ECB released euro area (and EU-25) accounts per institutional sector, on an annual basis covering 1999–2004. - Publication of quarterly euro area accounts per institutional sector is planned from spring 2007 onwards; work on non-financial balance sheets per sector continues. - Classification and compatibility: - A revised NACE classification is planned for 2007 in the context of the UN’s revision of ISIC; implementation at member-state level is planned for the 2008–2011 timeframe and will likely entail backward compatibility problems. - Fiscal statistics: - Eurostat launched a new section on Government Finance Statistics on its website and started publishing quarterly non-financial and financial data for general government of the euro area and EU-25 in spring 2006, as well as underlying government sector accounts for EU member states. - These accounts present fiscal data in an integrated framework, link with the EDP budget balance, and provide stock-flow adjustments. - Eurostat has stepped up monitoring through in-depth visits (EDP Dialogue Visits and Methodological Visits) and publishes results on its website. - Resources allocated to fiscal accounts were increased and a second internal unit was established, but many new positions remain to be filled and the new structure is not yet fully operational. - Labor market and productivity: - All EU Member States are now collecting data for the continuous quarterly Labor Force Survey (improved availability in 2005). - Eurostat has started publishing an improved detailed labor cost index and new national accounts-based quarterly employment data. - Work is ongoing to establish a euro area series on job vacancies. - Accuracy and comparability of labor productivity statistics remain hampered by difficulties measuring hours worked (non-standard contracts) and productivity in services; methodological differences with the US persist. - Prices and housing: - Ongoing harmonization of HICP index reference period and price collection length; priorities include quality adjustments and owner-occupied housing. - Eventual objective: construct a "net-acquisition" index for housing, with an "all dwellings" index to be constructed first; publication is envisaged, no decision on incorporation in HICP. - A pilot project is ongoing to construct an HICP at constant tax rates. - Eurostat formulated a recommendation on the statistical treatment of the Dutch health care reform during 2005. - Trade asymmetries and external statistics: - Asymmetries in intra-EU trade data reported by different member states are growing, especially for financial transactions; these asymmetries complicate measurement of EU and euro area external trade, domestic demand, GDP level, and household savings rates. - Eurostat plans work with selected high-asymmetry country pairs and increased transparency around transition from customs-based trade in goods statistics to BoP "goods" data; a reconciliation table will be part of future EU quality reports. - Financial sector indicators and housing market data: - A limited set of macroprudential indicators for the euro area is published in the fall issue of the ECB’s Financial Stability Report (Table 2). - All euro area countries are participating in the Coordinated Compilation Exercise for Financial Soundness Indicators, but the ECB’s consolidation approach and frequency differ from the Fund’s Compilation Guide on FSIs. - No harmonized and aggregated high-frequency housing market indicators (prices, housing starts) exist. - Principal Economic Indicators and structural indicators: - Work continues to improve coordination of release and revision policies, seasonal and working day adjustments, and harmonization. - Structural indicators to support the Lisbon-strategy have not yet been adapted to the 2005 revamp; a decision on this may be made by end-2006. - Publication of euro area accounts per institutional sector made indicators of corporate sector profitability (net operating surplus) available, but no timely quarterly or half-yearly indicators of corporate sector profitability exist. - Later in the year, Eurostat planned to start publishing detailed import prices at the 2-digit NACE level covering imports from outside the area. - Enlargement and historical series: - Eurostat and the ECB expect no major problems from expansion with new member states, since statistics for these countries are already collected. - Compilation of backward statistical series for the expanded euro area may have to rely on estimations and will be especially challenging for pre-1995 data. *Source: IMF staff report content provided in the document.* ### Appendix II. EU Policies Staff Research, 2003–05 ### Appendix II. EU Policies Staff Research, 2003–05 ### Monetary Policy and Inflation - Proposes indicators of underlying inflation (beyond the standard “core” measures), finding that this is presently running between 1½ and 2¼ percent, with most measures suggesting a figure below 2 percent. - Combines a suite of inflation forecasting models to provide a quantitative baseline outlook and balance-of-risks assessment. - Projects that inflation, presently running around 2½ percent, is set to decline to around 2 percent during 2007 and that the risks are roughly balanced. - Notes that area-wide underlying price pressures show no evidence of acceleration; wages stood 2.1-2.2 percent above last year’s level in 2006:Q1. - Headline HICP inflation reached 2.5 percent in May; core inflation is running around 1½ percent. - Oil prices are running somewhat above US$70 per barrel, the price underlying staff projections for 2007. - Staff estimate: an increase by 10 percent per barrel would add 0.1 percent to inflation. Key studies and findings: - “Measures of Underlying Inflation In The Euro Area: Assessment and Role for Informing Monetary Policy” (Emil Stavrev, 2006 Selected Issues): indicator proposals and model-based projections (see figures above). - “Declining Money Velocity in the Euro Area: Implications for the ECB’s Monetary Analysis” (Hamid Faruqee, 2005): velocity decline is variable; money–inflation nexus more reliable over longer horizons. - “House Prices and Monetary Policy in the Euro Area” (Anthony Annett, 2005): credit–house price links depend on country-specific institutions; house prices do not forecast CPI over short–medium term. - “Is Inflation Persistence Higher in the Euro Area than in the United States?” (Mads Kieler, 2003): inflation persistence declined significantly in the mid-1990s and is only moderately higher in the euro area. ### Fiscal Policy - Argues that the Stability and Growth Pact (SGP) is better suited to smaller countries, those with greater macroeconomic volatility, and those using a “commitment” (rules-based) fiscal governance rather than “delegation”; most new members share these characteristics. - For larger or differently governed countries, domestic governance reforms would improve the operation of the Pact. - Recommends strengthening the SGP by letting the Excessive Deficit Procedure focus on policies rather than outcomes, and by fostering time-consistent national policies, transparency, and ownership via stronger national governance institutions. - Finds that boom–bust asset price cycles make output gap and revenue elasticity estimates highly uncertain and exacerbate procyclical loosening and deficit biases. - Notes that although improving in 2005, public finances remain far from close to balance or surplus; five countries are close to or above the SGP’s 3 percent of GDP limit; absent further measures little improvement is expected for 2006-07. Key studies and findings: - “Enforcement and the Stability and Growth Pact: How Fiscal Policy Did and Did Not Change Under Europe’s Fiscal Framework” (Anthony Annett, 2006). - “Reforming the Stability and Growth Pact” (Annett, Decressin, Deppler, 2005): history, weaknesses (notably lack of adjustment during good times), and reforms to improve policy focus and national governance. - “Boom-Bust Phases in Asset Prices and Fiscal Policy Behavior” (Jaeger and Schuknecht, 2004): uncertainty in fiscal position estimates during cyclical extremes. ### Structural Reforms - Successful labor market reformers (case studies: Denmark, Ireland, the Netherlands, United Kingdom) show reform success is driven by forward-looking strategy and consistent, complementary fiscal and structural policies over many years rather than pure social choices. - Successful fiscal adjustment centered on welfare reform and government wage-bill restraint, using labor supply and revenue improvements to cut taxes and sustain reform momentum. - Product and factor market flexibility amplified the translation of wage moderation into jobs and increased real incomes without widening income distribution significantly. - The effectiveness of wage moderation in raising output and employment depends on the degree of product market regulation; the euro area’s overly regulated markets have hindered gains. - Evidence that wage moderation and some structural reforms induced firms to shift to more labor-intensive production, reversing earlier capital substitution; ICT-using services did not deliver a productivity surge in the euro area. - EU countries exhibit strong status quo bias; product market reform spurs labor market reform as rents fall; cross-border spillovers affect reforms; the open method of coordination remains viable but could be improved through streamlining and greater reliance on “naming and shaming.” Key studies and findings: - “Case studies and Beyond: Lessons from Successful Labor Market Reformers in Europe and Implications for its Social Model” (Tony Annett, 2006). - “Product Market Regulation and the Benefits of Wage Moderation” (Marcello Estevão, 2005). - “Why is Productivity Growth in the Euro Area So Sluggish?” (Marcello Estevão, 2004). - “Implementing Lisbon: Incentives and Constraints” (Xavier Debrun and Anthony Annett, 2004). ### Financial Sector - EU supervisory systems are of higher and more even quality than comparable non-EU countries but still show notable gaps relative to international standards. - FSAPs highlight the need to adjust supervisory frameworks to evolving international financial integration; fuller assessment of EU-wide regulatory and supervisory framework issues is difficult based on country FSAPs alone. - Developments in balance sheet and profitability indicators of Europe’s 100 largest banks do not cluster naturally around countries; EU-wide dynamics are as important as country-specific dynamics, implying risk detection and resolution need a strong cross-border perspective. - Reviews of European financial integration point to remaining obstacles in retail markets, collateral-based instruments, and financial infrastructure (payments, securities clearing and settlement). - Financial integration has led to convergence in risk profiles of publicly-traded European financial institutions, but not to lower risk levels; the challenge is aligning supervisory incentives and improving coordination. - The European financial system offers less scope for banks and markets to leverage comparative advantage (e.g., far less securitization than the United States); EU banks appear to underperform relative to US banks and operate in a less competitive environment. Key studies and findings: - “How Good Is Financial Sector Regulation and Supervision in Europe?” (Martin Čihák and Alexander Tieman, 2006). - “A Bank Business Correlation Perspective on Pan-European Supervision” (Jörg Decressin, 2006). - “The Integration of European Financial Markets” (Francois Haas, 2005). - “European Financial Integration, Stability, and Supervision” (De Nicolo, Corker, Tieman, van der Vossen, 2005). - “Banks and Markets in Europe and the United States” (Decressin and Kudela, 2005). ### Trade Policy and International Spillovers - EU eastern enlargement is expected to deepen trade and investment links between old and new members, stimulating intra-industry trade; new members have most to gain; impact on third countries’ trade and investment will be limited. - Monetary union boosted trade among member states by roughly 10 percent during the euro’s existence; trade gains did not come at the expense of extra-area trade. Dynamic trade integration effects rise over time. - A benign global rebalancing could boost domestic demand and potential growth in partner countries relative to the United States; an adjustment relying primarily on exchange rate shifts would be more challenging with limited exchange rate flexibility elsewhere. - EU–China trade growth includes increased electronics exports from China, as well as textiles and clothing. - Area-wide prices display incomplete exchange rate pass-through, consistent with euro currency-pricing and pricing-to-market behavior; expenditure-switching effects on the current account still operate but are generally small; substantial exchange rate adjustment may be needed for moderate external adjustment. Key studies and findings: - “EU Eastern Enlargement: Impact on Trade and FDI” (Jean-Jacques Hallaert, 2003). - “Measuring the Trade Effects of EMU” (Hamid Faruqee, 2004): ~10 percent trade boost. - “Global Rebalancing of Current Accounts: A Euro-Area Perspective” (Hamid Faruqee, 2004). - “The Changing Patterns of EU-China Trade” (Jean-Jacques Hallaert, 2004). - “Exchange Rate Pass-Through in the Euro Area: The Role of Asymmetric Pricing Behavior” (Hamid Faruqee, 2005). ### Supplementary Information (Staff Report update, July 25, 2006) - Revised national accounts: domestic demand and net exports in the first quarter were stronger than originally reported, mainly due to investment and exports. - Consumption growth reached 2.4 percent following 0.4 percent in 2005:Q4. - Indicators for 2006:Q2 point to strong activity and near-term upside risks: euro area industrial new orders index rose by 2.3 percent in May 2006; production grew by 1.6 percent in May 2006. - Retail trade volumes fell by 0.6 percent in May 2006 and have moved broadly sideways since fall 2005. - Manufacturing and services PMI indicators reached the highest levels since summer 2000. - Financial market participants expected quarterly real GDP growth of around 0.6-0.8 percent in 2006:Q2 and Q3; staff and Commission forecasts are at the lower end of this interval. - Headline inflation remained stable at 2.5 percent in June 2006. - Unemployment declined to 7.9 percent in May 2006. - ECB left interest rates unchanged at its July 6 meeting but signaled “strong vigilance”; market participants expected an interest rate increase on August 3, and markets saw rates at 3½ percent by end-year. - Financial integration developments: Commission opted against legislative action on securities clearing and settlement at this stage; Commission called for a code of practice with objectives and deadlines; ECB examining cross-border securities settlement system possibilities. - Commission’s Competition Directorate interim report: European retail banking markets remain highly fragmented with a range of entry barriers; report intended for consultation with no near-term enforcement actions expected. ### IMF Public Information Notice and Executive Board Assessment (August 1, 2006) - Growth picked up and broadened: real GDP, final domestic demand, and household consumption all grew between 1¾-2 percent in the year through 2006:Q1. - Recovery remains fragile and reliant on strong global growth; employment and consumption continue to lag. - Monetary conditions remain accommodative despite policy rate hikes since December 2005; area external current account is broadly balanced; exchange rate below 2004 highs. - Improved corporate fundamentals: nonfinancial corporate profitability strong; leverage under control; market-based financing recovering; bank-based borrowing robust. - Price pressures contained despite rising oil and administrative prices; headline HICP inflation 2.5 percent in May 2006; core inflation around 1½ percent; services price inflation easing. - Staff foresees actual growth around 2 percent in 2006-07; balance of risks somewhat to the upside near term but to the downside beyond 2006. - Directors welcomed recovery broadening, contained price pressures, and reformed SGP regaining traction; welcomed better-than-originally projected fiscal outcomes. *Source: _cr06287 - Appendix II. EU Policies Staff Research, 2003–05.* ### 2005. Equally, they welcomed the ongoing progress with the reform of product and ### _cr06287 - 2005. Equally, they welcomed the ongoing progress with the reform of product and ### Macroeconomic outlook and risks - Baseline: staff and authorities expect real GDP growth to remain around 2% in 2006 and 2007. - Short-term risks: Directors considered the balance of risks in 2006 to be on the upside. - Medium/longer-term risks: For 2007 and beyond, Directors saw risks tilting to the downside, citing: - Recovery of employment and consumption not yet firmly established. - Productivity growth continues to be sluggish. - Oil prices are volatile. - Global imbalances remain unresolved. - Specific downside triggers noted: higher energy prices, a possible disorderly correction of global imbalances, pressure for increased protectionism, and recent turbulence on global financial markets. ### Monetary policy assessment - Directors commended the deliberate pace of monetary withdrawal in response to large exogenous price shocks, considering it in line with the ECB's mandate. - Observations supporting caution on further rate increases: - Inflationary expectations remain well anchored. - Wage growth is subdued. - Absence of second-round effects from oil and administrative price hikes. - Inflation projected to ease over the next two years. - Some Directors urged close monitoring of upside inflation risks and flexible responses to keep inflation expectations well anchored. - ECB position (authorities’ statement): - Recent increases in the ECB’s key interest rates "reached 2.75% in June 2006" and were warranted. - ECB sees its monetary policy stance after these increases as still accommodative. - ECB Governing Council assesses upside risks to price stability over the medium term. - Inflation developments: annual HICP inflation rates above 2% persisted over several quarters and are likely to remain above 2% during the second half of 2006 and, on average, in 2007. - Identified upside risks to price stability over the medium term include: further increases in oil prices; stronger-than-expected pass-through of oil price rises to consumer prices; additional increases in administered prices and indirect taxes; stronger-than-expected wage and price developments owing to second-round effects. - Monetary analysis notes money and credit growth strengthened to the highest annual growth rates observed since the (unspecified) earlier period. ### Fiscal policy guidance - Key fiscal challenge: achieve broadly balanced fiscal positions by 2010, when the area’s population is projected to begin declining. - Concern: prospects for achieving necessary adjustment toward balance during the upswing remain uncertain. - Recommendation: - Countries at some distance from underlying balance should identify measures equivalent to at least ½ percent of GDP annual adjustment over the coming years, focused on the expenditure side. - Strengthen non-partisan national governance mechanisms to spell out policy implications in a forward-looking manner, given the soft nature of the Stability and Growth Pact’s preventive arm. ### Structural reforms and labor market - Progress acknowledged: significant progress over the years, buoyancy of employment over the past decade. - Remaining challenges: labor utilization and productivity performance still need improvement. - Policy priorities: - Steadfast pursuit of mutually reinforcing fiscal and structural policies to strengthen growth, stimulate employment, prepare for aging, and facilitate orderly unwinding of global imbalances. - Use integrated National Reform Programs under the reformed Lisbon process to foster ownership and carry forward product and labor market reforms. - Reforms that raise labor utilization remain paramount. - Policies need to devote more attention to boosting productivity, not just through R&D spending, but also by intensifying competition, especially in the services sector. ### Financial integration and supervision - Directors welcomed progress in integrating Europe’s financial markets and in strengthening cross-border collaboration among prudential authorities. - Remaining needs: - Policies should be more proactive in removing remaining cross-border barriers to integration. - Require forceful competition policy and public intervention where stakeholders hinder open, market-based solutions. - Further integration of supervision over complex groups is necessary to improve area-wide prudential policies and crisis management. - Directors welcomed the new Directive on AML/CFT and looked forward to its full implementation. ### Trade and external position - Directors stressed trade liberalization’s role in boosting productivity. - Expressed disappointment about recent developments in the Doha round and urged reconsideration of entrenched positions and resistance to undisciplined bilateralism. - Encouraged the EU to achieve effective liberalization of agricultural market access. - Commended the EU’s Aid for Trade agenda. - External position: broadly balanced; euro seen as falling within a fairly-valued range from a medium-run multilateral perspective. - Growth-enhancing structural reform recommended to limit downside risks to the euro area and facilitate orderly adjustment to global imbalances, with priority on strengthening competition in the services sector. ### Key quantitative indicators (selected rows from Table 1; values correspond to 1999 through 2007 where provided) - Real GDP: 3.0 3.9 1.9 0.9 0.8 2.1 1.3 2.1 1.8 - Private consumption: 3.4 3.2 1.9 0.9 1.0 1.5 1.3 1.8 1.5 - Gross fixed investment: 6.1 4.9 0.5 -1.5 0.8 2.3 2.3 3.5 3.3 - Potential GDP: 2.3 2.1 2.2 2.1 1.9 1.9 1.8 1.8 1.8 - Output gap (percent of potential GDP): 0.3 1.9 1.6 0.5 -0.7 -0.6 -1.1 -0.9 -0.9 - Employment: 2.0 2.4 1.6 0.7 0.4 0.6 0.7 0.9 0.8 - Unemployment rate: 9.2 8.2 7.8 8.3 8.7 8.9 8.6 8.0 7.9 - GDP deflator: 1.5 1.3 2.3 2.6 2.1 1.9 1.9 2.0 2.0 - Consumer prices: 1.1 2.1 2.3 2.2 2.1 2.1 2.2 2.2 2.2 - General government balance (percent of GDP): -1.3 -1.0 -1.9 -2.6 -3.0 -2.7 -2.3 -2.1 -2.0 - General government structural balance (percent of GDP): -1.3 -1.7 -2.5 -2.7 -2.7 -2.4 -2.0 -1.8 -1.6 - General government gross debt (percent of GDP): 72.1 69.6 68.3 68.1 69.3 69.8 70.8 70.2 69.6 - Short-term deposit rate: 3.0 4.4 4.2 3.3 2.3 2.1 2.3 2.9 ... - Long-term government bond yield: 4.6 5.5 5.0 4.9 3.9 3.8 3.4 4.0 ... - U.S. dollar per euro: 1.07 0.92 0.90 0.94 1.13 1.24 1.25 1.27 ... - Current account balance: -0.5 -1.5 -0.3 0.7 0.4 0.6 -0.3 -0.1 -0.1 *Source: IMF staff report and Executive Director statement, as presented in the provided document.* ### introduction of the euro – and in fact, the highest rates since the early 1990s. Loans to the ### _cr06287 - introduction of the euro – and in fact, the highest rates since the early 1990s. Loans to the ### Monetary policy and price stability - Interest rates are described as the highest since the early 1990s. - Loans to the private sector have been expanding at double-digit rates and have become broadly based across sectors. - Borrowing has risen more strongly by households (in particular for house purchase) and by non-financial corporations. - These developments confirm the stimulative impact that the low level of interest rates in the euro area is having on money and credit expansion. - Emphasis on the need to closely monitor price dynamics in a number of housing markets. - Cross-checking economic analysis with monetary analysis supports the assessment that upside risks to price stability prevail over the medium term. - On this basis, the Governing Council of the ECB reached the conclusion that a progressive withdrawal of monetary accommodation remains warranted. - Continued solid anchoring of inflation expectations in the euro area at levels consistent with price stability requires that markets and the public be firmly assured that the ECB will act in a timely manner to ensure that risks to price stability do not materialise. - The continued solid anchoring of inflation expectations is a prerequisite for monetary policy to make an ongoing contribution towards supporting sustainable economic growth and job creation in the euro area. ### Fiscal developments and fiscal policy - The euro-area authorities share the staff's view that there are important fiscal challenges for the euro area. - The average debt-to-GDP ratio exceeds 70%. - 7 out of 12 Member States have debt levels above the 60% reference value of the Treaty. - The population of the euro area is ageing, which will put further pressure on public finances by significantly lowering the euro area's growth potential and by substantially raising ageing-related expenditures. - Progress has been made towards securing more sustainable public finances in many member states, not least with respect to pension reform. - The staff's positive overall assessment of the reformed Stability and Growth Pact (SGP) is welcomed. - The first year of the application of the reformed SGP can be judged positive. - While remaining a rules-based system, the reformed SGP has stimulated a constructive and transparent economic policy dialogue. - The reformed Pact resulted in more national ownership of the budgetary rules as a result of a stronger economic rationale which ensures that economic differences between countries are better taken into account. - Budgetary adjustment in the EU has resumed and budgetary positions in 2005 have improved in structural terms by 0.8% of GDP in the euro area. - Further progress needs to be made to ensure compliance with the ‘preventive arm’ of the Pact which governs the attainment of sound budgetary balances in the medium-term. - Long-term fiscal sustainability challenges stemming from ageing populations should be at the heart of policy making. - Budgetary authorities are committed to making use of the positive budgetary developments in 2005 and the benign economic outlook to speed up the pace of deficit and debt reduction so as to reach their medium-term objective. - Taking advantage of the current window of opportunity to improve the budgetary position will contribute to a better policy mix with possibly lower long-term interest rates than otherwise, create more room for manoeuvre in the next downswing and contribute to reducing debt levels significantly before the budgetary effects of ageing set in. - Euro-area authorities agree that well-designed national fiscal rules and institutions may facilitate budgetary consolidation strategies as well as help avoiding pro-cyclical policies. ### Structural policies - Euro-area authorities welcome the staff's positive recognition of progress in structural reform, including the new organisation of the Lisbon process and the reforms implemented to date. - The new process, including National Reform Programmes, has contributed to improved national ownership of – and support for – the objectives of the Lisbon agenda. - National parliaments and social partners have started to become more involved; further improvements in governance of the Lisbon process are under way. - The Commission and the Member States are developing a methodology to assess progress in implementing proposed measures. - Structural reforms to date have had positive effects: - Active labor market policies, mainly focusing on the labor supply side, have contributed to employment growth. - The employment rate in the euro area has risen significantly since the turn of the century. - Pension systems and social security systems are being reformed. - Progress is being made in improving the Internal Market's legal and regulatory framework and in reducing administrative burdens. - All Member States have been reforming their product markets to enhance the business environment and stimulate entrepreneurship. - Despite progress, much remains to be done to reach the Lisbon objective for participation rates and to increase flexibility needed to enhance adjustment mechanisms in the euro area. - Labor market reform must continue to be paramount in reform programmes of euro-area Member States. - Recent performance with respect to labor productivity growth has been disappointing; labor productivity growth has been on a secular declining trend and in the past decade it has been below US productivity growth. - The staff points out that reform programmes need to devote more attention to boosting productivity, which will become essential given an ageing population. - Productivity strengthening is most necessary in the services sector, which accounts for 70% of the euro-area's current economic activity and which has low overall productivity growth. - Low productivity growth in services seems related to insufficient exploitation of ICT and to lack of competition in some services sectors, reflecting limited tradability, extensive domestic regulation and lack of a fully integrated single market for services. - Policy measures needed: - Increase competition in, and integration of, euro-area services markets. - Favor the spread of new technologies. - Enhance human capital. - Stronger competition in the services sector—by means of boosting productivity—would help accelerate growth and demand, facilitate an orderly adjustment to global imbalances and limit downside risks to the euro area. - The Services Directive is a step in the right direction and euro-area authorities are committed to ensure full and rapid implementation. ### Financial sector issues - The euro-area authorities share the staff's positive assessment of the health of the euro-area financial sector. - The performance and soundness of the sector has been improving for several years and is likely to strengthen further in line with the recovery in the real economy. - Significant risks to the financial sector persist and continued vigilance is required by policymakers. - Risks have a global dimension, but implications will vary among Member States depending on local economic and financial conditions. - The staff has highlighted specific risks facing Member States where house prices and/or household debt have risen sharply; while there is no evidence of a major risk to economic growth or financial stability in the Member States concerned, developments are being monitored carefully at both the national and euro-area level. - Financial sector integration would bring important area-wide productivity gains and has become a key element of the EU strategy for economic reform. - Integration of many national financial systems is highly complex; deadlines in the integration process should be realistic to avoid sub-optimal outcomes. - Progress already achieved: - Money markets, government bond markets and derivatives markets in the euro area are now either unified or substantially more integrated than before the introduction of the euro in 1999. - The corporate bond market and the market for investment funds have grown rapidly. - The process of financial integration is set to intensify as a common regulatory framework is progressively put in place through implementation of the Financial Services Action Plan (FSAP). - The FSAP is implemented at the EU level and Member States are transposing legislative elements into national laws; the Lamfalussy framework will assist in delivering consistent implementation across Member States. - The staff's description of the FSAP and Lamfalussy process as being captured by vested interests is regarded as exaggerated by the euro-area authorities. - Areas where efforts must be stepped up: - Clearing and settlement arrangements. - Cross-border consolidation in banking. - Obstacles to integration in both areas have been identified and appropriate policy reforms will be announced soon. - Staff highlights concerns about adequacy of current arrangements for oversight of cross-border transactions. - Arrangements for cross-border supervision have improved but remain priorities for action for 2005-2010. - Proposed pragmatic initiatives include mediation, delegation, harmonized reporting, with clear deadlines set by the Council. - Level-3 committees in the Lamfalussy framework will play an essential role in fostering convergence in supervisory practices and procedures. - Work to refine arrangements for financial crisis prevention and management is ongoing; in April 2006, a crisis management exercise was organized involving all relevant players at EU level, and further priorities will be set based on that experience. ### Euro area integration - The euro-area authorities do not share the staff's assessment that the euro area is not open (see paragraph 28). - On 11 July 2006, the euro area welcomed Slovenia as new member and remains open to all EU member states fulfilling the criteria as defined in the Treaty. - Integration of labour, product and financial markets in the euro area needs to be deepened further to enhance flexibility to adjust to economic shocks. ### International economic relations - Both IMF staff and euro-area authorities regret insufficient political readiness in some countries to conclude the Doha Development Agenda successfully and timely. - The European Union has taken the lead in all areas of the negotiations, including in agriculture where the EU made substantive proposals on market access, reduction of domestic support and committed to eliminate its export subsidies by 2013. - The EU offer in agriculture would create significant new export opportunities for third countries into European markets; the EU would have been ready to improve its offer, but this would have needed concurrent reciprocity from the United States on domestic support and by emerging market economies as regards industrial market access and services. - Authorities share staff concern that proliferation of bilateral and plurilateral free and regional trade arrangements could undermine the multilateral fabric of world trade; one-sided restraint in Europe is not considered an option given concerns about loss of global market share and recent bilateral deals signed between other major trading blocs. - The staff's positive assessment of the EU's Aid for Trade and Economic Partnership Agreements is welcomed; the EU's recent efforts in these areas have been described as ambitious and successful. *Source: content unit _cr06287 - introduction of the euro – and in fact, the highest rates since the early 1990s. Loans to the (PDF).* --- _Source: https://www.imf.org/-/media/websites/imf/imported-full-text-pdf/external/pubs/ft/scr/2006/_cr06287.pdf_