Public Information Notice: IMF Executive Board Discusses Euro Area Policies

July 31, 2007

Public Information Notices (PINs) form part of the IMF's efforts to promote transparency of the IMF's views and analysis of economic developments and policies. With the consent of the country (or countries) concerned, PINs are issued after Executive Board discussions of Article IV consultations with member countries, of its surveillance of developments at the regional level, of post-program monitoring, and of ex post assessments of member countries with longer-term program engagements. PINs are also issued after Executive Board discussions of general policy matters, unless otherwise decided by the Executive Board in a particular case. The staff report (use the free Adobe Acrobat Reader to view this pdf file) for the 2007 Article IV Consultation with Euro Area is also available.

Public Information Notice (PIN) No. 07/89
July 31, 2007

On July 25, 2007, the Executive Board of the International Monetary Fund (IMF) concluded the discussion of euro area policies.1


The euro area economy is doing well on the heels of a supportive external environment and generally sound policies. Real GDP growth has been running around 2½ percent; fiscal deficits are markedly lower than a few years ago; and strong export growth, improving profitability and balance sheets, and accommodative financial conditions have fostered a broad-based upswing of investment and employment.

Capacity utilization indicators are moving up, with some already close to previous cyclical peaks. Thus far labor does not appear to be a major constraining factor. Amid supply side-driven moderation, the cyclical response of wages appears to have diminished. Backward looking indicators show subdued wages through 2006 and wage settlements continue to surprise on the downside. While unemployment rates have fallen below the 2000 trough, equilibrium rates appear to have fallen further and labor force participation and population are on the rise. Key developments include the deregulation-enabled shift of employment toward part-time and temporary jobs; the rising labor force participation of women and older workers; high immigration; and more efficient welfare programs.

Since September 2006, headline inflation measured by the Harmonised Index of Consumer Prices (HICP) has been running in line with the European Central Bank's "close to but under" 2 percent target. Financial market-based measures, analysts expectations, and various indicators of inflation suggest that, adjusted for oil and administrative price as well as tax hikes, inflationary pressure has been mounting only gradually.

Fiscal policy performance was generally strong in 2006. Standard measures suggest that the area's cyclically-adjusted fiscal deficit fell by somewhat under 1 percentage point of GDP in 2006—exceeding staff's ½ percent of GDP benchmark for countries at a significant distance from close to balance or surplus. In general, higher-than-budgeted revenues have been allocated to debt reduction, even if not to the full extent by all countries.

In line with strengthening activity, the European Central Bank has raised the main policy rate eight times since December 2005 to 4 percent. Nonetheless, financial conditions are still on the accommodative side. The financial system is viewed as relatively healthy and financial market volatility as well as risk premia remain historically low, although there are some signs that the credit cycle is gradually turning.

The euro area's external setting is propitious. The area's external current account is broadly balanced and export growth has been dynamic. The euro's real effective exchange rate has appreciated by about 1 percent since the end of 2006 and is broadly unchanged from two and a half years ago.

Against this background, the staff projects above potential real GDP growth of around 2½ percent through 2008. The risks to growth are generally small and to the upside in the short run but widening and moving to the downside over the medium run, mainly on account of external risks relating to oil prices, global current account imbalances, potential investor flight from risk, and US growth.

Executive Board Assessment

Directors welcomed the euro area economy's move from recovery to upswing. Against the backdrop of a broadly equilibrated external position and exchange rate, they expected real GDP growth to remain above potential over the near term and employment gains to stay healthy thanks in part to reforms to labor markets and welfare systems.

Directors observed that with rising resource utilization inflationary pressures could be expected to build gradually and some further monetary policy tightening might be required. The necessary magnitude of further tightening would have to depend on wages and the pricing behavior of firms and also on the extent to which reforms and demographics have improved labor supply and productivity growth. In addition, further tightening would hinge on the evolution of external risks to activity further out, including those related to global imbalances and the exchange rate, which are presently seen on the downside.

Directors considered that the external position of the euro area remains roughly in balance and that the real effective exchange rate of the euro continues to trade within range of the medium-term equilibrium. They welcomed the broad-based structural reform efforts underway and underscored that their continued implementation, in line with the authorities' multilateral consultation commitments, will help strengthen prospects for an orderly resolution of global current account imbalances.

Directors welcomed the generally strong fiscal policy performances of 2006 and the announced intentions to reach medium-term fiscal objectives by 2010 at the latest. With a view to preparing for accelerated population aging soon after 2010, Directors encouraged the authorities of countries that have not yet reached these objectives to continue to lower their cyclically-adjusted fiscal deficits by at least ½ percent of GDP per year, consistent with the rules of the Stability and Growth Pact. Given the good economic times, they considered it particularly important not to repeat past mistakes and loosen fiscal targets in response to abundant revenues. In this regard, they supported the trend toward strengthening national fiscal policy rules and governance mechanisms.

Looking forward, Directors observed that, while immediate prospects were strong, population aging was likely to prompt a significant slowing of potential growth. In this setting, they considered achieving a joint structural acceleration of productivity and labor force participation rates to be the fundamental challenge. They agreed that the Lisbon Strategy was beginning to play an important role and that the transparency and governance of National Reform Programs could usefully be strengthened further to that effect. Past labor market reforms had clearly paid off, leading to a significant strengthening of employment growth, consistent with the area commitments under the Multilateral Consultation. Achieving the same for productivity growth would require raising the contestability of national services markets. Hastening the implementation of the Services Directive would be a significant step in this direction.

Directors also viewed the integration of the markets for financial services as one of the most promising avenues for boosting Europe's productivity and growth performance. They advocated raising the contestability of national retail markets and deepening Europe's capital markets. Accordingly, they emphasized the need for a prompt implementation of the Markets in Financial Instruments Directive and welcomed steps to integrate national payments and securities clearing and settlement systems as well as ongoing work to facilitate crossborder bank mergers and acquisitions.

Directors agreed that a further strengthening of Europe's crossborder financial stability framework could help promote progress towards efficient and effective financial crisis prevention, reduce moral hazard, and avoid unnecessary risks for national taxpayers. Directors also agreed that establishing the foundation for a decentralized but more integration-compatible financial stability framework required measures targeted at fostering cooperation, in particular in the area of supervision. Most Directors thought that this entailed an increased emphasis on joint responsibility and accountability, including mandates that call for minimizing the collective costs facing EU states from potential large cross-border financial institutions failures.

With trade having consistently been a boon to Europe's productivity performance, Directors emphasized the need for an ambitious conclusion to the Doha Round to boost the area's already high living standards. They therefore encouraged the authorities to resist protectionist pressures and agree to additional trade liberalization, in particular in agriculture.

It is expected that the next consultation on the euro area policies in the context of Article IV obligations of member countries will be held on the standard 12-month cycle.

Euro Area: Main Economic Indicators
(in percent change)
  2002 2003 2004 2005 2006 2007 2008

Demand and Supply


Private consumption

0.8 1.2 1.5 1.5 1.7 1.7 2.2

Public consumption

0.8 1.2 1.6 1.6 1.7 1.7 2.2

Gross fixed investment

-1.5 1.1 2.3 2.6 4.8 5.8 4.2

Final domestic demand

0.6 1.3 1.6 1.6 2.6 2.6 2.5

Stockbuilding 1/

-0.3 0.2 0.3 0.0 0.1 -0.1 0.0

Domestic Demand

0.4 1.5 2.0 1.8 2.5 2.5 2.5

Foreign balance 1/

0.5 -0.7 0.1 -0.3 0.2 0.1 -0.1

Exports 2/

1.7 1.1 6.8 4.2 8.2 5.9 5.7

Imports 2/

0.3 3.1 6.7 5.0 7.9 5.8 6.0

Real GDP

0.9 0.8 2.0 1.5 2.8 2.6 2.5

Resource Utilization


Potential GDP

2.0 1.9 1.9 1.9 2.0 2.1 2.1

Output gap

0.1 -1.0 -0.9 -1.3 -0.6 -0.1 0.2


0.9 0.6 0.7 0.7 1.4 1.3 0.9

Unemployment rate 3/

8.2 8.7 8.8 8.6 7.8 7.0 6.9



GDP deflator

2.6 2.1 1.9 1.9 1.8 2.1 1.9

Consumer prices

2.3 2.1 2.1 2.2 2.2 2.0 2.0

Public Finance 4/


General government balance

-2.6 -3.1 -2.8 -2.5 -1.6 -1.0 -1.1

General government structural balance

-2.6 -2.6 -2.4 -1.9 -1.3 -0.9 -1.0

General government gross debt

68.2 69.3 69.8 70.5 68.8 66.7 65.4

Interest Rates


Short-term deposit rate

3.3 2.3 2.1 2.3 3.1 ... ...

Long-term government bond yields

4.9 3.9 3.8 3.3 3.9 ... ...

Exchange Rates


U.S. dollar per euro

0.94 1.13 1.24 1.25 1.26 ... ...

Nominal effective rate (2000=100)

105.1 117.6 122.0 121.7 122.6 ... ...

Real effective rate (2000=100) 5/

107.1 122.3 127.8 128.0 128.0 ... ...

External Sector 4/ 6/


Current account balance

0.8 0.4 0.8 0.0 -0.2 -0.3 -0.4

Trade balance 7/

1.8 1.4 1.3 0.6 0.3 ... ...

Memorandum items 4/ 8/


Current account balance

0.7 0.5 1.1 0.3 0.0 -0.3 -0.5

Trade balance 7/

2.1 1.9 1.6 0.9 0.6 0.3 -0.1

Sources: IMF, World Economic Outlook; Eurostat, ECB Monthly Bulletin.

1/ Contribution to growth, in percentage points.

2/ Includes intra-euro area trade.


3/ In percent.


4/ In percent of GDP.


5/ Based on normalized unit labor costs.


6/ Based on ECB data, which exclude intra-euro area flows.

7/ Data for goods.


8/ Calculated as the sum of individual countries' balances.

1 Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board. At the conclusion of the discussion, the Managing Director, as Chairman of the Board, summarizes the views of Executive Directors, and this summary is transmitted to the country's authorities.


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