Regional Economic Outlook: Managing the Upswing in Uncertain Times

Europe, May 14, 2018

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Europe continues to enjoy strong growth; activity has firmed up in many economies and the expansion is largely driven by domestic demand.
Real GDP increased by 2.8 percent in 2017, up from 1.8 percent in 2016.
Forecast: growth to reach 2.6 percent in 2018 and decline to 2.2 percent in 2019.
Credit growth has finally picked up, helping Europe’s banks rebuild profitability.
Leading indicators have recently begun to ease but remain at high levels.
Fiscal adjustment and structural reform efforts are flagging amid the expansion.

Inflation and wage growth remain subdued in most advanced economies and are projected to gather pace only very gradually, given slack in labor markets.
In central and eastern Europe, wages are growing rapidly and inflation is expected to pick up appreciably in 2018, potentially affecting competitiveness.
Subdued wage dynamics in many advanced economies reflect:
- low inflation and inflation expectations,
- still-high unemployment and underemployment rates,
- sluggish productivity growth.
Evidence of very flat wage Phillips curves in advanced economies and cross-country spillovers contributing to wage moderation.
Employment is notably higher across Europe, and unemployment substantially down—there are even labor shortages in some countries.
Wage growth is stubbornly low in long‑standing European Union (EU) countries (EU15), though it has picked up notably in newer EU members.

The favorable outlook is subject to several risks, mainly to the downside over the medium term.
Immediate risks stem from rich valuations in global financial markets, notably an exceptionally low term premium and a growing tendency toward inward-looking economic policies.
Sustained large declines in stock prices are often harbingers of lower growth and inflation (Chapter 1).
With many policy rates close to the zero lower bound and central banks still engaged in unorthodox policies, the scope for further, effective policy easing in response to new shocks is limited.
Important uncertainty about how long the recovery can run even in the absence of external shocks: estimates for output gaps point to little slack in most economies, while broad measures of unemployment still appear high in key advanced economies.

Whether the recovery has the legs to last depends on the response of investment.
Chapter 1 shows that investment has generally been subdued and mainly for replacement purposes.
Investment has been much weaker than after the global crisis of 1991.
Europe’s cross-country integrated economy—including labor integration—creates potential for spillovers across countries (Chapter 2).

Rebuild room for fiscal maneuver and push forward with reforms to boost growth potential while prospects are favorable.
Monetary policy:
- In countries where inflation is still subdued, monetary policy should continue to be supportive to ensure a durable increase in inflation to targets.
- In countries where inflation is hitting targets, monetary policy should gradually normalize.
Fiscal policy:
- In many economies, policymakers should strive to bring fiscal deficits within range of balance over the next few years to restore automatic stabilizers and enable fiscal stimulus if downside risks materialize.
- Stabilizing and bringing down public debt would help cope with pressures from growing expenditures on pensions and health care.
- Fiscal adjustment should be driven first and foremost by efforts to improve the efficiency of government.
- Countries with ample fiscal space can and should use it to promote higher potential growth.
The combination of fiscal adjustment and easy monetary policy should help economies that have rebuilt competitiveness since the crisis continue to lower their still-high net external liability positions.

Complete the Banking Union: instituting a European Stability Mechanism to backstop the Single Resolution Fund would mark an important first step toward greater risk sharing.
Establish a central fiscal capacity: there is a strong case for it, but access should be strictly conditional on compliance with fiscal rules combined with mechanisms to prevent permanent transfers between countries.
Advance the Capital Markets Union, especially after the United Kingdom leaving the single market:
- Promote harmonization of insolvency regimes.
- Improve protection of cross-border investor rights.

Regional Economic Outlook: Managing the Upswing in Uncertain Times, May 2018.

9781484355114.pdf
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Eur Chapter 2
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Executive Summary
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