2012 Article IV Consultation with the Euro Area- Concluding Statement of IMF Mission
IMF News, June 21, 2012
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- Published: June 21, 2012
Overview
- Publication date: June 21, 2012.
- Purpose: Describes the preliminary findings of IMF staff at the conclusion of an IMF team consultation with European institutions for the annual evaluation of the euro area under Article IV of the IMF’s Articles of Agreement.
- IMF team consulted with the European Central Bank, the European Commission, the European Union Presidency, the European Systemic Risk Board, and the European Banking Authority from May 29 to June 11, 2012, for the annual evaluation of the euro area under Article IV of the IMF’s Articles of Agreement.
Key findings on the economic and financial environment
- The financial and economic environment continues to deteriorate:
- Investors are withholding funding from member states most in need, moving capital to safe havens and driving risk premiums to new records.
- Demand is weakening and unemployment increasing across the euro area.
- Lower growth and heightened market stress are compounding difficulties in reducing debt burdens.
- Risk of stagnation and long-term damage to potential growth will increase as unemployed workers lose skills and new workers find it difficult to join the active labor force.
- Important mitigating actions already taken:
- The ECB has lowered policy rates and conducted special liquidity interventions to address immediate bank funding pressures.
- A larger European and global firewall will provide more liquidity insurance to sovereigns.
- Ongoing reform of fiscal governance, especially the adoption of the Fiscal Compact, will help strengthen budgetary discipline.
- National governments have embarked on fiscal consolidation and reaffirmed commitment to debt sustainability and deficit targets.
- But the crisis calls for a stronger and more collective effort:
- Downward spirals between sovereigns, banks, and the real economy are stronger than ever.
- Concerns about banks’ solvency—because of large sovereign exposures and weak growth prospects—have diminished the effectiveness of liquidity operations.
- Sovereigns are struggling to backstop weak banks on their own, and absent collective mechanisms adverse feedback loops have led to spillovers across euro area countries.
- Contagion from further intensification of the crisis would be sizeable globally, with particularly large spillovers to neighboring EU economies.
Completing EMU: Banking union and fiscal integration (policy recommendations)
- General principle:
- A strong commitment toward a robust and complete monetary union would help restore faith in the viability of EMU; this requires a credible path to a banking union and greater fiscal integration, with better governance and more risk sharing, implemented over a clear timeline with concrete intermediate actions.
- Banking union (immediate priority):
- The proposed EU framework for harmonized national bank resolution processes is a necessary first step but needs to go further.
- Establish a deposit guarantee scheme at the regional level to help break links between domestic banks and their sovereigns and support depositor confidence.
- Create a common bank resolution authority backed by a common resolution fund to ensure burden sharing and limit fiscal costs.
- Support these by a common supervisory and macro-prudential framework to forestall further financial fragmentation.
- While desirable at the EU27 level, a banking union is critical for the euro 17.
- Fiscal integration and risk sharing:
- More fiscal integration, with risk sharing supported by stronger governance, can reduce the tendency for economic shocks in one country to imperil the euro area as a whole.
- Ultimately this could mean sufficiently large resources at the center, matched by proper democratic controls and oversight, to help insure budget shortfalls at the national level.
- Start with a broad-based dialogue about what a fuller fiscal union would imply for sovereignty and accountability, delivering a schedule for discussion, decision, and implementation.
- Intermediate step — limited common debt:
- Introduction of a limited form of common debt, with appropriate governance safeguards, can provide an intermediate step toward fiscal integration and risk sharing.
- Such debt securities could initially be restricted to shorter maturities and small size and be conditional on more centralized control (e.g., limited to countries that deliver on policy commitments; veto powers over national deficits; pledging of national tax revenues).
- Common bonds/bills financing could be used to provide backstops for common frameworks within the banking union.
Reviving growth: long-term adjustment priorities
- Tackle long-standing structural rigidities to raise long-term growth prospects:
- Labor market reforms to raise participation and address disparities in protection that confine “outsiders” (typically younger workers) to low-wage, temporary jobs.
- Southern Europe: increase competitiveness in the tradables sector through productivity-enhancing reforms (e.g., lowering barriers to entry, making it easier for small firms to expand into foreign markets) and labor market measures aligning nominal wages with productivity growth.
- Northern Europe: product market reforms to generate a more vibrant services sector and raise overall productivity.
- Targeted investment in infrastructure and human capital to support growth and employment.
- Improve competitiveness within the euro area:
- The euro is assessed to be broadly in line with fundamentals, but substantial competitiveness gaps between countries remain.
- Services sector reforms in surplus economies could improve disposable incomes and lead to higher external demand, including for deficit economies.
- Lowering unit labor costs in the tradables sector is essential for deficit countries.
- To foster relative price adjustment between the North and the South, monetary policy should ensure that overall inflation does not drop far below the two percent for the euro area as a whole, while allowing for larger inflation differentials between North and South.
Supporting growth: short-term policy actions
- Need for aggregate demand support while structural reforms take effect.
- Monetary policy:
- Monetary policy cannot provide a lasting solution to the underlying crisis, but with inflationary pressures expected to weaken substantially, the ECB has room, albeit limited, to ease policy rates and signal a commitment to a more accommodative stance for a prolonged period.
- The ECB needs to ensure monetary support is effective across the region and continue to provide ample liquidity support to banks under sufficiently flexible conditions.
- If necessary, unconventional measures should be used, including consideration of non-standard measures such as a re-activation of the SMP, additional LTROs with suitable collateral requirements, or the introduction of some form of quantitative easing.
- Fiscal policy:
- Fiscal consolidation should proceed decisively and credibly where market pressure is high, but more gradually elsewhere to help support demand in the region.
- Focus on fiscal targets expressed in structural, not nominal, terms, and anchor them by fully-specified multi-year plans.
- Flexible implementation of the current fiscal framework is essential.
- Banking sector support:
- Recapitalization of weak banks—including through direct support from EFSF/ESM resources—will help break adverse feedback loops between sovereign and banking stress at the national level.
- The EBA, the ESRB, and national authorities should coordinate policies to avoid excessive bank deleveraging and its adverse growth impact.
This statement describes the preliminary findings of IMF staff from the mission that consulted with European institutions from May 29 to June 11, 2012.