## The Euro Zone: What’s Next _IMF News, September 28, 2017_ ## Source details **Canonical URL:** [The Euro Zone: What’s Next](https://www.imf.org/en/news/articles/2017/09/28/sp092817-the-euro-zone-whats-next) ## Other formats - [Markdown version](/en/news/articles/2017/09/28/sp092817-the-euro-zone-whats-next/index.md) - [Structured JSON version](/en/news/articles/2017/09/28/sp092817-the-euro-zone-whats-next/index.json) - [Bundle manifest](/en/news/articles/2017/09/28/sp092817-the-euro-zone-whats-next/bundle-manifest.json) ## Bibliographic details - Authors: Poul Thomsen - Published: September 28, 2017 --- ### Economic outlook and recent performance - Quarterly growth has been positive for the last 17 quarters. - IMF June projection for 2017: 1.9 percent; ECB recently raised its projection for 2017 to 2.2 percent; IMF expects its own estimate to be close to that. - Real investment, excluding construction, has surpassed its pre-crisis level. - Recovery is broad-based: all euro area countries are growing above trend and unemployment is declining. - IMF measure of dispersion of growth rates across member states: the most evenly distributed recovery for more than two decades. - Cautionary point: “there are seven countries in the Euro Zone, among them several large ones, with public debt near or above hundred percent of GDP,” limiting policy buffers for future shocks. ### Monetary policy - IMF estimates the output gap for the euro area as a whole is closing fast. - Unemployment is down to 9 percent, of which IMF estimates only one percentage point to be cyclical. - Wage pressures are weak and core inflation is inching up only very slowly. - IMF projection: inflation in the euro area would reach 1.9% only by 2021. - Policy guidance and observations: - The ECB needs to maintain an accommodative policy stance for the foreseeable future. - Unconventional ECB measures have been critical to averting deflation risks and supporting recovery. - Unwinding unconventional measures will be gradual and does not imply an immediate end to accommodation. - Countries with the strongest cyclical positions will at times need inflation above the medium-term objective to achieve Euro Zone aggregate targets. - The ECB’s clear communication about maintaining accommodation as long as necessary should comfort investors. ### Fiscal policy - Historical context: fiscal policies have had to restore confidence and reduce public debt while avoiding choking the recovery. - Europe’s fiscal governance framework has acted as an important anchor; budget deficits have come down significantly since the crisis. - Concern: progress on fiscal consolidation has slowed in several countries where debt remains very high despite accelerating growth. - Key fiscal recommendations: - With growth recovering and output gaps narrowing fast, now is the time to rebuild fiscal space and place public debt on a firm downward trajectory. - Pursue gradual fiscal consolidation to ensure stronger buffers when the next adverse shock hits. - Rebalance fiscal policy to be more growth friendly by: - Making public spending more efficient and growth-oriented. - Making the tax system more supportive of job creation and productivity growth. - Countries with the least fiscal space should use the current window of opportunity to rebuild fiscal buffers to avoid difficult adjustments later. ### Structural reforms and productivity - Commission metrics show almost universally very limited progress on structural reforms in recent years. - The lack of productivity improvement is the central weakness: divergence in GDP per capita since euro adoption and divergence since the crisis (countries with lower per capita GDP have fallen further behind). - Persistent productivity gaps are the root cause of high structural unemployment and especially high youth unemployment in several countries. - IMF observations and guidance: - Structural reforms to boost productivity remain the overarching challenge for Euro Zone policymakers. - Specific reform measures differ across member states and are generally well understood by national policymakers. - IMF welcomes proposals to improve fiscal governance to incentivize productivity-boosting reforms at the national level. - Main obstacle: entrenched resistance from vested interests at the national level. ### Euro Zone architecture and risk-sharing mechanisms - Public sentiment: polls show support for the Euro at the highest level in more than a decade; renewed political support for further integration in some national policymakers. - Areas for further architectural work: - Complete the banking union: Single Supervisory Mechanism and Single Resolution Mechanism need to be accompanied by a common deposit insurance and a common fiscal backstop. - Advance capital markets union to enhance integration and risk sharing. - Consider a Central Fiscal Capacity to improve the euro area’s ability to offset shocks by alleviating fiscal space constraints in downturns and building buffers in good times; could be an element of an eventual common euro area budget. - Consideration of a “European Monetary Fund” to strengthen crisis prevention and crisis management, with critical issues including its role relative to existing European institutions and robustness to undue political interference. - Caveats and political constraints: - Any increased risk sharing must go hand-in-hand with risk reduction and solutions to legacy problems, including resolute resolution of problem banks. - Concerns about moral hazard and political resistance will temper the boldness and ambition of architectural reforms. - The Euro Zone is not a political union; progress will be gradual and evolutionary, requiring difficult political compromises. - IMF perspective: success of new institutions depends on overcoming problems that have marred the fiscal governance framework in the past. ### Central message and policy priorities - Central message: the current recovery is an important opportunity to strengthen resilience and growth potential of the currency union. - Immediate priorities for national policymakers: - Gradually rebuild fiscal buffers through fiscal consolidation. - Rebalance fiscal policy toward growth-enhancing spending and tax structures. - Push ahead with national structural reforms to boost productivity and raise potential output. - Avoid complacency and do not defer critical national measures expecting architectural changes to fully mitigate future shocks. - For countries with limited fiscal space and modest potential growth, the ability to avoid major pro-cyclical tightening when shocks occur depends on buffers built during the current recovery through fiscal adjustment and structural reforms. ### Conclusion - The outlook for the Euro Zone has improved significantly. - The recovery provides an opportunity to lay foundations at both national and central levels for a more resilient Euro Zone. - Challenges remain formidable, but there are good reasons for greater optimism about the future. *Speech at the Financial Times Investment Management Summit, London — Poul M. Thomsen, Director of the European Department, International Monetary Fund, September 28, 2017* --- ## References - [Poul M. Thomsen](https://www.imf.org/en/about/senior-officials/archive/poul-mathias-thomsen) - [France and the IMF](http://www.imf.org/external/country/FRA/index.htm) - [Germany and the IMF](http://www.imf.org/external/country/DEU/index.htm) - [Speeches](https://www.imf.org/en/news/searchnews) - [PRESS CENTER](http://presscenter.imf.org/) - [https://www.imf.org/en/home](https://www.imf.org/en/home) _Source: https://www.imf.org/en/news/articles/2017/09/28/sp092817-the-euro-zone-whats-next_