Loading component...
Euro Area -- Concluding Statement of the IMF Mission on Euro-Area Policies, In the Context of the 2004 Article IV Consultation Discussions with the Euro-Area Countries
May 18, 2004
May 18, 2004
1. The accession of ten new countries on May 1 represents the latest milestone in European integration. EMU and the euro continue to provide focus and momentum to the integration project. Within this context of historic achievements, this year's consultation provides another opportunity to ponder why the euro area is seemingly unable to deliver robust growth, both from a shorter- and longer-term perspective. With rapid population aging no longer the distant event it once was, providing answers to this question is becoming ever more pressing.
Growth Outlook
2. There are signs that the area's cyclical stagnation may be coming to an end. But while most of the global economy is already enjoying robust growth, the area's recovery remains gradual and overly dependent on booming global trade and favorable financial market conditions. Area-wide domestic demand is picking up at a hesitant pace, reflecting, in particular, ongoing weakness in the largest member country. Nevertheless, we share the central view of a gradual upturn. This view is based on the traditional presumption that strong external demand and relaxed financial conditions will spur corporates to resume capital spending and hiring, while private households will be willing to step up consumption in line with faster income growth.
3. However, the risks to the cyclical outlook remain tilted to the downside. The business environment is clouded by lingering uncertainties about the future pace and content of structural reforms, and high corporate indebtedness may continue to weigh on capital spending. Moreover, hiring during the recovery could be slow if the relatively sharp decline in labor productivity growth during the downswing proves symptomatic of labor hoarding. On the consumer side, spending could be constrained by subdued real disposable income growth. In addition, households' inclination to spend could be discouraged by unfavorable longer-term growth prospects and the increasing realization that welfare state promises will be difficult to fund in an aging society. On the external side, the momentum provided by the global trade boom could be stronger than projected, but higher commodity prices, particularly for energy, will weigh on the area's purchasing power and raise firms' input costs. Moreover, our analysis of global current account imbalances points to renewed appreciation pressure on the euro as a significant medium-term risk.
4. Our concerns about cyclical risks notwithstanding, the area's "real" growth problem is long term. The onset of rapid population aging is only one business cycle away, and, other things being equal, portends both a sharp slowing in longer-term growth and financially troubled welfare systems. Looking back, the euro area has slipped relative to the United States in per capita income levels over the past decade. This reflects incentive structures that have stymied the uptake of growth and employment opportunities offered by new technologies, integration, and globalization.
The Way Forward
5. Europe's social and economic model is at a crossroads. Looking ahead, slowing potential growth and unfavorable demographics will increasingly strain the delicate balance between social cohesion and financial discipline, a balance that has underpinned policy consensus in the postwar period. We believe that preferences and institutions can only be respected if the area embraces policies that tap its longer-term growth potential, mainly by boosting incentives to work. In this regard, the Lisbon agenda needs to be given a fresh lease on life at both the EU and country level through further prioritization. At the same time, the union needs credible policy frameworks to preserve its hard-won financial discipline.
Structural Policies
6. Although there has been progress, the need to impart momentum to structural policies is urgent. Progress has been most tangible in deregulating and integrating product and financial markets. While much remains to be done, basic directions and steps to be taken have been agreed, in good part because these reforms are largely guided and monitored at the EU level. The Financial Services Action Plan and the Lamfalussy approach to financial integration are cases in point. Even here, however, the issue remains whether the procedural innovations will prove sufficient to re-shape incentives at the national level to overcome current market segmentation. In this regard, we welcome the ECB initiative to try to steer the process in the banking area toward an EU-wide rule book.
7. The greatest concern, however, is over reform in areas where national competencies loom large. Here also there has been progress in recent years. But political fatigue has set in early—well short of the necessary restructuring of work incentives. What can be done? The problem is not deciding on what should be done at the country level. This is specified in the Broad Economic Policy Guidelines, which are widely viewed as charting the right course. The issue is rather how to give momentum to those policies at the national level through more decisive leadership at the EU level.
8. In this regard, three steps would be helpful:
• First, prioritize the Lisbon reform agenda. As presently formulated, that agenda is too diffuse and all-encompassing to provide leadership and generate momentum. In our view, the priority should be on strengthening incentives to work and innovate. Here, the review being carried out by the high-level group headed by Mr. Kok provides an important opportunity.
• Second, step up deregulation of goods and services markets, in line with the priorities of the Irish and upcoming Presidencies. Empirical evidence suggests that product market deregulation provides strong incentives for governments and social partners to reform national labor markets.
• Third, strengthen peer pressure on governments, including by clearly identifying and publicizing successful and lagging country cases. Leadership on structural reforms by the largest countries would provide additional incentives through competitive pressures on others.
Fiscal Policy Requirements
9. Although the controversies surrounding the SGP might suggest otherwise, we consider fiscal policies under that framework to have been broadly appropriate during the slowdown, at least from the vantage point of the area as a whole. Fiscal deficits have in the main reflected the unexpectedly protracted slowdown rather than policy choices. Nonetheless, these developments, coming on the heels of earlier shortsightedness of policies, have strained the procedural fabric and credibility of the SGP, which was designed more with an eye to dealing with errant fiscal policies than errant economies.
10. Going forward, we believe that the SGP's basic design as a framework that seeks to combine discipline and flexibility in line with the Treaty's provisions on fiscal limits remains appropriate. However, the experience of the last five years also suggests some lessons:
• Underlying fiscal balance targets should be tied more explicitly to fiscal sustainability considerations. This would bring the SGP more in line with the Treaty's emphasis on debt as well as deficit limits, providing the framework with better economic underpinnings.
• Better incentives are needed during good times to let the automatic stabilizers play fully and to ensure that necessary corrections of weak underlying fiscal positions are sustained. Broadly symmetric policy behavior over the cycle is a prerequisite for any rational fiscal policy rule.
• Although clearly not easy, the procedures of the Pact should be tuned to the proximate reasons leading to breaches of the 3 percent deficit limit, in particular by delineating the relative roles of policies and the economic environment.
11. In our mind, however, the greatest concern is not whether the Pact should be reformed, but whether the consensus on the need for a strong and disciplining fiscal framework for the union can be preserved. We are concerned by the increasingly loud voices counseling what might be viewed as a throwback to Europe's fiscal policy mis-adventures of the 1970s and 1980s, but this time against the backdrop of a much deteriorated medium- to long-term fiscal outlook. Heeding this counsel would be a severe setback, with potentially grave consequences for the monetary union and its member countries, many of which have found the SGP to provide a valuable external commitment device.
12. Against this backdrop, countries should demonstrate a continued commitment to medium-term fiscal discipline when planning and implementing their short-term fiscal policy stance. In particular, countries with weak budgetary positions should undertake measured but high-quality fiscal consolidation that improves the cyclically-adjusted deficit by at least
½ percent of GDP per annum while otherwise allowing the automatic stabilizers to operate. This benchmark may imply the need to take fiscal measures summing to significantly more than ½ percent of GDP if cyclically-adjusted deficits have a built-in tendency to increase.
Monetary Policy Requirements
13. The consensus is that the area's medium-term outlook for inflation remains benign. Headline and core inflation should decline well below 2 percent by 2005, reflecting continued slack in the economy, declining unit labor costs, and lagged pass-through effects from the euro's past appreciation. We recognize, however, some risks and uncertainties. On the upside, recent increases in commodity prices, particularly for oil, will put some upward pressure on headline inflation. Additional hikes in indirect taxes and administered prices are also upside risks. But, as in the past, there is a case for monetary policy to "see through" one-off increases in inflation as long as second-round effects do not materialize. The fact that wage moderation was sustained in the past in the face of similar shocks provides some comfort, particularly at this juncture. Medium-term inflation expectations also seem to remain within reassuring ranges. On the downside, two risks to medium-term price stability are noteworthy: the area's cyclical recovery; and renewed euro appreciation given persistent global current account imbalances.
14. Therefore, monetary policy should remain accommodative but be prepared to ease if the projected sustained recovery of domestic demand does not materialize and the outlook for price stability remains benign. Adding to the case for this policy line, economies recovering from boom-bust cycles in asset prices in low-inflation environments seem to be vulnerable to relapses in domestic demand, particularly when new shocks revive concerns about still unsettled balance sheet positions. Monetary policy can, however, only play a supportive role in helping the area's recovery, and it works best when underpinned by strong commitments to fiscal discipline and structural reforms.
Trade Policies
15. We strongly welcome the EU's new efforts to relaunch the stalled Doha round. The EU's recent offers to phase out all farm export subsidies and further limit negotiations on the Singapore issues provide fresh—and much needed—impetus for reaching agreement on a negotiating framework by July. We also welcome the recent decision to decouple a large part of domestic support for the production of Mediterranean products and would encourage eliminating further trade-distorting aspects of the CAP. In particular, an ambitious reform of the EU's protectionist sugar regime should remain a priority. On market access, we would urge more ambition, particularly on the need to find an acceptable formula for tariff cuts in line with the Doha agenda. In this context, the EU's proposal to exempt weak and poor WTO member countries from cutting their tariffs during the current Doha round could have unfortunate consequences. We see trade liberalization by developing countries, which includes the lowering of often high trade barriers among these countries themselves, as having great potential for spurring their development and growth. Finally, in negotiating bilateral and regional trade agreements, including with Mercosur, the EU should aim for comprehensive product coverage and ambitious goals for market access.
Statistics
16. Euro-area statistics are improving, but considerable gaps remain. Notwithstanding determined efforts led by Eurostat and the ECB, the available economic statistics are not commensurate with the euro area's status as the world's second-largest economy. Analysis is impeded by the absence or slow availability of key indicators, and many analysts, including ourselves, still spend too much time debating the meaning of numbers. Comprehensive and up-to-date statistics are lacking in particular on the institutional income accounts, the labor market, extra-area trade, and the flow of funds. Progress may require a shift of focus from simply aggregating national statistics to compiling them for the area as a whole. We would also note that EMU's fiscal surveillance framework needs to be underpinned by credible fiscal data that conform strictly with statistical regulations.
| Public Affairs | Media Relations | |||
|---|---|---|---|---|
| E-mail: | publicaffairs@imf.org | E-mail: | media@imf.org | |
| Fax: | 202-623-6278 | Phone: | 202-623-7100 | |
