February 7, 2022
Washington, DC : The Executive Board of the International Monetary Fund (IMF) concluded the 2021 discussions on common euro area policies with member countries. [1]
The euro area economy is recovering rapidly. After falling by about 6½ percent in 2020, euro area output has rebounded strongly since the second quarter of 2021 thanks to high vaccination levels, strong policy support, and increasing consumer and business adaptation to the pandemic, with real GDP having reached its pre-crisis level by the end of last year. Inflation accelerated in 2021, largely reflecting base effects from last year’s low energy prices and transitory factors. Looking ahead, supply chain disruptions, elevated energy prices, and the resurgence of Covid-19 cases—including those related to the Omicron variant—are likely to pose near-term headwinds to growth. However, these factors are expected to dissipate over the course of 2022, and the robust recovery is set to continue on account of a strong labor market, the normalization of the households’ savings rate, and the impulse provided by the Next Generation EU Plan. Upside inflation risks have increased. However, with temporary factors dissipating, inflation is projected to decline through 2022 and to remain below the ECB’s 2-percent target in the medium term.
Uncertainty remains high and is largely tied to the evolution of the pandemic. As elsewhere, the ongoing wave of infections and renewed concerns about newer and more transmissible Covid-19 variants highlight the continuing risk that the pandemic poses to the recovery, especially if it were to be accompanied by decreased vaccine effectiveness or incomplete vaccination coverage. The ongoing phasing-out of policy support, a potential correction in real estate markets, or spillovers from a sharp slowdown outside Europe could also create headwinds. Conversely, faster-than-expected adjustment to Covid-19 would boost activity, while a material unwinding of large household savings could significantly increase consumption, and an effective implementation of the envisaged reforms and investments could also raise medium-term growth prospects. Rising geopolitical tensions pose a new downside risk to growth and an upside risk to inflation, although the precise impact will depend on how events and related policy responses unfold in the coming weeks.
Executive Board Assessment [2]
Directors commended the authorities’ forceful economic policies, which, together with high vaccination levels and better adaptation to Covid-19, helped the euro area economy recover rapidly. Directors agreed that strong growth is set to continue, but also noted that uncertainty remains high and risks to the outlook remain dominated by pandemic dynamics and legacies.
Directors emphasized that fiscal policy should remain supportive, and, as the recovery takes hold, become increasingly targeted to support the vulnerable and limit scarring. They welcomed the approval of national Resilience and Recovery Plans and urged their rapid and high-quality implementation. Directors noted the debate on reforming the EU fiscal framework and agreed that a time-bound transitional arrangement could be desirable until the new rules become effective. They acknowledged that an expenditure growth rule with a debt anchor could be an attractive option for the new framework, and that an EU-level climate investment fund could complement the fiscal rules by creating scope for financing essential climate investments and realizing the potential for positive cross-border spillovers from carbon-mitigation efforts.
Directors observed that, despite rising near-term price pressures, inflation is expected to remain below target over the medium term. They generally concurred with the ECB’s recent decision to maintain an accommodative monetary policy stance until its medium-term inflation target is met, while retaining flexibility to adjust course should elevated underlying inflation prove to be more durable than currently projected. Directors welcomed the conclusions of the ECB’s strategy review, including an ambitious climate-related action plan.
Directors observed that, while the financial system appears resilient, bank supervisors need to ensure timely loss recognition and appropriate provisioning. They agreed that housing markets conditions warrant a more effective use of macroprudential policies in jurisdictions where real estate risks are higher. Continued progress on European financial architecture reforms and a faithful implementation of internationally agreed bank capital standards would help underpin global financial resilience and stability. Directors saw merit in establishing a single AML/CFT rulebook and making progress towards the harmonization of AML/CFT supervision.
Directors agreed that ambitious structural policies and sizable investments will be needed to increase euro area potential growth and support the digital and green transitions. In this context, they observed that the Next Generation EU provides a unique opportunity to make progress on these priorities. Labor market policies should focus on facilitating reallocation, including through programs for reskilling and upskilling of workers, and temporary and targeted subsidies. Improving the coverage of social safety nets by relying on progressivity and means-testing would help mitigate the impact on the vulnerable of structural economic shifts. Directors welcomed the EU’s climate change mitigation agenda, together with the authorities’ assurances that the design of any carbon border adjustment mechanism would be compatible with WTO rules.
Directors underscored that the emergence of the Omicron variant illustrated the criticality of continued EU efforts to ensure equitable global access to Covid-19 vaccines.
[1] Under Article IV of the IMF’s Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. Staff hold separate annual discussions with the regional institutions responsible for common policies for the countries in four currency unions—the Euro-Area, the Eastern Caribbean Currency Union, the Central African Economic and Monetary Union, and the West African Economic and Monetary Union. For each of the currency unions, staff teams visit the regional institutions responsible for common policies in the currency union, collect economic and financial information, and discuss with officials the currency union’s economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis of discussion by the IMF Executive Board. Both staff’s discussions with the regional institutions and the Board discussion of the annual staff report subsequently are considered an integral part of the Article IV consultation with each member.
[2] 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. An explanation of any qualifiers used in summings up can be found here: http://www.IMF.org/external/np/sec/misc/qualifiers.htm