Press Release No. 15/358

Press Release: IMF Executive Board Concludes 2015 Article IV Consultation on Euro Area Policies

July 27, 2015

On July 24, 2015, the Executive Board of the International Monetary Fund (IMF) concluded the Article IV consultation¹ with the Euro Area.

The recovery is strengthening, driven by rising domestic demand and supported by lower oil prices, the ECB’s quantitative easing under the expanded asset purchase program, and a weaker euro. The improving sentiment, rising inflation expectations, and easing credit conditions suggest that the recovery is likely to continue in the near term. In this context, euro area GDP is expected to accelerate from 1.5 percent this year to 1.7 percent next year. Headline inflation is expected to remain close to zero this year and rise to 1.1 percent next year, reflecting a still large output gap.

Risks to growth are now more balanced than in recent years when they were clearly to the downside. On the upside, low oil prices, quantitative easing, a weaker euro, and rising confidence could bring larger-than-anticipated benefits. Downside risks include lingering weakness and low inflation, a potential slowdown in emerging markets, geopolitical tensions, and financial market volatility, whether from asymmetric monetary policies or contagion from events in Greece.

But the medium-term outlook is subdued, as a chronic lack of demand, impaired corporate and bank balance sheets, and weak productivity continue to hold back employment and investment. Potential growth, estimated to average around only 1 percent over the medium term, is well below what is needed to reduce unemployment to acceptable levels in many countries. Because growth prospects are subdued and policy space is limited, the euro area is vulnerable to negative shocks and prolonged low growth, with negative spillovers.

Addressing the weak medium-term outlook requires a comprehensive policy response. Cleaning up bank balance sheets would encourage banks to lend and firms to invest, while accelerating structural reforms and strengthening further the economic governance framework would help secure lasting growth for Europe and create positive spillovers for the global economy.

Executive Board Assessment²

Executive Directors welcomed the strengthening of the recovery in the euro area on the back of lower oil prices and a weaker euro, supported by strong policy actions, notably by the European Central Bank. Directors noted, however, that the medium-term outlook remains subdued, held back by insufficient demand, still high unemployment, impaired balance sheets, and persistent structural weaknesses.

Directors considered that, while risks to the outlook are more balanced than in recent years, the euro area remains exposed to vulnerabilities. Although market reaction to the recent reform package passed in Greece has been broadly positive, further episodes of significant uncertainty and volatility arising from the situation cannot be ruled out. Directors urged policymakers to use all the available instruments, if needed, to manage contagion risks that might originate from Greece. They also highlighted the need to continue enhancing the architecture of the monetary union and European firewalls.

Directors recommended a concerted, comprehensive approach to bolster domestic demand, especially in surplus countries, clean up bank balance sheets, accelerate structural reforms to raise productivity, and strengthen the economic governance framework. They noted the complementarities among these priorities and the benefits of a more balanced policy mix in generating growth, employment, and positive external spillovers. These efforts would also facilitate further external rebalancing within the euro area.

Directors noted that quantitative easing under the expanded asset purchase program has improved confidence and financial conditions, and raised inflation expectations. They supported full implementation of the expanded asset purchase program, with flexibility in asset purchases, until there is a sustained adjustment in inflation consistent with meeting the medium-term price stability objective, while addressing potential financial stability concerns through macro-prudential policies.

Directors saw room for growth-friendly fiscal measures to lessen the burden on monetary policy and its potential spillover concerns. They considered that countries with fiscal space and low public debt should make full use of the flexibility embedded in the Stability and Growth Pact to support investment and structural reforms. They welcomed efforts underway to swiftly implement the centralized investment plan, carefully select high-return projects, and remove regulatory barriers. 3

Directors underscored the urgency of repairing bank balance sheets and severing bank-sovereign links, crucial for credit growth and effective monetary policy transmission. They encouraged comprehensive action to reduce the high level of non-performing loans, tighten supervision, improve insolvency regimes, and develop distressed debt markets. Directors stressed the need for common deposit insurance with an effective fiscal backstop, a well-resourced Single Resolution Fund, and ease of access to direct bank recapitalization from the European Stability Mechanism. They looked forward to further advancement toward a complete banking union.

Directors urged further reforms to improve labor markets and productivity, the business climate, and potential growth. They recommended focusing regional efforts on implementing the Services Directive, and establishing a single market in transport, energy, and the digital economy. Directors looked forward to an action plan to deepen the integration of capital markets, aimed at diversifying funding sources and enhancing cost efficiency.

Directors welcomed proposals for a more effective governance framework, including a consideration of outcome-based benchmarks for setting priorities in structural reforms. They noted that independent councils could help enhance monitoring and innovation. Directors also saw scope for simplifying the fiscal framework, based on a single fiscal anchor and a single operational target.

¹ Under Article IV of the IMF's Articles of Agreement, the IMF holds bilateral discussions with members, usually every year. A staff team visits the country, collects economic and financial information, and discusses with officials the country's economic developments and policies. On return to headquarters, the staff prepares a report, which forms the basis for discussion by the Executive Board.

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.