IMF Executive Board Concludes 2016 Article IV Consultation on Euro Area Policies
IMF News, July 8, 2016
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- Published: July 8, 2016
Overview and near-term outlook
- Press Release No. 16/326; consultation concluded on July 6, 2016; page dated July 8, 2016.
- Recent recovery has strengthened, supported by lower oil prices, a broadly neutral fiscal stance, and accommodative monetary policy.
- Growth and inflation projections:
- Euro area GDP growth is expected to decelerate from 1.6 percent this year to 1.4 percent in 2017, mainly due to the negative impact of the U.K. referendum outcome.
- Headline inflation is expected to increase from 0.2 percent this year to 1.1 percent next year, helped by gradually rising energy prices.
Risks and vulnerabilities
- Downside risks have grown:
- External: a further global slowdown could spill over and derail the domestic demand-led recovery.
- Domestic/political: spillovers from the U.K. post-referendum situation, the refugee surge, or a heightening of security concerns could increase uncertainty, hurt growth, and hinder policy and reform progress.
- Financial sector: banking and financial sector weaknesses in some countries.
- Structural: prolonged low growth and inflation increase vulnerability to shocks.
- Policy buffers are low.
Medium-term prospects
- Mediocre medium-term outlook due to crisis legacies and structural weaknesses:
- High unemployment, elevated public and private debt, and low productivity weigh on the outlook.
- Growth five-years ahead is expected to be about 1.5 percent, with headline inflation reaching only 1.7 percent.
Executive Board assessment — key findings
- Inflation and inflation expectations remain very low, below the ECB medium-term price stability objective.
- Crisis legacies—high unemployment and elevated debt—continue to weigh on the medium-term outlook.
- Risks are increasingly to the downside; political uncertainty (notably the U.K. referendum) has risen significantly.
- An intensification of the refugee surge could prompt additional border controls and hinder free movement within the single market.
- Without decisive collective action, the euro area remains vulnerable to instability and repeated crises of confidence.
Policy recommendations and priorities
- Collective action to boost growth, rebuild buffers, and strengthen integration:
- Structural reforms to improve productivity and reduce macroeconomic imbalances; examples highlighted:
- Reduced barriers to entry in retail and professional sectors.
- Improved public administration.
- Lower labor tax wedges.
- Reduced labor market duality.
- Use of outcome-based benchmarks to incentivize reforms and stronger enforcement of the Macroeconomic Imbalance Procedure.
- Fiscal policy:
- Pursue a more balanced policy mix through growth-friendly fiscal rebalancing and use of fiscal space where available.
- Expansion of centralized investment schemes or funds for common projects, given limited fiscal space at the national level.
- Countries without fiscal space should stick to consolidation plans and use interest savings to rebuild buffers.
- Access to any new central fiscal support could be conditional on implementation of structural reforms and compliance with fiscal rules; strengthen and simplify the fiscal framework and governance.
- Monetary policy:
- Directors concurred that monetary policy is appropriately accommodative.
- Negative interest rates have contributed to lower bank funding costs, higher asset values, and more bank lending.
- Most Directors cautioned that further rate cuts could have diminishing returns by squeezing banks’ net interest margins; a few Directors argued for a more holistic assessment including valuation gains and improved asset quality.
- If the inflation outlook deteriorates, further easing—primarily through expanded asset purchases—would be warranted.
- Banking sector and financial stability:
- Urged faster balance sheet repair as part of a broader strategy to foster consolidation in the banking sector.
- Encourage strong ECB action to set targets for banks to reduce impaired assets.
- Complementary measures: strengthen and harmonize insolvency and foreclosure frameworks; promote distressed debt markets.
- Where appropriate, use asset management companies to kick-start markets; in systemic cases, apply State aid rules flexibly.
- Consider common deposit insurance and a common fiscal backstop as essential to completing the banking union; accompany deposit insurance with measures to reduce banking sector risks.
- Any changes to prudential treatment of banks’ sovereign assets should be consistent with global standards.
- Urged further progress on capital markets union to diversify financing sources and enhance private risk sharing.
Policy rationale and conditionality
- Centralized fiscal support should be accompanied by a stronger governance framework to ensure compliance with fiscal and structural rules.
- Expansion of centralized fiscal instruments could be conditional on implementing structural reforms and respecting fiscal rules to improve incentives and enforceability.
IMF Executive Board summary of the 2016 Article IV consultation with the Euro Area.