- International Monetary Fund. European Dept.
- Published Date:
- May 2009
Regional Economi c Out look Europe Addressing the Crisis
© 2009 International Monetary Fund
Regional economic outlook: Europe. – Washington, D.C.: International Monetary Fund, 2009. – (World economic and financial surveys, 0258-7440)p.; cm.
“Addressing the crisis.”
Includes bibliographical references.
1. Economic forecasting – Europe. 2. Economic indicators – Europe. 3. Financial crises – Europe. 4. Crisis management – Europe. 5. Recessions – Europe. 6. Fiscal policy – Europe. 7. Financial services industry – Europe. 8. Banks and banking – Europe. I. International Monetary Fund. II. Series: World economic and financial surveys.
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- Executive Summary
- 1. Outlook: Galvanizing Recovery
- 2. Fiscal Policy in Advanced Countries: Effectiveness, Coordination, and Solvency Issues
- 3. European Emerging Economies in the Crisis: Impact and Recovery
- 1. Has the Financial Crisis Impaired Monetary Transmission in the Euro Area?
- 2. Growth Prospects in Emerging Europe After the Global Crisis
- 3. A Case Study in Coordination: Deposit Guarantee
- 4. Redesigning Financial Supervision in the European Union
- 5. Sovereign Financing Needs of Advanced Economies and the Rollover Risk
- 6. Is the Stability and Growth Pact an Obstacle to Adequate Fiscal Stabilization?
- 7. Crisis Duration Across Emerging Market
- 1. European Countries: Real GDP Growth and CPI Inflation, 2006–10
- 2. European Countries: External and Fiscal Balances, 2006–10
- 3. IMF Support for European Countries Affected by the Global Crisis
- 4. Headline Support for the Financial Sector and Up-Front Financing Need
- 5. Advanced European Economies: Estimated Cost of Discretionary Measures, 2008–10
- 6. Ranges of Fiscal Multipliers Used by IMF Country Teams
- 7. The Case for Fiscal Stimulus: Effects of Fiscal Stimulus Under Distressed Financial Markets
- 8. Coordination Gains: Cumulated Effects of Fiscal Stimulus on a Large Euro Area Country
- 9. Sovereign Spreads: Estimated Panel Regression
- 10. Solvency Concerns Increases Risk Premiums Thereby Reducing the Effectiveness of Fiscal Stimulus
- 11. A Snapshot of Emerging Markets
- 12. Did the Convergence Criteria Matter?
- 13. Correlation with Loan Loss Provisions
- 14. Banks in Emerging Europe Were Imprudent in the Past
- 15. Consumption Growth Is Correlated with Credit Growth
- 16. Consumption Growth Depends upon Credit Growth
- 1. Euro Area: Contribution to Growth, 2006–08
- 2. Selected European Countries: Headline and Core Inflation, January 2006–February 2009
- 3. iTraxx Credit Default Swap Europe Financials’ Index, March 2007–April 2009
- 4. Generalized Impulse Response Functions: Rate of Growth of Real GDP in Response to Negative Standard Error Shock to U.S. Equity Price Growth Rate
- 5. Estimating Shifts in the Global Price of Risk, 2007–March 2009
- 6. Selected European Countries: Growth of Real Credit to Private Sector, 2006–January 2009
- 7. Europe, Asia, and United States: Value of Trade, 1995–2007
- 9. Euro Area and United Kingdom: Liquidity Premium, 2007–April 2009
- 10. Government Support, Including Guarantees, to Banks, 2008–09
- 11. New Member States: Country-Specific Components of Sovereign Spreads, September 2008–January 2009
- 12. Key Short-Term Indicators
- 13. Selected Advanced Economies: Break-Even Inflation, 2007–April 2009
- 14. Germany, France, and Italy: Trade and GDP, 1991–2008
- 15. Advanced European Economies: Estimated Impact of Automatic Stabilizers on Fiscal Balances, 2008–09
- 16. Advanced European Economies: Fiscal Revenues During Episodes of House and Equity Price Busts
- 17. Projected Changes in Public Debt
- 18. Selected Euro Area Countries: Sovereign Spreads and Financial Institutions’ Expected Defaut Probabilities, 2008–January 2009
- 19. Estimated Common Component in Sovereign Spreads, 2001–January 2009
- 20. Contributions to the Change in Spreads
- 21. EMBIG Spreads, 2005–November 2008
- 22. Spreads and Banking System Characteristics
- 23. Residuals from the Fixed Effects Regression for Sovereign Spreads, January 2001–October 2008
This Regional Economic Outlook: Europe—Addressing the Crisis was written by Martin čihák, Srobona Mitra, Silvia Sgherri, and Edda Zoli under the guidance of Helge Berger, Luc Everaert, Ajai Chopra, and Marek Belka, with contributions from Ruben Atoyan, Xavier Debrun, Eugenio Cerutti, Wim Fonteyne, Jean-Jacques Hallaert, Jiri Jonáš, Philippe Karam, Uma Ramakrishnan, Romain Rancière, Emil Stavrev, and Athanasios Vamvakidis. This Regional Economic Outlook: Europe was coordinated by the EU Policies and Regional Studies Division of the IMF’s European Department. Xiangming Fang and Pavel Lukyantsau, Amara Myaing and Dominique Raelison, and Esha Ray and Thomas Walter provided research, administrative, and editorial assistance, respectively. Marina Primorac of the External Relations Department oversaw the production. The report is based on data available as of April 14, 2009. The views expressed in this report are those of the IMF staff and should not be attributed to Executive Directors or their national authorities.
Following a collapse in confidence and global demand, Europe has entered a deep recession. Further amplification of the downturn through adverse feedback effects between the financial system and the real economy is a key risk. Inflation has fallen sharply against the background of a broad-based and rapid decline in consumption, investment, and exports. The downturn is being felt across Europe’s advanced and emerging economies, owing to similarities in their exposure to global financial and real shocks, and strong regional trade and financial integration. Country-specific factors matter too, however, with some countries facing more extreme financing difficulties implementing adjustment programs supported by the IMF and other sources, including the European Union (EU).
Even assuming more forceful policy actions, the downturn is likely to last until early 2010, and the subsequent recovery is expected to be gradual. Restoring confidence, adjusting to a lower level of wealth, and reducing leverage in the financial sector will take time. And with a globally synchronized downturn, the scope for Europe to benefit from an export-led recovery is limited. Following the jarring global repricing of risk and the diminishing of risk appetite, the cost of capital will remain high for some time, and several emerging economies are facing a sudden retrenchment of capital inflows. With the reversal of commodity prices and the widening of the output gap, deflationary pressures have increased, but inflation expectations so far remain anchored in positive territory. Economies adjusting under fixed exchange rate regimes are particularly likely to see their price levels decline, while nominal exchange rate depreciations elsewhere could lessen downward pressure on inflation.
Building on ongoing progress, further policy action, especially in the financial sector, is required to restore market trust and confidence in all countries. In addition to continued liquidity provision, credible loss recognition must be undertaken, taking fully into account prospective losses from the economic downturn. Viable institutions need to be recapitalized, with public support as needed, while others should be resolved. Equally important is the ring-fencing of impaired assets in order to reduce uncertainty.
With the downturn likely to be protracted, macroeconomic policies will need to continue to support demand, while keeping an eye on the medium and longer run. Further room to reduce interest rates should be exploited swiftly, and additional unconventional easing will have to be considered, with appropriate safeguards to limit market distortions, ensure reversibility, and preserve the integrity of central banks. Fiscal policies to soften the downturn should continue into 2010, with an emphasis on effectiveness and sustainability. The pursuit of growth-enhancing structural reforms to tackle the aging-related increases in public costs looming on the horizon will be particularly important.
For Europe, addressing the current economic and financial crisis coherently and comprehensively across advanced and emerging economies provides an opportunity to emerge from the crisis with stronger policy institutions and substantial progress made toward its goals of integration and convergence. The benefits of coordination are particularly large in the financial area and in mitigating regional downside risks. Agreeing on basic methodologies to determine capital needs and the approach to deal with impaired assets will avoid distortions and policy arbitrage, and minimize collective costs. Similarly, full homehost coordination on loss recognition and recapitalization of cross border banks is an important element in this approach. Potential debt-servicing difficulties and disruptive exchange rate movements should be preempted with the involvement of EU institutions, and of the IMF where needed, by extending currency swap lines for emerging markets and clarifying the road maps for euro adoption.
Beyond the immediate crisis, improving the EU’s financial stability framework will be essential. Implementing the recommendations of the de Larosière report deserves strong support. Nonetheless, reforms will eventually need to go further to ensure a cross-sectoral integration of supervisory arrangements and establish an effective framework for crossborder crisis management and resolution.
With active fiscal policy firmly back on the agenda, it is important to address questions of its effectiveness and coordination (Chapter 2). Especially in a tightly integrated region under a common currency, such as the euro area, the benefits of fiscal expansion spill across borders while costs—namely increasing debt levels and potentially higher financing expenditure—amass locally. This creates significant room for a coordinated fiscal expansion, as a simultaneous areawide stimulus would yield much stronger growth effects than a stimulus in just one country. As for the content of the fiscal package, in current circumstances, spending on infrastructure and targeted transfers are likely to have the largest multipliers. General tax cuts or subsidies, either for consumers or firms, are likely to be less effective.
Effective fiscal policies will need to take into account the sustainability of public finances. While global developments have played a role in the recent increase in euro area sovereign interest rate differentials, country-specific factors—in particular rapidly rising projected debt levels, as well as concerns about the solvency of national banking systems and their budgetary consequences—have increasingly become important. One implication is that the impact of expansionary fiscal action will be larger in countries with lower public debt and relatively healthy banking sectors; this adds to the call to tailor fiscal action to the fiscal room available. Another implication is that, to maintain fiscal space, countries need to focus on reversible fiscal measures, formulate a plausible medium-term strategy, strengthen their fiscal frameworks at the national level, and make full use of the medium-term framework tied to the Stability and Growth Pact (SGP) where applicable.
Some of these concerns also feature in emerging market economies, although with substantial variation within the region (Chapter 3). In emerging Europe, too, the crisis has put a premium on sound policies at the country level. A large part of the differences in the way the crisis affected individual countries can be explained by diverging macroeconomic performance and external vulnerabilities, such as current account deficits. At the same time, the apparent ability of new EU member countries to attract cheaper funding because of their EU membership, the so-called EU halo effect, has disappeared. Gone as well is the notion that bank-based financing of external capital needs will guarantee stable capital inflows during a crisis. With western European parent banks in need of government support themselves, markets are taking a less sanguine view of extensive foreign ownership in the financial sector. Increasingly, recapitalization of banks is becoming a regional issue, merely underscoring the advantages of a coordinated European approach.
The banking sector could also hold a key to the speed of the recovery in emerging Europe. Measures to support credit, for instance through bank recapitalizations, can hold off a tightening of credit conditions, support consumption, and prevent recessions from becoming overly protracted in some countries. This mechanism is emphasized in recent IMF-supported programs, which have provided funds especially for meeting bank recapitalization needs. To reduce the procyclical volatility of bank profits and lending in the future, prudential rules on provisioning need to be strengthened once the crisis has dissipated. Also on the policy agenda should be the need for enhanced cross-border coordination among home and host central banks, supervisors, and governments.