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European Economic Outlook: Europe Set for Sustained Expansion, Says IMF

Author(s):
International Monetary Fund. External Relations Dept.
Published Date:
April 2007
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Europe’s upswing is showing momentum, creating bright prospects for 2007 and 2008, according to Michael Deppler, head of the IMF’s European Department. “The situation in Europe, which improved markedly last year, is set for a sustained expansion,” he told journalists at an April 14 press briefing during the IMF-World Bank Spring Meetings. Europe as a whole is expected to see growth of 3.4 percent in 2007, against 3.7 percent last year (see table). The euro area is set to expand by at least 2.3 percent this year.

Deppler noted that “part of this strong outlook is due to good policies. Monetary policy has been appropriately conducted, fiscal policies have gotten back on track, and countries have undertaken significant structural reforms.” In Europe’s advanced economies, continuing job creation, falling unemployment, and low inflation are providing the basis for stronger private consumption. In emerging—or perhaps more aptly named converging—Europe, business investment has been boosting production and export capacity, leading to strong growth. More broadly, growth has also benefited from the synergies between east and west, rooted in the general cyclical upswing as well as in more structural developments, such as enlargement.

Europe may well surprise on the upside

While external risks to Europe’s economic outlook are tilted to the downside, mainly because of the uncertainty surrounding the U.S. economy, Deppler thought that “it would take a very large negative external shock to significantly derail recovery in Europe” In fact, short-term indicators inspire confidence that the cyclical upswing may exceed expectations.

But there are still risks. A stronger-than-expected slowdown in the United States or a disorderly unwinding of global imbalances is possible, but the impact on Europe would likely be muted relative to the experience in 2001-02, when the bursting of the dotcom bubble dealt a shock both inside and outside Europe. Most important, the very large cross-border financial flows into central and eastern Europe could push convergence past its speed limits. While these flows have been used productively in most of converging Europe, financial convergence may be running ahead of fundamentals in some countries. Rapid credit growth could sow the seeds for trouble in the event of a generalized retrenchment from risky assets or a domestic policy slippage.

Good times ahead

The IMF predicts continued healthy growth in Europe for the next two years.

2006Proj.

2007
Proj.

2008
Output growth (annual rate in percent, weighted average)
Europe13.73.43.2
European Union (EU)23.22.82.7
Euro area32.62.32.3
Non-euro area advanced economies43.02.92.7
CEEC and Baltics56.35.75.0
Source: IMF staff estimates and projections.

Includes all 27 members of the EU, as well as Albania, Belarus, Bosnia and Herzegovina, Croatia, Iceland, Israel, Macedonia, Moldova, Norway, Russia, Serbia, Switzerland, Turkey, and Ukraine.

Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and United Kingdom.

Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Slovenia, and Spain.

Cyprus, Denmark, Malta, Sweden, and United Kingdom.

Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Slovakia.

Source: IMF staff estimates and projections.

Includes all 27 members of the EU, as well as Albania, Belarus, Bosnia and Herzegovina, Croatia, Iceland, Israel, Macedonia, Moldova, Norway, Russia, Serbia, Switzerland, Turkey, and Ukraine.

Austria, Belgium, Bulgaria, Cyprus, Czech Republic, Denmark, Estonia, Finland, France, Germany, Greece, Hungary, Ireland, Italy, Latvia, Lithuania, Luxembourg, Malta, Netherlands, Poland, Portugal, Romania, Slovakia, Slovenia, Spain, Sweden, and United Kingdom.

Austria, Belgium, Finland, France, Germany, Greece, Ireland, Italy, Luxembourg, Netherlands, Portugal, Slovenia, and Spain.

Cyprus, Denmark, Malta, Sweden, and United Kingdom.

Bulgaria, Czech Republic, Estonia, Hungary, Latvia, Lithuania, Poland, Romania, and Slovakia.

Productivity remains key

According to Deppler, “performance is improving, but we don’t know how much is cyclical and how much is structural.” Europe’s advanced economies are still failing to make notable inroads in closing the transatlantic divide in per capita GDP. Encouragingly, recent labor and product market reforms have helped reduce structural unemployment. But labor utilization remains low and signs of a much-needed revival in productivity growth are tentative.

The best way to achieve higher productivity and improve Europe’s potential growth rate is through strengthened competition. To that end, policymakers should seek to further deregulate product markets, complete the EU single market, especially through a swift implementation of the EU services directive, and foster financial integration.

For their part, Europe’s converging economies need to deliver the higher growth potential that investors are anticipating. They have made great strides compared with old EU member states, Deppler noted, but viewed over a decade, they are not doing as well as better-performing peers, notably in Asia. For these economies, sustaining the pace of structural reforms is essential. The new member states also need to put in place the policies that will allow them to successfully adopt the euro.

Making good times last

These are well-deserved good times for Europe, Deppler said. However, good times have in the past led to shortsightedness and policy mistakes. To keep up the positive momentum, it will be essential for countries to maintain a medium-term focus in their policies and not let today’s positive economic news sidetrack them from addressing the enduring challenges they face—aging, rigidities, and inefficiencies. For both western and eastern Europe, it is very important to take advantage of the current favorable conditions to continue fiscal adjustment and complement continued labor market reforms with a much greater push to improve productivity.

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