Journal Issue

IMF cuts growth forecast for euro area, urges compliance with Stability and Growth Pact

International Monetary Fund. External Relations Dept.
Published Date:
January 2002
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In its annual assessment of euro area economies, discussed by the IMF Executive Board on October 18 and published on October 29, the IMF said the region was still on track for recovery, but at a more gradual pace than previously forecast. “It’s coming, but in our view, not until next year,” said Michael Deppler, Director of the IMF’s European 1 Department, which covers the European Union countries. The IMF fore cast euro area GDP to grow by 0.75 percent in 2002 and 2.0 percent in 2003. In a conference call with the press, Deppler said that inflation was expected to recede next year to about 1.5 percent. “Hence, given the downside risks to the recovery, in our view, a bias toward interest rate cuts is needed. This is the view of both the staff and the Board,” he said. The euro, he added, continued to be undervalued, and so there was scope for further appreciation of the currency. The ECB has kept its main refinancing rate at 3.25 percent since November 2001.

Growth in Germany, Europe’s largest economy, was surprisingly weak. “Germany basically still needs to adjust to a shock—namely, unification—that has led to big increases in labor costs,” Deppler said. The report, written as part of the regular IMF monitoring of members’ economies, said that there were nagging concerns about the performance of the euro area. “With the prospects of a slower recovery abroad and an appreciated euro curtailing external demand, sustaining growth requires a strengthening of domestic demand. Historically, however, domestic demand has tended to follow rather than lead recoveries.”

The core of the problem is the fact that the three largest countries haven’t lived up to the rules.—Michael Deppler

Big 3 cause worries

The report said that the divergent underlying fiscal positions in the three largest economies of the euro area could further strain the credibility of the European Union’s (EU’s) SGP. The SGP, the fiscal framework for the monetary union, commits members to running budgets that are close to balance or in surplus in normal times, with the leeway to run deficits of up to 3.0 percent of GDP during downturns. “The core of the problem is the fact that the three largest countries basically haven’t lived up to the rules,” said Deppler. These countries’ structural deficits remain in the 1.5 to 2.0 percent range and, as a result, the cyclical weakness of economic activity has pushed overall deficits close to, or above, the 3 percent of GDP ceiling.

At their October 18 discussion of the report, the IMF’s Executive Directors endorsed a proposal that France, Germany, and Italy should commit to adjusting their underlying fiscal positions by at least 0.5 percent of GDP a year over the next few years until they reach close-to-balance structural positions. Such an approach would give needed fiscal credibility at both the national and areawide levels that could significantly curb the short-term negative demand effects of the adjustment, particularly if fiscal consolidation is anchored in expenditure reforms, according to a release on the Board’s discussion.

Deppler said that the SGP’s aim of a budget close to balance or in surplus was a good norm for the medium term because all of the countries in the euro area face steep increases in indebtedness arising from aging populations.

Labor reform needed

The IMF report said that the scope for boosting the euro area’s potential output through structural reforms remains large. “Following eight quarters of subpotential growth, the agenda has become increasingly urgent to implement,” the report said. Reforms are needed particularly in labor markets. “While productivity levels in Europe are fairly high in absolute terms, per capita income is much lower—about two–thirds the level of the United States,” said Deppler. “And this difference, in terms of the productivity performance versus the per capita income performance, is really rooted in different rates of utilization of labor, pointing to the need for Europeans to focus much more on labor market reforms.”

With respect to the trade policies of the EU, Directors emphasized that, given its prominent role in world trade, the EU has a special responsibility to pursue liberal trade policies, includingx in agricultural products; improve access to developing country exports; and advance the agenda of multilateral trade liberalization. They welcomed the leading role played by the EU in the successful launch of the Doha round of trade negotiations and the priority given by EU trade policy to further liberalization and better trade rules in the multilateral context. They were encouraged that further escalation of transatlantic trade disputes, which could have undermined progress under the Doha round, has so far been avoided.

Directors considered that reform of the Common Agricultural Policy (CAP) should be a policy priority for the EU, given the costs it imposes on EU consumers, trading partners, and agricultural markets. The proposals under the mid–term review of the CAP, which involve delinking financial support from production, are a crucial first step in this direction, and determined political leadership is now required to pursue reform comprehensively, including by aiming to eliminate agricultural export subsidies.

Directors welcomed the EU’s commitment to increase developing countries’ access to its market and urged the EU to go further by being prepared to eliminate or reduce tariff peaks and tariff escalation, including on export products of interest to developing countries. In textiles and clothing trade, quota removals should be accelerated in order to help smooth the adjustment in both EU industries and in those developing country suppliers currently protected by the quota system.

Copies of the Staff Report on the Monetary and Exchange Rate Policies of the Euro Area and the Trade Policies of the European Union and Selected Issues are available for $15.00 each from IMF Publications Services (see page 341 for ordering information). The Staff Report, Selected Issues, Public Information Notice, and a transcript of Michael Deppler’s press conference call are also available on the IMF website (

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