IMF Executive Board Discusses the Monetary and Exchange Rate Policies of the Euro Area

For the time being—and possibly for a considerable time to come—developments and prospects for the euro area are quite favorable. This upbeat outlook is underpinned by buoyant activity indicators and a supportive policy mix. High household and business confidence, rising capacity utilization and industrial production, strong job creation, and—so far—employment-friendly wage settlements point to sustained activity in the near term. Moreover, the macroeconomic fundamentals in the euro area appear much sounder than in previous recoveries.


For the time being—and possibly for a considerable time to come—developments and prospects for the euro area are quite favorable. This upbeat outlook is underpinned by buoyant activity indicators and a supportive policy mix. High household and business confidence, rising capacity utilization and industrial production, strong job creation, and—so far—employment-friendly wage settlements point to sustained activity in the near term. Moreover, the macroeconomic fundamentals in the euro area appear much sounder than in previous recoveries.


With domestic demand growth at about 3 percent and a more supportive external environment, euro-area activity has been buoyant so far in 2000, pushing the area-wide unemployment rate down to 9 percent in August. Real GDP growth for the area as a whole has been at a rate of 3.8 percent in the second quarter (year on year), after 3.4 percent in the first. Some recently released confidence indicators point, though, to a possible slowdown in the second half of the year.

Exchange rate pass-through and rising oil prices lifted headline inflation to 2.3 percent in August. Nonetheless, annualized core inflation (defined as the harmonized CPI net of energy and some food-related components) was subdued at 1.3 percent in August 2000. Recent wage settlements in some large economies suggest that wage moderation continues to prevail.

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In part because of the weakness of the euro, monetary conditions remain broadly supportive of activity in spite of the recent round of interest rate increases by the ECB (up a cumulative 225 basis points since November 1999). The constellation of national fiscal policies is also supporting area-wide aggregate demand, with pro-cyclical or neutral stances envisaged in the 2000 budgets of most countries after the overachievement of deficit targets in 1999.

On September 21, the ECB and other central banks intervened jointly in the foreign exchange market in support of the euro, leading to a sharp initial appreciation vis-à-vis the U.S. dollar. The exchange rate has since drifted back toward the pre-intervention level.

On current projections, euro-area real GDP growth is estimated at about 3½ percent for 2000 in a setting of broad price stability. Regional divergences in growth and inflation rates, reflecting in part the catching-up process in many EMU countries, are expected to continue, although narrowing somewhat. The main downside risks to the near-term outlook are linked to the possibility of a rapid turnaround of the external factors that have propelled euro-area growth, and of a worse-than-anticipated impact of high oil prices.

Executive Board Assessment

Executive Directors noted with satisfaction that favorable external developments and strong macroeconomic fundamentals have produced robust growth. Directors cautioned, though, that the persistence of high and volatile oil prices has heightened downside risks and might affect the otherwise favorable prospects for growth in the short run.

Directors were more uncertain about prospects over the medium and longer term, and noted in particular that lasting reductions in the level of unemployment in the euro area will not be possible if the ongoing expansion were not sustained. They saw risks both in a sharp reversal of the favorable external shocks that have helped to propel the euro area upturn and in the area’s structural rigidities that in the past have often interacted with insufficiently countercyclical fiscal policies to undercut upswings and exacerbate downturns. Some Directors expressed concern at the possibility that the inflationary effects of higher energy prices and a weak euro might also undermine the prevailing wage moderation.

Directors recognized that the monetary union has strengthened the macroeconomic structure of the euro area, including by bringing about a euro-area-wide based monetary policy, a better coordination of fiscal and structural policies, and a greater awareness at the national level of the competitiveness implications of wage developments. They stressed, nonetheless, that the import of these changes has not yet been tested by adversity, and thought that the present favorable economic circumstances provide an important opportunity to forge ahead with needed reforms.

Directors thus agreed that the most pressing challenge, from a regional as well as a global standpoint, is to implement policies that both sustain the expansion and make it more resilient. In particular, they urged euro-area policymakers to adhere closely to the key requirements of safeguarding price stability, establishing structurally balanced fiscal positions and avoiding pro-cyclical fiscal policies thereafter, and strengthening the supply side through a balanced and proactive strategy of tax, expenditure, and structural reforms.

Directors observed that monetary management has been appropriately cautious, with the rise in interest rates having helped to preserve medium-term price stability during a period of unexpectedly large and protracted oil price increases and euro weakness. They concurred that, as the effects of the external factors that have contributed to the firming up of the recovery and the buildup of cost pressures dissipate or are reversed, and if inflation shows signs of declining, the symmetric approach that has so far shaped policy would call for interest rates to be adjusted appropriately. In this context, it was also noted that the monetary authorities should focus on core inflation and be rather cautious in interpreting headline inflation.

Directors discussed the level of the euro and factors contributing to its recent evolution. They noted that the misalignment of the euro both vis-à-vis the United States dollar and in effective terms remains large. Directors considered that this misalignment should eventually correct, in part as cyclical divergences narrow and as underlying portfolio adjustments run their course, although they expressed a variety of views on the significance and nature of these portfolio adjustments. Several Directors commented that the correction would also be helped by further actions to address the structural rigidities that appear to have clouded euro-area prospects. Directors agreed that the September concerted intervention in support of the euro had helped in stabilizing the exchange rate by sending a signal that market participants wilt have to bear in mind in the future. They also considered that movements in the exchange rate should inform monetary decision making to the extent that they pose a threat to medium-term price stability.

In the fiscal domain, Directors agreed that the key challenge is how to implement supply-enhancing tax cuts while avoiding pro-cyclical fiscal policies. In this connection, they regretted that the current stance is somewhat pro-cyclical in the aggregate, and risks becoming increasingly so if the pace of consolidation does not keep up with the expansion. In future, closely integrated tax and expenditure policies that ensure that tax reductions do not run ahead of offsetting permanent cuts in public spending will be required.

More broadly, Directors stressed that the pursuit of at least neutral fiscal policies requires evaluating fiscal positions in relation to the cycle, thus targeting budgetary surpluses when activity is above potential. In their view, this would enhance the effectiveness of the monetary union by strengthening the policy mix and meeting the Stability and Growth Pact’s objective of close to balance or surplus in the medium term, thereby also preserving room for countercyclical policies when growth weakens.

Directors emphasized that national fiscal strategies should also encompass tax and expenditure objectives that effectively bolster the growth potential of the euro area. From this angle, tax cuts need to be carefully targeted to achieve the most beneficial supply-enhancing effects, and expenditure policies should focus on increasing the efficiency of public services. In this context, they noted that progress has been mixed, especially as regards expenditure reforms. A few Directors also called for rationalization of subsidies, which remain high in relation to GDP in several euro-area countries.

While acknowledging that structural reforms have advanced, Directors stressed that further efforts are essential to create headroom for growth and avoid capacity constraints from again choking off the expansion prematurely. In this connection, they welcomed the Lisbon summit decision to put structural reforms at the top of the European Union’s policy agenda. In labor markets, Directors stressed the importance of strengthening effective labor supply, inter alia, by tightening eligibility for benefits and sharpening the incentives for job search as well as by fostering in many cases more flexibility in wage determination.

In product markets, Directors agreed that there is room to promote competition in key sectors and remove administrative barriers to business formation as well as to some cross-border activities. Regarding the financial sector, Directors welcomed the intention of the euro-area authorities to keep the adequacy of present supervisory arrangements under review in order to ensure that they continue to work effectively, particularly as the interbank market becomes more closely integrated and pan-European institutions result from a continuing process of consolidation. Directors also discussed whether some consolidation or strengthened coordination of the existing institutional arrangements would be desirable and expressed a variety of views on this matter. It was also noted that further steps are needed to increase the integration of capital markets and the transparency of banking institutions in the euro area, for instance, by addressing the relatively weak disclosure rules and by instituting greater uniformity in the provision of accounting information, including better reporting of nonperforming loans.

Directors acknowledged that European Union (EU) internal surveillance over structural reforms has proved helpful, but argued that its effectiveness depends on its candor. As for EU surveillance over fiscal policies, they shared the view that the annual appraisals of stability programs by the Commission and the ECOFIN Council have proved beneficial and should continue. In this connection, Directors also noted the increasing role of the Euro Group as a forum for peer review, policy coordination, and harmonization.

Regarding statistical matters, Directors acknowledged the adequacy of existing data for surveillance purposes, but called for strengthening the euro-area’s statistical base in the dimensions most critical for monetary policy decision making.

With respect to the trade policies of the European Union as a whole, Directors welcomed the EU’s commitment to an early launch of a new round of multilateral trade negotiations, and the Commission’s initiative in promoting free access for the exports of the world’s poorest countries. In this connection, they urged the EU to implement promptly its latest proposal in favor of these countries. Directors recognized, though, that support for new multilateral negotiations would be enhanced if the EU also addressed the most restrictive and complex aspects of its own trade regime, including through a faster liberalization of agricultural, textile, and clothing markets, a reduction of subsidies, and a review of anti-dumping policy. Looking ahead, the impact of the EU’s policies on trade should also be kept in mind as the EU is enlarged. Directors expressed satisfaction that the EU has relied on the World Trade Organization’s Dispute Settlement Body procedures to resolve its bilateral trade disputes and encouraged it to abide by the Dispute Settlement Body’s rulings. Finally, Directors called on the EU to minimize the potential for regional and bilateral trade agreements to lead to trade diversion by pursuing multilateral trade liberalization at a similar pace.

Public Information Notices (PINs) are issued, (i) at the request of a member country, following the conclusion of the Article IV consultation for countries seeking to make known the views of the IMF to the public. This action is intended to strengthen IMF surveillance over the economic policies of member countries by increasing the transparency of the IMF’s assessment of these policies; and (ii) following policy discussions in the Executive Board at the decision of the Board.

Euro Area: Selected Economic Indicators

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Sources: IMF, IFS; European Central Bank; EUROSTAT; national authorities; and Fund staff estimates.

Staff projections.

Harmonized definition.

For 1995 based on national definitions.

In percent of labor force

Data do not include mobile telephone license receipts.

October 6, 2000

Data for the first seven months of 2000, in percent of projected 2000 GDP.

Total reserves minus gold (Eurosystem definition); end July from IFS.

September 2000 relative to 1999 average.


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. 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. The main features of the Board’s discussion of the staffs report on the monetary and exchange rate policies of the euro area are described in this PIN. In the present case, the Fund staff held discussions with European Union institutions, including the European Central Bank (ECB), in the context of the Article IV consultations with the countries forming the euro area. The ECB’s observer at the Fund participated in the meeting of the Executive Board.