Statement by Pier Carlo Padoan, Executive Director for Euro Area Policies

The continuing weakness of activity in the euro area reflects an amalgam of cyclical and long-term forces that are likely to shape the outlook and to challenge policies. Financial conditions in the area have improved along with those in global markets, though financial fragilities may be impairing the transmission to firms. The aging of the population could entail significant declines in potential output growth and lower expected lifetime income resources. Forward-looking policies are needed to improve the quality and ensure long-term sustainability.


The continuing weakness of activity in the euro area reflects an amalgam of cyclical and long-term forces that are likely to shape the outlook and to challenge policies. Financial conditions in the area have improved along with those in global markets, though financial fragilities may be impairing the transmission to firms. The aging of the population could entail significant declines in potential output growth and lower expected lifetime income resources. Forward-looking policies are needed to improve the quality and ensure long-term sustainability.

Italy holds the Presidency of the Eurogroup at present, and my statement expresses the common views of the euro area Member states and the European Community in their respective fields of competence.

The authorities of the euro area Member States welcome the staff’s assessment of economic developments and prospects for the euro area. They are in broad agreement with the policy conclusions. In addition to outlining where differences of view appear, this statement will update the Board on recent economic developments and policy actions taken at the European level.

Short term economic outlook

Economic growth in the euro area has practically stagnated in the first half of 2003, but a recovery is expected to start in the second half of the year. There are encouraging signs in this direction: real disposable income is rising, the quality of corporate balance sheets is gradually being improved, several forward-looking indicators have improved and more optimism is being priced in financial markets. Moreover, there are signs of growth picking up in many parts of the world, including in the US, which in turn should foster growth in the euro area. For the year as a whole, however, the growth rate in the euro area is most likely to be below earlier expectations as weak economic activity in the first half of the year weighs on the overall result. While GDP growth will be clearly below 1% in 2003, it will move towards the potential rate in the course of 2004.

The authorities agree with the Fund that the weakness of economic activity in the euro area reflects a combination of cyclical and structural factors. Growth was dampened by subdued international trade growth, low business and consumer confidence, the aftermath of the stock market bubble and the related growing debt at firm level in some sectors since the end of the 1990s. More fundamentally, structural rigidities in labour markets as well as insufficient competition in some sectors makes adjustments to shocks more difficult and hampers potential growth.

On the other hand, the factors leading to a pick-up in domestic demand are in place. Monetary and financial conditions are supportive to growth; the profit situation is improving; the stronger euro has helped in bringing inflation down, thereby underpinning real incomes; there are no major macroeconomic imbalances in the euro area; there may well be pent-up consumption demand; and there is room for private savings to decline.

Exchange rate developments

The euro area authorities view the rise of the euro over the past two years as beneficial on balance. From a global perspective, when the exchange rates of major currencies move to levels more consistent with fundamentals this is welcome, provided that the movement is orderly. From an internal euro-area perspective, a stronger euro is reducing imported inflation and supports real disposable income. Whilst the appreciation of the euro has meant that profit margins of exporters are under pressure, it should be noted that their competitiveness position is now back to its long-term average. Looking at the recent trend, it seems that overshooting has been avoided so far, so that the stronger euro should over the medium term contribute to a re-balancing of the sources of growth from external to internal channels, and will, on balance, be a positive development both for the euro area and the global economy.

That said, the staff rightly points out that the euro area has borne a disproportionally large share of the burden of adjustment to a lower dollar. We share the staff’s view that a more equitable global distribution of any further adjustment burden is both desirable and needed from the point of view of reducing imbalances in the global economy and achieving balanced growth in the major currency regions.

Monetary policy and the outlook for price stability

We appreciate the conclusion of the IMF staff report that monetary policy has been appropriate in the euro area in the light of its economic conditions, as reflected in the outlook for price stability over the medium term. The assessment of the Governing Council of the ECB of the current outlook for price stability which is based on information from economic analysis and monetary analysis is broadly in line with the analysis contained in the report.

Starting with the economic analysis, economic activity stagnated in the first half of 2003, broadly in line with previous expectations. At the same time, as also indicated in the report, there is increasing reason to expect that economic activity will recover gradually in the second half of 2003 and strengthen further in 2004. Among the factors expected to support economic growth in the euro area, the low levels of interest rates and, more generally, favourable financing conditions should be highlighted. In line with the report, the ECB too assesses that the balance of risks to this outlook is tilted to the downside, although risks may have declined recently.

Turning to the outlook for prices, developments in food and oil prices may contribute to some temporary and limited volatility in inflation rates over the next few months. Beyond the short term, the outlook continues to be favourable. Annual inflation rates are expected to fall in 2004 and remain below 2 percent. In addition to base effects, further dampening effects stemming from the pass-through of the past appreciation of the euro are expected. Moreover, the gradual economic recovery should be accompanied by moderate wage developments and price setting behaviour, and is not therefore expected to contribute to price pressures. At the same time, the ECB is of the view that there is currently no risk of deflation in the euro area.

As regards the monetary analysis, monetary growth remained strong and there is significantly more liquidity available in the euro area than needed to finance non-inflationary growth. The low level of interest rates all along the maturity spectrum has contributed to a high demand for liquid assets, as well as to a stabilisation of credit growth in spite of the weak economic activity. Although a large part of the excess liquidity in the euro area has been caused by portfolio shifts, the ample liquidity needs to be closely monitored. In view of the current economic situation, excess liquidity is not likely to translate into inflationary pressures at present. However, if it were to persist at the time of a significant strengthening of economic activity, it could cause inflationary pressures to build up over the medium term.

All in all, cross-checking the information from the two pillars points to a favourable outlook for price stability over the medium term. Reflecting this assessment, the Governing Council of the ECB decided at its meeting on 31 July 2003 that the current monetary policy stance is appropriate. The ECB will continue to monitor carefully all factors that might affect this assessment and will continue to conduct monetary policy with the aim to maintain price stability, in accordance with its mandate and following its monetary policy strategy.

The ECB appreciates the staff’s reaction to the clarification of May 2003 regarding the monetary policy strategy. In particular, the staff has highlighted that the clarification of the definition of price stability has dispelled misunderstandings that might have occurred in the past. The ECB notes the staff’s agreement that its definition of price stability provides a sufficient safety margin to avert the risk of deflation and is also capable of addressing the implications of inflation differentials within the euro area. Regarding the two-pillar framework, the ECB welcomes the IMF staff’s understanding that monetary analysis is used to assess medium to long-term trends in inflation as a means of cross-checking the short to medium-term indications coming from economic analysis.

Fiscal policies

The euro area authorities broadly agree with the staff’s view on the key elements of the fiscal policy framework, notably as regards the importance of clear fiscal rules based on a target on the budget balance (a flow), while at the same time taking account of public debt levels (a stock). We also agree that more generally longer run and cyclical considerations have to be balanced. The increased emphasis on the long-term sustainability of public finances is also welcome as well as the link between budgetary consolidation and supportive structural reform.

The latest available information suggests that budgetary outcomes in many countries of the euro area will fall short of the targets in 2003, implying a continued deterioration of public finances. This strengthens the call for a strict monitoring of budgetary developments and application of the common fiscal rules. In implementing the Stability and Growth Pact, the impact of the economic cycle on budgetary positions has been taken explicitly into account, with a focus on cyclically-adjusted budgetary developments. However, the 3% reference value of the Maastricht Treaty remains a “hard ceiling” not to be breached. Those Member States that breached it have been put under the excessive deficit procedure (i.e. Portugal, Germany and France), which foresees the implementation of a credible consolidation path.

The authorities agree that automatic stabilisers play an important role in cushioning the slowdown. For Member States that have not yet reached a balanced position in cyclically-adjusted terms, this should be done around a consolidation path of the cyclically-adjusted deficit of at least 0.5 a percent of GDP per year, and provided the 3 % limit is not breached. Those Member States in excessive deficit should correct it no later than the year following its identification in conformity with the Treaty and the SGP provisions which provides for some flexibility.

The euro area authorities agree with the staff on the need for more forward-looking policies to improve the quality and sustainability of public finances. For instance, short-term one-off measures should not be used to put off necessary structural reforms. While the euro area authorities agree with the staff on the importance of a durable achievement of long-run goals, we consider that achieving consolidation rather than postponing it is the appropriate way to ensure sound and sustainable public finances.

Structural reform

The euro area authorities broadly concur with the staff’s assessment on the need for structural reforms to step up growth potential. While the area’s growth performance is similar to that of the US in per capita terms, there is considerable scope for making better use of labour resources—which is in itself important for raising social cohesion and growth potential, as well as for the functioning of EMU and the sustainability of public finances. We must therefore ensure that the momentum of reforms does not slow just after the benefits of earlier reforms and wage moderation began to manifest themselves in the years preceding the present downturn, notably in the form of reduced structural unemployment and increased labour force participation. This structural improvement is an important part of the explanation for why the impact of the current downturn on employment has been and remains relatively soft, compared to previous cycles.

The slow recovery however shows that structural reforms should go forward: in this respect, one should note that significant reforms have been initiated recently, including on pension systems in some of the large Member States (and contrary to what is said in paragraphs 12 and 50, structural reform has not been moved off the EU policy agenda). Steps have also been taken to strengthen the coordination of structural reforms at EU level, and we welcome the positive assessment by the staff on these steps. Of course, there is a considerable scope for further progress, and it is essential now that the agreed reform agenda is fully implemented and, as the staff notes, that this new spirit of reform will be sustained long into the future. Certainly, immediate, substantial and sustained progress, particularly on labour market reforms, will be required to maintain confidence in the Lisbon agenda of rising employment rates and improved competitiveness and dynamism more generally. Reform in product markets and measures to increase research and innovation are also main components of the EU’s structural reform agenda. There is in particular a need to increase competition, integration in the network industries and to open up public procurement to greater competition and to raise R&D to the EU’s target of 3% of GDP. On the positive side, recent progress in reforming the aviation, energy and railway should be noted as well.

With regards to financial markets, the staff report notes that there has been further progress in creating a single financial market. Eighty per cent of the original measures of the Financial Services Action Plan (FSAP) have now been completed. Important agreements have been reached in 2003 on directives on insider trading and market manipulation, pension funds, company law, prospectuses and the taxation of savings income. However, there are still important measures pending (e.g. the directives on take-overs, investment services and transparency obligations for securities issuers). With the 2005 deadline in sight, the Commission is currently finalising the last set of legislative proposals (which will include capital adequacy, insurance solvency and reinsurance supervision). Consistent transposition and implementation of the FSAP will be facilitated by the extension of the four-level “Lamfalussy framework” for securities markets to banking, insurance and conglomerates. The new arrangements will speed up the legislative process and increase its transparency.

In response to concerns regarding corporate governance and statutory audit, the Commission published two communications on 21st May. The communication on corporate governance includes an action plan, covering key issues such as the disclosure by companies of their governance structures and practices, the reinforcement of shareholder rights, the role of non-executives or supervisory directors, the quality of corporate reporting, and the coordination of Member States’ efforts in the area of corporate governance. On statutory audit, important short-term priorities are the incorporation of the principles on auditor independence in a Directive, and the strengthening of public oversight of the audit profession through European co-ordination.

Trade Issues

The Doha Development Agenda (DDA) is currently the EU’s number one trade policy priority. Half way through the scheduled negotiations, the Cancun Ministerial meeting of all WTO Members will be a key staging post of the Round. The EU’s objective for Cancun is to achieve meaningful progress in the DDA negotiations, which must: (1) address all DDA issues and reflect the interests of all WTO members, (2) better integrate developing countries in world trade, and (3) make a significant contribution to sustainable development. In light of the current state of the international economy, the EU considers the conclusion of the DDA to be particularly important in order to boost global economic growth and development opportunities.

In order to re-launch the agricultural negotiations, the EU and the US in August presented a joint framework paper. It focuses on domestic support, market access and export competition. Moreover, the recently agreed reform of the European Common Agricultural Policy, designed to enhance the efficiency of the EU’s agricultural market, is a significant contribution to correct trade distortions. Its positive effects will amplify as Member States are expected to introduce significant de-coupling of subsidies from levels of production. Furthermore, it should be recalled that a significant proportion of the EU’s agricultural imports from developing countries, and almost all from least-developed countries, are duty free thanks to existing EU import preferences for these countries.

The EU, the US, and Canada, have also tabled in the WTO a joint paper to facilitate negotiations on market access - tariffs and non-tariff barriers - for industrial goods. The paper proposes ambitious tariff cuts and the reduction of differences in tariff rates across WTO Members. This approach includes measures for granting developing countries special and differential treatment, as well as flexibility to manage their tariffs on the basis of their economic needs. In particular, the joint paper proposes a system of “credits” that allows developing countries to cut their tariff less than developed countries would do, when justified by their economic situation. Additional flexibility should also be granted to the poorest developing countries.