Euro Area Policies
2008 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Member Countries

This 2008 Article IV Consultation on euro area policies highlights that 10 years after its launch, monetary union is a distinct success and the euro area a zone of stability in the international economy. However, economic union remains work in progress. Improved wage setting and labor market reforms have contributed to the creation of some 16 million jobs over the past decade. Similarly, the single market program and product market reforms have raised productivity in affected sectors. The outlook for financial stability is highly uncertain, although the area’s financial system remains sound.


This 2008 Article IV Consultation on euro area policies highlights that 10 years after its launch, monetary union is a distinct success and the euro area a zone of stability in the international economy. However, economic union remains work in progress. Improved wage setting and labor market reforms have contributed to the creation of some 16 million jobs over the past decade. Similarly, the single market program and product market reforms have raised productivity in affected sectors. The outlook for financial stability is highly uncertain, although the area’s financial system remains sound.

I. Cyclical Developments and Prospects

1. Euro–area economic developments have contributed to global stability, but a series of largely external shocks are now moving the economy away from external and internal balance. The area’s external current account is still close to balance, fiscal policy has generally been sound, and structural reforms are advancing, broadly in line with commitments under the Fund’s Multilateral Consultations. But prospects have deteriorated.

2. Following a strong showing in 2008Q1, real GDP growth is decelerating, in the wake of several adverse economic shocks. Growth in 2008Q1 was much higher than projected, reflecting a remarkably strong performance of the German economy—which, to an appreciable extent, was driven by special factors—but also greater robustness elsewhere. Abstracting from volatility in quarterly data, however, the current cycle peaked in 2006 (Table 1), with real GDP growth since then slowing (Figure 1). In particular:

  • The recent surge in oil and food prices will put further strain on already weak euro–area consumption growth, despite unemployment rates near 25–year lows (Figure 2). To the extent that the oil price shock is increasingly becoming a global supply shock, its negative impact on consumption will be less and less offset by growing external demand.

  • Investment has been moderating, as interest rates and risk premia have been rising (Figure 3) and prospects for external demand weakening (Figure 4). The turmoil has directly affected parts of the area’s financial system, and linkages with the United States remain important (Box 1 and Figure 5). But the area’s growing trade with emerging market economies—where growth has remained relatively robust thus far—has been a supportive factor.

Table 1.

Euro Area: Main Economic Indicators

(in percent change)

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Sources: IMF, World Economic Outlook; Eurostat, ECB Monthly Bulletin.

Contribution to growth.

Includes intra-euro area trade.

In percent.

In percent of GDP.

US dollar rate, as of June 23, 2008; nominal and real effective rates, as of May 2008.

Based on normalized unit labor costs.

Based on ECB data, which exclude intra-euro area flows.

Data for goods.

Eurostat data.

Figure 1.
Figure 1.

Euro Area: Leading Indicators

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Eurostat, Reuters, IFO, INSEE, National Bank of Belgium, and staff calculations.

Oil Prices 1/

(Euros per barrel)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: IMF, World Economic Outlook.1/ Simple average of three spot prices; Dated Brent, West Texas Intermediate, and the Dubai Fateh
Figure 2.
Figure 2.

Euro Area: Labor Market Indicators

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Eurostat; OECD; EC Quarterly Business and Consumer Survey; and IMF staff estimates.1/ Excluding Greece, Luxembourg, and Slovenia.2/ Prime–age males, 25–54 years old.
Figure 3.
Figure 3.

Euro Area: Financial Market Indicators

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Bloomberg; and Datastream.1/ IBoxx corporate bond rates over German benchmark bond yields.
Figure 4.
Figure 4.

Euro Area: External Developments

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: ECB; Haver Analytics; IMF, World Economic Outlook.1/ Staff estimate, based on a time series estimate with stochastic trend, a macroeconomic balance approach, and an external sustainability assessment.2/ Rest of the world calculated as residual (excludes global discrepancy).3/ Excludes intra–area trade (ECB data).
Figure 5.
Figure 5.

Euro Area and United States: Co–movements in Activity and Financial Variables

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Haver, IFS, Eurostat, and IMF staff calculations.

Economic activity in the euro area has slowed.

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: Eurostat.

Spillovers Between the Euro Area and the United States

This box summarizes the estimation results from a VAR and a generalized dynamic factor model for the size of the spillovers and the strength of the trade and the financial sector channels through which shocks between the euro area and the United States are transmitted (Figure 5).

The estimation results suggest that the degree of co–movement in activity and the financial sector between the two regions is high and has increased over time. In particular:

  • The slowdowns in growth are highly synchronized—all significant US downturns have either coincided with or been followed by sharp slowdowns in the euro area.

  • The spillovers seem large; on average a one percentage point decline in US real GDP growth shaves off ¼ percentage point of euro area growth within two quarters, with a maximum impact of close to ½ percentage point after one year. However, since the size of spillovers differs from case to case, these estimates cannot be applied mechanically.

  • The cycles in the euro area and the United States have been largely and increasingly driven by common shocks. In particular, the share of euro–area real GDP growth explained by common shocks increased from 37 percent in 1980–1993 to 54 percent during 1994–2007.

Euro Area and United States: Contribution of Common Shocks

(Percent variance explained by one common factor)

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Sources: Fund staff estimates.

Both trade and financial transmission channels have become stronger over time, with the trade channel likely playing mainly via third country effects.

Against this backdrop, discussions focused on the degree of resilience of the euro–area economy, which has been stronger than expected thus far, with past reforms having made for greater labor market robustness and more job–friendly wage setting.

3. The current account has remained broadly balanced but competitiveness has been eroded, albeit to a limited extent (Tables 2, 3 & 4). A steady increase in the investment rate of nonfinancial corporations has been funded by rising corporate and public savings, while household savings have moved broadly sideways. The area’s exporters have weathered the appreciation of the euro well. In line with the strong performance of euro–area exporters, the ULC–based real exchange rate has changed little since 2003, suggesting that pressures from the appreciating euro have been offset by subdued unit labor costs. Nonetheless, the real effective exchange rate of the euro is currently some 15 percent higher than its 1993–2006 average, having appreciated by about 10 percent since end–2006, carrying the euro beyond its medium–run fundamentals—in a measure of at least 10 percent according to staff estimates (Box 2). The effect of this appreciation depends on its source—staff estimates that it might shave off at least ¼ percent from real GDP growth over the near term. EC representatives underscored that its adverse effects would grow the longer it lasted, as currency hedges expire, wages accelerate from the unusually low growth rates observed during 2003–05, and production is adapted to lower profitability. There is also some concern that the reaction to currency appreciation may be non–linear, becoming abruptly more intense beyond a difficult–to–pinpoint threshold.

Table 2.

Euro Area: Balance of Payments

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Sources: ECB; Eurostat; Datastream; IMF, World Economic Outlook.

End of period stocks.

Table 3.

Euro Area: Net Investment Position 1/

(in percent of GDP)

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Source: European Central Bank.

Data correspond to the end of the indicated period. They are expressed as a percent of the cumulated GDP of the four quarters ending on that date.

Table 4.

Euro Area: Medium-term Current Account

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Source: World Economic Outlook.

Subdued ULC offset pressure from the euro appreciation.

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: ECB.

Assessing the External Competitiveness of the Euro Area

The latest appreciation leaves the euro on the strong side relative to fundamentals. The projected medium–run current account deficit stands at about ¾ percent of GDP, while real exchange rate models put the equilibrium at a surplus of 0.2 percent of GDP.*Based on the latest exchange rates, CGER estimates place the euro’s overvaluation in a range of 5–20 percent. However, staff considers the equilibrium real exchange rate (ERER) estimate too high since the commodity terms of trade used in the standard ERER calculation tend to overstate the degree of terms of trade deterioration for the euro area over the past several years, as suggested by recovering export margins since the dip in mid–2004 (Figure 6). By the same token, however, the trade elasticities with respect to the exchange rate might also be lower than implicit in the macroeconomic balance and external sustainability approaches. All in all, staff sees the real effective exchange rate of the euro at least 10 percent stronger than warranted by medium–run fundamentals.

CGER Assessment of the Euro Effective Exchange Rate

(Percent deviation from estimated equilibrium)

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Based on 3 percent real effective euro appreciation in May relative to the average in the base period (Jan. 30–Feb. 27, 2008).

EC and ECB representatives broadly agreed with staff’s assessment. They underscored their concern that the euro has been bearing an undue burden of the depreciation of the US dollar, while the area has made considerable progress toward delivering on its commitments under the multilateral consultations (Table 5).

* For details, see Exchange Rate Assessments: CGER Methodologies, IMF Occasional Paper 261
Figure 6.
Figure 6.

Euro Area: Margins of Exporters to Main Export Destinations

(Export unit value relative to ULC in manufacturing, 2000=100)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Eurostat, OECD, IMF staff calculations.
Table 5.

Euro Area: Policy Progress and Plans Relevant to the IMFC Strategy

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4. Housing markets present risks but mainly from a medium–run rather than short–run perspective. Many euro–area countries have experienced house price rises similar to those seen in the United States and residential investment has been well–above its long–term average. Prices are now slowing and investment is forecast to weaken noticeably. The impact of tightening lending conditions and reduced credit availability would be felt strongly in some member states, according to the Commission, and house price slumps in these “hot spots” could, via financial linkages, trigger a broader decline in other euro–area countries. However, EC and ECB representatives underscored that the effects on growth for the area as a whole would be contained. The limited amount of non–prime lending, relatively low loan–to–value ratios, and few opportunities for equity withdrawal would limit the scope for pernicious feedback loops between the housing and financial sectors as well as the broader real economy. Staff agrees and sees adjustment in this sector making for important medium–run headwinds, after providing noticeable support over the past decade.


House prices in some euro area countries are a downside risk.

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: Staff calculations.

5. Balance sheets outside the financial sector still seem relatively robust, which should support activity (Figure 7). Balance sheets of corporations are stronger than at the onset of the last credit cycle downturn and there is scant evidence of a significant investment overhang. However, European businesses are relatively dependent on bank lending and are more leveraged than their US peers, which makes investment vulnerable to the ongoing tightening of credit. Amid tougher financing conditions and cost pressures, default rates are expected to rise from their recent historically low levels, with highly–leveraged corporations and real–estate related businesses being particularly vulnerable. Household leverage has been rising but generally remains appreciably lower than in the United States or the United Kingdom, while personal savings—at some 14 percent of household income—are much higher. Pockets of vulnerability exist among households in countries that have seen rapid house price appreciation, in particular where variable–rate mortgages are common.

Figure 7.
Figure 7.

Euro Area and United States: Leverage Ratios

(In percent)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Haver Analytics; and IMF staff calculations.

6. The latest ECB Financial Stability Review describes the outlook for financial stability as “highly uncertain,” although the area’s financial system remains sound (Table 6). 1 The euro area’s financial system entered the turmoil from a position of strength. Until 200 mid–2007, financial sector profitability had been buoyed by strong loan growth, record low provisioning, and high 50 trading revenue. However, the turmoil has materially impacted bank profitability, even though capital buffers remain largely intact, and banks’ operating environment has become much more adverse. Funding costs have increased considerably, particularly for lower–rated banks, and balance sheet constraints have tightened as several market segments closed down (Figures 8 & 9). Interbank markets have dried up at longer maturities and spreads have risen as banks started hoarding liquidity amid mounting concerns about running into liquidity constraints, and the need to bring off–balance sheet exposures back on balance sheet. Loan losses have started to increase. In this context, banks have retrenched from risk–taking and significantly tightened lending standards. The ECB sees the outlook for financial stability as depending on three factors: developments in asset markets—notably in the US and other housing markets—and in the broader economy; the way banks respond to their more challenging operating environment; and the extent to which initiatives and measures aimed at restoring confidence and strengthening financial system resilience are eventually implemented.

Table 6.

Financial Conditions of Large and Complex Banking Groups in the Euro Area

(2004 - H1 2007)

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Sources: Individual institutions’ financial reports and ECB calculations.
Figure 8.
Figure 8.

Euro Area: Corporate Bond Rates and Equity Prices

(Yields in percent, spreads in basis points)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Thomson Financial/DataStream; and Bloomberg.1/ IBoxx corporate bond rates over German benchmark bond yields.
Figure 9.
Figure 9.

Euro Area: Credit Markets

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Thomson Financial/DataStream; Bloomberg; and CitiBank.

Costs of insurance against banks’ default 1/

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: Datastream.1/5–year senior CDS spreads, simple average. U.S.: Citigroup, Bank of America, JPMorgan Chase, Wachovia, Wells Fargo, Washington Mutual. Euro area: Deutsche Bank, HVB, Commerzbank, BNP Paribas, Credit Agricole, Societe Generale, Unicredito, Banca MDP di Siena.

7. Household credit has slowed significantly and credit to non–financial corporations, which has shown buoyant growth thus far, is generally expected to follow. ECB staff viewed lending to households behaving in line with normalizing conditions in euro–area housing markets. Bank lending to euro–area non–financial corporations has, in contrast, continued to expand, seemingly unimpaired thus far by the financial turmoil (Figure 10).2 However, credit standards reported in the euro–area bank lending survey point to an appreciable tightening of conditions (Figure 11). Unlike in recent episodes, the expected tightening of bank credit would probably not be offset by an increased availability of bond and equity financing. Staff analysis suggests that tightening financial conditions tend to have a significant impact on credit with a noticeable lag (Box 3). ECB representatives agreed that corporate credit growth would likely slow.

Figure 10.
Figure 10.

Euro Area: Growth in Bank Loans and Securities Issuance

(in percent)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: ECB.
Figure 11.
Figure 11.

Euro Area: Changes in Credit Standards to Enterprises and Households

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: European Central Bank.

8. However, absent further shocks, supply–side effects from the financial sector on activity were reckoned to be manageable (Box 3). Market–based indicators of vulnerability have stabilized. EC and ECB representatives thought that good progress had been made with respect to loan loss recognition and recapitalization but felt that it was too early to conclude that the worst was over, considering also that many banks still have to release results. In this regard, the ECB noted lingering uncertainty about the possibility of further large losses disclosed over the next few quarters, with the adjustment process likely to be protracted. Still, in their view, the bulk of the euro area’s many banks would not be directly affected by the subprime turmoil, offering some reassurance. Furthermore, it was noted that the losses disclosed by financial institutions have so far largely reflected mark–to–market write–downs on hard–to–value assets, with the related possibility that the credit loss outturns may ultimately prove less severe. The common view thus was that the shutdown of various wholesale market segments and rising risk premia would restrain credit but that an outright credit crunch would be avoided.

9. Substantial uncertainty is associated with spillover risks between the euro area and emerging Europe, but growth in emerging Europe would still support euro–area exports. The real and financial linkages between the euro area and emerging Europe have become much stronger in recent years.3 The convergence trend of emerging Europe is projected to continue, albeit at a slower pace, as growth rates in recent years have been above estimates of potential for most countries and an adjustment is already under way. The risks to this scenario are considerable, since the emerging European economies, partly due to their openness, are more vulnerable to a global slowdown than those of the euro area,4 and these vulnerabilities could be amplified through financial channels. However, so far spillovers from euro area financial and real sector developments to emerging Europe have been limited.

10. Hence, the central scenario underlying IMF/EC/ECB projections is for a significant slowdown, but no recession or prolonged period of sluggish activity, such as during 2002–05. Staff projections foresee real GDP growth moderating from an annual pace of about 1¾ percent in 2008H1 to just over Y2 percent in 2008H2, before reaccelerating to a 1 Y2 percent pace and above starting in 2009Q2. The output gap would widen to about 1 percent of potential GDP in 2009. Both EC and ECB projections foresee a broadly similar pattern of activity but with higher growth at the trough, mainly on account of more robust consumption.

The euro–area economy slows signif recession.

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Not adjusted for working days.

11. The risks around the projections are considered large. On the downside feature further increases in energy and food prices, including related protectionist pressures; an accelerated deleveraging that sets off broader asset price deflation and a global credit crunch; and an abrupt unwinding of global imbalances and sharp appreciation of the euro. On the upside, risks relate to still buoyant employment and therefore higher–than–projected consumption. There could also be some decline in energy and food prices, to the extent that speculative forces have played some role in these markets. Overall, staff considered the risks around its projection as broadly balanced, while EC and ECB staff—relative to their slightly higher projection for real GDP growth—saw them as tilted to the downside.


Risks to growth are broadly balanced.

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Financial Sector Stress, Credit Volume, and Euro Area Output

An analysis * of linkages between the euro–area financial and real sectors shows that the supply of bank loans responds negatively to declines in bank soundness. Specifically, a two standard deviation drop in distance to default for large euro area banks (which is the decline observed in July 2007–May 2008) can be associated with a 3 percentage point reduction in real credit growth. The analysis also shows that, in turn, a 1 percentage point decrease in bank loan supply corresponds to a 0.1 percentage point decline in real GDP in the euro area.

Sources: Staff calculations based on data from Datastream. Note: Distance to default is the difference between the expected value of assets at maturity and the default threshold, which is a function of the value of the liabilities. A higher distance to default is associated with a lower probability of default.

Based on these estimates, the developments in large euro–area banks’ stocks since last summer imply a–0.3 percentage point impact on output. Alternatively, combining these estimates with April 2008 GFSR data on estimated losses in large euro area banks–0.2 percentage point impact on output. EC work suggests similar numbers. These effects may be larger if banks are subjected to more shocks or if losses in non–euro area banks have an appreciable euro–area impact (euro–area banks account for only 37 percent of the “European bank” losses in the GFSR, the rest being accounted for mostly by Swiss and U.K. banks).


Global Bank Subprime and Alt–A Losses, March 2008

(billions of U.S. dollars)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Regarding the linkages between interest rates, lending volumes, and output, VAR calculations confirm that higher interest rates transmit to loan volumes and output with lags. The maximum impact on loans comes with a lag of 6 quarters, while the first 3 quarters are characterized by very little impact on corporate credit (and even a small “hump” in household credit).


Impulse response to corporate lending rate increase by 1

(64 basis points)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

* See Selected Issues, Chapter I, and forthcoming IMF Working Paper “From Subprime Losses to Subprime Growth? Evidence from the euro area”, by Martin Čihák and Petya Koeva Brooks.

II. Inflation and Monetary Policy

12. All main forecasts expect headline inflation to decline appreciably. Headline inflation is kept up around 3½ percent mainly by high energy and food prices and is forecast by staff to move below 2 percent some time in 2009, a projection that ECB and EC representatives considered “slightly optimistic”, though it is not ostensibly out of line with their central scenarios. The key considerations are:

  • Energy and food prices are assumed to stabilize in 2009 and inflation expectations have remained anchored. ECB surveys suggest that the probability that analysts attach to inflation reaching or exceeding 2 percent over the long term has been rising only gradually and that the average of analysts’ point estimates is still holding at 1.9 percent.

  • Compensation per employee has been growing at the low level of around 2½ percent per annum since 1999, despite large price shocks and falling unemployment (Figure 12).

  • Data for labor compensation in 2008Q1 suggest that wage hikes have reached the relatively higher 2000–03 range, with settlements in industry and construction pulling ahead. But with below potential output growth through 2009, staff projects that any further acceleration will remain contained. The Commission forecast is similar, with unit labor cost growth settling below 2 percent in 2009. While neither the EC nor ECB staff projections assume broad–based second–round effects, their representatives stressed the acceleration in labor compensation during 2007—with negotiated wages increasing 2.8 percent according to 2008Q1 data, up from 2.2 percent in 2007—and saw rising risks. Staff derives more reassurance from the past performance of the labor market: these wage increases are not out of line with projections and, usually, labor markets tend to peak after the cycle has turned.

Inflation to decline during 2008/09

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Figure 12.
Figure 12.

Euro Area: Inflation and Labor Costs

(in percent, unless otherwise specified)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Eurostat; ECB; and Haver Analytics.1/ Excludes energy, food, alcohol, and tobacco.

Labor market performance has been improving.

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: OECD, ECB, and Fund staff estimates.

13. The inflation outlook is widely considered highly uncertain, with ECB representatives seeing the risks clearly on the upside. Energy and food prices have been surprising on the upside repeatedly and headline inflation is hovering at levels that are the highest in a decade. There is also a risk that the effect of the ongoing catch–up of wages in Germany is not sufficiently countered by moderating wage growth in other parts of the area, or that it is even emulated. Both EC and ECB representatives stressed the upside risks related to second–round effects on account of inflation overshooting the 2 percent target for many months, pointing to the threat presented by wage indexation schemes in a number of euro–area member countries. Staff viewed the related risks as relatively contained given the details of most of the indexation schemes in question and argued that downside risks to inflation become more relevant beyond the near term. There was agreement that these risks relate to a greater–than–projected weakening of activity, further euro appreciation, and a reversal of commodity prices, to the extent speculative forces have been at play.5 But all of the mission’s interlocutors—except the employers and trade unions—saw upside risks prevailing.


Financial conditions have tightened considerably

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

1/ The formula gives equal weight (0.5) to the deviation from the inflation target and the output gap; the lower band is based on an estimate of the natural rate from a factor model using a panel of international interest rates—the upper band is based on a natural interest rate equal to 4.15 percent.

14. Amid robust money and credit growth, the ECB has kept rates on hold thus far.6 The ECB has been drawing attention to “continuing very vigorous money and credit growth and the absence of significant constraints on bank loan supply up to now” (Figure 13). In its view, robust underlying monetary expansion continues to point to upside risks to price stability over the medium to longer term. Staff attaches less importance to monetary aggregates in assessing inflation prospects (¶17).

Figure 13.
Figure 13.

Euro Area: Money and Credit

(in percent, unless otherwise specified)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: ECB; Datastream; Bloomberg; and IMF staff calculations.1/ Deviations from 1990–2004 mean.2/ Based on M3 corrected for the estimated impact of portfolio shifts. Deviation (in percent of the actual real stock, deflated by HICP) from an estimate of the long–run real stock that would have resulted from constant nominal M3 growth at its reference value of 4.5 percent and HICP inflation in line with the ECB’s definition of price stability, taking December 1998 as the base period.

15. The discussions focused on how to balance the immediate upside risks to price stability from high commodity and food prices with the downside pressures stemming from weakening activity going forward. Financial conditions have tightened appreciably since the summer of 2007: 12–month interbank rates are up 1 percentage point, reaching 5Y2 percent—a level last attained in the mid-1990s; risk premia have widened by 50–200bp; and the real effective exchange rate has appreciated by some 5 percent. At the same time, economic prospects have worsened. The question is whether policy tightening is needed to keep inflation expectations well–anchored and move inflation to below 2 percent over the medium run. ECB representatives have recently suggested that this may be the case, underscoring that the situation requires “a state of heightened alertness” and leading markets to price in a 25bp hike in July, with a small probability of another 25bp move by end–year (Figure 14). For its part, staff does not see a compelling case for further tightening. First, central projections of EC, ECB, and IMF staff foresee real GDP growth slowing to below potential, with inflation declining appreciably, at least to very close to 2.0 percent by end–2009 (or less in the case of IMF staff). Second, all market–relevant interest rates—the exceptions are ECB policy rates and government bond yields—are already noticeably above “neutral”, which staff estimates in a broad range centered around 4–4Y2 percent. Thus, there is already a good deal of insurance against upside risks to price stability in the system. And third, tightening in the face of a still uncertain outlook for financial stability carries its own risks. Accordingly, staff considers that rates should stay on hold. Tightening, however, would be appropriate if, contrary to prevailing projections, forward–looking indicators no longer pointed to significantly growing slack, or wage settlements for 2009 hinted at accelerating labor costs.

Figure 14.
Figure 14.

Euro Area: Monetary and Policy and Market Expectations

(in percent, unless otherwise specified)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: Bloomberg; Datastream; ECB; Eurostat; and IMF staff calculations.1/ Survey of Professional Forecasters.

16. Regarding the monetary policy framework, ECB representatives stressed the usefulness of the two–pillar approach to monetary policy. The motivation for the monetary analysis, which complements economic analysis, is that the ECB sees “the more drawn–out and persistent trends in inflation” to be “empirically closely associated with the medium–term trend growth of money.” There is, therefore, in the ECB’s view, a need to explicitly take information from monetary developments, which might otherwise risk being overlooked or underestimated, into due account in policy considerations. As an example, ECB representatives mentioned the hike in interest rates in December 2005, which hinged crucially on the upside risks to price stability identified by the monetary analysis. Currently, ECB work is geared toward further refining its monetary analysis with a view to gaining a better understanding of financial sector and asset price developments and their relations to economic growth and inflation.

17. Staff welcomed the work on broadening monetary analysis but saw room for clarifying the relative role of monetary aggregates in the presentation of monetary policy decisions. Monetary analysis has proven useful in understanding the recent financial turmoil—shedding light, for example, on the issue of re–intermediation—and its possible impact on economic growth. However, while monetary analysis has some value for gauging inflationary pressure over the policy–relevant medium run, this is limited (particularly in recent years) and not independent of non–monetary factors.7 As a result, staff considers that the signals from the analysis of monetary aggregates are overemphasized in the presentation of monetary policy decisions. The fruits of the work on broadening monetary analysis, aside from bringing new medium–to longer–run considerations to bear on monetary policy (e.g., asset prices), could therefore usefully lead to a presentation of policy decisions that unifies economic and monetary analysis and that provides a clearer narrative of the relative role of monetary aggregates in influencing the policy stance.

III. Liquidity Management

18. The ECB has taken a number of initiatives to ease tensions in money markets. The ECB’s broad list of eligible collateral and counterparties—other central banks have since moved in this direction—proved a significant advantage from the start of the turmoil; relatively high but flexible reserve requirements have provided a useful buffer to banks; and the ECB’s toolkit allows significant scope for adapting its operations to the needs of the market. The ECB conducted fine–tuning operations, increased the share of liquidity provided through its three–month refinancing operations, and introduced six–month operations.8 As a result, the maturity of refinancing operations has increased significantly, although there has been no net injection of liquidity over the respective reserve maintenance periods.

19. While generally satisfied with the liquidity management framework, ECB representatives noted that it remained under active review. The fact that interbank term spreads remain elevated is seen to reflect liquidity hoarding in response to bank balance–sheet stress—notably fear of potentially harsh market punishment—and counterparty risk, which has however been diminishing. There was agreement that little more was left for liquidity management perse to do to foster a return of markets to normal. 9 This did not exclude the possibility that the framework might be reviewed, if necessary to foster interbank transactions. Similarly, the collateral received remains under continuous assessment, to ensure it meets the Eurosystem’s risk tolerance level and that the rules outlined in the collateral framework are strictly applied. In this context it was also noted that the possibility for banks to use as collateral asset–backed securities that they have originated themselves likely helped prevent a complete shut down of primary markets in the medium term. However, this could not be an alternative to the restoration of a deep and orderly functioning market offering true secured funding possibilities and thus the ECB stood ready to review this practice if necessary to restart markets. Staff also noted that, to limit moral hazard, liquidity management at the systemic level should be accompanied by a more rules–based approach to managing stress at the individual bank level (¶29). Longer–term, further integrating and developing secured interbank markets—via further progress in current efforts to integrate clearing and settlement systems—could reduce the risk and impact of similar stress.


The maturity of refinancing operations has increased significantly

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: ECB

IV. Fiscal Policy

20. The fiscal position of the euro area improved in 2007 and now compares favorably to that in other parts of the world, marking a success for the reformed Stability and Growth Pact (SGP). In structural terms, the fiscal accounts of the euro area as a whole reached a close–to–balanced position (Figure 15). All excessive deficit procedures vis–à–vis euro–area countries have been closed, and about half of the countries reached or exceeded their “close to balance or surplus” medium–term objectives (MTO). Concurrently, the general government debt ratio continued to fall.

Figure 15.
Figure 15.

Euro Area: Fiscal Developments

(In percent of GDP, unless otherwise noted)

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Sources: European Commission; IMF, World Economic Outlook; and IMF staff calculations.

21. However, a number of countries still face appreciable fiscal challenges, partly as a result of insufficient adjustment during the upswing. Countries that have not reached their MTO include almost all those with high public debt. This is troubling, as population aging–related outlays are set to accelerate soon after 2010 and add some 3¾–5 percent of GDP to public expenditure by 2050. Also, the structural balance for 2007 may well turn out to be lower than presently estimated to the extent that tax elasticities have been procyclical; and overall stimulus in 2008 could turn out somewhat larger than the modest boost planned thus far (largely by relatively well–positioned countries), given pressures for measures to support citizens’ purchasing power in the face of ever higher commodity prices. Staff argued that tax policy should not be used to limit the pass–through of rising energy prices. At the June ECOFIN, Ministers reiterated their Manchester commitment of 2005 to avoid policies that prevent adjustment; regarding energy and food price–related challenges facing poorer segments of the population, the commitment calls for interventions to remain short–term, targeted, and non–distortionary. 10 More recently, though, interpretations of this commitment appear to be varying across countries

22. Some countries’ fiscal deficits risk exceeding the Maastricht limit over the near term, potentially testing the reformed Pact’s excessive deficit procedure. The Commission has issued a fiscal policy advice to France, calling for strengthening the pace of budgetary consolidation so as to ensure that a suitable safety margin against breaching the 3 percent of GDP deficit threshold is soon attained.11 Under EC and staff forecasts, other countries’ safety margins (e.g., Italy, Portugal) also risk being rather narrow.

23. There was broad agreement that the SGP rules provided the appropriate compass for fiscal policy in dealing with the current downturn. Accordingly, automatic stabilizers should be allowed to play freely, except in countries where this might lead to breaches of the Maastricht reference value. Countries that have reached their MTOs could consider additional discretionary loosening, but others need to continue to adjust at a pace of at least ½ percent of GDP per annum, unless in “bad times” (as defined under the revised SGP). Several considerations support this approach: (i) a more activist stance would undermine the many benefits of countries’ gradual moves toward a more rules–based fiscal policy; (ii) medium–run fiscal adjustment plans in Stability Programs still need to be backed up with measures; (iii) fiscal space needs to be preserved for higher aging–related outlays in the future; (iv) the implementation of fiscal actions that are high–quality, timely, temporary, and well–targeted faces high political economy hurdles in many countries; and (v) stimulus may lead to a further widening of government bond spreads in some countries while running counter to real exchange rate desiderata.

24. The country authorities reiterated their support for the SGP. Last year’s commitment to reach MTO by 2010 had been made on the understanding that “good times” prevailed, notwithstanding negative output gaps in parts of the area. Ministers were generally intent on sticking with this objective, notwithstanding deteriorated cyclical prospects. For their part, Italy and France aim to attain their MTOs in 2011 and 2012, respectively. In virtually all countries, reaching these objectives will require the adoption of measures that have yet to be specified in Stability Programs.

V. Integrating Europe’s Financial Sector

25. The EU’s financial stability framework is being reformed. The core issue is that national authorities’ fiduciary responsibilities are toward national governments and parliaments, limiting the incentives to work toward a common EU–wide stability framework, which is essential for full financial integration.12 Growing recognition of the limitations of the existing arrangements and their tensions with financial integration, combined with the impetus provided by the financial turmoil, has forged a convergence of views in favor of reform. Staff has for some time been arguing for more information sharing; better crisis prevention, management, and resolution frameworks, including at national levels; and greater joint accountability and responsibility for EU–wide financial stability.

26. New policy principles and a Memorandum of Understanding (MoU) ask member states to look beyond national borders when managing and resolving crises.13 The MoU commits member states to act in crises in ways that minimize the “potential harmful economic impacts at the lowest overall collective costs.” If public resources are needed to achieve a cost–minimizing solution to a crisis, then “direct budgetary net costs are shared among Member States on the basis of equitable and balanced criteria.” The formal recognition of a collective responsibility and of cost–sharing is an innovative step forward. However, it is widely recognized that tensions between national interests in times of severe crises would probably not be resolved via a non–binding MoU. Furthermore, staff noted its concern—shared by others—that the MoU risked adding a large number of bilateral, trilateral, etc. committees to an already complex supervisory cross–border set–up, rather than taking a true multilateral approach, which would also facilitate international coordination.14 The MoU is to be tested with a crisis simulation exercise in 2009.

27. Efforts are also underway to accelerate financial integration. EU Directives typically provide considerable latitude for country–specific regulatory and supervisory policies and practices. It is now recognized that such broad latitude creates unnecessary costs for financial market participants and may hinder the completion of the single market. The current reform program seeks to reinforce the EU Committees of Supervisors (Lamfalussy level 3 committees—CEBS, CESR, CEIOPS)—which have been set up with a view to fostering regulatory and supervisory convergence—by giving them more resources, introducing scope for qualified majority voting, and strengthening the national application of the “Level 3 guidelines”, while keeping their non–binding nature (“comply or explain”). In addition, the May ECOFIN called on member states to endow their supervisors’ statutes with a European mandate so that they “are able to take into account the EU dimension in the performance of their duties, including having regard to the financial stability concerns in other Member States in exercising their duties.”

28. Moreover, a number of initiatives are underway to strengthen specific elements of the EU financial stability framework, including in response to the latest turmoil. These include developing proposals to speed up work on the convergence of regulatory and financial reporting; improve Deposit Guarantee Schemes and, relatedly, allow for authorities to apply early intervention and reorganization measures to cross–border groups; and assess the obstacles to asset transferability that could hinder crisis management of cross–border groups, with a view to forestalling counter–productive ring–fencing of assets, and facilitating smooth crisis management. The response to the latest turmoil—on which the European institutions are working with international standard setters—covers four areas: enhancing transparency; improving valuation of financial products; strengthening prudential requirements; and making markets function better.15 Priorities include introducing international standards for liquidity regulation; reducing incentives for regulatory arbitrage, off–balance sheet exposures, and exposure concentration; and strengthening the oversight of credit rating agencies.

29. The mission welcomed the ongoing efforts and pressed for legal and practical steps to effectively implement the agreed policy principles. In the wake of the financial turmoil, the political will should be found to make rapid progress in several areas:

  • establishing a multilateral platform for real–time sharing of systemically relevant supervisory information among supervisors and central banks, including the ECB, given central banks’ roles in providing liquidity, overseeing payments systems, and assessing financial stability; and the need for better coordination and early crisis detection;

  • improving Deposit Guarantee Schemes: the standards for speed of payouts, limiting co–insurance, and informing depositors could be raised, without major legislative action;

  • determining common criteria for applying early intervention and reorganization measures, especially to cross–border groups; ultimately, this will need to be supplemented with progress on thornier issues, such as moving to a convergent bankruptcy framework. Difficulties are considerable, as such progress would require substantial changes to EU members’ legal frameworks.

  • giving “teeth” to the planned European dimension in the mandates of national supervisory authorities, clearly ruling out “beggar–thy–neighbor”–type policies, supported by appropriate accountability (Box 4).

A “European Mandate” for Financial Sector Supervisors *

Tendencies towards economic nationalism in financial sector regulation and supervision could in principle be countered if regulators and supervisors were mandated to take into account common European interests. The mission discussed proposals for a European mandate, bearing in mind several issues:

  • The European mandate should be formulated in such a way as to focus on financial sector stability and efficiency. It could state an overall objective, followed by a more specific list of “dos and don’ts” (e.g., do work toward integrating EU financial markets; don’t take unilateral actions with adverse spillovers on other EU countries).

  • At a minimum, member institutions of the so–called Level 3 Lamfalussy Committees (i.e., supervisors and regulators) as well as the Committees themselves should be covered.

  • The mandate should preferably have the force of law and have precedence in case of conflict with national mandates. Voluntary mechanisms can help implement a European mandate during normal times, but may seize up in stress situations.

  • Accountability must match the mandate. The EU Commission (with assistance of the Lamfalussy Committees) would be competent to review observance of a European mandate enshrined in an EU legal instrument. The private sector should also be empowered to assess whether authorities are fulfilling their mandates, and to challenge those that are not.

* For further details, see Selected Issues, Chapter IV, and the forthcoming IMF Working Paper “A European Mandate for Financial Sector Authorities in the EU”, by Daniel Hardy.

VI. 10 Years of Emu: Progressing with Economic Union

30. While monetary union has been a distinct success, economic union remains work in progress. The labor market has performed better than anticipated by the many critics who considered the euro area as falling far short of an optimal currency area. Nonetheless, productivity growth has been lackluster and intra–area economic divergences are a concern. Specifically:

  • Living standards have been improving but less than might have been hoped. Labor utilization is no longer far off a trajectory that hits the 2010 Lisbon target (an employment–to–working age population ratio of 70 percent). This testifies to the success of past reforms that have boosted job creation to US levels, notwithstanding appreciably lower population growth. At the same time, however, productivity growth has been sluggish.

  • While integration is much higher now than before EMU, the euro area is still experiencing large internal imbalances. 16 To a significant extent, these are adjustment dynamics that reflect convergence from different starting points and progressing integration following the introduction of a single currency; they will take time to work out in full. However, countries’ imbalances also reflect important remaining structural differences and, in the current environment, constitute a source of vulnerability.


Labor productivity growth has been lackluster.

Citation: IMF Staff Country Reports 2008, 262; 10.5089/9781451813081.002.A001

Source: ECB; and Haver Analytics.

31. The Lisbon Agenda is seen to offer a shared vehicle to address intra–area divergences but countries’ reform programs need to be reoriented in a coordinated manner. Staff and the Commission concurred that National Reform Programs (NRP) under the Lisbon Agenda need to focus more on making the single market a reality, particularly by opening up national services markets—including for financial services—to competition from EU partners. Tellingly, productivity growth has been particularly sluggish in services and differences in services price inflation account for a large part of inflation and competitiveness divergences. Progress in this direction is also consistent with the area’s commitments under the Fund’s Multilateral Consultations (Table 5). The Commission also underscored that financial market reforms could facilitate other structural reforms by helping advance their payoffs. Moreover, reforms need to focus on facilitating labor market adjustment in response to shocks, even if much progress has been made in this respect since the mid–1990s.

32. The Commission saw a clear need to broaden and deepen intra–area surveillance to address internal macroeconomic imbalances.17 Spillovers and interdependencies meant that current account and competitiveness divergences represent a concern not just for the country in question but for the euro area as a whole—the same reasoning applied to euro–area candidate countries, notably those already in ERM–2. The Commission also thought that more could be done with existing surveillance instruments to strengthen the incentives to pursue reforms that foster internal adjustment. To that effect, it inter alia proposes establishing a peer review mechanism based on the analytical framework developed under the Lisbon Strategy to take account of fiscally costly but adjustment–friendly structural reforms when implementing the SGP. Lastly, the Commission highlighted the need to enhance the euro area’s international role, by developing common positions and by consolidating its representation, ultimately leading to a single seat in relevant international financial institutions and fora.

33. Staff supported the objective of improving internal surveillance but stressed the risks related to allowing for a trade–off between fiscal adjustment under the SGP and structural reforms. Fiscal adjustment and structural reforms are often complements: successful reform countries have typically progressed on both fronts at the same time. 18 Moreover, such a trade–off would be difficult to implement objectively. This could undermine the benefits of a rules–based fiscal framework, including greater predictability of fiscal policy, as well as peer pressure to respect the SGP. The Commission was confident that these problems could be avoided, provided a rigorous monitoring framework is put in place.

VII. Trade Policy and Food Prices

34. The EU continues to seek to conclude on the substance of a Doha Round agreement before the end of 2008. Commission representatives were of the view that significant progress is being made with respect to agricultural products and were cautiously hopeful that a broad agreement on Doha could be reached this year. In its bilateral trade relations, the EU has entered into interim or final economic partnership agreements with more than thirty African, Caribbean, and Pacific (ACP) countries in the last several months and will seek more final agreements with these and other ACP countries in the coming year. These are intended to be WTO–consistent free trade agreements (FTAs) to replace the Cotonou preferences for the ACP countries. While it attaches top priority to multilateral trade liberalization, the EU is also pursuing FTA negotiations with India, Korea, and the ASEAN and Mercosur countries, and is negotiating international investment agreements on behalf of the member states.

35. The Commission has launched various initiatives to address the challenges posed by rising food prices. Its strategy is to help developing countries cope through targeted development aid; ensure that market incentives are in place for a supply response to develop; and discourage export taxes and other barriers to international trade. The EU has taken various measures, notably suspending the “set–aside” for 2008–09, which should increase its cultivated farmland by about 10 percent. The Commission is of the view that the reformed Common Agricultural Policy (CAP) offers the appropriate incentives to trigger a supply response to the high food prices from European farmers, contributing to a good harvest in 2008. A “health check” of the CAP will be conducted next year, and will include consideration of abolishing the “set–aside” as well as further efforts to reduce supply restrictions. The EU’s policies on biofuels—the production of which consumes a small but growing fraction of grains—are being kept under review.

VIII. Staff Appraisal

36. Ten years after its launch, monetary union is a distinct and promising success. EMU’s macroeconomic policy framework has brought stability, both inside and outside the euro area, and the union has been expanding, with Slovakia set to become its newest member. In particular, despite major terms of trade shocks, labor costs have been subdued and employment growth remarkably strong over the past decade. The relative protection offered by EMU must, however, not detract from the effort of building a vibrant economic union to realize monetary union’s full potential. Notwithstanding important achievements, this remains work in progress.

37. Conjuncturally, the 10th anniversary of EMU witnessed the euro–area economy being strained by a combination of decelerating activity and uncomfortably high inflation. High commodity and food prices, tighter financial conditions, weakening real estate markets, and slowing external demand are buffeting the economy, as is the appreciation of the real effective exchange rate of the euro, which is now on the strong side of medium–run fundamentals. As a result, growth will likely slow substantially in the coming quarters, before reaccelerating toward trend in 2009 as the effects of the various shocks unwind. However, the uncertainties around this baseline projection are large.

38. Monetary policy has to balance the risk of a broad–based increase in inflation with the prospect of gradually building disinflationary forces generated by the economic slowdown. Much now hinges on how labor costs and inflation expectations evolve. As the economy slows, reduced demand for labor and pressure on employers’ margins should act as restraining forces. Assuming stabilizing commodity and food prices, inflation should thus recede appreciably in 2009—as reflected in official forecasts. The uncertainties around the outlook for inflation are exceptionally large, and while the durable improvements achieved under EMU in the functioning of labor markets and in anchoring inflation expectations provide some reassurance, risks of second–round effects remain. As do, conversely, the risks that could stem—in an already strained financial environment—from a further tightening of financial conditions, beyond that observed since summer 2007, when economic prospects were distinctly brighter. In this setting, a case for tightening would nonetheless arise if, contrary to prevailing projections, forward–looking indicators no longer pointed to significantly widening slack or 2009 wage settlements hinted at accelerating labor costs, raising the risk of rising inflation expectations. In the absence of such signals, however, policy rates are best kept on hold.

39. Further development of the ECB’s monetary analysis would help strengthen an already solid policy framework. The ongoing efforts to broaden the analysis of the determinants of inflation, including financial market and asset price developments, are welcome. This work could usefully lead to a unified presentation of policy decisions that integrates monetary and economic analysis, thereby providing a clearer portrayal of the relative role of monetary aggregates in influencing the policy stance.

40. The ECB’s liquidity management has been timely and proactive and its framework—while possibly subject to refinements—has proven flexible and robust. The broad lists of eligible collateral and counterparties and relatively high but flexible reserve requirements have acted as helpful stabilizers from the very start of the turmoil. Nonetheless, banks’ balance–sheet stresses and fears of liquidity shortages are likely to keep interbank term spreads high for some time. The ECB is appropriately keeping its operational framework under continuous review, assessing carefully the collateral it receives and ensuring that the framework’s rules are strictly applied. Longer–term, further developing secured interbank markets could reduce the risk and impact of similar stress, underscoring the urgency of integrating clearing and settlement systems.

41. Political leadership and a strong multilateral spirit will be needed to move decisively toward the greater joint responsibility and accountability for EU financial stability implied in recent ECOFIN decisions. The agreed principles for cross–border crisis management are mould–breaking. The key challenge now is to fully align the legal underpinnings of nationally–anchored financial stability frameworks with the commonly agreed principles. The recent Memorandum of Understanding on crisis management and the intention to strengthen the Level–3 Committees of Supervisors are significant steps forward, but should be complemented by more binding arrangements. In this regard, the planned introduction of a European dimension in the mandates of national supervisory authorities should clearly rule out “beggar–thy–neighbor”–type policies and provide appropriate accountability. Also, a multilateral platform for real–time sharing of systemically–relevant supervisory information among supervisors and central banks, including the ECB, is urgently needed. Medium term, firmer arrangements are needed to underpin the principles of collective crisis cost minimization and sharing of fiscal costs based on equitable and balanced criteria. All these steps will require strong political leadership—in many ways akin to that leading to the creation of the common currency—in a multilateral approach that would also facilitate collaboration with non–EU countries, which is essential in a globalized financial system with large cross–border financial institutions.

42. A rules–based fiscal policy serves countries best, notably in today’s uncertain environment. The SGP has improved fiscal discipline, although about half of the euro area countries still face persistent challenges in meeting its objectives. Given growing expenditure pressures from catering to aging populations and the risk of unanticipatedly large cyclicality in fiscal fortunes, the room for policy adjustment in response to the current downturn must be a function of the leeway allowed by the SGP. Furthermore, tax policy should not be used to hamper adjustment to rising energy and food prices. Looking further ahead, stronger national fiscal rules and domestic governance mechanisms could help achieve more predictable and efficient fiscal policies in countries that struggle with relatively high public deficits and debt.

43. The structural reform momentum needs to be kept up and re–oriented in a coordinated manner to improve adjustment in response to intra–area disparities and make further progress on commitments under the Fund’s Multilateral Consultations. The ongoing reforms are bearing fruit, contributing to the marked growth in employment and to improved productivity in liberalized sectors. However, large parts of the services sector remain unaffected, forfeiting important income, resilience, and inflation benefits. Accordingly, the reform recommendations under the Lisbon Agenda for the euro area as a whole appropriately emphasize accelerating services market reform and financial integration. Greater consistency of National Reform Programs with these euro–area recommendations is needed, requiring enhanced policy coordination.

44. Prompt action is needed to conclude the Doha Round and bolster multilateral liberalization. The right response to high food prices is to lower agricultural trade barriers and subsidies so as to foster the production and free trade of agricultural products. Approaches that emphasize self–sufficiency with respect to food production should therefore be resisted and biofuels policies kept under review. EU leadership in facilitating an ambitious and balanced conclusion to the Doha Round can provide a critical counterweight to rising protectionist pressures.

45. It is proposed that the next consultation on euro–area policies in the context of the Article IV obligations of member countries follow the standard 12–month cycle.

Appendix I—Statistical Issues Euro Area Policies

Statistics for the euro area (and the EU–27) are produced by Eurostat and the ECB, generally on the basis of data reported by the statistical services of member states. These statistics are of sufficient quality, scope, and timeliness to allow effective macroeconomic surveillance. Nonetheless, certain gaps and weaknesses remain, and these can be difficult to resolve given institutional and other complexities, including the changing composition of the euro area and EU. Although a high level of harmonization has been achieved in the statistical systems of the EU Member States, national idiosyncrasies continue to represent fundamental obstacles that can affect the comparability of data, for example due to differences in the structure of countries’ financial systems. The IMF’s Dissemination Standards Bulletin Board (DSBB)19 provides comprehensive information on the Euro area’s statistical practices for the Special Data Dissemination Standard (SDDS) data categories. Recent and ongoing developments include:

  • The introduction of NACE rev. 2 will have a significant impact on the availability of data. 20 NACE rev. 2 came into force on January 1, 2008, and will be introduced gradually during the 2008–11 period. It provides a better and more detailed classification of economic activities, tailored to the structure of a modern economy. It better captures services and outsourcing and will lead to an increase in the measured share of services in output. For the short–term statistics, Eurostat is working with the member states to ensure that time series are recalculated back to 2000. However, in other areas the limited potential for backcasting means that NACE rev 2 will lead to significantly shorter dataseries or statistical breaks. The publication of some series will be interrupted during the transition period.

  • The Principal European Economic Indicators produced by Eurostat are under review. Consideration is being given to adding housing market indicators and further tightening timeliness standards (as most existing targets have been met). Production guidelines with respect to seasonal and calendar day adjustments have been approved and will come into effect in the second half of the year. Work to harmonize revision policies is ongoing, as is work on euro area vintage data.

  • For the national accounts, the ESA 95 transmission program was changed substantially at the end of 2007, requiring member states to report more harmonized data in greater detail. Also, guidelines for seasonal adjustment and calendar adjustment have been issued. Responsibility for the quarterly and annual sectoral accounts has been merged and their timeliness has improved. Work is ongoing to extend the annual series backward to 1995 and the quarterly series to 1999. Work on nonfinancial balance sheets is ongoing as a long–term project, given important technical challenges. Eurostat has discontinued the publication of national accounts at constant prices in favor of chain–linked data at previous year’s prices.

  • A new regulation was issued in November 200721 that focuses the Harmonized Indices of Consumer Prices (HICP) on “consumption segments” rather than products. The regulation prescribes quality adjustments and gives Eurostat the ability to issue standards for quality adjustment following a case–by–case approach. Pilot work on an HICP index at constant tax rates has not been completed, partly because some large countries decided not to participate. A regulation is being prepared to harmonize the treatment of seasonal items, and an HICP Manual should be finalized shortly.

  • Work continues on the compilation of harmonized HICP data on prices for owner–occupied housing. A pilot project covering 12 countries was completed last year, and was followed by a new stage including 26 of the EU’s 27 member states. Eurostat has also produced a manual on owner–occupied housing, and has embarked on a two–year project to produce an international manual for residential real estate prices.

  • Eurostat has started the release of a quarterly Government Finance Statistics publication using the summary page presentation and of historic Excessive Deficit Procedure (EDP) data on deficits and debt (i.e., prior to the notification period that covers the last 4 years). It has also tightened the statistical accounting rules for securitization operations by governments and is looking into the treatment of government guarantees provided to financial institutions and of government debt issued specifically to swap against private financial assets. Eurostat’s stepped–up monitoring of member states’ fiscal accounts is improving and becoming more consistent. All related documentation is published on its website. Resources for fiscal monitoring have been increased significantly, with available staff doubling between 2004 and 2008, but the workload has expanded even more due to EU expansion and increased data volumes.

  • A new framework regulation has been introduced to harmonize the compilation of quarterly data on job vacancies22. Work continues to enhance and harmonize the measurement quality of “hours worked,” which serves as input for various other statistics including the Labor Cost Index. Work is ongoing with a view to improve the models used for the calculation of the monthly unemployment rates published by Eurostat.

  • In the area of short–term statistics, ongoing work focuses primarily on prices and output in the services sector. A series of workshops has been organized with price statisticians of Member States to ensure the harmonized compilation of Services Producer Price Indices, reporting of which will start later this year. Eurostat aims to produce an index of services production by 2012. A new series on import prices, compiled on the basis of reporting by importers, has recently been published and allows a clear differentiation between import prices and unit values.

  • With regard to structural business statistics, a new regulation has been introduced covering statistics on business services and business demographics. An ad–hoc survey is ongoing on international sourcing and a survey on access to financial services by SMEs is being considered.

  • A comprehensive 5–year overhaul of business statistics (“Modernization of European Enterprise and Trade Statistics”, MEETS) is about to start with the objectives of improving the coverage and quality of data while also reducing the reporting burden on enterprises.

  • The regulations covering Intrastat and Extrastat reporting23 are being revised, in part with a view to reducing the reporting burden on enterprises. Asymmetries in intra–EU trade and balance of payment statistics persist; data confidentiality is among other things an obstacle for the ongoing efforts to reduce these asymmetries. The ongoing revision of the basic statistical legislation us expected to facilitate the exchange of confidential data between the EU Member States and Eurostat.


See ECB Financial Stability Review, June 2008.


ECB analysis does not point to major re–intermediation effects.


For example, econometric models suggest that the accelerated growth in emerging Europe in the past five years and the increased share of the euro area have contributed 0.2–0.4 percentage points to euro area annual growth (Regional Economic Outlook: Europe, November 2007).


See Regional Economic Outlook: Europe, April 2008.


Rules of thumb suggest that a 10 percent real effective appreciation of the euro reduces prices by 0.5 percentage points in two years, while 10 percent permanent decline of oil prices reduces inflation by 0.1 percentage points in a year.


This report was finalized before the July 3 meeting of the ECB Governing Council.


See Selected Issues Paper, Chapter II; and forthcoming IMF Working Papers “The ECB’s Monetary Analysis Revisited” by Helge Berger, Thomas Harjes, and Emil Stavrev; “The Information Content of Money in Forecasting Euro Area Inflation” by Helge Berger and Emil Stavrev; and “Does Global Liquidity Matter for Monetary Policy in the Euro Area?” by Helge Berger and Thomas Harjes.


Also, currency swap lines have been established with the Federal Reserve to facilitate the provision of U.S. dollar liquidity in euro area markets.


See Selected Issues, Chapter III, and the forthcoming IMF Working Paper “Bridge Over Troubled Waters: Liquidity Management in the Euro Area”, by Martin Čihák and Thomas Harjes.


ECOFIN Manchester Press Release, September 2005.


The policy advice is a new fiscal surveillance policy instrument, introduced under the 2005 reform of the SGP, which is available to the Commission and does not require Council approval.


See ¶25–28 in Euro Area Policies: 2007 Article IV Consultation –Staff Report and ing Europe’s Financial Markets, by Jörg Decressin, Hamid Faruqee, and Wim Fonteyne.


EU Memorandum of Understanding on Cross–Border Financial Stability–financialstability2008en.pdf


Specifically, under the MoU countries that share a single or several financial groups are to conclude non–legally binding Voluntary Specific Cooperation Agreements for shared financial groups, which are to provide for “specific and detailed crisis management procedures”, including the establishment of “Cross–Border Stability Groups” (CBSG) that build on “Domestic Standing Groups” (DSG) as well as existing “colleges of supervisors” (CS). These will operate alongside the level 3 Committees (CEBS, CESR, CEIOPS), the European System of Central Banks (ESCB), and the Financial Services Committee of EU Finance Ministries.


For further details see May 15, 2008, “ECOFIN Council of Finance Ministers adopt conclusions on financial supervision and provision of financial stability in the EU”.


For further analysis see Stavrev (2007), Growth and Inflation Dispersions in EMU: Reasons, the Role of Adjustment Channels, and Policy Implications.


For further details, see European Commission, EMU@10.


See Annett (2007), Lessons from Successful Labor Market Reformers in Europe.


Available at:


NACE stands for Nomenclature Générale des Activités Economiques dans les Communautés Européennes and is the European classification system of economic activities. NACE is fully compatible with the UN’s ISIC classification, but provides greater detail.


Commission Regulation (EC) No. 1334/2007.


European Parliament and Council Regulation (EC) No 4533/2008


Intrastat covers intra–EU trade and is based on reporting by businesses. Extrastat covers extra–EU trade and is based on customs declarations.

Euro Area Policies: 2008 Article IV Consultation: Staff Report; Staff Supplement; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Member Countries