Euro Area Policies: 2011 Article IV Consultation-Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Member Countries

International Monetary Fund

doi:10.5089/9781462339556.002.A001

Euro Area Policies

2011 Article IV Consultation-Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Member Countries

Author: International Monetary Fund

Publication Date:: 18 Jul 2011

eISBN:: 9781462339556

Language:: English

Keywords:: ISCR; CR; euro; authority; single market; crisis; Euro Area authorities; monetary union; headline inflation; banking system; member country; Plus Pact; Global

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In this study, the risks related to the euro area sovereign debt crisis are analyzed. Methods used to implement the European Financial Stability Facility (EFSF) are overviewed, and the European Stability Mechanism (ESM), the European Systemic Risk Board (ESRB), and the European Supervisory Authority (ESA) are the important framework for financial reforms and macroprudential policies. In this paper, the improvement over the fiscal and structural governance stability and growth pact (SGP) and excessive deficit procedure (SDP) is discussed. Finally, the findings of spillover analysis are outlined.

Abstract

1. The resilient recovery of the euro area economy stands in marked contrast with the authorities’ struggle to come to grips with the sovereign crisis affecting some member states and casting a shadow over the EMU project. The recovery in the core economies has become broad based and less dependent on public support, while inflation has risen, but several member states remain in dire shape. More than a year after Greece called upon international financial support, the Greek sovereign debt crisis is again dominating headlines and the choices made in its resolution will shape the future of the euro area. There is much agreement about what went wrong, but no consistent roadmap ahead, leaving both orderly and disorderly outcomes on the table, with possible significant regional and global spillovers. Moreover, despite genuine efforts to strengthen governance and cooperation at the center, the reaction by national authorities and economic agents has been one of retrenchment, threatening to turn back the clock on economic and financial integration, the very foundation of EMU. These developments could easily jeopardize the recovery and cloud the medium-term growth outlook.

2. Against this background, the discussions focused on the following key issues: (a) the strength of the recovery and its consequences for macroeconomic policies and the periphery; (b) the risks associated with the sovereign crisis affecting some member states and its resolution; (c) the capacity of the financial system to deal with illiquid private assets, sovereign tensions, and changes in the regulatory environment; and (d) the requirements for a resilient and stable EMU. Clearly, all these issues are interconnected: resolving the sovereign tensions in a way that fosters economic and financial integration will underpin confidence in EMU and help the financial system; fixing the financial system will in turn make handling the sovereign crisis easier; and strengthening EMU’s governance will provide confidence to investors that future difficulties can be safely handled.

I. Steadying the Recovery

A. Expansion in the Offing but Not Everywhere

3. The economic recovery in the euro area has surprised on the upside over the past year. Robust global demand and a turn in the inventory cycle supported a rebound from the worst recession in decades. Despite the sovereign debt problems in some countries and weakness in the banking system, the recovery is broadly following the historical pattern of previous upturns and showed robustness in early 2011, with very strong first quarter growth (Figure 1). Firms are rebuilding profit margins but corporate investment activity is still far below pre-crisis levels, despite low funding costs in most countries. Household consumption fared better as the crisis-induced spike in precautionary savings has unwound.

4. Sharp growth divergences persist across the area and are set to shape the outlook (Box 1). A majority of members is experiencing solid economic activity supported by increasingly healthy labor markets and relatively sound balance sheets of households and firms. Their economies are pulling away from those suffering from a sovereign debt crisis (Greece, Ireland, Portugal), the legacy of real estate bubbles (e.g., Spain), and chronic underperformance (e.g., Italy) that are working through various combinations of a correction of pre-crisis imbalances, high debt, unemployment and tensions in financial markets, alongside balance sheet adjustment, sectoral restructuring and deep fiscal austerity measures. At the same time, member states’ current account imbalances have been reduced since the crisis mainly reflecting the contraction in domestic demand in deficit countries (Figure 2). However, in many deficit countries private capital inflows have largely been replaced with ECB and official financing, which is unsustainable.

Box 1.

A Two-Speed Recovery in the Euro Area¹

The euro area recovery is a tale of two speeds, with a majority of member states cruising and the others stalling or falling. Indeed, the very strong first quarter outturn was driven by the northern euro area, led by Germany, but also France, the Netherlands, Belgium, and Austria, while growth in Italy, Spain, and Greece was weaker and Portugal posted negative growth. Expected growth divergence remains large: 2011 growth is currently projected to range from nearly -4 percent in Greece and about -2 percent in Portugal to over 3 percent in Germany, Estonia, Finland, Luxembourg, and Slovakia.

Sources: IMF, World Economic Outlook; Haver Analytics; Eurostat; and IMF staff calculations.1/EA17 excluding Greece, Ireland, and Portugal.

The recovery in private consumption will remain uneven reflecting the largely divergent income and labor market dynamics and wealth developments. With improving income and labor market conditions, consumption is recovering in Germany, France, and Italy, although it remains subdued in Spain where a drag from negative wealth effects dominates. Rising disposable income is poised to support consumption in Germany and elsewhere, while ongoing labor market adjustment and fiscal withdrawal in Spain and peripheral economies may weaken consumption. In a number of countries, especially Germany, where the deterioration in labor markets was relatively contained during the global crisis—thanks to labor hoarding practices and partial unemployment schemes—labor markets are stabilizing. In contrast, unemployment has risen markedly in the wake of bursting housing bubbles, notably in Spain and Ireland, leaving many low-skilled, young, and temporary workers without a job and threatening to increase inequalities. Private consumption in Greece, Ireland, and Portugal is set to continue lagging the rest of the euro area.

Sources: IMF, World Economic Outlook; Haver Analytics; European Central Bank; Eurostat; and IMF staff calculations based on behavioral equations.

Private investment will likely strengthen in most member states, while its behavior remains uncertain in vulnerable economies. Investment is on the rebound in Germany and beginning to recover in France and Italy, but it continues to plunge in Spain, partly reflecting the housing market correction that has weighed on residential investment. As demand has strengthened, the accelerator effect has turned positive, except in Spain, but higher labor costs remain a constraint, as do higher costs of capital, except in Germany. The drag on firms’ profitability from higher labor costs is set to fade away, and firms are now in a better position to resume investment, having preserved human capital during the downturn. However, increasing tiering in costs of capital will remain a challenge as long as sovereign bond markets are under pressure, while ongoing housing market corrections will continue to be a constraint in some countries. Investment in Greece, Ireland, and Portugal will likely keep on lagging the rest of the euro area.

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

¹/ Prepared by Irina Tytell.

5. There was broad agreement that the recovery in the bulk of the euro area was relatively sound and becoming less dependent on public support. The ECB and Commission stressed that growth in the core had consistently surprised on the upside, with increasing contributions from private domestic demand. They noted that as expected following a financial crisis, growth and potential growth would be subdued for some time, a view the staff shares. Indeed, growth is expected to soften in the second half of 2011.

Real GDP Forecast for 2011-12

(Percent)

Sources: ECB; EC; IMF WEO database; Consensus Forecasts.

6. Going forward, all agreed that high energy and food prices will cut into disposable income and together with fiscal consolidation and high unemployment weigh on growth. Persistent and elevated unemployment is causing much pain in several member states and is likely to hold back consumption (Box 1). Fiscal consolidation is set to dampen growth in the short term, but sound finances are needed to underpin confidence and support a more solid medium-term outlook. Despite higher energy efficiency in Europe than in other large economies, the sharp increase in energy costs over the past year is likely to constitute a drag on growth in the near term.

7. One overarching concern is whether investment will fully assume its key role in the recovery. Typically, strong investment activity follows the rebound in trade and drives the business cycle upswing in its early phase. While some member states did see a rebound of investment demand (Box 1), overall euro area investment contracted in the second half of 2010 and began to recover strongly only in the first quarter of 2011. Rising profits and higher equity prices have lifted firms’ net worth and should increasingly accelerate investments as uncertainty about the outlook and risks diminish. However, higher interest rates and sovereign spreads in some member states that are increasingly being transmitted to corporate funding costs may hold back stronger investment activity.¹ And bank deleveraging in response to a running down of illiquid private assets, funding strains, and the new regulatory environment is likely to dampen investment activity (Section III).

8. In sum, provided the crisis in the periphery is contained, the outlook is for modest growth ahead. While there are considerable cross-country differences, the aggregate output gap is set to close steadily over the next two years. Serious trouble in the periphery spilling over into the core would upset this scenario, with a very unpredictable outcome and significantly larger spillover effects (Section II).² Policies will need to be geared toward minimizing this risk, but will otherwise need to take into account the underlying cyclical developments.

B. Restoring Fiscal Health

9. Public finances are in poor shape following the crisis, making fiscal consolidation a top priority (Figure 3). The euro area aggregate budget deficit has deteriorated sharply since 2007 and public debt has reached record highs in many countries. Discretionary fiscal measures accounted for about half of the deterioration in the euro area deficit. The fiscal burden and expected debt dynamics associated with a weak growth outlook led to severe sovereign funding pressure in Greece, Ireland and Portugal and their governments turned to the EU/IMF for financial aid. It was agreed that maintaining easier fiscal policies in the core for the benefit of the periphery would be of little help, as direct demand effects are small,³ interest rate effects may offset the gains, and contingent fiscal liabilities loomed.

10. There was agreement that fiscal consolidation should continue broadly as planned. The 2010 fiscal deficit for the euro area remained at the previous year’s level of about 6 percent of GDP. The targeted adjustment that countries have agreed to under the Excessive Deficit Procedures (EDP) of the Stability and Growth Pact (SGP) is substantial, mostly expenditure-based and frontloaded where funding pressures are most severe (Figure 3). The adjustment is included in the staff and authorities’ baseline scenarios. In discussing its impact, the authorities argued that the counterfactual without fiscal consolidation was unlikely to be positive for growth, as risk premia would rapidly increase, eroding confidence compared to the consolidation scenario.

11. Consolidation is proceeding, but it will be important that announced plans are implemented and policy gaps filled. Faster growing economies should let automatic stabilizers work and reach their EDP targets earlier than planned. Crisis countries might have to extend their plans in line with program requirements, but consolidation will have to continue. While the periphery was lagging, the authorities saw little alternative to credible fiscal consolidation across the region. They agreed that targets were appropriate, but noted that specific measures need to be identified as of 2012.

12. Declining debt is required over the long run. Staff projects the debt-to-GDP ratio to peak at slightly below 90 percent in 2012 and gradually decline thereafter. Reducing debt-to-GDP ratios to sustainable levels will require action on all fronts to restore competitiveness and reinvigorate growth; pursue strong and sustained fiscal consolidation; and reform pension and health care systems. New rules to guide the path of debt towards the 60 percent target and to control spending have been proposed and subject to strengthened governance procedures (see Section IV.B).

C. Inflation and Monetary Policy

13. Headline inflation has accelerated sharply in early 2011 mostly on the back of higher energy and food prices. Since February, inflation has exceeded 2 percent with the largest contributions coming from energy and food prices. Here the strong recovery of demand in many emerging markets played a role, with the stronger euro compensating some of the resulting price pressures. But supply factors including tensions in the Middle East and adverse weather conditions also mattered.

14. But underlying inflation has also picked up. Core inflation, trimmed means and other measures of underlying inflation hovered around 1 percent for most of 2010 but have increased more recently (Figure 4). This reflects elements of the cost-push shock induced by higher energy and food prices and dissipating disinflationary pressure from a closing output gap. Higher indirect taxes and administered prices added to the picture. The authorities saw a continuing gradual rise in underlying inflation, a view supported by key indicators:

Industrial producer prices. While input price pressures further down the production chain remain moderate so far, intermediate goods prices have risen strongly fueled by higher energy and commodity costs.
Wages. Various labor cost indicators are holding steady, reflecting a still weak area-wide labor market. However, as in particular the ECB emphazised, strong employment prospects in some countries and wage indexation in others could soon result in higher wage outcomes which, if not matched by productivity gains, could lead to price pressure. The expectation of higher headline inflation would accelerate this process.
Profits. Profitability of nonfinancial firms has been recovering quickly. But profit margins still remain somewhat below historical averages and may limit companies’ ability to absorb higher input costs.
Capacity utilization. Capacity utilization has recovered considerably since the start of the recession and is approaching its historical average while in the faster growing parts of the region, historical levels have already been exceeded. This could create the expectation of future cost and price increases.
Money and credit. The ECB considers the underlying pace of monetary expansion gradually increasing and cautions that monetary liquidity remains ample and may accommodate price pressures.

15. Against this background, headline inflation is expected to peak at elevated levels in 2011 and recede to slightly below 2 percent in 2012. The forecast assumes that energy and food prices will be stabilizing and inflation expectations will stay well anchored to keep underlying inflation in check. Most forward-looking measures of inflation currently remain at around 2 percent, but break-even inflation rates have risen amidst some volatility (Figure 5) and the baseline incorporates an upward adjustment of interest rates in order to keep expected and actual inflation below the 2 percent threshold by 2012. Model calculations confirm this pattern although in a small dynamic stochastic general equilibrium (DSGE) model, inflation is more sluggish, probably due to the highly stylized nature of the model (Box 2). The ECB staff reported that simulations using a larger-scale model of the euro area suggest that inflation would be higher if monetary policy adjustment was delayed.

Inflation Forecast for 2011-12

(Percent)

Sources: ECB; EC; IMF WEO database; Consensus Forecasts.

Box 2.

Euro Area Inflation Projections

This box presents two models to forecast euro area inflation. Against the backdrop of elevated rates of inflation, a key question is whether the current surge will subside or give way to second-round effects. For this purpose, two models are used: a time series model forecasting the major subcomponents of the CPI index; and a small structural DSGE model.

The time series ‘bottom-up’ model reveals a decline in inflation by late 2011, mainly owing to a decline in energy price inflation under the baseline. Separate estimations of food, energy, and core inflation suggest that inflationary pressures would likely subside as energy prices stabilize. Core inflation would remain contained and the pass-through from energy prices to headline inflation would be limited. However, uncertainty over the path of inflation appears quite large towards the end of 2012, with estimates ranging between 1.1 and 2.2 percent, although the upper bound remains close to the ECB target.

Sources: Haver Analytics; and IMF staff estimates.

The DSGE model forecasts higher—albeit also slowly downward trending—inflation, reaching levels still significantly above 2 percent by end-2012. This forecast is based on an inflations expectations-augmented Phillips curve, an aggregate demand equation specified in terms of the output gap and the real interest rate, and a policy reaction function specified as a standard Taylor rule with interest rates inertia. The interaction between the variables in the model as well as a series of stochastic shocks imply a rise in inflation to a maximum by early 2012 before gradually declining by end-2012, as the model sees policy rates increase to about 3 percent.

1/ Prepared by Nico Valckx.2/ Based on Emil Stavrev, 2006, “Measures of Underlying Inflation in the Euro Area: Assessment and Role for Informing Monetary Policy,” IMF Working Paper No. 06/197.

16. The outlook calls for a gradual withdrawal of monetary stimulus. The ECB highlighted that the exit from record-low interest rates would help prevent the currently high rates of headline inflation from becoming entrenched and forestall excessive risk taking in search for yield. At the same time, the recovery is expected to move at a moderate speed and some of the price pressure related to energy and food prices should dissipate on its own. Moreover, regulatory changes in the banking sector are likely to increase bank lending spreads in the future. This suggests a gradual approach to monetary tightening. That said, the impact of an ECB interest rate hike on banks is far from uniform (see text figure) and will vary, among many things, with the interest rate elasticity of the balance sheet and possibly the location of banks.⁴ It could even be positive in some program countries as it allows banks to reprice variable rate assets tied to the policy rate. Moreover, the ECB underscored that its primary mandate is price stability for the euro area overall and staff analysis suggests that the difference between the common interest rate and what standard macroeconomic policy rules would suggest for individual member countries is likely to remain small (Figure 6).

17. The ECB clarified that it was not committed to a path of rising policy rates. While acknowledging the arguments for a gradual approach put forward by staff, the ECB stressed it would adjust interest rates as necessary to anchor inflation and inflation expectations at below, but close to 2 percent—which could mean a faster or slower path of adjustment as necessary.

18. All agreed that the extraordinary crisis measures would need to remain in place as a safeguard against financial and sovereign market tensions but should not become a permanent substitute for resolving these tensions. As the functioning of money and interbank markets improved and reliance on the ECB’s deposit facility fell, the ECB discontinued one-year refinancing operations, shrinking its overall balance from around 620 billion euro in May 2009 to currently around 450 billion euro. Staff argued, however, that refinancing at a fixed rate with full allotment continues to be critical for banks with limited access to wholesale or interbank funding, and there is a need to keep it in place for now. The ECB confirmed that the exit from unconventional support measures would be dictated by the evolution of financial market tensions, but should not foster delays in tackling underlying problems.

II. Risks and Spillovers: Focus on Sovereign Tensions

19. Solvency concerns in some member states persist and could spill over to the core of the euro area and threaten the recovery. Markets continue to price in significant default risk for some member states (Figure 7). Banks in Greece, Ireland and Portugal have significantly increased their government debt exposure during 2010. Shunned by financial markets and faced with deposit withdrawals, they survive only because the ECB meets in full their demands for liquidity against collateral of rapidly declining quality (Figure 8).

20. Cross-country financial exposure and the risk of contagion remain high. In the absence of mitigating policies, a sovereign default or disorderly bank failures could send shockwaves through Europe’s financial sector and liquidity could well dry up again, with potentially strong and negative global spillovers,⁵ underscoring the need for actions to mitigate contagion, which could spread through the following channels:

Direct exposure to sovereigns and banks at risk of default. According to the latest BIS data, banks have reduced further their cross-country exposure. Nevertheless, several French and German banks remain significantly exposed to credit risk in the periphery. Having in place adequate bank recapitalization plans in these markets would help mitigate contagion risk.
Sudden large credit losses may trigger a bank run in the absence of adequate liquidity and bank recapitalization facilities. Strengthened commitments to deposit insurance schemes, and domestic guarantees on bank assets and new debt issuances would further reduce market fears. A sovereign or bank default may affect the incentive structure of other sovereigns and banks.
A credit event may reveal unexpected counterparty risks if sellers of default protection cannot live up to commitments. On the other hand, default protection could also shield some investors from losses, with an uncertain net effect.
A bank funding shock and sharp fall in equity prices could accelerate deleveraging while macro policies have very limited space to respond. Credit backstops would help mitigate the risk of a damaging credit crunch.

Both the Commission and the ECB considered that a sovereign default or a credit event would likely trigger contagion to the core euro area economies with severe economic consequences. Staff however also saw serious risks of contagion, even under a strategy which tries to avoid default or credit events.

21. The staff and authorities agreed that seeking an orderly solution to the sovereign difficulties in the periphery, and in particular in Greece, was of the utmost importance. The focus should be on strong program implementation, with sufficient proceeds from privatization, adequate financing from other official sources on terms supporting debt sustainability, and private sector based solutions to banking problems (such as cross-border takeovers). This strategy, however, might be difficult to reach given the scale of the targeted adjustment, its possible social repercussions, as well as unfavorable financial market circumstances. The ECB was concerned that a credit event would require it to exclude the affected sovereign debt from its eligible collateral with devastating implications for the country’s financial system and scope for spillovers.

22. The crisis has changed a basic paradigm of the euro area, namely that all sovereign debt of euro area member countries is equal. This premise lost credibility in the eyes of market participants some time ago, with markets taking their cue from the discussion about the role of private sector involvement in the design of the European Stability Mechanism (ESM), the permanent successor of the European Financial Stability Facility (EFSF). The Commission and the ECB shared the view that, while market discipline should be pursued, doing so in the midst of a sovereign debt crisis is poorly timed. In their view, such a shift could overburden a thinly capitalized banking system not yet completely ready to shift away from zero risk weight on sovereign holdings, and default could become self fulfilling. Alternatively, public funding could gradually overtake private funding, de facto making common bond issuance increasingly a feature of the euro area and calling into question whether national fiscal sovereignty can be preserved within EMU.

23. Limiting any further damage is now crucial. Aside from strong program implementation, staff emphasized the need to quickly scale up the capacity and flexibility of the EFSF and to go further than planned by allowing the EFSF to intervene in secondary markets and assist with problems in the financial system (see next section). More generally, it will be important to bring the discussion about private sector involvement to completion—both in specific programs and in the context of the ESM. And having in place adequate bank recapitalization plans is essential to mitigate contagion from sovereign tensions. The authorities observed that political constraints delayed clear progress on many of these fronts but emphasized that crisis management efforts had been substantial, noting that in the end courageous decisions had been taken to preserve the stability of the euro area. They anticipated that this time too a solution would be found.

24. In comparison to the sovereign tensions, other downside risks appear manageable. Geopolitical problems in the Middle East and disruptions to energy supply could derail global growth. Fiscal consolidation could have stronger adverse effects on domestic demand than currently expected. Persistent weaknesses in the banking sector could put an additional drag on credit supply and delay the much needed normalization in lending conditions. The euro, which is now broadly in line with fundamentals, has been relatively volatile recently. It could move away from this value on either side, not only as a function of developments in the sovereign crisis in the periphery, but also as a result of policy changes abroad or the unwinding of global imbalances, a risk emphasized by the authorities.

III. Strengthening the Financial Sector

25. The euro area’s banking system continues to display weaknesses. Leverage remains high, as does dependence on wholesale funding, while considerable refinancing needs will compete with sovereign and corporate issues over the next few years. In the periphery, banks are vulnerable from large exposures to their governments and real estate and from high marginal wholesale funding costs. Indeed the emergence of funding gaps has contributed to heightened competition for deposits in several member states. In other member states, weak governance in some banks led to structurally low profitability and the global financial crisis pushed capital to very thin levels making them vulnerable to any further shocks. Core euro area banks are significantly exposed to the periphery. A number of banks, not exclusively in the peripheral member states, still have to work through a large share of doubtful assets. Recognizing losses promptly, provisioning adequately, and restructuring weak banks will be key. Meanwhile, banks are under pressure to meet and exceed Basel III capital requirements ahead of schedule.

26. It will be important to get deleveraging right and balance the needs for strengthened bank balance sheets and adequate supply of credit to finance the recovery. Large companies issued debt at record levels over the past two years but banks continue to provide the overwhelming share of external funding for many firms. Bank lending conditions are stabilizing and credit to firms appears to have bottomed out in the euro area, but many SMEs continue to lack access to bank credit. As Basel III is implemented, banks are likely to pass on some of the costs associated with the regulatory changes which may put further upward pressure on lending rates and limit credit supply especially if the deleveraging is achieved through shrinking assets (Box 3). Nonetheless, capital raising is not likely to have large output effects and long-term benefits outweigh the costs.

Box 3.

Bank Deleveraging in the Euro Area¹

Euro area banks’ leverage remains high by international standards.¹ Before the 2008 crisis, euro area banks relied on wholesale funding to keep capital-asset ratios low and turn a relatively weak operating performance into high returns on equity. Since the beginning of the crisis, banks have gradually reduced wholesale funding and, to a degree, leverage ratios, but leverage levels generally remain high, both in absolute terms and compared to the U.S. and U.K. In order to withstand potential future income shocks, euro area banks will need to increase their capital buffers.

Staff estimates suggest that bank profitability is going to remain low overall, questioning the capacity of banks to rely on retained earnings to build capital buffers. Staff projects that profitability will improve slightly under the baseline WEO scenario but will stay far below pre-crisis levels, mainly because of persistently high nonperforming loans. Slightly less than half of the banks, accounting for 30 percent of banking sector assets included in the exercise, would remain unprofitable until 2015. Moreover, exposures of core euro area banks to the program countries are high as a percent of bank capital. According to BIS official data, exposure of German, French, Belgium but also Irish banks is particularly high. Hence, many European banks will have little alternative but to resort to private equity markets to rebuild their capital buffers.

Building capital buffers faster and to higher levels than required under the Basel III agreement will come at moderate output costs. According to Fund estimates based on the BCBS MAG study, the peak output loss from increasing capital requirements by 1 percentage point of risk weighted assets range from about 0.29 percent to 0.32 percent depending on the country and the speed of implementation. Importantly, a faster implementation of Basel III—for example within 2 years instead of the 6 years currently envisaged—would make virtually no difference in term of the average output loss, suggesting that fast equity issuance would not penalize economic growth.² This reinforces the call for strengthening the banking sector through capital issuance rather than lending, which would likely add to the output effects.

¹/ Prepared by Thierry Tressel and Nico Valckx²/ See also the IMF Regional Economic Outlook for Europe (REO) on deleveraging in the euro area, May 2011 (pp. 10-12).

27. There was agreement on the unequivocal need for substantially more and higher quality bank capital and the restructuring of weak institutions. Many banks remain very dependent on short-term wholesale funding and the reliance on ECB refinancing remains high, especially for banks of the periphery. Yet the experience of Japan shows that insufficient restructuring and regulatory forbearance following a financial crisis can lead to serious macroeconomic consequences in an economy where bank-based financing still dominates. Bank equity issuance has been stepped up, including since the beginning of the year and in the run-up to the current stress tests, but less adjustment has taken place in the euro area than in the United States and the United Kingdom, in terms of recapitalization and the reduction of reliance on wholesale funding. Against this background, the ECB concurred that banks should recapitalize well ahead of the Basel III timetable, in line with market pressures, with a strong frontloading especially by second tier weak banks. The authorities agreed that overall capital needs were likely to be manageable, while acknowledging that program countries had, however, run out of fiscal capacity. The lack of progress in raising capital was seen as the result of shareholder protection, public sector stakes, and the focus on national solutions. The authorities were confident that the ongoing stress test exercise would be more credible and of higher quality and intended to press banks close to the chosen threshold to raise capital as well. Staff emphasized the need for consistent follow up of the stress tests and expressed concern about the incomplete treatment of sovereign risks. Staff also urged the authorities to raise capital as soon as possible, as was happening in some countries.

28. It will be important to look for private cross-border solutions to strengthen the euro area’s financial system. The Commission and the ECB agreed that clear priority should be given to private sector solutions, including private capital raising and cross-border mergers and acquisitions. Staff emphasized that the relevant Directives for Cross-Border Acquisitions and Takeovers should be applied, or reviewed if necessary, to overcome the formal and informal national obstacles to the free flow of equity capital. Public support may nonetheless still be necessary and should be made available in a manner coordinated across the EU.

29. Staff argued that re-developing the market for securitization, appropriately regulated and based on high quality standards, should complement credit supply as bank deleveraging proceeds. European regulators should actively support the development of market-based alternatives for corporate finance to reduce the dependency of the euro area economy on the banking system. The ECB noted that the structure of the financial system has served Europe well in the past but agreed that the development of securities markets should not be impeded. There was agreement that many banks that depend heavily on ECB financing would have problems regaining market access in the near term. Staff argued for establishing a conditional term funding facility for private illiquid (but performing) assets, operated by the ECB with the explicit backing of euro area sovereigns (e.g., via the EFSF) to protect the ECB’s independence and flexibility, and reinforce the need to tackle the banking problems at their root. This would also relieve pressure on the ECB in the context of private sector involvement in crisis countries. However, the ECB felt that this was beyond its remit.

IV. Securing Economic and Monetary Union

30. Incomplete economic, financial and fiscal integration is casting a shadow on the future of EMU and weighing on the euro area’s growth potential. National policymakers in the euro area need to move away from the illusion that a national approach to fiscal, financial, and structural issues preserves sovereignty in a monetary union. Instead, they should focus on the fact that interconnectedness requires more common thinking from an area wide perspective. While progress has been made in strengthening governance, political obstacles remain to be overcome. The staff sees the ultimate need to deal with the financial system at the euro area rather than the national level and to put in place some form of ex ante fiscal risk sharing, conditional on prudent fiscal policies and in the context of a binding economic governance framework that would remove remaining obstacles to the free flow of goods, labor, and capital across all sectors and national borders of the euro area. This may be a tall order, but without a decisive breakthrough in these areas, the euro area is unlikely to live up to its potential.

A. Financial Sector Reforms and Macroprudential Policies

31. Establishing the credibility and effectiveness of the key new elements of the EU financial sector architecture now in place is a priority.⁶ The European Systemic Risk Board (ESRB) and the European Supervisory Authorities (ESAs) have become operational, and should become the core of a more coordinated and integrated European financial stability framework. However, their credibility needs to be established, and some gaps remain in the framework that limit its effectiveness. Particularly important will be the collaboration among EU institutions, including regarding data and information sharing, and the relationship with national authorities. The ESRB should move ahead forcefully in developing the EU macroprudential policy toolkit in collaboration with other EU institutions and national authorities.⁷

32. There was agreement that rapid progress towards establishing the single rule book is needed, and Capital Requirements Directive 4 (CRD4) should implement Basel III swiftly and without exceptions. The Commission and the ECB called for harmonization of new rules at the EU level with scope for providing some flexibility for macroprudential purposes. Staff supported the position that capital requirements should be set at an ambitiously high common level (above Basel III) to reflect prevailing balance sheet uncertainties, a high degree of interconnectedness and the lack of an effective resolution framework for banks operating cross-border. In addition, capital regulations must allow sufficient flexibility to introduce macroprudential tools, including adjusting capital and liquidity requirements or varying risk weights, to mitigate systemic risk that could jeopardize financial stability. This flexibility needs to extend to capital surcharges for systemically important financial institutions. The ESRB should play a prominent role in the coordination and calibration of macroprudential instruments, including on key aspects of home-host coordination and reciprocity, and finding a balance between rules and discretion.⁸ Staff suggested that the zero risk weight for sovereign bonds in bank capital requirements will need to be adjusted to reflect the market perception of sovereign risk and the design of the ESM, which should be taken into account when strengthening bank capital.

33. The staff called for faster progress toward a unified European financial supervisory, resolution and stability framework. The European Banking Authority must become effective rapidly to guarantee high standards of supervision for banks operating across euro area and EU borders, including through the building of a prudential database and data sharing with and among national authorities. The staff felt that it would be important to complete the EU financial stability framework with the establishment of a European Resolution Authority backed by common deposit guarantee and resolution funds—that could be financed by a levy on the industry—to improve ex-post burden sharing and provide an EU-centered backstop for both liquidity and solvency support. At the minimum, such an end-goal would need to be agreed upon now. This would provide the right incentives to underpin the cooperation in the new supervisory architecture, allow the use of cross-border private sector based solutions to address banking problems and end the intertwining of sovereign and bank balance sheets. This approach would be fully consistent with the objective of limiting the use of taxpayer funds while minimizing market disruptions.

34. With responsibility for supervision remaining national, the authorities felt that some of the staff’s proposal would be infeasible, at least in the short run. While there was general agreement on the need for a more common approach to the financial system in the EU, and especially in the euro area—a point emphasized by the ECB, the authorities felt that it was premature to consider the establishment of a European Resolution Authority. Instead, the current proposal is for setting up resolution colleges (bringing together national resolution authorities) and harmonizing national resolution tools and deposit guarantee schemes. The authorities also felt that the new institutions needed to be given time to establish their effectiveness and envisaged a review of the entire framework in 2014. The staff responded that the national approach had proven deficiencies, and that fixing weaknesses identified by the EFFE should not be delayed.

B. Advancing Policy Coordination in the Euro Area

35. The staff feels that governance reforms currently envisaged will have to go further to establish an effective EMU. Effective crisis management and a resilient monetary union call for some delegation of countries’ sovereignty to the center, that would have an authoritative say in the formation of national policies, and issue a reasonable amount of well-managed debt, supported by larger and credible revenues.⁹ This would put both public finances and the financial system on a sounder footing and require adjustments in the structure, institutions and political underpinnings of the euro area that go beyond the Treaty. However, the authorities see the current political economy as divided on the need for such an approach.

36. The ESM presents a first step towards a fiscal insurance scheme for the euro area. The ESM will provide support for countries facing sovereign funding pressures. Its final design and coverage should encourage prudent national policies while preserving financial integration of EMU and the attractiveness of its sovereign debt instruments which is key for a large reserve currency. Financial support under ESM should not be conditional on debt restructuring and be conducive to continuing private sector engagement. The ESM could evolve into a European debt management agency if the political will were mustered for limited fiscal integration that included common bonds backed by enhanced euro area fiscal capacity.

37. The new Euro Plus Pact should become an important instrument to accelerate economic integration of the euro area (Box 4). Under the Pact, national leaders coordinate and commit to a limited set of national policies, key to promoting competitiveness and employment and safeguarding financial stability and fiscal sustainability. Measures announced so far, however, do not live up to expectations. To become an important instrument to govern economic policies, commitments should be more ambitious, concrete and time-bound. Other EU enforcement instruments of common polices such as guidelines and recommendations (e.g. the employment guidelines), or directives (e.g. the Services Directive)—should be strengthened. The new Excessive Imbalances Procedure (EIP) could help detect and correct policies giving rise to unsustainable imbalances.

38. Successful fiscal consolidation requires more stringent budgetary surveillance at the EU level (Table 1). Recent reforms are important steps in this direction. The European semester, which establishes an ex ante peer review of member states’ plans prior to the finalization of national budgets, has become the key policy coordination tool to strengthen fiscal discipline, complemented by the Euro Plus Pact. New SGP rules will include an amended EDP with numerical benchmarks also for debt reduction in countries exceeding 60 percent of GDP and a cap on growth in public spending net of discretionary revenue measures to encourage saving revenue windfalls. Sanctions will start already in the preventive arm of the SGP and be more progressive. However, a number of concerns remain regarding the effectiveness of the SGP. In particular, the standard decision-making process with qualified majority voting in the Council still applies to the initiation of the EDP and the possibility to suspend sanctions and extend deadlines for countries under the EDP.

Table 1.

Euro Area: Main Economic Indicators, 2005-12

(Percent change)

Sources: IMF, World Economic Outlook; Global Data Source; DataStream; Eurostat; and ECB Monthly Bulletin.

^¹/Contribution to growth.

^²/Includes intra-euro area trade.

^³/In percent.

^⁴/In percent of GDP.

^⁵/Latest monthly available data for 2011.

^⁶/CPI based.

^⁷/Based on ECB data, which excludes intra-euro area flows.

Table 1.

Euro Area: Main Economic Indicators, 2005-12

(Percent change)

				2005	2006	2007	2008	2009	2010	2011	2012
										staff projection
Demand and Supply
	Real GDP			1.7	3.1	2.9	0.4	-4.1	1.8	2.0	1.7
			Private consumption	1.8	2.1	1.7	0.4	-1.1	0.8	1.0	1.2
			Public consumption	1.6	2.2	2.2	2.3	2.5	0.7	-0.1	0.0
			Gross fixed investment	3.2	5.4	4.7	-0.8	-11.4	-0.8	3.7	2.8
		Final domestic demand		2.1	2.8	2.4	0.5	-2.7	0.5	1.3	1.3
			Stockbuilding ¹/	-0.2	0.1	0.2	-0.2	-0.9	0.5	0.0	-0.1
		Domestic Demand		1.9	3.0	2.6	0.4	-3.4	0.9	1.2	1.2
		Foreign balance ¹/		-0.2	0.1	0.2	0.1	-0.7	0.8	0.8	0.6
			Exports ²/	5.1	8.6	6.3	0.9	-13.1	11.2	6.9	4.8
			Imports ²/	5.8	8.5	5.8	0.8	-11.9	9.3	5.3	3.8
Resource Utilization
		Potential GDP		1.6	1.6	1.8	1.5	0.5	0.9	1.1	1.3
		Output gap		-0.3	1.2	2.3	1.2	-3.5	-2.7	-1.9	-1.4
		Employment		1.0	1.7	1.8	0.7	-1.9	-0.5	0.3	0.5
		Unemployment rate ³/		9.1	8.4	7.6	7.7	9.5	10.1	10.0	9.6
Prices
		GDP deflator		2.0	1.9	2.4	2.1	1.0	0.8	1.4	1.6
		Consumer prices		2.2	2.2	2.1	3.3	0.3	1.6	2.6	1.8
Public Finance ⁴/
		General government balance		-2.5	-1.3	-0.6	-2.0	-6.3	-5.9	-4.2	-3.3
		General government structural balance		-2.7	-2.3	-2.1	-2.6	-4.3	-4.0	-3.0	-2.4
		General government gross debt		70.1	68.5	66.3	69.9	79.4	85.5	87.8	88.3
Interest Rates ³/ ⁵/
		EURIBOR 3-month offered rate		2.2	3.1	4.3	4.6	1.2	0.8	1.4	…
		10-year government benchmark bond yield		3.4	3.9	4.3	4.4	4.0	3.8	4.4	…
Exchange Rates ⁵/
		U.S. dollar per euro		1.24	1.26	1.37	1.47	1.39	1.33	1.4	…
		Nominal effective rate (2000=100)		126.6	127.0	132.3	138.8	140.6	130.9	133.8	…
		Real effective rate (2000=100) ⁶/		121.5	120.8	124.4	128.4	128.9	118.6	119.8	…
External Sector ⁴/ ⁷/
		Current account balance		0.1	-0.1	0.1	-1.5	-0.3	-0.4	0.1	0.3

Sources: IMF, World Economic Outlook; Global Data Source; DataStream; Eurostat; and ECB Monthly Bulletin.

^¹/Contribution to growth.

^²/Includes intra-euro area trade.

^³/In percent.

^⁴/In percent of GDP.

^⁵/Latest monthly available data for 2011.

^⁶/CPI based.

^⁷/Based on ECB data, which excludes intra-euro area flows.

Table 1.

Euro Area: Main Economic Indicators, 2005-12

(Percent change)

				2005	2006	2007	2008	2009	2010	2011	2012
										staff projection
Demand and Supply
	Real GDP			1.7	3.1	2.9	0.4	-4.1	1.8	2.0	1.7
			Private consumption	1.8	2.1	1.7	0.4	-1.1	0.8	1.0	1.2
			Public consumption	1.6	2.2	2.2	2.3	2.5	0.7	-0.1	0.0
			Gross fixed investment	3.2	5.4	4.7	-0.8	-11.4	-0.8	3.7	2.8
		Final domestic demand		2.1	2.8	2.4	0.5	-2.7	0.5	1.3	1.3
			Stockbuilding ¹/	-0.2	0.1	0.2	-0.2	-0.9	0.5	0.0	-0.1
		Domestic Demand		1.9	3.0	2.6	0.4	-3.4	0.9	1.2	1.2
		Foreign balance ¹/		-0.2	0.1	0.2	0.1	-0.7	0.8	0.8	0.6
			Exports ²/	5.1	8.6	6.3	0.9	-13.1	11.2	6.9	4.8
			Imports ²/	5.8	8.5	5.8	0.8	-11.9	9.3	5.3	3.8
Resource Utilization
		Potential GDP		1.6	1.6	1.8	1.5	0.5	0.9	1.1	1.3
		Output gap		-0.3	1.2	2.3	1.2	-3.5	-2.7	-1.9	-1.4
		Employment		1.0	1.7	1.8	0.7	-1.9	-0.5	0.3	0.5
		Unemployment rate ³/		9.1	8.4	7.6	7.7	9.5	10.1	10.0	9.6
Prices
		GDP deflator		2.0	1.9	2.4	2.1	1.0	0.8	1.4	1.6
		Consumer prices		2.2	2.2	2.1	3.3	0.3	1.6	2.6	1.8
Public Finance ⁴/
		General government balance		-2.5	-1.3	-0.6	-2.0	-6.3	-5.9	-4.2	-3.3
		General government structural balance		-2.7	-2.3	-2.1	-2.6	-4.3	-4.0	-3.0	-2.4
		General government gross debt		70.1	68.5	66.3	69.9	79.4	85.5	87.8	88.3
Interest Rates ³/ ⁵/
		EURIBOR 3-month offered rate		2.2	3.1	4.3	4.6	1.2	0.8	1.4	…
		10-year government benchmark bond yield		3.4	3.9	4.3	4.4	4.0	3.8	4.4	…
Exchange Rates ⁵/
		U.S. dollar per euro		1.24	1.26	1.37	1.47	1.39	1.33	1.4	…
		Nominal effective rate (2000=100)		126.6	127.0	132.3	138.8	140.6	130.9	133.8	…
		Real effective rate (2000=100) ⁶/		121.5	120.8	124.4	128.4	128.9	118.6	119.8	…
External Sector ⁴/ ⁷/
		Current account balance		0.1	-0.1	0.1	-1.5	-0.3	-0.4	0.1	0.3

Sources: IMF, World Economic Outlook; Global Data Source; DataStream; Eurostat; and ECB Monthly Bulletin.

^¹/Contribution to growth.

^²/Includes intra-euro area trade.

^³/In percent.

^⁴/In percent of GDP.

^⁵/Latest monthly available data for 2011.

^⁶/CPI based.

^⁷/Based on ECB data, which excludes intra-euro area flows.

39. The directive on national fiscal frameworks will encourage prudent national fiscal behavior. By setting institutional incentives for responsible budgetary policy (Figure 9), the directive is a necessary complement to the SGP reform. The proposal is meant to make fiscal rules more binding, enhance medium-term orientation to fiscal policy, improve fiscal transparency, and contemplates the possibility of national councils responsible for independent surveillance of budgetary policies. The directive could be made more effective by requiring systematic disclosure of information on state-owned corporations and public private partnerships, spelling out good practices for fiscal rules, escape clauses and budget control, and extending the list of fiscal risks beyond contingent liabilities. Other critical elements of budgetary frameworks such as budgetary unity and the need for a top-down sequence in budget preparation would be most welcome.

40. Securing a more dynamic and resilient monetary union through deeper integration has broad support, but there are differences in ambition. The ECB particularly welcomed the mission’s attention to the benefits of completing the integration of European capital, labor, goods and services markets, while the Commission pointed at the many longstanding initiatives in this direction and the need to review some of the relevant directives to replenish its toolbox. Both hold high hopes for the new Excessive Imbalances Procedure to foster the opening up of markets and other structural reforms at the national level, but the ECB remains disappointed by the lack of ambition in the area of fiscal governance.

Box 4.

Governance Reform: Are We There Yet?¹

The history of the European project is marked by a tension between the pursuit of deeper integration and its members’ will to perpetuate economic nationalism. The creation of the customs union during the 1960s—granting to the Union exclusive competence on external commercial policy—was followed by the launch of the single market in the 1980s, giving the Union shared competence with member states. Still countries’ legislative role in internal market matters is subordinated to that of the EU. By contrast, in the fiscal, structural and macroprudential areas, the Union just exerts a coordinating role, supplemental to members’ policies. There is an inescapable dilemma between absolute control by the national state, deep cross border economic integration and full democratic integration (Rodrick, 2011). This is why decentralization in economic policy is challenging the integrity of the European construction.

The crisis has prompted reforms to strengthen EU’s coordinating role of fiscal, structural and financial policies, while keeping national sovereignty in these areas mostly intact. The governance package foresees a reform of the SGP and a new EIP. The revamped SGP will help contain pro-cyclical policies in good times (by capping the expenditure-to-GDP ratio), make the debt criterion operational (by placing under EDP countries reducing indebtedness at a yearly pace lower than 1/20^th of the distance from the 60 percent limit), and strengthen enforcement (including by a wider spectrum of sanctions). While welcome steps, the effectiveness of fiscal surveillance could be substantially improved by: (i) introducing legal provisions requiring the correction of past upward drifts in public expenditure; (ii) calibrating more ambitious and country differentiated Medium-Term Objectives (MTOs) to realistically face sustainability challenges posed by the crisis and aging populations; (iii) initiating EDPs by reverse qualified majority (RQM), whereby the Commission’s recommendation prevails unless the Council decides otherwise by qualified majority; (iv) restricting sanction waivers; and (v) tightening legal deadlines for corrective action.

As fiscal excesses may be neither the only nor the most important source of macroeconomic imbalances, the new EIP is being introduced as a complement to the revised SGP. Imbalances can be of two kinds, internal (if prompted by irresponsible fiscal behavior, credit excesses and asset bubbles) and external (if rooted in competitiveness deficiencies), both affecting the current account balance (CAB) and international investment positions (IIP). The EIP comprises a preventive arm, identifying imbalances and their underlying causes, and a corrective arm, requiring the adoption of adequate fiscal, structural and macroprudential remedies. Current proposals helpfully identify general objectives, but to be effective, EIP regulations will have to: (i) specify alert thresholds for key indicators (CAB and IIP at the very least, given their comprehensive character); (ii) set out binding deadlines throughout the EIP; and (iii) use RQM in the activation of the EIP and all relevant steps.

The proposed governance package steps up the amount of surveillance, peer pressure, and sanctions—yet it leaves Rodrick’s trilemma unresolved: more coordination helps, but a fully integrated Economic and Monetary Union will need to shape national economic policies in a more intrusive way that ensures that common interests prevail also (or in particular) in times of crisis. A genuine fiscal and economic union can deliver this, but additional and bold institutional changes will be needed. For example:

Shared competence over fiscal matters for sovereigns breaching the region’s rules. This could require, among other things, the establishment of a euro area institution vested with powers to override national policies conflicting with the common interest. An alternative route to ensure responsible fiscal behavior would be to constitutionally mandate constraints on national borrowing (for example, as part of the planned national fiscal framework Directive)
Risk-sharing against country-specific shocks. Some ex ante fiscal risk sharing would be beneficial but the quid pro quo for a sizable flow of transfers within the region must be more binding fiscal governance including the delegation of some sovereignty towards the center. Along similar lines, a more complete euro area financial stability framework backed by a proper EU banking supervisory authority, would be desirable.
Euro area fiscal stabilization would require an increase in the resources managed by the center, while Eurobonds would ensure an efficient inter-temporal allocation of fiscal capacity. Given the size and liquidity of its market, the Eurobond should have a substantially lower cost than the weighted average of the national bond yields. And appropriate design should avoid moral hazard issues (Delpla and Weizsacker, 2010).
Enhanced flexibility in capital, labor and product markets will be needed to insure countries against protracted adjustment. While fiscal transfers should assist countries when shocks affect their fundamentals, they will never be sizable enough to fully substitute for market-driven adjustment.

A more resilient EMU is likely to require curbing the powers of national governments and amending the Treaty and Constitutional laws in a major way. But such a curb is more apparent than real compared to the cost of crises caused by lack of integration.

¹/ Prepared by Esther Perez-Ruiz.

C. Growing Out of Crisis

41. Overcoming the euro area sovereign crisis requires Europe to finally unleash its growth potential and complete economic and financial integration. Europe’s ambitious growth agenda for the past decade failed and the income gap with the US and other advanced countries increased further even before the crisis hit. Lack of determined political action, an overloaded agenda, poor coordination and conflicting priorities all contributed. A more dynamic and stronger economy is now crucial to safeguard Europe’s cohesion, reduce imbalances and allow the countries under sovereign stress to grow out of crisis. Reforms should focus on:

42. ¹⁰

Measures to deepen financial integration and reduce public ownership and involvement in the banking sector. Domestic banks often enjoy protected “national champion” status, and prevent sufficient competition and efficiency, also hampered by the lack of standardization of financial products.
Lowering remaining barriers to competition still present in network industries, retail trade and regulated professions; and removing unnecessary procedures and costs weighing on entrepreneurship. Reform and harmonization of bankruptcy proceedings would facilitate exit of inefficient firms. For SMEs this can be achieved by transposing to national legislations the principles stipulated in the Small Business Act.
An ambitious liberalization of the 160-odd professions covered by the Services Directive is imperative to raise efficiency and competitiveness (since many services serve as inputs for final export goods), especially in the periphery. Alignment with best liberalization practices can benefit from the peer review under the Mutual Evaluation Process and greater involvement of the European Court of Justice.
Improving enforcement of competition rules and strengthening the independence of national competition authorities.
Addressing labor market segmentation, informal economy and inadequate wage flexibility (especially in countries suffering from competitiveness problems) in a move towards a Single Labor Market. Upgrading education systems will be important to enhance productivity, especially in the periphery. More flexible arrangements for part-time work should help raise employment rates, especially for women where they remain low. Pension reforms could support higher employment rates for older people.
A deficit-neutral shift in taxes from labor to consumption (e.g., VAT), preferably coordinated across the euro area. Competitive corporate tax rates and simplification and harmonization of tax codes and regulations should limit the burden on firms across the EU. Further trade liberalization, the unwinding of sectoral subsidies and the end to disguised forms of protectionism are needed as well.

V. Staff Appraisal

43. Despite strengthened economic activity in the euro area, the handling of the sovereign crisis in the periphery will define the outlook and the future of the economic and monetary union. A dominating core is pulling ahead of a periphery facing daunting challenges, with very high debt levels, severe competitiveness problems, and fragile banking systems. While strong national policy action will remain essential and courageous common steps have been taken to address the crisis, policymakers now need to make a fundamental choice between allowing national domestic considerations to upset the project of integration and monetary union, or forging ahead to strengthen EMU. The latter is the only viable course of action, without which tensions from the periphery could flare up and infect the core of the euro area with large regional and global spillovers.

44. If contagion from the periphery can be contained, macroeconomic policies should be able to reflect that the recovery is becoming less dependent on public sector support. Pursuing fiscal consolidation as planned would then enhance confidence, with positive spillovers to the rest of the world, provided policy gaps between announced targets and actual policies are closed and automatic stabilizers are allowed to work. Program countries may need to extend their adjustment path to minimize the recessionary impact of their adjustment, subject to available financing. With price pressures up but still moderate, monetary accommodation can be withdrawn at a very gradual pace, while leaving some unconventional measures in place to attend to pockets of stress in the financial system.

45. To resolve the crisis in the periphery, not only strong national program implementation, but also a cohesive and cooperative approach by all euro area stakeholders will be essential. Rapid implementation of the commitment to scale up the EFSF and a further extension of its potential uses is important to confirm that member countries “will do whatever it takes to safeguard the stability of the euro area.” In this context, it will be essential to use great care in communicating to markets the modality of private sector involvement, and avoid any impression that under the ESM, financial support will be conditional on debt restructuring. Consistent treatment of sovereign risk will also require revisiting the capital risk weighting of sovereign debt in financial sector balance sheets.

46. Strengthening the financial system to allow banks to deal with remaining uncertainties is an immediate priority. Capital raising from private sources should move ahead immediately and the follow up to the ongoing stress tests should lift capital to levels that can handle the current high degree of uncertainty and mitigate the contagion from the sovereign crisis affecting some member states. Any residual public support that must be put in place should be coordinated across the EU. There is also merit in considering a term funding facility for illiquid, but still performing, private assets, with the explicit backing of the euro area sovereigns, e.g., through the EFSF/ESM. And capital market development should be embraced rather than resisted to reduce the dependence of the euro area economy on the banking system.

47. To succeed, all these actions need to be undertaken in the context of a consistent push to strengthen EMU:

The interconnectedness of the financial system argues for a rapid completion of the financial stability framework of the euro area, building on recent progress. The missing piece, crisis management and resolution with a common backstop (largely funded by the industry to protect the taxpayer), needs to be put in place without delay. Meanwhile, ambitious and common rules for regulation and supervision should be adopted without exception, to underpin the single financial market, while leaving sufficient room for macroprudential policies, coordinated by the ESRB. A full fledged EU FSAP taking into account interconnectedness would be useful.
Stronger economic governance of the euro area is indispensable, combined with a greater degree of ex ante fiscal risk sharing. The welcome efforts underway to strengthen the SGP’s preventive and corrective arms, upgrade national fiscal frameworks, promote policy coordination under the European Semester, foster structural reform under the Euro Plus Pact, and detect and correct imbalances under the EIP need to be taken further. All these governance tools will need to be made more binding and relevant for national decision making, with quasi-automatic activation and tighter deadlines.
More economic and financial integration is essential for a dynamic and stable EMU and to boost potential growth. This calls for the completion of the single market. Labor, goods, and services, and especially equity capital need to flow freely across sectors and borders. A fully integrated economy has no need for “national champions,” and calls for a consistent and broad application of relevant European regulations and Directives. In this context, executing the structural reform agenda with more emphasis on ensuring contestability and competition will greatly bolster growth prospects.

48. Given the euro area’s role in the global economy, success in addressing the sovereign crisis in some of its member countries and raising growth has a significant impact elsewhere. A cohesive and cooperative approach containing the sovereign crises will limit global spillovers. At the same time, the rest of the world will profit from policies that lift the euro area’s growth potential, and would have positive, though modest, external spillovers. Similarly, the EU’s support for a successful Doha round of trade liberalization remains essential.

49. The staff proposes 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.

Table 2.

Euro Area: Balance of Payments

Source: ECB.

^¹/End of period stocks.

Table 2.

Euro Area: Balance of Payments

			2003	2004	2005	2006	2007	2008	2009	2010
			(Billions of euros)
Current account			20.9	60.8	10.9	-12.7	7.3	-142.4	-25.6	-36.7
	Goods		98.7	94.1	42.2	8.1	42.3	-22.5	37.5	20.7
	Services		22.5	32.9	39.6	42.5	47.9	40.9	33.8	41.0
	Income		-44.8	-6.8	2.4	16.6	5.3	-63.3	-6.3	1.6
	Current transfers		-56.1	-59.5	-73.4	-79.6	-87.9	-97.9	-90.7	-100.3
Capital account			12.2	16.6	12.0	9.6	4.8	9.3	6.6	7.7
Financial account			-14.0	-78.6	-35.2	-6.2	3.1	141.5	9.9	34.3
	Direct investment		-9.7	-79.4	-203.9	-159.6	-90.4	-236.1	-109.1	-78.4
	Portfolio investment		54.4	44.1	106.4	186.0	126.8	283.3	270.5	143.3
		Equity	32.8	-2.3	105.1	89.5	102.3	13.5	65.0	66.9
		Debt instruments	21.4	46.6	3.5	98.1	25.4	270.0	206.8	76.0
	Financial derivatives		-13.7	-8.3	-17.3	-0.7	-67.0	-82.7	37.3	8.0
	Other investment		-72.8	-47.9	62.1	-30.9	38.7	180.3	-193.2	-28.1
	Reserve assets		28.0	12.6	18.2	-1.1	-4.9	-3.4	4.6	-10.1
Errors and omissions			-19.1	1.1	12.4	9.4	-15.1	-8.3	9.3	-5.4
			(Percent of GDP)
Current account			0.3	0.8	0.1	-0.1	0.1	-1.5	-0.3	-0.4
	Goods		1.3	1.2	0.5	0.1	0.5	-0.2	0.4	0.2
	Services		0.3	0.4	0.5	0.5	0.5	0.4	0.4	0.4
	Income		-0.6	-0.1	0.0	0.2	0.1	-0.7	-0.1	0.0
	Current transfers		-0.7	-0.8	-0.9	-0.9	-1.0	-1.1	-1.0	-1.1
Capital account			0.2	0.2	0.1	0.1	0.1	0.1	0.1	0.1
Financial account			-0.2	-1.0	-0.4	-0.1	0.0	1.5	0.1	0.4
	Direct investment		-0.1	-1.0	-2.5	-1.9	-1.0	-2.5	-1.2	-0.9
	Portfolio investment		0.7	0.6	1.3	2.2	1.4	3.1	3.0	1.6
		Equity	0.4	0.0	1.3	1.0	1.1	0.1	0.7	0.7
		Debt instruments	0.3	0.6	0.0	1.1	0.3	2.9	2.3	0.8
	Financial derivatives		-0.2	-0.1	-0.2	0.0	-0.7	-0.9	0.4	0.1
	Other investment		-1.0	-0.6	0.8	-0.4	0.4	1.9	-2.2	-0.3
	Reserve assets		0.4	0.2	0.2	0.0	-0.1	0.0	0.1	-0.1
Errors and omissions			-0.3	0.0	0.2	0.1	-0.2	-0.1	0.1	-0.1
Memorandum items:
GDP (billions of euros)			7,559.7	7,869.5	8,161.7	8,575.1	9,035.4	9,264.3	8,970.4	9,203.3
Reserves of the eurosystem ¹/
	(billions of euros)		306.7	281	320.1	325.8	347.2	374.2	462.4	591.2

Source: ECB.

^¹/End of period stocks.

Table 2.

Euro Area: Balance of Payments

			2003	2004	2005	2006	2007	2008	2009	2010
			(Billions of euros)
Current account			20.9	60.8	10.9	-12.7	7.3	-142.4	-25.6	-36.7
	Goods		98.7	94.1	42.2	8.1	42.3	-22.5	37.5	20.7
	Services		22.5	32.9	39.6	42.5	47.9	40.9	33.8	41.0
	Income		-44.8	-6.8	2.4	16.6	5.3	-63.3	-6.3	1.6
	Current transfers		-56.1	-59.5	-73.4	-79.6	-87.9	-97.9	-90.7	-100.3
Capital account			12.2	16.6	12.0	9.6	4.8	9.3	6.6	7.7
Financial account			-14.0	-78.6	-35.2	-6.2	3.1	141.5	9.9	34.3
	Direct investment		-9.7	-79.4	-203.9	-159.6	-90.4	-236.1	-109.1	-78.4
	Portfolio investment		54.4	44.1	106.4	186.0	126.8	283.3	270.5	143.3
		Equity	32.8	-2.3	105.1	89.5	102.3	13.5	65.0	66.9
		Debt instruments	21.4	46.6	3.5	98.1	25.4	270.0	206.8	76.0
	Financial derivatives		-13.7	-8.3	-17.3	-0.7	-67.0	-82.7	37.3	8.0
	Other investment		-72.8	-47.9	62.1	-30.9	38.7	180.3	-193.2	-28.1
	Reserve assets		28.0	12.6	18.2	-1.1	-4.9	-3.4	4.6	-10.1
Errors and omissions			-19.1	1.1	12.4	9.4	-15.1	-8.3	9.3	-5.4
			(Percent of GDP)
Current account			0.3	0.8	0.1	-0.1	0.1	-1.5	-0.3	-0.4
	Goods		1.3	1.2	0.5	0.1	0.5	-0.2	0.4	0.2
	Services		0.3	0.4	0.5	0.5	0.5	0.4	0.4	0.4
	Income		-0.6	-0.1	0.0	0.2	0.1	-0.7	-0.1	0.0
	Current transfers		-0.7	-0.8	-0.9	-0.9	-1.0	-1.1	-1.0	-1.1
Capital account			0.2	0.2	0.1	0.1	0.1	0.1	0.1	0.1
Financial account			-0.2	-1.0	-0.4	-0.1	0.0	1.5	0.1	0.4
	Direct investment		-0.1	-1.0	-2.5	-1.9	-1.0	-2.5	-1.2	-0.9
	Portfolio investment		0.7	0.6	1.3	2.2	1.4	3.1	3.0	1.6
		Equity	0.4	0.0	1.3	1.0	1.1	0.1	0.7	0.7
		Debt instruments	0.3	0.6	0.0	1.1	0.3	2.9	2.3	0.8
	Financial derivatives		-0.2	-0.1	-0.2	0.0	-0.7	-0.9	0.4	0.1
	Other investment		-1.0	-0.6	0.8	-0.4	0.4	1.9	-2.2	-0.3
	Reserve assets		0.4	0.2	0.2	0.0	-0.1	0.0	0.1	-0.1
Errors and omissions			-0.3	0.0	0.2	0.1	-0.2	-0.1	0.1	-0.1
Memorandum items:
GDP (billions of euros)			7,559.7	7,869.5	8,161.7	8,575.1	9,035.4	9,264.3	8,970.4	9,203.3
Reserves of the eurosystem ¹/
	(billions of euros)		306.7	281	320.1	325.8	347.2	374.2	462.4	591.2

Source: ECB.

^¹/End of period stocks.

Appendix I. Statistical Issues¹

Statistics for the euro area (and the EU-27) are produced by Eurostat and the ECB in collaboration with National Statistical Institutes (NSIs) and National Central Banks (NCBs). These statistics are generally of sufficient quality, scope, and timeliness to allow effective macroeconomic surveillance, thanks to major progress made since the start of EMU. However, the financial crisis and the situation in some member states have generated a number of challenges for official statistics. This appendix summarizes recent ongoing developments and desirable improvements clustered under thematic areas.

Information Gaps Initiative (IGI): As members of the Inter-Agency Group (IAG)², Eurostat and the ECB are collaborating with the IMF to take forward the 20 recommendations endorsed by the G-20 in 2009 to address key information gaps in economic and financial statistics.

Noteworthy are Eurostat’s efforts to support the conceptual work on measuring cross-border exposures on corporate groups on a consolidated national basis, including by the development of a Euro Groups Register (EGR). Equally promising are ongoing PEEI-related initiatives (developed in collaboration with the UN and the IMF) to form an integrated view of business, growth and acceleration cycles; refine turning point techniques; and to construct a composite indicator for early warning purposes at the euro area level.
The ECB was generally content with the progress made under the IGI and the leadership provided by the IMF in this regard. While it saw the collection and distribution of macroeconomic data on a good track, challenges remain with regard to macroprudential data. These include data sharing and confidentiality issues as well completing the legal groundwork for non-bank institutions. Complementing existing initiatives, the ECB is working on a securities holding database for the euro area that is planned to be completed within 2-3 years

Public finance statistics-actions to tackle statistical issues in program countries: Fiscal and other public sector reporting are being improved in Greece, Ireland and Portugal, in line with requirements established in EC/ECB/IMF-supported adjustment programs. Measures taken in 2011 by the Greek government to prevent the recurrence of data under- and misreporting include a Memoranda of Understanding of ELSTAT with 9 ministries and entities aiming to improve the compilation of ESA95 general government fiscal statistics; collection of data on arrears covering both current and investment expenditure across all central government units (including, line ministries, social security funds, public hospitals, extra budgetary funds, and the largest local governments) and the monthly publication of a consolidated report for the general government. To help ensure timely reports, the incentives of agencies and ministries have been adapted by introducing automatic sanction for delays in reporting. The newly compiled statistics by the Central Bank of Ireland include positions vis-à-vis nonresidents with breakdown by type of financial instruments, maturity, and currency; and separate datasets for banks servicing the domestic market and those focusing on the nonresident market. This data show that foreign exposure to the Irish banking system has fallen sharply. In Portugal, the SOEs, PPPs, and social security decisions with fiscal implications will be integrated within the budget process; and fiscal arrears will be monitored more closely.

Washington, D.C. 20431 • Telephone 202-623-7100 • Fax 202-623-6772 • http://www.imf.org

Public finance data-Directive on National Fiscal Framework (NFFs)s: The draft directive on NFFs aims to align fiscal behavior with SGP commitments. To facilitate fiscal and liquidity control, countries will be required to publish cash based fiscal data at a monthly frequency, (before the end of the following month) for all government levels except local entities; and explain the methodology used for the reconciliation of cash and ESA-based data. However, Eurostat has plans neither collect nor to disseminate cash-level data. Fiscal transparency will be enhanced by expanding the perimeter of government to include all extra-budgetary funds and bodies, and also by the disclosure on data on contingent liabilities. More broadly, Member states have been asked to report to the ECOFIN on the estimated fiscal impact of the revised ESA by autumn 2011. Going forward, it will be essential that member states take all necessary measures to facilitate Eurostat’s verification of public financial data.

Public finance statistics-Stock-Flow Adjustment (SFA): Factors contributing to changes in government debt other than government deficits are regularly monitored by Eurostat. SFAs have been consistently positive in recent years for the euro area aggregate, peaking at 3.2 percent of GDP in 2008 (and situating at 0.9 and 1.9 percent respectively in 2009 and 2010). Concerns that governments may resort to SFA transactions to ensure deficit compliance with EDP requirements justify the proposal for incorporating SFAs analysis in the revamped SGP.

Public finances—Statistical consequences of the EFSF: In cooperation with the Central Bank of Luxembourg and STATEC, Eurostat is defining the content and structure of the template that will be used to estimate the impact of the EFSF on GFS and BoP payments statistics in euro area countries. Figures will be reported on a monthly basis, with the first release being scheduled for July 2011.

Pensions systems: To improve the comparability of pension schemes the 2008-SNA requires the comprehensive recording of all pension entitlements accrued by households regardless of the type of social security arrangement. Pension tables are already elaborated on a voluntary basis by eight euro area members. In the absence of SNA specific guidelines, Eurostat is holding regular seminars with the ECB, NCBs and NSIs to give methodological guidance to NSIs, and providing TA where needed. A fully-fledged release of data is only targeted by 2014 with the new ESA 2010 transmission program.

Short-term business statistics (STS): Work in collaboration with NSIs proceeds to improve STS indicators and PEEIs along various dimensions, including the implementation of the ESS guidelines for seasonal adjustment and ensuring consistency between the euro area GDP and the Industrial Production Index (IPI), as well as consistency of the latter with individual countries’ IPIs. Timeliness of STS statistics improved in the last years, in particular for PEEIs-related STS. Nevertheless some indicators still lag US dissemination speed.

Price statistics: Key priorities in this area include

HICP improvements: The new rules³ on the treatment of seasonal products took effect with the index of January 2011 requiring some NSIs to change their calculation methods in order to comply with the new standards. Implementation acts will follow in member states until November 2011, with Eurostat closely following on the impact of the implementation. Early indications suggest a moderate positive impact on euro area headline inflation (+ 0.1 percentage points on average for the EU during the first [two] quarters), with a relatively higher impact in Southern countries, mostly driven by the food and clothing sub-components. New minimum standards for the quality of HICP weighting⁴ will require additional efforts from NSIs during 2011 to ensure implementation by January 2012. Eurostat is also pursuing changes in the production of monthly euro area inflation flash estimates, with a possible breakdown to four main components (processed food, unprocessed food, non-energy industrial goods, and services).
House Price Indexes (HPI) and Owner-Occupied Housing (OOH): Eurostat is leading work to improve real estate price information in the context of IGI Recommendation #19, with OOH remaining a high priority methodological development for the HICP. Pilot projects geared by the NSIs and coordinated by Eurostat have lead to the release of the first experimental data. Eurostat is preparing a legal act to insure the continuation of the project beyond its pilot phase. Eurostat is considering the possibility of including the quarterly House Price Indices in the list of PEEIs.
Handbook of Residential Property Price Index (RPPI): Lack of homogeneity of methodologies in the compilation of RPPIs makes this a highly problematic area and the release of the Handbook should, at least in principle, help promote good and more consistent practice. Preliminary work and plans are for a companion Handbook for Commercial Property Price Indices.

Structural Business Statistics (SBS): SBS are being improved along the lines of the Program for the Modernization of European Enterprise and Trade Statistics (MEETS)⁵ launched in 2008. Actions this year focus on constructing data warehouses and developing further tools for micro data linking; back casting data (e.g. in business demography statistics); and improving the collection of data on access to financing by SMEs. The creation of a register for MNEs operating in the European market (the Euro Groups Register, or EGR) has been partly outsourced to private providers. The EGR is seen as a promising tool for compilation of a number of statistics affected by globalization (e.g. FDI, trade, and knowledge), currently suffering from fragmentation and inconsistency problems.

Balance of Payments and International Trade Statistics (ITS): Users are generally satisfied with ITS data (Quality Report, 2010). Ongoing work aims to improve statistics on SEMs involved in international trade, for instance by using VAT data to measure trade not covered by Intrastat reporting. Data for 2008 and 2009 will be disseminated in the coming months. On asymmetries, a longstanding concern of Eurostat, the outcome of reconciliation exercises carried out during 2011, has been largely positive. The FDI network has proved a useful platform to share confidential data on large FDI transactions, helping identify asymmetries and improve quality data in this area.

Staff research found that a significant share of a sovereign’s increased funding costs are passed on to its banks and nonfinancial corporates, see Selected Issues Paper, Chapter 1.

See Spillover Report for the Euro Area.

See Staff Report for Germany 2011 Article IV Consultation.

See Selected Issues Paper, Chapter 2.

See Spillover Report for the Euro Area.

For detailed analysis, please consult the accompanying background paper, entitled “Lessons from the European Financial Stability Framework Exercise” (EFFE).

For a discussion of the interplay between national and supranational macroprudential policy frameworks, see Selected Issues Paper, Chapter 3.

See Selected Issues Paper, Chapter 3.

See Selected Issues Paper, Chapter 4 which discusses these issues in more detail.

For a discussion of the main growth drivers and constraints, please consult the Selected Issues Paper, Chapter 5.

Participants in the discussions comprised Helge Berger, Esther Perez and Nico Valckx (all EUR), Mauricio Soto (FAD), and Miguel Alves, Claudia Dziobek, Manik Shrestha, Mick Silver, and Mark van Wersch, (all STA). Mark van Wersch acted as STA coordinator.

The IAG was established to coordinate improvements of economic and financial statistics after the crisis. Members of the IAG are the IMF (chair), the BIS, Eurostat, the ECB, the OECD, the UNSC and the World Bank.

Regulation EC No 330/2009.

Regulation EC No 1114/2010.

Decision EC No 1297/2008.

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Euro Area Policies: 2011 Article IV Consultation-Staff Report; Public Information Notice on the Executive Board Discussion; and Statement by the Executive Director for Member Countries

Author: International Monetary Fund

Volume/Issue:: Volume 2011: Issue 184

Publisher:: International Monetary Fund

ISBN:: 9781462339556

ISSN:: 1934-7685

Pages:: 49

DOI:: https://doi.org/10.5089/9781462339556.002

Keywords
I. Steadying the Recovery
II. Risks and Spillovers: Focus on Sovereign Tensions
III. Strengthening the Financial Sector
IV. Securing Economic and Monetary Union
V. Staff Appraisal
- Appendix I. Statistical Issues1

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Euro Area: Current Crisis Compared to Past Episodes

(Annual percentage change, unless otherwise indicated)

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Intra Euro Area Imbalances

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Contribution to Growth

(Percent, quarter-on-quarter, sa)

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Corporate Investment and Household Saving Rates

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Real GDP

(Index, 2008Q1 = 100)

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Unemployment Rate

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Cumulative Q-on-Q Dynamic Contributions to Consumption Growth Recovery, 2009Q2-2010Q4

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Cumulative Q-on-Q Dynamic Contributions to Investment Growth Recovery, 2009Q2-2010Q4

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Private Consumption

(Index, 2008Q1 = 100)

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Gross Fixed Investment

(Index, 2008Q1 = 100)

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Euro Area: Deficit and Debt Developments, 2007-10

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Euro Area: Inflation, Labor Costs, Unemployment and Output Gap

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Euro Area: Monetary Policy

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Bottom up Model

(Percent)

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Monthly Output Gap Model

(Percent)

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Euro Area: Monetary Policy Stress

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Interest rate increase does not hurt banks and would curtail periphery bank losses.

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Euro Area: Sovereign and Banking Sector Risk Spillovers

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Euro Area: Banking Sector Health, 2000-10

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Selected Advanced Countries: Claims on Domestic Banks and Public Sector 1/

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Tangible Common Equity and Wholesale Funding, 2007-10

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Return on Assets

(Percent)

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Peak Output Losses Under Different Implementation Horizons of Basel III

(Percent)

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EU 27: National Budgetary Frameworks and Fiscal Outcomes

Table 2.

Euro Area: Balance of Payments

			2003	2004	2005	2006	2007	2008	2009	2010
			(Billions of euros)
Current account			20.9	60.8	10.9	-12.7	7.3	-142.4	-25.6	-36.7
	Goods		98.7	94.1	42.2	8.1	42.3	-22.5	37.5	20.7
	Services		22.5	32.9	39.6	42.5	47.9	40.9	33.8	41.0
	Income		-44.8	-6.8	2.4	16.6	5.3	-63.3	-6.3	1.6
	Current transfers		-56.1	-59.5	-73.4	-79.6	-87.9	-97.9	-90.7	-100.3
Capital account			12.2	16.6	12.0	9.6	4.8	9.3	6.6	7.7
Financial account			-14.0	-78.6	-35.2	-6.2	3.1	141.5	9.9	34.3
	Direct investment		-9.7	-79.4	-203.9	-159.6	-90.4	-236.1	-109.1	-78.4
	Portfolio investment		54.4	44.1	106.4	186.0	126.8	283.3	270.5	143.3
		Equity	32.8	-2.3	105.1	89.5	102.3	13.5	65.0	66.9
		Debt instruments	21.4	46.6	3.5	98.1	25.4	270.0	206.8	76.0
	Financial derivatives		-13.7	-8.3	-17.3	-0.7	-67.0	-82.7	37.3	8.0
	Other investment		-72.8	-47.9	62.1	-30.9	38.7	180.3	-193.2	-28.1
	Reserve assets		28.0	12.6	18.2	-1.1	-4.9	-3.4	4.6	-10.1
Errors and omissions			-19.1	1.1	12.4	9.4	-15.1	-8.3	9.3	-5.4
			(Percent of GDP)
Current account			0.3	0.8	0.1	-0.1	0.1	-1.5	-0.3	-0.4
	Goods		1.3	1.2	0.5	0.1	0.5	-0.2	0.4	0.2
	Services		0.3	0.4	0.5	0.5	0.5	0.4	0.4	0.4
	Income		-0.6	-0.1	0.0	0.2	0.1	-0.7	-0.1	0.0
	Current transfers		-0.7	-0.8	-0.9	-0.9	-1.0	-1.1	-1.0	-1.1
Capital account			0.2	0.2	0.1	0.1	0.1	0.1	0.1	0.1
Financial account			-0.2	-1.0	-0.4	-0.1	0.0	1.5	0.1	0.4
	Direct investment		-0.1	-1.0	-2.5	-1.9	-1.0	-2.5	-1.2	-0.9
	Portfolio investment		0.7	0.6	1.3	2.2	1.4	3.1	3.0	1.6
		Equity	0.4	0.0	1.3	1.0	1.1	0.1	0.7	0.7
		Debt instruments	0.3	0.6	0.0	1.1	0.3	2.9	2.3	0.8
	Financial derivatives		-0.2	-0.1	-0.2	0.0	-0.7	-0.9	0.4	0.1
	Other investment		-1.0	-0.6	0.8	-0.4	0.4	1.9	-2.2	-0.3
	Reserve assets		0.4	0.2	0.2	0.0	-0.1	0.0	0.1	-0.1
Errors and omissions			-0.3	0.0	0.2	0.1	-0.2	-0.1	0.1	-0.1
Memorandum items:
GDP (billions of euros)			7,559.7	7,869.5	8,161.7	8,575.1	9,035.4	9,264.3	8,970.4	9,203.3
Reserves of the eurosystem ¹/
	(billions of euros)		306.7	281	320.1	325.8	347.2	374.2	462.4	591.2

Source: ECB.

^¹/End of period stocks.

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Abstract

I. Steadying the Recovery

A. Expansion in the Offing but Not Everywhere

B. Restoring Fiscal Health

C. Inflation and Monetary Policy

II. Risks and Spillovers: Focus on Sovereign Tensions

III. Strengthening the Financial Sector

IV. Securing Economic and Monetary Union

A. Financial Sector Reforms and Macroprudential Policies

B. Advancing Policy Coordination in the Euro Area

C. Growing Out of Crisis

V. Staff Appraisal

Appendix I. Statistical Issues1

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Appendix I. Statistical Issues¹