Abstract
In my capacity as President of EUPJMF and Euro Area representative at the Board, I submit this Buff statement on the Euro Area consultation on Common Euro Area Policies. It reflects the common view of the Member States of the euro area and the relevant European Union Institutions in their fields of competence.
In my capacity as President of EUPJMF and Euro Area representative at the Board, I submit this Buff statement on the Euro Area consultation on Common Euro Area Policies. It reflects the common view of the Member States of the euro area and the relevant European Union Institutions in their fields of competence.
The authorities of the euro area Member States and the EU Institutions are grateful to staff and the mission team led by Mr. Gerson and Mr. Balakrishnan for the open and fruitful consultations and their constructive policy advice. The authorities are in broad agreement with the findings and recommendations in the Euro Area Policies Staff Report, including on new and existing risks and the high level of uncertainty surrounding the current outlook and the need for policy to sustain the recovery. We particularly welcome the acknowledgement of the importance of action at EU and Member States level in responding to the pandemic and underpinning a strong economic rebound, while noting the call for continued agility of policy measures, with a focus on containing economic scarring, in particular through facilitating the reallocation of resources, while protecting vulnerable groups.
The authorities concur on the importance of increasing global vaccine production and ensuring equitable access to vaccines. In the short run, we agree on the need to ensure the acceleration of the delivery of vaccines, diagnostics and therapeutics for countries that are lagging behind in vaccine rollout, and re-affirm the strong commitment at EU level in this respect. The EU has been, and still is, the world’s leading exporter and donator of vaccines from the beginning. Since December 2020, the EU has exported over 1.4 billion vaccine doses to more than 150 countries. As of January 25, the EU Member States have shared over 405 million vaccine doses to partner countries, of which 277 million have been already delivered to recipients. More specifically, we have the following comments on the Staff Report:
Economic outlook and risks
The authorities share staffs overall assessment of the euro area’s economic outlook and the forecast for a sustained expansion, predicated on continued adaptation to COVID-19. Since restrictions have been eased compared to the start of 2021, the euro area economy has been rebounding from the COVID-19 pandemic recession faster than previously expected and the gap with the pre-pandemic output level has now virtually closed in the euro area. Following the disruptions to economic activity in 2020 and early 2021, the rebound in spring 2021 was supported by unprecedented policy support as well as effective vaccination campaigns. Households responded to the improving epidemiological situation and the gradual relaxation of containment measures with a strong recovery in consumption that propelled growth. The savings rate should gradually return to its pre-crisis level; however, the large additional savings accumulated during the crisis are not expected to be spent in the short term, as survey data point to only small declines in consumers’ intentions to save. In 2022, growth should be supported by an improving labour market, a further reduction in the savings rate, favourable financing conditions and the continued deployment of the Recovery and Resilience Facility (RRF). Although growth is projected to remain uneven across countries and sectors, pre-pandemic output levels have been achieved or are within reach in all Member States in 2022. According to the European Commission autumn forecast, which was finalised before the spread of the omicron variant, real GDP in the euro area is estimated to have rebounded sharply in 2021 by 5 percent and is set to continue expanding by 4.3 percent in 2022 and by 2.4 percent in 2023. By next year, real GDP is therefore expected to converge to the growth path that the economy was set to follow before the pandemic. According to the Commission autumn forecast, output gap is expected to close in 2022 and become positive in 2023.
The uncertainty surrounding the economic outlook remains high, in particular linked to the recent deterioration in the epidemiological situation, and the balance of risks remains tilted to the downside. Although the impact of the pandemic on economic activity has weakened, the recent surge in COVID-19 infections coupled with the re-imposition of some restrictions suggests that some downside risks to the economic outlook are materialising. Moreover, the euro area economy has been facing new headwinds. The supply side of the economy has struggled to accommodate the abrupt swings in the level and composition of demand. Labour and skills shortages have become a growing concern in some sectors and Member States. Surging energy prices are also weighing on the growth momentum in the short term. Although industrial production and retail trade came in strong in the beginning of the fourth quarter, survey-based indicators published after the publication of the Commission’s autumn forecast have softened. However, upside risks to the economic outlook are also present. The main one is related to potential efficiency gains and durable boost to productivity. Reforms and investments supported by the RRF will be key in this respect. The authorities take note of the further risks identified by the Fund’s staff. In that context, the authorities consider that the current level of potential output as well as its future developments are uncertain and they remain cautious about the timing of a closure in the output gap.
External sector policies
The authorities take note of staffs assessment of the euro area’s external position, acknowledging the uncertainties and challenges in the external assessment amid the pandemic crisis. The pandemic has had an uneven impact on countries’ external positions depending on their economic structure and institutional features. We take note of the staffs acknowledgment of euro area’s external position in 2020 being broadly in line with fundamentals, according to its assessment methodology. The Staff Report further notes that the euro area current account surplus is projected to widen further in 2021, to a level considered as ‘moderately stronger’ than implied by medium-term fundamentals and desirable policies. In carrying out such an assessment, we agree with staff that given the current economic uncertainty, it is difficult to provide firm views and that a more comprehensive assessment of the euro area’s external balances during 2021 can only be provided at a later stage.
Monetary policy and inflation outlook
We share the Fund’s overall assessment of recent inflation dynamics. Inflation in 2021 increased more strongly than initially assumed. This was mainly due to a surge in energy prices and strong base effects, but also because demand continued to outpace constrained supply in some sectors linked to supply-side disruptions and the re-opening of the economy. Inflation is expected to remain elevated in the near term, but to decline in the course of 2022 as energy prices are expected to stabilise and price pressures stemming from global supply bottlenecks are expected to subside. Although there is uncertainty as to how long this will take, current forecasts point towards a reduction of inflation to below the ECB’s target in late 2022. Looking ahead to 2023 and 2024, inflation is projected to remain below the ECB’s target, around levels closer to 2 percent. However, these forecasts are subject to a high degree of uncertainty. The gradual return of the economy to full capacity and further improvements in the labor market should, over time, support stronger growth in wages. Market- and survey-based measures of longer-term inflation expectations have moved closer to 2 percent in recent months. These factors will help underlying inflation to move up and bring headline inflation to the ECB’s target over the medium term. We agree with the staffs assessment that second-round wage effects of currently elevated inflation remain contained at present, but we are closely monitoring any signs of emergence of such effects.
The ECB’s accommodative monetary policy stance and the sustained favourable financing conditions continue to provide crucial support to the economy and the inflation outlook. The new strategy is contributing to the return of inflation to the 2 percent medium-term price stability objective. In 2021, the ECB maintained a very accommodative monetary policy stance, while it adjusted its pace of purchases to preserve favourable financing conditions. This was essential throughout 2021 for the economy to continue its recovery and to progressively offset the negative impact of the pandemic on the projected path of inflation. Following the conclusion of its strategy review in July, the Governing Council announced the adoption of a new, symmetric inflation target of 2 percent. In December, progress in the economic recovery and in the medium-term inflation outlook was judged to be sufficiently advanced to announce a step-by-step reduction in the pace of asset purchases over the course of 2022. At the same time, the Governing Council declared that in view of medium-term inflation remaining below the Governing Council’s target, sufficient monetary accommodation remained essential.
The ECB takes note of the challenges identified by IMF staff in integrating climate change considerations into the Eurosystem monetary policy operation framework, but notes that these largely stem from an imperfect understanding of the announced actions and their objectives. As outlined in the climate change action plan, the adjustment of the framework guiding the allocation of corporate bond purchases will include taking into account the alignment of issuers with, as a minimum, EU legislation implementing the Paris agreement through climate change-related metrics or commitments of the issuers to such goals: this does not imply restricting purchases to “green” corporate assets. Possible adjustments to the collateral framework would aim to enhance—rather than undermine—the ECB’s own balance sheet risk management by ensuring that all relevant risks, including those arising from climate change, are well reflected. Finally, green TLTROs are not part of the current climate change action plan. The ECB reiterates that the action plan is in line with its obligations and independence, and that the design of the measures will be proportionate and will not in any way prejudice the price stability objective. When implementing any measure, the ECB will carefully consider all the technical and legal aspects. The ECB encourages the IMF to deepen its analysis of these issues going forward and stands ready to provide additional information on the ongoing activities.
Fiscal policy
The authorities broadly share the staffs views on fiscal policy in the euro area. The general government deficit in the euro area is expected to narrow marginally in 2021 to 7.1 percent of GDP and then set to decline considerably in 2022 to 3.9 percent of GDP, while the euro area fiscal stance, according to the Commission assessment, is projected to remain supportive in 2021 and 2022. We will continue to use and coordinate national fiscal policies to effectively underpin a sustainable and inclusive recovery and maintain a moderately supportive euro area fiscal stance in 2022, taking into account national budgets and the funding provided by the RRF. Member States with low or medium debt ratios should pursue a supportive fiscal stance in 2022, while Member States with high debt should use the RRF to finance additional investment in support of the recovery and the twin transitions, while pursuing a prudent fiscal policy. In December 2021, those high-debt Member States where the planned growth of nationally financed current expenditure was not considered sufficiently prudent, according to the Commission assessment, have been invited to take the necessary measures within their national budgetary processes to limit the growth of nationally financed current expenditure. Reflecting the degree of uncertainty, the authorities also highlight the need to keep fiscal policy agile, in order to be able to react to the evolution of the pandemic.
With the economic recovery taking hold, the focus should be on gradually pivoting fiscal measures from temporary emergency measures to targeted recovery support measures, including investments that promote a sustainable and inclusive recovery, consistent with the green and digital transitions. Due to the pandemic shock to economic activity and the ensuing fiscal response, general government debt in the euro area is estimated to have peaked at 100 percent of GDP in 2021. Recently granted state guarantees add risk to public finances from the potential materialisation of contingent liabilities in the future. Fiscal policies should be differentiated, taking into account the strength of the recovery, and should ensure fiscal sustainability and enhance investments, while bearing in mind the need to reduce divergences. A gradual, continuous and growth-friendly debt reduction will be a policy objective across a large part of the euro area. We also take note of the staffs call for medium-term consolidation plans to be submitted already now, and against this background, we highlight that the upcoming Stability Programmes will be submitted in spring 2022. In spring 2022, the European Commission will also reassess the situation and take stock of the application of the general escape clause. Based on the latest forecast, the conditions for the deactivation of the general escape clause as of 2023 are met, while country-specific situations will continue to be taken into account after the deactivation of the clause.
The authorities take note of the Fund’s call for reforming the fiscal framework, fostering sustainability while allowing adequate room for macroeconomic stabilisation and preventing counterproductive spending cuts. The authorities acknowledge staffs views on the main features of such reformed fiscal rules, including the need for appropriate ownership and political will. While recalling that a debate is ongoing on the challenges and objectives for the review, the authorities take note of the Fund’s initial analysis and suggestions, and look forward to staffs announced further input for the review in early 2022.
Structural policies
The authorities share the Fund’s message on the importance of the NGEU recovery package to help the recovery, facilitate reallocation, build back better, and tackle inequality. The effective and rapid implementation of the reforms and investments included in the recovery and resilience plans are key to contribute effectively to the achievement of the euro area policy priorities. The authorities concur that these policy actions will all contribute to ensuring a sustainable and inclusive recovery, sustain growth potential and enhance resilience, and they agree on the need to mitigate the risk of increasing economic divergence. The authorities recall that one of the Facility’s main innovative features is its performance-based nature, as the funds will be disbursed as Member States implement the coherent investments and reforms set out as milestones and targets in the Council Implementing Decisions. The authorities take note of the staffs call for NGEU Funds to adhere to the highest standards of transparency and accountability.
The authorities underline how the swift and forceful policy response has been effective in mitigating the impact of the crisis on the labour market, as also recognised by the staffs assessment. Policy support, including through short-time work schemes and other job retention measures, has supported businesses activity throughout the crisis and has limited the rise in the unemployment rate and the drop in disposable income.
We concur on the need to shift policy attention towards pandemic-induced and structural labour transition and reallocation, while protecting the most vulnerable. While noting that the use of short-time work schemes has declined in line with the improvement in economic conditions, the authorities take note of the recommendation to continue phasing out these schemes, and of the Fund’s analysis on labour market reallocation. The authorities find that there is a need to transition from emergency to recovery measures in labour markets by ensuring effective labour market policies supporting job transitions, combining measures tackling skill shortages, strengthening upskilling and re-skilling, providing targeted hiring incentives and enhancing the capacity of public employment services to address labour market mismatches. The authorities take note that policy measures that facilitate job transitions and labour market re-integration will be needed to support adjustment and mitigate social impacts especially for the young, women, and low-skilled workers. In view of the challenges emerging from the COVID-19 crisis, and those related to the green and digital transition, it is important to develop and adapt social protection systems, while strengthening access. In this respect, the Commission has put forward a recommendation on an Effective Active Support to Employment following the COVID-19 crisis (EASE). Divergences have widened less than initially expected, but the COVID-19 crisis has nevertheless had substantial territorial, sectorial, and distributional implications, and we concur on the risks of increasing inequality and widening divergences between and within countries.
Climate Policies
EU policies have a critical role in accelerating the green transition. The authorities welcome the IMF’s positive views on the Fit for 55 agenda. The Commission’s proposals aim to make climate, energy, land use, buildings, transport and taxation policies fit for reducing net greenhouse gas emissions by at least 55 percent by 2030 compared to 1990 levels, an objective enshrined in the European Climate Law. So far, through the RRF,1 the combined climate investments amount to around 40 percent of the total RRF funds allocated, above the 37 percent target set in the Regulation. The authorities acknowledge the Fund staffs concerns on Carbon Border Adjustment Mechanism compatibility with WTO rules and other international commitments, while highlighting the non-discriminatory nature of the instrument and the compatibility with WTO rules and other international obligations. We take note and appreciate the analysis by the Fund on RRPs impact on GHG emissions, and the policy recommendations at EU level. Finally, the authorities recognise that coordinated national climate policies are key, while highlighting that mitigation policies must take into account the different capacities of Member States to take action at the required pace.
Financial sector policies
Measures taken to provide support to firms have been critical and the rise in bankruptcies has remained limited so far. Many support measures lapsed or were terminated in 2021. However, the authorities recognise that the pandemic has left many firms with weaker balance sheets, which might constrain their ability to finance investment in the near term and compromise their repayment capacity. Timely withdrawal of policy support measures is a difficult balancing act. In this context, improving access to finance for companies, strengthening firms’ balance sheets and enhancing the capacity and efficiency of insolvency frameworks is crucial. It will be important to continue monitoring the effectiveness of policy support packages, while also focusing on a more targeted support for the solvency of viable firms that have come under stress, and making greater use of equity-type instruments.
Euro area banks have successfully coped with the challenges of the COVID-induced crisis. Strong solvency and liquidity positions, in a context of massive monetary and fiscal policy support to the wider economy, have allowed them to maintain adequate financing of the economy while preserving financial stability. We are well aware of the challenges for the banks going forward, reflecting both structural factors and the continued phasing out of monetary and fiscal support measures.
The phasing out of policy support measures to address the effects of the COVID crisis is ongoing. It will continue in an orderly fashion, taking into account the evolution of the pandemic. Prudential standards for banks, which have been adapted in response to the crisis, have already been and will be further normalised gradually and predictably. In particular, proper loss recognition remains imperative in order to preserve stability of the banks and the financial system as a whole. We agree that banks should now focus future lending on viable borrowers and that Member States should ensure that their insolvency regimes facilitate the most effective workout of non-performing loans on banks’ balance sheets.
The COVID-induced crisis highlighted the need to strengthen the resilience of the non-bank financial sector. Vulnerabilities in this sector, including potential redemption pressures and ensuing liquidity risk, warrant close monitoring. We take note of the Fund’s assessment that a strengthening of the prudential framework for money market funds, investment funds and other non-banks should be implemented in a way that reflects macroprudential perspectives.
The recent acceleration in real estate prices represents a potential risk to financial stability. In parts of the euro area, these risks may be amplified by high levels of household debt. In many euro-area Member States, macro-prudential tools have been deployed to mitigate these risks but we concur with the Staff Report that, in some cases, borrower-based macro-prudential tools could be used more effectively. In those countries where materialising real estate risks would be likely to spill over to the real economy or where cyclical risks go beyond real estate risks, an activation of the countercyclical capital buffer should also be considered. In addition, supply-side policies, such as changes in taxation and fostering rental markets and housing supply, might be warranted to stabilise real-estate prices.
The EU is working to implement global regulatory standards that will make banks more shock-resilient for the challenges ahead. In particular, the Commission has adopted a proposal to implement the final stage of the Basel III agreement, which is now under negotiation with the Council and European Parliament. The proposal meets international commitments, while reflecting the specific features of the EU banking system. Beyond the Basel III implementation, the proposal also aims to enhance the current EU prudential framework and increase the consistency of the EU single rulebook in different areas, such as ESG risk management, Fit and Proper assessment and supervisory powers. In addition, reflections on regulatory standards continue in close cooperation with international partners on how to ensure resilience of the EU financial sector to climate-related risk, building notably on enhanced monitoring, stress testing, and disclosures. The EU encourages the IMF to deepen its analysis of climate-change-related financial risks and related financial policies in the future Article IV reports.
Work on the Banking Union and the Capital Markets Union remains of high priority. For the Banking Union, it is focused on agreeing, on a consensual basis, on a stepwise and time-bound work plan on all outstanding elements and with the same level of ambition. The agreement amending the Treaty on the European Stability Mechanism and the early introduction of the backstop to the Single Resolution Fund will enter into force as early as possible. We will continue to deepen and integrate European capital markets in the Capital Markets Union, also on the basis of the package of proposals by the European Commission of November 2021. This package includes the creation of a European Single Access Point for corporate data, and amendments of the European Long-Term Investment Funds Regulation, the Alternative Investment Fund Managers Directive and the Markets in Financial Instruments Regulation to make EU capital markets more integrated and efficient. Further steps in deepening the EMU should take into account the lessons learnt from the Union’s comprehensive economic policy response to the COVID-19 crisis.
We share the view of staff that establishing a single rulebook on anti-money laundering and countering the financing of terrorism (AML/CFT) and enhancing supervision via the creation of an EU-level AML/CFT authority can reduce fragmentation and strengthen the integrity of the financial system. To this end, the Council and European Parliament are currently negotiating on the basis of a proposal from the European Commission.
Trade Policies and Global Issues
The authorities re-affirm the EU’s strong support for a rules-based multilateral trading system and the engagement on global issues. The authorities welcome staffs acknowledgment of the EU’s leadership role on WTO reform and efforts to address underlying sources of global trade tensions and investment distortions. We welcome the recognition of the importance of the EU-US trade agreement on steel and aluminium, while also acknowledging the global nature of the issue. The authorities express commitment to global solutions, but re-affirm the legitimacy and proper design of WTO-consistent unilateral actions.
Globalisation has made it necessary to adjust the taxation framework to fit an increasingly digitalised economy. In this context, the authorities highlight the importance of timely implementation of the OECD/G20 Inclusive Framework on base erosion and profit shifting agreement (BEPS) and recall that all euro area Member States, and indeed all EU members of the Inclusive Framework on BEPS joined the international agreement in October 2021. The European Commission has proposed a Directive to ensure a global minimum effective tax rate of 15 percent for large groups operating in the European Union.
The expenditures reported for the RRF are based on the information on climate tracking published as part of the Commission’s analyses of the national recovery and resilience plans (RRPs). The data reported cover the 22 RRPs endorsed so far, and will evolve as more plans are assessed.