Publication - IMF Country Report No. 20/324 2020 Consultation on Common Euro Area Policies - Press Release; Staff Report; and Statement by the Executive Director for Member Countries
The COVID-19 pandemic has led to severe socio-economic dislocations and hardship. Supported by an unprecedented policy response and by the easing of lockdown measures as the infection rate moderated, the euro area economy initially recovered strongly from the pandemic’s first wave. However, a large second wave and reimposition of containment measures suggest much slower growth momentum in the near term. The outlook is for a subdued economic recovery and low inflation, with a significant permanent output loss relative to the pre-crisis trajectory.
Uncertainty remains extremely high, mainly due to different pandemic scenarios, including regarding the availability and effectiveness of potential vaccines and therapies and behavioral changes. Output growth is expected to be much lower through 2021Q1 than projected in 2020 October World Economic Outlook (WEO) but may rebound beyond then in light of recent promising news on vaccine development.
The key policy challenge is to continue countering the pandemic while facilitating a robust and inclusive recovery, including by addressing the health crisis, containing economic scarring, supporting resource reallocation and transformation to greener and more digital economies, and limiting the crisis’s impact on inequality and poverty. In a downside scenario, sizable further stimulus would be needed.
• Fiscal policy will need to continue providing broad-based support during the second wave. Once the pandemic wanes, however, policy will have to manage the transition from necessary lifelines to facilitating a durable recovery. Priorities include investing in climate change mitigation and digitalization, while addressing likely increases in inequality and poverty. The Next Generation EU recovery funds can help finance the investments needed to respond to climate change, though achieving the EU’s emission reduction goals will require a broader set of measures. Importantly, a positive experience with Next Generation EU could help build political support for a permanent central fiscal capacity. Further policy support—including potentially at the EU level once current facilities were exhausted—would be required if the outlook deteriorates markedly. Over the medium term, fiscal policy will need to be adjusted to sustainably boost growth. Credible and carefully calibrated fiscal consolidation strategies will be needed in high-debt countries.
Additional monetary policy stimulus is needed to support the recovery and facilitate a sustained increase in inflation. An expansion of asset purchase programs should be the first line of defense, but other options should also be considered. In a downside scenario, and if the inflation outlook is significantly downgraded or inflation expectations drift downwards, substantial additional accommodation will be needed via existing and new policy instruments. A clear, transparent, and well-communicated symmetric point inflation target would have significant benefits, and the ECB’s upcoming monetary policy strategy review should therefore formally codify the Governing Council’s recent emphasis on symmetry of their inflation aim into such a point target. In the context of an extended period of undershooting the medium-term inflation aim, a flexible average inflation target—like that adopted by the Federal Reserve— could also be explored.
Supportive financial sector measures should be maintained until the recovery is well underway, while capital and liquidity buffers should be rebuilt gradually to ensure banks’ continued capacity to extend credit. As nonperforming loans (NPLs) are likely to surge, especially when extraordinary support measures expire, swift balance sheet repair will be critical to support intermediation, including by adopting credible NPL reduction strategies and strengthening insolvency frameworks. Improving the EU’s crisis resolution capabilities, completing the banking union, and further advancing the capital market union are also key to further increasing euro area resilience.
Structural policies should focus on facilitating reallocation of resources to expanding firms and sectors, limiting scarring, and protecting the vulnerable. A combination of adjusting job retention schemes, strengthening social safety nets, promoting job search, enhancing training programs, and providing carefully targeted hiring subsidies will likely be necessary to achieve these multiple objectives. More broadly, to make sure people are not left behind, a more fundamental rethink of how to adapt labor market policies to respond to accelerating automation and to facilitate green and digital transformations may be needed. Public support to firms should be selective and ideally provided only to otherwise viable firms whose operations are impaired by health risks or social-distancing restrictions. To limit the cost to the taxpayer and incentivize the necessary reallocation, such support should be given on a temporary basis with appropriate private sector risk sharing and be gradually withdrawn as the recovery is firmly established. Globally, the EU should continue to be a strong proponent of a rules-based international trade regime.
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