ECONOMIC HEALTH CHECK
IMF Urges Swift Action to Restore Confidence and Growth in Euro Area
IMF Survey online - June 7, 2010
- Pace of fiscal consolidation should be tailored to each country's needs
- Spurring euro area growth is essential
- Restructuring of Europe's financial system should be accelerated
The current euro area crisis results from fiscally unsustainable policies in some countries, delayed repair of the financial system, insufficient progress in establishing the discipline and flexibility needed for a smooth functioning of monetary union, and deficient governance of the euro area, according to the IMF’s annual review of euro area policies, released on June 7.
European policymakers need to take decisive action to complete their project of monetary union, said the IMF.
While recognizing that the immediate crisis response has been bold, demonstrating the euro-zone’s capability to act together when pushed, the IMF analysis said it will be imperative to quickly secure the operation of the European Financial Stability Facility. The IMF added that crisis management is not an alternative to the corrective policy actions and fundamental reforms needed to reinforce the foundation of the European Monetary Union.
Following the conclusion of the IMF’s annual analysis of the euro area economy, Managing Director Dominique Strauss-Kahn emphasized the importance of fiscal responses being adapted to the individual circumstances of each country. “Fiscal sustainability is certainly an important aim that countries all around the world, not only in Europe, but including in Europe, have to take into account. But you have to differentiate those policies depending on the fiscal room that the different countries may have, and taking into account the balance between the fact that you have to go back on a sustainable track on the fiscal side and the fact that you need to maintain the highest possible level of growth. So it leads to different actions in different countries,” he told reporters following a June 7 meeting of the Eurogroup finance ministers in Luxembourg.
The IMF’s annual review noted that a one-size-fits-all fiscal adjustment strategy should be avoided, with the response being adapted to the individual characteristics of each of the euro area’s 16 member countries. At the same time, the IMF said that countries facing market pressures have no choice but to go ahead with forceful fiscal adjustment. “Delayed or half-hearted fiscal consolidation in countries facing high spreads could trigger a further loss of financial market confidence in the fiscal sustainability of some member states, a spike in risk premiums and a sharp depreciation of the euro.”
Overall, the area-wide fiscal stance is correctly set to remain broadly neutral in 2010 as countries with manageable debt dynamics continue to provide adequate support to nurture the recovery. But all euro area countries must make additional efforts to turn around unfavorable debt dynamics over the medium term, the statement said. This will inevitably entail comprehensive reforms to pension and health systems, and other entitlement programs, a process that is already well under way in many countries in emerging Europe that were hit hard by the crisis, and of course in Greece.
The IMF statement also emphasized the importance of protecting vulnerable groups during the reform and adjustment process.
After years of slow reforms, the longstanding problem of anemic growth in the euro area must now be forcefully addressed, the IMF statement said. “Higher growth is not only important for its own sake, but essential to help secure fiscal sustainability and strengthen the cohesion of the euro area.”
Reforms have been clearly identified in the context of the European Union’s Lisbon strategy, but the tools to bring about the needed coordinated implementation have been lacking until now, the statement said. Key reforms include making the labor market more effective, removing disincentives to work embedded in various public policies, enhancing wage bargaining flexibility, and further liberalizing services sectors.
More generally, financial sector reform remains a key priority and must be coordinated, both within Europe and globally, the statement said. Coordination is required to avoid regulatory arbitrage by financial institutions when it comes to new capital and liquidity requirements, surcharges on systemic institutions, and measures to address rapid credit growth and liquidity mismatches. “For the euro area, a robust calibration in all areas is required to increase the banking system’s resilience to any future shocks,” the IMF statement said.
Reforming economic and financial governance
The IMF annual review also focused on broader reforms required in the economic and financial governance of the euro zone. “The euro area fiscal framework needs to be substantially strengthened to deliver the collective fiscal responsibility required for a well-functioning monetary union,” said the IMF statement. It highlighted two areas in particular:
• Focus on enforcing budgetary discipline, helped by fundamental legislative reform, and on addressing macroeconomic imbalances.
• Extend the progress made in establishing more harmonized regulation and supervision of the EU financial system to the area of crisis management and resolution.
The IMF’s Executive Board will meet at a date to be announced to formally discuss the euro area Article IV report.