IMF Concludes Article IV Consultation With Euro Zone

by Ulrika Lomas, Tax-News.com, Brussels

06 August 2009

On July 30, 2009, the Executive Board of the International Monetary Fund (IMF) released the conclusion the Article IV Consultation on Euro Area Policies.

The euro area remains in recession, with signs of improvement yet to evolve into a recovery, the IMF noted. The large drop in financial wealth, an associated increase in private savings, tight financing conditions, and the adjustment of global imbalances are key drivers of the economic decline, exacerbated by the correction of home-grown imbalances in some countries, stated the IMF.

Headline inflation has fallen sharply to zero percent in May 2009 from its peak of 4% in mid-2008, largely reflecting base effects from the steep decline of commodity prices, but also the significant weakening in economic activity, according to the IMF. Core inflation excluding energy, food alcohol and tobacco eased by less, declining to an average of 1.6%, after hovering around 1.9% during 2007–2008. Given large output gaps, inflation is widely projected to remain significantly below 2% in 2009–2010. Against this background the ECB has eased monetary policy significantly, with policy rates currently at 1% from 4.25% in early October 2008.

The euro area’s financial system remains under considerable strain although actions undertaken by policymakers have helped contain systemic risk, according to the IMF. The ECB has deployed a wide array of unconventional measures, noted the IMF: it lengthened the term funding of its liquidity provision, widened its collateral requirements, and has been providing unlimited term funding at fixed rates since October 2008.

The EU members have agreed to an overhaul of their financial stability arrangements. The two new cross-border institutions to be created—a European System of Financial Supervisors and a European Systemic Risk Board—will seek to address existing shortcomings in the EU’s financial stability arrangements and the tensions with advancing the EU’s single financial market objective that have been exposed by the global financial crisis.

The fiscal position of the euro area is projected to deteriorate significantly, as public finances are used to shore up the financial system and cushion the downturn. Euro area governments have committed large resources to guarantee, recapitalize, and resolve financial institutions. As a result, the euro area’s fiscal deficit is projected to increase from 0.6% of GDP in 2007 to 6.9% by 2010, pushing up government debt significantly over the period.

In its recommendations, the IMF welcomed the broad arsenal of macroeconomic policies and financial sector interventions deployed by euro area authorities and Member States to address the crisis. The IMF emphasized that further decisive policy action, especially in the financial sector, is essential to achieve a recovery and return to self-sustaining growth. The IMF also noted that the crisis could dampen potential growth, calling for reinvigorated structural reforms.

The IMF welcomed the June 2009 European Council endorsement of an ambitious reform of the EU’s financial stability architecture, including through the creation of a European Systemic Risk Board and the establishment of a European System of Financial Supervisors. The IMF emphasized that the reform should be implemented according to the envisaged timetable and on a well-coordinated basis. Securing adequate resources, effective decision-making mechanisms, and independence for the new entities, as well as an unconstrained information flow within the new architecture, will all be essential, notes the IMF.

The IMF has recommended that fiscal policy should continue to support economic activity in 2010, but emphasized that credible medium-term consolidation programs should be put in place to address solvency concerns. The IMF urged that surveillance over progress toward medium-term consolidation objectives should be stepped up at both the EU and national levels.

The IMF concluded in underscoring that the crisis provides a window of opportunity to push forward with intensified structural reforms needed to address long-standing rigidities. With economic restructuring ahead, the IMF encouraged a heightened focus on training, education, and job-matching. The IMF further noted that implementing the services directive, revamping the Lisbon agenda, and facilitating an ambitious and early conclusion of the Doha round will contribute to the foundations of a solid recovery.

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