EUR-Lex Access to European Union law
This document is an excerpt from the EUR-Lex website
Document 52012SC0301
COMMISSION STAFF WORKING DOCUMENT Assessment of the 2012 national reform programmes and stability programmes for the EURO AREA Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the implementation of the broad guidelines for the economic policies of the Member States whose currency is the euro
COMMISSION STAFF WORKING DOCUMENT Assessment of the 2012 national reform programmes and stability programmes for the EURO AREA Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the implementation of the broad guidelines for the economic policies of the Member States whose currency is the euro
COMMISSION STAFF WORKING DOCUMENT Assessment of the 2012 national reform programmes and stability programmes for the EURO AREA Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the implementation of the broad guidelines for the economic policies of the Member States whose currency is the euro
/* SWD/2012/0301 final */
COMMISSION STAFF WORKING DOCUMENT Assessment of the 2012 national reform programmes and stability programmes for the EURO AREA Accompanying the document Recommendation for a COUNCIL RECOMMENDATION on the implementation of the broad guidelines for the economic policies of the Member States whose currency is the euro /* SWD/2012/0301 final */
Content 1. Executive Summary 3 2. Economic Situation and
Outlook . 4 3. Main Economic Challenges and
Policy Responses . 5 3.1. Restoring and maintaining stability.................................................................................... 5 3.1.1. Financial stability . 5 3.1.2. Fiscal policy . 8 3.2. Adjusting imbalances and enhancing growth . 12 3.2.1. Adjusting internal imbalances in the euro area . 12 3.2.2. Structural reforms to boost growth and adjustment capacity . 19 Euro Plus Pact – assessment of the implementation of the commitments . 21 4. Strengthening policy
coordination in the euro area . 23 4.1. The crisis highlighted weaknesses in euro area governance . 23 4.2. The reform of economic governance in the euro area . 24 1. Executive
Summary Over the last year the crisis in the euro area went through its most
acute phase to date. At its centre was a dangerous
feedback loop between sovereigns, the banking system and the deteriorating
economic outlook. As banks in Europe hold large amounts of domestic sovereign
debt, concerns about the sustainability of sovereign debt spilled over to the
banking sector. In turn, banks’ limited capacity to absorb losses added to the
sovereign risk as governments were perceived as ultimate backstops for ailing
financial institutions. Finally, feeble growth prospects – weakened further by
private and public deleveraging – increased the concerns about debt
sustainability and banks' profitability, led to higher debt refinancing costs
and endangered debt sustainability in a self-fulfilling way. This intense phase of the crisis showed the strength of cross-border
spillovers in the euro area. The sovereign debt
problems in the euro area started in 2010 as an isolated case. The crisis has
since then spread to other vulnerable Member States revealing or compounding
various home-grown problems, including built-up macro-economic imbalances or
weaknesses in the banking sector. Finally even Member States that had been regarded
as financially sound became affected and the crisis became system-wide in the
second half of 2011. This reveals the strength of spillovers in the euro area –
due to close economic and financial links and common policy frameworks – and is
a call against complacency for those seemingly unaffected. Determined policy actions to break the negative feedback loops and
strengthen policy frameworks helped to contain the crisis. The Roadmap to stability and growth adopted by the
Commission in October 2012[1] set out a comprehensive
plan to respond to the crisis, which guided policy makers in their reform
efforts. In particular, the second Greek adjustment programme has been agreed
on the basis of an orderly restructuring of government debt. Other vulnerable
Member States, in particular those under the EU/IMF adjustment programmes, have
started bold policy reforms. Consolidation in the whole euro area has progressed
broadly as planned even if additional measures are necessary in some cases. These
national efforts have been paralleled by actions at the European level: EU-level
initiatives with greatest growth potential have been accelerated; the size and
scope of financial stability mechanisms has been strengthened; banks have
strengthened their capital base in a coordinated exercise led by the European
Banking Authority; the European Central Bank has taken measures to alleviate
funding stress in the banking sector. Finally, far reaching governance reforms
were agreed on, aiming at closer monitoring and surveillance of fiscal and
economic policies. A continuous and consistent policy effort to address the looming
challenges is necessary. The above policy measures
led to some tentative improvement in the first months of 2012, but volatility
increased again recently due to adverse macroeconomic developments, persistent
concerns about the banking system and intensified policy uncertainty in some
Member States. This shows that markets remain exceptionally tense and vigilant
and confidence is still weak. This is also a reminder that any improvement of
the situation hinges crucially on maintaining an appropriate policy response at
the national and the euro-area level. Therefore it is of paramount importance to
continue with reform efforts to address the medium- and longer-term challenges
of the euro area, in particular to: -
revive growth already in the short term and
increase growth potential, notably by strengthening market integration and
liberalisation with the aim in particular to unlock private savings for productive
investment and to improve competitiveness. -
reduce the high debt burden in the public and
private sector in a well-coordinated manner across countries and across sectors
in a way that does not excessively constrain economic growth; in particular: §
reduce the high public debt in the context of
credible medium-term fiscal consolidation strategies, which strike the right
balance between the need for consolidation, reform and growth; §
reduce of large imbalances among euro area
countries via broad structural reforms increasing adjustment capacity and
appropriately differentiated fiscal policies; -
continue financial repair in particular to
ensure a sound banking sector, able to provide healthy financing to the economy. Strong spillovers and interconnectedness in the euro area demand
robust economic governance and close economic surveillance. The bold reforms in economic governance of the euro area enacted
so far and in the pipeline go a long way in meeting the requirements of strong
governance and surveillance in a monetary union and laying strong foundations
for a stable and sound euro area. Nevertheless, further steps are necessary in
the medium term to complete the architecture of the EMU. 2. Economic
Situation and Outlook The economic situation in the euro area deteriorated significantly
over the last year. After contracting at the end of
2011 euro area GDP stabilised at the beginning of 2012. The loss of confidence
due to the intensifying sovereign debt crisis, the oil price increases and the
decelerating of world output growth have been weighing on growth. While the risk of acute problems in the banking system has been
eased by prompt policy action at the end of 2011, economic prospects remain
sluggish. The European Commission spring forecast
sees GDP as almost flat (-0.3%) in 2012, while a moderate expansion is forecast
for 2013 (1.0%). This subdued recovery is predicated on a return of confidence
and thus on the assumption that the crisis is contained and the
financial-market situation normalises. Indeed, escalation of the crisis remains
the largest downside risk, which could re-ignite the vicious feedback loop
between the financial sector and the real economy and significantly reduce
growth prospects. Growth differences among the euro area Member States are expected to
persist. There have been visible growth differences
among the euro area countries since the outbreak of the global economic and
financial crisis. These are expected to continue in the forecast horizon as
Member States suffering from the legacy of internal and external imbalances
are likely to register a much later and more protracted transition to a
recovery than countries with lower structural impediments (see also Section
3.2). 3. Main
Economic Challenges and Policy Responses The euro area faces a number of intertwined challenges. They are discussed
below under two main headings reflecting relevant policy areas and policy
instruments. Section 3.1. discusses challenges related to financial and fiscal
policies in the euro area, section 3.2. discusses challenges stemming from low
growth and large macroeconomic imbalances. Each section contains an assessment
of policy actions in the euro area, with a focus on the response to the recommendations
that were addressed to the euro area Member States in 2011. 3.1. Restoring and maintaining stability 3.1.1. Financial stability Graph 1. Programme countries' sovereign spreads 10 year maturity, difference to Germany Source: Reuters Ecowin The financial sector worldwide and in Europe was hard hit during the
crisis. The general reassessment of risk during the
global economic and financial crisis triggered large falls in asset prices and
eroded the capital base of Europe's banks, some of which had to be rescued by
national public authorities. Against a background of economic recession
exerting increasing pressure on public finances, these rescue operations, were
in some cases big enough to undermine the sustainability of the sovereigns
concerned. This – together with the revision of public finance figures in Greece – severely undermined the confidence in sovereign bonds in many euro area Member
States. The prices of sovereign bonds of countries which were regarded as
vulnerable declined and further reduced the capital of banks, which had
invested heavily in these bonds before the crisis (Graph 1). This interdependence
between weak banks and weak sovereigns in the context of slowing growth has
created a very dangerous feedback loop. The aggravating crisis significantly
undermined investors' confidence in the quality of banks’ balance sheets and
hindered their access to funding. The crisis became system-wide in the second
half of 2011 when financial stress spread onto other euro area sovereign
markets, reflecting the strong spillovers existing in the single currency area
(Graphs 2 and 3). Graph 2. Selected Member States' sovereign spreads 10-year maturity, difference to Germany || Graph 3. Financial price indicators for euro area corporations || Source: Reuters Ecowin || Note: Expressed in standard deviations derived from daily averages 2005-2011. Source: Reuters Ecowin Policy measures introduced in the second half of 2011 and at the
beginning of 2012 helped to rebuild market confidence in the early months of
2012, but the improvement proved temporary. In
particular, the 3-year Very Long Term Refinancing Operations (VLTRO) carried
out by the ECB filled acute refinancing gaps for euro area banks by
guaranteeing banks access to medium-term funding at low cost. Also, to reassure
markets about the banks’ ability to withstand shocks and maintain adequate
capital, the October 2011 European Council agreed on an EU-wide
recapitalisation plan coordinated by the European Banking Authority (EBA). The
overall positive implementation of EU/IMF financial assistance programmes for Portugal and Ireland also contributed to improved market sentiment as did the ambitious reform
programmes in other vulnerable countries. Other policy actions, such as the
agreement on the second Greek adjustment programme, further strengthening of
the firewalls and the reinforcement of fiscal governance also improved the
sentiment towards euro area economies. Unfortunately, the improvement in
sentiment proved only temporary and investors' confidence deteriorated again,
which shows how fragile financial markets remain and that a failure to continue
implementing appropriate policies can quickly turn market sentiment. While further deleveraging in the banking sector is necessary to
restore investor confidence, the challenge is to ensure that it does not unduly
constrain the flow of credit to the economy. Recent
funding strains and continuous pressure to increase capital have raised
concerns that banks could excessively reduce credit supply (Graph 6). As
bank credit is a major source of funding for the real economy in the euro area,
in particular for the small and medium-sized enterprises, a credit crunch would
have severe repercussions for growth and employment and could eventually impair
growth potential if sustained over a prolonged period. To counter this risk,
national supervisors have been requested to ensure that banks’ plans to
strengthen capital ratio lead to an appropriate increase of capital rather than
to excessive deleveraging and lending disruptions. At this stage, there is no
clear-cut evidence that the deleveraging process has become excessive or disorderly
with disruptive consequences on the real economy. Nevertheless, the
heterogeneity across Member States is large and the aggregate picture may hide
different situations at country level. Graph 4: Bank lending to the private non-financial sector in the euro area Note: monthly flows adjusted for sales and securitisation; seasonally adjusted. Source: ECB The run-down of problematic assets, accumulated before the crisis,
is essential to restore the flow of credit to the economy. The continuing low interest-rate environment coupled with banks'
reluctance to recognise losses or foreclose properties could increase the
propensity of banks to forebear on loans or other problematic assets. Delaying
loss recognition, could constrain lending to more creditworthy borrowers,
reduce potentially productive investment and exert negative effect on growth..
Therefore correct and transparent risk recognition and timely restructuring is necessary
to ensure the health of both the banking system and the economy. The ECB extraordinary liquidity measures have given the banks a
breathing space. The VLTROs have alleviated acute
funding strains in the banking sector and which will allow banks to provide
lending to the economy, once economic conditions improve. However, the high returns offered by some sovereign bonds have encouraged
some banks to further invest in domestic government debt, thus increasing
interconnectedness between banks and sovereigns. Thus, it is of
paramount importance that the window of opportunity offered by the VLTROs is
used by banks to proceed with financial repair and restructuring of balance
sheets, while maintaining credit flow to the economy, so that a more resilient
banking sector is in place when the VLTROs come to maturity. Financial sector restructuring has continued over the last 12 months
in the euro area. Following last year’s
recommendation to the euro area countries to improve the functioning and
stability of the financial system, many Member States pursued the
restructuring of their financial sector (CY, DE, ES, EL, IE, PT) and
strengthened their supervisory framework (BE). Nevertheless, the measures sometimes
lack ambition or a comprehensive approach (DE, SI). The crisis has slowed the
financial integration process and ambitious steps to
accelerate and deepen financial integration may be needed. Already before the crisis, it was acknowledged that the EU model of
cross-border banking was not stable under the existing institutional setting,
in particular with respect to supervision and management of banking crises. This
has proved particularly damaging in the context of the monetary union, due to
closer financial and real linkages and the inter-linkages with the sovereign. Although banks have broadly maintained their cross-border
presence so far, there are signs of declining cross-border activities and banks
retrenching behind national borders. As part of their balance sheets
restructuring banks have started to divest non-core assets, which often include
foreign assets, although the pattern of the divestments is not clear-cut. To counter this trend of financial
dis-integration more coordination at European level is required in supervision and
crisis management frameworks. More specifically, a
closer integration among the euro area countries in supervisory structures and
practices, in cross-border crisis management and burden sharing, towards a
"banking union" would be an important complement to the current
structure of EMU. In the same vein, to sever the link between banks and the
sovereigns, direct recapitalisation by the ESM might be envisaged. 3.1.2. Fiscal policy Since the outbreak of the crisis public debt has increased
substantially in the euro area. While the levels
and trajectories of debt differed substantially across euro area Member States
before the crisis, the increase since its outbreak was universal. This has been
to the largest extent due to the significant role public finances played to
support the economy and the financial sector during the global economic and
financial crisis. However, insufficient efforts to reduce debt during good
economic times before the crisis have also made some countries more vulnerable
to economic shocks. Since the onset of the crisis in 2007, government debt
levels across the euro-area have increased by more than 20 percentage points
and reached 88% of GDP in 2011, with large differences across Member States. It
is fair to point out, however, that although the euro-area is at the epicentre
of the sovereign debt crisis, the overall increases and levels of government
debt-to-GDP ratios are actually higher in both the US and Japan (Graph 5). A combination of factors makes the reduction of high public debt an
acute challenge per se and in particular in the context of the euro area
monetary union. First, risk aversion on sovereign
debt markets have increased markedly, probably over-correcting the subdued
levels prevailing before, as investors have reassessed the prospects of
sovereign debt sustainability in face of increased debt levels and a depressed
growth outlook. This has led to a surge in financing costs for some
governments, which in turn endanger debt sustainability in these Member States
already in the medium term. Second, the crisis has revealed very large
spillovers between euro-area sovereigns that increase the risks of developing
systemic crises, i.e. a situation when developments in the euro area as a whole
play larger role in investors' perception of a Member country than the
developments in the country concerned. And third, budgetary costs stemming from
ageing populations have implications for fiscal sustainability in the longer
term. The sizeable magnitude of the fiscal adjustment required to bring down
currently high debt-to-GDP ratios in most Member States calls for a durable and
sustained fiscal consolidation strategy. Fiscal consolidation has been ongoing in the euro area and the
Member States have undertaken significant consolidation efforts. The headline government deficit in the euro area has fallen by 2.1
pp. to 4.1% of GDP in 2011. Government debt, however, continued rising and
reached 87.2% of GDP. As the reduction in the headline deficit-to-GDP ratio
took place in the context of slowing output growth, it amounts to significant
consolidation effort. Indeed, the cyclically adjusted budget balance improved
by 1 pp. and reached 3.4% of GDP in 2011. This shows that the euro area Member
States have broadly achieved the structural consolidation efforts planned in
the 2011 updates of their Stability Programmes. Stability Programmes show that the consolidation is expected to
continue. According to the plans set out in the
Stability Programmes, fiscal deficit in the euro area will decline to around 3%
of GDP in 2012 and further to less than 1% of GDP in 2015. The gross public
debt is planned to still increase, however, and exceed 90% in 2012, before
falling around 85% in 2015, but large differences in debt levels are expected
to persist over the programme horizon. Graph 5. Development in government debt and deficit in the euro area, US and Japan 2007-2013 (% of GDP) Source: Commission Services While euro area Member States have to restore sustainability in
their public finances, there are short-term growth effects of fiscal
consolidation. In general, fiscal consolidations
entail short-term contractionary effects on economic activity. These effects
are likely to be larger now – in a post-financial crisis recession – than
during a usual cyclical slowdown. This is because a larger share of household
and firms are now credit constrained and are more sensitive to changes in
current income and profits rather than to interest rates. Moreover, the already
accommodative stance of monetary policy and the impairment of the transmission
mechanism due to problems in the banking sector limit the scope for any
offsetting stimulus from this source. The main challenge for fiscal policy is to pursue fiscal
consolidation in a growth friendly manner. Credible
medium-term growth-friendly consolidation programmes are of utmost importance
to simultaneously reduce the high debt levels and to mitigate potential
negative growth effects of consolidation. Credibility of consolidation is one
of key factors here: short-term adverse growth effects are typically found to
be smaller for consolidation efforts which are perceived to be permanent. There
are four dimensions of growth-friendly nature of consolidation:
(i) differentiation of the pace across countries, (ii) strong
attention to the composition of consolidation, including a clear focus on
curbing age-related spending, and (iii) accompanying reform of budgetary
institutions. (i)
The size of fiscal challenge differs among the euro area Member
States and calls for differentiated speed of consolidation. The Stability and Growth Pact provides a flexible and rule-based
framework to guide the differentiated pace of consolidation. The application of the EU fiscal rules is based on economic
analysis and legal provisions, together with an overall assessment of the
structural sustainability of public finances. The framework allows for
objectively-based differentiation between Member States according to their
fiscal space and macroeconomic conditions (Graph 6). The assessment of the
budgetary measures taken by the Member States, in particular in structural
terms, is central to the implementation of the rules. The strategy of fiscal exit from the extraordinary measures adopted
to cushion the effect of the crisis reflects the flexibility embedded in EU
fiscal rules. Specifically, Member States which face high and potentially rising risk premia do not have much room for manoeuvre
to deviate from their nominal fiscal targets, even if macroeconomic conditions
turn out worse than expected. However, other Member States are in a position to
fully let their automatic stabilisers play along the structural adjustment
path. Graph 6. Government deficit and debt in 2011, euro area Member States (% of GDP) Source: Commission Services (ii)
The composition of fiscal consolidation is critical to minimise the
negative effects on growth. Expenditure retrenchment can have important signalling effect. Due to the inherent difficulties in implementing expenditure-based
consolidation strategies, their adoption is instrumental in signalling the
commitment to cut fiscal deficits. Thus, spending retrenchment is a
precondition to underpin credibility and prevent risk premia from rising
further. However, a growth-friendly consolidation also requires prioritising
growth-supporting public expenditure so as not to undermine the already weak
growth potential of the euro area economy. Public investment has particular
importance in this respect as investment expenditure increase growth via
domestic demand already in the short term, while have a positive effect on the
supply side in the long term. Especially in some Member States, which face
extraordinarily low interest rates there is a case for adopting policies to
promote productive investment, as it is very likely that its private and social
returns would exceed the funding costs. However, it is also important to pay
particular attention to the efficiency and effectiveness of the expenditure
programmes. However, as the size of the required fiscal adjustment is
significant, part of it might have to come from the revenue side in many Member
States. This is particularly relevant in Member
States where large consolidation needs are combined with some room for
potential tax revenue increases or where there is a need to restore tax bases
eroded by the crisis. There are several ways to increase tax revenue which do
not involve outright tax hikes. Improving tax compliance and administration
should be the first lever to use. Where this is not sufficient or where tax
compliance is already high, broadening of the tax base should be considered.
Moreover, improving compliance and broadening the tax bases are valuable aims
of tax policy per se as they increase the efficiency of taxation and reduce
economic distortions. As a last option, increasing tax rates or introducing new
taxes might be unavoidable in some cases. In such cases it is necessary to pay
utmost attention to minimising the possible negative effects on growth by
focusing on the least detrimental taxes such as consumption taxes or recurrent
property taxes. Appropriate tax policies can also contribute to growth and
competitiveness and reduce imbalances in the economy. Tax policy should generally focus on growth-friendly changes in
the structure and design of existing tax systems. In particular, an increase in
the tax burden on labour and capital has more detrimental effects on growth and
competitiveness than is the case with other types of taxes, such as on
consumption, property and environmental taxes. This is particularly relevant
for some euro area Member States, which need to significantly improve their
competitiveness. The potential distributional impact of tax changes also needs
to be carefully assessed. Any reduction in the tax burden on labour should be
centred on the most vulnerable labour market groups, given that these often
face particularly high disincentives to work and suffer from relatively high
labour costs. With particular relevance for the euro area, tax reforms should
also address the incentives to build up debt, embedded in corporate income tax
systems and the housing taxation. The composition of consolidation has not always been growth-friendly. Although consolidation efforts have
been generally expenditure-based, only a few Member States have safeguarded
growth-enhancing items, such as R&D (IT) or education (DE). Others (PT, IT)
prioritised capital expenditure, notably by enhancing the use of EU structural
funds. In several Member States, the efficiency of public spending has been
improved (EE, FI). Measures on the revenue side have also been frequent. A
number of Member States have opted for tax increases. These sometimes improved
the structure of taxation shifting the tax burden away from labour (IT). More
often the changes did not go in the right direction, as the tax burden on
labour (AT, ES, FR) or on capital (ES) has increased, even if other, less
growth-harmful options have not been fully exploited. There were also measures reducing
distortions in property taxation (PT) or increases in consumption taxation
(FR), but no shift towards environmental taxes have been recorded. Tackling the budgetary implications of ageing population is key for public
finance sustainability. Due to the negative impact
of the crisis on growth, the age-related expenditure is now expected to be a
larger burden for public finances. On the basis of current policies, the ratio
of age-related public expenditure to GDP is projected to increase by 4¾
percentage points by 2060. There are however large differences across countries
with Belgium, Cyprus, Luxembourg, Malta, the Netherlands, Slovenia and Slovakia facing particular challenges. Pensions represent a very large and rising share
of public expenditure in the euro area: more than 12% of GDP today and
projected to rise to 14% in 2060. In Member States that face highest pension
costs, but also in others, reforms in pensions, health and long-term care would
improve the long-term sustainability of public finances, underpin the
credibility of the current consolidation efforts and help to strengthen
investor confidence. Progress has been made with respect to pension reforms, but health
care reforms are lagging behind. The looming
challenge of ageing population has over the last decade prompted the majority
of Member States to adapt pension systems with the aim of putting them on a
more sustainable footing. This trend has continued over the last year. The recent
pension reforms in some euro area Member States notably Greece, Italy and Spain are having visible positive budgetary impacts. However, further reforms are
in many cases necessary. Less progress has been made in the area of health care
systems, where the challenge is to balance the need for universal health care
and long-term care with an increasing demand related to ageing population,
technological development and growing patient expectations in all age
categories. Sound reforms are thus needed to achieve both a more efficient use
of limited public resources and the provision of high quality health care. (iii)
Reforms
of national budgetary frameworks can make an important contribution to
consolidation and alleviate growth-consolidation trade-offs. Improving national budget processes by drawing on identified best
practices would improve fiscal policy-making on a lasting basis. Moreover, credible budgetary frameworks, oriented towards ensuring
fiscal sustainability, can create more room for short-term stabilisation role
of public finances. If markets' expectations are firmly anchored in a credible
medium-term path, i.e. if investors trust policy makers will reduce deficits in
the medium-term, they will be less sensitive to the short-term fluctuation of
fiscal aggregates, leaving more room for stabilisation policies. To anchor the
expectations, the role of national fiscal frameworks and EU surveillance is
crucial. Visible progress has been achieved in improving fiscal frameworks. Most countries have embarked on ambitious reforms of major
structural elements of their fiscal frameworks, putting in place new or tighter
fiscal rules (in some cases at constitutional level), strengthening
multi-annual planning and setting up fiscal councils. These efforts should be
pursued to provide tangible deliverables strengthening the budgetary process.
In particular the transposition of the Directive on requirements for budgetary
frameworks by the end of 2012 – as committed by euro area Heads of State and
Governments – and the swift implementation of the fiscal compact would send an
unambiguous message that the euro area is putting in place the appropriate
mechanisms to achieve a credible and lasting fiscal consolidation process. Budgetary discipline and solidarity in the euro area could also be
fostered by the common issuance of sovereign debt instruments. Creating a new market segment based on
common issuance would address the current shortage of investor demand for the
sovereign bonds of many euro-area Member States. In dependence of their design,
such an instrument would provide participating Member States with more secure
access to refinancing at a generally lower rate through a lower liquidity
premium and less market volatility. A number of suggestions in this direction
have been brought forward, including the issuance of mutualised bonds combined
with a debt redemption fund as suggested by the German Council of Economic
Advisers, different options of Stability Bonds as outlined in the Commission's
Green Paper or the common issuance of short-term debt securities (E-Bills).
Even if common issuance were not to play a role in managing the sovereign debt crisis, such an
instrument would contribute to efficient financial integration by facilitating the transmission of monetary policy and making
available high-quality collateral that can be more easily used on a
cross-border basis. However, the net effects of common issuance will be
positive only if the potential disincentives for fiscal discipline can be
controlled. The successful application of the new economic governance
framework already in force and in the process of being put in place may be a
significant step towards fulfilling the preconditions for common issuance. The
Commission will come forward with proposals following the analysis of the
results of the consultation undertaken on its Green Paper. 3.2. Adjusting imbalances and enhancing growth 3.2.1. Adjusting internal imbalances in the euro area One of the salient features of the first decade of the euro area’s
existence was the gradual accumulation of macroeconomic imbalances. Their most visible manifestation was the increasing divergence in
external positions. Some Member States saw their current account deficit rise
to very high levels while others accumulated substantial current account
surpluses[2] (Graph 7). The mounting current account deficits and surpluses were a
counterpart to large capital flows across the euro area countries. Capital inflows benefited mostly those Member States where the real
returns on investment appeared the highest. While these capital flows partially
reflected sound catching-up processes, particularly in the initial period, they
also reflected a generalised mis-pricing of credit risk and were ultimately to
result in a misallocation of resources within the recipient economies and
became a significant ingredient of unsustainable macroeconomic trends. Part of
the capital flows was channelled into unproductive uses and fuelled domestic
demand booms, which were associated with excessive credit expansions and
raising debt in the private and/or public sectors and housing bubbles in some
euro area countries (Graph 8). Graph 7. Decomposition of current account developments in the euro area || Graph 8. External and internal imbalances before the crisis || Source: Commission Services || Source: Commission Services Note: Average private credit (transactions) as % GDP and average current account over 2000-2007. The past divergence in external positions within the euro area was mainly
due to diverging developments in the private sector
(Graphs 9 and 10). A look at the sectoral net lending/borrowing in surplus and
deficit countries in the euro area shows that the key driver of the growing
divergences in external positions prior to the onset of the crisis was the
non-financial private sector. Although government sector balances were somewhat
more negative in deficit countries than in surplus countries, their
contribution to overall imbalances was generally more limited compared to the
private sector.[3] However, the developments
in the rest of the private sector were documenting growing divergences: while
in surplus countries the financial balance of the private sector on average
improved, in deficit countries it progressively deteriorated up to 2007. The household
sectors in both surplus and deficit countries were on average net lenders over
the whole period, while the net lending position was much weaker in the latter
and, moreover, deteriorating in the run up to the crisis. The non-financial
corporations were net borrowers in deficit countries while they turned into net
lenders in surplus countries. The advent of the crisis has set in motion
important consolidation of private balance sheets – both of households and
non-financial corporations. This consolidation does not necessarily affect only
deficit countries but also those with current account surpluses. Graph 9: Net lending/borrowing as % of GDP by sector – euro area "surplus" countries || Graph 10: Net lending/borrowing as % of GDP by sector – euro area "deficit" countries || Source: Eurostat Note: Surplus countries are BE, DE, LU, NL, AT, FI (based on average external position in the period 2000-2010). || Source: Eurostat Note: Deficit countries are EE, IE, EL, ES, FR, IT, CY, MT, PT, SI, SK (based on average external position in the period 2000-2010). The onset of the crisis triggered a reversal in the previous trends
and current account imbalances in the euro area have been significantly reduced
since. Currently, the dispersion of current account
imbalances has dropped significantly compared to the peak. The gaps between
actual current account balances and their 'norms' determined by fundamental
factors have shrunk substantially (Graph 11). In the years preceding the
crisis, a majority of countries recorded current account balances which were
below what could be expected on the basis of the underlying fundamentals. As
the largest adjustment so far took place on the side of current account deficit
countries, the average current account gap approached zero and turned positive
thereafter. While to a large extent the reduction in deficits was linked to
depressed domestic demand and imports, deficit countries have also started
improving their export performance. According to the Commission spring forecast
their export markets shares are forecast to improve more than those of the
surplus countries. Although to a lesser extent, some rebalancing is taking place on the
surplus side as well. Since 2007 all surplus
countries have noticeably reduced their surpluses. Particularly, in Germany the composition of growth has changed visibly over the recent past. Domestic demand
became the main driving force behind output growth and in 2011 has been growing
by almost 2 pp. faster than in the euro area as a whole. Also unit labour costs
accelerated faster in 2011 than on average in the euro area and recent wage
negotiations also point further in this direction. According to Commission
spring forecast these trends are expected to continue in the forecast horizon.
Graph 11. Developments in current account 'gaps' in the euro area || Graph 12. Actual current account (CA) balance and IIP-stabilising CA (2012-2020) || Source: European Commission Note: Current account 'gaps' show the difference between actual current accounts and 'norms' based on the approach by Salto and Turrini (2010). || Source: European Commission Note: The current account stabilising international investment position (IIP-stabilising CA) shows the CA balance necessary to keep the net IIP-to-GDP ratio constant given the growth projections for 2012-2020. On the way forward, a key issue is whether the recorded narrowing of
imbalances is structural or will be reversed once cyclical conditions improve. There are indications that at least part of the observed rebalancing
is of a more structural nature and therefore likely to be relatively persistent.
To the extent the recent corrections reflect reassessment of income
expectations and risk premia rather than purely cyclical drops in output, they
could prove sustainable. Given the high level of external liabilities in most deficit
countries, market pressure for rebalancing should remain high in the years to
come and a reversal of the balance sheet adjustment appears unlikely. Also,
fiscal consolidation needs are generally larger in deficit than in surplus
countries, so the public sector is likely to contribute to rebalancing in the
longer term. Finally, the adjustment in many deficit countries is accompanied
by changes in relative prices which is a precondition for the required
reallocation of resources within the economies. Even if the adjustment on the deficit side has been large, there are
indications that it has not been complete in those countries which had the
highest current account deficit. While there
has often been a radical adjustment in flows, some of these countries still
feature very high levels of external liabilities as showed by the net
international investment positions (NIIP) as a share of GDP. Given the high
level of net liabilities and weak growth dynamics, there is a need for further
improvements in current accounts, particularly in trade balances, to bring the
NIIP-to-GDP ratios on a declining trend (Graph 10). Given the growth prospects
over the coming decade, external indebtedness in Greece, France, Italy, Cyprus, Malta and Portugal would continue increasing if current account deficits
stayed at the current level. This does not necessarily jeopardise external
sustainability in countries with relatively favourable external positions such
as France but would be an additional drag for countries with already high
levels of external debt. Graph 13. Euro area Member States' sectoral Net Financial Assets, (% of GDP), 2010 Source: Commission Services Note: Net financial asset (NFA) positions are defined as financial assets less financial liabilities. The NFA positions represent the national accounting counterpart of the net international investment position (NIIP) and allow exploring savings-investment balances in a sectoral perspective. The graph depicts the situation in the euro area countries by looking at three dimensions: (1) the ratio between the NFA position of households to that of firms ("coverage ratio"), which gives an indication to what extent domestic private savings are sufficient to finance the needs of firms. The light colour indicates full coverage and the dark colour reflects less than full coverage. A priori it is expected that firms are on average net investors (negative NFA) and that households are net savers (positive NFA) while financial corporations are, on average, intermediaries (balanced NFA position); (2) the government NFA gives an indication of the role of the public sector in complementing/supplementing a potential savings gap in the private sector (a negative sign indicates net general government liabilities); (3) the NFA of the economy as a whole to the rest of the world links the internal position with the economies external needs/capacities (a negative sign means net external liabilities). Surplus countries are in circles. The required improvement in current accounts to stabilise or reduce
external indebtedness often implies even more ambitious improvements in trade
balances. This is due to the negative net
investment income payments which these countries need to pay, i.e. interest
payments on foreign loans, dividends on foreign investment or other factor
payments. As the income balances are primarily linked to the stock of external
liabilities, they are rather persistent. So far, much of the adjustment in
deficit countries took place via changes in trade balances which in turn were
mostly driven by drops in imports induced by contractions in domestic demand.
To regain sustainability of external positions, countries like Greece, Spain, Cyprus or Portugal need to turn their trade deficits (including net transfers) into
surpluses in order to compensate for the relatively high negative income
balances. This will inter alia require important improvements in their
competitiveness to recoup the losses registered before the crisis. Ensuring
that wage developments contribute to regaining labour cost competitiveness and
implementing measures that tackle nominal rigidities in product markets is
crucial in this respect. To avoid increasing unemployment, the measures
supporting price and cost adjustments need to be complemented by reforms
facilitating reallocation of resources across firms and sectors. Primarily,
labour and capital will have to be channelled from non-tradable activities,
which expanded before the crisis, to the export sector. Labour market reforms
in line with the principle of flexicurity are particularly relevant for that
purpose. The large stock of debt in the deficit countries also underlines the
importance of external financing conditions for these Member States, as the large
stocks of external liabilities make them more sensitive to changes in financing
costs. Structural reforms addressing the problems underlying the imbalances,
together with progress in restoring the sustainability of public finances, will
help rebuild the confidence in financial markets and keep the costs of
financing of existing liabilities at viable levels. Unlike current account deficits, large and sustained current account
surpluses do not raise concerns about the sustainability of external debt or
financing capacity for the countries concerned. Persistent
surpluses can be justified if they are the result of the exogenous factors,
such as the availability of natural resources, competitiveness of enterprises or
come from the structural features of the economy that determine saving and
investment, e.g. countries with an ageing population may find it opportune to
save today (i.e. run current account surpluses) to avoid a drop in consumption
in the future. Nevertheless, it is possible that large and persistent current
account surpluses can be caused by less benign factors, related to the
functioning of markets, e.g. the way the financial sector allocates resources, or
policies that constrain domestic demand and investment opportunities. When the
latter is the case, reforms that help strengthen domestic demand and growth
potential would be welfare enhancing for the Member State concerned. The
reductions in excess domestic savings over investment could, moreover, benefit
other euro area countries, where no exchange rate exist to respond to
persistent current account imbalances, though the strength of such growth
spillovers is surrounded by significant uncertainty. Moreover, a closer look at the surplus economies reveals significant
heterogeneity of the sector composition of their external positions and hence
the potential for external rebalancing. A first
investigation of the euro area "surplus" economies shows that they
are rather diverse as regards the relative situations of the different sectors
in the economy (Graph 13):
As regards the general government sector, Finland and Luxembourg had in 2010 overall positive financial position, i.e. their public sectors
held larger amount of assets than liabilities. This is because of both
relatively low stock of liabilities and a large stock of funded assets,
stemming mainly from the investment of employment pension schemes. In the
case of Austria, Germany and the Netherlands these countries had net
public liabilities positions (net "public debtors" in
Graph 13), derived essentially from the large stock of gross
liabilities (Graph 14).
Austria stands out of the group of surplus
countries as it shows overall net liabilities with respect to the rest of
the world (although they appear very limited) despite the past accumulation
of current account surpluses.
Looking at the situation in the private sector, a similar
grouping of countries emerges. The private sectors in Austria, Germany and the Netherlands are the main providers of financing in these economies. In Austria and Germany, households are saving enough to compensate for firms' borrowing, which
partially (in the case of Austria) or fully compensates for their net
public liabilities. In the Netherlands, the household savings rate is
virtually zero and firms provide financing for the rest of the economy
(positive net lending). This coverage ratio (see the note in
Graph 13) is partial for Finland and Luxembourg.
The sectoral differences among the surplus countries will shape the
rebalancing pattern in the coming years. These differences
in the financial positions of the different sectors and the potential
interlinkages between the sectors can have an impact of deleveraging on
external positions. In particular, the interplay between the savings-investment
balances of the public and the private sector via existing deleveraging
pressures will influence the external position in the coming years: ·
In surplus Member States with net government
liabilities, fiscal consolidation can be expected to contribute to negative
feedback effects on growth and upward pressures on the external position. Graph
14 shows gross debt (non-consolidated) of the general government, which, in
2011, stood above 75% of GDP for Germany, Austria and the Netherlands (upper panel) and was mainly accumulated over the previous 4 years (lower
panel). Graph 14. Gross debt in the euro area countries: sector decomposition Source: Commission Services Note: The government debt data in the graph consist of securities other than shares (F3) and loans (F4) and are reported on a non-consolidated basis for consistency with the data for private sectors and so differ with the data reported in the context of the EU fiscal surveillance. Upper panel: levels in 2011 (% of GDP); bottom panel: change over 2007-2010 and 2010-2011, percentage points of GDP. 2011 data is calculated on the basis of the first three quarters and is not available for Ireland and Luxembourg. ·
The likely impact of public consolidation on the
economy and on the external balance will depend on its interplay with private
deleveraging pressures. On the one hand, countries with a modest level of private
indebtedness (Graph 14, upper panel) have room for increases in domestic
consumption and investment, compensating the public consolidation effect, as is
the case for Germany, which went through a prolonged deleveraging phase in the
decade before the crisis. This is particularly important when current account
surpluses are driven by anaemic private demand and when sluggish domestic
consumption and investment reflect weaknesses in the functioning of specific
sectors in the economy such as services markets. In these circumstances,
current accounts surpluses can be the counterpart of lower-than-necessary
living standards of the domestic population. Structural reforms that address
these weaknesses will be instrumental in releasing the constrained domestic
demand and make the economies more competitive. On the other hand, countries
with a debt overhang in the private sector, like the Netherlands, are likely to
witness complementary deleveraging forces to those of the public sector,
reinforcing their effects on growth and their upward bias on the external
position. ·
Finally, "public savers" with net
government assets might feel lesser deleveraging pressures, as the general government
provides a buffer for potential balance sheet repair in the private sector. Graph 15. Net lending/borrowing and the international investment position (IIP) Source: Commission services There are additional issues related to surplus countries that
require further investigation. For instance, it is
interesting to note that in some surplus countries the international investment
position has not improved in spite of substantial and sustained current account
surpluses. This may partially be due to valuation effects linked to exchange
rate movements, and differences in the composition and valuation of foreign
assets and liabilities, but can also indicate that the capital exports have
been channeled to unprofitable investments and raise questions about the
efficiency of the financial sector in channelling resources to most productive
uses[4].
For instance, the cummulated current account surpluses since 2000 in Germany, the Netherlands or Austria are significantly above the change in the net international
investment position over the same period, although it is necessary to point out
that the period was characterised by a global mispricing of risk. (Graph 15). As the above analysis shows, the nature, strength and direction of
interlinkages between deficits and surpluses in the euro area require thorough
investigation to shed light on the way surplus countries could contribute to
the overall rebalancing. The Commission intends to publish a dedicated study on
this issue in the autumn of 2012. 3.2.2. Structural reforms to boost growth and adjustment
capacity Entrenched growth divergences, in particular if linked to a high
debt burden, creates problems in the context of a monetary union. The Commission's spring economic forecast shows continuous
growth divergence, with Member States with ongoing adjustment lagging behind. However,
the adjustment is likely to continue beyond the horizon of the current
forecast, creating risk of entrenched growth divergence. This is
problematic in a monetary union and in particular so if the slow-growth
countries are highly indebted as slow-growth countries experience higher real
interest rates, which aggravates the debt problem further. The growth weakness caused by deleveraging only adds to
long-standing problems of low potential growth in the euro area. The euro area's growth potential was already relatively weak
before the crisis, with the crisis putting an additional, significant, strain
on trends. Over the medium term, potential growth rates of 0.8% are expected, compared
with rates of around 2¼ % at the beginning of 2000s. This downward
revision represents a significant deterioration in euro area’s economic
performance over a relatively short period of time. The main contributor to
this downward revision has been a strong downward pressure on total factor
productivity growth, which can be to a large extent explained by declining
growth rates of human and knowledge capital. Therefore, the euro area as a whole faces a double challenge of
rebalancing and strengthening growth in the medium and long term. Growth need to be revived already in the medium term as without
growth deleveraging and rebalancing would be much more difficult to achieve. At
the same time, it is necessary to carefully manage the process of deleveraging
in various sectors in order to control its negative impact on growth and avoid
negative feedbacks. While the challenges and hence the urgency of action is
greater in the deficit countries, it is necessary to bear in mind the risks for
the whole euro area, which stem from continuing growth divergence and
persisting imbalances. Structural reforms that increase contestability and flexibility of
markets can enhance growth and facilitate adjustment. In some countries private savings have built up and investment has
been held back by high regulatory barriers in some sectors. There is therefore
potential to unlock saving overhang and induce investment and hence growth by
liberalisation policies that aim at facilitating entry and exit to and from
closed sectors. More contestable markets improve adjustment capacity i.e. facilitate
reallocation of production factors across sectors – in particular from
non-tradable to tradable sectors – and improve price and non-price
competitiveness. To that end, while respecting the need for fiscal
consolidation, productive public expenditure need to be prioritised. The
reforms of the wage setting mechanism could improve the adjustment of wages to better
reflect productivity developments and enhance the scope for real wage
adjustment. Changes in the employment protection legislation could contribute
to a faster reallocation of resources across sectors, thereby sustaining the
adjustment in countries with large current account deficits. Lower tax burden
on labour and
Euro Plus
Pact – assessment of the implementation of the commitments In early 2011, euro area
Member States, as well as Bulgaria, Denmark, Latvia, Lithuania, Poland and Romania agreed on the Euro Plus Pact. In the context of the Pact, Member
States have committed to reforms in the four areas: fostering competitiveness,
fostering employment, enhancing the sustainability of public finances and
reinforcing financial stability. They have recognised that pragmatic
coordination of tax policies is a necessary element of stronger economic policy
coordination, and have committed to engage in structured discussions on tax
policy issues. The reform commitments of the participating Member States are
reflected in their Stability or Convergence Programmes and National Reform
Programmes. In 2011, Member States
took up many commitments in the policy areas identified in the Pact. However,
the implementation of the commitments varied considerably across the Member States and policy areas. Only a few Member States met all their commitments. In many
cases the government had made the relevant legislative proposals, while the
adoption of legislation was delayed, e.g. due to discussion in the national
Parliament of with social partners. Most progress was made
on reforms to foster competitiveness and in particular to improve business
environment. Member States simplified the administrative requirements for
businesses and introduced new services. Most Member States met their
commitments to promote education and innovation, e.g. to ensure additional
funding for universities and research institutes. Less progress was made to
enhance competition in services and to revise wage setting mechanisms, either
in the private or public sector. Member States also
introduced reforms to increase labour participation and to lower labour taxes.
Fewer measures were taken to improve life-long learning and reduce undeclared
work. Member States delivered
on their commitments to strengthen the sustainability of public finances and
put forward legislative proposals on pension systems and national fiscal rules.
In many cases, however, the adoption of new legislation has been delayed and
thee implementation postponed. Member States that had targeted certain deficit
or debt levels generally managed to meet their commitments. Financial sector reforms
were somewhat mixed, with only a few Member States increasing the efficiency of
the regulation and supervision of the financial sector. Member States also
safeguarded financial stability by taking measures to diversify the structure
of the economy. March 2012 European
Council invited Member States to include in their National Reform Programmes
and Stability or Convergence Programmes further commitments, focused on a small
number of essential, timely and measurable reforms to achieve the objectives of
the Pact. Several Member States answered to this invitation and presented new
commitments. The new commitments are
relevant for achieving the objectives of the Pact. Most of them are timely and
measurable, with clear objectives to be implemented within the next 12 months.
In many cases, Member States have also indicated expected costs and benefits of
their measures. However, the measures often refer to already ongoing projects. As indicated in the
Pact, the Commission will continue monitoring the implementation of the
commitments in the framework of the European semester. The Commission will
report on the progress in its Staff Working Documents on country assessment
next spring. effective active labour market policies and employment policies can boost
job creation, in particular in light of the risks of building up of long-term
unemployment. In the current context of low growth, fiscal challenges and social
tensions there is a need to sustain the reform momentum. While pursuing growth-friendly consolidation and prioritising
items such as investments in skills, reforms that (i) show positive growth
impact already in the short- to medium term and which (ii) do not involve large
fiscal costs should be given priority. Most regulatory reforms fulfil these
criteria: opening up over-regulated sectors does not involve fiscal costs. The
same holds for reforms to improve business environment and for most reforms in
the labour market, such as reforms to wage bargaining or employment protection
systems as well as providing better incentives to work. The effects on
productivity resulting from such reforms can be enhanced by accompanying active
labour market and skills policies. In a similar vein, pension reforms have a
double positive effect on public finances and on growth as they reduce implicit
public liabilities and enhance sustainability while increasing labour supply,
even though the effects are visible only beyond the short term. Additionally, in
the context of the specific challenges they face, euro area Member States
should be vanguards in implementation of some EU-wide tools, such as the Single
Market and the Services Directive. While bearing limited fiscal costs,
political costs of these reforms should not be underestimated. This is an
argument for an appropriate distribution of the reform burden across the
population, including addressing the poverty implications, rather than
abandoning the reforms, bearing in mind that the crisis has disproportionately
affected those who had already been in a vulnerable situation. Graph 16. Change in responsiveness to OECD's Going for Growth recommendations OECD's euro area countries Source: OECD Common monetary policy and strong cross-border spillovers give a
case for stronger coordination of structural reforms in the euro area. Structural reforms are crucial in a monetary union, where
due to the lack of monetary policy tool at the national level and the fixed
intra-area exchange rates most of the adjustment has to take place via markets.
Moreover, in face of strong spillover effects in the euro area, strong
coordination – e.g. in the form of ex ante discussion of major policy plans,
which could have large spill-over effects – is necessary to properly account
for increased reform externalities. Over the last 12 months, progress with structural reforms in the
euro area has been correlated with the intensity of market pressure (Graph 16). Programme countries and some vulnerable countries
introduced ambitious reforms, in particular in labour markets, financial
markets, professional service sectors, network industries and their overall
frameworks for competition. However, in other countries the pace of reform was
sluggish. In a number of countries (BE, CY, ES, IT, EL, IE, LU), recently
enacted or adopted labour market reforms, including in wage setting mechanisms,
represent important steps toward an enhanced and more balanced labour market
adjustment to shocks. The major on-going or planned reform processes will have
to be translated into legislation, implemented successfully, and followed up
with additional measures if necessary. However, as a result of tax changes, the
tax burden on labour has recently increased in several euro area Member States
(AT, ES, FR). A few euro area Member States have increased R&D (IT) or education
expenditure (DE), while it has not been a common trend. Only few Member States
enacted reforms to increase competition in the retail sector (IT, IE) or to
remove unjustified restrictions on professional services (IT, IE, PT, EL),
while in other Member States, for which recommendations in these areas were
issued last year, reforms stalled or lacked ambition. Implementation of the single market and the services directive has
been relatively good, if uneven. Importantly,
progress has been made in the implementation of the Services Directive. In
general, euro area Member States with high levels of barriers to a single
market for services before the Directive was adopted have cut their barriers
significantly. Some (ES, SK) seem to have made particularly good progress, but
others (AT, MT) have clearly been less diligent. 4. Strengthening
policy coordination in the euro area 4.1. The crisis highlighted weaknesses in euro area
governance Economic flexibility has long been recognised as a crucial
adjustment channel in EMU. The original
architecture of EMU combined a single, supranational monetary policy with
national economic policies coordinated at the EU level. Historically, there was
no close precedent for this construction by which to judge its design merits.
Academic literature on optimum currency areas suggested that the extent to
which the region was prone to asymmetric macroeconomic shocks and the extent to
which it could absorb these through economic flexibility would be two critical
factors in determining its durability. Economic flexibility of individual
Member States has generally remained low since the launch of the euro, while
the crisis has shown that a monetary union can at times place even stronger
demands on adjustment capacity than originally thought. Markets failed to induce sufficient discipline during the first ten
years of EMU. At a global level, nominal interest
rates fell and country-specific risk premia virtually evaporated, encouraging
greater risk taking. In the euro area, this trend was amplified first by the
elimination of currency risk among the Member States. Secondly, the ECB fixes policy
interest rates which in nominal terms are the same for the whole euro area,
while inflation differences between Members remained considerable. This entailed
large differences in real interest rates, which in turn fuelled capital inflows
driving asset price bubbles and exaggerating the strength of macroeconomic
performance. Weaknesses in macroeconomic surveillance and enforcement at both the
Member State and the EU level meant that the misallocation of resources and
consequent macro-financial imbalances were not detected early enough and
adequately addressed by policymakers. Apparent
strong macroeconomic performance across the euro area prior to the crisis hid the
underlying structural problems in public finances and macro-economic
fundamentals.[5] The SGP was met with lax
implementation at the Council level. Furthermore, the analysis, design and
conduct of economic policy remained compartmentalised and did not adequately
take into account the interaction between fiscal issues and wider
macro-economic imbalances (asset price bubbles, competitiveness and external
borrowing developments). Surveillance did not sufficiently cover non -fiscal
issues, which allowed macroeconomic imbalances to develop unchecked. The dynamics of switching from a 'good' equilibrium to a 'bad' one
during the crisis gained further strength due to the cross-country spillovers. Investors appeared to infer from sovereign funding difficulties in
one economy that countries economically and financially connected to it would
eventually receive an equivalent tightening of sovereign bond market access. In
the early stages of the crisis, these cross-border contagion effects were
magnified by the lack of appropriate financial backstops. Not all of the
observed negative spillovers were purely speculative or confidence-based,
however. Strong trade linkages in the euro area spread the negative growth
impact of falling aggregate demand in one country to trading partners via lower
imports. Moreover, deeper financial integration in the euro area since the
start of EMU meant a greater exposure of Member States to each other, implying
that a deterioration in one Member State also pushed up risks for partner
economies in the euro area. 4.2. The reform of economic governance in the euro area Since the crisis erupted, the EU and the euro area have engaged in a
comprehensive strengthening of its economic governance. The reforms introduced and those in the pipeline address the
identified weaknesses in economic policy surveillance through the integration
of surveillance across policy areas; a better timing of policy guidance to
achieve an impact on national policy formulation; stronger incentives, and a
widening of surveillance to cover macro-economic imbalances. Enforcement
mechanisms have been introduced specifically for the euro area. The European Semester integrates the surveillance of the economic
policies covered by the Europe 2020 strategy, as well as the preventive parts
of the Stability and Growth Pact and the Macroeconomic Imbalances Procedure, and
provides policy guidance to Member States before they finalise their budgets
and economic reform plans. The new approach of
integrated surveillance embodied in the European Semester ensures a more
holistic assessment across macro-economic, structural and employment policies.
It has led inter alia to a more systematic assessment of the risks to the
fiscal policy path arising from the build-up of macro-economic imbalances, such
as housing bubbles or excessive credit growth. It also provides a framework for
reinforced coordination and multilateral surveillance of employment and social
policies. The surveillance and coordination of fiscal policies have been radically
strengthened. The "six-pack" of
legislation on economic governance has reinforced both the preventive and the
corrective arm of the SGP. It defines quantitatively the meaning of a
"significant deviation" from the MTO or the adjustment path towards
it and operationalises the debt criterion of the Excessive Deficit Procedure through
a numerical benchmark. A central innovation is the use of
reverse-qualified-majority voting in Council decisions on most sanctions. Finally,
the six pack also sets minimum requirements for all main aspects of fiscal
frameworks at national level. Further strengthening of fiscal surveillance is in the pipeline. The proposed Regulation on common provisions for monitoring and
assessing draft budgetary plans and ensuring the correction of excessive
deficit of the Member States in the euro area complements the six-pack. It
aims at better synchronising key steps in preparation of national budgets and
at ensuring minim quality standards in national budgetary processes. The
proposal also strengthens further ex-ante fiscal surveillance and
ensures an appropriate integration of EU policy recommendations in the national
budgetary preparations. The Treaty on Stability, Coordination and Governance
in the Economic and Monetary Union (TSCG), signed by the euro area Member
States together with eight other Member States, contains commitments to further
strengthen fiscal and economic surveillance. In particular, in TSCG contracting
parties committed to lay down in national legislation rules of balanced budgets
in structural terms, complemented by an automatic correction mechanism in case
of a significant deviation. The Macroeconomic Imbalances Procedure has introduced systematic economic
surveillance in all areas that could potentially lead to harmful imbalances. It will reduce the risk of a build-up of macro-economic imbalances
by systematic monitoring and preventive recommendations. Where larger risks are
observed, the enforcement of policy recommendations is strengthened by the
possibility of sanctions in case of non-compliance. In its first Alert Mechanism
Report[6], the Commission
identified seven euro area Member States (along with five non-euro area Member
States) which may be affected by harmful macroeconomic imbalances, such as
deteriorating positions of competitiveness, a high level of indebtedness or
corrections of asset price bubbles. These Member States have been subject to
in-depth reviews (IDR)[7], which investigated the
nature of the imbalances in greater detail. The in-depth reviews confirmed that seven euro area Member States
face macroeconomic imbalances which call for policy action. The analysis identified macroeconomic imbalances in seven euro
area countries, which are, however, not excessive in nature. The IDRs confirmed
that adjustment is proceeding, which is evident from reductions in current
account deficits, retrenchment in credit flows, or corrections in housing
prices. The accumulated stocks of imbalances, nevertheless, pose a formidable
challenge for many euro area Member States. The levels of external, private and
public indebtedness imply a pressing need for deleveraging which is likely to
have an adverse impact on growth in the years to come. The results underline
the broad variety of situations in which these euro area Member States find
themselves and the need for a country-specific approach. The new EU financial supervisory framework has already been
instrumental in addressing the fragmented landscape of national supervision. A new supervisory architecture in the EU became operational in January
2011. Its central innovation is the establishment of the European Systemic Risk
Board to provide a comprehensive European view on macro-prudential risk
analysis. It enhances the effectiveness of early warning mechanisms by
improving the interaction between micro-and macro-prudential analysis and by
allowing for risk assessments to be translated into action by the relevant
authorities. By creating three European Supervisory Authorities[8],
the reform has also brought about better co-ordination between national
supervisors, including binding decisions requiring them to take action where
necessary and a clearer focus on working towards a common rulebook by
developing technical standards in the areas defined in legislation. The new
setup also helps ensure more complete exchange of information and views at an
earlier stage. The establishment of robust euro-area financial stability mechanisms
has also implied an important step forward in euro-area governance. The creation of the European Financial Stability Facility (EFSF)
and the European Financial Stabilisation Mechanism (EFSM) in May 2010 closed
this important gap in the institutional setup of the euro area. However, both
these elements of the European safety net are temporary in nature and a permanent
European Stability Mechanism (ESM) will be established on 1 July 2012. At the
end of March 2012, the combined ceiling of ESM and EFSF lending capacity was
raised to EUR 700 bn, which together with the funds provided by EFSM
and the Greek Loan Facility, implies an overall lending capacity of EUR 800 bn. Effective decision making arrangements are crucial for an efficient
implementation of the strengthened surveillance framework for the euro area. The Eurogroup and the Euro Summit have special responsibility in
this regard. The euro area summit in October 2011 already took some first
decisions to enhance the decision-making structure in the Eurogroup: some of
these have already been implemented, including the organisation of regular euro
area summits under a permanent President, and the creation of Permanent chairmanship
for the Eurogroup Working Group. In the future, additional reforms to economic governance may be
considered to complete the institutional structure of EMU. The changes made so far have in some cases touched on issues
traditionally tied to national sovereignty. In some instances, they appear to
have exhausted the scope of action possible under the Treaty on the Functioning
of the EU. Nevertheless, the question remains as to whether stronger
coordination of economic policies will be sufficient or whether there needs to
be progress towards closer integration of economic policy making. The crisis
experience has underlined the importance of this issue. Over the medium term,
the momentum for further integration in the monetary union may increase,
particularly if the success of the governance changes made recently enhances
confidence and mutual trust among euro area partners. [1] COM(2011) 669 final [2] For more
information see e.g. Quarterly Report on the Euro Area, No. 1/2009, European
Commission; European Economy No. 1/ 2010, Surveillance of intra-euro area
competitiveness and imbalances, European Commission. [3] Also, the net
lending/borrowing positions of the financial sector were relatively small and
broadly similar, reflecting the intermediation role of financial institutions. [4] Although there is
no indication that the financial systems of countries with persistent current
account surpluses are structurally worse in allocating capital than the
financial systems of countries with persistent current account deficits. [5] Even reforms of
the Stability and Growth Pact in 2005, which were designed to take better into
account cyclical conditions, suffered from conceptual difficulties in adequately
distinguishing trend growth from the cycle. [6] COM(2012) 68 final of 14.2.2012 [7] SEC(2012) 150-161 [8] The European Banking Authority, the European Insurance and
Occupational Pensions Authority and the European Securities Markets Authority