Europe's recovery is expected to solidify, but comprehensive and bold policy action will be needed to restore fiscal health, address remaining weaknesses in the financial sector, and implement reforms to restore competiveness and growth, the IMF said.
In the latest Regional Economic Outlook (REO) for Europe: Strengthening the Recovery, the IMF sees growth for all of Europe at 2.4 and 2.6 percent for 2011 and 2012, respectively, after 2.4 percent last year. The IMF projects growth in advanced Europe to expand by 1.7 and 1.9 percent this year and next, compared with 1.7 percent in 2010. Growth in emerging Europe is expected to be stronger, at 4.3 percent in 2011 and 2012, after 4.2 percent in 2010, with all countries posting growth for the first time since the 2008–09 crisis.
The REO sees European inflation at 3.8 percent this year on the back of the economic upturn, and buoyant commodity prices before easing back to 3 percent in 2012. The REO assumes that the increase in food and energy prices remains temporary without second-round effects on inflation, obviating the need for sharp monetary tightening, which could hurt the recovery.
Unemployment rose sharply in the euro area periphery, and youth and temporary workers everywhere were particularly hard hit by the crisis. The rise in unemployment during the crisis also led to an increase in inequality and the REO calls for more inclusive labour markets, in particular where dual markets are prevalent, to narrow income inequalities.
To prevent new crises, more vigilance is called for, better institutions to deal with financial sector problems must be developed, and more, rather than less, financial and economic integration is needed. Furthermore, restoring productivity growth in the affected countries will be key—a task that, the REO notes, goes well beyond the changes in European governance frameworks and the completion of financial integration.
The main risk to the outlook for Europe arises from tensions in the euro area periphery. Other global worries also pose risks, but concerns about overheating in the continent’s emerging economies are more muted than in other regions.
Advanced Europe: Tackling the Sovereign Crisis
Strong national policies remain the best line of defense to restore confidence. The REO notes that fiscal consolidation plans—essential to secure medium-term sustainability—are rightly differentiated across countries. But structural reforms will be needed to generate solid and sustainable growth—the best antidote against entrenched unemployment and declining standards of living. Meanwhile, monetary policy can remain accommodative, though normalisation lies ahead as growth recovers and the balance of inflation risks shifts.
Most of all, restoring confidence in the euro area’s banking system is a prerequisite to turning the page on the crisis. The upcoming round of stress tests provides an opportunity to address remaining vulnerabilities and will need to be followed by credible steps to increase capital buffers of viable banks. Efforts to strengthen the banking systems in vulnerable countries will need to accelerate, and policies to promote deeper integration of the EU financial system, including cross-border merger and acquisitions, should be part of the solution too, along with further progress in strengthening EU institutions and governance.
An additional strengthening of the EU-wide policy response, building on the March 24–25 decisions, will also be essential. Stronger economic governance and an integrated financial stability framework at the EU level will help prevent the build up of macroeconomic imbalances, as witnessed prior to the crisis.
© International Monetary Fund
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