Economic growth across Europe is slowly picking up, which is good news. But the recovery is still modest and measures to boost economic growth and create jobs are important.
Western Europe: picking up the pace
The recovery projected last October for the euro area has solidified. This is reflected in our revised forecasts—e.g., the 2014 forecast for the euro area is up from 1 percent last October to 1.2 percent now, with important upgrades in countries like Spain. These revisions reflect the stronger data flow on the back of past policy actions, the revival of investor confidence, and the waning drag from fiscal consolidation. The positive impact on program countries is palpable—improving economies, lower spreads, and evidence of market access. We’ve also seen a welcome pick-up in growth in the UK (almost 3 percent is expected for 2014).
While stronger growth prospects and market sentiment are welcome, there is still much to do to solidify and pick up the pace of the recovery, not least because unemployment remains unacceptably high in too many places. Unfortunately, the headwinds in the euro area are many. We have previously emphasized the role of debt overhangs in firms and households, of fragmented financial markets, and of policy uncertainty. Action is being taken in all these areas, both at the country level and pan-European level, with steps to Banking Union—the single supervisor, the asset quality review and stress tests—especially important to ensuring the adequacy of bank capital and market confidence.
More recently, we have emphasized the role of “lowflation”, i.e., of a large and persistent undershoot relative to the ECB’s medium-term inflation target of 2 percent. Persistently low inflation puts pressure on debtors, real lending rates, relative price adjustment and jobs. We welcome the attention the ECB is paying to this risk, and its recent statement stresses that it is considering further action, including unconventional policies within its mandate.
I would also emphasize the role of structural reforms in reviving longer-term growth, which has taken a hit from several years of under-investment and unemployment. This is the subject of our book, just published on Jobs and Growth: Supporting the European Recovery. Beyond the near term challenges for macroeconomic policy support and deeper integration in Europe, the book focuses on three medium-term priorities: reducing high levels of public and private debt; implementing product and labor market reforms; and taking advantage of new growth opportunities through innovation and further integration into global supply chains.
Emerging Europe: strengthening policies
Growth in most of Central, Eastern and Southeastern Europe is recovering in the wake of euro area recovery, but growth in the region as a whole will be held back—we have marked it down since last October—by the expected contraction in Ukraine and slowdowns in Russia and Turkey. External funding conditions have also become more challenging. Even before tensions in Ukraine flared, we saw that capital flows into the region had started to reverse, with portfolio flows turning negative in late 2013 (this development comes on top of the on-going bank deleveraging the region has faced). In the near-term, these forces will offset—perhaps even more than offset—the tailwind from Euro Area recovery.
Although the reversal in capital flows has hurt most emerging markets, the hit to those with stronger policy frameworks and fundamentals has been less. This underlines the need to strengthen policies. Those with exchange rate and monetary policy flexibility should continue to use it as the first line of defense against volatility. All countries, especially those with weaker fundamentals, need to address legacy issues and problems exposed by the crisis: structural weaknesses that hold back growth and keep unemployment high; non-performing loans that hamstring credit; and exhausted fiscal buffers.
Finally, a word on Ukraine, where we face the very difficult confluence of a geo-political crisis and an economic one. The authorities are showing a remarkable capacity to rise to the occasion, with unprecedented action to tackle not only immediate problems but also chronic ones. This includes action to:
- ensure exchange rate flexibility and competitiveness;
- stabilize the financial system and confidence in banks;
- gradually reduce the fiscal deficit;
- adjust energy prices from far-below-world levels (with safeguards for the poor); and
- implement wider reforms to tackle corruption, governance and the business climate.
There is still work to do to finalize some actions and ensure that the program is financed. If all goes well, we expect our Board will consider the program in late April/early May.
See webcast of the Europe press conference.